Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  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 MARCH 31, 2015.

 

OR

 

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

 

FOR THE TRANSITION PERIOD FROM               TO             .

 

Commission File Number:  333-179121

 

Hughes Satellite Systems Corporation

(Exact Name of Registrant as Specified in Its Charter)

 

Colorado

 

45-0897865

(State or Other Jurisdiction of Incorporation or Organization)

 

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

 

 

 

100 Inverness Terrace East, Englewood, Colorado

 

80112-5308

(Address of Principal Executive Offices)

 

(Zip Code)

 

 (303) 706-4000

(Registrant’s Telephone Number, Including Area Code)

 

Not Applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes o  No x*

 

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

 

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

 

Large accelerated filer o

Accelerated filer o

Non-accelerated filer x

Smaller reporting company o

 

 

(Do not check if a smaller

 

 

 

reporting company)

 

 

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

 

As of April 29, 2015, the Registrant’s outstanding common stock consisted of 1,000 shares of common stock, $0.01 par value per share.

 

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

 


*     The registrant currently is not subject to the filing requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 and is filing this Quarterly Report on Form 10-Q on a voluntary basis.  The registrant has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months as if it were subject to such filing requirements during the entirety of such period.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

Disclosure Regarding Forward-Looking Statements

 

i

 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1.

 

Financial Statements

 

1

 

 

Condensed Consolidated Balance Sheets as of March 31, 2015 (Unaudited) and December 31, 2014

 

1

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three Months Ended March 31, 2015 and 2014 (Unaudited)

 

2

 

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2015 and 2014 (Unaudited)

 

3

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

4

Item 2.

 

Management’s Narrative Analysis of Results of Operations

 

29

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

*

Item 4.

 

Controls and Procedures

 

38

 

 

 

 

 

PART II - OTHER INFORMATION

 

Item 1.

 

Legal Proceedings

 

39

Item 1A.

 

Risk Factors

 

39

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

*

Item 3.

 

Defaults upon Securities

 

*

Item 4.

 

Mine Safety Disclosures

 

39

Item 5.

 

Other Information

 

39

Item 6.

 

Exhibits

 

40

 

 

Signatures

 

41

 


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

 



Table of Contents

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q (“Form 10-Q”) contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended and Section 21E of the Exchange Act of 1934, as amended including but not limited to statements about our estimates, expectations, plans, objectives, strategies, and financial condition, expected impact of regulatory developments and legal proceedings, opportunities in our industries and businesses and other trends and projections for the next fiscal quarter and beyond. All statements, other than statements of historical facts, may be forward-looking statements. Forward-looking statements may also be identified by words such as “anticipate,” “intend,” “plan,” “goal,” “seek,” “believe,” “estimate,” “expect,” “predict,” “continue,” “future,” “will,” “would,” “could,” “can,” “may” and similar terms.  These forward-looking statements are based on information available to us as of the date of this Form 10-Q and represent management’s current views and assumptions.  Forward-looking statements are not guarantees of future performance, events or results and involve potential known and unknown risks, uncertainties and other factors, many of which may be beyond our control and may pose a risk to our operating and financial condition.  Accordingly, actual performance, events or results could differ materially from those expressed or implied in the forward-looking statements due to a number of factors including, but not limited to:

 

·                  our reliance on our primary customer, DISH Network Corporation (“DISH Network”), for a significant portion of our revenue;

 

·                  our ability to bring advanced technologies to market to keep pace with our competitors;

 

·                  significant risks related to the construction, launch and operation of our satellites, such as the risk of material malfunction on one or more of our satellites, changes in the space weather environment that could interfere with the operation of our satellites, and our general lack of commercial insurance coverage on our satellites;

 

·                  our failure to adequately anticipate the need for satellite capacity or the inability to obtain satellite capacity for our Hughes segment; and

 

·                  the failure of third-party providers of components, manufacturing, installation services and customer support services to appropriately deliver the contracted goods or services.

 

Other factors that could cause or contribute to such differences include, but are not limited to, those discussed under the caption “Risk Factors” in Part II, Item 1A of this Form 10-Q and in Part I, Item 1A of our most recent Annual Report on Form 10-K (“Form 10-K”) filed with the Securities and Exchange Commission (“SEC”), those discussed in “Management’s Narrative Analysis of Results of Operations” herein and in our Form 10-K and those discussed in other documents we file with the SEC.

 

All cautionary statements made herein should be read as being applicable to all forward-looking statements wherever they appear. Investors should consider the risks and uncertainties described herein and should not place undue reliance on any forward-looking statements. We do not undertake, and specifically disclaim, any obligation to publicly release the results of any revisions that may be made to any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

 

i



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1.   FINANCIAL STATEMENTS

 

HUGHES SATELLITE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

 

 

 

As of

 

 

 

March 31,
2015

 

December 31,
2014

 

 

 

(Unaudited)

 

(Audited)

 

Assets

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

219,393

 

$

225,557

 

Marketable investment securities

 

432,647

 

394,992

 

Trade accounts receivable, net of allowance for doubtful accounts of $11,627 and $11,950, respectively

 

139,175

 

140,193

 

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

 

18,470

 

19,249

 

Deferred tax assets

 

158,107

 

157,949

 

Inventory

 

62,656

 

51,597

 

Prepaids and deposits

 

34,793

 

30,938

 

Advances to affiliates, net

 

712

 

736

 

Other current assets

 

7,503

 

7,625

 

Total current assets

 

1,073,456

 

1,028,836

 

Noncurrent Assets:

 

 

 

 

 

Restricted cash and cash equivalents

 

18,698

 

17,652

 

Property and equipment, net of accumulated depreciation of $1,873,371 and $2,053,636, respectively

 

2,270,021

 

2,274,568

 

Regulatory authorizations

 

471,658

 

471,658

 

Goodwill

 

504,173

 

504,173

 

Other intangible assets, net

 

145,462

 

157,100

 

Other investments

 

34,375

 

32,969

 

Other noncurrent assets, net

 

174,781

 

177,628

 

Total noncurrent assets

 

3,619,168

 

3,635,748

 

Total assets

 

$

4,692,624

 

$

4,664,584

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Trade accounts payable

 

$

103,289

 

$

93,783

 

Trade accounts payable - DISH Network

 

19

 

18

 

Current portion of long-term debt and capital lease obligations

 

28,895

 

39,746

 

Advances from affiliates, net

 

7,740

 

23,792

 

Deferred revenue and prepayments

 

53,441

 

61,063

 

Accrued interest

 

43,756

 

8,890

 

Accrued compensation

 

20,885

 

20,128

 

Accrued expenses and other

 

70,314

 

82,533

 

Total current liabilities

 

328,339

 

329,953

 

Noncurrent Liabilities:

 

 

 

 

 

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

 

2,318,526

 

2,325,417

 

Deferred tax liabilities

 

556,702

 

539,560

 

Advances from affiliates

 

8,385

 

8,352

 

Other noncurrent liabilities

 

89,475

 

91,705

 

Total noncurrent liabilities

 

2,973,088

 

2,965,034

 

Total liabilities

 

3,301,427

 

3,294,987

 

Commitments and Contingencies (Note 12)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity:

 

 

 

 

 

Preferred Stock, $0.001 par value; 1,000,000 shares authorized:

 

 

 

 

 

Hughes Retail Preferred Tracking Stock, $0.001 par value; 300 shares authorized, 81.128 shares issued and outstanding at each of March 31, 2015 and December 31, 2014

 

 

 

Common stock, $0.01 par value; 1,000,000 shares authorized, 1,000 shares issued and outstanding at each of March 31, 2015 and December 31, 2014

 

 

 

Additional paid-in capital

 

1,362,500

 

1,361,599

 

Accumulated other comprehensive loss

 

(40,023

)

(31,346

)

Accumulated earnings

 

58,338

 

29,331

 

Total HSS shareholders’ equity

 

1,380,815

 

1,359,584

 

Noncontrolling interests

 

10,382

 

10,013

 

Total shareholders’ equity

 

1,391,197

 

1,369,597

 

Total liabilities and shareholders’ equity

 

$

4,692,624

 

$

4,664,584

 

 

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

 

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HUGHES SATELLITE SYSTEMS CORPORATION

 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

 

 

For the Three Months
 Ended March 31,

 

 

 

2015

 

2014

 

Revenue:

 

 

 

 

 

Services and other revenue - other

 

$

269,679

 

$

261,667

 

Services and other revenue - DISH Network

 

131,441

 

99,244

 

Equipment revenue - other

 

48,051

 

41,832

 

Equipment revenue - DISH Network

 

1,063

 

11,570

 

Total revenue

 

450,234

 

414,313

 

Costs and Expenses:

 

 

 

 

 

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

 

129,918

 

132,346

 

Cost of sales - equipment (exclusive of depreciation and amortization)

 

45,211

 

47,406

 

Selling, general and administrative expenses

 

70,545

 

63,271

 

Research and development expenses

 

5,554

 

4,492

 

Depreciation and amortization

 

108,014

 

108,185

 

Total costs and expenses

 

359,242

 

355,700

 

Operating income

 

90,992

 

58,613

 

 

 

 

 

 

 

Other Income (Expense):

 

 

 

 

 

Interest income

 

1,099

 

955

 

Interest expense, net of amounts capitalized

 

(45,086

)

(48,747

)

Equity in earnings of unconsolidated affiliate

 

1,397

 

770

 

Other, net (includes reclassification of realized (gains) losses on available- for-sale (“AFS”) securities out of accumulated other comprehensive loss of zero and $8, respectively)

 

(1,053

)

231

 

Total other expense, net

 

(43,643

)

(46,791

)

Income before income taxes

 

47,349

 

11,822

 

Income tax provision, net

 

(17,973

)

(201

)

Net income

 

29,376

 

11,621

 

Less: Net income attributable to noncontrolling interests

 

369

 

299

 

Net income attributable to HSS

 

$

29,007

 

$

11,322

 

 

 

 

 

 

 

Comprehensive Income:

 

 

 

 

 

Net income

 

$

29,376

 

$

11,621

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

Foreign currency translation adjustments

 

(10,234

)

2,190

 

Unrealized gains on AFS securities and other

 

1,557

 

806

 

Recognition of previously unrealized gains on AFS securities included in net income

 

 

(8

)

Total other comprehensive income (loss), net of tax

 

(8,677

)

2,988

 

Comprehensive income

 

20,699

 

14,609

 

Less: Comprehensive income attributable to noncontrolling interests

 

369

 

534

 

Comprehensive income attributable to HSS

 

$

20,330

 

$

14,075

 

 

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

 

2



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HUGHES SATELLITE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2015

 

2014

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net income

 

$

29,376

 

$

11,621

 

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

 

 

 

 

 

Depreciation and amortization

 

108,014

 

108,185

 

Equity in earnings of unconsolidated affiliate

 

(1,397

)

(770

)

Amortization of debt issuance costs

 

1,521

 

1,413

 

Realized gains on marketable investment securities and other investments, net

 

 

(8

)

Stock-based compensation

 

1,220

 

619

 

Deferred tax expense (benefit)

 

17,035

 

(2,956

)

Changes in current assets and current liabilities, net

 

(9,568

)

40,726

 

Changes in noncurrent assets and noncurrent liabilities, net

 

2,504

 

(5,739

)

Other, net

 

(1,824

)

2,930

 

Net cash flows from operating activities

 

146,881

 

156,021

 

Cash Flows from Investing Activities:

 

 

 

 

 

Purchases of marketable investment securities

 

(90,594

)

(52,678

)

Sales and maturities of marketable investment securities

 

52,683

 

36,271

 

Purchases of property and equipment

 

(92,310

)

(46,001

)

Changes in restricted cash and cash equivalents

 

(1,046

)

(3,011

)

Other, net

 

(4,953

)

(4,723

)

Net cash flows from investing activities

 

(136,220

)

(70,142

)

Cash Flows from Financing Activities:

 

 

 

 

 

Repayment of long-term debt and capital lease obligations

 

(15,038

)

(17,193

)

Net proceeds from issuance of Hughes Retail Preferred Tracking Stock (Note 2)

 

 

11,404

 

Other

 

779

 

19

 

Net cash flows from financing activities

 

(14,259

)

(5,770

)

Effect of exchange rates on cash and cash equivalents

 

(2,566

)

990

 

Net increase (decrease) in cash and cash equivalents

 

(6,164

)

81,099

 

Cash and cash equivalents, beginning of period

 

225,557

 

163,709

 

Cash and cash equivalents, end of period

 

$

219,393

 

$

244,808

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

Cash paid for interest (including capitalized interest)

 

$

10,820

 

$

11,794

 

Capitalized interest

 

$

2,355

 

$

 

Cash paid for income taxes

 

$

975

 

$

2,424

 

Satellites and other assets financed under capital lease obligations

 

$

160

 

$

663

 

Reduction of capital lease obligation for AMC-15 and AMC-16 satellites

 

$

4,500

 

$

 

Increase in capital expenditures included in accounts payable, net

 

$

4,414

 

$

1,151

 

Net noncash assets transferred from DISH Network in exchange for HSS Tracking Stock (Note 2)

 

$

 

$

71,048

 

Net assets transferred from EchoStar related to Tracking Stock Transaction (Note 2)

 

$

 

$

315,643

 

 

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

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1.                   Organization and Business Activities

 

Principal Business

 

Hughes Satellite Systems Corporation (which, together with its subsidiaries, is referred to as “HSS,” the “Company,” “we,” “us” and/or “our”) is a holding company and a direct subsidiary of EchoStar Corporation (“EchoStar”).  We are a global provider of satellite operations, video delivery solutions, and broadband satellite technologies and services for home and office, delivering innovative network technologies, managed services, and solutions for enterprises and governments.

 

We currently operate in two business segments.

 

·                  Hughes — which provides satellite broadband internet access to North American consumers and broadband network services and equipment to domestic and international enterprise markets.  The Hughes segment also provides managed services to large enterprises and solutions to customers for mobile satellite systems.

 

·                  EchoStar Satellite Services (“ESS”) — which uses certain of our owned and leased in-orbit satellites and related licenses to provide satellite services on a full-time and occasional-use basis primarily to DISH Network, Dish Mexico, S. de R.L. de C.V. (“Dish Mexico”), a joint venture that EchoStar entered into in 2008, United States (“U.S”) government service providers, internet service providers, broadcast news organizations, programmers, and private enterprise customers.

 

We were formed as a Colorado corporation in March 2011 to facilitate the acquisition (the “Hughes Acquisition”) of Hughes Communications, Inc. and its subsidiaries (“Hughes Communications”) and related financing transactions.  In connection with our formation, EchoStar contributed the assets and liabilities of its satellite services business, including its principal operating subsidiary of its satellite services business, EchoStar Satellite Services L.L.C., to us.  In addition, as a result of the Satellite and Tracking Stock Transaction described in Note 2 below, DISH Network owns shares of our preferred tracking stock representing a 28.11% economic interest in the residential retail satellite broadband business of our Hughes segment.

 

Note 2.                   Hughes Retail Preferred Tracking Stock

 

Satellite and Tracking Stock Transaction

 

On February 20, 2014, HSS and EchoStar entered into agreements with certain subsidiaries of DISH Network pursuant to which, effective March 1, 2014, (i) EchoStar issued shares of its newly authorized Hughes Retail Preferred Tracking Stock (the “EchoStar Tracking Stock”) and HSS issued shares of its newly authorized Hughes Retail Preferred Tracking Stock (the “HSS Tracking Stock” and together with the EchoStar Tracking Stock, the “Tracking Stock”) to DISH Network in exchange for five satellites (EchoStar I, EchoStar VII, EchoStar X, EchoStar XI, and EchoStar XIV), including the assumption of related in-orbit incentive obligations, and $11.4 million in cash and (ii) DISH Network began receiving certain satellite services on these five satellites from us (the “Satellite and Tracking Stock Transaction”).  Immediately upon receipt of net assets (consisting of two of the five satellites and related in-orbit incentive obligations) from DISH Network in exchange for EchoStar Tracking Stock, EchoStar transferred such net assets to us.  The Tracking Stock tracks the residential retail satellite broadband business of our Hughes segment, including certain operations, assets and liabilities attributed to such business (collectively, the “Hughes Retail Group” or “HRG”) HSS has adopted a policy statement (the “Policy Statement”) setting forth management and allocation policies for purposes of attributing all of the business and operations of HSS to either the Hughes Retail Group or the “HSSC Group,” which is defined as all other operations of HSS, including all existing and future businesses, other than the Hughes Retail Group.  Among other things, the Policy Statement governs how assets, liabilities, revenue and expenses are attributed or allocated between HRG and the HSSC Group.  Such attributions and allocations generally do not affect the amounts reported in our consolidated financial statements, except for the attribution of shareholders’ equity and net income or loss between the holders of Tracking Stock and common stock.  The Policy Statement also does not significantly affect the way that management assesses operating performance and allocates resources within our Hughes segment.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

We provide unaudited attributed financial information for HRG and the HSSC Group in an exhibit to our periodic reports on Form 10-Q and Form 10-K.  See Note 2 to our consolidated financial statements included in our Form 10-K for the year ended December 31, 2014 for a description of the rights and obligations of EchoStar, HSS and DISH Network with respect to the Tracking Stock, the initial recording of the Satellite and Tracking Stock Transaction and the satellites received from DISH Network as part of the Satellite and Tracking Stock Transaction.  Set forth below is information about certain terms of the Tracking Stock.

 

Description of the Tracking Stock

 

Tracking stock is a type of capital stock that the issuing company intends to reflect or “track” the economic performance of a particular business component within the company, rather than reflect the economic performance of the company as a whole.  The Tracking Stock is intended to track the economic performance of the Hughes Retail Group.  The shares of the Tracking Stock issued to DISH Network represent an aggregate 80.0% economic interest in the Hughes Retail Group, of which a 28.11% interest was issued as HSS Tracking Stock and a 51.89% interest was issued as EchoStar Tracking Stock.  In addition to the remaining 20.0% economic interest in the Hughes Retail Group, HSS retains all economic interest in the wholesale satellite broadband business and other businesses of HSS.  The Hughes Retail Group is not a separate legal entity and therefore cannot own assets, issue securities or enter into legally binding agreements.  Holders of the Tracking Stock have no direct claim to the assets of the Hughes Retail Group; rather, holders of the Tracking Stock are stockholders of its respective issuer (EchoStar or HSS) and are subject to all risks and liabilities of the issuer.  Also, holders of EchoStar Tracking Stock do not have any direct equity interest in HSS, but have an indirect interest in HSS through EchoStar’s ownership of our outstanding common stock.  Holders of shares of the Tracking Stock vote with holders of the outstanding shares of common stock of its respective issuer, as a single class, with respect to any and all matters presented to stockholders for their action or consideration.  Each share of the Tracking Stock is entitled to one-tenth (1/10th) of one vote.  The HSS Tracking Stock is a series of HSS preferred stock consisting of 300 authorized shares with a par value of $0.001 per share, of which 81.128 shares were issued to DISH Network on March 1, 2014.  The EchoStar Tracking Stock is a series of EchoStar preferred stock consisting of 13,000,000 authorized shares with a par value of $0.001 per share, of which 6,290,499 shares were issued to DISH Network on March 1, 2014.

 

Note 3.                   Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information.  Accordingly, these financial statements do not include all of the information and notes required for complete financial statements prepared in accordance with GAAP.  In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Our results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the full year.  For further information, refer to the consolidated financial statements and notes thereto included in our Form 10-K for the year ended December 31, 2014.

 

Principles of Consolidation

 

We consolidate all majority owned subsidiaries, investments in entities in which we have controlling interest and variable interest entities where we are the primary beneficiary.  For entities we control but do not wholly own, we record a noncontrolling interest within shareholders’ equity for the portion of the entity’s equity attributed to the noncontrolling ownership interests.  We use the equity method to account for investments in entities that we do not control but have the ability to significantly influence the operating decisions of the investee.  When we do not have the ability to significantly influence the operating decisions of the investee, the cost method is used.  All significant intercompany balances and transactions have been eliminated in consolidation.

 

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Table of Contents

 

HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the balance sheets, the reported amounts of revenue and expense for each reporting period, and certain information disclosed in our notes to the condensed consolidated financial statements.  Estimates are used in accounting for, among other things, amortization periods for deferred revenue and deferred subscriber acquisition costs, revenue recognition using the percentage-of-completion method, allowances for doubtful accounts, allowances for sales returns and rebates, warranty obligations, self-insurance obligations, deferred taxes and related valuation allowances, uncertain tax positions, loss contingencies, fair value of financial instruments, fair value of awards granted under EchoStar’s stock-based compensation plans, fair value of assets and liabilities acquired in business combinations, lease classifications, asset impairments, useful lives and methods for depreciation and amortization of property, equipment and intangible assets, goodwill impairment testing, royalty obligations, and allocations that affect the periodic determination of net income or loss attributable to the Tracking Stock.  We base our estimates and assumptions on historical experience, observable market inputs and on various other factors that we believe to be relevant under the circumstances.  Due to the inherent uncertainty involved in making estimates, actual results may differ from previously estimated amounts, and such differences may be material to our condensed consolidated financial statements.  Weakened economic conditions may increase the inherent uncertainty in the estimates and assumptions indicated above.  We review our estimates and assumptions periodically and the effects of revisions are reflected in the period they occur or prospectively if the revised estimate affects future periods.

 

Fair Value Measurements

 

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

 

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

 

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

 

·                  Level 3, defined as unobservable inputs for which little or no market data exists, consistent with characteristics of the asset or liability that would be considered by market participants in a transaction to purchase or sell the asset or liability.

 

Transfers between levels in the fair value hierarchy are considered to occur at the beginning of the quarterly accounting period.  There were no transfers between levels for each of the three months ended March 31, 2015 or 2014.

 

As of March 31, 2015 and December 31, 2014, the carrying amounts of our cash and cash equivalents, trade accounts receivable, net of allowance for doubtful accounts, accounts payable and accrued liabilities were equal to or approximated fair value due to their short-term nature or proximity to current market rates.

 

Fair values of our current marketable investment securities are based on a variety of observable market inputs.  For our investments in publicly traded equity securities, fair value ordinarily is determined based on a Level 1 measurement that reflects quoted prices for identical securities in active markets.  Fair values of our investments in other marketable debt securities generally are based on Level 2 measurements, as the markets for such debt securities are less active.  Trades of identical debt securities on or near the measurement date are considered a strong indication of fair value.  Matrix pricing techniques that consider par value, coupon rate, credit quality, maturity and other relevant features also may be used to determine fair value of our investments in marketable debt securities.

 

Fair values for our publicly traded long-term debt are based on quoted market prices in less active markets and are

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

categorized as Level 2 measurements.  The fair values of our privately held debt are Level 2 measurements and are estimated to approximate their carrying amounts based on the proximity of their interest rates to current market rates.  As of March 31, 2015 and December 31, 2014, the fair values of our in-orbit incentive obligations, based on measurements categorized within Level 2 of the fair value hierarchy, approximated their carrying amounts of $85.1 million and $85.8 million, respectively.  We use fair value measurements from time-to-time in connection with impairment testing and the assignment of purchase consideration to assets and liabilities of acquired companies. Those fair value measurements typically include significant unobservable inputs and are categorized within Level 3 of the fair value hierarchy.

 

Research and Development

 

The portion of our cost of sales, consisting of research and development funded by customers was approximately $5.7 million for each of the three months ended March 31, 2015 and 2014.  In addition, we incurred $5.6 million and $4.5 million for the three months ended March 31, 2015 and 2014, respectively, for research and development expenses not funded by customers, which has been reflected as such within our condensed consolidated statements of operations and comprehensive income (loss).

 

Capitalized Software Costs

 

Development costs related to software for internal use and externally marketed software are capitalized and amortized using the straight-line method over the estimated useful life of the software, not in excess of five years.  Capitalized costs of internal-use software are included in “Property and equipment, net” and capitalized costs of externally marketed software are included in “Other noncurrent assets, net” in our condensed consolidated balance sheets.  Externally marketed software is generally included in the equipment we sell to customers.  We conduct software program reviews for externally marketed capitalized software costs at least annually, or as events and circumstances warrant such a review, to determine if capitalized software development costs are recoverable and to ensure that costs associated with programs that are no longer generating revenue are expensed.  As of March 31, 2015 and December 31, 2014, the net carrying amount of externally marketed software was $51.9 million and $48.9 million, respectively.  We capitalized $5.0 million of costs related to development of externally marketed software for each of the three months ended March 31, 2015 and 2014.  For the three months ended March 31, 2015 and 2014, we recorded $1.9 million and $0.8 million, respectively, of amortization expense relating to our externally marketed software.

 

New Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”).  It outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance.  The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.”  ASU 2014-09 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods, and may be applied either retrospectively to prior periods or as a cumulative-effect adjustment as of the date of adoption.  Early adoption was not permitted.  In April 2015, the FASB proposed Accounting Standards Update that would defer for one year the effective date of the new revenue standard and also proposed to permit entities to early adopt the standard.  Management has not selected a transition method and is assessing the impact of adopting this new accounting standard on our consolidated financial statements and related disclosures.

 

In February 2015, the FASB issued Accounting Standards Update No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis (“ASU 2015-02”).  This standard amends the consolidation guidance for variable interest entities (“VIEs”) and general partners’ investments in limited partnerships and similar entities.  ASU 2015-02 is effective for annual periods beginning after December 15, 2015 and interim periods within those annual periods, and requires either a retrospective or a modified retrospective approach as of the beginning of the fiscal year of adoption. Early adoption is permitted.  We are assessing the impact of adopting this new accounting standard on our consolidated financial statements and related disclosures.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, (“ASU 2015-03”). This standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of debt liability, consistent with debt discounts or premiums.  ASU 2015-03 is effective for annual periods beginning after December 15, 2015 and interim periods within those annual periods, and requires a retrospective approach to adoption. Early adoption is permitted.  Based on our preliminary assessment, upon adoption of this standard, we expect to present unamortized deferred costs in other noncurrent assets with a carrying amount of $37.5 million and $39.1 million as of March 31, 2015 and December 31, 2014, respectively, as a reduction of our long-term debt balances.  We do not expect to adopt this standard prior to the effective date.

 

Note 4.                   Other Comprehensive Income (Loss) and Related Tax Effects

 

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

 

Accumulated other comprehensive loss includes cumulative foreign currency translation losses of $39.4 million and $29.2 million as of March 31, 2015 and December 31, 2014, respectively.

 

Note 5.                   Investment Securities

 

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

 

 

 

As of

 

 

 

March 31,
2015

 

December 31,
2014

 

 

 

(In thousands)

 

Marketable investment securities—current:

 

 

 

 

 

Corporate bonds

 

$

406,373

 

$

367,291

 

Strategic equity securities

 

13,815

 

12,669

 

Other

 

12,459

 

15,032

 

Total marketable investment securities—current

 

432,647

 

394,992

 

Other investments—noncurrent:

 

 

 

 

 

Cost method

 

15,438

 

15,438

 

Equity method

 

18,937

 

17,531

 

Total other investments—noncurrent

 

34,375

 

32,969

 

Total marketable and other investments

 

$

467,022

 

$

427,961

 

 

Marketable Investment Securities

 

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

 

Corporate Bonds

 

Our corporate bond portfolio includes debt instruments issued by individual corporations, primarily in the industrial and financial services industries.

 

Strategic Equity Securities

 

Our strategic investment portfolio consists of investments in shares of common stock of public companies, which are highly speculative and have experienced and continue to experience volatility.  The value of our investment portfolio depends on the value of such shares of common stock.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Other

 

Our other current marketable investment securities portfolio includes investments in various debt instruments, including U.S. government bonds and variable rate demand notes.

 

Other Investments - Noncurrent

 

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

 

Unrealized Gains (Losses) on Marketable Investment Securities

 

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

 

 

 

Amortized

 

Unrealized

 

Estimated

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

 

 

(In thousands)

 

As of March 31, 2015

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

406,727

 

$

61

 

$

(415

)

$

406,373

 

Other

 

12,458

 

1

 

 

12,459

 

Equity securities - strategic

 

14,176

 

1,574

 

(1,935

)

13,815

 

Total marketable investment securities

 

$

433,361

 

$

1,636

 

$

(2,350

)

$

432,647

 

As of December 31, 2014

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

367,949

 

$

8

 

$

(666

)

$

367,291

 

Other

 

15,031

 

1

 

 

15,032

 

Equity security - strategic

 

14,176

 

1,718

 

(3,225

)

12,669

 

Total marketable investment securities

 

$

397,156

 

$

1,727

 

$

(3,891

)

$

394,992

 

 

As of March 31, 2015, restricted and non-restricted marketable investment securities included debt securities of $371.8 million with contractual maturities of one year or less and $47.0 million with contractual maturities greater than one year.  We may realize proceeds from certain investments prior to their contractual maturity as a result of our ability to sell these securities prior to their contractual maturity.

 

Marketable Investment Securities in a Loss Position

 

The following table reflects the length of time that our available-for-sale securities have been in an unrealized loss position.  We do not intend to sell these securities before they recover or mature, and it is more likely than not that we will hold these securities until they recover or mature.  We believe that these changes in the estimated fair values of these securities are primarily related to temporary market conditions.

 

 

 

As of

 

 

 

March 31, 2015

 

December 31, 2014

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

Loss

 

Value

 

Loss

 

 

 

(In thousands)

 

Less than 12 months

 

$

327,266

 

$

(2,349

)

$

357,887

 

$

(3,891

)

12 months or more

 

4,000

 

(1

)

 

 

Total

 

$

331,266

 

$

(2,350

)

$

357,887

 

$

(3,891

)

 

Sales of Marketable Investment Securities

 

We recognized minimal gains from the sales of our available-for-sale marketable investment securities for each of the three months ended March 31, 2015 and 2014.  We recognized minimal and zero losses from the sales of our available-for-sale marketable investment securities for the three months ended March 31, 2015 and 2014, respectively.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Proceeds from sales of our available-for-sale marketable investment securities totaled $7.5 million and zero for the three months ended March 31, 2015 and 2014, respectively.

 

Fair Value Measurements

 

Our current marketable investment securities are measured at fair value on a recurring basis as summarized in the table below. As of March 31, 2015 and December 31, 2014, we did not have investments that were categorized within Level 3 of the fair value hierarchy.

 

 

 

As of

 

 

 

March 31, 2015

 

December 31, 2014

 

 

 

Total

 

Level 1

 

Level 2

 

Total

 

Level 1

 

Level 2

 

 

 

(In thousands)

 

Cash equivalents

 

$

162,433

 

$

30,635

 

$

131,798

 

$

148,645

 

$

18,926

 

$

129,719

 

Debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

406,373

 

$

 

$

406,373

 

$

367,291

 

$

 

$

367,291

 

Other

 

12,459

 

 

12,459

 

15,032

 

 

15,032

 

Equity securities - strategic

 

13,815

 

13,815

 

 

12,669

 

12,669

 

 

Total marketable investment securities

 

$

432,647

 

$

13,815

 

$

418,832

 

$

394,992

 

$

12,669

 

$

382,323

 

 

Note 6.                   Trade Accounts Receivable

 

Our trade accounts receivable consisted of the following:

 

 

 

As of

 

 

 

March 31,
2015

 

December 31, 
2014

 

 

 

(In thousands)

 

Trade accounts receivable

 

$

126,302

 

$

135,609

 

Contracts in process, net

 

24,500

 

16,534

 

Total trade accounts receivable

 

150,802

 

152,143

 

Allowance for doubtful accounts

 

(11,627

)

(11,950

)

Trade accounts receivable - DISH Network

 

18,470

 

19,249

 

Total trade accounts receivable, net

 

$

157,645

 

$

159,442

 

 

As of March 31, 2015 and December 31, 2014, progress billings offset against contracts in process amounted to $2.9 million and $2.5 million, respectively.

 

Note 7.                   Inventory

 

Our inventory consisted of the following:

 

 

 

As of

 

 

 

March 31,
2015

 

December 31,
2014

 

 

 

(In thousands)

 

Finished goods

 

$

48,127

 

$

39,495

 

Raw materials

 

5,654

 

5,170

 

Work-in process

 

8,875

 

6,932

 

Total inventory

 

$

62,656

 

$

51,597

 

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 8.                   Property and Equipment

 

Property and equipment consisted of the following:

 

 

 

Depreciable

 

As of

 

 

 

Life

 

March 31,

 

December 31,

 

 

 

(In Years)

 

2015

 

2014

 

 

 

 

 

(In thousands)

 

Land

 

-

 

$

12,086

 

$

12,075

 

Buildings and improvements

 

1 - 30

 

73,594

 

73,191

 

Furniture, fixtures, equipment and other

 

1 - 12

 

342,011

 

339,330

 

Customer rental equipment

 

2 - 4

 

527,043

 

498,181

 

Satellites - owned

 

10 - 15

 

2,381,120

 

2,381,120

 

Satellites acquired under capital leases

 

10 - 15

 

665,518

 

935,104

 

Construction in progress

 

-

 

142,020

 

89,203

 

Total property and equipment

 

 

 

4,143,392

 

4,328,204

 

Accumulated depreciation

 

 

 

(1,873,371

)

(2,053,636

)

Property and equipment, net

 

 

 

$

2,270,021

 

$

2,274,568

 

 

Construction in progress consisted of the following:

 

 

 

As of

 

 

 

March 31,
2015

 

December 31, 
2014

 

 

 

(In thousands)

 

Progress amounts for satellite construction, including prepayments under capital leases and launch costs:

 

 

 

 

 

EUTELSAT 65 West A

 

$

30,600

 

$

26,049

 

EchoStar 105/SES-11

 

62,124

 

28,470

 

Other

 

100

 

101

 

Uplinking equipment

 

26,216

 

21,124

 

Other

 

22,980

 

13,459

 

Construction in progress

 

$

142,020

 

$

89,203

 

 

Depreciation expense associated with our property and equipment consisted of the following:

 

 

 

For the Three Months
 Ended March 31,

 

 

 

2015

 

2014

 

 

 

(In thousands)

 

Satellites

 

$

49,087

 

$

47,563

 

Furniture, fixtures, equipment and other

 

12,217

 

14,243

 

Customer rental equipment

 

30,187

 

27,892

 

Buildings and improvements

 

1,292

 

1,450

 

Total depreciation expense

 

$

92,783

 

$

91,148

 

 

Satellites

 

As of March 31, 2015, we utilized 18 of our owned and leased satellites in geosynchronous orbit, approximately 22,300 miles above the equator.  We depreciate our owned satellites on a straight-line basis over the estimated useful life of each satellite.  Two of our satellites are accounted for as capital leases and are depreciated on a straight-line basis over the terms of the satellite service agreements.  Three of our satellites are accounted for as operating leases.

 

Recent Developments

 

AMC-15 and AMC-16.  In August 2014, in connection with the execution of agreements related to EchoStar 105/SES-11, we entered into amendments that extend the terms of our existing agreements with SES for satellite services on AMC-15 and AMC-16.  As amended, the term of our agreement for satellite services on certain transponders on AMC-15 was extended from December 2014 through the in-service date of EchoStar 105/SES-11.  The amended agreement for the AMC-16 satellite services extends the term for the satellite’s entire communications capacity, subject

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

to available power, for one year following expiration of the initial term in February 2015.  The extended terms of these agreements are being accounted for as operating leases.

 

Satellite Anomalies

 

Certain of our satellites have experienced anomalies, some of which have had a significant adverse impact on their remaining useful lives and/or the commercial operation of the satellites.  There can be no assurance that existing and future anomalies will not further impact the remaining useful life and/or the commercial operation of any of the satellites in our fleet.  In addition, there can be no assurance that we can recover critical transmission capacity in the event one or more of our in-orbit satellites were to fail.  We generally do not carry in-orbit insurance on our satellites; therefore, we generally bear the risk of any uninsured in-orbit failures.  Pursuant to the terms of the agreements governing certain portions of our indebtedness, we are required, subject to certain limitations on coverage, to maintain launch and in-orbit insurance for SPACEWAY 3, EchoStar XVI, and EchoStar XVII.

 

We have previously disclosed in our financial statements as of and for the year ended December 31, 2014 anomalies in prior years that affect our in-service owned and leased satellites, including EchoStar III, EchoStar VI, EchoStar VIII, EchoStar XII, and AMC-16.  We are not aware of any additional anomalies that have occurred with respect to any of our owned or leased satellites in 2015 as of the date of this report that affected the commercial operation of these satellites.  EchoStar III and EchoStar VI are fully depreciated and EchoStar III is being used as an in-orbit spare; accordingly, the prior anomalies affecting these satellites have not had a significant effect on our operating results and cash flows.  EchoStar XII has experienced several anomalies, which have resulted in a loss of electrical power.  Those anomalies have not had a significant adverse impact on service under the related satellite services agreement with DISH Network for EchoStar XII; however, the anomalies have increased the risk of future transponder failures that could result in reductions in our revenue.

 

Satellite Impairments

 

We evaluate our satellites for impairment and test for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable.  Certain of the anomalies previously disclosed, may be considered to represent a significant adverse change in the physical condition of a particular satellite.  However, based on the redundancy designed within each satellite, certain of these anomalies are not necessarily considered to be significant events that would require a test of recoverability.

 

Note 9.                   Goodwill and Other Intangible Assets

 

Goodwill

 

The excess of the cost of an acquired business over the fair values of net tangible and identifiable intangible assets at the time of the acquisition is recorded as goodwill. Goodwill is assigned to our reporting units of our operating segments and is subject to impairment testing annually, or more frequently when events or changes in circumstances indicate the fair value of a reporting unit is more likely than not less than its carrying amount.

 

As of March 31, 2015 and December 31, 2014, all of our goodwill was assigned to reporting units of our Hughes segment.  We test this goodwill for impairment annually in the second quarter.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Other Intangible Assets

 

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

 

 

 

Weighted

 

As of

 

 

 

Average

 

March 31, 2015

 

December 31, 2014

 

 

 

Useful life

 

 

 

Accumulated

 

Carrying

 

 

 

Accumulated

 

Carrying

 

 

 

(in Years)

 

Cost

 

Amortization

 

Amount

 

Cost

 

Amortization

 

Amount

 

 

 

 

 

(In thousands)

 

Customer relationships

 

8

 

$

270,300

 

$

(168,798

)

$

101,502

 

$

270,300

 

$

(161,762

)

$

108,538

 

Contract-based

 

4

 

64,800

 

(63,604

)

1,196

 

64,800

 

(61,810

)

2,990

 

Technology-based

 

6

 

51,417

 

(32,856

)

18,561

 

51,417

 

(30,714

)

20,703

 

Trademark portfolio

 

20

 

29,700

 

(5,693

)

24,007

 

29,700

 

(5,321

)

24,379

 

Favorable leases

 

4

 

4,707

 

(4,511

)

196

 

4,707

 

(4,217

)

490

 

Total other intangible assets.

 

 

 

$

420,924

 

$

(275,462

)

$

145,462

 

$

420,924

 

$

(263,824

)

$

157,100

 

 

Customer relationships are amortized predominantly in relation to the expected contribution of cash flow to the business over the life of the intangible asset.  Other intangible assets are amortized on a straight-line basis over the periods the assets are expected to contribute to our cash flows.  Amortization expense, including amortization of externally marketed capitalized software, was $15.2 million and $17.0 million for the three months ended March 31, 2015 and 2014, respectively.

 

Note 10.            Debt and Capital Lease Obligations

 

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

 

 

 

As of

 

 

 

March 31, 2015

 

December 31, 2014

 

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

 

 

Amount

 

Value

 

Amount

 

Value

 

 

 

(In thousands)

 

6 1/2% Senior Secured Notes due 2019

 

$

1,100,000

 

$

1,203,422

 

$

1,100,000

 

$

1,177,000

 

7 5/8% Senior Notes due 2021

 

900,000

 

994,500

 

900,000

 

994,500

 

Other

 

1,777

 

1,777

 

1,197

 

1,197

 

Subtotal

 

2,001,777

 

$

2,199,699

 

2,001,197

 

$

2,172,697

 

Capital lease obligations

 

345,644

 

 

 

363,966

 

 

 

Total debt and capital lease obligations

 

2,347,421

 

 

 

2,365,163

 

 

 

Less: Current portion

 

(28,895

)

 

 

(39,746

)

 

 

Long-term portion of debt and capital lease obligations

 

$

2,318,526

 

 

 

$

2,325,417

 

 

 

 

Note 11.            Income Taxes

 

Our tax provision for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period.  Each quarter we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment.

 

Our quarterly tax provision, and our quarterly estimate of our annual effective tax rate, is subject to significant volatility due to several factors, including variability in accurately predicting our pre-tax and taxable income and loss and the mix of jurisdictions to which they relate, income and losses from investments, changes in tax laws and relative changes of expenses or losses for which tax benefits are not recognized.  Additionally, our effective tax rate can be more or less volatile based on the amount of pre-tax income.  For example, the impact of discrete items and non-deductible expenses on our effective tax rate is greater when our pre-tax income is lower.

 

Income tax expense was approximately $18.0 million for the three months ended March 31, 2015 compared to $0.2 million for the three months ended March 31, 2014.  Our effective income tax rate was 38.0% for the three months ended March 31, 2015 compared to 1.7% for the same period in 2014.  The variation in our effective tax rate from the U.S. federal statutory rate for the same period in 2014 was primarily due to lower state effective tax rate.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 12.            Commitments and Contingencies

 

Commitments

 

As of March 31, 2015, our satellite-related obligations were approximately $922.8 million.  Our satellite-related obligations primarily include payments pursuant to agreements for the construction of the EUTELSAT 65 West A and EchoStar 105/SES-11 satellites, payments pursuant to launch services contracts, executory costs for our capital lease satellites, costs under satellite service agreements and in-orbit incentives relating to certain satellites, as well as commitments for long term satellite operating leases and satellite service arrangements.

 

Contingencies

 

Separation Agreement

 

In 2008, DISH Network Corporation contributed its digital set-top box business and certain infrastructure and other assets, including certain of its satellites, uplink and satellite transmission assets, real estate, and other assets and related liabilities to EchoStar (the “Spin-off”).  In connection with the Spin-off, EchoStar entered into a separation agreement with DISH Network that provides, among other things, for the division of certain liabilities, including liabilities resulting from litigation.  Under the terms of the separation agreement, EchoStar has assumed certain liabilities that relate to its business, including certain designated liabilities for acts or omissions that occurred prior to the Spin-off.  Certain specific provisions govern intellectual property related claims under which, generally, EchoStar will only be liable for its acts or omissions following the Spin-off and DISH Network will indemnify EchoStar for any liabilities or damages resulting from intellectual property claims relating to the period prior to the Spin-off, as well as DISH Network’s acts or omissions following the Spin-off.

 

Litigation

 

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

 

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

 

California Institute of Technology

 

On October 1, 2013, the California Institute of Technology (“Caltech”) filed suit against two of our subsidiaries, Hughes Communications, Inc. and Hughes Network Systems, LLC, as well as against DISH Network, DISH Network L.L.C., and dishNET Satellite Broadband L.L.C., in the United States District Court for the Central District of California alleging infringement of United States Patent Nos. 7,116,710; 7,421,032; 7,916,781; and 8,284,833, each of which is entitled “Serial Concatenation of Interleaved Convolutional Codes forming Turbo-Like Codes.”  Caltech asserted that encoding data as specified by the DVB-S2 standard, infringes each of the asserted patents.  In the operative Amended Complaint, served on March 6, 2014, Caltech claims that the

 

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(Unaudited)

 

HopperTM set-top box that we design and sell to DISH Network, as well as certain of our Hughes segment’s satellite broadband products and services, infringe the asserted patents by implementing the DVB-S2 standard.  On September 26, 2014, Caltech requested leave to amend its Amended Complaint to add us and EchoStar Technologies L.L.C. as defendants, as well as to allege that a number of additional set-top boxes infringe the asserted patents.  On November 7, 2014, the Court rejected that request.  Additionally, on November 4, 2014, the Court ruled that the patent claims at issue in the suit are directed to patentable subject matter.  On February 17, 2015, Caltech filed a second complaint in the same district against the same defendants alleging that Hughes’ Gen4 HT1000 and HT1100 products infringe the same patents asserted in the first case.  We answered that complaint on March 24, 2015. The trial for the first case which was scheduled to commence on April 20, 2015, was vacated by the Court on March 16, 2015 and a new trial date has yet to be set. On May 5, 2015, the Court granted summary judgment for us on a number of issues, finding that Caltech’s damages theory improperly apportioned alleged damages, that allegations of infringement against DISH Network, DISH Network L.L.C., and dishNET Satellite Broadband L.L.C. should be dismissed from the case, and affirming that Caltech could not assert infringement under the doctrine of equivalents.  The Court also granted motions by Caltech seeking findings that certain of its patents were not indefinite or subject to equitable estoppel.  The Court otherwise denied motions for summary judgment, including a motion by Caltech seeking summary judgment of infringement.

 

We intend to vigorously defend these cases.  In the event that a court ultimately determines that we infringe the asserted patents, we may be subject to substantial damages, which may include treble damages, and/or an injunction that could require us to materially modify certain features that we currently offer to our consumers.  We cannot predict with any degree of certainty the outcome of the suits or determine the extent of any potential liability or damages.

 

Elbit

 

On January 23, 2015, Elbit Systems Land and C4I LTD and Elbit Systems of America Ltd. (together referred to as “Elbit”) filed a complaint against our subsidiary Hughes Network Systems LLC, as well as against Black Elk Energy Offshore Operations, LLC, Bluetide Communications, Inc. and Helm Hotels Group, in the United States District Court for the Eastern District of Texas, alleging infringement of United States Patent Nos. 6,240,073 (the “073 patent”) and 7,245,874 (“874 patent”).  The 073 patent is entitled “Reverse Link for a Satellite Communication Network” and the 874 patent is entitled “Infrastructure for Telephony Network.”  Elbit alleges that the 073 patent is infringed by broadband satellite systems that practice the Internet Protocol Over Satellite standard.  Elbit alleges that the 874 patent is infringed by the manufacture and sale of broadband satellite systems that provide cellular backhaul service via connections to E1 or T1 interfaces at cellular backhaul base stations.  On March 16, 2015, the defendants filed motions to dismiss portions of Elbit’s complaint.  On April 2, 2015, Elbit responded to those motions to dismiss and further filed an amended complaint removing Helm Hotels Group as a defendant, but making similar allegations against a new defendant Country Home Investments, Inc.  On April 20, 2015, defendants filed motions to dismiss portions of Elbit’s amended complaint.

 

We intend to vigorously defend this case. In the event that a court ultimately determines that we infringe the asserted patents, we may be subject to substantial damages, which may include treble damages, and/or an injunction that could require us to materially modify certain features that we currently offer to consumers. We cannot predict with any degree of certainty the outcome of the suit or determine the extent of any potential liability or damages.

 

TQ Beta LLC

 

On June 30, 2014, TQ Beta LLC (“TQ Beta”) filed suit against DISH Network, DISH DBS Corporation, DISH Network L.L.C., as well as us, EchoStar Technologies, L.L.C, and Sling Media, Inc., a subsidiary of EchoStar, in the United States District Court for the District of Delaware, alleging infringement of United States Patent No. 7,203,456 (“the ‘456 patent”), which is entitled “Method and Apparatus for Time and Space Domain Shifting of Broadcast Signals.”  TQ Beta alleges that the Hopper, Hopper with Sling, ViP 722 and ViP 722k DVR devices, as well as the DISH Anywhere service and DISH Anywhere mobile application, infringe the ‘456 patent, but has not specified the amount of damages that it seeks.  TQ Beta is an entity that seeks to license an acquired patent portfolio without itself practicing any of the claims recited therein.  Trial is set for January 12, 2016.

 

We intend to vigorously defend this case.  In the event that a court ultimately determines that we infringe the asserted patents, we may be subject to substantial damages, which may include treble damages, and/or an injunction that could require us to materially modify certain features that we currently offer to consumers.  We cannot predict with any degree of certainty the outcome of the suit or determine the extent of any potential liability or damages.

 

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(Unaudited)

 

Other

 

In addition to the above actions, we are subject to various other legal proceedings and claims which arise in the ordinary course of our business.  In our opinion, the amount of ultimate liability with respect to any of these actions is unlikely to materially affect our financial position, results of operations or liquidity, though the outcomes could be material to our operating results for any particular period, depending, in part, upon the operating results for such period.

 

Note 13.            Segment Reporting

 

Operating segments are business components of an enterprise for which separate financial information is available and regularly evaluated by the chief operating decision maker (“CODM”), who for HSS, is the Company’s Chief Executive Officer.  Under this definition, we operate two primary business segments.

 

·                  Hughes — which provides satellite broadband internet access to North American consumers and broadband network services and equipment to domestic and international enterprise markets.  The Hughes segment also provides managed services to large enterprises and solutions to customers for mobile satellite systems.

 

·                  EchoStar Satellite Services which uses certain of our owned and leased in-orbit satellites and related licenses to provide satellite services on a full-time and occasional-use basis primarily to DISH Network, Dish Mexico, U.S. government service providers, internet service providers, broadcast news organizations, programmers, and private enterprise customers.

 

The primary measure of segment profitability that is reported regularly to our CODM is earnings before interest, taxes, depreciation and amortization, or EBITDA.  Our segment operating results do not include real estate and other activities, costs incurred in certain satellite development programs and other business development activities, expenses of various corporate departments, and our centralized treasury operations, including income from our investment portfolio and interest expense on our debt.  These activities are accounted for in the “All Other and Eliminations” column in the table below.  Total assets by segment have not been reported herein because the information is not provided to our CODM on a regular basis.  The Hughes Retail Group is included in our Hughes segment and our CODM reviews separate HRG financial information only to the extent such information is included in our periodic filings with the SEC.  Therefore, we do not consider HRG to be a separate operating segment.

 

Transactions between segments were not significant for the three months ended March 31, 2015 and 2014.

 

The following table presents revenue, EBITDA, and capital expenditures for each of our operating segments:

 

 

 

 

 

EchoStar

 

All

 

 

 

 

 

 

 

Satellite

 

Other and

 

Consolidated

 

 

 

Hughes

 

Services

 

Eliminations

 

Total

 

 

 

(In thousands)

 

For the Three Months Ended March, 31, 2015

 

 

 

 

 

 

 

 

 

External revenue

 

$

324,950

 

$

125,198

 

$

86

 

$

450,234

 

Intersegment revenue

 

$

330

 

$

200

 

$

(530

)

$

 

Total revenue

 

$

325,280

 

$

125,398

 

$

(444

)

$

450,234

 

Capital expenditures

 

$

64,527

 

$

27,783

 

$

 

$

92,310

 

EBITDA

 

$

91,273

 

$

106,419

 

$

1,289

 

$

198,981

 

For the Three Months Ended March, 31, 2014

 

 

 

 

 

 

 

 

 

External revenue

 

$

314,371

 

$

99,872

 

$

 

$

414,243

 

Intersegment revenue

 

$

400

 

$

949

 

$

(1,279

)

$

70

 

Total revenue

 

$

314,771

 

$

100,821

 

$

(1,279

)

$

414,313

 

Capital expenditures

 

$

45,972

 

$

29

 

$

 

$

46,001

 

EBITDA

 

$

81,939

 

$

84,782

 

$

779

 

$

167,500

 

 

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(Unaudited)

 

The following table reconciles total consolidated EBITDA to reported “Net income attributable to HSS” in our condensed consolidated statements of operations and comprehensive income (loss):

 

 

 

For the Three Months Ended
March 31,

 

 

 

2015

 

2014

 

 

 

(In thousands)

 

EBITDA

 

$

198,981

 

$

167,500

 

Interest income and expense, net

 

(43,987

)

(47,792

)

Depreciation and amortization

 

(108,014

)

(108,185

)

Income tax provision, net

 

(17,973

)

(201

)

Net income attributable to HSS

 

$

29,007

 

$

11,322

 

 

Note 14.            Related Party Transactions

 

EchoStar

 

We and EchoStar have agreed that we shall have the right, but not the obligation, to receive from EchoStar certain corporate services, including among other things: treasury, tax, accounting and reporting, risk management, legal, internal audit, human resources, and information technology.  In addition, we occupy certain office space in buildings owned by EchoStar and pay a portion of the taxes, insurance, utilities and maintenance of the premises in accordance with the percentage of the space we occupy.  These services are provided at cost.  We may terminate a particular service we receive from EchoStar for any reason upon at least 30 days’ notice.  We recorded expenses for services received from EchoStar of $3.4 million and $2.8 million for the three months ended March 31, 2015 and 2014, respectively.

 

DISH Network

 

Following the Spin-off, EchoStar and DISH Network have operated as separate publicly-traded companies.  However, pursuant to the Satellite and Tracking Stock Transaction, described in Note 2 and below, DISH Network owns Hughes Retail Preferred Tracking Stock representing an aggregate 80.0% economic interest in the residential retail satellite broadband business of our Hughes segment, including certain operations, assets and liabilities attributed to such business.  In addition, a substantial majority of the voting power of the shares of EchoStar and DISH Network is owned beneficially by Charles W. Ergen, our Chairman, and by certain trusts established by Mr. Ergen for the benefit of his family.

 

In connection with and following the Spin-off, EchoStar and DISH Network have entered into certain agreements pursuant to which we and EchoStar obtain certain products, services and rights from DISH Network; DISH Network obtains certain products, services and rights from us and EchoStar; and we and DISH Network have indemnified each other against certain liabilities arising from our respective businesses.  EchoStar also may enter into additional agreements with DISH Network in the future.  Generally, the amounts DISH Network pays for products and services provided under the agreements are based on our cost plus a fixed margin (unless noted differently below), which varies depending on the nature of the products and services provided.

 

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

 

“Services and other revenue — DISH Network”

 

Satellite Services Provided to DISH Network.  Since the Spin-off, we have entered into certain satellite service agreements pursuant to which DISH Network receives satellite services on certain satellites owned or leased by us.  The fees for the services provided under these satellite service agreements depend, among other things, upon the orbital location of the applicable satellite, the number of transponders that are providing services on the applicable satellite, and the length of the service arrangements.  The terms of each service arrangement is set forth below:

 

EchoStar I, EchoStar VII, EchoStar X, EchoStar XI and EchoStar XIV.  As part of the Satellite and Tracking Stock Transaction discussed in Note 2, on March 1, 2014, we began providing certain satellite services to DISH Network on the EchoStar I, EchoStar VII, EchoStar X, EchoStar XI and EchoStar XIV satellites.  The term of

 

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(Unaudited)

 

each satellite services agreement generally terminates upon the earlier of:  (i) the end of life of the satellite; (ii) the date the satellite fails; or (iii) a certain date, which depends upon, among other things, the estimated useful life of the satellite.  DISH Network generally has the option to renew each satellite service agreement on a year-to-year basis through the end of the respective satellite’s life.  There can be no assurance that any options to renew such agreements will be exercised.

 

EchoStar VIII.  In May 2013, DISH Network began receiving satellite services from us on EchoStar VIII as an in-orbit spare. Effective March 1, 2014, this satellite services arrangement converted to a month-to-month service agreement. Both parties have the right to terminate this agreement upon 30 days’ notice.

 

EchoStar IX.  Effective January 2008, DISH Network began receiving satellite services from us on EchoStar IX.  Subject to availability, DISH Network generally has the right to continue to receive satellite services from us on EchoStar IX on a month-to-month basis.

 

EchoStar XII.  DISH Network receives satellite services from us on EchoStar XII.  The term of the satellite services agreement terminates upon the earlier of: (i) the end of life of the satellite; (ii) the date the satellite fails or the date the transponder(s) on which the service was being provided under the agreement fails; or (iii) a certain date, which depends upon, among other things, the estimated useful life of the satellite.  DISH Network generally has the option to renew the agreement on a year-to-year basis through the end of the satellite’s life.  There can be no assurance that any options to renew this agreement will be exercised.

 

EchoStar XVI.  During December 2009, we entered into an initial ten-year transponder service agreement with DISH Network, pursuant to which DISH Network receives satellite services from us on EchoStar XVI.  Effective December 21, 2012, we and DISH Network amended the transponder service agreement to, among other things, change the initial term to generally expire upon the earlier of: (i) the end-of-life or replacement of the satellite; (ii) the date the satellite fails; (iii) the date the transponder(s) on which service is being provided under the agreement fails; or (iv) four years following the actual service commencement date.  Prior to expiration of the initial term, we, upon certain conditions, and DISH Network have the option to renew for an additional six-year period.  If either we or DISH Network exercise our respective six-year renewal options, DISH Network has the option to renew for an additional five-year period prior to expiration of the then-current term.  There can be no assurance that any option to renew this agreement will be exercised.  We began to provide satellite services on EchoStar XVI to DISH Network in January 2013.

 

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

 

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

 

QuetzSat-1 Agreement.  During 2008, we entered into a ten-year satellite service agreement with SES Latin America, which provides, among other things, for the provision by SES Latin America to us of service on 32 DBS transponders on the QuetzSat-1 satellite.  Concurrently, in 2008, we entered into a transponder service agreement with DISH Network, pursuant to which DISH Network receives satellite services on 24 of the DBS transponders on QuetzSat-1.  QuetzSat-1 was launched on September 29, 2011 and was placed into service during the fourth quarter of 2011 at the 67.1 degree west longitude orbital location.  In the interim, we provided

 

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(Unaudited)

 

DISH Network with alternate capacity at the 77 degree west longitude orbital location.  During the third quarter of 2012, we and DISH Network entered into an agreement pursuant to which we receive certain satellite services from DISH Network on five DBS transponders on the QuetzSat-1 satellite.  In January 2013, QuetzSat-1 was moved to the 77 degree west longitude orbital location and DISH Network commenced commercial operations at such location in February 2013.

 

Under the terms of our contractual arrangements with DISH Network, we began to provide service to DISH Network on the QuetzSat-1 satellite in February 2013 and will continue to provide service through the remainder of the service term.  Unless extended or earlier terminated under the terms and conditions of our agreement with DISH Network for the QuetzSat-1 satellite, the initial service term will expire in November 2021.  Upon expiration of the initial service term, DISH Network has the option to renew the agreement for the QuetzSat-1 satellite on a year-to-year basis through the end of life of the QuetzSat-1 satellite.  Upon an in-orbit failure or end of life of the QuetzSat-1 satellite, and in certain other circumstances, DISH Network has certain rights to receive service from us on a replacement satellite.  There can be no assurance that any options to renew this agreement will be exercised or that DISH Network will exercise its option to receive service on a replacement satellite.

 

103 Degree Orbital Location/SES-3.  During May 2012, we entered into a spectrum development agreement (the “103 Spectrum Development Agreement”) with Ciel Satellite Holdings Inc. (“Ciel”) to develop certain spectrum rights at the 103 degree west longitude orbital location (the “103 Spectrum Rights”).  During June 2013, we and DISH Network entered into a spectrum development agreement (the “DISH 103 Spectrum Development Agreement”) pursuant to which DISH Network may use and develop the 103 Spectrum Rights.  Unless earlier terminated under the terms and conditions of the DISH 103 Spectrum Development Agreement, the term generally will continue for the duration of the 103 Spectrum Rights Agreement.

 

In connection with the 103 Spectrum Development Agreement, during May 2012, we also entered into a ten-year service agreement with Ciel pursuant to which we receive certain satellite services from Ciel on the SES-3 satellite at the 103 degree orbital location (the “103 Service Agreement”).  During June 2013, we and DISH Network entered into an agreement pursuant to which DISH Network receives certain satellite services from us on the SES-3 satellite (the “DISH 103 Service Agreement”).  Under the terms of the DISH 103 Service Agreement, DISH Network makes certain monthly payments to us through the service term.  Unless earlier terminated under the terms and conditions of the DISH 103 Service Agreement, the initial service term will expire on the earlier of: (i) the date the SES-3 satellite fails; (ii) the date the transponder(s) on which service was being provided under the agreement fails; or (iii) ten years following the actual service commencement date.  Upon in-orbit failure or end of life of the SES-3 satellite, and in certain other circumstances, DISH Network has certain rights to receive service from us on a replacement satellite.  There can be no assurance that DISH Network will exercise its option to receive service on a replacement satellite.

 

Satellite and Tracking Stock Transaction.  On February 20, 2014, we entered into agreements with DISH Network to implement a transaction pursuant to which, among other things: (i) on March 1, 2014, EchoStar and HSS issued shares of the Tracking Stock to DISH Network in exchange for five satellites owned by DISH Network (EchoStar I, EchoStar VII, EchoStar X, EchoStar XI and EchoStar XIV) (including related in-orbit incentive obligations and interest payments of approximately $58.9 million) and approximately $11.4 million in cash; and (ii) on March 1, 2014, DISH Network began receiving certain satellite services on these five satellites from us.  See Note 2 for further information.

 

TT&C Agreement.  Effective January 1, 2012, we entered into a telemetry, tracking and control (“TT&C”) agreement pursuant to which we provide TT&C services to DISH Network and its subsidiaries for a period ending on December 31, 2016 (the “2012 TT&C Agreement”).  The 2012 TT&C Agreement replaced the TT&C agreement we entered into with DISH Network in connection with the Spin-off. The fees for services provided under the 2012 TT&C Agreement are calculated at either:  (i) a fixed fee or (ii) cost plus a fixed margin, which will vary depending on the nature of the services provided.  DISH Network is able to terminate the 2012 TT&C Agreement for any reason upon 60 days’ notice.

 

In connection with the Satellite and Tracking Stock Transaction, on February 20, 2014, we amended the TT&C Agreement to cease the provision of TT&C services to DISH Network for the EchoStar I, EchoStar VII, EchoStar X,

 

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(Unaudited)

 

EchoStar XI and EchoStar XIV satellites.  Effective March 1, 2014, we provide TT&C services for DISH Network’s D-1 satellite.

 

Blockbuster Agreements.  On April 26, 2011, DISH Network acquired substantially all of the assets of Blockbuster, Inc. (the “Blockbuster Acquisition”).  On June 8, 2011, we completed the Hughes Acquisition.  Hughes Network Systems, LLC (“HNS”) provided certain broadband products and services to Blockbuster, Inc. (“Blockbuster”) pursuant to an agreement that was entered into prior to the Blockbuster Acquisition and the Hughes Acquisition.  Subsequent to both the Blockbuster Acquisition and the Hughes Acquisition, Blockbuster entered into a new agreement with HNS pursuant to which Blockbuster could continue to purchase broadband products and services from our Hughes segment (the “Blockbuster VSAT Agreement”).

 

Effective February 1, 2014, all services to all Blockbuster locations, including Blockbuster franchisee locations, terminated in connection with the closing of all of the Blockbuster retail locations.

 

Radio Access Network Agreement.  On November 29, 2012, HNS entered into an agreement with DISH Network L.L.C. pursuant to which HNS constructed for DISH Network a ground-based satellite radio access network for a fixed fee.  The parties mutually agreed to terminate this agreement in the fourth quarter of 2014.

 

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

 

Hughes Broadband Distribution Agreement.  Effective October 1, 2012, HNS and dishNET Satellite Broadband L.L.C. (“dishNET”), a wholly-owned subsidiary of DISH Network, entered into a distribution agreement (the “Distribution Agreement”) pursuant to which dishNET has the right, but not the obligation, to market, sell and distribute the Hughes satellite internet service (the “Hughes service”).  dishNET pays HNS a monthly per subscriber wholesale service fee for the Hughes service based upon a subscriber’s service level, and, beginning January 1, 2014, based upon certain volume subscription thresholds.  The Distribution Agreement also provides that dishNET has the right, but not the obligation, to purchase certain broadband equipment from us to support the sale of the Hughes service.  The Distribution Agreement has an initial term of five years with automatic renewal for successive one year terms unless terminated by either party with a written notice at least 180 days before the expiration of the then-current term.  On February 20, 2014, HNS and dishNET entered into an amendment to the Distribution Agreement which, among other things, extended the initial term of the Distribution Agreement through March 1, 2024.  Upon expiration or termination of the Distribution Agreement, the parties will continue to provide the Hughes service to the then-current dishNET subscribers pursuant to the terms and conditions of the Distribution Agreement.

 

DBSD North America Agreement.  On March 9, 2012, DISH Network completed its acquisition of 100% of the equity of reorganized DBSD North America, Inc. (“DBSD North America”).  Prior to DISH Network’s acquisition of DBSD North America and our completion of the Hughes Acquisition, DBSD North America and HNS entered into an agreement pursuant to which our Hughes segment provides, among other things, hosting, operations and maintenance services of DBSD North America’s satellite gateway and associated ground infrastructure.  This agreement automatically renewed for a one-year period ending on February 15, 2016, and will renew for one additional one-year period unless terminated by DBSD North America upon at least 30 days’ notice prior to the expiration of any renewal term.

 

“Cost of sales — services and other — DISH Network”

 

Satellite Services Received from DISH Network.  Since the Spin-off, EchoStar entered into certain satellite services agreements pursuant to which, it receives certain satellite services from DISH Network on certain satellites owned or leased by DISH Network.  The fees for the services provided under these satellite services agreements depend, among other things, upon the orbital location of the applicable satellite, the number of transponders that are providing services on the applicable satellite and the length of the service term.  In November 2012, HNS entered

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

into a satellite service agreement pursuant to which HNS received satellite services from DISH Network on the D-1 satellite for research and development.  This agreement terminated on June 30, 2014.

 

“General and administrative expenses — DISH Network”

 

Professional Services Agreement.  In connection with the Spin-off, EchoStar entered into various agreements with DISH Network including the Transition Services Agreement, Satellite Procurement Agreement and Services Agreement, which all expired on January 1, 2010 and were replaced by a Professional Services Agreement.  During 2009, EchoStar and DISH Network agreed that EchoStar shall continue to have the right, but not the obligation, to receive the following services from DISH Network, among others, certain of which were previously provided under the Transition Services Agreement: information technology, travel and event coordination, internal audit, legal, accounting and tax, benefits administration, program acquisition services and other support services.  Additionally, EchoStar and DISH Network agreed that DISH Network would continue to have the right, but not the obligation, to engage us to manage the process of procuring new satellite capacity for DISH Network (previously provided under the Satellite Procurement Agreement), receive logistics, procurement and quality assurance services from EchoStar (previously provided under the Services Agreement) and other support services.  A portion of these costs and expenses have been allocated to us in the manner described above under the caption “EchoStar.”  The Professional Services Agreement automatically renewed on January 1, 2015 for an additional one-year period and renews automatically for successive one-year periods thereafter, unless terminated earlier by either party upon at least 60 days’ notice.  However, either party may terminate the Professional Services Agreement in part with respect to any particular service it receives for any reason upon at least 30 days’ notice.

 

Real Estate Lease Agreements.  Since the Spin-off, we have entered into lease agreements pursuant to which we lease certain real estate from DISH Network.  The rent on a per square foot basis for each of the leases is comparable to per square foot rental rates of similar commercial property in the same geographic area at the time of the lease, and we are responsible for our portion of the taxes, insurance, utilities and maintenance of the premises.  The license for certain space at 796 East Utah Valley Drive in American Fork, Utah is for a period ending on July 31, 2017, subject to the terms of the underlying lease agreement. This license was terminated during the fourth quarter of 2014.

 

“Other agreements — DISH Network”

 

Tax Sharing Agreement. As a subsidiary of EchoStar, we are an indirect party to EchoStar’s tax sharing agreement with DISH Network that was entered into in connection with the Spin-off.  This agreement governs EchoStar and DISH Network’s respective rights, responsibilities and obligations after the Spin-off with respect to taxes for the periods ending on or before the Spin-off.  Generally, all pre-Spin-off taxes, including any taxes that are incurred as a result of restructuring activities undertaken to implement the Spin-off, are borne by DISH Network, and DISH Network will indemnify EchoStar for such taxes.  However, DISH Network is not liable for and will not indemnify EchoStar for any taxes that are incurred as a result of the Spin-off or certain related transactions failing to qualify as tax-free distributions pursuant to any provision of Section 355 or Section 361 of the Internal Revenue Code of 1986, as amended because of: (i) a direct or indirect acquisition of any of EchoStar’s stock, stock options or assets; (ii) any action that EchoStar takes or fails to take; or (iii) any action that EchoStar takes that is inconsistent with the information and representations furnished to the IRS in connection with the request for the private letter ruling, or to counsel in connection with any opinion being delivered by counsel with respect to the Spin-off or certain related transactions.  In such case, EchoStar will be solely liable for, and will indemnify DISH Network for, any resulting taxes, as well as any losses, claims and expenses.  The tax sharing agreement will only terminate after the later of the full period of all applicable statutes of limitations, including extensions, or once all rights and obligations are fully effectuated or performed.

 

In light of the tax sharing agreement, among other things, and in connection with EchoStar’s consolidated federal income tax returns for certain tax years prior to and for the year of the Spin-off, during the third quarter of 2013, EchoStar and DISH Network agreed upon a supplemental allocation of the tax benefits arising from certain tax items resolved in the course of the IRS’s examination of EchoStar’s consolidated tax returns.  As a result, DISH Network agreed to pay EchoStar an amount that includes $93.1 million of the federal tax benefit they received as a result of our operations, which has been classified as other noncurrent assets in our consolidated balance sheets as of March 31, 2015 and December 31, 2014.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Other Agreements

 

Hughes Systique Corporation (“Hughes Systique”)

 

We contract with Hughes Systique for software development services.  In February 2008, Hughes agreed to make available to Hughes Systique a term loan facility of up to $1.5 million.  Also in 2008, Hughes funded an initial $0.5 million to Hughes Systique pursuant to the term loan facility.  In 2009, HNS funded the remaining $1.0 million of its $1.5 million commitment under the term loan facility.  The loans bear interest at 6%, payable annually, and are convertible into shares of Hughes Systique upon non-payment or an event of default.  In May 2014, Hughes and Hughes Systique entered into an amendment to the term loan facility to increase the interest rate from 6% to 8%, payable annually, to reflect current market conditions.  The loans, as amended, matured on May 1, 2015.  In April 2015, Hughes Systique repaid $0.7 million of the outstanding principal of the loan and we extended the maturity date of the loan to May 1, 2016 on the same terms.  In addition to our 44.1% ownership in Hughes Systique, Mr. Pradman Kaul, the President of Hughes Communications, Inc. and a member of EchoStar’s Board of Directors and his brother, who is the CEO and President of Hughes Systique, in the aggregate, owned approximately 25.9%, on an undiluted basis, of Hughes Systique’s outstanding shares as of March 31, 2015.  Furthermore, Mr. Pradman Kaul serves on the board of directors of Hughes Systique.  We are considered the “primary beneficiary” of Hughes Systique due to, among other factors, our ability to significantly influence and direct the operating and financial decisions of Hughes Systique and our obligation to provide financial support in the form of term loans.  As a result, we are required to consolidate Hughes Systique’s financial statements in our condensed consolidated financial statements.

 

Dish Mexico

 

EchoStar owns 49% of an entity that provides direct-to-home satellite service in Mexico known as Dish Mexico, and we provide certain satellite services to Dish Mexico.  We recognized satellite services revenue from Dish Mexico of approximately $5.8 million for each of the three months ended March 31, 2015 and 2014.  As of March 31, 2015 and December 31, 2014, we had trade accounts receivable from Dish Mexico of approximately $3.9 million.

 

Deluxe/EchoStar LLC

 

We own 50% of Deluxe/EchoStar LLC (“Deluxe”), a joint venture that we entered into in 2010 to build an advanced digital cinema satellite distribution network targeting delivery to digitally equipped theaters in the U.S. and Canada.  We account for our investment in Deluxe using the equity method.  We recognized revenue from Deluxe for transponder services and the sale of broadband equipment of approximately $0.7 million and $0.9 million for the three months ended March 31, 2015 and 2014, respectively.  As of March 31, 2015 and December 31, 2014, we had trade accounts receivable from Deluxe of approximately $0.1 million and $0.2 million, respectively.

 

Note 15.            Supplemental Guarantor and Non-Guarantor Financial Information

 

Certain of our wholly-owned subsidiaries (together, the “Guarantor Subsidiaries”) have fully and unconditionally guaranteed, on a joint and several basis, the obligations of our 6 1/2% senior secured notes due 2019 and 7 5/8 % senior notes due 2021 (collectively, the “Notes”), which were issued on June 1, 2011.  See Note 10 for further information on the Notes.

 

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

 

The indentures governing the Notes contain restrictive covenants that, among other things, impose limitations on our ability and the ability of our restricted subsidiaries to pay dividends or make distributions, incur additional debt,

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

make certain investments, create liens or enter into sale and leaseback transactions, merge or consolidate with another company, transfer and sell assets, or enter into transactions with affiliates.

 

The condensed consolidating financial information presented below should be read in conjunction with our condensed consolidated financial statements and notes thereto included herein.

 

Condensed Consolidating Balance Sheet as of March 31, 2015

(In thousands)

 

 

 

 

 

Guarantor

 

Non-
Guarantor

 

 

 

 

 

 

 

HSS

 

Subsidiaries

 

Subsidiaries

 

Eliminations

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

157,464

 

$

30,188

 

$

31,741

 

$

 

$

219,393

 

Marketable investment securities

 

426,240

 

6,407

 

 

 

432,647

 

Trade accounts receivable, net

 

 

101,934

 

37,241

 

 

139,175

 

Trade accounts receivable - DISH Network, net

 

 

18,354

 

116

 

 

18,470

 

Inventory

 

 

52,084

 

10,572

 

 

62,656

 

Advances to affiliates, net

 

10

 

270,431

 

 

(269,729

)

712

 

Other current assets

 

11

 

180,378

 

24,494

 

(4,480

)

200,403

 

Total current assets

 

583,725

 

659,776

 

104,164

 

(274,209

)

1,073,456

 

Restricted cash and cash equivalents

 

10,559

 

7,500

 

639

 

 

18,698

 

Property and equipment, net

 

 

2,217,402

 

52,619

 

 

2,270,021

 

Regulatory authorizations

 

 

471,658

 

 

 

471,658

 

Goodwill

 

 

504,173

 

 

 

504,173

 

Other intangible assets, net

 

 

145,462

 

 

 

145,462

 

Investment in subsidiaries

 

3,094,800

 

85,538

 

 

(3,180,338

)

 

Advances to affiliates

 

700

 

1,716

 

 

(2,416

)

 

Other noncurrent assets, net

 

51,829

 

163,600

 

8,016

 

(14,289

)

209,156

 

Total assets

 

$

3,741,613

 

$

4,256,825

 

$

165,438

 

$

(3,471,252

)

$

4,692,624

 

Liabilities and Shareholders’ Equity (Deficit)

 

 

 

 

 

 

 

 

 

 

 

Trade accounts payable

 

$

 

$

92,156

 

$

11,133

 

$

 

$

103,289

 

Trade accounts payable - DISH Network

 

 

19

 

 

 

19

 

Current portion of long-term debt and capital lease obligations

 

 

26,533

 

2,362

 

 

28,895

 

Advances from affiliates, net

 

256,154

 

1,824

 

19,491

 

(269,729

)

7,740

 

Accrued expenses and other

 

104,644

 

64,113

 

24,119

 

(4,480

)

188,396

 

Total current liabilities

 

360,798

 

184,645

 

57,105

 

(274,209

)

328,339

 

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

 

2,000,000

 

316,977

 

1,549

 

 

2,318,526

 

Advances from affiliates

 

 

 

10,801

 

(2,416

)

8,385

 

Other non-current liabilities

 

 

660,403

 

63

 

(14,289

)

646,177

 

Total HSS shareholders’ equity (deficit)

 

1,380,815

 

3,094,800

 

85,538

 

(3,180,338

)

1,380,815

 

Noncontrolling interests

 

 

 

10,382

 

 

10,382

 

Total liabilities and shareholders’ equity (deficit)

 

$

3,741,613

 

$

4,256,825

 

$

165,438

 

$

(3,471,252

)

$

4,692,624

 

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Condensed Consolidating Balance Sheet as of December 31, 2014

(In thousands)

 

 

 

 

 

 

 

Non-

 

 

 

 

 

 

 

 

 

Guarantor

 

Guarantor

 

 

 

 

 

 

 

HSS

 

Subsidiaries

 

Subsidiaries

 

Eliminations

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

142,762

 

$

51,592

 

$

31,203

 

$

 

$

225,557

 

Marketable investment securities

 

388,440

 

6,552

 

 

 

394,992

 

Trade accounts receivable, net

 

 

96,881

 

43,312

 

 

140,193

 

Trade accounts receivable - DISH Network, net

 

 

19,118

 

131

 

 

19,249

 

Advances to affiliates, net

 

10

 

191,384

 

 

(190,658

)

736

 

Inventory

 

 

42,996

 

8,601

 

 

51,597

 

Other current assets

 

39

 

176,657

 

24,296

 

(4,480

)

196,512

 

Total current assets

 

531,251

 

585,180

 

107,543

 

(195,138

)

1,028,836

 

Restricted cash and cash equivalents

 

9,553

 

7,500

 

599

 

 

17,652

 

Property and equipment, net

 

 

2,225,085

 

49,483

 

 

2,274,568

 

Regulatory authorizations

 

 

471,658

 

 

 

471,658

 

Goodwill

 

 

504,173

 

 

 

504,173

 

Other intangible assets, net

 

 

157,100

 

 

 

157,100

 

Investment in subsidiaries

 

3,038,984

 

83,644

 

 

(3,122,628

)

 

Advances to affiliates

 

700

 

1,716

 

 

(2,416

)

 

Other noncurrent assets, net

 

39,062

 

161,763

 

9,772

 

 

210,597

 

Total assets

 

$

3,619,550

 

$

4,197,819

 

$

167,397

 

$

(3,320,182

)

$

4,664,584

 

Liabilities and Shareholders’ Equity (Deficit)

 

 

 

 

 

 

 

 

 

 

 

Trade accounts payable

 

$

295

 

$

82,928

 

$

10,560

 

$

 

$

93,783

 

Trade accounts payable - DISH Network

 

 

18

 

 

 

18

 

Current portion of long-term debt and capital lease obligations

 

 

37,979

 

1,767

 

 

39,746

 

Advances from affiliates, net

 

193,671

 

1,494

 

19,285

 

(190,658

)

23,792

 

Accrued expenses and other

 

66,000

 

81,337

 

29,757

 

(4,480

)

172,614

 

Total current liabilities

 

259,966

 

203,756

 

61,369

 

(195,138

)

329,953

 

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

 

2,000,000

 

323,889

 

1,528

 

 

2,325,417

 

Advances from affiliates

 

 

 

10,768

 

(2,416

)

8,352

 

Other non-current liabilities

 

 

631,190

 

75

 

 

631,265

 

Total HSS shareholders’ equity (deficit)

 

1,359,584

 

3,038,984

 

83,644

 

(3,122,628

)

1,359,584

 

Noncontrolling interests

 

 

 

10,013

 

 

10,013

 

Total liabilities and shareholders’ equity (deficit)

 

$

3,619,550

 

$

4,197,819

 

$

167,397

 

$

(3,320,182

)

$

4,664,584

 

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
for the Three Months Ended March 31, 2015.

(In thousands)

 

 

 

HSS

 

Guarantor 
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminations

 

Total

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

Services and other revenue - other

 

$

 

$

246,411

 

$

36,531

 

$

(13,263

)

$

269,679

 

Services and other revenue - DISH Network

 

 

131,262

 

179

 

 

131,441

 

Equipment revenue - other

 

 

44,854

 

5,981

 

(2,784

)

48,051

 

Equipment revenue - DISH Network

 

 

1,063

 

 

 

1,063

 

Total revenue

 

 

423,590

 

42,691

 

(16,047

)

450,234

 

Costs and Expenses:

 

 

 

 

 

 

 

 

 

 

 

Costs of sales - services and other (exclusive of depreciation and amortization)

 

 

118,087

 

25,094

 

(13,263

)

129,918

 

Cost of sales - equipment (exclusive of depreciation and amortization)

 

 

43,056

 

4,590

 

(2,435

)

45,211

 

Selling, general and administrative expenses

 

 

62,894

 

8,000

 

(349

)

70,545

 

Research and development expenses

 

 

5,554

 

 

 

5,554

 

Depreciation and amortization

 

 

106,392

 

1,622

 

 

108,014

 

Total costs and expenses

 

 

335,983

 

39,306

 

(16,047

)

359,242

 

Operating income

 

 

87,607

 

3,385

 

 

90,992

 

Other Income (Expense):

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

833

 

58

 

251

 

(43

)