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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the Quarterly Period Ended June 30, 2010

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: 001-33040

 

 

HUGHES COMMUNICATIONS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   13-3871202
(State or Other Jurisdiction of
Incorporation or Organization)
 

(I.R.S. Employer

Identification No.)

11717 Exploration Lane, Germantown, Maryland 20876

(Address of Principal Executive Offices and Zip Code)

(301) 428-5500

(Registrant’s Telephone Number, Including Area Code)

 

 

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. x Yes ¨ 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ Yes ¨ No

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 (check one):

Large accelerated filer  ¨                                                                 Accelerated filer  x

Non-accelerated filer  ¨    (Do not check if a smaller reporting company)    Smaller reporting company  ¨

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

The number of shares of the registrant’s common stock outstanding as of July 30, 2010 was 21,845,339.

 


Table of Contents

TABLE OF CONTENTS

 

          Page
PART I—FINANCIAL INFORMATION    1
Item 1.    Financial Statements    1
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    33
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    52
Item 4.    Controls and Procedures    54
PART II—OTHER INFORMATION    55
Item 1.    Legal Proceedings    55
Item 1A.    Risk Factors    55
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    55
Item 3.    Defaults Upon Senior Securities    55
Item 4.    (Removed and Reserved)    56
Item 5.    Other Information    56
Item 6.    Exhibits    56
SIGNATURES    57

 

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Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

HUGHES COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share amounts)

(Unaudited)

 

     June 30,
       2010       
    December 31,
2009
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 162,027      $ 261,038   

Marketable securities

     60,408        47,188   

Receivables, net

     160,339        163,816   

Inventories

     58,349        60,244   

Prepaid expenses and other

     24,677        22,476   
                

Total current assets

     465,800        554,762   

Property, net

     666,174        602,403   

Capitalized software costs, net

     47,896        49,776   

Intangible assets, net

     12,963        14,524   

Goodwill

     5,093        5,093   

Other assets

     72,447        75,836   
                

Total assets

   $ 1,270,373      $ 1,302,394   
                

LIABILITIES AND EQUITY

    

Current liabilities:

    

Accounts payable

   $ 101,607      $ 119,461   

Short-term debt

     6,778        6,750   

Accrued liabilities and other

     123,452        131,774   
                

Total current liabilities

     231,837        257,985   

Long-term debt

     713,019        714,957   

Other long-term liabilities

     19,079        16,356   
                

Total liabilities

     963,935        989,298   
                

Commitments and contingencies

    

Equity:

    

Hughes Communications, Inc. (“HCI”) stockholders’ equity:

    

Preferred stock, $0.001 par value; 1,000,000 shares authorized and no shares issued and outstanding as of June 30, 2010 and December 31, 2009

     -        -   

Common stock, $0.001 par value; 64,000,000 shares authorized; 21,638,836 shares and 21,633,539 shares issued and outstanding as of June 30, 2010 and December 31, 2009, respectively

     22        22   

Additional paid in capital

     734,552        730,809   

Accumulated deficit

     (414,773     (410,543

Accumulated other comprehensive loss

     (22,036     (16,247
                

Total HCI stockholders’ equity

     297,765        304,041   
                

Noncontrolling interests

     8,673        9,055   
                

Total equity

     306,438        313,096   
                

Total liabilities and equity

   $ 1,270,373      $ 1,302,394   
                

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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Table of Contents

HUGHES COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  

Revenues:

        

Services revenues

   $ 193,190      $ 173,383      $ 381,130      $ 335,748   

Hardware sales

     59,178        82,444        114,431        160,294   
                                

Total revenues

     252,368        255,827        495,561        496,042   
                                

Operating costs and expenses:

        

Cost of services

     123,396        111,059        239,109        217,729   

Cost of hardware products sold

     55,582        77,283        116,468        151,488   

Selling, general and administrative

     49,306        46,144        99,631        90,385   

Loss on impairments

     -        45,400        -        45,400   

Research and development

     5,355        5,698        10,270        11,049   

Amortization of intangible assets

     771        1,504        1,561        2,889   
                                

Total operating costs and expenses

     234,410        287,088        467,039        518,940   
                                

Operating income (loss)

     17,958        (31,261     28,522        (22,898

Other income (expense):

        

Interest expense

     (15,520     (15,554     (31,630     (29,390

Interest income

     656        207        1,247        527   

Other loss, net

     -        (345     -        (345
                                

Income (loss) before income tax (expense) benefit and equity in earnings of unconsolidated affiliates

     3,094        (46,953     (1,861     (52,106

Income tax (expense) benefit

     (1,565     (479     (2,784     176   

Equity in earnings of unconsolidated affiliates

     -        -        -        170   
                                

Net income (loss)

     1,529        (47,432     (4,645     (51,760

Net (income) loss attributable to the noncontrolling interests

     381        (310     415        (678
                                

Net income (loss) attributable to HCI stockholders

   $ 1,910      $ (47,742   $ (4,230   $ (52,438
                                

Income (loss) per share:

        

Basic

   $ 0.09      $ (2.23   $ (0.20   $ (2.45

Diluted

   $ 0.08      $ (2.23   $ (0.20   $ (2.45

Shares used in computation of per share data:

        

Basic

     21,499,944        21,365,794        21,490,479        21,362,250   

Diluted

     22,748,725        21,365,794        21,490,479        21,362,250   

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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HUGHES COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Dollars in thousands, except per share amounts)

(Unaudited)

 

    HCI Shareholders’s Equity              
    Common
Stock
($.001  par value)
     Additional
Paid-In
Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Noncontrolling
Interest
        Total      

Balance at January 1, 2009

  $ 22      $ 724,558      $ (357,850   $ (28,583   $ 5,711      $ 343,858   

Consolidation of Hughes Systique Corporation

               3,372        3,372   

Share-based compensation and other

         3,618              3,618   

Purchase of subsidiary shares from noncontrolling interests

         (90           (90

Comprehensive income (loss):

              

Net income (loss)

           (52,438       678        (51,760

Foreign currency translation adjustments

             6,202        (826     5,376   

Unrealized gain on hedging instruments

             5,368        -        5,368   

Reclassification of realized loss on hedging instruments

             1,965        -        1,965   
                                                

Balance at June 30, 2009

  $ 22      $ 728,086      $ (410,288   $ (15,048   $ 8,935      $ 311,707   
                                                

Balance at January 1, 2010

  $ 22      $ 730,809      $ (410,543   $ (16,247   $ 9,055      $ 313,096   

Share-based compensation and other

         3,743              3,743   

Comprehensive income (loss):

              

Net loss

           (4,230       (415     (4,645

Foreign currency translation adjustments

             (2,436     33        (2,403

Unrealized loss on hedging instruments

             (5,434     -        (5,434

Reclassification of realized loss on hedging instruments

             2,783        -        2,783   

Unrealized loss on available-for-sale securities

             (702     -        (702
                                                

Balance at June 30, 2010

  $ 22      $ 734,552      $ (414,773   $ (22,036   $ 8,673      $ 306,438   
                                                

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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HUGHES COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

     Six Months Ended
June 30,
 
     2010     2009  

Cash flows from operating activities:

    

Net loss

   $ (4,645   $ (51,760

Adjustments to reconcile net loss to net cash flows from operating activities:

    

Depreciation and amortization

     62,111        46,330   

Amortization of debt issuance costs

     1,323        891   

Share-based compensation expense

     3,789        3,624   

Equity in earnings from unconsolidated affiliates

     -        (170

Loss on impairments

     -        45,400   

Other

     46        365   

Change in other operating assets and liabilities, net of acquisition:

    

Receivables, net

     1,551        7,257   

Inventories

     1,046        (169

Prepaid expenses and other

     356        4,887   

Accounts payable

     (18,805     3,635   

Accrued liabilities and other

     (3,941     (23,351
                

Net cash provided by operating activities

     42,831        36,939   
                

Cash flows from investing activities:

    

Change in restricted cash

     144        112   

Purchases of marketable securities

     (66,031     -   

Proceeds from sales of marketable securities

     52,781        -   

Expenditures for property

     (121,389     (53,301

Expenditures for capitalized software

     (6,170     (7,762

Proceeds from sale of property

     264        93   

Cash acquired, consolidation of Hughes Systique Corporation

     -        828   

Other, net

     -        (75
                

Net cash used in investing activities

     (140,401     (60,105
                

Cash flows from financing activities:

    

Short-term revolver borrowings

     3,263        -   

Repayments of revolver borrowings

     (3,745     -   

Net decrease in notes and loans payable

     -        (78

Long-term debt borrowings

     2,586        141,107   

Repayment of long-term debt

     (3,928     (5,505

Debt issuance costs

     (1,734     (4,500
                

Net cash provided by (used in) financing activities

     (3,558     131,024   
                

Effect of exchange rate changes on cash and cash equivalents

     2,117        (1,507
                

Net increase (decrease) in cash and cash equivalents

     (99,011     106,351   

Cash and cash equivalents at beginning of the period

     261,038        203,816   
                

Cash and cash equivalents at end of the period

   $ 162,027      $ 310,167   
                

Supplemental cash flow information:

    

Cash paid for interest

   $ 33,562      $ 26,596   

Cash paid for income taxes

   $ 4,594      $ 2,467   

Supplemental non-cash disclosures related to:

    

Capitalized software and property acquired, not paid

   $ 23,113     

Investment in Hughes Telematics, Inc.

     $ 13,000   

Consolidation of Hughes Systique Corporation

     $ 5,328   

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1:    Organization, Basis of Presentation and Summary of Significant Accounting Policies

Hughes Communications, Inc. (“HCI” and, together with its consolidated subsidiaries, the “Company” or “we,” “us,” and “our”) was formed as a Delaware corporation on June 23, 2005 and we are a publicly traded company. Our stock trades on the NASDAQ Global Select Market under the symbol “HUGH.”

We operate our business primarily through our wholly-owned subsidiary, Hughes Network Systems, LLC (“HNS”). We are a telecommunications company that provides equipment and services to the broadband communications marketplace. We have extensive technical expertise in satellite, wireline and wireless communications which we utilize in a number of product and service offerings. In particular, we offer a spectrum of broadband equipment and services to the managed services market, which is comprised of enterprises with a requirement to connect a large number of geographically dispersed locations with reliable, scalable, and cost-effective applications, such as credit card verification, inventory tracking and control, and broadcast video. We provide broadband network services and systems to the international and domestic enterprise markets and satellite broadband Internet access to North American consumers, which we refer to as the Consumer market. In addition, we provide networking systems solutions to customers for mobile satellite, telematics and wireless backhaul systems. These services are generally provided on a contract or project basis and may involve the use of proprietary products engineered by us.

We have five reportable segments, which we operate and manage as strategic business units and organize by products and services. We measure and evaluate our reportable segments based on the operating earnings of the respective segments. Our business segments include: (i) the North America Broadband segment; (ii) the International Broadband segment; (iii) the Telecom Systems segment; (iv) the HTS Satellite segment; and (v) the Corporate and Other segment. The North America Broadband segment consists of the Consumer group, which delivers broadband internet service to consumer customers, and the Enterprise group, which provides satellite, wireline and wireless communication networks and services to enterprises. The International Broadband segment consists of our international service companies and provides managed network services and equipment to enterprise customers and broadband service providers worldwide. The Telecom Systems segment consists of the Mobile Satellite Systems group, the Telematics group, and the Terrestrial Microwave group. The Mobile Satellite Systems group provides turnkey satellite ground segment systems to mobile system operators. The Telematics group previously provided development engineering and manufacturing services to Hughes Telematics, Inc. (“HTI”). However, as a result of the unfavorable impact of the economy on the automobile industry, HTI terminated substantially all of the development engineering and manufacturing services with us in August 2009. We expect our future revenue from the Telematics group to be insignificant. The Terrestrial Microwave group provides point-to-multipoint microwave radio network systems that are used for both cellular backhaul and broadband wireless access. The HTS Satellite segment, which is a new segment starting in 2010, consists of activities related to the development, construction and launch of high throughput satellites and currently represents construction activities of our new satellite, Jupiter. The Corporate and Other segment includes our wholly-owned subsidiary Rare Medium, LLC, certain minority interest investments held by us, and our corporate offices and assets not specifically related to another business segment.

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared in accordance with: (i) generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information; (ii) the instructions to Form 10-Q; and (iii) the guidance of Rule 10-01 of Regulation S-X under the Securities and Exchange Act of 1934, as amended, for financial statements required to be filed with the Securities and Exchange Commission (“SEC”). They include the assets, liabilities, results of operations and cash flows of the Company, including its domestic and foreign subsidiaries that are more than 50% owned or for which the Company is deemed to be the primary beneficiary as defined by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “ASC”) 810 “Consolidation.” Entities in which the Company holds at least 20% ownership or in which there are other indicators of significant influence are generally accounted for by the equity method, whereby the Company records its proportionate share of the entities’ results of operations. Entities in which the Company holds less than 20% ownership and does not have the

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

ability to exercise significant influence are generally carried at cost. As permitted under Rule 10-01 of Regulation S-X, certain notes and other financial information normally required by GAAP have been condensed or omitted. Management believes the accompanying condensed consolidated financial statements reflect all normal and recurring adjustments necessary for a fair presentation of the Company’s financial position, results of operations, and cash flows as of and for the periods presented herein. Our results of operations for the three and six months ended June 30, 2010 may not be indicative of our future results. These condensed consolidated financial statements are unaudited and should be read in conjunction with our audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009.

All intercompany balances and transactions with subsidiaries and other consolidated entities have been eliminated.

Use of Estimates in the Preparation of the Condensed Consolidated Financial Statements

The preparation of our condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Management bases its estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be affected by changes in those estimates.

New Accounting Pronouncements

Recently Adopted Accounting Guidance

In January 2010, the FASB issued Accounting Standard Update (“ASU”) 2010-06 to improve disclosures about fair value measurements. ASU 2010-6 clarifies certain existing disclosures and requires new disclosure regarding significant transfers in and out of Level 1 and Level 2 of fair value measurements and the reasons for the transfer. In addition, ASU 2010-06 clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The amendments in ASU 2010-06 were effective for fiscal years beginning after December 15, 2009, and for interim periods within those fiscal periods. The adoption of ASU 2010-06 did not have a material impact on our disclosure about fair value measurements.

In June 2009 and December 2009, the FASB amended ASC 810 changing certain consolidation guidance and requiring improved financial reporting by enterprises involved with variable interest entities (“VIE”). The amendments provide guidance in determining when a reporting entity should include the assets, liabilities, noncontrolling interest and results of activities of a VIE in its consolidated financial statements. The amendments to ASC 810 were effective for the first annual reporting period beginning after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. The adoption of amendments to consolidation rules did not have any impact on our disclosures relating to our VIE activity and our financial statements.

Accounting Guidance Not Yet Effective

In October 2009, the FASB issued ASU 2009-14 to amend ASC 605 “Revenue Recognition.” The amendments in this update change the accounting model for revenue arrangements that include both tangible products and software elements. The amendments in ASU 2009-14 will be effective for us beginning January 1, 2011, with early adoption permitted. We are currently evaluating the impact these amendments will have on our financial statements when they become effective.

In October 2009, the FASB issued ASU 2009-13 amending ASC 605 related to revenue arrangements with multiple deliverables. Among other things, ASU 2009-13 provides guidance for entities in determining the accounting for multiple deliverable arrangements and establishes a hierarchy for determining the amount of revenue to allocate to the various deliverables. We are currently evaluating the impact ASU 2009-13 will have on our financial statements when it becomes effective on January 1, 2011. Early adoption is permitted.

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 2:    Consolidation of Hughes Systique Corporation

Hughes Systique Corporation (“Hughes Systique”) is a communications consulting and software company. HNS has contracts with Hughes Systique for software development services. The founders of Hughes Systique include Pradman Kaul, our Chief Executive Officer (“CEO”) and President and certain former employees of HNS, including Pradeep Kaul, who is the CEO and President of Hughes Systique, HNS’ former Executive Vice President and the brother of our CEO and President. The Company acquired an equity investment in Hughes Systique Series A Preferred Stock (“HSC Preferred Stock”) of $3.0 million and $1.5 million in October 2005 and January 2008, respectively.

In February 2008, the Company and Nextwave Broadband Inc. (“Nextwave”), a former significant shareholder of Hughes Systique, agreed to make available to Hughes Systique a term loan facility (the “Loan”) of up to $3.0 million. Under the Loan, each loan request was to be at least $1.0 million, and the Loan was to be funded equally by the Company and Nextwave. The Loan has a fixed interest rate of 6%, and it is convertible into common shares of Hughes Systique upon non-payment or an event of default. Hughes Systique has the option to pay the interest annually or to convert the interest to principal as a “payment in kind.” In February 2008, the Company and Nextwave each funded $0.5 million as part of a $1.0 million loan drawdown. In March 2009, Hughes Systique requested and the Company funded the remaining $1.0 million of its original $1.5 million loan commitment. As a result, the Company is not obligated to provide any further funding to Hughes Systique under the Loan.

On March 11, 2009, Hughes Systique entered into a termination and settlement agreement with Nextwave (the “Termination Agreement”). The Termination Agreement provided for the following: (i) Hughes Systique relieved Nextwave of its obligation to fund its remaining commitment under the Loan; (ii) Nextwave waived Hughes Systique’s obligation to repay amounts previously funded, together with accrued interest; and (iii) Hughes Systique waived Nextwave’s obligations for the purchase of services under existing agreements and Nextwave’s obligation to repay outstanding accounts receivable of approximately $0.8 million. Additionally, Nextwave’s ownership in HSC Preferred Stock, which represented approximately 31.79% of Hughes Systique’s equity, was converted to a reduced level of ownership, representing a 5% interest in Hughes Systique’s common stock. The effect of these transactions has increased, on an undiluted basis, our ownership in Hughes Systique to approximately 45.23% and the ownership of our CEO and President and his brother in Hughes Systique to approximately 25.61%. Pursuant to ASC 810, these transactions caused a reconsideration event on March 11, 2009, resulting in the Company becoming the “primary beneficiary” of Hughes Systique, a VIE. As a result, the Company is required to consolidate Hughes Systique’s assets and liabilities and results of operations for periods beginning on March 12, 2009 (the “Consolidation Date”). In accordance with ASC 805 “Business Combinations,” the basis of Hughes Systique’s assets and liabilities were adjusted to their fair values. The excess of the fair value of the net assets consolidated from Hughes Systique over their carrying value has been reflected as goodwill in accordance with ASC 805. We believe that the goodwill resulting from the consolidation of Hughes Systique corresponds to the expected future prospects of Hughes Systique. The total amount of goodwill is not expected to be deductible for tax purposes.

The following table summarizes the fair values of Hughes Systique’s assets and liabilities at the Consolidation Date (in thousands):

 

           Amount        

Current assets

   $ 5,250   

Property

     717   

Intangible assets

     1,329   

Goodwill

     2,432   
        

Total assets

     9,728   
        

Current liabilities

     (2,808

Long-term liabilities

     (763
        

Total liabilities

     (3,571
        

Net assets consolidated prior to noncontrolling interest

     6,157   

Noncontrolling interest

     (3,372
        

Net assets consolidated

   $ 2,785   
        

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Based on the valuation of Hughes Systique’s intangible assets, using an income approach, the fair values of the intangible assets at the Consolidation Date were as follows (in thousands):

 

          Weighted Average
Useful Lives
(years)
       Amount    

Customer relationships

   7    $ 620

Favorable leases

   3      629

Backlog

   2      80
            

Total amortizable intangible assets

      5    $ 1,329
            

Hughes Systique’s revenue, after eliminating inter-company transactions, was $0.9 million and $0.6 million, respectively, for the three months ended June 30, 2010 and 2009 (since the acquisition date), and $1.7 million and $0.9 million, respectively, for the six months ended June 30, 2010 and 2009 (since the acquisition date). Pro forma financial statements are not presented for Hughes Systique at the acquisition date as its results of operations were not material to our condensed consolidated financial statements.

Note 3:    Marketable Securities

The amortized cost basis and estimated fair value of available-for-sale marketable securities are summarized as follows (in thousands):

 

     Cost
Basis
   Gross
  Unrealized  
Gain
   Estimated
  Fair Value  

June 30, 2010:

        

U.S. government bonds and treasury bills

   $       50,392    $         26    $ 50,418

Other debt securities

     9,990      -      9,990
                    

Total available-for-sale securities

   $ 60,382    $ 26    $ 60,408
                    

December 31, 2009:

        

U.S. government bonds and treasury bills

   $ 22,155    $ 6    $ 22,161

Other debt securities

     25,019      8      25,027
                    

Total available-for-sale securities

   $ 47,174    $ 14    $ 47,188
                    

Our investments in U.S. government bonds and treasury bills have AAA/AAa and Aaa/AAa ratings from Standard & Poor’s (“S&P”) and Moody’s, respectively. The investments in Other debt securities have A-1/A-1+ and P-1 ratings from S&P and Moody’s, respectively. In addition to these investments, we hold marketable equity securities as a long-term investment in Other assets (see Note 8—Other Assets for further discussion).

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 4:    Receivables, Net

Receivables, net consisted of the following (in thousands):

 

         June 30,    
2010
    December 31,
2009
 

Trade receivables

   $ 144,194      $ 154,863   

Contracts in process

     23,810        16,952   

Other receivables

     3,748        4,101   
                

Total receivables

     171,752        175,916   

Allowance for doubtful accounts

     (11,413     (12,100
                

Total receivables, net

   $ 160,339      $ 163,816   
                

Trade receivables included $7.9 million and $8.7 million of amounts due from related parties as of June 30, 2010 and December 31, 2009, respectively. Advances and progress billings offset against contracts in process amounted to $1.3 million and $0.3 million as of June 30, 2010 and December 31, 2009, respectively.

Note 5:    Inventories

Inventories consisted of the following (in thousands):

 

         June 30,    
2010
   December 31,
2009
 

Production materials and supplies

   $ 7,502    $ 7,896   

Work in process

     18,291      15,615   

Finished goods

     32,556      36,733   
               

Total inventories

   $ 58,349    $   60,244   
               

Inventories are carried at the lower of cost or market, principally using standard costs adjusted to reflect actual cost, based on variance analyses performed throughout the year. Inventories are adjusted to net realizable value using management’s best estimates of future use. In making its assessment of future use or recovery, management considers the aging and composition of inventory balances, the effects of technological and/or design changes, forecasted future product demand based on firm or near-firm customer orders and alternative means of disposition of excess or obsolete items.

 

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 6:    Property, Net

Property, net consisted of the following (dollars in thousands):

 

         Estimated
  Useful Lives  
(years)
       June 30,    
2010
    December 31,
2009
 

Land and improvements

   10    $ 5,885      $ 5,885   

Buildings and leasehold improvements

   2 - 30      33,653        32,996   

Satellite related assets

   15      380,394        380,394   

Machinery and equipment

   1 - 7      298,940        251,648   

VSAT operating lease hardware

   2 - 5      16,918        18,945   

Furniture and fixtures

   5 - 7      1,603        1,571   

Construction in progress

 

- Jupiter

        130,242        66,555   
 

- Other

        16,388        12,888   
                     

Total property

          884,023        770,882   

Accumulated depreciation

        (217,849     (168,479
                     

Total property, net

        $ 666,174      $ 602,403   
                     

Satellite related assets primarily consist of SPACEWAYTM 3 (“SPACEWAY 3”), a broadband satellite system with a unique architecture for broadband data communications. In April 2008, we placed SPACEWAY 3 into service and began to depreciate its related costs on a straight-line basis over the estimated useful life of 15 years. Satellite related assets include the costs associated with the construction and launch of the satellite, insurance premiums for the satellite launch and the in-orbit testing period, interest incurred during the construction of the satellite, and other costs directly related to the satellite.

In June 2009, HNS entered into an agreement with Space Systems/Loral, Inc. (“SS/L”) under which SS/L will manufacture our next-generation, high throughput geostationary satellite (“Jupiter”). Jupiter will employ a multi-spot beam, bent pipe Ka-band architecture and will provide additional capacity for the HughesNet service in North America. The construction of Jupiter began in July 2009 and we began to capitalize all direct costs associated with the construction and the launch of the satellite, including interest incurred during the construction of the satellite. We anticipate launching Jupiter in the first half of 2012.

For the three and six months ended June 30, 2010, we capitalized $2.7 million and $4.7 million, respectively, of interest related to the construction of Jupiter. There was no capitalized interest expense for the three and six months ended June 30, 2009.

 

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 7:    Intangible Assets, Net

Intangible assets, net consisted of the following (dollars in thousands):

 

     Estimated
 Useful Lives 
(years)
     Cost Basis      Accumulated
Amortization
    Net Basis

June 30, 2010:

          

Backlog and customer relationships

   2 - 8    $ 10,486    $ (4,939   $ 5,547

Patented technology and trademarks

   8 - 10      15,275      (8,208     7,067

Favorable leases

   3      629      (280     349
                        

Total intangible assets, net

      $ 26,390    $ (13,427   $ 12,963
                        

December 31, 2009:

          

Backlog and customer relationships

   2 - 8    $ 22,312    $ (16,133   $ 6,179

Patented technology and trademarks

   2 - 10      15,745      (7,854     7,891

Favorable leases

   3      629      (175     454
                        

Total intangible assets, net

      $ 38,686    $ (24,162   $           14,524
                        

We amortize the recorded values of our intangible assets over their estimated useful lives. As of June 30, 2010, we retired $12.3 million of our intangible assets as they were fully amortized. We recorded amortization expense of $0.8 million and $1.5 million for the three months ended June 30, 2010 and 2009, respectively, and $1.6 million and $2.9 million for the six months ended June 30, 2010 and 2009, respectively. Estimated future amortization expense as of June 30, 2010 is as follows (in thousands):

 

     Amount

Remaining six months ending December 31, 2010

   $ 1,522

Year ending December 31,

  

2011

     3,028

2012

     2,854

2013

     2,818

2014

     1,326

2015

     1,325

Thereafter

     90
      

Total estimated future amortization expense

   $           12,963
      

 

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 8:    Other Assets

Other assets consisted of the following (in thousands):

 

         June 30,    
2010
   December 31,
2009

Subscriber acquisition costs

   $ 27,356    $ 29,884

Debt issuance costs

     13,240      12,899

Other

     31,851      33,053
             

Total other assets

   $ 72,447    $ 75,836
             

As of June 30, 2010, “Other” included our cost method and equity method investments, which includes our investment in HTI. On March 12, 2009, we exchanged $13.0 million of receivables that HTI owed to us for HTI convertible preferred stock (“HTI Preferred Stock”) as part of a $50.0 million private placement of HTI Preferred Stock. In connection with the merger of HTI with Polaris Acquisition Corp. (the “Merger”), which occurred on March 31, 2009, HTI became a publicly traded company and our HTI Preferred Stock was converted into approximately 3.3 million shares of HTI common stock (“HTI Shares”), of which 1.3 million shares and 2.0 million shares are referred to as Non-escrowed shares and Escrowed shares, respectively. The HTI shares are subject to certain restrictions and/or earn-out provisions pursuant to the merger agreement.

As of June 30, 2010, the Non-escrowed shares had a fair value of $3.5 million. We recorded an unrealized loss of $0.1 million and $0.7 million for the three and six months ended June 30, 2010, respectively, and of $3.1 million since the inception of our investment in the Non-escrowed shares in “Accumulated other comprehensive loss” (“AOCL”).

The Escrowed shares are held by HTI in escrow, and the release of these shares is subject to various earn-out provisions based on HTI attaining specified stock prices of $20.00, $24.50 and $30.50 over specified periods within 5 years after the Merger. If the full earn-out is achieved, our investment could represent approximately 3.8% of HTI’s outstanding common stock. If the earn-out is not attained, all or a portion of the Escrowed shares will be forfeited. In addition to the risk and valuation fluctuations associated with the earn-out target, the carrying value of the investment in HTI may be subject to fair value adjustments in future reporting periods. We account for the Escrowed shares using the cost method in accordance with ASC 325 “Investments—Other,” as the Escrowed shares are not considered marketable equity securities as of June 30, 2010. As of June 30, 2010, the carrying value and estimated fair value of the HTI Escrowed shares was $1.1 million and $0.6 million, respectively.

Note 9:    Debt

Short-term and current portion of long-term debt consisted of the following (dollars in thousands):

 

     Interest Rates at
June 30, 2010
       June 30,    
2010
   December 31,
2009

VSAT hardware financing

   8.00% - 15.00%    $ 3,161    $ 3,158

Revolving bank borrowings

   8.25% - 8.75%      1,066      1,547

Capital lease and other

   6.00% - 39.60%      2,551      2,045
                

Total short-term and the current portion of long-term debt

      $ 6,778    $ 6,750
                

As of June 30, 2010, HNS had outstanding revolving bank borrowings of $1.1 million, which had a weighted average variable interest rate of 8.75%. The borrowings were obtained by HNS’ subsidiaries in India and Europe under revolving lines of credit with several local banks. There is no requirement for compensating balances for these borrowings. The total amount available for borrowing by our foreign subsidiaries under various revolving lines of credit was $4.8 million as of June 30, 2010.

 

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Long-term debt consisted of the following (dollars in thousands):

 

     Interest Rates at
June 30, 2010
       June 30,    
2010
   December 31,
2009

Senior Notes(1)

   9.50%    $   588,990    $   587,874

Term Loan Facility

   7.62%      115,000      115,000

VSAT hardware financing

   8.00% - 15.00%      4,453      5,861

Capital lease and other

   6.00% - 39.60%      4,576      6,222
                

Total long-term debt

      $ 713,019    $ 714,957
                

 

(1) Includes 2006 Senior Notes and 2009 Senior Notes.

On March 16, 2010, HNS entered into a credit agreement with JP Morgan Chase Bank, N.A. and Barclays Capital to amend and restate its senior secured $50 million revolving credit facility (the “Revolving Credit Facility”). Pursuant to the terms of the agreement, among other changes, the maturity date of the Revolving Credit Facility was extended to March 16, 2014, subject to an early maturity date of 91 days prior to March 16, 2014 in the event HNS’ 2009 and 2006 Senior Notes and HNS’ Term Loan Facility (as defined below) are not (i) repaid in full or (ii) refinanced with new debt (or amended) with maturities of no earlier than 91 days after March 16, 2014. The terms of the Revolving Credit Facility were amended to be: (i) in respect of the interest rate, at our option, the Alternative Borrowing Rate (as defined in the Revolving Credit Facility) plus 2.00% or the Adjusted London Interbank Offered Rate (“LIBOR”) (as defined in the Revolving Credit Facility) plus 3.00% and (ii) in respect of the participation fee for outstanding letters of credit, 3.00% per annum, in each case subject to downward adjustment based on our leverage ratio. For the six months ended June 30, 2010 and 2009, there were no borrowings under the Revolving Credit Facility. As of June 30, 2010, the Revolving Credit Facility had total outstanding letters of credit of $5.3 million and an available borrowing capacity of $44.7 million.

In May 2009, HNS, along with its subsidiary, HNS Finance Corp., as co-issuer, completed a private debt offering of $150.0 million of 9.50% senior notes maturing on April 15, 2014 (the “2009 Senior Notes”). Interest on the 2009 Senior Notes is accrued from April 15, 2009 and is paid semi-annually in arrears on April 15 and October 15 of each year, beginning on October 15, 2009. As of June 30, 2010 and December 31, 2009, HNS recorded $3.0 million of accrued interest payable related to the 2009 Senior Notes.

In February 2007, HNS borrowed $115 million from a syndicate of banks (the “Term Loan Facility”), which matures on April 15, 2014. The interest on the Term Loan Facility is paid quarterly at Adjusted LIBOR (as defined in the Term Loan Facility) plus 2.50% per annum. To mitigate the variable interest rate risk associated with the Term Loan Facility, HNS entered into a swap agreement to swap the Adjusted LIBOR for a fixed interest rate of 5.12% per annum (the “Swap Agreement”). As a result, the Term Loan Facility has a fixed interest rate of 7.62% per annum. As of June 30, 2010 and December 31, 2009, interest accrued based on the Swap Agreement and the Term Loan Facility was $0.8 million.

In April 2006, HNS issued $450 million of 9.50% senior notes maturing on April 15, 2014 (the “2006 Senior Notes”). Interest on the 2006 Senior Notes is paid semi-annually in arrears on April 15 and October 15. As of June 30, 2010 and December 31, 2009, we recorded $8.9 million of accrued interest payable related to the 2006 Senior Notes.

Although the terms and covenants with respect to the 2009 Senior Notes are substantially identical to the 2006 Senior Notes, the 2009 Senior Notes were issued under a separate indenture and do not vote together with the 2006 Senior Notes. Each of the indentures governing the 2006 Senior Notes and the 2009 Senior Notes (collectively, the “Senior Notes”), the agreement governing the amended Revolving Credit Facility and the agreement governing the Term Loan Facility require HNS to comply with certain affirmative and negative covenants: (i) in the case of the indentures, for so long as any Senior Notes are outstanding; (ii) in the case of the amended Revolving Credit Facility, so long as the amended Revolving Credit Facility is in effect; and (iii) in the case of the Term Loan Facility, for so long as the Term Loan Facility remains outstanding. Negative covenants contained in these agreements include limitations on the ability of HNS and/or certain of its subsidiaries to incur additional indebtedness; issue redeemable stock and subsidiary preferred stock; incur liens; pay dividends or

 

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distributions or redeem or repurchase capital stock; prepay, redeem or repurchase debt; make loans and investments; enter into agreements that restrict distributions from HNS’ subsidiaries; sell assets and capital stock of our subsidiaries; enter into certain transactions with affiliates; consolidate or merge with or into, or sell substantially all of our assets to, another person; and enter into new lines of business. In addition to these negative covenants, the amended Revolving Credit Facility, the indentures governing the Senior Notes and/or the agreement governing the Term Loan Facility contain affirmative covenants that require us to: (i) preserve our businesses and properties; (ii) maintain insurance over our assets; (iii) pay and discharge all material taxes when due; and (iv) furnish the lenders’ administrative agent our financial statements for each fiscal quarter and fiscal year, certificates from a financial officer certifying that no Event of Default or Default has occurred during the fiscal period being reported, litigation and other notices, compliance with laws, maintenance of records and other such customary covenants. HNS and its subsidiaries comprise a substantial portion of the Company’s net assets and results of operations since January 1, 2006. Because of the negative covenants above, there are certain restrictions on the sale of HNS’ assets. As of June 30, 2010 and December 31, 2009, HNS’ net assets were $192.6 million and $200.0 million, respectively. Management believes that HNS was in compliance with all of its debt covenants as of June 30, 2010.

In July 2006, we entered into a capital lease with 95 West Co., Inc. (“95 West Co.”) and its parent, Miraxis License Holdings, LLC (“MLH”), which are our related parties as discussed in Note 15—Transactions with Related Parties. Pursuant to the capital lease agreement, 95 West Co. and MLH agreed to provide a series of coordination agreements allowing HNS to operate SPACEWAY 3 at the 95° west longitude orbital slot where 95 West Co. and MLH have higher priority rights. As of June 30, 2010, the remaining debt balance under the capital lease was $4.9 million, which was included in “Capital lease and other” in the short-term and long-term debt tables above. The remaining payments under the capital lease are subject to conditions in the agreement including our ability to operate SPACEWAY 3 and are $1.0 million for each of the years ending December 31, 2011 through 2016.

Note 10:    Financial Instruments

Interest Rate Swap

The interest on the Term Loan Facility was at Adjusted LIBOR plus 2.50% per annum. To mitigate the variable interest rate risk associated with the Term Loan Facility, we entered into the Swap Agreement to swap the Adjusted LIBOR for a fixed interest rate of 5.12% per annum. As a result, the Term Loan Facility has a fixed interest rate of 7.62% per annum. We account for the Swap Agreement as a cash flow hedge in accordance with ASC 815-30 “Derivatives and Hedging—Cash Flow Hedges.” Accordingly, we recorded a net unrealized loss of $1.7 million and $2.7 million for the three and six months ended June 30, 2010, respectively, and a net unrealized gain of $2.8 million and $7.3 million, respectively, for the comparable periods in 2009 in AOCL associated with the fair market valuation of the interest rate swap. The remaining net interest payments based on the Swap Agreement and the Term Loan Facility are paid quarterly and estimated to be approximately $4.4 million for the six months ending December 31, 2010, $8.8 million for each of the years ending December 31, 2011 through 2013 and $3.3 million for the year ending December 31, 2014. For the three months ended June 30, 2010 and 2009, we recorded $2.2 million and $2.3 million, respectively, of interest expense on the Term Loan Facility. For the six months ended June 30, 2010 and 2009, we recorded $4.4 million and $4.5 million, respectively, of interest expense on the Term Loan Facility.

Note 11:    Fair Value

Under ASC 820 “Fair Value Measurements and Disclosures,” fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date, and the principal market is defined as the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability. If there is no principal market, the most advantageous market is used. This is the market in which the reporting entity would sell the asset or transfer the liability with the price that maximizes the amount that would be received for the asset or minimizes the amount that would be paid to transfer the liability. ASC 820 clarifies that fair value should be based on assumptions market participants would make in pricing the asset or liability. Where available, fair value is based on observable quoted market prices or derived from observable market data. Where observable prices or inputs are not available, valuation models are used (i.e. Black-Scholes, a

 

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barrier option model or a binomial model). ASC 820 established the following three levels used to classify the inputs used in measuring fair value measurements:

Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.

Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on the assumptions market participants would use in pricing the asset or liability based on the best available information.

In determining fair value, we use various valuation approaches, including market, income and/or cost approaches. Other valuation techniques involve significant management judgment. As of June 30, 2010, the carrying values of cash and cash equivalents, receivables, net, accounts payable, and debt, except for the Senior Notes as described below, approximated their respective fair values.

Our investment in the HTI Shares was measured using Level 1 and Level 2 inputs for the Non-escrowed shares and Escrowed shares, respectively. The fair value of the Non-escrowed shares, as shown in the table below, was determined based on the quoted market prices. For the three and six months ended June 30, 2010, we recognized an unrealized loss of $0.1 million and $0.7 million, respectively, in AOCL related to the Non-escrowed shares. The fair value of the Escrowed shares, as shown in the table below, was determined using market observable data and utilizing a barrier option pricing model. The valuation of the Escrowed shares reflects the Company’s best estimate of what market participants would use in pricing the investment based on the best available information. For the six months ended June 30, 2010, the estimated fair value of the Escrowed shares declined by $0.5 million from its carrying value of $1.1 million at December 31, 2009 to $0.6 million at June 30, 2010. Based on our valuation analysis in accordance with ASC 320-10-35 “Investments—Debt and Equity Securities—Subsequent Measurement,” we determined that the decline in the estimated fair value of the Escrowed shares during the current quarter is not an “other than temporary” impairment.

Our Senior Notes were categorized as Level 1 of the fair value hierarchy as we utilized pricing for recent market transactions for identical notes.

Our Term Loan Facility originally had a variable interest rate based on observable interest rates plus 2.50% per annum. To mitigate the variable interest rate risk, we entered into the Swap Agreement to swap the Adjusted LIBOR for a fixed interest rate of 5.12% per annum. As a result, the Term Loan Facility has a fixed interest rate of 7.62% per annum. We adjust the value of the interest rate swap on a quarterly basis. The fair value of the interest rate swap was categorized as Level 2 of the fair value hierarchy.

Assets and liabilities measured at fair value on a recurring basis are summarized below (dollars in thousands):

 

               June 30, 2010
           Level         

Included In

         Carrying      
Value
    Fair
      Value      

Marketable securities

   1    Marketable securities    $ 60,408      $ 60,408

HTI Non-escrowed Shares

   1    Other assets    $ 3,510      $ 3,510

HTI Escrowed Shares

   2    Other assets    $ 1,121      $ 574

2006 Senior Notes

   1    Long-term debt    $       450,000      $       456,750

2009 Senior Notes

   1    Long-term debt    $ 138,990 (1)    $ 151,718

Interest rate swap on the Term Loan Facility

   2    Other long-term liabilities    $ 13,173      $ 13,173

 

(1) Amount represents the face value of $150.0 million, net the remaining original issue discount of $11.0 million.

 

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Note 12:    Income Taxes

For the three and six months ended June 30, 2010, we recorded a net income tax expense of $1.6 million and $2.8 million, respectively. For the three and six months ended June 30, 2009, we recorded a net income tax expense of $0.5 million and a net income tax benefit of $0.2 million, respectively. The net income tax benefit is attributable to our Indian subsidiary as a result of being engaged in telecommunications infrastructure development. Indian tax law provides for a deduction of 100% of profits and gains derived from qualifying infrastructure businesses for ten consecutive assessment years. Because of our U.S. federal net operating loss (“NOL”) carryforward position and full valuation allowance against our net deferred tax assets, our income tax expense represents taxes associated with our foreign subsidiaries and state taxes. As of June 30, 2010, we have not met the “more-likely-than-not” criteria of ASC 740 “Income Taxes” on deferred tax assets in certain jurisdictions, thus we maintained a full valuation allowance on these deferred tax assets. As of June 30, 2010, we estimated that our remaining NOL carry-forwards were approximately $323.2 million, expiring between the years 2012 and 2030, if unused, and our capital loss carry-forwards were approximately $13.7 million, expiring between 2010 and 2014, if unused.

Certain of our subsidiaries are expected to utilize a portion of their net operating loss carry-forwards during 2010. Several of these subsidiaries have not met the more-likely–than-not criteria and therefore maintain a full valuation allowance on their deferred tax assets as of June 30, 2010. Any benefit realized from the reversal of valuation allowance will be recorded as a reduction to income tax expense.

As a result of the tax sharing agreement between LightSquared, Inc. (“LightSquared” and formerly SkyTerra Communications, Inc.) and the Company, we are currently entitled to an estimated $1.1 million reimbursement from LightSquared at the time LightSquared realizes the benefit of the alternative minimum tax credit related to its 2006 Federal income tax return. This reimbursement has been reflected on our books as a long-term receivable from LightSquared.

In accordance with ASC 740, we have identified unrecognized tax benefits related to tax positions of $11.1 million as of December 31, 2009 and no additional unrecognized tax benefits through June 30, 2010. If recognized, the total unrecognized tax benefits would impact our effective tax rate. Following is a description of the tax years that remain subject to examination by major tax jurisdictions:

 

United States - Federal

   1994 and forward

United States - Various States

   1994 and forward

United Kingdom

   2005 and forward

Germany

   2004 and forward

Italy

   2005 and forward

India

   1995 and forward

Mexico

   2000 and forward

Brazil

   2003 and forward

Note 13:    Employee Share-Based Payments

2006 Equity and Incentive Plan

In January 2006, we adopted and our Board of Directors approved the 2006 Equity and Incentive Plan (the “Plan”). The Plan provides for the grant of equity-based awards, including restricted common stock, restricted stock units, stock options, stock appreciation rights and other equity-based awards, as well as cash bonuses and long-term cash awards to directors, officers, employees, advisors and consultants of the Company and its subsidiaries who are selected by our Compensation Committee for participation in the Plan. We recorded compensation expense related to the restricted stock awards, issued to members of our Board of Directors, our executives, a contractor and HNS’ employees, and restricted stock units, issued only to our international employees, after adjustment for forfeitures, of $0.7 million for each of the three months ended June 30, 2010 and 2009 and $1.4 million and $1.5 million for the six months ended June 30, 2010 and 2009,

 

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respectively. As of June 30, 2010, we had $2.1 million of unrecognized compensation expense related to the restricted stock awards and restricted stock units, which will be recognized over the remaining weighted average life of 1.21 years.

Summaries of non-vested restricted stock awards and restricted stock units are as follows:

Restricted Stock Awards

 

             Shares             Weighted-Average
Grant-Date

Fair Value

Non-vested at December 31, 2009

   162,360      $ 27.37

Forfeited

   (2,000   $ 46.97

Vested

   (34,550   $ 16.17
        

Non-vested at June 30, 2010

   125,810      $           30.14
        

Restricted Stock Units

As of June 30, 2010 and December 31, 2009, we had 8,675 non-vested restricted stock units with a weighted-average grant-date fair value of $28.73.

Stock Option Program

On April 24, 2008, our Compensation Committee made stock option awards under the Plan (the “Stock Option Program”), which consisted of the issuance of non-qualified stock options to employees of the Company and its subsidiaries. The grant and exercise price of the stock options is the closing price of the Company’s common stock on the date of the grant. Any options forfeited or cancelled before exercise will be deposited back into the Option Pool and will become available for award under the Stock Option Program. Each grant has a 10 year life and vests 50% on the second anniversary of the grant date and 25% on each of the third and fourth anniversaries of the grant date. The fair value of each option award was estimated on the date of grant using a Black-Scholes option valuation model.

On March 19, 2009, we offered eligible participants in the Stock Option Program the opportunity to exchange (the “Exchange Offer”) all or a portion of their eligible outstanding stock options for new stock options, on a one-for-one basis, through an exchange offer, which expired on April 16, 2009. Each new option (the “New Options”) has an exercise price of $14.47, which was the closing price of our common stock on April 15, 2009, and a new vesting schedule to reflect the new grant date of April 16, 2009.

As a result of the Exchange Offer, which was completed on April 16, 2009, 546,900 outstanding stock options (representing 100% participation) were exchanged, and the estimated fair value of the New Options of $2.3 million was computed using a Black-Scholes option valuation model based on the new grant date. The compensation expense related to the New Options is recognized on a straight-line basis over the four-year vesting period beginning on the date of grant.

The key assumptions for the option awards for the six months ended June 30, 2010 are as follows:

 

     Six Months Ended
June 30, 2010

Volatility

   45.90%

Expected term

   5 years

Risk-free interest rate

   2.59%

 

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A summary of option activity under the Stock Option Program is presented below:

 

     Option
    Shares    
    Weighted-Average
Exercise Price
   Weighted
Average
Remaining
Contractual
Life
   Aggregate
Intrinsic
Value(1)

Outstanding at December 31, 2009

   648,050      $ 16.77    9.37    $ 6,326

Granted

   5,000      $       27.96    9.76    $ -

Forfeited or expired

   (10,050   $ 15.21      
              

Outstanding at June 30, 2010

   643,000      $ 16.88    8.88    $       5,299
              

Vested and expected to vest at June 30, 2010

   578,700      $ 16.88    8.88    $ 4,769
              

Exercisable at June 30, 2010

   -      $ -      
              

 

          

(1)    In thousands.

          

The compensation expense related to stock option awards to our employees is recognized on a straight-line basis over the four-year vesting period beginning on the date of grant. We recorded compensation expense of $1.0 million and $0.9 million for the three months ended June 30, 2010 and 2009, respectively, and $2.0 million and $1.7 million for the six months ended June 30, 2010 and 2009, respectively. As of June 30, 2010, we had $8.2 million of unrecognized compensation expense for non-vested stock options, which will be recognized over the remaining weighted average period of 2.86 years.

HNS’ Bonus Unit Plan

In July 2005, HNS adopted an incentive bonus unit plan (the “Bonus Unit Plan”), pursuant to which bonus units were granted to certain employees of the Company. The bonus units provide for time vesting over five years and are subject to a participant’s continued employment with HNS. Pursuant to the Bonus Unit Plan, if participants in the Bonus Unit Plan are employed by HNS at the time of the predetermined exchange dates, they are entitled to exchange their vested bonus units for shares of our common stock. The number of our common stock shares to be issued upon each exchange is calculated based upon the fair market value of the vested bonus unit divided by the average closing trading price of our common stock for the 20 business days immediately preceding the date of the exchange. We recognized compensation expense of $0.2 million for each of the three months ended June 30, 2010 and 2009 and $0.4 million for each of the six months ended June 30, 2010 and 2009 related to the Bonus Unit Plan. As of July 15, 2010, approximately 2.1 million bonus units vested and were exchanged for approximately 207,000 shares (net of income tax withholding) of our common stock pursuant to the Bonus Unit Plan. The remaining 300,000 bonus units will vest on July 15, 2011.

The following table summarizes changes in bonus units under the Bonus Unit Plan:

 

         Three Months Ended    
June  30,
       Six Months Ended    
June  30,
     2010    2009           2010                   2009     

Non-vested, beginning balance

   2,439,500    2,500,000    2,453,250      2,500,000

Forfeited

   -    -    (13,750   -
                    

Non-vested ending balance

   2,439,500    2,500,000    2,439,500      2,500,000
                    

HNS’ Class B Membership Interests

HNS’ Class B membership interests were issued to certain members of our senior management, two of HNS’ former senior management and a member of our Board of Directors. The Class B membership interests are subject to certain vesting requirements, with 50% of the Class B membership interests subject to time vesting over five years and the other 50% vesting based upon certain performance criteria. At the holders’ election, vested Class B membership interests may be

 

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exchanged for our common stock. The number of shares of our common stock to be issued upon such exchange is based upon the fair market value of such vested Class B membership interest tendered for exchange divided by the average closing trading price of our common stock for the 20 business days immediately preceding the date of such exchange. As of June 30, 2010, 3,247 of the 3,280 outstanding Class B membership interests were vested. If the total outstanding Class B membership interests were to convert into our common stock as of June 30, 2010, they could be exchanged for approximately 565,000 shares of our common stock. On September 25, 2009, we registered 75,000 shares of our common stock with the SEC on Form S-8 to be issued, from time to time, upon the exchange of the Class B membership interests.

Pursuant to ASC 718 “Compensation—Stock Compensation,” HNS determined that the Class B membership interests had nominal value at the date of grant, and, accordingly, minimal compensation expense was recorded for each of the three and six months ended June 30, 2010 and 2009. A summary of Class B membership interests activities is as follows:

 

         Three Months Ended    
June  30,
      Six Months Ended    
June  30,
     2010     2009         2010                 2009      

Outstanding beginning balance

   3,330      3,656   3,330      3,656

Converted to HCI common shares

   (50   -   (50   -
                    

Outstanding balance at June 30,

   3,280      3,656   3,280      3,656
                    

Note 14:    Long-Term Cash Incentive Retention Program

In 2005, HNS established a one-time employee retention program (“Retention Program”), which was designed to retain certain employees chosen by HNS’ senior management. As a result of HNS successfully attaining 100% of its earnings goal for 2008, as defined in the Retention Program, HNS paid an aggregate of $14.7 million to eligible participants under the Retention Program in 2009, of which $13.2 million was accrued as of December 31, 2008.

Note 15:    Transactions with Related Parties

In the ordinary course of our operations, we enter into transactions with related parties to purchase and/or sell telecommunications services, equipment, and inventory. Related parties include all entities that are related to Apollo Management, L.P. and its affiliates (collectively “Apollo”), our controlling stockholder.

Hughes Telematics, Inc.

In July 2006, HNS granted a limited license to HTI allowing HTI to use the HUGHES trademark. The license is limited in that HTI may use the HUGHES trademark only in connection with its business of automotive telematics and only in combination with the TELEMATICS name. As partial consideration for the license, the agreement provides that HNS will be HTI’s preferred engineering services provider. The license is royalty-free, except that HTI has agreed to pay a royalty to HNS in the event HTI no longer has a commercial or affiliated relationship with HNS.

In October 2007, HNS entered into an agreement with HTI and a customer of HTI, whereby HNS agreed to assume the rights and performance obligations of HTI in the event that HTI fails to perform its obligations due to a fundamental cause such as bankruptcy or the cessation of its telematics business. In connection with that agreement, HNS and HTI have entered into a letter agreement pursuant to which HTI has agreed to take certain actions to enable HNS to assume HTI’s obligations in the event that such action is required. However, as a result of the Merger, as defined and described in Note 8—Other Assets, HNS’ obligations to HTI and its customer expired when HTI became a public company in March 2009 with an initial market capitalization value greater than $300.0 million.

In January 2008, HNS entered into an agreement with HTI for the development of an automotive telematics system for HTI, comprising the telematics system hub and the Telematics Control Unit (“TCU”), which will serve as the user appliance in the telematics system. The agreement also provided that, subject to certain specified performance conditions, HNS will serve as the exclusive manufacturer and supplier of TCU’s for HTI.

 

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In March 2009, we made an equity investment in HTI, which represented approximately 3.8% of HTI’s outstanding common stock. See Note 8—Other Assets for further discussion. In August 2009, HTI terminated substantially all of the development engineering and manufacturing services with HNS as a result of the bankruptcy filing of one of HTI’s customers. On December 18, 2009, HNS entered into a promissory note with HTI (“Promissory Note”) for $8.3 million of account receivables that HTI owed to HNS. The Promissory Note has a maturity date of December 31, 2010 and an interest rate of 12% per annum.

HTI is controlled by an affiliate of Apollo. Jeffrey A. Leddy, a member of HNS’ Board of Managers and our Board of Directors, is the CEO and a director of HTI and owns less than 2% of HTI’s equity as of June 30, 2010. In addition, Andrew Africk and Aaron Stone, members of HNS’ Board of Managers and our Board of Directors, are directors of HTI and partners of Apollo.

Hughes Systique Corporation

HNS has contracted with Hughes Systique, an entity consolidated with the Company, for software development services. In addition to our 45.23% ownership in Hughes Systique, our CEO and President and his brother, who is the CEO and President of Hughes Systique, in the aggregate, owned approximately 25.61%, on an undiluted basis, of Hughes Systique’s outstanding shares as of June 30, 2010. Furthermore, our CEO and President and Jeffrey A. Leddy, a member of our Board of Directors and HNS’ Board of Managers, serve on the board of directors of Hughes Systique. As a result of the Termination Agreement, we are required to consolidate Hughes Systique’s results of operations in our operating results. For a description of additional transactions entered into between the Company and Hughes Systique, see Note 2—Consolidation of Hughes Systique Corporation.

Agreement with 95 West Co., Inc.

In July 2006, HNS entered into an agreement with 95 West Co. and its parent, MLH, pursuant to which 95 West Co. and MLH agreed to provide a series of coordination agreements which allow HNS to operate its SPACEWAY 3 at an orbital position where such parties have higher-priority rights. Jeffrey A. Leddy, a member of our Board of Directors and HNS’ Board of Managers, is the managing director of 95 West Co. and MLH and also owns a small interest in each. Andrew Africk, another member of our Board of Directors and HNS’ Board of Managers, is also a director of MLH. As part of the agreement, HNS agreed to pay $9.3 million, in annual installments of $0.3 million in 2006, $0.75 million in each year between 2007 and 2010 and $1.0 million in each year between 2011 and 2016 for the use of the orbital position, subject to conditions in the agreement including HNS’ ability to operate SPACEWAY 3. As of June 30, 2010, the remaining debt balance under the capital lease was $4.9 million, which was included in “Capital lease and other” in the short-term and long-term debt tables included in Note 9—Debt.

Smart & Final, Inc.

As of June 30, 2010, Apollo owned, directly or indirectly, 95% of Smart & Final, Inc. (“Smart & Final”). We provide broadband products and services to Smart & Final.

Other

Certain members of our Board of Directors and officers serve on the boards of directors of some of our affiliates. In some cases, such directors and officers have received stock-based compensation from such affiliates for their service. In those cases, the amount of stock-based compensation received by the directors and officers is comparable to stock-based compensation awarded to other non-executive members of the affiliates’ boards of directors.

 

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Related Party Transactions

Sales and purchase transactions with related parties are as follows (in thousands):

 

     Three Months Ended
June  30,
   Six Months Ended
June  30,
             2010                    2009                    2010                    2009        

Sales:

           

HTI

   $           200    $ 7,660    $ 501    $ 14,728

Smart & Final

     122      114      245      266
                           

Total sales

   $ 322    $         7,774    $         746    $       14,994
                           

Purchases:

           

Hughes Systique(1)

   $ -    $ -    $ -    $ 1,591
                           

Total purchases

   $ -    $ -    $ -    $ 1,591
                           

 

(1) For the period after March 11, 2009, Hughes Systique’s results of operations are consolidated with the Company’s operating results.

Assets resulting from transactions with related parties are as follows (in thousands):

 

          June 30,     
2010
   December 31,
2009

Due from related parties:

     

HTI

   $ 7,844    $ 8,652

Smart & Final

     50      52
             

Total due from related parties

   $       7,894    $       8,704
             

 

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Note 16:    Segment Data

Set forth below is selected financial information for our operating segments (in thousands). There were no intersegment transactions.

 

     North
America
Broadband
    International
Broadband
   Telecom
Systems
   HTS
Satellite(1)
    Corporate
and Other
    Consolidated  

As of or For the Three Months Ended June 30, 2010

              

Revenues

   $ 178,024      $ 47,853    $ 25,456    $ -      $ 1,035      $ 252,368   

Operating income (loss)

   $ 12,821      $ 2,549    $ 4,663    $ (928   $ (1,147   $ 17,958   

Depreciation and amortization

   $ 27,141      $ 3,631    $ 1,043    $ -      $ 163      $ 31,978   

Assets

   $ 623,819      $ 172,296    $ 45,976    $ 133,284      $ 294,998      $ 1,270,373   

Capital expenditures

   $ 20,219      $ 2,484    $ 50    $ 35,629      $ 2,340      $ 60,722   

As of or For the Three Months Ended June 30, 2009

              

Revenues

   $ 175,242      $ 50,520    $ 29,344    $ -      $ 721      $ 255,827   

Operating income (loss)(2)

   $ (36,770   $ 5,105    $ 2,611    $ -      $ (2,207   $ (31,261

Depreciation and amortization

   $ 20,237      $ 3,008    $ 974    $ -      $ 218      $ 24,437   

Assets

   $ 642,672      $ 177,772    $ 61,678    $ -      $ 388,592      $ 1,270,714   

Capital expenditures

   $ 21,487      $ 6,589    $ 361    $ -      $ 1,610      $ 30,047   

As of or For the Six Months Ended June 30, 2010

              

Revenues

   $ 352,019      $ 91,309    $ 50,148    $ -      $ 2,085      $ 495,561   

Operating income (loss)

   $ 22,437      $ 1,393    $ 8,371    $ (1,786   $ (1,893   $ 28,522   

Depreciation and amortization

   $ 52,660      $ 7,057    $ 2,067    $ -      $ 327      $ 62,111   

Assets

   $ 623,819      $ 172,296    $ 45,976    $ 133,284      $ 294,998      $ 1,270,373   

Capital expenditures

   $ 46,357      $ 6,671    $ 203    $ 68,396      $ 5,932      $ 127,559   

As of or For the Six Months Ended June 30, 2009

              

Revenues

   $ 340,850      $ 95,404    $ 58,606    $ -      $ 1,182      $ 496,042   

Operating income (loss)(2)

   $ (35,020   $ 6,336    $ 8,100    $ -      $ (2,314   $ (22,898

Depreciation and amortization

   $ 38,422      $ 5,716    $ 1,941    $ -      $ 251      $ 46,330   

Assets

   $ 642,672      $ 177,772    $ 61,678    $ -      $ 388,592      $ 1,270,714   

Capital expenditures

   $ 46,331      $ 9,913    $ 818    $ -      $ 4,001      $ 61,063   

 

(1) There were no activities for the three and six months ended June 30, 2009.
(2) Operating loss for North America Broadband includes $44.4 million of impairment loss related to our prepaid deposit to Sea Launch, which was impaired in 2009.

 

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Note 17:    Comprehensive Loss

Comprehensive loss is as follows (in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
         2010             2009             2010             2009      

Net income (loss)

   $ 1,529      $ (47,432   $ (4,645   $ (51,760
                                

Other comprehensive income (loss):

        

Foreign currency translation adjustments

     (1,674     6,783        (2,403     5,376   

Unrealized gain (loss) on hedging instruments

     (3,111     31        (5,434     5,368   

Reclassification of realized loss on hedging instruments

     1,415        2,819        2,783        1,965   

Unrealized loss on available-for-sale securities

     (55     -        (702     -   
                                

Total other comprehensive income (loss)

     (3,425     9,633        (5,756     12,709   
                                

Comprehensive loss

     (1,896     (37,799     (10,401     (39,051

Comprehensive loss attributable to the noncontrolling interest

     599        516        382        148   
                                

Comprehensive loss attributable to HCI

   $ (1,297   $ (37,283   $ (10,019   $ (38,903
                                

Note 18:    Commitments and Contingencies

Litigation

We are periodically involved in litigation in the ordinary course of our business involving claims regarding intellectual property infringement, product liability, property damage, personal injury, contracts, employment and worker’s compensation. We do not believe that there are any such pending or threatened legal proceedings, including ordinary litigation incidental to the conduct of our business and the ownership of our properties that, if adversely determined, would have a material adverse effect on our business, financial condition, results of operations or liquidity.

In October 2008, Hughes Telecommunicaçoes do Brasil Ltda. (“HTB”), a wholly-owned subsidiary of HNS, received a tax assessment of approximately $6.3 million from the State of São Paulo Treasury Department. The tax assessment alleges that HTB failed to pay certain import taxes to the State of São Paulo. We do not believe the assessment is valid and plan to dispute the State of São Paulo’s claims and to defend vigorously against these allegations. Therefore, we have not recorded a liability. It is the opinion of management that such litigation is not expected to have a material adverse effect on our financial position, results of operations or cash flows.

In March 2009, an arbitration panel ruled in favor of HNS in its arbitration against Sea Launch Limited Partnership and Sea Launch Company, LLC (collectively, “Sea Launch”) entitling HNS to a full refund of $44.4 million (the “Deposit”) in payments made to Sea Launch in connection with launch services for SPACEWAY 3, in addition to interest of 10% per annum on the $44.4 million from July 10, 2007 until payment on the Deposit is received in full. As a result of Sea Launch filing a voluntary petition to reorganize under Chapter 11 of the U.S. Bankruptcy Code, our efforts to pursue collection of the arbitral award were stayed under the bankruptcy laws. In June 2009, based upon information made available in the bankruptcy proceedings and other factors, the Company concluded that the value of the previously-recorded Deposit was impaired and recorded an impairment loss of $44.4 million. On May 27, 2010, HNS entered into a settlement agreement with Sea Launch to resolve the claim that HNS filed in the Sea Launch bankruptcy (the “Settlement Agreement”). The Settlement Agreement provides that Sea Launch will irrevocably issue to HNS two credits, each in the amount of $22.2 million (the “Credits”), in satisfaction and discharge of HNS’ bankruptcy claim. The Credits may be used by HNS to defray the cost of up to two

 

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launches contracted by December 31, 2015, and scheduled to occur by December 31, 2017. In addition, subject to the terms and conditions of the Settlement Agreement, one or both Credits may be transferred to third parties. The bankruptcy court has approved the Settlement Agreement, and its terms have been incorporated into the court’s order approving Sea Launch’s plan of reorganization. The Settlement Agreement will become effective upon the effectiveness of the plan of reorganization, which is expected to occur later in 2010.

On May 18, 2009, the Company and HNS received notice of a complaint filed in the U.S. District Court for the Northern District of California by two California subscribers to the HughesNet service. The plaintiffs complain about the speed of the HughesNet service, the Fair Access Policy, early termination fees and certain terms and conditions of the HughesNet subscriber agreement. The plaintiffs seek to pursue their claims as a class action on behalf of other California subscribers. On June 4, 2009, the Company and HNS received notice of a similar complaint filed by another HughesNet subscriber in the Superior Court of San Diego County, California. The plaintiff in this case also seeks to pursue his claims as a class action on behalf of other California subscribers. Both cases have been consolidated into a single case in the U.S. District Court for the Northern District of California. We believe that the allegations in both complaints are not meritorious and we intend to vigorously defend these matters.

On December 18, 2009, the Company and HNS received notice of a complaint filed in the Cook County, Illinois, Circuit Court by a former subscriber to the HughesNet service. The complaint seeks a declaration allowing the former subscriber to file a class arbitration challenging early termination fees under the subscriber agreement. We believe that the allegations in this complaint are not meritorious and we intend to vigorously defend this matter.

Commitments

In June 2009, HNS entered into an agreement with SS/L for the construction of Jupiter and has agreed to make installment payments to SS/L upon the completion of each milestone as set forth in the agreement. In connection with the construction of Jupiter, HNS entered into a contract with Barrett Xplore Inc. (“Barrett”), whereby Barrett agreed to lease user beams and purchase gateways and terminals for the Jupiter satellite that are designed to operate in Canada. In April 2010, HNS entered into an agreement with Arianespace for the launch of Jupiter in the first half of 2012. Pursuant to the agreement, the Ariane 5 heavy launcher will launch Jupiter into geosynchronous transfer orbit from Guiana Space Centre in Kourou, French Guiana. As of June 30, 2010, our obligation for the construction and launch of Jupiter was approximately $274.8 million.

We are contingently liable under standby letters of credit and bonds in the aggregate amount of $24.1 million that were undrawn as of June 30, 2010. Of this amount, $5.3 million was issued under the Revolving Credit Facility; $1.7 million was secured by restricted cash; $1.0 million related to insurance bonds; and $16.1 million was issued under credit arrangements available to our Indian and Brazilian subsidiaries. Certain letters of credit issued by our Indian subsidiaries are secured by their assets. As of June 30, 2010, these obligations were scheduled to expire as follows: $8.6 million in 2010; $12.0 million in 2011; $0.7 million in 2012; and $2.8 million in 2013 and thereafter.

Note 19:    Supplemental Guarantor and Non-Guarantor Financial Information

On August 8, 2007, the Company filed a shelf registration statement on Form S-3, as amended on November 15, 2007, to register shares of our common stock, preferred stock, and warrants and debt securities and non-convertible debt securities of HNS and HNS Finance Corp., a finance subsidiary which is HNS’s wholly-owned subsidiary (the “Co-Issuer”), as co issuers. In connection with any future issuance of debt securities of HNS and the Co-Issuer, we will, and one or more of our other subsidiaries may, on a joint and several basis, offer full and unconditional guarantees of the obligations of HNS and the Co-Issuer, under such debt securities. The registration statement was declared effective by the Securities and Exchange Commission on November 19, 2007.

In lieu of providing separate unaudited financial statements of HNS, the Co-Issuer and HNS’ guarantor subsidiaries, condensed financial statements prepared in accordance with Rule 3-10 and Rule 5-04 of Regulation S-X are presented below. The column marked “Parent” represents our results of operations, with the subsidiaries accounted for using the equity method. The column marked “Subsidiary Issuer” represents the results of HNS. The column marked “Guarantor

 

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Subsidiaries” includes the results of HNS’ guarantor subsidiaries and the Co-Issuer, which is a co-issuer of HNS’ Senior Notes and which had no assets, operations, revenues or cash flows for the periods presented. The column marked “Non-Guarantor Subsidiaries” includes the results of non-guarantor subsidiaries of the Company and HNS. Eliminations necessary to arrive at the information for the Company on a consolidated basis for the periods presented are included in the column so labeled. Separate financial statements and other disclosures concerning the Co-Issuer and HNS’ Guarantor Subsidiaries are not presented because management has determined that they are not material to investors.

The following represents the supplemental condensed financial statements of the Company, HNS, the Guarantor Subsidiaries and the Non-guarantor Subsidiaries. These condensed financial statements should be read in conjunction with our condensed consolidated financial statements and notes thereto.

Condensed Consolidated Balance Sheet as of June 30, 2010

(In thousands)

(Unaudited)

 

     Parent    Subsidiary
Issuer
   Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
   Eliminations     Total

Assets

                

Cash and cash equivalents

   $ 57,430    $ 93,402    $ 210    $ 10,985    $ -      $ 162,027

Marketable securities

     35,388      25,020      -      -      -        60,408

Receivables, net

     6,936      121,410      52      51,387      (19,446     160,339

Inventories

     -      44,977      -      13,372      -        58,349

Prepaid expenses and other

     477      7,343      75      16,782      -        24,677
                                          

Total current assets

     100,231      292,152      337      92,526      (19,446     465,800

Property, net

     -      606,181      32,410      27,583      -        666,174

Investment in subsidiaries

     193,076      112,188      -      -      (305,264     -

Other assets

     9,071      98,169      1,289      31,518      (1,648     138,399
                                          

Total assets

   $ 302,378    $ 1,108,690    $ 34,036    $ 151,627    $ (326,358   $ 1,270,373
                                          

Liabilities and equity

                

Accounts payable

   $ 1,032    $ 80,498    $ 164    $ 35,914    $ (16,001   $ 101,607

Short-term debt

     -      2,246      -      4,532      -        6,778

Accrued liabilities and other

     757      104,453      -      21,687      (3,445     123,452
                                          

Total current liabilities

     1,789      187,197      164      62,133      (19,446     231,837

Long-term debt

     -      709,900      -      3,119      -        713,019

Other long-term liabilities

     -      18,965      -      1,762      (1,648     19,079

Total HCI stockholders’ equity

     297,765      192,628      28,023      84,613      (305,264     297,765

Noncontrolling interests

     2,824      -      5,849      -      -        8,673
                                          

Total liabilities and equity

   $     302,378    $     1,108,690    $       34,036    $       151,627    $     (326,358   $   1,270,373
                                          

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Condensed Consolidated Balance Sheet as of December 31, 2009

(In thousands)

(Unaudited)

 

     Parent    Subsidiary
Issuer
   Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
   Eliminations     Total

Assets

                

Cash and cash equivalents

   $ 74,787    $ 173,991    $ 1,091    $ 11,169    $ -      $ 261,038

Marketable securities

     16,062      31,126      -      -      -        47,188

Receivables, net

     7,794      115,948      628      64,237      (24,791     163,816

Inventories

     -      47,437      138      12,669      -        60,244

Prepaid expenses and other

     264      7,421      234      14,557      -        22,476
                                          

Total current assets

     98,907      375,923      2,091      102,632      (24,791     554,762

Property, net

     -      542,642      32,792      26,969      -        602,403

Investment in subsidiaries

     200,687      115,136      -      -      (315,823     -

Other assets

     9,724      102,045      3,221      31,842      (1,603     145,229
                                          

Total assets

   $ 309,318    $ 1,135,746    $ 38,104    $ 161,443    $ (342,217   $ 1,302,394
                                          

Liabilities and equity

                

Accounts payable

   $ 1,442    $ 97,114    $ 2,272    $ 39,171    $ (20,538   $ 119,461

Short-term debt

     -      2,054      -      4,696      -        6,750

Accrued liabilities and other

     701      110,088      714      24,524      (4,253     131,774
                                          

Total current liabilities

     2,143      209,256      2,986      68,391      (24,791     257,985

Long-term debt

     -      710,259      -      4,698      -        714,957

Other long-term liabilities

     -      16,191      -      1,768      (1,603     16,356

Total HCI stockholders’ equity

     304,041      200,040      29,197      86,586      (315,823     304,041

Noncontrolling interests

     3,134      -      5,921      -      -        9,055
                                          

Total liabilities and equity

   $     309,318    $   1,135,746    $       38,104    $       161,443    $     (342,217   $     1,302,394
                                          

 

26


Table of Contents

HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Condensed Consolidated Statement of Operations for the Three Months Ended June 30, 2010

(In thousands)

(Unaudited)

 

     Parent     Subsidiary
Issuer
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Total  

Revenues

   $ -      $             222,325      $               372      $         36,618      $         (6,947   $       252,368   
                                                

Operating costs and expenses:

            

Costs of revenues

     -        157,791        -        27,609        (6,422     178,978   

Selling, general and administrative

     968        40,467        817        7,579        (525     49,306   

Research and development

     -        5,355        -        -        -        5,355   

Amortization of intangible assets

     -        683        -        88        -        771   
                                                

Total operating costs and expenses

     968        204,296        817        35,276        (6,947     234,410   
                                                

Operating income (loss)

     (968     18,029        (445     1,342        -        17,958   

Other income (expense):

            

Interest expense

     -        (15,248     -        (412     140        (15,520

Interest income

     102        479        -        215        (140     656   

Equity in earnings (losses) of subsidiaries

     2,590        (262     -        -        (2,328     -   
                                                

Income (loss) before income tax expense

     1,724        2,998        (445     1,145        (2,328     3,094   

Income tax expense

     (2     (204     -        (1,359     -        (1,565
                                                

Net income (loss)

     1,722        2,794        (445     (214     (2,328     1,529   

Net (income) loss attributable to noncontrolling interests

     188        -        (142     335        -        381   
                                                

Net income (loss) attributable to HCI stockholders

   $             1,910      $ 2,794      $ (587   $ 121      $ (2,328   $ 1,910   
                                                

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Condensed Consolidated Statement of Operations for the Three Months Ended June 30, 2009

(In thousands)

(Unaudited)

 

     Parent     Subsidiary
Issuer
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Total  

Revenues

   $ -      $         223,235      $         2,195      $         38,759      $ (8,362   $         255,827   
                                                

Operating costs and expenses:

            

Costs of revenues

     -        166,510        1,503        27,961        (7,632     188,342   

Selling, general and administrative

     977        37,659        1,205        7,033        (730     46,144   

Loss on impairments

             1,000        44,400        -        -        -        45,400   

Research and development

     -        4,966        732        -        -        5,698   

Amortization of intangible assets

     -        1,105        281        118        -        1,504   
                                                

Total operating costs and expenses

     1,977        254,640        3,721        35,112        (8,362     287,088   
                                                

Operating income (loss)

     (1,977     (31,405     (1,526     3,647        -        (31,261

Other income (expense):

            

Interest expense

     -        (15,318     -        (260     24        (15,554

Interest and other income (loss), net

     66        (250     -        70        (24     (138

Equity in earnings (losses) of subsidiaries

     (45,970     1,469        -        -        44,501        -   
                                                

Income (loss) before income tax expense

     (47,881     (45,504     (1,526     3,457        44,501        (46,953

Income tax expense

     (1     (206     -        (272     -        (479
                                                

Net income (loss)

     (47,882     (45,710     (1,526     3,185        44,501        (47,432

Net (income) loss attributable to noncontrolling interests

     140        -        (609     159        -        (310
                                                

Net income (loss) attributable to HCI stockholders

   $ (47,742   $ (45,710   $ (2,135   $ 3,344      $         44,501      $ (47,742
                                                

 

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Table of Contents

HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Condensed Consolidated Statement of Operations for the Six Months Ended June 30, 2010

(In thousands)

(Unaudited)

 

     Parent     Subsidiary
Issuer
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Total  

Revenues

   $ -      $         434,796      $ 1,360      $         72,695      $ (13,290   $         495,561   
                                                

Operating costs and expenses:

            

Costs of revenues

     -        313,119        306        54,556        (12,404     355,577   

Selling, general and administrative

             1,738        81,553                2,189        15,037        (886     99,631   

Research and development

     -        9,815        455        -        -        10,270   

Amortization of intangible assets

     -        1,217        168        176        -        1,561   
                                                

Total operating costs and expenses

     1,738        405,704        3,118        69,769        (13,290     467,039   
                                                

Operating income (loss)

     (1,738     29,092        (1,758     2,926        -        28,522   

Other income (expense):

            

Interest expense

     -        (31,041     -        (760     171        (31,630

Interest and other income (loss), net

     158        120        870        270        (171     1,247   

Equity in losses of subsidiaries

     (2,971     (508     -        -        3,479        -   
                                                

Income (loss) before income tax expense

     (4,551     (2,337     (888     2,436        3,479        (1,861

Income tax expense

     (4     (431     (3     (2,346     -        (2,784
                                                

Net income (loss)

     (4,555     (2,768     (891     90        3,479        (4,645

Net (income) loss attributable to noncontrolling interests

     325        -        (283     373        -        415   
                                                

Net income (loss) attributable to HCI stockholders

   $ (4,230   $ (2,768   $ (1,174   $ 463      $         3,479      $ (4,230
                                                

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Condensed Consolidated Statement of Operations for the Six Months Ended June 30, 2009

(In thousands)

(Unaudited)

 

     Parent     Subsidiary
Issuer
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Total  

Revenues

   $ -      $         433,050      $         4,027      $         73,497      $ (14,532   $         496,042   
                                                

Operating costs and expenses:

            

Costs of revenues

     -        325,893        2,168        54,084        (12,928     369,217   

Selling, general and administrative

             2,190        74,438        2,558        12,803        (1,604     90,385   

Loss on impairments

     1,000        44,400        -        -        -        45,400   

Research and development

     -        9,622        1,427        -        -        11,049   

Amortization of intangible assets

     -        2,208        563        118        -        2,889   
                                                

Total operating costs and expenses

     3,190        456,561        6,716        67,005        (14,532     518,940   
                                                

Operating income (loss)

     (3,190     (23,511     (2,689     6,492        -        (22,898

Other income (expense):

            

Interest expense

     -        (28,971     -        (441     22        (29,390

Interest and other income (loss), net

     326        (103     -        151        (22     352   

Equity in earnings (losses) of subsidiaries

     (49,734     2,401        -        -        47,333        -   
                                                

Income (loss) before income tax (expense) benefit

     (52,598     (50,184     (2,689     6,202                47,333        (51,936

Income tax (expense) benefit

     (2     (380     -        558        -        176   
                                                

Net income (loss)

     (52,600     (50,564     (2,689     6,760        47,333        (51,760

Net (income) loss attributable to noncontrolling interests

     162        -        (1,138     298        -        (678
                                                

Net income (loss) attributable to HCI stockholders

   $ (52,438   $ (50,564   $ (3,827   $ 7,058      $ 47,333      $ (52,438
                                                

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Condensed Consolidated Statement of Cash Flows for the Six Months Ended June 30, 2010

(In thousands)

(Unaudited)

 

     Parent     Subsidiary
Issuer
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Total  

Cash flows from operating activities:

            

Net income (loss)

   $ (4,555   $ (2,768   $ (891   $ 90      $         3,479      $ (4,645

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

     6,396        39,232                652                4,675        (3,479             47,476   
                                                

Net cash provided by (used in) operating activities

     1,841        36,464        (239     4,765        -        42,831   
                                                

Cash flows from investing activities:

            

Change in restricted cash

     52        (1     -        93        -        144   

Purchases of marketable securities

     (33,416     (32,615     -        -        -        (66,031

Proceeds from sales of marketable securities

     14,166        38,615        -        -        -        52,781   

Expenditures for property

     -        (115,001     (642     (5,746     -        (121,389

Expenditures for capitalized software

     -        (6,170     -        -        -        (6,170

Proceeds from sales of property

     -        20        -        244        -        264   
                                                

Net cash used in investing activities

     (19,198     (115,152     (642     (5,409     -        (140,401
                                                

Cash flows from financing activities:

            

Short-term revolver borrowings

     -        -        -        3,263        -        3,263   

Repayments of revolver borrowings

     -        -        -        (3,745     -        (3,745

Long-term debt borrowings

     -        1,116        -        1,470        -        2,586   

Repayment of long-term debt

     -        (1,283     -        (2,645     -        (3,928

Debt issuance costs

     -        (1,734     -        -        -        (1,734
                                                

Net cash used in financing activities

     -        (1,901     -        (1,657     -        (3,558
                                                

Effect of exchange rate changes on cash and cash equivalents

     -        -        -        2,117        -        2,117   
                                                

Net decrease in cash and cash equivalents

     (17,357     (80,589     (881     (184     -        (99,011

Cash and cash equivalents at beginning of period

     74,787        173,991        1,091        11,169        -        261,038   
                                                

Cash and cash equivalents at end of period

   $         57,430      $         93,402      $ 210      $ 10,985      $ -      $ 162,027   
                                                

 

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HUGHES COMMUNICATIONS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Condensed Consolidated Statement of Cash Flows for the Six Months Ended June 30, 2009

(In thousands)

(Unaudited)

 

    Parent     Subsidiary
Issuer
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Total  

Cash flows from operating activities:

           

Net income (loss)

  $ (52,600   $             (50,564)      $ (2,689   $             6,760      $ 47,333      $ (51,760

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

    33,690        102,917        2,731        (3,306     (47,333     88,699   
                                               

Net cash provided by (used in) operating activities

    (18,910     52,353        42        3,454        -        36,939   
                                               

Cash flows from investing activities:

           

Change in restricted cash

    (1     (1     -        114        -        112   

Expenditures for property

    -        (43,933     (1,142     (8,226     -        (53,301

Expenditures for capitalized software

    -        (7,762     -        -        -        (7,762

Proceeds from sales of property

    -        18        6        69        -        93   

Cash acquired, consolidation of Hughes Systique

    -        -        -        828        -        828   

Other, net

    (75     -        -        -        -        (75
                                               

Net cash used in investing activities

    (76     (51,678     (1,136     (7,215     -        (60,105
                                               

Cash flows from financing activities:

           

Net decrease in notes and loans payable

    -        -        -        (78     -        (78

Long-term debt borrowings

    -        137,338        -        3,769        -        141,107   

Repayment of long-term debt

    -        (4,294     -        (1,211     -        (5,505

Debt issuance costs

    -        (4,500     -        -        -        (4,500
                                               

Net cash provided by financing activities

    -        128,544        -        2,480        -        131,024   
                                               

Effect of exchange rate changes on cash and cash equivalents

    -        -        -        (1,507     -        (1,507
                                               

Net increase (decrease) in cash and cash equivalents

    (18,986     129,219        (1,094     (2,788     -        106,351   

Cash and cash equivalents at beginning of period

                103,281        75,956        2,013        22,566        -        203,816   
                                               

Cash and cash equivalents at end of period

  $ 84,295      $ 205,175      $ 919      $ 19,778      $ -      $             310,167   
                                               

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the Company’s financial condition and results of operations are based upon financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America and should each be read together with our condensed consolidated financial statements and the notes to those condensed consolidated financial statements included elsewhere in this report. This report contains forward-looking statements that involve risks and uncertainties, including statements regarding our capital needs, business strategy, expectations and intentions within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent our expectations or beliefs concerning future events. We urge you to consider statements that use the terms “believe,” “do not believe,” “anticipate,” “expect,” “plan,” “may,” “estimate,” “strive,” “intend,” “will,” “should,” and variations of these words or similar expressions are intended to identify forward-looking statements. These statements reflect our current views with respect to future events and because our business is subject to numerous risks, and uncertainties, our actual results could differ materially from those anticipated in the forward-looking statements, including those set forth below under this “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” “Special Note Regarding Forward-Looking Statements” and contained elsewhere in this report. All forward-looking statements speak only as of the date of this report. Actual results will most likely differ from those reflected in these forward-looking statements and the differences could be substantial. We disclaim any obligation to update these forward-looking statements or disclose any difference, except as may be required by securities laws, between our actual results and those reflected in these statements. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements in this report are reasonable, we can give no assurance that such plans, intentions or expectations will be achieved.

Overview

Hughes Communications, Inc. (“HCI” and, together with its consolidated subsidiaries, the “Company” or “we,” “us,” and “our”) operates its business primarily through Hughes Network Systems, LLC (“HNS”), our wholly-owned subsidiary, a telecommunications company. We provide equipment and services to the broadband communications marketplace. We have extensive technical expertise in satellite, wireline and wireless communications which we utilize in a number of product and service offerings. In particular, we offer a spectrum of broadband equipment and services to the managed services market, which is comprised of enterprises with a requirement to connect a large number of geographically dispersed locations with reliable, scalable, and cost-effective applications, such as credit card verification, inventory tracking and control, and broadcast video. We provide broadband network services and systems to the international and domestic enterprise markets and satellite broadband Internet access to North American consumers, which we refer to as the Consumer market. In addition, we provide networking systems to customers for mobile satellite, telematics and wireless backhaul systems. These services are generally provided on a contract or project basis and may involve the use of proprietary products engineered by us.

Strategic Initiatives and Their Impact on Our Results of Operations

We generated a net income attributable to our stockholders of $1.9 million and a net loss attributable to our stockholders of $47.7 million for the three months ended June 30, 2010 and 2009, respectively, and a net loss attributable to our stockholders of $4.2 million and $52.4 million for the six months ended June 30, 2010 and 2009, respectively. The changes in our net income were significantly impacted by the $45.4 million impairment losses recognized in 2009, primarily related to our prepaid deposit (the “Deposit”) paid to Sea Launch Company, LLC (“Sea Launch”). In addition, our gross margin for the three and six months ended June 30, 2010 improved by $5.9 million and $13.2 million, respectively, compared to the same periods in 2009. The increase in our net income attributable to our stockholders for the three and six months ended June 30, 2010 was partially offset by the increase in our selling, general and administrative expenses as we increased our efforts in promoting our products and services.

Technology—We incorporate advances in technology to reduce costs and to increase the functionality and reliability of our products and services. Through the usage of advanced spectrally efficient modulation and coding methodologies, such as DVB-S2, and proprietary software web acceleration and compression techniques, we

 

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continue to improve the efficiency of our networks. In addition, we invest in technologies to enhance our system and network management capabilities, specifically our managed services for enterprises. We also continue to invest in next generation technologies that can be applied to our future products and services.

Acquisitions, Strategic Alliances and Divestitures—We continue to focus on expanding the identified markets for our products, services and network solutions in our North America Broadband, International Broadband and Telecom Systems segments. Consistent with our strategy to grow and improve our financial position, we also review our competitive position on an ongoing basis and, from time to time, consider various acquisitions, strategic alliances and divestitures which we believe would be beneficial to our business. We, from time to time, consider various alternatives related to the ownership structure of a new satellite, capacity features and other factors that would promote long term growth while meeting the needs of our customers.

In June 2009, HNS entered into an agreement with Space Systems/Loral, Inc. (“SS/L”) under which SS/L will manufacture our next-generation, high throughput geostationary satellite (“Jupiter”). Jupiter will employ a multi-spot beam, bent pipe Ka-band architecture and will provide additional capacity for the HughesNet service in North America. In connection with the construction of Jupiter, HNS entered into a contract with Barrett Xplore Inc. (“Barrett”), whereby Barrett agreed to lease user beams and purchase gateways and terminals for the Jupiter satellite that are designed to operate in Canada. In April 2010, HNS entered into an agreement with Arianespace for the launch of Jupiter in the first half of 2012. Pursuant to the agreement, the Ariane 5 heavy launcher will launch Jupiter into geosynchronous transfer orbit from Guiana Space Centre in Kourou, French Guiana. As of June 30, 2010, our obligation for the construction and launch of Jupiter was approximately $274.8 million.

Key Business Metrics

Business Segments—We divide our operations into five distinct segments—(i) the North America Broadband segment; (ii) the International Broadband segment; (iii) the Telecom Systems segment; (iv) the HTS Satellite segment; and (v) the Corporate and Other segment. Within the North America Broadband segment, sales are attributed to the Consumer group, which delivers broadband internet service to consumer customers, and the Enterprise group, which provides satellite, wireline and wireless communication networks and services to enterprises. The International Broadband segment consists of our international service companies and provides managed network services and equipment to enterprise customers and broadband service providers worldwide. The Telecom Systems segment consists of the Mobile Satellite Systems group, the Telematics group, and the Terrestrial Microwave group. The Mobile Satellite Systems group provides turnkey satellite ground segment systems to mobile system operators. The Telematics group previously provided development engineering and manufacturing services to Hughes Telematics, Inc. (“HTI”). However, as a result of the unfavorable impact of the economy on the automobile industry, HTI terminated substantially all of the development engineering and manufacturing services with us in August 2009. We expect our future revenue from the Telematics group to be insignificant. The Terrestrial Microwave group provides point-to-multipoint microwave radio network systems that are used for both cellular backhaul and broadband wireless access. The HTS Satellite segment, which is a new segment starting in 2010, consists of activities related to the development, construction and launch of high throughput satellites and currently represents construction activities of Jupiter. The Corporate and Other segment includes our wholly-owned subsidiary Rare Medium, LLC, certain minority interest investments held by us, and our corporate offices and assets not specifically related to another business segment. Due to the complementary nature and common architecture of our services and products across our business segments, we are able to leverage our expertise and resources within our various operating units to yield significant cost efficiencies.

Revenues—We generate revenues from the sale and financing of hardware and the provision of services. In our North America and International Broadband segments, we generate revenues from services and hardware. In our Telecom Systems segment, we generate revenues primarily from the development and sale of hardware. Some of our enterprise customers purchase equipment separately and operate their own networks. These customers include large enterprises, incumbent local exchange carriers, governmental agencies and resellers. Contracts for our services vary in length depending on the customers’ requirements.

Services—Our services revenue is varied in nature and includes total turnkey communications services, terminal relocation, maintenance and changes, transponder capacity and multicast or broadcast services. Our services are offered on a contractual basis, which vary in length based on the particular end market. Typically, our

 

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large enterprise customers enter into a three- to five-year contract, and our consumer customers enter into a 24-month contract. We bill and recognize service revenues on a monthly per site basis. For enterprise customers who receive services from our network operations, our services include the following:

 

Service Type  

Description

Broadband
connectivity
 

 •

 

 •

  

Provides basic transport, intranet connectivity services and internet service provider services

 

Applications include high-speed internet access, IP VPN, multicast file delivery and streaming, point-of-sale credit transactions, enterprise back-office communications, and satellite backup for frame relay service and other terrestrial networks

    
Managed network
services
 

 •

 

 •

  

Provides one-stop turnkey suite of bundled services that include wireline and wireless satellite networks

 

Includes network design program management, installation management, network and application engineering services, proactive network management, network operations, field maintenance and customer care

    
ISP services and
hosted application
 

 •

   Provides internet connectivity and hosted customer-owned and managed applications on our network facilities
 

 •

   Provides the customer application services developed by us or in conjunction with our service partners
 

 •

   Includes internet access, e-mail services, web hosting and online payments
Digital media
services
 

 •

   Digital content management and delivery including video, online learning and digital signage applications
Customized business
solutions
 

 •

   Provides customized, industry-specific enterprise solutions that can be applied to multiple businesses in a given industry

Our services to enterprise customers are negotiated on a contract-by-contract basis with price varying based on numerous factors, including number of sites, complexity of system and scope of services provided. We have the ability to integrate these service offerings to provide comprehensive solutions for our customers. We also provide managed services to our customers who operate their own dedicated network facilities and charge them a management fee for the operation and support of their networks.

Hardware—We offer our enterprise customers the option to purchase their equipment up front or to finance the sale through a third-party leasing company as part of their service agreement under which payments are made over a fixed term. Our consumer customers have the option to purchase the equipment up front or, beginning in September 2008, to rent the equipment with a 24-month service contract. Hardware revenues of the North American Enterprise group and International Broadband segment are derived from: (i) network operating centers; (ii) radio frequency terminals (earth stations); (iii) VSAT components including indoor units, outdoor units, and antennas; (iv) voice, video and data appliances; (v) routers and DSL modems; and (vi) system integration services to integrate all of the above into a system.

We also provide specialized equipment to our Mobile Satellite Systems and Terrestrial Microwave customers. Through large multi-year contracts, we develop and supply turnkey networking and terminal systems for various operators who offer mobile satellite-based services. We also supply microwave-based networking equipment to mobile operators for back-hauling their data from cellular telephone sites to their switching centers. In addition, local exchange carriers use our equipment for broadband access traffic from corporations bypassing local phone companies. The size and scope of these projects vary from year to year by customer and do not follow a pattern that can be reasonably predicted.

 

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Market trends impacting our revenues— The following table presents our revenues by end market for the three and six months ended June 30, 2010 and 2009 (dollars in thousands):

Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009

 

     Three Months Ended
June 30,
   Variance  
           2010                2009              Amount                 %          

Revenues:

          

Services revenues

   $ 193,190    $ 173,383    $ 19,807      11.4

Hardware sales

     59,178      82,444      (23,266   (28.2 )% 
                        

Total revenues

   $ 252,368    $ 255,827    $ (3,459   (1.4 )% 
                        

Revenues by end market:

          

North America Broadband segment:

          

Consumer

   $ 117,578    $ 104,206    $ 13,372      12.8

Enterprise

     60,446      71,036      (10,590   (14.9 )% 
                        

Total North America Broadband segment

     178,024      175,242      2,782      1.6
                        

International Broadband segment

     47,853      50,520      (2,667   (5.3 )% 
                        

Telecom Systems segment:

          

Mobile Satellite Systems

     20,628      19,369      1,259      6.5

Telematics

     200      7,659      (7,459   (97.4 )% 

Terrestrial Microwave

     4,628      2,316      2,312      99.8
                        

Total Telecom Systems segment

     25,456      29,344      (3,888   (13.2 )% 
                        

Corporate and Other segment

     1,035      721      314      43.6
                        

Total revenues

   $ 252,368    $ 255,827    $ (3,459   (1.4 )% 
                        

The following table presents our churn rate, average revenue per unit (“ARPU”), average monthly gross subscriber additions, and subscribers as of or for the three months ended June 30, 2010 and 2009:

 

     As of or For the
Three Months Ended June 30,
    Variance  
     2010     2009         Amount                 %          

Churn rate(1)

     2.01     2.27     (0.26 )%    (11.5 )% 

ARPU(2)

   $ 73      $ 70      $ 3      4.3

Average monthly gross subscriber additions(1)

     15,800        16,600        (800   (4.8 )% 

Subscribers(1)

     545,500        473,100        72,400      15.3

 

(1) Relates to our Consumer group and our small/medium enterprise and wholesale business customers who receive subscription services. The small/medium enterprise and wholesale business customers are part of our Enterprise group. The Consumer and Enterprise groups are part of our North America Broadband segment. The trend of the metric has been substantially similar for the Consumer group and the small/medium enterprise and wholesale business customers.
(2) Relates only to our Consumer group, which is part of our North America Broadband segment.

North America Broadband Segment

Revenue from our Consumer group for the three months ended June 30, 2010 increased by 12.8% to $117.6 million compared to the same period in 2009. The growth in our Consumer group has been driven primarily by three factors: (i) the substantial growth in the number of subscribers arising from increased consumer awareness of our products and services as a result of the expansion of our use of direct mail campaigns and television commercials targeting geographic areas that have historically been underserved by DSL and cable services; (ii) value-added services, such as express repair and web premium content services, and the election by our customers to utilize the consumer rental program and to subscribe to higher level service plans resulting in an increase in ARPU; and (iii) improvements in customer retention as shown by the reduction in the churn rate.

As of June 30, 2010 and 2009, we achieved a total subscription base of 545,500 and 473,100, respectively, which included 32,100 and 22,500, respectively, subscribers in our small/medium enterprise and wholesale

 

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businesses. Our ARPU, which is used to measure average monthly consumer subscription service revenues on a per subscriber basis, was $73 and $70 for the three months ended June 30, 2010 and 2009, respectively. ARPU is calculated by dividing the total service revenues from the Consumer group for the reporting period by the sum of the total number of subscribers in our Consumer group at the end of each month in the reporting period. Our ARPU calculation may not be consistent with other companies’ calculation in the same or similar businesses as we are not aware of any uniform standards for calculating ARPU.

Revenue from our North American Enterprise group for the three months ended June 30, 2010 decreased by 14.9% to $60.4 million compared to the same period in 2009. The decrease was primarily due to delays in customer buying decisions impacting new hardware orders. Enterprise service revenue is generally characterized by long term contracts.

International Broadband Segment

Revenue from our International Broadband segment for the three months ended June 30, 2010 decreased by 5.3% to $47.9 million compared to the same period in 2009, primarily due to delays in customer buying decisions impacting new hardware orders. The decrease was partially offset by $1.9 million resulting from the favorable impact of currency exchange due to the depreciation of the U.S. dollar.

Telecom Systems Segment

Revenue from our Telecom Systems segment for the three months ended June 30, 2010 decreased by 13.2% to $25.5 million compared to the same period in 2009. The decrease was due to the reduction of $7.5 million in revenue from our Telematics group, which was partially offset by the increase in revenue from our Terrestrial Microwave group.

Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009

 

     Six Months Ended
June 30,
   Variance  
           2010                2009              Amount             %      

Revenues:

          

Services revenues

   $ 381,130    $ 335,748    $ 45,382      13.5

Hardware sales

     114,431      160,294      (45,863   (28.6 )% 
                        

Total revenues

   $ 495,561    $ 496,042    $ (481   (0.1 )% 
                        

Revenues by end market:

          

North America Broadband segment:

          

Consumer

   $ 230,932    $ 202,935    $ 27,997      13.8

Enterprise

     121,087      137,915      (16,828   (12.2 )% 
                        

Total North America Broadband segment

     352,019      340,850      11,169      3.3
                        

International Broadband segment

     91,309      95,404      (4,095   (4.3 )% 
                        

Telecom Systems segment:

          

Mobile Satellite Systems

     40,033      37,835      2,198      5.8

Telematics

     501      14,728      (14,227   (96.6 )% 

Terrestrial Microwave

     9,614      6,043      3,571      59.1
                        

Total Telecom Systems segment

     50,148      58,606      (8,458   (14.4 )% 
                        

Corporate and Other segment

     2,085      1,182      903      76.4
                        

Total revenues

   $ 495,561    $ 496,042    $ (481   (0.1 )% 
                        

 

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The following table presents our churn rate, ARPU, average monthly gross subscriber additions, and subscribers as of or for the six months ended June 30, 2010 and 2009:

 

     As of or For the
Six Months Ended June 30,
    Variance  
     

        2010        

   

        2009        

   

    Amount    

   

        %        

 

Churn rate(1)

     2.00     2.28     (0.28 )%    (12.3 )% 

ARPU(2)

   $ 73      $ 69      $ 4      5.8

Average monthly gross subscriber additions(1)

     17,500        17,100        400      2.3

Subscribers(1)

     545,500        473,100        72,400      15.3

 

(1) Relates to our Consumer group and our small/medium enterprise and wholesale business customers who receive subscription services. The small/medium enterprise and wholesale business customers are part of our Enterprise group. The Consumer and Enterprise groups are part of our North America Broadband segment. The trend of the metric has been substantially similar for the Consumer group and the small/medium enterprise and wholesale business customers.
(2) Relates only to our Consumer group, which is part of our North America Broadband segment.

North America Broadband Segment

Revenue from our Consumer group for the six months ended June 30, 2010 increased by 13.8% to $230.9 million compared to the same period in 2009. The growth in our Consumer group has been driven primarily by three factors: (i) the substantial growth in the number of subscribers arising from increased consumer awareness of our products and services as a result of the expansion of our use of direct mail campaigns and television commercials targeting geographic areas that have historically been underserved by DSL and cable services; (ii) value-added services, such as express repair and web premium content services, and the election by our customers to utilize the consumer rental program and to subscribe to higher level service plans resulting in an increase in ARPU; and (iii) improvements in customer retention as shown by the reduction in the churn rate.

As of June 30, 2010 and 2009, we achieved a total subscription base of 545,500 and 473,100, respectively, which included 32,100 and 22,500, respectively, subscribers in our small/medium enterprise and wholesale businesses. Our ARPU was $73 and $69 for the six months ended June 30, 2010 and 2009, respectively.

Revenue from our North American Enterprise group for the six months ended June 30, 2010 decreased by 12.2% to $121.1 million compared to the same period in 2009. The decrease was primarily due to delays in customer buying decisions impacting new hardware orders. Enterprise service revenue is generally characterized by long term contracts.

International Broadband Segment

Revenue from our International Broadband segment for the six months ended June 30, 2010 decreased by 4.3% to $91.3 million compared to the same period in 2009, primarily due to delays in customer buying decisions impacting new hardware orders. The decrease was partially offset by the continued growth of our expanding array of solutions and global services to enterprises and government organizations in Brazil and the Africa/Middle East region, and $6.1 million resulting from the favorable impact of currency exchange due to the depreciation of the U.S. dollar.

Telecom Systems Segment

Revenue from our Telecom Systems segment for the six months ended June 30, 2010 decreased by 14.4% to $50.1 million compared to the same period in 2009. The decrease was due to the reduction of $14.2 million in revenue from our Telematics group, which was partially offset by the increase in revenue from our Terrestrial Microwave group.

Cost of Services—Our cost of services primarily consists of transponder capacity leases, hub infrastructure, customer care, wireline and wireless capacity, depreciation expense related to network infrastructure and capitalized

 

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hardware and software, and the salaries and related employment costs for those employees who manage our network operations and other project areas. These costs are dependent on the number of customers served and have increased relative to our growth. We continue to execute a number of cost containment and efficiency initiatives that were implemented in previous years. In addition, the migration to a single upgraded platform for ongoing consumer customers from our North America Broadband segment has enabled us to leverage our satellite bandwidth and network operation facilities to achieve further cost efficiencies. The costs associated with transponder capacity leases for the Consumer group are expected to decline as more customers are added to the SPACEWAY network.

Cost of Hardware Products Sold—We outsource a significant portion of the manufacturing of our hardware for our North America and International Broadband and Telecom Systems segments to third-party contract manufacturers. Our cost of hardware products sold relates primarily to direct materials and subsystems (e.g., antennas), salaries and related employment costs for those employees who are directly associated with the procurement and manufacture of our products and other items of indirect overhead incurred in the procurement and production process. Cost of hardware products sold also includes certain engineering and hardware costs related to the design of a particular product for specific customer programs. In addition, certain software development costs are capitalized in accordance with Accounting Standards Codification 985-20 “Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” and amortized to cost of hardware products sold over their estimated useful lives. As we have developed new product offerings, we have reduced product costs due to higher levels of component integration, design improvements and volume increases.

Subscriber acquisition costs (“SAC”) are associated with our Consumer group and are comprised of three elements: (i) the subsidy for the cost of hardware and related installation; (ii) certain sales and marketing expense; and (iii) dealer and customer service representative commissions on new installations/activations. The subsidy for cost of hardware and related cost of installation is deferred and amortized over the shorter of the initial contract period or the useful life of the hardware as a component of cost of hardware products sold for hardware related sales or cost of services for activities related to the consumer rental program. The portion of SAC related to sales and marketing is expensed as incurred. Dealer and customer service representative commissions are deferred and amortized over the initial contract period as a component of sales and marketing expense.

Selling, General and Administrative (“SG&A”)—Selling expenses primarily consist of the salaries, commissions, related benefit costs of our direct sales force and marketing staff, advertising, channel compensations on new activations which are deferred and amortized over the initial consumer contract period, travel, allocation of facilities, and other directly related overhead costs for our domestic and international businesses. General and administrative expenses include bad debt expense and salaries and related employee benefits for employees associated with common supporting functions, such as accounting and finance, risk management, legal, information technology, administration, human resources, and senior management. Selling, general, and administrative costs also include facilities costs, third-party service providers’ costs (such as outside tax and legal counsel, and insurance providers), bank fees related to credit card processing charges and depreciation of fixed assets.

Research and Development (“R&D”)—R&D expenses primarily consist of the salaries of certain members of our engineering staff plus an applied overhead charge. R&D expenses also include engineering support for existing platforms and development efforts to build new products and software applications, subcontractors, material purchases and other direct costs in support of product development.

 

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Results of Operations

Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009

Revenues

 

     Three Months Ended
June  30,
    Variance

(Dollars in thousands)

         2010                 2009               Amount                 %        

Services revenues

   $ 193,190      $ 173,383      $   19,807        11.4%

Hardware sales

     59,178        82,444        (23,266   (28.2)%
                          

Total revenues

   $ 252,368      $ 255,827      $ (3,459   (1.4)%
                          

% of revenue to total revenues:

        

Services revenues

     76.6     67.8    

Hardware sales

     23.4     32.2    

Services Revenues

The increase in services revenues was attributable to our North America Broadband segment. Revenues from our Consumer group increased by $17.3 million to $111.5 million for the three months ended June 30, 2010 compared to $94.2 million for the same period in 2009 resulting primarily from the increase in our consumer subscriber base. The increase in the Consumer group was partly due to a larger percentage of our customers utilizing the consumer rental program, for which we recognized $9.0 million and $3.3 million of services revenues for the three months ended June 30, 2010 and 2009, respectively.

Services revenue from our North America Enterprise group increased by $6.9 million to $47.2 million for the three months ended June 30, 2010 compared to $40.3 million for the same period in 2009. The increase reflected the growth in our managed services business, new contracts awarded in prior periods that provided incremental services revenue in the first quarter of 2010 and the growth in our small/medium and wholesale subscriber base.

Services revenue from our International Broadband segment increased by $1.6 million to $32.1 million for the three months ended June 30, 2010 from $30.5 million for the same period in 2009, primarily due to an increase of $1.8 million resulting from the favorable impact of currency exchange due to the depreciation of the U.S. dollar.

The increase in services revenue was partially offset by a decrease in revenue of $6.3 million from our Telecom Systems segment to $1.4 million for the three months ended June 30, 2010 compared to $7.7 million for the same period in 2009, mainly as a result of a significant reduction in revenues from the Telematics group.

Hardware Sales

Hardware sales from our North America Broadband segment decreased by $21.5 million to $19.3 million for the three months ended June 30, 2010 compared to $40.8 million for the same period in 2009.

Despite the growth in the subscriber base, hardware sales in the Consumer group decreased by $4.0 million to $6.0 million for the three months ended June 30, 2010 compared to $10.0 million for the same period in 2009. The decrease was due to an increase in (i) the utilization of the consumer rebate program which reduced hardware revenues and (ii) customers utilizing the consumer rental program, which revenues are accounted for as services revenues, instead of the previously offered deferred purchase plan, which revenues were accounted for as hardware sales.

Hardware revenue from our North America Enterprise group also decreased by $17.5 million to $13.3 million for the three months ended June 30, 2010 compared to $30.8 million for the same period in 2009. The decrease was

 

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due to a lower volume of shipments as customers delayed their buying decisions as well as the changes in the product mix where the emphasis on managed services has led to lower upfront hardware revenue and an increase in recurring service revenue.

In addition, hardware sales from our International Broadband segment decreased by $4.2 million to $15.8 million for the three months ended June 30, 2010 compared to $20.0 million for the same period in 2009. The decrease was primarily due to a decrease in shipment volume to our enterprise customers as delays in customer buying decisions impacted new hardware orders.

Hardware sales from our Telecom Systems segment increased by $2.5 million to $24.1 million for the three months ended June 30, 2010 compared to $21.6 million for the same period in 2009, primarily due to the increase in hardware revenue from the Terrestrial Microwave group.

Cost of Revenues

 

     Three Months Ended
June 30,
    Variance  

(Dollars in thousands)

           2010                     2009                 Amount                 %          

Cost of services

   $ 123,396      $ 111,059      $ 12,337      11.1

Cost of hardware products sold

     55,582        77,283        (21,701   (28.1 )% 
                          

Total cost of revenues

   $ 178,978      $ 188,342      $ (9,364   (5.0 )% 
                          

Cost of Services

Cost of services increased in conjunction with the increase in services revenue, mainly due to the growth in our consumer subscriber base and our managed services businesses in the North America Broadband segment. Support costs for the growth included customer service, wireline and wireless costs, field services, network operations and depreciation expense, which increased by $11.6 million for the three months ended June 30, 2010 compared to the same period in 2009. The increases were partially offset by lower transponder capacity lease expense. We expect transponder capacity lease expense for the Consumer group to continue to decrease as more customers are placed on the SPACEWAY network.

In addition, cost of services from our International Broadband segment increased by $3.3 million, primarily due to an increase in the number of enterprise and global service sites in service across Brazil and the Africa/Middle East region. The increase in cost of services was partially offset by a decrease of $5.2 million from the Telecom Systems segment to $1.0 million for the three months ended June 30, 2010 compared to $6.2 million for the same period in 2009, mainly related to the Telematics group.

Cost of Hardware Products Sold

Cost of hardware products sold decreased in conjunction with the reduction in hardware sales. The decrease was mainly attributable to a decrease in cost of hardware products sold from our North America Broadband segment of $17.5 million to $29.0 million for the three months ended June 30, 2010 compared to $46.5 million for the same period in 2009.

Despite the growth in the consumer subscriber base, the cost of hardware products sold in the Consumer group decreased by $6.7 million to $12.3 million for the three months ended June 30, 2010 compared to $19.0 million for the same period in 2009. The decrease was due to (i) an increase in the number of customers utilizing the consumer rental program, for which hardware cost is accounted for as a component of services cost, instead of the previously offered deferred purchase plan, which cost was accounted for as hardware cost, and (ii) a decrease in hardware unit cost as a result of improved manufacturing efficiency.

In addition, cost of hardware products sold from our International Broadband segment decreased by $4.6 million to $9.3 million for the three months ended June 30, 2010 compared to $13.9 million for the same period in 2009, primarily due to a decrease in hardware sales.

 

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Cost of hardware products sold from our Telecom Systems segment remained flat at $17.3 million for the three months ended June 30, 2010 compared to $16.9 million for the same period in 2009.

Selling, General and Administrative Expense

 

     Three Months Ended
June 30,
    Variance

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

    %    

Selling, general and administrative expense

   $ 49,306      $ 46,144      $ 3,162      6.9%

% of revenue

     19.5%        18.0%       

SG&A expense increased mainly due to higher marketing costs of $2.7 million, primarily in our North America operations, as we increased targeted spending for our consumer business. From time to time, we modify our marketing strategy to attract new customers, which may impact our SG&A expense.

Loss on Impairments

 

     Three Months Ended
June 30,
    Variance

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

    %    

Loss on impairments

   $ -      $ 45,400      $ (45,400   (100.0)%

% of revenue

     0.0%        17.7%       

There was no impairment loss recognized in 2010. In 2009, we recognized $45.4 million of impairment losses, primarily related to the Deposit paid to Sea Launch.

Research and Development

 

     Three Months Ended
June 30,
    Variance

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

    %    

Research and development

   $ 5,355      $ 5,698      $ (343   (6.0)%

% of revenue

     2.1%        2.2%       

R&D decreased due to a reduction in development activities of $1.8 million from our North America Broadband segment. This decrease was partially offset by the increase in R&D activities of $0.9 million and $0.3 million related to the construction of Jupiter and our Mobile Satellite Systems group, respectively.

Amortization of Intangible Assets

 

     Three Months Ended
June 30,
   Variance

(Dollars in thousands)

  

        2010        

  

        2009        

  

    Amount    

   

    %    

Amortization of intangible assets

   $ 771    $ 1,504    $ (733   (48.7)%

% of revenue

     0.3%      0.6%     

Amortization of intangible assets decreased primarily due to the impact of fully depreciated intangible assets in 2009.

 

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Operating Income (loss)

 

     Three Months Ended
June 30,
    Variance

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

        %        

Operating income (loss)

   $ 17,958      $ (31,261   $ 49,219      157.4%

% of revenue

     7.1%        (12.2)%       

For the three months ended June 30, 2010, we generated $18.0 million of operating income compared to an operating loss of $31.3 million for the same period in 2009. The change in operating income (loss) was significantly impacted by the recognition of $45.4 million in impairment losses, which was primarily related to the Deposit paid to Sea Launch, in 2009. In addition, our gross margin was higher by $5.9 million for the three months ended June 30, 2010 compared to the same period in 2009. The increase in our operating income for the three months ended June 30, 2010 was partially offset by higher SG&A expenses as we increased our efforts in promoting our products and services.

Interest Expense

 

     Three Months Ended
June 30,
    Variance

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

        %        

Interest expense

   $ 15,520      $ 15,554      $ (34   (0.2)%

Interest expense primarily relates to interest on the $450 million of 9.50% senior notes maturing on April 15, 2014 (the “2006 Senior Notes”), $150.0 million of 9.50% senior notes maturing on April 15, 2014 (the “2009 Senior Notes”) and the $115 million term loan maturing on April 15, 2014 (the “Term Loan Facility”) less capitalized interest associated with the construction of our satellite. Interest expense for the three months ended June 30, 2010 remained flat compared to the same period in 2009. For the three months ended June 30, 2010, interest expense related to the 2009 Senior Notes was higher by $2.4 million compared to the same period in 2009, mainly due to the recognition of a full quarter of interest expense in 2010 versus a partial quarter of interest expense in 2009 as the 2009 Senior Notes were issued in May 2009. The increase in interest expense was offset by $2.7 million of capitalized interest associated with the construction of Jupiter for the three months ended June 30, 2010. There was no capitalized interest for the three months ended June 30, 2009.

Interest and Other Income (Loss), Net

 

     Three Months Ended
June 30,
    Variance  

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

        %        

 

Interest income

   $         656      $     207      $         449      216.9

Other loss, net

     -        (345)        345      100.0
                          

Total interest and other income (loss), net

   $ 656      $ (138   $ 794      575.4
                          

The increase in interest and other income (loss), net was primarily due to interest earned on certain notes and extinguishment of certain lease financings.

 

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Income Tax Expense

 

     Three Months Ended
June 30,
    Variance

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

        %        

Income tax expense

   $ 1,565      $ 479      $ 1,086      226.7%

Changes in income tax expense are generally attributable to state income taxes and income earned from certain of our foreign subsidiaries. Our income tax expense for the three months ended June 30, 2009 was partially offset by the income tax benefit of $0.9 million generated by our Indian subsidiary as a result of its engagement in telecommunications infrastructure development. Indian tax law provides for a deduction of 100% of profits and gains derived from qualifying infrastructure businesses for ten consecutive assessment years. This benefit is available to us through the tax assessment year of 2015/2016.

Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009

Revenues

 

     Six Months Ended
June 30,
    Variance

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

        %        

Services revenues

   $ 381,130      $ 335,748      $ 45,382      13.5%

Hardware sales

     114,431        160,294        (45,863   (28.6)%
                          

Total revenues

   $ 495,561      $ 496,042      $ (481   (0.1)%
                          

% of revenue to total revenues:

        

Services revenues

     76.9%        67.7%       

Hardware sales

     23.1%        32.3%       

Services Revenues

The increase in services revenues was attributable to our North America Broadband segment. Revenues from our Consumer group increased by $36.1 million to $217.5 million for the six months ended June 30, 2010 compared to $181.4 million for the same period in 2009 resulting primarily from the increase in our consumer subscriber base. The increase in the Consumer group was partly due to a larger percentage of our customers utilizing the consumer rental program, for which we recognized $16.1 million and $5.1 million of services revenues for the six months ended June 30, 2010 and 2009, respectively.

In addition, revenue from our North America Enterprise group increased by $13.3 million to $94.8 million for the six months ended June 30, 2010 compared to $81.5 million for the same period in 2009. The increase reflected the growth in our managed services business, new contracts awarded in prior periods that provided incremental service revenue in the first quarter of 2010 and the growth in our small/medium and wholesale subscriber base.

Furthermore, services revenue from our International Broadband segment increased by $7.4 million to $64.0 million for the six months ended June 30, 2010 from $56.6 million for the same period in 2009, primarily due to the continued growth of our expanding array of solutions and global services to enterprises and government organizations in Brazil and the Africa/Middle East region. Also, contributing to the increase was $5.5 million as a result of the favorable impact of currency exchange due to the depreciation of the U.S. dollar.

Partially offsetting the increase was a decrease in revenue from our Telecom Systems segment of $12.4 million to $2.7 million for the six months ended June 30, 2010 compared to $15.1 million for the same period in 2009, mainly as a result of a significant reduction in revenues from the Telematics group.

 

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Hardware Sales

Hardware sales from our North America Broadband segment decreased by $38.3 million to $39.7 million for the six months ended June 30, 2010 compared to $78.0 million for the same period in 2009.

Despite the growth in the subscriber base, hardware sales in the Consumer group decreased by $8.1 million to $13.4 million for the six months ended June 30, 2010 compared to $21.5 million for the same period in 2009. The decrease was due to an increase in (i) the utilization of the consumer rebate program which reduced hardware revenues and (ii) customers utilizing the consumer rental program, which revenues are accounted for as services revenues, instead of the previously offered deferred purchase plan, which revenues were accounted for as hardware sales.

Hardware revenue from our North America Enterprise group also decreased by $30.2 million to $26.3 million for the six months ended June 30, 2010 compared to $56.5 million for the same period in 2009. The decrease was due to a lower volume of shipments as customers delayed their buying decisions as well as the changes in the product mix where the emphasis on managed services has led to lower upfront hardware revenue and an increase in recurring service revenue.

In addition, hardware sales from our International Broadband segment decreased by $11.5 million to $27.3 million for the six months ended June 30, 2010 compared to $38.8 million for the same period in 2009. The decrease was primarily due to the completion of the rollout of terminal shipments on a multi-year contract for a large lottery operator in the United Kingdom and a decrease in shipment volume to our enterprise customers as delays in customer buying decisions impacting new hardware orders. These decreases were slightly offset by a $0.6 million favorable impact of currency exchange due to the depreciation of the U.S. dollar.

Hardware sales from our Telecom Systems segment increased by $3.9 million to $47.4 million for the six months ended June 30, 2010 compared to $43.5 million for the same period in 2009, mainly due to the increase in hardware revenue from the Terrestrial Microwave group.

Cost of Revenues

 

     Six Months  Ended
June 30,
    Variance  

(Dollars in thousands)

           2010                     2009                 Amount                 %          

Cost of services

   $ 239,109      $ 217,729      $ 21,380      9.8

Cost of hardware products sold

     116,468        151,488        (35,020   (23.1 )% 
                          

Total cost of revenues

   $ 355,577      $ 369,217      $ (13,640   (3.7 )% 
                          

Cost of Services

Cost of services increased in conjunction with the increase in services revenues, mainly due to the growth in our consumer subscriber base and our managed services businesses in the North America Broadband segment. Support costs for the growth included customer service, wireline and wireless costs, field services, network operations and depreciation expense, which increased by $23.5 million for the six months ended June 30, 2010 compared to the same period in 2009. The increases were partially offset by lower transponder capacity lease expense. We expect transponder capacity lease expense for the Consumer group to continue to decrease as more customers are placed on the SPACEWAY network.

In addition, cost of services from our International Broadband segment increased by $8.1 million, primarily due to an increase in the number of enterprise and global service sites in service across Brazil and the Africa/Middle East region. The increase was partially offset by a decrease of $9.4 million in cost of services from the Telecom Systems segment to $2.0 million for the six months ended June 30, 2010 compared to $11.4 million for the same period in 2009, mainly related to the Telematics group.

 

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Cost of Hardware Products Sold

Cost of hardware products sold decreased in conjunction with the reduction in hardware sales. The decrease was mainly attributable to a decrease in cost of hardware products sold from our North America Broadband segment of $28.0 million to $64.1 million for the six months ended June 30, 2010 compared to $92.1 million for the same period in 2009.

Despite the growth in the consumer subscriber base, the cost of hardware products sold in the Consumer group decreased by $9.6 million to $29.5 million for the six months ended June 30, 2010 compared to $39.1 million for the same period in 2009. The decrease was due to (i) an increase in the number of customers utilizing the consumer rental program, for which hardware cost is accounted for as a component of services cost, instead of the previously offered deferred purchase plan, which cost was accounted for as hardware cost and (ii) a decrease in hardware unit cost as a result of improved manufacturing efficiency.

In addition, cost of hardware products sold from our International Broadband segment decreased by $9.2 million to $17.5 million for the six months ended June 30, 2010 compared to $26.7 million for the same period in 2009, primarily due to a decrease in hardware sales.

The decrease in cost of hardware products sold was partially offset by the increase of $2.2 million in costs from our Telecom Systems segment resulting from the corresponding increase in hardware cost from the Terrestrial Microwave group.

Selling, General and Administrative Expense

 

     Six Months Ended
June 30,
    Variance  

(Dollars in thousands)

           2010                     2009                 Amount                 %          

Selling, general and administrative expense

   $ 99,631      $ 90,385      $ 9,246        10.2

% of revenue

     20.1     18.2    

SG&A expense increased mainly due to higher: (i) marketing costs of $6.5 million, primarily in our North America operations as we increased targeted spending for our consumer business and (ii) administrative costs of $2.8 million, primarily related to our North American operations and international subsidiaries for the six months ended June 30, 2010 compared to the same period in 2009. From time to time, we modify our marketing strategy to attract new customers, which may impact our SG&A expense.

Loss on Impairments

 

     Six Months Ended
June 30,
    Variance  

(Dollars in thousands)

           2010                     2009                 Amount                 %          

Loss on impairments

   $ -      $ 45,400      $ (45,400 )      (100.0 )% 

% of revenue

     0.0     9.2    

There was no impairment loss recognized in 2010. In 2009, we recognized $45.4 million of impairment losses, primarily related to the Deposit paid to Sea Launch.

 

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Research and Development

 

     Six Months Ended
June 30,
    Variance  

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

        %        

 

Research and development

   $ 10,270      $ 11,049      $ (779   (7.1 )% 

% of revenue

     2.1     2.2    

R&D decreased due to a reduction in development activities of $3.4 million from our North America Broadband segment. This decrease was partially offset by the increase in R&D activities of $1.7 million and $0.6 million related to the construction of Jupiter and our Mobile Satellite Systems group, respectively.

Amortization of Intangible Assets

 

     Six Months Ended
June 30,
    Variance  

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

   

        %        

 

Amortization of intangible assets

   $ 1,561      $ 2,889      $ (1,328   (46.0 )% 

% of revenue

     0.3     0.6    

Amortization of intangible assets decreased primarily due to the impact of fully depreciated intangible assets in 2009.

Operating Income (loss)

 

     Six Months Ended
June  30,
    Variance  

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

  

        %        

 

Operating income (loss)

   $ 28,522      $ (22,898   $ 51,420    224.6

% of revenue

     5.8     (4.6 )%      

For the six months ended June 30, 2010, we generated $28.5 million of operating income compared to an operating loss of $22.9 million for the same period in 2009. The change in operating income (loss) was significantly impacted by the recognition of $45.4 million in impairment losses, which was primarily related to the Deposit paid to Sea Launch, in 2009. In addition, our gross margin was higher by $13.2 million for the six months ended June 30, 2010 compared to the same period in 2009. The increase in our operating income for the six months ended June 30, 2010 was partially offset by higher SG&A expenses as we increased our efforts in promoting our products and services.

Interest Expense

 

     Six Months Ended
June 30,
    Variance  

(Dollars in thousands)

  

        2010        

   

        2009        

   

    Amount    

  

        %        

 

Interest expense

   $ 31,630         $ 29,390         $ 2,240    7.6

Interest expense primarily relates to interest on the 2006 Senior Notes, the 2009 Senior Notes and the Term Loan Facility less capitalized interest associated with the construction of our satellite. The increase in interest expense was primarily due to higher interest expense recognized on the 2009 Senior Notes for the six months in 2010 compared to two months in 2009 as the 2009 Senior Notes were issued in May 2009. The increase was partially offset by $4.7 million of capitalized interest associated with the construction of Jupiter for the six months ended June 30, 2010. There was no capitalized interest for the six months ended June 30, 2009.

 

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Interest and Other Income (Loss), Net

 

     Six Months Ended
June  30,
    Variance  

(Dollars in thousands)

           2010                     2009                 Amount                  %          

Interest income

   $ 1,247      $ 527      $ 720      136.6

Other loss, net

     -        (345     345      100.0
                          

Total interest and other income (loss), net

   $ 1,247      $ 182      $ 1,065      585.2
                          

The increase in interest and other income (loss), net was primarily due to interest earned on certain notes and the extinguishment of certain lease financings.

Income Tax (Expense) Benefit

 

     Six Months Ended
June  30,
   Variance  

(Dollars in thousands)

           2010                     2009                Amount                  %          

Income tax (expense) benefit

   $ (2,784   $ 176    $ (2,960   (1,681.8 )% 

Changes in income tax (expense) benefit are generally attributable to state income taxes and income earned from certain of our foreign subsidiaries. Our income tax (expense) benefit was partially offset by $0.2 million for the six months ended June 30, 2010 compared to an offset of $2.1 million for the same period in 2009 of income tax benefit generated by our Indian subsidiary as a result of it being engaged in telecommunications infrastructure development. Indian tax law provides for a deduction of 100% of profits and gains derived from qualifying infrastructure businesses for ten consecutive assessment years. This benefit is available to us through the tax assessment year of 2015/2016.

Liquidity and Capital Resources

 

     Six Months Ended
June  30,
    Variance  

(Dollars in thousands)

           2010                     2009                 Amount                  %          

Net cash provided by (used in):

        

Operating activities

   $ 42,831      $ 36,939      $ 5,892      16.0

Investing activities

   $ (140,401   $ (60,105   $ 80,296      133.6

Financing activities

   $ (3,558   $ 131,024      $ (134,582   (102.7 )% 

Net Cash Flows from Operating Activities

The increase in net cash provided by operating activities for the six months ended June 30, 2010 was primarily due to the increase in our net income of $62.9 million, prior to noncash depreciation and amortization expense compared to the same period in 2009. The increase was partially offset by $45.4 million impairment losses recognized in 2009 and by $12.1 million of changes in our operating assets and liabilities. The decrease related to our operating assets and liabilities was primarily due to our efforts in managing our cash collection on receivables balance, as evidenced by the improvement in the “days sales outstanding” metric to 56 days as of June 30, 2010 from 65 days as of June 30 2009, and timing for settlement of obligation to vendors.

Net Cash Flows from Investing Activities

The increase in net cash used in investing activities was mainly due to an increase in capital expenditures of $66.5 million, primarily related to the construction of our Jupiter satellite and a net increase in marketable securities of $13.3 million.

 

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Capital expenditures for the six months ended June 30, 2010 and 2009 are shown as follows (in thousands):

 

     Six Months Ended
June 30,
      
         2010            2009          Variance    

Capital expenditures:

        

Jupiter program

   $ 65,597    $ -    $ 65,597   

Capital expenditures—VSAT

     48,440      47,852      588   

Capital expenditures—other

     5,931      4,112      1,819   

Capitalized software

     6,170      7,762      (1,592

SPACEWAY program

     1,411      1,260      151   

VSAT operating lease hardware

     10      77      (67
                      

Total capital expenditures

   $ 127,559    $ 61,063    $ 66,496   
                      

Net Cash Flows from Financing Activities

For the six months ended June 30, 2010, the net cash used in our financing activities mainly related to the repayment of our long-term and short-term debt and debt issuance costs associated with the refinancing of our revolving credit facility. For the six months ended June 30, 2009, our net cash provided by financing activities was mainly related to the private debt offering of the 2009 Senior Notes in May 2009.

Future Liquidity Requirements

As of June 30, 2010, our Cash and cash equivalents and Marketable securities were $222.4 million and our total debt was $719.8 million. We are leveraged as a result of our indebtedness.

On March 16, 2010, HNS entered into a credit agreement with JP Morgan Chase Bank, N.A. and Barclays Capital to amend and restate its senior secured $50 million revolving credit facility (the “Revolving Credit Facility”). Pursuant to the terms of the agreement, among other changes, the maturity date of the Revolving Credit Facility was extended to March 16, 2014, subject to an early maturity date of 91 days prior to March 16, 2014 in the event HNS’ 2009 and 2006 Senior Notes and HNS’ Term Loan Facility (as defined below) are not (i) repaid in full or (ii) refinanced with new debt (or amended) with maturities of no earlier than 91 days after March 16, 2014. The terms of the Revolving Credit Facility were amended to be: (i) in respect of the interest rate, at our option, the Alternative Borrowing Rate (as defined in the Revolving Credit Facility) plus 2.00% or the Adjusted London Interbank Offered Rate (“LIBOR”) (as defined in the Revolving Credit Facility) plus 3.00% and (ii) in respect of the participation fee for outstanding letters of credit, 3.00% per annum, in each case subject to downward adjustment based on our leverage ratio. As of June 30, 2010, the total outstanding letters of credit and the available borrowing capacity under the Revolving Credit Facility was $5.3 million and $44.7 million, respectively. As of June 30, 2010, the Revolving Credit Facility was rated Baa3 and BB- by Moody’s and Standard & Poor’s (“S&P”), respectively.

In May 2009, HNS, along with its subsidiary, HNS Finance Corp., as co-issuer, completed a private debt offering of $150.0 million of 9.50% senior notes maturing on April 15, 2014 (the “2009 Senior Notes”). The 2009 Senior Notes are guaranteed on a senior unsecured basis by each of HNS’ current and future domestic subsidiaries that guarantee any of HNS’ indebtedness or indebtedness of HNS’ other subsidiary guarantors. Interest on the 2009 Senior Notes is accrued from April 15, 2009 and is paid semi-annually in arrears on April 15 and October 15 of each year, beginning on October 15, 2009. HNS received net proceeds of approximately $133.6 million from the offering. HNS has used and intends to continue to use these net proceeds for general corporate purposes, which could include working capital needs, corporate development opportunities (which may include acquisitions), capital expenditures and opportunistic satellite fleet expansion. As of June 30, 2010, the 2009 Senior Notes were rated B1 and B by Moody’s and S&P, respectively. As of June 30, 2010, HNS had recorded $3.0 million of accrued interest payable related to the 2009 Senior Notes.

In February 2007, HNS borrowed $115 million from a syndicate of banks pursuant to a senior unsecured

 

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credit agreement (the “Term Loan Facility”), which matures on April 15, 2014. The Term Loan Facility is guaranteed, on a senior unsecured basis, by all of HNS’ existing and future subsidiaries that guarantee its existing 2006 Senior Notes and the Revolving Credit Facility. The interest on the Term Loan Facility is paid quarterly at Adjusted LIBOR (as defined in the Term Loan Facility) plus 2.50%. To mitigate the variable interest rate risk associated with the Term Loan Facility, HNS entered into an agreement to swap the Adjusted LIBOR for a fixed rate of 5.12% per annum (the “Swap Agreement”). As a result, the Term Loan Facility has a fixed interest rate of 7.62% per annum and is subject to certain mandatory and optional prepayment provisions and contains negative covenants and events of default, in each case, substantially similar to those provisions contained in the indentures governing the Senior Notes. The remaining net interest payments on the Term Loan Facility are estimated to be approximately $4.4 million for the six months ending December 31, 2010, $8.8 million for each of the years ending December 31, 2011 through 2013 and $3.3 million for the year ending December 31, 2014. As of June 30, 2010, the Term Loan was rated B1 and B by Moody’s and S&P, respectively.

In April 2006, HNS issued $450 million of 9.50% senior notes maturing on April 15, 2014 (the “2006 Senior Notes”), which are guaranteed on a senior unsecured basis by HNS and each of its current and future domestic subsidiaries that guarantee any of HNS’ indebtedness or indebtedness of HNS’ other subsidiary guarantors. Interest on the 2006 Senior Notes is paid semi-annually in arrears on April 15 and October 15. As of June 30, 2010, we had recorded $8.9 million of accrued interest payable related to the 2006 Senior Notes. As of June 30, 2010, the 2006 Senior Notes were rated B1 and B by Moody’s and S&P, respectively.

Although the terms and covenants with respect to the 2009 Senior Notes are substantially identical to the 2006 Senior Notes, the 2009 Senior Notes were issued under a separate indenture and do not vote together with the 2006 Senior Notes. Each of the indentures governing the 2006 Senior Notes and 2009 Senior Notes (collectively, the “Senior Notes”), the agreement governing the amended Revolving Credit Facility and the agreement governing the Term Loan Facility require HNS to comply with certain affirmative and negative covenants: (i) in the case of the indentures, for so long as any Senior Notes are outstanding; (ii) in the case of the amended Revolving Credit Facility, for so long as the amended Revolving Credit Facility is in effect; and (iii) in the case of the Term Loan Facility, for so long as the Term Loan Facility remains outstanding. Negative covenants contained in these agreements include limitations on the ability of HNS and/or certain of its subsidiaries to incur additional indebtedness; issue redeemable stock and subsidiary preferred stock; incur liens; pay dividends or distributions or redeem or repurchase capital stock; prepay, redeem or repurchase debt; make loans and investments; enter into agreements that restrict distributions from HNS’ subsidiaries; sell assets and capital stock of our subsidiaries; enter into certain transactions with affiliates; consolidate or merge with or into, or sell substantially all of our assets to, another person; and enter into new lines of business. In addition to these negative covenants, the amended Revolving Credit Facility, the indentures governing the Senior Notes and/or the agreement governing the Term Loan Facility contain affirmative covenants that require us to: (i) preserve our businesses and properties; (ii) maintain insurance over our assets; (iii) pay and discharge all material taxes when due; and (iv) furnish the lenders’ administrative agent our financial statements for each fiscal quarter and fiscal year, certificates from a financial officer certifying that no Event of Default or Default has occurred during the fiscal period being reported, litigation and other notices, compliance with laws, maintenance of records and other such customary covenants. HNS and its subsidiaries comprise a substantial portion of our net assets and results of operations since January 1, 2006. Because of the negative covenants above, there are certain restrictions on the sale of HNS’ net assets. As of June 30, 2010 and December 31, 2009, HNS’ consolidated net assets were $192.6 million and $200.0 million, respectively. Management believes that the Company was in compliance with all of its debt covenants as of June 30, 2010.

Our subsidiaries primarily meet their working capital requirements through their respective operations or the utilization of local credit facilities. Occasionally, the subsidiaries utilize temporary advances to/from HNS to meet temporary cash requirements. Certain of our foreign subsidiaries maintain various revolving lines of credit and term loans funded by their respective local banks in local currency. As of June 30, 2010, the aggregate balance outstanding under these loans was $3.2 million. Our subsidiaries may be restricted from paying dividends to HNS under the terms of these loans.

HNS and its subsidiaries are separate and distinct legal entities and, except for HNS’ existing and future subsidiaries that are or will be guarantors of the Senior Notes, the Term Loan Facility and the Revolving Credit Facility, they will have no obligation, contingent or otherwise, to pay amounts due under the Senior Notes, Term Loan Facility and the Revolving Credit Facility, or to make any funds available to pay those amounts, whether by dividend, distribution, loan or other payment.

 

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In August 2007, we filed a shelf registration statement on Form S-3, as amended on November 15, 2007, to register shares of our common stock, preferred stock, and warrants and debt securities and non-convertible debt securities of HNS and HNS Finance Corp., as co issuers. In the event HNS issues debt securities pursuant to the shelf registration statement, we will, and one or more of our other subsidiaries may, on a joint and several basis, offer full and unconditional guarantees of HNS’ and HNS Finance Corp.’s obligations under the debt securities.

In July 2006, we entered into an agreement with 95 West Co., Inc. (“95 West Co.”) and its parent, Miraxis License Holdings, LLC (“MLH”), pursuant to which 95 West Co. and MLH agreed to provide a series of coordination agreements allowing the Company to operate SPACEWAY 3 at the 95° West Longitude orbital slot where 95 West Co. and MLH have higher priority rights. Our remaining obligations with 95 West Co. as of June 30, 2010 are subject to conditions in the agreement including our ability to operate SPACEWAY 3 and are $1.0 million for each of the years ending December 31, 2011 through 2016.

In June 2009, HNS entered into an agreement with SS/L for the construction of Jupiter and have agreed to make installment payments to SS/L upon the completion of each milestone as set forth in the agreement. In connection with the construction of Jupiter, HNS entered into a contract with Barrett, whereby Barrett agreed to lease user beams and purchase gateways and terminals for the Jupiter satellite that are designed to operate in Canada. In April 2010, HNS entered into an agreement with Arianespace for the launch of Jupiter in the first half of 2012. Pursuant to the agreement, the Ariane 5 heavy launcher will launch Jupiter into geosynchronous transfer orbit from Guiana Space Centre in Kourou, French Guiana. As of June 30, 2010, our obligation for the construction and launch of Jupiter was approximately $274.8 million.

Based on our current and anticipated levels of operations and conditions in our markets and industry, we expect to meet our short-term cash requirements through the use of cash on hand and cash from operations that we expect to generate. We expect to meet our long-term cash requirements through a combination of (i) cash on hand and cash from operations that we expects to generate and (ii) a possible refinancing of HNS’ senior notes and/or term loan that mature in 2014. We believe that our current resources are sufficient to meet our short-term cash requirements. We do not currently anticipate accessing the $50 million Revolving Credit Facility. However, our ability to fund these needs and to comply with the financial covenants under our debt agreements depends on our future operating performance and cash flow, which is subject to prevailing economic conditions, the level of spending by our customers and other factors, many of which are beyond our control. Any future acquisitions, joint ventures, acquisition of a satellite, or other similar transactions will likely require additional capital and there can be no assurance that any such capital will be available to us on acceptable terms, if at all.

Contractual Obligations

There have been no material changes to our contractual obligations since December 31, 2009, as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009, except for items listed below:

 

   

On March 16, 2010, HNS entered into an amended and restated credit agreement with JP Morgan Chase Bank, N.A. and Barclays Capital to amend and restate our senior secured $50 million revolving credit facility (the “Revolving Credit Facility”). See the Future Liquidity Requirements section for a discussion of the Revolving Credit Facility.

 

   

In April 2010, HNS entered into an agreement with Arianespace for the launch of Jupiter in the first half of 2012. Pursuant to the agreement, the Ariane 5 heavy launcher will launch Jupiter into geosynchronous transfer orbit from Guiana Space Centre in Kourou, French Guiana.

Commitments and Contingencies

For a discussion of commitments and contingencies, see Note 18—Commitments and Contingencies to our unaudited condensed consolidated financial statements included in Part I-Item 1 of this report.

 

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Off-Balance Sheet Arrangements

We are required to issue standby letters of credit and bonds primarily to support certain sales of our equipment to international government customers. These letters of credit are either bid bonds to support contract bids or to support advance payments made by customers upon contract execution and prior to equipment being shipped, or guarantees of performance issued in support of its warranty obligations. Bid bonds typically expire upon the issue of the award by the customer. Advance payment bonds expire upon receipt by the customer of equipment, and performance bonds typically expire when the warranty expires, generally one year after the installation of the equipment.

As of June 30, 2010, we had $24.1 million of contractual obligations to customers and other statutory/governmental agencies, which were secured by letters of credit issued through us and our subsidiaries’ credit facilities. Of this amount, $5.3 million was issued under the Revolving Credit Facility; $1.7 million was secured by restricted cash; $1.0 million related to insurance bonds; and $16.1 million was issued under credit arrangements available to our Indian and Brazilian subsidiaries. Certain letters of credit issued by our Indian subsidiaries are secured by their assets.

Seasonality

Like many communications infrastructure equipment vendors, a significant amount of our hardware sales occur in the second half of the year due to our customers’ annual procurement and budget cycles. Large enterprises and operators usually allocate their capital expenditure budgets at the beginning of their fiscal year (which often coincides with the calendar year). The typical sales cycle for large complex system procurements is 6 to 12 months, which often results in the customer expenditure occurring towards the end of the year. Customers often seek to expend the budgeted funds prior to the end of the year and the next budget cycle. As a result, interim results are not indicative of the results to be expected for the full year.

Inflation

Historically, inflation has not had a material effect on our results of operations.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. We evaluate these estimates and assumptions on an ongoing basis. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions and conditions. For a description of our critical accounting policies, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as included in our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission on March 3, 2010 (File number 001-33040).

New Accounting Pronouncements

For a discussion of new accounting pronouncements, see Note 1—Organization, Basis of Presentation and Summary of Significant Accounting Policies to the Company’s unaudited condensed consolidated financial statements included in Part I-Item 1 of this report.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The following discussion and the estimated amounts generated from the sensitivity analyses referred to below include forward-looking statements of market risk which assume for analytical purposes that certain adverse market

 

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conditions may occur. Actual future market conditions may differ materially from such assumptions because the amounts shown below are the result of analyses used for the purpose of assessing possible risks and the mitigation thereof. Accordingly, you should not consider the forward-looking statements as projections by us of future events or losses.

General

Our cash flows and earnings are subject to fluctuations resulting from changes in foreign currency exchange rates, interest rates and changes in the market value of our equity investments. We manage our exposure to those market risks through internally established policies and procedures and, when deemed appropriate, through the use of derivative financial instruments. We enter into derivative instruments only to the extent considered necessary to meet our risk management objectives and do not enter into derivative contracts for speculative purposes.

Foreign Currency Risk

We generally conduct our business in United States dollars. However, as our international business is conducted in a variety of foreign currencies, it is exposed to fluctuations in foreign currency exchange rates. Our objective in managing our exposure to foreign currency changes is to reduce earnings and cash flow volatility associated with foreign exchange rate fluctuations. Accordingly, we may enter into foreign exchange contracts to mitigate risks associated with foreign currency denominated assets, liabilities, commitments and anticipated foreign currency transactions. As of June 30, 2010, we had an estimated $13.6 million of foreign currency denominated receivables and payables outstanding, and $5.3 million of hedge contracts in place to partially mitigate foreign currency risk. The differences between the face amount of the foreign exchange contracts and their estimated fair values were not material as of June 30, 2010.

The impact of a hypothetical 10% adverse change in exchange rates on the fair value of foreign currency denominated net assets and liabilities of our foreign subsidiaries would be an estimated loss of $7.2 million as of June 30, 2010.

Marketable Securities Risk

We have a significant amount of cash that is invested in marketable securities which is subject to market risk due to interest rate fluctuations. We have established an investment policy which governs our investment strategy and stipulates that we diversify investments among United States Treasury securities and other high credit quality debt instruments that we believe to be low risk. We are averse to principal loss and seek to preserve our invested funds by limiting default risk and market risk.

Interest Rate Risk

HNS’ Senior Notes and outstanding borrowings related to very small aperture terminal hardware financing arrangements are not subject to interest rate fluctuations because the interest rate is fixed for the term of the instrument. We are subject to variable interest rates on certain other debt including the Revolving Credit Facility and the Term Loan Facility. To the extent we draw against the credit facility, increases in interest rates would have an adverse impact on our results of operations.

To mitigate the variable interest rate risk associated with the Term Loan Facility, we entered into the Swap Agreement to swap the variable LIBOR based interest on the Term Loan Facility for a fixed interest rate of 5.12% per annum. The remaining net interest payments based on the Swap Agreement and the Term Loan Facility are paid quarterly and estimated to be approximately $4.4 million for the six months ending December 31, 2010, $8.8 million for each of the years ending December 31, 2011 through 2013 and $3.3 million for the year ending December 31, 2014. The security for our interest obligation under the Swap Agreement is the same as the security for the Revolving Credit Facility described in Note 9—Debt to our unaudited condensed consolidated financial statements included in Part I-Item 1 in this report.

 

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Market Concentration and Credit Risk

We provide services and extend credit to a number of equipment customers, service providers, and a large number of consumers, both in the United States and around the world. We monitor our exposure to credit losses and maintain, as necessary, allowances for anticipated losses. Financial instruments which potentially subject us to a concentration of credit risk consist of cash, cash equivalents and marketable investments. Although we maintain cash balances at financial institutions that exceed federally insured limits, these balances are placed with high credit quality financial institutions.

Commodity Price Risk

All of our products contain components whose base raw materials have undergone dramatic cost fluctuations in the last 24 months. Fluctuations in pricing of raw materials have the ability to affect our product costs. Although we have been successful in offsetting or mitigating our exposure to these fluctuations, such changes could have an adverse impact on our product costs. We are unable to predict the possible impact of changes in commodity prices.

 

Item 4. Controls and Procedures

Disclosure Controls and Procedures

As required by Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934, the Company has evaluated, with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, the effectiveness of its disclosure controls and procedures (as defined in such rules) as of the end of the period covered by this report. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms.

Our management, including the Company’s Chief Executive Officer and Chief Financial Officer, does not expect that the Company’s disclosure controls and procedures will prevent all errors and all frauds. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.

Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting that occurred during the second quarter of 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company continues to review its disclosure controls and procedures, including its internal controls over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.

 

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PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings

We are periodically involved in litigation in the ordinary course of our business involving claims regarding intellectual property infringement, product liability, property damage, personal injury, contracts, employment and worker’s compensation. We do not believe that there are any such pending or threatened legal proceedings, including ordinary litigation incidental to the conduct of our business and the ownership of our properties that, if adversely determined, would have a material adverse effect on our business, financial condition, results of operations or liquidity.

On June 22, 2009, Sea Launch filed a voluntary petition to reorganize under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware. As a result of this filing, our efforts to pursue collection of the arbitral award from Sea Launch were stayed under the bankruptcy laws. On May 27, 2010, HNS entered into a settlement agreement with Sea Launch to resolve the claim that HNS filed in the Sea Launch bankruptcy (the “Settlement Agreement”). The Settlement Agreement provides that Sea Launch will irrevocably issue to HNS two credits, each in the amount of $22.2 million (the “Credits”), in satisfaction and discharge of HNS’ bankruptcy claim. The Credits may be used by HNS to defray the cost of up to two launches contracted by December 31, 2015, and scheduled to occur by December 31, 2017. In addition, subject to the terms and conditions of the Settlement Agreement, one or both Credits may be transferred to third parties. The bankruptcy court has approved the Settlement Agreement, and its terms have been incorporated into the court’s order approving Sea Launch’s plan of reorganization. The Settlement Agreement will become effective upon the effectiveness of the plan of reorganization, which is expected to occur later in 2010.

On May 18, 2009, the Company and HNS received notice of a complaint filed in the U.S. District Court for the Northern District of California by two California subscribers to the HughesNet service. The plaintiffs complain about the speed of the HughesNet service, the Fair Access Policy, early termination fees and certain terms and conditions of the HughesNet subscriber agreement. The plaintiffs seek to pursue their claims as a class action on behalf of other California subscribers. On June 4, 2009, the Company and HNS received notice of a similar complaint filed by another HughesNet subscriber in the Superior Court of San Diego County, California. The plaintiff in this case also seeks to pursue his claims as a class action on behalf of other California subscribers. Both cases have been consolidated into a single case in the U.S. District Court for the Northern District of California. We believe that the allegations in both complaints are not meritorious and we intend to vigorously defend these matters.

On December 18, 2009, the Company and HNS received notice of a complaint filed in the Cook County, Illinois, Circuit Court by a former subscriber to the HughesNet service. The complaint seeks a declaration allowing the former subscriber to file a class arbitration challenging early termination fees under the subscriber agreement. Based on our investigation, we believe that the allegations in this complaint are not meritorious and we intend to vigorously defend this matter.

No other material legal proceedings have commenced or been terminated during the period covered by this report.

 

Item 1A. Risk Factors

For a discussion of the risk factors affecting the Company, see “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K filed with respect to the Company’s fiscal year ended December 31, 2009. There have been no material changes in the risk factors previously disclosed in such Annual Report on Form 10-K.

 

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

None.

 

Item 3. Defaults Upon Senior Securities

None.

 

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Item 4. (Removed and Reserved)

 

Item 5. Other Information

None.

 

Item 6. Exhibits

 

Exhibit
    Number    

 

Description

10.1**   Launch Services Agreement by and between Hughes Network Systems, LLC and Arianespace dated April 30, 2010.
31.1*   Certification of Chief Executive Officer of Hughes Communications, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*   Certification of Chief Financial Officer of Hughes Communications, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32*   Certification of Chief Executive Officer and Chief Financial Officer of Hughes Communications, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

* Filed herewith.
** Filed herewith and portions of the agreement have been omitted pursuant to a confidential treatment request.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: August 4, 2010   HUGHES COMMUNICATIONS, INC.
  (Registrant)
    /s/ PRADMAN P. KAUL
   
  Name:   Pradman P. Kaul
  Title:   Chief Executive Officer and President
    (Principal Executive Officer)
    /s/ GRANT A. BARBER
   
  Name:   Grant A. Barber
  Title:   Executive Vice President and Chief Financial Officer
    (Principal Financial Officer)

 

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