filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
market. Of the $1.063 billion of revenue backlog as of December 31, 2012, we expect to recognize approximately $391 million of revenue in 2013.
We continue our efforts in growing our consumer revenue, which depends on our success in adding new subscribers on our Hughes segment’s satellite networks. Accordingly, we may need to adjust our service offerings in response to the offerings of our competitors, including ViaSat Communications, Inc. In addition, we focus on expanding our enterprise business, both domestically and internationally. However, the growth of the enterprise business relies heavily on global economic conditions.
Acquisition of Hughes Communications, Inc. On June 8, 2011, we completed the acquisition of Hughes Communications, Inc. and its subsidiaries (“Hughes Communications”). In connection with the acquisition of Hughes Communications (the “Hughes Acquisition”), we recorded $504 million of goodwill, which was assigned to reporting units of the Hughes segment (“Hughes goodwill”). During the second quarter of 2012, we performed step one of our annual two-step test of impairment of such goodwill. Step one involves a comparison of the estimated fair value of the reporting unit with its carrying amount, including goodwill. We estimated fair value of the reporting units using discounted cash flow techniques, which included significant assumptions about prospective financial information, terminal value and discount rates. Based on this quantitative test, we determined that the estimated fair values of the Hughes reporting units were in excess of the corresponding carrying amounts, including goodwill. Accordingly, we concluded that goodwill assigned to the Hughes segment was not impaired and it was not necessary to perform step-two of the two-step goodwill impairment test. Due to the relatively short period of time that had elapsed since the date of the Hughes Acquisition and the absence of significant changes in our business forecasts and market-based assumptions during that period, the estimated fair values and carrying amounts of our reporting units (which reflect fair value measurements on the acquisition date) had not changed significantly from the acquisition date. Consequently, the estimated fair values of our reporting units did not exceed their corresponding carrying amounts by a substantial amount. If the estimated cash flows reflected in our fair value estimates were decreased by 10% and/or the discount rate used to discount such cash flows were increased by 10%, a portion of our goodwill would have been impaired and it would have been necessary to perform step two of the impairment test to determine the amount of the impairment loss. Based on review and assessment of the business as of December 31, 2012, no “triggering” events were identified that indicated that the Hughes goodwill was impaired as of December 31, 2012. See Note 9 in the Notes to our Consolidated Financial Statements in Item 15 of this report for further discussion of our goodwill. Also, see Item 1A. “Risk Factors” for information about the risks related to the Hughes Acquisition.
EchoStar Satellite Services Segment
Our EchoStar Satellite Services segment operates its business using ten of its owned and leased in-orbit satellites, including EchoStar XVI launched in November 2012. We lease capacity on a full-time and occasional-use basis primarily to DISH Network, and secondarily to Dish Mexico, United States government service providers, state agencies, Internet service providers, broadcast news organizations, programmers and private enterprise customers. We continue to pursue expanding our business offerings by providing value added services such as telemetry, tracking and control services to third parties. However, there can be no assurance that we will be able to effectively compete against our competitors due to their significant resources and operating history.
We depend on DISH Network for a significant portion of the revenue for our EchoStar Satellite Services segment and we expect that DISH Network will continue to be the primary source of revenue for our EchoStar Satellite Services segment. Therefore, our results of operations are and will be closely linked to the performance of DISH Network’s pay-TV service as well as changes in DISH Network’s satellite capacity requirements. In November 2012, we launched EchoStar XVI, which is fully leased to DISH Network beginning in the first quarter of 2013, for the delivery of direct-to-home (“DTH”) broadcast services to DISH Network customers in the United States. Any termination or reduction in the services we provide to DISH Network would increase excess capacity on our satellites and require that we aggressively pursue alternative sources of revenue for this segment. Possible adverse effects on the EchoStar Technologies segment from DISH Network’s possible decline in gross subscriber additions are not expected to materially impact the revenue generated within the EchoStar Satellite Services segment in the near term. As of December 31, 2012 and 2011, our EchoStar Satellite Services segment had contracted revenue backlog attributable to satellites currently in orbit of approximately $1.440 billion and $1.285 billion, respectively, and contracted backlog attributable to satellites under construction of zero and $621
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
million, respectively. Of the $1.440 billion of contracted backlog as of December 31, 2012, we expect to recognize approximately $251 million of revenue in 2013.
While we also expect to provide services to other customers, the number of potential new customers for our EchoStar Satellite Services segment is small and may be limited as prospective customers that have been competitors of DISH Network may continue to view us as a competitor due to our common ownership with DISH Network.
Our ability to expand revenues in the EchoStar Satellite Services segment will likely require that we displace incumbent suppliers that generally have well established business models and often benefit from long-term contracts with their customers. As a result, to grow our EchoStar Satellite Services segment we may need to develop or otherwise acquire access to new satellite-delivered services so that we may offer differentiated services to prospective customers. However, there can be no assurance that we would be able to develop or otherwise acquire access to such differentiated services or develop the sales and marketing expertise necessary to sell such services profitably.
In addition, as our satellite fleet ages, we will be required to evaluate replacement alternatives such as acquiring, leasing or constructing additional satellites, with or without customer commitments for capacity, which may require us to seek additional financing. However, there can be no assurance that such financing will be available to fund any such replacement alternatives on terms that would be attractive to us or at all.
New Business Opportunities
We are exploring opportunities to selectively pursue partnerships, joint ventures and strategic acquisition opportunities, domestically and internationally. We believe that investments in these types of opportunities, such as the Brazil DTH market, may allow us to increase our existing market share, expand into new markets, broaden our portfolio of products and intellectual property, and strengthen our relationships with our customers. With our extensive experience in designing, developing, and distributing digital set-top boxes and related products, we can leverage the broader adoption of advanced technologies within set-top boxes to create opportunities for us. We believe that DTH satellite and broadband services are particularly well-suited for countries without extensive telecommunications and cable infrastructure, and we intend to continue to seek new investments and customer relationships with international DTH satellite service and broadband service providers. Our available satellite capacity provides us, in certain cases, with the ability to initiate new services quickly.
In July 2012, we and DISH Network formed DISH Digital L.L.C. (“DISH Digital”), which is owned two-thirds by DISH Network and one-third by EchoStar. DISH Digital was formed to develop and commercialize certain advanced technologies. We, DISH Network and DISH Digital entered into the following agreements with respect to DISH Digital: (i) a contribution agreement pursuant to which we and DISH Network contributed certain assets, including goodwill associated with our acquisition of certain assets of Move Networks, Inc. in 2010 (See Note 15 in the Notes to our Consolidated Financial Statements in Item 15 of this report for further discussion of our acquisition of Move Network, Inc.), in exchange for our respective ownership interests in DISH Digital; (ii) a limited liability company operating agreement, which provides for the governance of DISH Digital; and (iii) a commercial agreement. Pursuant to the commercial agreement, DISH Digital, among other things, has: (a) certain rights and corresponding obligations with respect to DISH Digital’s business; and (b) the right, but not the obligation, to receive certain services from us and DISH Network, respectively. Since a substantial majority of the voting power of the shares of both us and DISH Network is owned beneficially by Charles W. Ergen, our Chairman and DISH Network’s Chairman, or by certain trusts established by Mr. Ergen for the benefit of his family, this is a formation of an entity under common control and a step up in basis is not allowed; therefore, each party’s contributions were recorded at book value for accounting purposes.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
Adverse Economic Conditions
Our ability to grow or maintain our business may be adversely affected by weak global and domestic economic conditions, including wavering consumer confidence and constraints on discretionary purchasing, unemployment, tight credit markets, declines in global and domestic stock markets, falling home prices and other factors that may adversely affect the markets in which we operate. Our ability to increase our income or to generate additional revenues will depend in part on our ability to organically grow our businesses, identify and successfully exploit opportunities to acquire other businesses or technologies, and enter into strategic partnerships. These activities may require significant additional capital that may not be available on terms that would be attractive to us or at all. In particular, volatile credit markets, which have significantly impacted the availability and cost of financing, specifically in the leveraged finance markets, may significantly constrain our ability to obtain financing to support our growth initiatives. These developments in the credit markets may increase our cost of financing and impair our liquidity position. In addition, these developments may cause us to defer or abandon business strategies and transactions that we would otherwise pursue if financing were available on acceptable terms.
Furthermore, unfavorable events in the economy, including deterioration in the credit and equity markets could cause consumer demand for pay-TV services and consequently sales of our digital set-top boxes to DISH Network, Bell TV, Dish Mexico and other international customers to decline materially because consumers may delay purchasing decisions or reduce or reallocate their discretionary spending, which would also have an adverse effect on our Hughes segment.
EXPLANATION OF KEY METRICS AND OTHER ITEMS
Equipment revenue — DISH Network. “Equipment revenue — DISH Network” primarily includes sales of digital set-top boxes and related components, including Slingboxes and related hardware products, and sales of satellite broadband equipment and related equipment, primarily related to the Hughes service, to DISH Network.
Equipment revenue - other. “Equipment revenue - other” primarily includes sales of digital set-top boxes and related components to Bell TV, Dish Mexico, and other domestic and international customers, including sales of Slingboxes and related hardware products and sales of broadband equipment and networks to customers in our enterprise and consumer markets.
Services and other revenue — DISH Network****. “Services and other revenue — DISH Network” primarily includes revenue associated with satellite and transponder leasing, satellite uplinking/downlinking, signal processing, conditional access management, telemetry, tracking and control, professional services, facilities rental revenue, and other services provided to DISH Network. Beginning in October 2012, “Services and other revenue — DISH Network” also include subscriber wholesale service fee for the Hughes service sold to dishNET.
Services and other revenue - other. “Services and other revenue - other” primarily includes the sales of enterprise and consumer broadband services, as well as maintenance and other contracted services. “Services and other revenue - other” also includes revenue associated with satellite and transponder leasing, satellite uplinking/downlinking, and other services provided to customers other than DISH Network.
Cost of sales — equipment. “Cost of sales — equipment” principally includes costs associated with digital set-top boxes and related components sold to DISH Network, Bell TV, Dish Mexico, and other domestic and international customers, including costs associated with Slingboxes and related hardware products. “Cost of sales — equipment” also includes the cost of broadband equipment and networks sold to customers in our enterprise, consumer markets, and to DISH Network.
Cost of sales - services and other. “Cost of sales — services and other” primarily includes the cost of broadband services provided to our enterprise customers, consumer customers, and to DISH Network, as well as the cost of providing maintenance and other contracted services. “Cost of sales — services and other” also includes the costs associated with satellite and transponder leasing, satellite uplinking/downlinking, signal processing, conditional access management, telemetry, tracking and control, professional services, facilities rental revenue, and other services provided to our customers, including DISH Network.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
Research and development expenses. “Research and development expenses” primarily includes costs associated with the design and development of products to support future growth by reducing costs and providing new technology and innovations to our customers.
Selling, general and administrative expenses. “Selling, general and administrative expenses” primarily includes selling and marketing costs and employee-related costs associated with administrative services (i.e., information systems, human resources and other services), including non-cash, stock-based compensation expense. It also includes professional fees (i.e., legal, information systems and accounting services) and other items associated with facilities and administrative services provided by third parties.
Impairments of assets. “Impairments of assets” includes of impairments of our goodwill and certain of our intangible assets.
Interest income. “Interest income” primarily includes interest earned on our cash, cash equivalents and marketable investment securities, including accretion on debt securities.
Interest expense, net of amounts capitalized****. “Interest expense, net of amounts capitalized” primarily includes interest expense associated with the Notes, capital lease obligations (net of capitalized interest), other debt and amortization of debt issuance costs.
Realized gain on marketable investment securities and other investments. “Realized gains on marketable investment securities and other investments” primarily includes gains on the sale or exchange of investments and “other-than-temporary” impairments of marketable and other investment securities.
Gains on investments accounted for at fair value, net. “Gains on investments accounted for at fair value, net” includes unrealized gains and losses from changes in fair value of marketable and other strategic investments accounted for at fair value.
Other, net. “Other, net” primarily includes transaction costs related to acquisitions and dividends received from our marketable investment securities.
Earnings before interest, taxes, depreciation and amortization (“EBITDA”). EBITDA is defined as “Net income attributable to EchoStar” plus “Interest expense, net of amounts capitalized” net of “Interest income,” “Income taxes benefit (provision), net” and “Depreciation and amortization.” EBITDA is not a measure determined in accordance with the United States generally accepted accounting principles (“GAAP”). This “non-GAAP measure” is reconciled to “Net income attributable to EchoStar” in our discussion of “Results of Operations” below. EBITDA should not be considered a substitute for operating income, net income or any other measure determined in accordance with GAAP. Conceptually, EBITDA measures the amount of income generated each period that could be used to service debt, pay taxes and fund capital expenditures. EBITDA should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. EBITDA is used by our management as a measure of operating efficiency and overall financial performance for benchmarking against our peers and competitors. Management believes EBITDA provides meaningful supplemental information regarding liquidity and the underlying operating performance of our business. Management also believes that EBITDA is useful to investors because it is frequently used by securities analysts, investors, and other interested parties to evaluate companies in our industry.
Subscribers. Subscribers include customers that subscribe to our Hughes segment’s small/medium enterprise service, HughesNet and dishNET services, and other reseller arrangements.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
RESULTS OF OPERATIONS
Basis of Presentation
The following discussion and analysis of our consolidated results of operations, financial condition, and liquidity are presented on a historical basis. Our results of operations for the year ended December 31, 2011 also include those of Hughes Communications after June 8, 2011, the date the Hughes Acquisition was completed. Therefore, our results of operations for the year ended December 31, 2012 are not comparable to our results of operations for the years ended December 31, 2011 and 2010.
Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011.
| As of or For the Years Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | Variance | |||||||||||
| Statements of Operations Data | 2012 | 2011 | Amount | % | ||||||||
| (Dollars in thousands) | ||||||||||||
| Revenue: | ||||||||||||
| Equipment revenue - DISH Network | $ | 1,028,588 | $ | 1,158,293 | $ | (129,705 | ) | (11.2 | ) | |||
| Equipment revenue - other | 621,495 | 513,504 | 107,991 | 21.0 | ||||||||
| Services and other revenue - DISH Network | 515,176 | 496,636 | 18,540 | 3.7 | ||||||||
| Services and other revenue - other | 956,445 | 592,998 | 363,447 | 61.3 | ||||||||
| Total revenue | 3,121,704 | 2,761,431 | 360,273 | 13.0 | ||||||||
| Costs and Expenses: | ||||||||||||
| Cost of sales - equipment | 1,397,512 | 1,414,791 | (17,279 | ) | (1.2 | ) | ||||||
| % of Total equipment revenue | 84.7 | % | 84.6 | % | ||||||||
| Cost of sales - services and other | 691,922 | 492,702 | 199,220 | 40.4 | ||||||||
| % of Total services and other revenue | 47.0 | % | 45.2 | % | ||||||||
| Selling, general and administrative expenses (including DISH Network) | 372,644 | 303,276 | 69,368 | 22.9 | ||||||||
| % of Total revenue | 11.9 | % | 11.0 | % | ||||||||
| Research and development expenses | 69,649 | 50,966 | 18,683 | 36.7 | ||||||||
| % of Total revenue | 2.2 | % | 1.8 | % | ||||||||
| Depreciation and amortization | 457,326 | 385,894 | 71,432 | 18.5 | ||||||||
| Impairments of assets | 32,765 | 32,964 | (199 | ) | (0.6 | ) | ||||||
| Total costs and expenses | 3,021,818 | 2,680,593 | 341,225 | 12.7 | ||||||||
| Operating income | 99,886 | 80,838 | 19,048 | 23.6 | ||||||||
| Other Income (Expense): | ||||||||||||
| Interest income | 11,176 | 10,821 | 355 | 3.3 | ||||||||
| Interest expense, net of amounts capitalized | (153,029 | ) | (82,593 | ) | (70,436 | ) | 85.3 | |||||
| Realized gains on marketable investment securities and other investments | 177,558 | 13,666 | 163,892 | * | ||||||||
| Gains on investments accounted for at fair value, net | — | 15,871 | (15,871 | ) | (100.0 | ) | ||||||
| Equity in earnings (losses) of unconsolidated affiliates | (438 | ) | 11,860 | (12,298 | ) | * | ||||||
| Other, net | 59,531 | (24,688 | ) | 84,219 | * | |||||||
| Total other income (expense), net | 94,798 | (55,063 | ) | 149,861 | * | |||||||
| Income before income taxes | 194,684 | 25,775 | 168,909 | * | ||||||||
| Income tax benefit (provision), net | 16,329 | (21,501 | ) | 37,830 | * | |||||||
| Effective tax rate | (8.4 | )% | 83.4 | % | ||||||||
| Net income | 211,013 | 4,274 | 206,739 | * | ||||||||
| Less: Net income (loss) attributable to noncontrolling interests | (35 | ) | 635 | (670 | ) | * | ||||||
| Net income attributable to EchoStar | $ | 211,048 | $ | 3,639 | $ | 207,409 | * | |||||
| Other Data: | ||||||||||||
| EBITDA | $ | 793,898 | $ | 482,806 | $ | 311,092 | 64.4 | |||||
| Subscribers | 659,000 | 626,000 | 33,000 | 5.3 |
- Percentage is not meaningful.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
Equipment revenue — DISH Network. “Equipment revenue — DISH Network” totaled $1.029 billion for the year ended December 31, 2012, a decrease of $130 million or 11.2% compared to the same period in 2011. The decrease was primarily due to lower revenue earned from the sales of set top boxes and related accessories as a result of a decline in the average revenue per unit of set top boxes and related accessories. The decline in set top-box and related accessories pricing was driven by a change in product mix and continued manufacturing efficiencies.
Equipment revenue — other. “Equipment revenue — other” totaled $621 million for the year ended December 31, 2012, an increase of $108 million or 21.0% compared to the same period in 2011. The increase was primarily related to (i) higher equipment revenue of $95 million generated by our Hughes segment from the sales of broadband equipment and networks to customers in our enterprise and consumer markets and (ii) higher sales of set-top boxes and related accessories to our international customers of $16 million.
Services and other revenue — other. “Services and other revenue — other” totaled $956 million for the year ended December 31, 2012, an increase of $363 million or 61.3% compared to the same period in 2011. The increase was primarily related to higher services revenue of $354 million generated by our Hughes segment from the sales of broadband services to customers in our enterprise and consumer markets, and customers’ maintenance and other contracted services and higher transponder services of $9 million provided by our EchoStar Satellite Service segment.
Cost of sales — equipment****. “Cost of sales - equipment” totaled $1.398 billion for the year ended December 31, 2012, a decrease of $17 million or 1.2% compared to the same period in 2011. The decrease was attributable to lower equipment costs incurred of $114 million corresponding with lower sales to DISH Network. The decrease was partially offset by an increase of $85 million in costs associated with higher sales of broadband equipment and networks to customers in our enterprise and consumer markets generated by the Hughes segment and an increase of $13 million in costs corresponding to higher sales of set top-boxes and related accessories to our international customers.
Cost of sales — services and other****. “Cost of sales — services and other” totaled $692 million for the year ended December 31, 2012, an increase of $199 million or 40.4% compared to the same period in 2011. The increase was primarily attributable to higher cost of sales of $184 million incurred by the Hughes segment as a result of higher sales of broadband services to customers in our enterprise and consumer markets, and customers’ maintenance and other contracted services and higher costs of $28 million associated with certain services we provided to DISH Network. The increase was partially offset by lower cost of sales of $13 million relating to the termination of our satellite lease contract on EchoStar I with DISH Network effective July 2012. “Cost of sales — services and other” represented 47.0% and 45.2% of total services and other revenue for the years ended December 31, 2012 and 2011, respectively. The increase in the expense to revenue ratio principally resulted from an increase in revenue and expenses from our Hughes segment.
Selling, general and administrative expenses. “Selling, general and administrative expenses” totaled $373 million for year ended December 31, 2012, an increase of $69 million or 22.9% compared to the same period in 2011. The increase primarily related to higher marketing and advertising expenses and other general and administrative expenses of $72 million incurred by our Hughes segment. “Selling, general and administrative expenses” represented 11.9% and 11.0% of total revenue for the years ended December 31, 2012 and 2011, respectively. The increase in the expense to revenue ratio principally resulted from an increase in revenue and expenses from our Hughes segment.
Depreciation and amortization. “Depreciation and amortization” expense totaled $457 million for the year ended December 31, 2012, an increase of $71 million or 18.5% compared to the same period in 2011. The increase was primarily related to higher amortization and depreciation expense of $67 million from our Hughes segment and an increase in depreciation expense of $27 million related to satellites that were accounted for as capital leases. The increase was partially offset by lower depreciation expense recorded in 2012 primarily due to the retirement of certain of our assets.
Impairments of assets. “Impairments of assets” totaled $32.8 million for the year ended December 31, 2012, a decrease of $0.2 million or 0.6% compared to the same period in 2011. Our 2012 impairments relate to certain
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
contract rights associated with the Hughes Acquisition that were determined to have a lower probability of being realized than was assumed in prior estimates, goodwill associated with the EchoStar Technologies segment, and certain of our regulatory authorizations. Our 2011 impairment was related to the impairment of our CMBStar satellite. See Note 8 or Note 9 for the impairment recorded in 2012 and 2011, respectively, in the Notes to our Consolidated Financial Statements in Item 15 of this report for further discussion.
Interest expense, net of amounts capitalized. “Interest expense, net of amounts capitalized” totaled $153 million for the year ended December 31, 2012, an increase of $70 million or 85.3% compared to the same period in 2011. The increase was primarily related to higher interest expense of: (i) $58 million incurred on the Notes and (ii) $11 million incurred on our capital lease obligations.
Realized gains on marketable investment securities and other investments. “Realized gains on marketable investment securities and other investments” totaled $178 million for the year ended December 31, 2012, an increase of $164 million compared to the same period in 2011. The increase primarily related to higher gains recognized on sales of marketable investment securities and other investments in 2012.
Other, net. “Other, net” totaled $60 million for the year ended December 31, 2012, an increase of $84 million compared to the same period in 2011. The increase was primarily related to dividends received of $46 million from one of our strategic investments in 2012 and transaction costs incurred related to the Hughes Acquisition of $35 million in 2011.
Earnings before interest, taxes, depreciation and amortization. EBITDA was $794 million for the year ended December 31, 2012, an increase of $311 million or 64.4% compared to the same period in 2011. The increase was primarily due to higher services revenue recognized in 2012 and gains of $164 million recognized on sales of our marketable investment securities and other investments. The increase in EBITDA was partially offset by higher cost of sales on services and higher “Selling, general and administrative expenses” incurred for the year ended December 31, 2012. The following table reconciles EBITDA to the accompanying consolidated financial statements.
| For the Years Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | Variance | |||||||||||
| 2012 | 2011 | Amount | % | |||||||||
| (In thousands) | ||||||||||||
| EBITDA | $ | 793,898 | $ | 482,806 | $ | 311,092 | 64.4 | |||||
| Interest expense, net | (141,853 | ) | (71,772 | ) | (70,081 | ) | 97.6 | |||||
| Income tax benefit (provision), net | 16,329 | (21,501 | ) | 37,830 | * | |||||||
| Depreciation and amortization | (457,326 | ) | (385,894 | ) | (71,432 | ) | 18.5 | |||||
| Net income attributable to EchoStar | $ | 211,048 | $ | 3,639 | $ | 207,409 | * |
- Percentage is not meaningful.
Income tax benefit (provision), net. Our income tax benefit totaled approximately $16 million for the year ended December 31, 2012 compared to an income tax provision of $22 million for the same period in 2011. Our effective income tax rate was (8.4%) for the year ended December 31, 2012 versus 83.4% for the same period in 2011. Our effective tax rate for the years ended December 31, 2012 and 2011 were significantly impacted by the changes in our valuation allowance for deferred taxes that are capital in nature.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010.
| As of or For the Years Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | Variance | |||||||||||
| Statements of Operations Data | 2011 | 2010 | Amount | % | ||||||||
| (Dollars in thousands) | ||||||||||||
| Revenue: | ||||||||||||
| Equipment revenue - DISH Network | $ | 1,158,293 | $ | 1,470,173 | $ | (311,880 | ) | (21.2 | ) | |||
| Equipment revenue - other | 513,504 | 347,765 | 165,739 | 47.7 | ||||||||
| Services and other revenue - DISH Network | 496,636 | 468,399 | 28,237 | 6.0 | ||||||||
| Services and other revenue - other | 592,998 | 64,032 | 528,966 | * | ||||||||
| Total revenue | 2,761,431 | 2,350,369 | 411,062 | 17.5 | ||||||||
| Costs and Expenses: | ||||||||||||
| Cost of sales - equipment | 1,414,791 | 1,553,129 | (138,338 | ) | (8.9 | ) | ||||||
| % of Total equipment revenue | 84.6 | % | 85.4 | % | ||||||||
| Cost of sales - services and other | 492,702 | 236,356 | 256,346 | * | ||||||||
| % of Total services and other revenue | 45.2 | % | 44.4 | % | ||||||||
| Selling, general and administrative expenses (including DISH Network) | 303,276 | 143,555 | 159,721 | * | ||||||||
| % of Total revenue | 11.0 | % | 6.1 | % | ||||||||
| Research and development expenses | 50,966 | 46,093 | 4,873 | 10.6 | ||||||||
| % of Total revenue | 1.8 | % | 2.0 | % | ||||||||
| Depreciation and amortization | 385,894 | 228,911 | 156,983 | 68.6 | ||||||||
| Impairments of assets | 32,964 | — | 32,964 | * | ||||||||
| Total costs and expenses | 2,680,593 | 2,208,044 | 472,549 | 21.4 | ||||||||
| Operating income | 80,838 | 142,325 | (61,487 | ) | (43.2 | ) | ||||||
| Other Income (Expense): | ||||||||||||
| Interest income | 10,821 | 14,472 | (3,651 | ) | (25.2 | ) | ||||||
| Interest expense, net of amounts capitalized | (82,593 | ) | (14,560 | ) | (68,033 | ) | * | |||||
| Realized gains on marketable investment securities and other investments | 13,666 | 2,923 | 10,743 | * | ||||||||
| Gains on investments accounted for at fair value, net | 15,871 | 144,473 | (128,602 | ) | (89.0 | ) | ||||||
| Equity in earnings (losses) of unconsolidated affiliates | 11,860 | (2,813 | ) | 14,673 | * | |||||||
| Other, net | (24,688 | ) | 1,953 | (26,641 | ) | * | ||||||
| Total other income (expense), net | (55,063 | ) | 146,448 | (201,511 | ) | * | ||||||
| Income before income taxes | 25,775 | 288,773 | (262,998 | ) | (91.1 | ) | ||||||
| Income tax provision, net | (21,501 | ) | (84,415 | ) | 62,914 | (74.5 | ) | |||||
| Effective tax rate | 83.4 | % | 29.2 | % | ||||||||
| Net income | 4,274 | 204,358 | (200,084 | ) | (97.9 | ) | ||||||
| Less: Net income attributable to noncontrolling interests | 635 | — | 635 | * | ||||||||
| Net income attributable to EchoStar | $ | 3,639 | $ | 204,358 | $ | (200,719 | ) | (98.2 | ) | |||
| Other Data: | ||||||||||||
| EBITDA | $ | 482,806 | $ | 517,772 | $ | (34,966 | ) | (6.8 | ) | |||
| Subscribers | 626,000 | 578,200 | 47,800 | 8.3 |
- Percentage is not meaningful.
Equipment revenue — DISH Network. “Equipment revenue — DISH Network” totaled $1.158 billion for the year ended December 31, 2011, a decrease of $312 million or 21.2% compared to the same period in 2010. The decrease was primarily due to lower revenue earned from the sales of set-top boxes, partially offset by an increase in the average revenue per unit due to a change in sales mix towards higher end models like HD DVRs. Pursuant to the receiver agreement in effect during 2011, set-top boxes were sold to DISH Network at cost plus a fixed margin, resulting in a decline in revenue per unit when lower set-top box costs are incurred.
Equipment revenue - other. “Equipment revenue - other” totaled $514 million for the year ended December 31, 2011, an increase of $166 million or 47.7% compared to the same period in 2010. The increase was primarily related to revenue of $161 million contributed by our Hughes segment from the sale of broadband equipment and networks to customers in our enterprise and consumer markets.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
Services and other revenue - other. “Services and other revenue - other” totaled $593 million for the year ended December 31, 2011, an increase of $529 million compared to the same period in 2010. The increase was primarily related to services revenue of $513 million contributed by our Hughes segment from the sale of broadband services to customers in our enterprise and consumer markets, and customers’ maintenance and other contracted services.
Cost of sales — equipment****. “Cost of sales — equipment” totaled $1.415 billion for the year ended December 31, 2011, a decrease of $138 million or 8.9% compared to the same period in 2010. The decrease primarily resulted from a decrease in sales of digital set-top boxes and related components to DISH Network, partially offset by a $128 million increase in costs associated with the sale of broadband equipment and networks sold to customers in our enterprise and consumer markets from our Hughes segment. “Cost of sales — equipment” represented 84.6% and 85.4% of total equipment revenue for the years ended December 31, 2011 and 2010, respectively. The improvement in the expense to revenue ratio principally resulted from the decrease in sales of set-top boxes and related components to DISH Network which have lower margins as sales are at cost plus a fixed margin.
Cost of sales — services and other****. “Cost of sales — services and other” totaled $493 million for the year ended December 31, 2011, an increase of $256 million compared to the same period in 2010. This change primarily related to costs of $236 million associated with the sale of broadband services provided to customers in our enterprise and consumer markets, and customers’ maintenance and other contracted services from our Hughes segment. “Cost of sales — services and other” represented 45.2% and 44.4% of total services and other revenue for the years ended December 31, 2011 and 2010, respectively. The increase in the expense to revenue ratio principally resulted from an increase in revenue and expenses from our Hughes segment.
Selling, general and administrative expenses. “Selling, general and administrative expenses” totaled $303 million for the year ended December 31, 2011, an increase of $160 million compared to the same period in 2010. This change primarily resulted from an increase in marketing and advertising expenses and other general and administrative expenses, of which $132 million was associated with our Hughes segment. “Selling, general and administrative expenses” represented 11.0% and 6.1% of total revenue for the years ended December 31, 2011 and 2010, respectively. The increase in the expense to revenue ratio principally resulted from an increase in revenue and expenses from our Hughes segment as well as a decrease in equipment revenue from DISH Network.
Depreciation and amortization. “Depreciation and amortization” expense totaled $386 million for the year ended December 31, 2011, an increase of $157 million or 68.6% compared to the same period in 2010. The increase was primarily attributable to additional amortization and depreciation expense of $166 million from our Hughes segment.
Impairments of assets. “Impairments of assets” of $33 million for the year ended December 31, 2011 resulted from impairment of our CMBStar satellite. See Note 8 in the Notes to our Consolidated Financial Statements in Item 15 of this report for further discussion.
Interest expense, net of amounts capitalized. “Interest expense, net of amounts capitalized” totaled $83 million for the year ended December 31, 2011, an increase of $68 million compared to the same period in 2010. This change primarily resulted from an increase in interest expense related to the issuance of our Notes during the second quarter of 2011, partially offset by an increase in capitalized interest associated with the construction of our satellites.
Gains on investments accounted for at fair value, net. “Gains on investments accounted for at fair value, net” for the year ended December 31, 2011 was a net gain of $16 million, a $129 million decrease compared to the same period in 2010. This decrease was attributable to investments accounted for under the fair value method. See Note 5 under “Investments in TerreStar” in the Notes to our Consolidated Financial Statements in Item 15 of this report for further discussion.
Earnings before interest, taxes, depreciation and amortization. EBITDA was $483 million for the year ended December 31, 2011, a decrease of $35 million or 6.8% compared to the same period in 2010. The decrease was primarily due to: 1) higher cost of sales on services and “Selling, general and administrative expenses” incurred in 2011 and 2) lower gains on investment accounted for at fair value recognized in 2011. The decrease was partially offset by higher services revenue earned in 2012. The following table reconciles EBITDA to the accompanying consolidated financial statements.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
| For the Years Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | Variance | |||||||||||
| 2011 | 2010 | Amount | % | |||||||||
| (In thousands) | ||||||||||||
| EBITDA | $ | 482,806 | $ | 517,772 | $ | (34,966 | ) | (6.8 | ) | |||
| Interest expense, net | (71,772 | ) | (88 | ) | (71,684 | ) | * | |||||
| Income tax provision, net | (21,501 | ) | (84,415 | ) | 62,914 | (74.5 | ) | |||||
| Depreciation and amortization | (385,894 | ) | (228,911 | ) | (156,983 | ) | 68.6 | |||||
| Net income attributable to EchoStar | $ | 3,639 | $ | 204,358 | $ | (200,719 | ) | (98.2 | ) |
- Percentage is not meaningful.
Income tax benefit (provision), net. The income tax provision totaled $22 million for the year ended December 31, 2011, a decrease of $63 million compared to the same period in 2010. This change resulted from a decrease in “Income before income taxes” offset by an increase in our effective tax rate. Our effective tax rate for the year ended December 31, 2011 was impacted by the changes in our valuation allowance for deferred taxes that are capital in nature.
Net income attributable to EchoStar. Our net income attributable to EchoStar was $4 million for the year ended December 31, 2011, a decrease of $201 million compared to the same period in 2010. This change was primarily attributable to the changes in revenue and expenses discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Cash, Cash Equivalents and Current Marketable Investment Securities
We consider all liquid investments purchased within 90 days of their maturity to be cash equivalents. See “Item 7A. — Quantitative and Qualitative Disclosures about Market Risk” in this Annual Report on Form 10-K for further discussion regarding our marketable investment securities. As of December 31, 2012, our cash, cash equivalents and current marketable investment securities totaled $1.548 billion compared to $1.696 billion as of December 31, 2011, a decrease of $148 million. This decrease in cash, cash equivalents and current marketable investment securities was primarily driven by cash generated from operations of $505 million, net proceeds from the sales of marketable investment securities of $278 million, partially offset by capital expenditures of $513 million, acquisition of regulatory authorizations of $98 million, and repayment of long-term debt and capital lease obligations of $60 million.
We have investments in various debt and equity instruments including corporate bonds, corporate equity securities, government bonds, and variable rate demand notes (“VRDNs”). VRDNs are long term floating rate municipal bonds with embedded put options that allow the bondholder to sell the security at par plus accrued interest. All of the put options are secured by a pledged liquidity source. Our VRDN portfolio is comprised of investments in municipalities and corporations, which are backed by financial institutions or other highly rated companies that serve as the pledged liquidity source. While they are classified as marketable investment securities, the put option allows VRDNs to be liquidated generally on the same day or on a five business day settlement basis. As of December 31, 2012 and 2011, we held VRDNs, within our current marketable investment securities portfolio, with fair values of $66 million and $219 million, respectively. Our other current marketable investment securities portfolio consists of primarily corporate and government bonds. As of December 31, 2012 and 2011, we held $694 million and $648 million, respectively, of corporate and government bonds and other investment securities.
The following discussion highlights our cash flow activities for the years ended December 31, 2012, 2011 and 2010.
Cash flows from operating activities. We typically reinvest the cash flow from operating activities in our business. For the years ended December 31, 2012, 2011 and 2010, we reported net cash inflows from operating activities of $505 million, $447 million and $404 million, respectively.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
The net cash flows from operating activities for the year ended December 31, 2012 increased by $58 million compared to the same period in 2011. The improvement was primarily attributable to the increase in net income of $163 million adjusted to exclude non-cash changes in: (i) “Depreciation and amortization;” (ii) “Realized gains on marketable investment securities and other investments;” (iii) “Equity in losses (earnings) of unconsolidated affiliates;” (iv) “Gains on investments accounted for at fair value, net;” (v) “Deferred tax expense (benefit);” and (vi) “Other, net.” The increase in net income adjusted to exclude non-cash was partially offset by a $103 million decrease from changes in operating assets and liabilities related to timing differences between the incurrence of expense and cash payments.
The net cash flows from operating activities for the year ended December 31, 2011 increased by $43 million compared to the same period in 2010. The improvement was primarily attributable to cash generated of $55 million from changes in operating assets and liabilities related to timing differences between the incurrence of expense and cash payments. The increase in net cash flows from operating activities was partially offset by a $4 million decrease in net income adjusted to exclude non-cash changes in: (i) “Depreciation and amortization;” (ii) “Realized gains on marketable investment securities and other investments;” (iii) “Gains on investments accounted for at fair value, net;” (iv) the impairment of our CMBStar satellite; and (v) “Deferred tax expense (benefit).”
Cash flows from investing activities. Our investing activities generally include purchases and sales of marketable investment securities, capital expenditures, acquisitions, and strategic investments. For the years ended December 31, 2012, 2011 and 2010, we reported net cash outflows from investing activities of $347 million, $1.888 billion and $239 million, respectively.
The net cash outflows from investing activities for the year ended December 31, 2012 decreased by $1.541 billion compared to the same period in 2011. The decrease was primarily due to the acquisition cost of Hughes Communications of $2.075 billion, net of cash received and proceeds from the sale of a strategic investment of $713 million, both of which provided a net cash outflow of $1.362 billion for the years ended December 31, 2011. In addition, the decrease in net cash outflows was attributable to higher net sales of our marketable investment securities of $348 million for the year ended December 31, 2012 compared to the same period in 2011. The decrease in net cash outflows was partially offset by higher capital expenditures of $136 million incurred in 2012 compared to 2011.
The net cash outflows from investing activities for the year ended December 31, 2011 increased by $1.649 billion compared to the same period in 2010. The increase was due to the acquisition costs of Hughes Communication of $2.075 billion, net of cash received and higher capital expenditures of $180 million incurred in 2011 compared to 2010. The increase in net cash outflow was partially offset by proceeds from the sale of a strategic investment of $713 million in 2011.
Cash flows from financing activities. Our financing activities generally include proceeds related to the issuance of long-term debt and cash used for the repurchase, redemption or payment of long-term debt and capital lease obligations. For the years ended December 31, 2012, 2011 and 2011, we reported a net cash outflows from financing activities of $44 million, a net cash inflow from financing activities of $1.914 billion, and a net cash outflows from financing activities of $47 million, respectively.
The net cash outflows from financing activities decreased $1.958 billion for the year ended December 31, 2012 compared to the same period in 2011 and increased $1.961 billion for the year ended December 31, 2011 compared to the same period in 2010. The change in net cash flow from 2010 to 2011 and from 2011 to 2012 was primarily due to the one-time proceeds received of $2.0 billion from the issuance of the Notes in 2011.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
Obligations and Future Capital Requirements
Contractual Obligations and Off-Balance Sheet Arrangements
As of December 31, 2012 future maturities of our contractual obligations are summarized as follows:
| Payments due in the Year Ending December 31, | ||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total | 2013 | 2014 | 2015 | 2016 | 2017 | Thereafter | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||||
| Long-term debt obligations | $ | 2,002,041 | $ | 1,661 | $ | 207 | $ | 165 | $ | 8 | $ | — | $ | 2,000,000 | ||||||||
| Capital lease obligations | 486,458 | 66,048 | 72,535 | 26,269 | 29,095 | 32,472 | 260,039 | |||||||||||||||
| Interest expense on long-term debt and capital lease obligations | 1,329,344 | 186,475 | 183,531 | 175,524 | 172,704 | 169,569 | 441,541 | |||||||||||||||
| Satellite-related obligations | 919,669 | 216,511 | 203,748 | 168,908 | 49,494 | 40,641 | 240,367 | |||||||||||||||
| Operating lease obligations | 70,429 | 19,196 | 16,613 | 13,052 | 8,031 | 5,434 | 8,103 | |||||||||||||||
| Purchase and other obligations | 250,554 | 243,257 | 2,296 | 1,667 | 1,667 | 1,667 | — | |||||||||||||||
| Payments in connection with acquisition | 15,770 | 11,189 | 4,581 | — | — | — | — | |||||||||||||||
| Total | $ | 5,074,265 | $ | 744,337 | $ | 483,511 | $ | 385,585 | $ | 260,999 | $ | 249,783 | $ | 2,950,050 |
“Satellite-related obligations” primarily includes, among other things, costs for our capital lease satellites, transponder agreements and in-orbit incentives relating to EchoStar XVI and EchoStar XVII, which were launched in the second half of 2012. In addition, “Satellite-related obligations” also includes our commitment relating to a launch contract we entered into with Arianespace, SA in November 2012 to launch multiple new satellites over a multi-year period.
Our “Purchase and other obligations” primarily consists of binding purchase orders for digital set-top boxes and related components. Our purchase obligations can fluctuate significantly from period to period due to, among other things, management’s control of inventory levels, and can materially impact our future operating asset and liability balances, and our future working capital requirements.
The table above does not include $30 million of liabilities associated with unrecognized tax positions that were accrued as of December 31, 2012 and are included on our Consolidated Balance Sheets. We do not expect any portion of this amount to be paid or settled within the next 12 months.
In certain circumstances, the dates on which we are obligated to make these payments could be delayed. These amounts will increase to the extent we procure insurance for our satellites or contract for the construction, launch, or lease of additional satellites.
O****ff-Balance Sheet Arrangements
Other than from the transactions below, we generally do not engage in off-balance sheet financing activities or use derivative financial instruments for hedge accounting or speculative purposes.
As of December 31, 2012, we had $33 million of letters of credit and insurance bonds. Of this amount, $1 million was secured by restricted cash; $4 million was related to insurance bonds; and $28 million was issued under credit arrangements available to our foreign subsidiaries. Certain letters of credit issued by our foreign subsidiaries are secured by their assets.
As of December 31, 2012, we had foreign currency forward contracts with a notional value of $28 million, primarily in connection with a revenue contract in Mexico. From time to time, we may enter into foreign currency forward contracts, or take other measures, to mitigate risks associated with foreign currency denominated assets, liabilities, commitments and anticipated foreign currency transactions.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
Satellite Insurance
We generally do not carry insurance for any of the in-orbit satellites that we use because we believe that the premium costs are uneconomical relative to the risk of satellite failure. However, pursuant to the terms of the agreements governing certain portions of our indebtedness, we are required, subject to certain limitations on coverage, to maintain launch and in-orbit insurance for SPACEWAY 3, EchoStar XVI, and EchoStar XVII. The loss of a satellite or other satellite malfunctions or anomalies could have a material adverse effect on our financial performance which we may not be able to mitigate by using available capacity on other satellites. 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. In addition, the loss of a satellite or other satellite malfunctions or anomalies could affect our ability to comply with Federal Communications Commission and other regulatory obligations and our ability to fund the construction or acquisition of replacement satellites for our in-orbit fleet in a timely fashion, or at all.
Future Capital Requirements
We primarily rely on our existing cash and marketable investment securities balances, as well as cash flow generated through our operations to fund our investment needs. Since we currently depend on DISH Network for a substantial portion of our revenue, our cash flow from operations depends heavily on its needs for equipment and services. To the extent that DISH Network’s gross subscriber additions decrease or DISH Network experiences a net loss of subscribers, sales of our digital set-top boxes and related components to DISH Network may further decline, which in turn could have a further material adverse effect on our financial position and results of operations. In November 2012, we entered into a launch agreement with Arianespace, SA to launch multiple new satellites over a multi-year period. As of December 31, 2012, our remaining obligations related to EchoStar XVI, EchoStar XVII and the launch contract with Arianespace, SA totaled $329 million. As a result, there can be no assurance that we will have positive cash flows from operations. Furthermore, if we experience negative cash flows, our existing cash and marketable investment securities balances may be reduced.
We have a significant amount of outstanding indebtedness. As of December 31, 2012, our total indebtedness was $2.002 billion. Our liquidity requirements will be significant, primarily due to our debt service requirements. In addition, our future capital expenditures are likely to increase if we make additional investments in infrastructure necessary to support and expand our business, or if we decide to purchase one or more additional satellites. Other aspects of our business operations may also require additional capital. We periodically evaluate various strategic initiatives, the pursuit of which also could require us to raise significant additional capital.
Satellites
As our satellite fleet ages, we will be required to evaluate replacement alternatives such as acquiring, leasing, or constructing additional satellites, with or without customer commitments for capacity. We also may construct or lease additional satellites in the future to provide satellite services at additional orbital locations or to improve the quality of our satellite services.
Stock Repurchases
Pursuant to a stock repurchase plan approved by our Board of Directors, we are authorized to repurchase up to $500 million of our outstanding shares of Class A common stock through and including December 31, 2013. During the years ended December 31, 2012 and 2011, we did not repurchase any common stock under this plan. During the year ended December 31, 2010, we repurchased 34,000 shares of our Class A common stock for $605,000.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect amounts reported therein. Management bases its estimates, judgments, and assumptions on historical experience and on various other factors that are believed to be relevant under the circumstances. Actual results may differ from previously estimated amounts, and such differences may be material to the consolidated financial statements. Estimates and assumptions are reviewed periodically, and the
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
effects of revisions are reflected prospectively in the period they occur. The following represent what we believe are the critical accounting policies that may involve a high degree of estimation, judgment, and complexity. For a summary of our significant accounting policies, including those discussed below, see Note 2 in Notes to our Consolidated Financial Statements in Item 15 of this report.
Marketable and Other Investment Securities
We hold investments in debt and equity securities of various companies, including marketable investments in publicly traded securities and non-marketable investments in securities of privately held companies. Our marketable investment securities ordinarily are accounted for as available for sale; accordingly, we report those securities at fair value on a recurring basis and generally recognize unrealized holding gains and losses in other comprehensive income. Except in unusual circumstances, the estimated fair values of our marketable investment securities are determined by reference to quoted prices for identical securities or based primarily on other observable market inputs. Our investments in non-marketable securities typically are strategic investments in privately held companies and may be highly speculative. We account for such investments using the equity method when we exert significant influence over the investee; otherwise, we account for such investments using the cost method.
All of our investments are subject to quarterly evaluations to determine whether an other-than-temporary impairment has occurred, in which case we record an impairment loss in determining net income. For our marketable investment securities, our impairment evaluation considers factors such the length of time the security has been in a continuous unrealized loss position, the magnitude of the unrealized loss, current market conditions, company-specific information, and whether we may dispose of the investment in the foreseeable future. Generally, it is not practicable to estimate fair value of our cost method and equity method investments on a recurring basis. Our impairment evaluation for such investments considers whether events or changes in circumstances have occurred that may have a significant adverse effect on the fair value of the investment (“impairment indicator”). In determining whether impairment indicators exist, we consider available information such as recent company financial statements, business plans and current economic conditions. When we determine that an impairment indicator exists, we estimate the fair value of the investment and record an impairment loss if the estimated fair value is below the carrying amount of the investment. In these circumstances, our fair value estimates may reflect significant unobservable inputs.
Our periodic investment impairment evaluations require us to make significant estimates, judgments and assumptions about uncertain future events. In some cases, there may be limited or no observable market data to support significant assumptions in our estimates. As a result of weakening economic conditions, or other future events and changes in circumstances affecting our investments, we may subsequently determine that an investment is impaired or that an existing impairment is other than temporary. Such events and changes in circumstances could result in our recognition of material investment impairment losses in the future.
Fair Value of Financial Instruments
Fair value estimates of our financial instruments are made at a point in time, based on relevant market data and the specific characteristics of the financial instrument. Weak economic conditions have in prior periods resulted in inactive markets for certain of our financial instruments, including certain debt securities that historically have been included in “Other investment securities” on our Consolidated Balance Sheets. For certain of these instruments, there may be limited or no observable market data. Fair value estimates for financial instruments for which limited or no observable market data is available are based on judgments regarding current economic conditions, liquidity discounts, currency, credit and interest rate risks, loss experience, bankruptcy and other factors. These estimates involve significant uncertainties and judgments and generally are less precise than measurements of fair value based on observable market data. We make certain assumptions related to expected maturity date, credit and interest rate risk based upon market conditions and prior experience. As a result, such calculated fair value estimates may not be realizable in a current sale or immediate settlement of the instrument. In addition, changes in the underlying assumptions used in the fair value measurement technique, including liquidity risks and estimates of future cash flows, could significantly affect these fair value estimates, which could have a material adverse impact on our financial position and results of operations.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
Impairment of Long-lived Assets
We evaluate our long-lived assets other than goodwill and intangible assets with indefinite lives, for impairment whenever events and changes in circumstances indicate that their carrying amounts may not be recoverable. The carrying amount of a long-lived asset or asset group is considered to be impaired when the anticipated undiscounted cash flows from such asset or asset group is less than its carrying amount. In that event, an impairment loss is recorded in the determination of operating income based on the amount by which the carrying amount exceeds the estimated fair value of the long-lived asset or asset group. Fair value is determined primarily using discounted cash flow techniques reflecting the estimated cash flows and discount rate that would be assumed by a market participant for the asset or asset group under review. Our discounted cash flow estimates typically include assumptions based on unobservable inputs and may reflect probability-weighting of alternative scenarios. Impairment losses on long-lived assets to be disposed of by sale are determined in a similar manner, except that fair value estimates are reduced for estimated selling costs. Changes in estimates of future cash flows, discounts rates and other assumptions could result in recognition of additional impairment losses in future periods.
Impairment Goodwill and Indefinite-lived Intangible Assets
We test our goodwill for impairment annually and more frequently when events or changes in circumstances indicate that an impairment may have occurred. There are two steps to the goodwill impairment test. Step one compares the fair value of a reporting unit with its carrying amount, including goodwill. If the reporting unit’s carrying amount exceeds its estimated fair value, it is necessary to perform the second step of the impairment test, which compares the implied fair value of reporting unit goodwill with the carrying amount of such goodwill to determine the amount of impairment loss. A substantial majority of our goodwill was recorded in connection with our 2011 acquisition of Hughes Communications and was assigned to reporting units of our Hughes segment. We test such goodwill annually in our second fiscal quarter. In our most recent test of such goodwill in the second quarter of 2012, we estimated fair value of the reporting units using discounted cash flow techniques, which included significant assumptions about prospective financial information, terminal value and discount rates. Based on this quantitative test, we determined that the fair values of the reporting units were in excess of the corresponding carrying amounts, including goodwill. Accordingly, we concluded that the goodwill was not impaired and it was not necessary to perform the second step of the goodwill impairment test. If the estimated cash flows reflected in our fair value estimates were decreased by 10% and/or the discount rate used to discount such cash flows were increased by 10%, a portion of our goodwill would have been impaired and it would have been necessary to perform step two of the impairment test to determine the amount of the impairment loss.
Our indefinite-lived intangible assets consist primarily of regulatory authorizations for the use of spectrum in specified orbital locations. We test these intangible assets annually in our fourth fiscal quarter, or more frequently if events or changes in circumstances indicate that an impairment may have occurred. We recognize an impairment loss in the determination of operating income when we determine that the carrying amount of an intangible asset exceeds its estimated fair value. Fair value is determined primarily using discounted cash flow techniques reflecting the estimated cash flows and discount rate that we believe would be assumed by market participants. Our cash flow projections typically include significant assumptions based on unobservable inputs. Changes in economic conditions, laws and regulations, technology, competition and other factors could affect the assumptions reflected in our fair value estimates and may result in future intangible asset impairments.
Business Combinations
When we acquire a business, we assign the purchase price to the acquired assets and liabilities based upon their fair value using various valuation techniques, including the market approach, income approach, and/or cost approach. The accounting standard for business combinations requires most identifiable assets, liabilities, noncontrolling interests and goodwill acquired to be recorded at fair value. Transaction costs related to the acquisition of the business are expensed as incurred. Costs associated with the issuance of debt associated with a business combination are capitalized and included as a yield adjustment to the underlying debt’s stated rate. Acquired intangible assets other than goodwill are amortized over their estimated useful lives unless the lives are determined to be indefinite. Amortization of these intangible assets is recorded on a straight line basis over an average finite useful
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
life primarily ranging from approximately one to twenty years or in relation to the estimated discounted cash flows over the life of the intangible.
Revenue Recognition
Our Hughes segment enters into contracts to design, develop, and deliver telecommunication networks to customers in our enterprise market. These contracts for telecommunication networks require significant effort to develop and construct the network, over an extended time period. Revenue under these contracts is recognized using the percentage-of-completion method of accounting. Depending on the nature of the deliverables in each arrangement, we recognize revenue under the cost-to-cost method or the units of delivery method. Under the cost-to-cost method, sales are recorded equivalent to costs incurred plus a portion of the profit expected to be realized, based on the ratio of costs incurred to estimated total costs at completion. Under the units of delivery method, sales are recorded as products are delivered and costs are recognized based on the expected profit for the entire agreement. Profits expected to be realized on long-term contracts are based on estimates of total revenue and costs at completion. These estimates are reviewed and revised periodically throughout the lives of the contracts, and adjustments to profits resulting from such revisions are recorded in the accounting period in which the revisions are made. Estimated losses on contracts are recorded in the period in which they are identified. Changes in our estimates related to revenue recognition for these contracts could result in significant changes in our revenue or costs, which could be material to our consolidated results of operations.
Income Taxes
Our income tax policy is to record the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying consolidated balance sheets, as well as operating loss and tax credit carryforwards. Determining necessary valuation allowances requires us to make assessments about the timing of future events, including the probability of expected future taxable income and available tax planning opportunities. We periodically evaluate our need for a valuation allowance based on both historical evidence, including trends, and future expectations in each reporting period. Any such valuation allowance is recorded in either “Income tax benefit (provision), net” on our Consolidated Statements of Operations and Comprehensive Income (Loss) or “Accumulated other comprehensive income within “Stockholders’ equity” on our Consolidated Balance Sheets. Future performance could have a significant effect on the realization of tax benefits, or reversals of valuation allowances, as reported in our consolidated results of operations.
Management evaluates the recognition and measurement of uncertain tax positions based on applicable tax law, regulations, case law, administrative rulings and pronouncements, and the facts and circumstances surrounding the tax position. Changes in our estimates related to the recognition and measurement of the amount recorded for uncertain tax positions could result in significant changes in our “Income tax benefit (provision), net” on our Consolidated Statements of Operations and Comprehensive Income (Loss) which could be material to our consolidated results of operations.
Contingent Liabilities
A significant amount of management judgment is required in determining when, or if, an accrual should be recorded for a contingency and the amount of such accrual. Estimates generally are developed in consultation with counsel and are based on an analysis of potential outcomes. Due to the uncertainty of determining the likelihood of a future event occurring and the potential financial statement impact of such an event, it is possible that upon further development or resolution of a contingent matter, a charge could be recorded in a future period to “Selling, general and administrative expenses” on our Consolidated Statements of Operations and Comprehensive Income (Loss) which could be material to our consolidated results of operations and financial position.
New Accounting Pronouncements
For a discussion of new accounting pronouncements, see Note 2 in the Notes to our Consolidated Financial Statements in Item 15 of this report. We do not anticipate that any recently issued accounting pronouncements will have a significant effect on our consolidated financial statements.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Continued
Seasonality
For our EchoStar Technologies and EchoStar Satellite Services segments, we are affected by seasonality to the extent it impacts our customers. Our customers in the pay-TV industry, including DISH Network, our largest customer, typically experience seasonality. Historically, the first half of the year generally produces fewer new subscribers for the pay-TV industry than the second half of the year. However, we cannot provide assurance that this will continue in the future.
For our Hughes segment, like many communications infrastructure equipment vendors, a higher amount of our hardware revenues occur in the second half of the year due to our customers’ annual procurement and budget cycles. Large enterprises and operators often allocate their capital expenditure budgets at the beginning of their fiscal year (which often coincides with the calendar year). The typical sales cycle for large complex system procurements is 6 to 12 months, which often results in the customer expenditure occurring towards the end of the year. Customers often seek to expend the budgeted funds prior to the end of the year and the next budget cycle.
Inflation
Inflation has not materially affected our operations during the past three years. We believe that our ability to increase the prices charged for our products and services in future periods will depend primarily on competitive pressures or contractual terms.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risks Associated with Financial Instruments and Foreign currency
Our investments and debt are exposed to market risks, discussed below.
Cash, Cash Equivalents and Current Marketable Investment Securities
As of December 31, 2012, our cash, cash equivalents and current marketable investment securities had a fair value of $1.548 billion. Of the $1.548 billion, a total of $1.492 billion was invested in: (a) cash; (b) variable rate demand notes convertible into cash at par value plus accrued interest generally in five business days or less; (c) debt instruments of the U.S. government and its agencies; (d) commercial paper and corporate notes with an overall average maturity of less than one year and rated in one of the four highest rating categories by at least two nationally recognized statistical rating organizations; and/or (e) instruments with similar risk, duration and credit quality characteristics to the commercial paper and corporate obligations described above. The primary purpose of these investing activities has been to preserve principal until the cash is required to, among other things, fund operations, make strategic investments, and expand the business. Consequently, the size of this portfolio fluctuates significantly as cash is received and used in our business. The value of this portfolio is negatively impacted by credit losses; however, this risk is mitigated through diversification that limits our exposure to any one issuer.
Interest Rate Risk
A change in interest rates would not affect the fair value of our cash, or materially affect the fair value of our cash equivalents due to their maturities of less than 90 days. A change in interest rates would affect the fair value of current marketable investment securities portfolio; however, we normally hold these investments to maturity. Based on our current non-strategic investment portfolio of $1.492 billion as of December 31, 2012, a hypothetical 10% change in average interest rates during 2012 would not have a material impact on their fair value due to the limited duration of our investments.
Our cash, cash equivalents and current marketable investment securities had an average annual rate of return for the year ended December 31, 2012 of 0.8%. A change in interest rates would affect our future annual interest income from this portfolio, since funds would be re-invested at different rates as the instruments mature. A hypothetical 10% decrease in average interest rates during 2012 would result in a decrease of approximately $1.1 million in annual interest income.
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