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Hughes Communications, Inc. (NASDAQ:HUGH)

Q3 2009 Earnings Call

November 4, 2009 2:00 pm ET

Executives

Pradman Kaul – President & CEO

Grant Barber – EVP & CFO

Deepak Dutt – VP, Treasurer, IR

Analysts

James Ratcliffe – Barclays Capital

Chris Quilty – Raymond James

Jennifer Fritzsche – Wells Fargo

Lawrence Harris – CL King

Unidentified Analyst – The Hartford

Ned Zachar – KLS Diversified

Adam Spellman – PPM America

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2009 Hughes Communications Inc. earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Deepak Dutt, Vice President of Investor Relations. Please proceed sir.

Deepak Dutt

Good afternoon everybody. Welcome to our third quarter 2009 earnings call. Before we begin, I would like to remind everyone that this conference call, including the question-and-answer session may contain statements that are forward-looking, as that term is defined by the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are based on management’s current beliefs as well as assumptions made by and information currently available to management and are subject to risks and uncertainties.

Actual results may differ materially from those contained in these forward looking statements and we refer you to the documents we file from time to time with the SEC, specifically our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our periodic 8-K filings including the 8-K filed with this press release and our registration statements on Form S-3.

With that I’d like to turn the call over to Pradman Kaul, President and Chief Executive Officer.

Pradman Kaul

Thank you Deepak and good afternoon everyone. I’d like to start with our consumer business which once again delivered a great performance in this quarter. Every metric showed strong growth: 50,000 gross ads; 17,000 net ads; consumer ARPU $71.00, up $3.00; churn at 2.3%, down from 2.6% in Q3 2008; and service revenue up 19% over Q3 2008.

Activations on SPACEWAY continued at a brisk pace and there were over 208,000 subscribers on SPACEWAY as of September 30. As you can see this business continues to fire on all cylinders and remains our premier growth engine.

Now to our revenues in the third quarter, our total revenue in Q3 2009 of $251 million was down $21 million from Q3 of 2008. Service revenues were up $19 million and hardware revenues were down $40 million.

All of our three broadband businesses, North American enterprise, international enterprise, and consumer, contributed to this impressive service revenue growth with consumer being the primary contributor with a growth of $16 million.

This solid growth in broadband services is precisely what our strategy called for. The decline of $40 million in hardware revenue was primarily due to two reason. MobileSat was down $10 million due to the completion of a few development contracts and as we’ve stated previously these programs are opportunistic in nature and their wind down comes as no surprise.

North American and international enterprise segments were down approximately $30 million in hardware sales primarily because of delayed contract awards. Its worth noting that in our industry today many companies or enterprises are delaying new contracts because of the economy and third quarter results of major companies are showing large declines in enterprise hardware revenues.

I’m hopeful that as the economy recovers we will see a reversal of this effect. So to summarize the quarter’s revenue performance our broadband services revenue continues to grow with strength led by the consumer business with the enterprise businesses also contributing to it.

The hardware revenue decline is largely due to contract award slowdown in both enterprise segments. This continued transformation to a service model evidenced by our service to hardware revenue mix [employing] to 70-30 in Q3 2009 is encouraging and completely in line with our stated strategy.

Two other highlights in Q3 2009 were our adjusted EBITDA and cash performance. Adjusted EBITDA was a record $44 million for a strong growth of 13% over Q3 2008. This is the result of the continued margin expansion from putting more subscribers on SPACEWAY, combined with prudent operating expense management.

We also generated $74 million of cash from operations compared to $26 million in Q3 2008. Grant will address more details on these elements in his presentation. We booked $208 million in this quarter in new orders and orders came from many enterprises like GTech, Burger King, Social Security Administration, Equiva, Yum, Barrett, Rite Aid, etc. in North America and the World Bank, Ethiopian Telecom, Metro Info Tech, Martins Brazil, and BP Spain in our international broadband segment.

Let me now turn it over to Grant and I’ll come back with some closing comments at the end.

Grant Barber

Thank you Pradman, and good afternoon. As Pradman mentioned in his comments we’re pleased to have completed another good quarter, continuing the trends that we have highlighted on previous calls and ended Q3 in strong financial shape.

The growth in our North American broadband business led by our consumer business and continued focus on cost control enabled us to show strong adjusted EBITDA growth over the third quarter of last year.

At Hughes revenues for the third quarter of 2009 were $251.4 million, a decrease of $20.4 million or 7% below the third quarter of 2008. Revenues for the first nine months of 2009 were $747.5 million, a decrease of $27.1 million or 4% below the same period last year.

The North American broadband business continued to be the primary growth driver as revenue for the third quarter of $174.1 million was up $4.7 million or 3% above the third quarter of last year. Year to date the North America business revenue was $515 million, an increase of $27.5 million or 6% above the same period last year.

This increase was once again driven by strong performance in the consumer business which grew revenues by 12% in the quarter to $107.1 million. Our year to date consumer revenues were $310 million, an increase of $29.3 million or 10% above the same period last year.

Our North America enterprise business had revenues of $67 million, a decrease of $6.5 million below the third quarter of 2008. Year to date our North America enterprise business revenues were $205 million, a decrease of $1.8 million, essentially flat to the same period last year.

The international broadband segment revenue of $47.5 million decreased $12.5 million below the third quarter of 2008. As you will recall from our earlier earnings calls in 2008 was when we delivered the terminal shipments on a multiyear contract for a large lottery operator in the UK impacting the year on year hardware comparisons.

The unfavorable impact of currency exchange caused by the appreciation of the US dollar continued in the third quarter and impacted the year on year comparisons by another $3.8 million. After reflecting these items we continue to be pleased with the performance in our international business.

Our service revenue in the quarter grew by 21% primarily due to an increase in the number of enterprise sites and service across Europe and Brazil. For the first nine months of 2009 our international revenue was $142.9 million, a decrease of $27.2 million below the same period last year with the shortfall again being the 2008 shipments to the UK Lottery company and the unfavorable foreign exchange impact of the strengthening US dollar, which reduced our international revenues by $20.5 million.

The underlying service revenue continues to be a strategic focus for us as the international service revenue for the first nine months of 2009 was up by 10% above the same period in 2008, again reflecting the increases primarily from our Europe and Brazil operations.

The telecom systems segment delivered revenue of $28.8 million, a decrease of $13.4 million below the third quarter of 2008, and for the first nine months of 2009 revenues were $87.4 million, a decrease of $29.2 million below the comparable period of last year.

The decrease for both periods were primarily due to the reduction in revenue from our mobile satellite systems group as several development contracts are reaching their completion stage. As we’ve highlighted on previous earnings calls, the revenue for this group is opportunity driven and is subject to life cycle of customer contracts as they move from the design and development to the delivery and maintenance of completed networks.

From a services hardware mix perspective our solid growth continues to be delivered from our services. Our services component was $176.3 million, an increase of $19.3 million or 12% above the third quarter of 2008.

For the first nine months of 2009 our service revenues were $512 million, an increase of $56.9 million or 13% above the same period of last year. Hardware revenues in the quarter were $75.2 million, a decrease of $39.7 million or 35% below the third quarter of 2008 reflecting the 2008 terminal shipments to the UK Lottery operator and the mobile satellite contracts as I mentioned earlier.

The services component continuing the trend we discussed on the previous calls, increased to 70% of total revenue for the third quarter of 2009, up from 58% of revenue in the third quarter of last year. This is a reflection of the strong performance in our consumer business as we delivered growth in both subscriber count and ARPU and continued investment and focus in our global services organizations.

Operating expenses for the third quarter of 2009 were $53.4 million, an increase of $2.9 million or 6% above the third quarter of last year. This increase we entirely due to the higher marketing costs of approximately $5 million in our North American operations as we increased targeted spending for our consumer business and reductions of approximately $1 million in each of our R&D and G&A lines as we continue to maintain a strong focus on spending constraints.

Operating income for Hughes was $15.6 million for the third quarter of 2009 compared to operating income of $18.4 million in the same quarter of last year. Net interest expense for the quarter was $17.2 million, an increase of $4.5 million from the third quarter of last year primarily reflecting the interest on the new senior notes and lower rates of return on our invested cash.

For the first nine months of 2009 net interest expense was $46.1 million, an increase of $12.5 million above the same period of last year. This increase was as a result of the $5.8 million in interest on the new notes, $4.3 million of interest in 2008 associated with the construction and launch of SPACEWAY 3 that was capitalized last year and a $2.6 million reduction in interest income reflecting the lower rates of return on our invested cash.

The net loss for the third quarter of 2009 was $2.6 million or $0.12 a share on a fully diluted basis. This compares with net income of $3.2 million or $0.15 a share in the third quarter of last year. A table and reconciliation of adjusted EBITDA are attached to the press release. We believe that these non-GAAP measures provide useful information by excluding specific items that are not indicative of our core operating results.

Adjusted EBITDA was $44.3 million or 18% of revenue in the third quarter of 2009, an increase of $5 million or 13% over the third quarter of 2008. Again this increase was primarily due to the increased services business profitability and prudent control of operating costs.

Adjusted EBITDA for the first nine months of 2009 was $117.4 million, an increase of $11.2 million or 11% above the first nine months of last year. For Hughes Network Systems LLC, our principal operating subsidiary, adjusted EBITDA for the quarter was $45.1 million, an increase of $4.9 million or 12% above the third quarter of last year.

For the first nine months adjusted EBITDA was $118.7 million, an increase of $9.8 million or 9% above the same period last year. Moving to Hughes Communications cash and balance sheet, we generated net cash from operations of $74 million in the third quarter bringing our total net cash from operations for the first nine months of 2009 to $111 million.

This compares to $40 million generated in the first nine months of last year. Capital expenditures for the third quarter were $43.2 million, and $104.3 million for the first nine months. In summary we generated over $30 million in free cash flow in the quarter and ended the quarter with a strong cash and marketable securities position of $326 million.

As we outlined in the headlines of our press release for the third quarter we booked new orders of $208 million, revenues of $251 million and adjusted EBITDA of $44 million. In summary we continue to execute on our plan and deliver strong operating performance and capital management.

At this time I’d like to turn the call back to Pradman for further comments.

Pradman Kaul

Thank you Grant, some observations now as we look ahead, we have a strong backlog of $822 million. As you may know this does not include orders from the consumer business although consumers sign contracts for a two-year term.

The fourth quarter has historically been a strong quarter for consumer activations and for enterprise hardware sales. I also want to address two agreements which we announced recently with Barrett Xplore and Avanti.

Barrett is currently a major customer for us in Canada for the consumer market using SPACEWAY. Under the new agreement Barrett has committed to acquire approximately 14% of the capacity of Jupiter, our new high throughput Ka-band satellite that’s currently under construction and which we expect to launch in Q1 of 2012.

In addition Barrett will acquire gateways and VSAT terminals from us. The value of the contract is expected to exceed $100 million. This agreement will improve the cash flow and the internal rate of return on the Jupiter satellite program. We expect that Barrett will be able to serve over 200,000 subscribers with this space segment.

Avanti is a UK based operator that will be launching HYLAS, a Ka-band satellite in the middle of 2010 to offer broadband service to European customers. This agreement has two important aspects for us. First Avanti will acquire gateways and customer premise equipment from us for their third party which will [inaudible] operators and second, we will lease space segment on HYLAS from Avanti at very competitive prices which we will leverage to expand our managed service offerings in the European market.

This agreement is entirely in line with our strategy to keep expanding our managed service offerings throughout the world. We look forward to productive and long-term relationships with both companies. As I mentioned earlier we continue to activate consumers on SPACEWAY and expand our margin through the release of leased [Ku-band] transponders and we are beginning to see the margin and EBITDA benefit increase as the result.

The Jupiter satellite program construction is progressing on schedule and we are pleased with our relationship with Loral on that program. Finally we continue to work a number of other strategic opportunities for fleet expansion as well as tactical opportunities for broadband enterprise and consumer sales to fuel our growth in the years ahead.

Deepak Dutt

We are now ready to start the question-and-answer part of the call. If there are follow-up questions after the call from the financial community please direct them to me through our Investor Relations line. Members of the media should contact Judy Blake.

Contact information for both of us is available on the website, www.hughes.com. We’ll take a few minutes to get the Q&A process started, after which, the operator will you take over and coordinate the session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of James Ratcliffe – Barclays Capital

James Ratcliffe – Barclays Capital

Couple of questions, first off can you talk about how you see the ViaSat WildBlue deal effecting the US consumer SMD market dynamic.

Pradman Kaul

We don’t really see much of a change in the competitive market dynamics from today. As you know today there are two of us competing this market, WildBlue and us. WildBlue has their space segment capacity today with Anik F2 and WildBlue 1, and we have SPACEWAY and WildBlue uses ViaSat’s technology and equipment and we use our own.

Once this acquisition is complete and nothing really changes, there’ll still be two competitors in the marketplace and the two competitors will be using their own satellites and one will be using ViaSat’s hardware technology, the other will be using our, we’ll be using obviously our technology. So I don’t really see any change in the market dynamics.

James Ratcliffe – Barclays Capital

Do you think there’s a timing issue at all in terms of the timing of the ViaSat 1 launch versus the Jupiter launch in that they may have an edge for some period of time when you’re essentially maxed out on SPACEWAY 3.

Pradman Kaul

We don’t expect to be maxed out on SPACEWAY 3 in that timeframe. We are planning on SPACEWAY 3 to be available for our consumers into the time period that we expect to launch Jupiter. So really I don’t see any advantage one way or the other. In fact, to be honest we believe we have an advantage between now and the time ViaSat 1 is launched because we have capacity in SPACEWAY all over the country and as you know, WildBlue has had to close a few beams now and then to account for saturation of beams.

James Ratcliffe – Barclays Capital

And working cap particularly looks like receivables were a major source of cash in the quarter is that sustainable or should we expect to see that reverse in future periods.

Grant Barber

Well what we did as you know its been a significant focus of ours both on collecting on the receivables that we have and extending the payables as much as possible as well. So the combination of the dropping the DSO to approximately 60 days for us down from the 63 to 65 that we’ve traditionally been has been a big source of cash in the quarter.

And I would say that plus our inventory turns have been the key focuses for us, and they will continue to be going forward.

James Ratcliffe – Barclays Capital

Do you think there’s more to be done there or have we kind of gotten where we’re going to get.

Grant Barber

I think a big part of that will depend on what the economy is. As I say we’re extending out our payables, clearly the enterprise customers we deal with are trying to do the same thing. But I think we have good relationships and we’ll stay on top of that.

Operator

Your next question comes from the line of Chris Quilty – Raymond James

Chris Quilty – Raymond James

Got a question on the consumer business, you’ve had a real nice trend with the ARPU continuously moving up, and can you help us understand is that, do you think that’s primarily due to the fact that your consumers are stepping up the packages that they have or is it more of a mix issue where you’re adding more of the SMD type customers that would typically sign up a package that might be two or three X what a traditional consumer would subscribe for.

Pradman Kaul

The consumer ARPU that we give you doesn’t include the SMD. It excludes those guys. So its pure consumer by themselves. But I think what you’re seeing there is two factors, one we are selling some value added services to the consumers. We’re beginning to introduce more and more of them and we are hoping that will continue to allow us to expand, increase the ARPU.

And the second is you’re seeing the mix of the rental consumers versus the up front purchase which adds that $10 per month on the rental program and that, the mix of that changes and the small rental then those up front payment customers you get an effect on the ARPU going up to.

Chris Quilty – Raymond James

That was actually an additional question, what percent of your new subscribers took the lease plan this quarter.

Grant Barber

They were about 60%.

Chris Quilty – Raymond James

Okay and is that up or consistent with prior quarters.

Grant Barber

We’ve been between 53%, 55% and 60% over the past quarters. If you recall we just introduced it in September of last year so we believe its gained more traction over the last few quarters.

Chris Quilty – Raymond James

And I know you don’t normally discuss subscriber acquisition costs, but is there anything else different you’ve been doing in terms of targeting consumers in order to, the stepped up gross ads you’ve experienced over the last several quarters.

Grant Barber

No nothing significant, you’ll see I did comment on the last two calls that we’ve stepped up our direct advertising and mailing to more of the discretionary sales and marketing and targeted it at the consumer market, but nothing significantly different in the plans.

Chris Quilty – Raymond James

And you mentioned in the press release but I don’t think in your script the winding down of the Telematics opportunity, does that presume that that’s going to zero, its not something on the near-term horizon or is it just winding down near-term stuff.

Pradman Kaul

No, its both to zero. I think we’ve pretty much shut down the program and I think going forward we’ll not, we’ll have very very insignificant revenues.

Chris Quilty – Raymond James

And final question on the M&A front are you finding anything for use of proceeds for that money you raised earlier this year and obviously it wasn’t to buy ProtoStar 1 because I think they went off the rails in the bidding process there.

Pradman Kaul

We are looking at any given, we’re probably looking at three or four opportunities and as of today that’s probably still a true statement. And we had really wanted to invest that money but we haven’t come up with anything yet.

Chris Quilty – Raymond James

Okay, don’t let it burn a hole in your pocket.

Pradman Kaul

We want to spend it wisely.

Operator

Your next question comes from the line of Jennifer Fritzsche – Wells Fargo

Jennifer Fritzsche – Wells Fargo

My big question is about margins, we saw a nice improvement almost 200 basis points sequentially in terms of margins, it looks like cost of services has stabilized here. Should we continue to see this margin improvement going forward and if you can talk to the drivers there, is this because some of the transponders are coming off lease or any color there would be helpful.

Grant Barber

A couple of things, if you look at the split between the service and the hardware, you know as I commented we’ve been increasing the services component, typically the services business for us is more profitable. So as that service revenue hit a 70% of the total, naturally that will drive with it higher service margins that we’ve been experiencing in the past.

We’re also focused on increasing the service profitability in the consumer market and I think that is proving out as well. You mentioned the transponders, we continue to give back approximately one transponder a month within the quarters and with that has a significant improvement in our space segment as we’ve commented earlier.

So those are the two big things that are driving up the service margin for us.

Jennifer Fritzsche – Wells Fargo

Can you talk about how many transponders still exist on leases as of September.

Grant Barber

Yes, in the North American market—

Pradman Kaul

We have 99 transponders as of the end of Q3.

Operator

Your next question comes from the line of Lawrence Harris – CL King

Lawrence Harris – CL King

Just sort of as a follow-up to the question on margins, you did well in terms of the growth in EBITDA this quarter and I was wondering if you have sort of a target for EBITDA margins over the next year or two. Where do you think EBITDA margins can go.

Grant Barber

I think as you know we don’t typically give guidance on EBITDA but I think if you look at the trends that we’ve talked about and the focus on the service business for us and the consumer market I think I would use what our existing statements to try and guide what that profitability will be going forward.

Lawrence Harris – CL King

And looking at orders, it looks like orders were down sequentially, to what extent may that have been effected by seasonality, and you certainly expressed some confidence that we could see I guess some good, better performance here in the fourth quarter. Any sort of comments in terms of the seasonality aspect of orders.

Pradman Kaul

We have some seasonality but I think the major reason that I would say the Q3 orders were down is as I mentioned in my notes, we had some delays in enterprise orders both domestically and internationally.

And we believe that’s not a result of the seasonality but more a result of the economy where companies are going slow on new infrastructure type of orders. We’re hopeful that Q4 is going to be better and because we see the economy beginning to rebound a little bit but again without giving you specific guidance we hope to have a better Q4 then we did Q3.

Operator

Your next question comes from the line of Unidentified Analyst – The Hartford

Unidentified Analyst – The Hartford

I was wondering if you could just give us some color on the capacity utilization of SPACEWAY 3, if you could just, at sort of what level of utilization are you at now.

Pradman Kaul

It’s a difficult question to give you a quantifiable answer because as you know in the multi spot beam satellite the utilization varies from beam to beam. And we have all [hundred] uplink beams and but if I look at it in a growth way based on the current traffic per customer we have 200,000 subs as we mentioned, 208,000 at the end of Q3.

We expect that we have somewhere between 600,000 to 800,000 subs capacity when SPACEWAY is full. So if you use that as a guide you could say roughly 30% filled and there’s about 70% to go.

Unidentified Analyst – The Hartford

And you noted that you did not think you would reach capacity or be capacity constrained before Jupiter was commercially operational, is that correct.

Pradman Kaul

Yes, until the first quarter of 2012 kind of thing. And you know again it was a statistical statement and you may have a beam or two that will be full, and we’ll come up with other strategies to go around it but generally as a satellite, that’s our hope.

Unidentified Analyst – The Hartford

And then back to the makeup of revenue between service and hardware, you’re sort of at the 70/30% contribution levels, is there sort of a target that you’re aiming for in terms of maintaining a certain base from the hardware side as well.

Grant Barber

No I think a big piece of that split depends on as Pradman mentioned earlier the closure on the hardware component of some of the enterprise businesses plus the mobile satellite business which typically are shown as hardware deliveries for us. So 70 was a peak level for us over the last few quarters.

Unidentified Analyst – The Hartford

So could actually reverse potentially, or we’d see an increase in the hardware contribution as some of those contracts finally kick in.

Grant Barber

Yes it could somewhat if we had a stronger fourth quarter on some of the hardware deliverables, but most of our enterprise deals will be a bundled hardware and services piece. The key thing that keeps powering the service piece ahead is the, I would say the continued growth in the consumer business which most of that revenue shows up as services.

Operator

Your next question comes from the line of Ned Zachar – KLS Diversified

Ned Zachar – KLS Diversified

I’d like to follow-up up on the margin questions that came up before, the street is looking for pretty healthy growth in EBITDA in 2010 and I think you’re probably reluctant to comment on those numbers specifically but to the extent that you can talk about the progress you’re making in moving subscribers and business onto your own transponders, is that on track on time relative to what you’ve been talking about over the last year or so.

Pradman Kaul

Yes, we’re right on track.

Operator

Your final question comes from the line of Adam Spellman – PPM America

Adam Spellman – PPM America

I had two questions, first I was hoping could you just comment on the consumer broadband market specifically ViaSat has spent a lot of time articulating they think they’re new satellite will actually be competitive with some wire line solutions, I was wondering, I wanted to get your thoughts on that and then a related question, could you just talk about where you see future, where’s the growth coming from. Is it kind of in outlying areas of cities or is it in these true kind of rural areas.

Pradman Kaul

As we’ve been saying our market is primarily a subscriber who doesn’t have access to broadband on DSL or cable. And we believe that that market is roughly 10 to 15 million subscribers in North America, in the United States. And so that’s the market that we are focused on. We are not trying to compete with the wire line guys at this stage.

Now where do these guys exist, they exist, its surprising its not just the rural areas but its also the suburban and [inaudible] of major metropolitan cities and we find that most of our subscribers, it’s a very good correlation with where the people are because in every geographic area where there are a lot of people, there are neighborhoods, there are segments which still don’t have DSL or cable coverage.

And we continue to be able to sell to them very very well. Currently for the next two or three years, I don’t see a change in that strategy because we continue to get ARPU significantly greater per sub, like $71 per sub, which is much, much higher then any DSL or cable subscriber gets. And we don’t want to jeopardize that market.

Adam Spellman – PPM America

What about competitive impact from LTE, next generation of wireless, or Wimax.

Pradman Kaul

I believe that there’ll be some small overlap between Wimax or LTE or any of these new wireless techniques, but if you look at the cost and you look at the rollout scenarios that these companies like Clearwire and Sprint and all are putting out, they’re not still going into the areas because they can’t justify the economics.

They’re not building out in areas where our subscribers are. So while there will be a little overlap, we don’t expect a significant overlap and for the next five years at least I personally expect that these guys are going to be investing their money for infrastructure in areas where the density of subscribers is much higher then the density in the markets that we are trying to sell.

Adam Spellman – PPM America

And just in terms of the cash balance, can you at least help us frame out are there certain areas that you’re looking to invest and do you have a timeframe after which you would just look to do something else with the cash.

Grant Barber

At this point I think as Pradman said, we’re looking at three or four opportunities and that’s not unusual. We’re on an ongoing basis looking at opportunities. We’ve said in there, we’re looking at growing our penetration, growing the service piece of our business as a complimentary or tuck in acquisitions and we continue to look at those areas.

I think at this time when we take a look at the market we think the right opportunities are there and haven’t looked at alternative uses for the cash at this point.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Deepak Dutt

Thanks Operator, and I just want to say thank you everyone for participating in the call today and this ends the call, thank you.

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Source: Hughes Communications, Inc. Q3 2009 Earnings Call Transcript
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