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
Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
Our results of operations for the year ended December 31, 2011 does not include the operations of Hughes Communications prior to 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 year ended December 31, 2011.
| 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 | |||||||||
| Impairment of long-lived 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, net | 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, net | (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 | * | ||||||||
| | | | | | | | | | | | | | |
| 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, end of period(1) | 636,000 | 602,000 | 34,000 | 5.6 | |||||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Percentage is not meaningful.
(1)
Excludes approximately 23,000 and 24,000 subscribers as of December 31, 2012 and 2011, respectively, receiving services through third parties who have capacity arrangements with us previously reported in our subscriber totals.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
Equipment revenue—DISH Network. "Equipment revenue—DISH Network" totaled $1.03 billion for the year ended December 31, 2012, a decrease of $129.7 million or 11.2% compared to the same period in 2011.
Equipment revenue—DISH Network from our EchoStar Technologies segment for the year ended December 31, 2012 decreased by $152.9 million, or 13.2%, to $1.01 billion compared to the same period in 2011. Our EchoStar Technologies segment offers multiple set-top boxes with different price points depending on their capabilities and functionalities. The revenue and associated margins we earn on sales are determined largely through periodic negotiations that could result in prices reflecting, among other things, the set-top boxes and other equipment that meet our customers' current sales and marketing priorities, the product and service alternatives available from other equipment suppliers, our ability to respond to customer requirements, and to differentiate ourselves from other equipment suppliers on bases other than pricing. In addition products containing new technologies and features typically have higher initial prices, which reduce over time as demand decreases or as DISH Network's demand for new or refurbished units changes. The decrease in our equipment revenue from DISH Network was primarily due to a 22.0% decrease in the weighted average price of set-top boxes, offset partially by a 6.0% increase in unit sales of set-top boxes. Additionally, unit sales of related accessories increased 134.7%, offset partially by a 60.7% decrease in weighted average price of related accessories.
Equipment revenue—DISH Network from our Hughes segment for the year ended December 31, 2012 increased by $23.2 million to $23.8 million compared to the same period in 2011. The increase was primarily due to the commencement of broadband equipment sales to DISH Network pursuant to the Distribution Agreement we entered into with dishNET in October 2012.
Equipment revenue—other. "Equipment revenue—other" totaled $621.5 million for the year ended December 31, 2012, an increase of $108.0 million or 21.0% compared to the same period in 2011.
Equipment revenue—other from our EchoStar Technologies segment for the year ended December 31, 2012 increased by $13.7 million, or 3.9%, to $365.9 million compared to the same period in 2011. The increase was primarily due to an increase in sales of $16.2 million of set-top boxes and related accessories sold to our international customers, which was partially offset by the decrease in sales of $2.6 million of Sling boxes.
Equipment revenue—other from our Hughes segment for the year ended December 31, 2012 increased by $95.3 million, or 59.2%, to $256.2 million compared to the same period in 2011. The increase was due to a partial-year revenue earned in 2011 compared to a full-year of revenue earned 2012 as the Hughes Acquisition was not completed until June 2011.
Services and other revenue—other. "Services and other revenue—other" totaled $956.4 million for the year ended December 31, 2012, an increase of $363.4 million or 61.3% compared to the same period in 2011.
Services and other revenue—other from our Hughes segment for the year ended December 31, 2012 increased by $355.1 million, or 69.2%, to $868.5 million compared to the same period in 2011. The increase was due to partial-year revenue earned in 2011 compared to a full-year of revenue earned 2012 as the Hughes Acquisition was not completed until June 2011.
Services and other revenue—other from our EchoStar Satellite Services segment for the year ended December 31, 2012 increased by $14.5 million, or 23.3%, to $76.5 million compared to the
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
same period in 2011. The increase was mainly due to higher transponder services of $11.1 million provided in 2012 compared to 2011.
Cost of sales—equipment. "Cost of sales—equipment" totaled $1.40 billion for the year ended December 31, 2012, a decrease of $17.3 million or 1.2% compared to the same period in 2011.
Cost of sales—equipment from our EchoStar Technologies segment for the year ended December 31, 2012 decreased by $121.4 million, or 9.4%, to $1.17 billion compared to the same period in 2011. The decrease was attributable to a decrease in equipment costs of $133.3 million, related directly to a decrease in sales of set-top boxes and related accessories sold to DISH Network. The decrease was partially offset by an increase in cost of sales of $13.0 million, primarily related to an increase in sales of set-top boxes and related accessories to our other international customers.
Cost of sales—equipment from our Hughes segment for the year ended December 31, 2012 increased by $104.3 million, or 81.2%, to $232.7 million compared to the same period in 2011. The increase was due to partial-year expenses recognized in 2011 compared to a full-year of expenses recognized in 2012 as the Hughes Acquisition was not completed until June 2011.
Cost of sales—services and other. "Cost of sales—services and other" totaled $691.9 million for the year ended December 31, 2012, an increase of $199.2 million or 40.4% compared to the same period in 2011.
Cost of sales—services and other from our EchoStar Technologies segment for the year ended December 31, 2012 increased by $18.8 million, or 11.1%, to $188.7 million compared to the same period in 2011. The increase was primarily attributable to a $16.6 million increase in support costs related to engineering services provided in 2012 compared to 2011 and a $4.0 million increase in uplink/downlink costs.
Cost of sales—services and other from our Hughes segment for the year ended December 31, 2012 increased by $186.3 million, or 79.1%, to $421.9 million compared to the same period in 2011. The increase was due to partial-year expenses recognized in 2011 compared to a full-year of expenses recognized in 2012 as the Hughes Acquisition was not completed until June 2011.
Cost of sales—services and other from our EchoStar Satellite Services segment for the year ended December 31, 2012 decreased by $10.5 million, or 14.7%, to $60.8 million compared to the same period in 2011. The decrease was primarily attributable to a decrease in cost of sales of $13.4 million due to the termination of our satellite lease agreement with DISH Network for EchoStar I in July 2012, partially offset by a $3.8 million increase in cost of sales related to the increase in transponder revenue in 2012.
Selling, general and administrative expenses. "Selling, general and administrative expenses" totaled $372.6 million for year ended December 31, 2012, an increase of $69.4 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 $72.0 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, which was acquired in connection with the Hughes Acquisition in June 2011.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
Depreciation and amortization. "Depreciation and amortization" expense totaled $457.3 million for the year ended December 31, 2012, an increase of $71.4 million or 18.5% compared to the same period in 2011. The increase was primarily related to higher amortization and depreciation expense of $67.0 million incurred from our Hughes segment as we did not complete the Hughes Acquisition until June 2011. In addition, the increase in depreciation expense was attributable to an increase of $25.7 million related to satellites that were accounted for as capital leases, partially offset by a decrease in depreciation expense of $6.7 million from our EchoStar Satellite Services segment related to EchoStar VI, which was fully depreciated in August 2012. The overall increase in depreciation and amortization expense from our Hughes segment and EchoStar Satellite Services segment was partially offset by lower amortization and depreciation expense of $11.7 million from our EchoStar Technologies segment, primarily relating to the retirement of certain assets.
Impairments of long-lived assets. "Impairments of long-lived 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 a $22.0 impairment of certain 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 impairment of $6.6 million associated with the EchoStar Technologies segment, and an impairment of $4.2 million of certain of our regulatory authorizations. Our 2011 impairment loss of $33.0 million was related to the impairment of our CMBStar satellite. See Note 8 and Note 9 for a discussion of the impairments recorded in 2012 and 2011, respectively, in the Notes to Consolidated Financial Statements in Item 15 of this report.
Interest expense, net of amounts capitalized. "Interest expense, net of amounts capitalized" totaled $153.0 million for the year ended December 31, 2012, an increase of $70.4 million or 85.3% compared to the same period in 2011. The increase was primarily related to higher interest expense of: (i) $58.4 million incurred on the Notes and (ii) $10.7 million incurred on our capital lease obligations.
Realized gains on marketable investment securities and other investments, net. "Realized gains on marketable investment securities and other investments, net" totaled $177.6 million for the year ended December 31, 2012, an increase of $163.9 million compared to the same period in 2011. The increase primarily related to higher gains of $168.2 million recognized on sales of certain of our strategic investments in public companies in 2012.
Other, net. "Other, net" totaled $59.5 million for the year ended December 31, 2012, an increase of $84.2 million compared to the same period in 2011. The increase was primarily related to dividends received of $46.0 million from a special dividend declaration from one of our strategic investments in 2012, and transaction costs of $35.3 million related to the Hughes Acquisition in 2011.
Earnings before interest, taxes, depreciation and amortization. EBITDA was $793.9 million for the year ended December 31, 2012, an increase of $311.1 million or 64.4% compared to the same period in 2011. The increase was primarily due to an increase in gains of $163.9 million recognized on sales of our strategic marketable investment securities, an increase in operating income of $90.5 million, a dividend received of $46.0 million from one of our strategic investments in 2012, and transaction costs of $35.3 million incurred in 2011 relating to the Hughes Acquisition. The increase in EBITDA was partially offset by the gains recognized of $15.9 million from the sale of investments accounted for at
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
fair value in 2011 and the decrease in equity in earnings of $12.3 million from unconsolidated affiliates. The following table reconciles EBITDA to the accompanying consolidated financial statements.
| For the Years Ended December 31, | Variance | ||||||||||||
| 2012 | 2011 | Amount | % | ||||||||||
| (Dollars in thousands) | |||||||||||||
| EBITDA | $ | 793,898 | $ | 482,806 | $ | 311,092 | 64.4 | ||||||
| Interest income and 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 $16.3 million for the year ended December 31, 2012 compared to an income tax provision of $21.5 million for the same period in 2011. Our effective income tax rate was (8.4%) for the year ended December 31, 2012 compared to 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.
Segment Operating Results
Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
| For the Year Ended December 31, 2012 | EchoStar Technologies | Hughes | EchoStar Satellite Services | All Other and Eliminations | Consolidated Total | |||||||||||
| (In thousands) | ||||||||||||||||
| Total revenue | $ | 1,660,029 | $ | 1,158,714 | $ | 277,985 | $ | 24,976 | $ | 3,121,704 | ||||||
| Capital expenditures | $ | 69,809 | $ | 292,222 | $ | 118,998 | $ | 31,976 | $ | 513,005 | ||||||
| EBITDA | $ | 110,933 | $ | 265,756 | $ | 212,549 | $ | 204,660 | $ | 793,898 | ||||||
| For the Year Ended December 31, 2011 | ||||||||||||||||
| Total revenue | $ | 1,780,642 | $ | 676,222 | $ | 278,125 | $ | 26,442 | $ | 2,761,431 | ||||||
| Capital expenditures | $ | 81,420 | $ | 156,768 | $ | 119,004 | $ | 19,980 | $ | 377,172 | ||||||
| EBITDA | $ | 144,753 | $ | 167,100 | $ | 197,848 | $ | (26,895 | ) | $ | 482,806 |
EchoStar Technologies Segment
| For the Years Ended December 31, | Variance | ||||||||||||
| 2012 | 2011 | Amount | % | ||||||||||
| (Dollars in thousands) | |||||||||||||
| Total revenue | $ | 1,660,029 | $ | 1,780,642 | $ | (120,613 | ) | (6.8 | ) | ||||
| Capital expenditures | $ | 69,809 | $ | 81,420 | $ | (11,611 | ) | (14.3 | ) | ||||
| EBITDA | $ | 110,933 | $ | 144,753 | $ | (33,820 | ) | (23.4 | ) |
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
Revenue
EchoStar Technologies segment total revenue for the year ended December 31, 2012 decreased by $120.6 million, or 6.8%, compared to the same period in 2011, as a result of a $139.1 million decrease in total equipment revenue, offset partially by a $18.5 million increase in total service revenue primarily due to a decrease in sales of set-top boxes and related accessories to DISH Network.
Capital Expenditures
EchoStar Technologies segment capital expenditures for the year ended December 31, 2012 decreased by $11.6 million, or 14.3%, compared to the same period in 2011, primarily due to the construction of a data center in 2011 that did not occur in 2012.
EBITDA
EchoStar Technologies segment EBITDA for the year ended December 31, 2012 was $110.9 million, a decrease of $33.8 million or 23.4% compared to the same period in 2011. The decrease was primarily driven by lower equipment revenue earned from the sales of set-top boxes and related accessories, higher research and development costs and impairment of goodwill.
Hughes Segment
| For the Years Ended December 31, | Variance | ||||||||||||
| 2012 | 2011 | Amount | % | ||||||||||
| (Dollars in thousands) | |||||||||||||
| Total revenue | $ | 1,158,714 | $ | 676,222 | $ | 482,492 | 71.4 | ||||||
| Capital expenditures | $ | 292,222 | $ | 156,768 | $ | 135,454 | 86.4 | ||||||
| EBITDA | $ | 265,756 | $ | 167,100 | $ | 98,656 | 59.0 |
Revenue
Hughes segment total revenue for the year ended December 31, 2012 increased by $482.5 million, or 71.4%, compared to the same period in 2011, primarily due to partial-year revenue earned in 2011 compared to a full-year of revenue earned in 2012 as the Hughes Acquisition was not completed until June 2011.
Capital Expenditures
Hughes segment capital expenditures for the year ended December 31, 2012 decreased by $135.5 million, or 86.4%, compared to the same period in 2011, primarily due to a decrease in satellite expenditures related to EchoStar XVII, which was launched in July 2012.
EBITDA
Hughes segment EBITDA for the year ended December 31, 2012 was $265.8 million, an increase of $98.7 million or 59.0% compared to the same period in 2011. The increase was primarily due to partial-year revenue and expenses recognized in 2011 compared to a full-year of revenue and expenses recognized in 2012 as the Hughes Acquisition was not completed until June 2011.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
EchoStar Satellite Services Segment
| For the Years Ended December 31, | Variance | ||||||||||||
| 2012 | 2011 | Amount | % | ||||||||||
| (Dollars in thousands) | |||||||||||||
| Total revenue | $ | 277,985 | $ | 278,125 | $ | (140 | ) | (0.1 | ) | ||||
| Capital expenditures | $ | 118,998 | $ | 119,004 | $ | (6 | ) | (0.0 | ) | ||||
| EBITDA | $ | 212,549 | $ | 197,848 | $ | 14,701 | 7.4 |
Revenue
EchoStar Satellite Services segment total revenue for the year ended December 31, 2012 increased by $0.1 million, or 0.1%, compared to the same period in 2011, primarily due to a $0.1 million increase in sales of transponder services to DISH Network.
Capital Expenditures
EchoStar Satellite Services segment capital expenditures for the year ended December 31, 2012 remained flat compared to the same period in 2011.
EBITDA
EchoStar Satellite Services segment EBITDA for the year ended December 31, 2012 was $212.5 million, an increase of $14.7 million or 7.4% compared to the same period in 2011. The increase was primarily due to lower cost of sales of $13.4 million relating to the termination of our satellite lease contract on EchoStar I with DISH Network, which was effective in July 2012.
All Other and Eliminations
EBITDA
All Other and Eliminations EBITDA for the year ended December 31, 2012 was income of $204.7 million, compared to a loss of $26.9 million for the same period in 2011. The $231.6 million increase in EBITDA was primarily due to increases in gains of $148.8 million on marketable investment securities and other investments, non-recurring dividends of $46.0 million received from a strategic investment in 2012, and $35.3 million in non-recurring transaction costs related to the Hughes Acquisition in 2011.
LIQUIDITY AND CAPITAL RESOURCES
Cash, Cash Equivalents and Current Marketable Investment Securities
We consider all liquid investments purchased with an original maturity of 90 days or less 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, 2013, our cash, cash equivalents and current marketable investment securities totaled $1.62 billion compared to $1.55 billion as of December 31, 2012, an increase of $73.1 million.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
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 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, 2013 and 2012, we held VRDNs, within our current marketable investment securities portfolio, with fair values of $34.7 million and $66.1 million, respectively. Our other current marketable investment securities portfolio consists primarily of corporate and government bonds. As of December 31, 2013 and 2012, we held $918.2 million and $693.5 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, 2013, 2012 and 2011.
Cash flows from operating activities. We typically reinvest the cash flow from operating activities in our business. For the years ended December 31, 2013, 2012 and 2011, we reported net cash inflows from operating activities of $450.5 million, $505.1 million and $447.0 million, respectively.
Net cash flows from operating activities for the year ended December 31, 2013 decreased by $54.6 million compared to the same period in 2012. The decrease was primarily attributable to lower net income of $37.6 million adjusted to exclude: (i) "Depreciation and amortization;" (ii) "Realized gains on marketable investment securities and other investments, net;" (iii) "Equity in losses (earnings) of unconsolidated affiliates, net;" (iv) "Impairment of long-lived assets", (v) "Deferred tax benefit;" and (vi) "Other, net."
Net cash flows from operating activities for the year ended December 31, 2012 increased by $58.1 million compared to the same period in 2011. The improvement was primarily attributable to the increase in net income of $162.6 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 $103.0 million decrease from changes in operating assets and liabilities related to timing differences between the incurrence of expense and cash payments.
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, 2013, 2012 and 2011, we reported net cash outflows from investing activities of $570.3 million, $346.8 million and $1.89 billion, respectively.
Net cash outflows from investing activities for the year ended December 31, 2013 increased by $223.5 million compared to the same period in 2012. The increase in cash outflows primarily related to an increase of $446.0 million in net purchases of marketable investment securities. This increase was partially offset by a $121.1 million reduction in capital expenditures, decrease of $56.7 million in acquisitions of regulatory authorizations, and proceeds of $40.4 million in 2013 from the transfer of a regulatory authorization and satellite launch services contract to DISH Network.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
Net cash outflows from investing activities for the year ended December 31, 2012 decreased by $1.54 billion compared to the same period in 2011. The decrease was primarily due to the net acquisition cost of Hughes Communications of $2.08 billion partially offset by proceeds from the sale of a strategic investment of $712.9 million in 2011. In addition, the decrease in net cash outflows was attributable to higher net proceeds from our marketable investment securities of $347.8 million in 2012 compared to 2011. The decrease in net cash outflows was partially offset by a $135.8 million increase in capital expenditures in 2012 compared to 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, 2013, 2012 and 2011, we reported net cash inflows from financing activities of $18.3 million, net cash outflows from financing activities of $44.0 million, and net cash inflows from financing activities of $1.91 billion, respectively.
Net cash inflows from financing activities increased to $18.3 million for the year ended December 31, 2013 compared to net cash outflows of $44.0 million for the same period in 2012. The increase was primarily due to higher proceeds of $55.8 million received from Class A common stock options exercised and stock issued under our Employee Stock Purchase Plan and an increase in excess tax benefit from stock option exercises, which was partially offset by an increase in repayments of long-term debt of $8.2 million.
Net cash outflows from financing activities decreased by $1.96 billion for the year ended December 31, 2012 compared to the same period in 2011. The decrease was primarily due to the one-time proceeds received of $2.00 billion from the issuance of the Notes in 2011.
Obligations and Future Capital Requirements
Contractual Obligations and Off-Balance Sheet Arrangements
The following table summarizes our contractual obligations at December 31, 2013 and the effect such obligations are expected to have on our liquidity and cash flow in future periods:
| Payments due in the Year Ending December 31, | ||||||||||||||||||||||
| Total | 2014 | 2015 | 2016 | 2017 | 2018 | Thereafter | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||||
| Long-term debt obligations | $ | 2,001,588 | $ | 1,431 | $ | 150 | $ | 7 | $ | — | $ | — | $ | 2,000,000 | ||||||||
| Capital lease obligations | 420,800 | 68,360 | 28,005 | 29,074 | 32,414 | 35,949 | 226,998 | |||||||||||||||
| Interest expense on long-term debt and capital lease obligations | 1,143,017 | 180,475 | 175,822 | 172,990 | 169,863 | 166,378 | 277,489 | |||||||||||||||
| Satellite-related obligations | 1,106,738 | 466,992 | 236,438 | 68,222 | 52,414 | 45,914 | 236,758 | |||||||||||||||
| Operating lease obligations | 71,170 | 22,143 | 18,589 | 12,918 | 8,460 | 2,830 | 6,230 | |||||||||||||||
| Purchase and other obligations | 212,108 | 207,107 | 1,667 | 1,667 | 1,667 | — | — | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| Total | $ | 4,955,421 | $ | 946,508 | $ | 460,671 | $ | 284,878 | $ | 264,818 | $ | 251,071 | $ | 2,747,475 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
"Satellite-related obligations" primarily includes, among other things, payment pursuant to agreements for the construction of the EchoStar XIX and TerreStar-2 satellites, payments pursuant to launch services contracts, executory costs for our capital lease satellites, costs under transponder agreements and in-orbit incentives relating to certain satellites.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
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 amounts related to deferred tax liabilities, unrecognized tax positions and certain other amounts recorded in our noncurrent liabilities as the timing of any payments is uncertain. The table also excludes long-term deferred revenue and other long-term liabilities that do not require future cash payments.
In certain circumstances, the dates on which we are obligated to pay our contractual obligations could change.
Off-Balance Sheet Arrangements
Other than 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, 2013, we had $39.4 million of letters of credit and insurance bonds. Of this amount, $8.1 million was secured by restricted cash; $12.4 million related to insurance bonds; and $18.9 million was issued under credit arrangements available to our foreign subsidiaries. Certain letters of credit are secured by assets of our foreign subsidiaries.
As of December 31, 2013, we had foreign currency forward contracts with a notional value of $8.4 million in place to partially mitigate foreign currency exchange risk. 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.
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 DISH Network's 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
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
could have a further material adverse effect on our financial position and results of operations. As of December 31, 2013, our remaining obligations related to EchoStar XVI, EchoStar XVII, EchoStar XIX, TerreStar-2 and launch contracts with Arianespace, SA and International Launch Services, Inc. totaled $553.6 million. 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, 2013, our total indebtedness was $2.42 billion, of which $420.8 million related to capital lease obligations. 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 could also 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 may also 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 $500.0 million of our outstanding shares of Class A common stock through and including December 31, 2014. For the years ended December 31, 2013, 2012 and 2011, we did not repurchase any common stock under this plan.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with GAAP requires us to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the balance sheets, the reported amounts of revenue and expenses for each reporting period, and certain information disclosed in the Notes to Consolidated Financial Statements in Item 15 of this report. We base our estimates, judgments, and assumptions on historical experience and on various other factors that we believe to be relevant under the circumstances. Actual results may differ from previously estimated amounts, and such differences may be material to our consolidated financial statements. 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. 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 Consolidated Financial Statements in Item 15 of this report.
Marketable Securities and Other Investments
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
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
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 gains and losses in other comprehensive income (loss). 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 have the intent and ability to hold 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. As part of our evaluation, we review available information such as recent company financial statements, business plans and current economic conditions for factors that may indicate an impairment of our investments. When we determine that an investment is impaired and the impairment is other-than-temporary, we adjust the carrying amount of the investments to its estimated fair value and recognize an impairment loss in earnings. 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 investments" in 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
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
estimates, which could have a material adverse impact on our financial position and results of operations.
Impairment of Long-lived Assets
We evaluate our long-lived assets other than goodwill or 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 not be recoverable when the estimated future 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. Estimated losses on long-lived assets to be disposed of by sale may be 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. We may bypass the two-step quantitative impairment test when we determine based on a qualitative assessment that it is more likely than not that the fair value of a reporting unit exceeds its carrying amount including goodwill.
As of December 31, 2013, our goodwill consisted entirely of goodwill assigned to reporting units of our Hughes segment in connection with the 2011 acquisition of Hughes Communications, Inc. and its subsidiaries ("Hughes Acquisition"). We test the goodwill related to the Hughes segment annually in our second fiscal quarter. In the second quarter of 2013, we determined based on a qualitative assessment that it was more likely than not that the fair values of our Hughes reporting units exceeded their carrying amounts including goodwill. Our qualitative assessment considered the results of our quantitative annual impairment test in 2012 and generally favorable trends in the operations of the reporting units and in other significant inputs that would be used to determine fair value. Depending on our assessment of future events and changes in circumstances, we may be required to perform the two-step quantitative impairment test in the future. We may determine that some or all of our goodwill is impaired in connection with future impairment tests.
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
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
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 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 and mobile satellite systems markets. 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
We 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" in our Consolidated Statements of Operations and Comprehensive Income (Loss) or "Accumulated other
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
comprehensive income (loss)" within "Stockholders' equity" in 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" in 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 whether an accrual should be recorded for a loss 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 in our Consolidated Statements of Operations and Comprehensive Income (Loss) which could be material to our consolidated results of operations and financial position. 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.
New Accounting Pronouncements
For a discussion of new accounting pronouncements, see Note 2 in the Notes to 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.
Seasonality
For our EchoStar Technologies segment, we are affected by seasonality to the extent it impacts our customers as a result of their sales and promotion activities, which can vary from year to year. Although the seasonal impacts have not been significant, 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 trend will continue in the future.
For our Hughes segment, service revenue is generally not impacted by seasonal fluctuations other than those related to fluctuations related to sales and promotional activities. However, like many communications infrastructure equipment vendors, a higher amount of our hardware revenue 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 six 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. In the Hughes consumer business, we see a similar seasonality for consumer acquisitions, and therefore hardware revenue, as is seen in the consumer and retail sectors where the first and fourth calendar quarters tend to be higher than the second and third quarters.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Continued
Our EchoStar Satellite Services segment is not generally affected by seasonal impacts.
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, 2013, our cash, cash equivalents and current marketable investment securities had a fair value of $1.62 billion. Of this amount, a total of $1.59 billion was invested in: (a) cash; (b) 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; (c) VRDNs convertible into cash at par value plus accrued interest generally in five business days or less; (d) debt instruments of the U.S. government and its agencies; 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 may be 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 our current marketable debt securities portfolio; however, we normally hold these investments to maturity. Based on our current non-strategic investment portfolio of $1.59 billion as of December 31, 2013, a hypothetical 10% change in average interest rates during 2013 would not have a material impact on the fair value of our cash, cash equivalents and debt securities portfolio due to the limited duration of our investments.
Our cash, cash equivalents and current marketable debt securities had an average annual rate of return for the year ended December 31, 2013 of 1.1%. 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 2013 would have resulted in a decrease of approximately $1.4 million in annual interest income.
Strategic Marketable Investment Securities
As of December 31, 2013, we held current strategic investments in the publicly traded common stock of several public companies with a fair value of $33.6 million. These investments, which are held for strategic and financial purposes, are concentrated in a small number of companies, are highly
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