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Intelsat SA (NYSE:I)

Q3 2013 Earnings Call

October 31, 2013 11:00 AM ET

Executives

Dianne VanBeber – VP, IR and Corporate Communications

David McGlade – Chairman and CEO

Michael McDonnell – EVP and CFO

Analysts

Phil Cusick – JPMorgan

Batya Levi – UBS

Simon Flannery – Morgan Stanley

Brian Russo – Deutsche Bank

Jason Kim – Goldman Sachs

Bryan Kraft – Evercore Partners

Henrik Nyblom – Nomura

Andrew Spinola – Wells Fargo

Keith Hanauer – Barclays

Andrea Lobo Prabhu – Goldman Sachs

Operator

Good day, ladies and gentlemen and welcome to the Intelsat Q3, 2013 Financial Results Conference Call. My name is Lisa and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms. Dianne VanBeber, Vice President, Investor Relations and Corporate Communications. Please proceed, ma’am.

Dianne VanBeber

Welcome everyone and thank you for joining Intelsat’s third quarter 2013 earnings conference call. We issued a press release this morning with our key financial tables which is available on our website. David McGlade, our Chairman and CEO and Executive Vice President and CFO, Michael McDonnell, are here to offer you additional detail on Intelsat’s business and financial performance. Following their prepared remarks they’ll happy to take your questions.

During today’s call we will discuss adjusted EBITDA and other financial metrics not prepared in accordance with U.S. Generally Accepted Accounting Principles including EBITDA related margins and free cash flow from operations. We provide reconciliations of these metrics to the most directly comparable GAAP measures in the earnings release. Later today we’ll be filing the results of Intelsat SA on Form 6-K with the SEC. The 6-K has all the information typically available in the 10-Q. You can find the filing on our website.

Additionally, our conversation today will include forward-looking statements reflected in our current expectations for future industry conditions as well as our business strategy, market trends and positioning and expected future financial performance. Those forward-looking statements are subject to risks and uncertainties many of which are outside of our control.

Please refer to the Safe Harbor statement included in our IPO perspectives of April 2013 for information regarding some of the factors that could cause our actual results to differ materially from our expectations. Finally, please be aware that our conference call today is opened to the investment community and media, with the media invited to participate in listen-only mode. Members of the media are not authorized to quote, either directly or in substance any participant in the call who is not a representative of Intelsat.

Thanks again for joining us today. And now, I’m pleased to introduce David McGlade, Intelsat’s, Chairman and Chief Executive Officer.

David McGlade

Thank you, Dianne. Good morning everyone. Intelsat’s results in the third quarter demonstrate the ability of our diversified business to deliver stable and strong cash flows. At $652 million total company revenue in the third quarter was essentially unchanged as compared to the third quarter of 2012. Our business is performing well although pressures from the U.S. government budget sequestration and to a lesser extent the effects of increased competition in the Africa region are impacting our growth rates.

Our media business delivered solid growth with continuing lift from the new satellites that entered service during 2011 and 2012. Our network services business results reflect a positive contribution of broadband mobility applications. Growth in mobility is being largely offset however by the environment in Africa. Our government business declined worse in the quarter. While the performance in the year ago quarter was quite strong this is also clear that the impacts from the U.S. budget environment and sequestration have to come more pronounced.

The impact of adjusted EBITDA was not as significant because the primary contributor to decline was off network government revenues which earns lower margins. Total company adjusted EBITDA in the third quarter of 2013 was $508 million also essentially unchanged as compared to the third quarter of 2012. The adjusted EBITDA margin remains steady at 78% of revenue. Our contracted backlog ended the quarter at $10.3 billion on par with the prior quarter. At four times trailing revenue, our healthy backlog provides our business with predictability and visibility into future cash flow.

Overall we are reporting a solid quarter that generated strong cash flows, a key element of our two phase investment thesis, which initially features the use of our increasing cash flow to delever our business and create equity value. The third quarter results provide further evidence of our ability to deliver on this strategy as our business generated $333 million in free cash flow from operations. Subsequent to quarter end we made pre-payments of $100 million on our outstanding debt for a total of over $600 million in debt reduction since the beginning of 2013. In the quarter we also made excellent progress on supporting the second phase of our investment thesis, building towards strong organic growth by marketing the capacity of our current suite and our next generation satellites Intelsat Epic. We report on this progress as we discuss the performance of our three customer sets.

Network services posted revenue of $300 million in the third quarter, a 1% increase to the year ago quarter. Transponder service growth was driven by cell backhaul applications in Latin America and enterprise broadband applications. Managed services growth came from new service activations for maritime and aeronautical broadband service providers in the U.S. and Europe and ell backhaul services in Asia. Revenue in these growing applications and regions was largely offset by declines in some of the network services we provide in Africa. Two trends dominated in Africa expecting the competitive environment.

The first expanding deployment of terrestrial fiber has been present in that region for a number of years. The second trend is increased supply from traditional satellite operators that have more recently entered the region. The interactive growth profile in the continent from which we benefited in past years has drawn other satellite operators that in many cases like the scale and resilience of the services we provide in the region. These operators compensate for this smaller position by using price to gain market share with the customer set that for certain applications is very price conscious. These trends are having a more volatile impact on the lower end of the market where some of our service provider customers have struggled to adopt a viable cost structure. That puts pressure on our bad debt expense in the third quarter.

We remain intense on maintaining a disciplined approach to our business activity in the region. Our strategy in environments like today’s Africa is always to focus on the more intensive uses of satellite capacity, where we are part of their core infrastructure requirements. These customers are more likely to be interested in the network resilience and long-term network planning that we can provide. In addition to using this strategy in Africa we have used the same approach with marketing our services in faster growing regions like Latin America with measurable results.

Latin America continues to be an attractive region. While Brazil has been the source of much demand over the past several years there is also a strong growth in the Andean region in Mexico. For instance in the third quarter Intelsat received new and renewed agreements for services to [Consorcio Ecuador] and Telefónica Móviles for use in cell backhaul networks. Mobility applications are a major focus of our broadband infrastructure business, a source of long-term sustainable growth. In the third quarter we’ve signed a new agreement with Panasonic Avionics, a global leader in the provision of broadband and entertainment services for commercial airlines. The new long term contract is first for services on the second of Intelsat’s next generation Epic satellites, Intelsat 33e planned for launch in 2016.

Panasonic Avionics we use the capacity to extend its global network from Europe through the Middle East and North and Southeast Asia. This complements the North America to Europe infrastructure provided by the previously contracted capacity on Intelsat 29e. The media business delivered 4% revenue growth in the third quarter of 2013 to $222 million. New business in the quarter was driven primarily by expansions of existing direct owned platforms in Latin America and Africa and content distribution in Asia. An example of this is our new contract with Discovery Communications. In the third quarter Discovery contracted for new and renewed transponder services on the Intelsat 19 satellite expanding the distribution of its programming in the region located at 166 degrees East Intelsat 19 host of leading video neighborhood in the Pacific Ocean region and reaches more than 37 million Pay-TV subscribers.

Separately Deutsche Telekom affiliate Slovak Telekom signed a long-term agreement from multiple transponders at the Intelsat 1 West neighborhood, a leading hotspot for Central and Eastern European media platforms. Slovak Telekom we use the capacity to provide a DTH service. Over the last 24 months we’ve done a very good job of executing on our capacity launches achieving high fill rates for our neighborhoods. Our next catalyst for growth in media will come in late 2014 when we launch Intelsat 30.

Revenue from government customers of $122 million in the third quarter declined 10% from the prior year primarily as a result of sequestration related reductions and consolidations. A substantial portion for that all of this decline in revenue was from low margin off network services such as third-party transponder services and sales of hardware. This mix mitigated the negative impact to adjusted EBITDA and margins. We have indicated for the past several quarters that sequestration and further reductions in government spending will have a direct impact on our government business. Our current view is that these concerns will remain for the balance of 2013 and as we plan for 2014. Visibility remains limited but the pace of RFP issuance and subsequent awards continuing to slow since our last earnings report in August. That said substantially all of the services we provide to our U.S. government customers are important for the achievement of their missions. And these going forward will continue with same task orders.

For instance that the two Custom COMSATCOM or CS2 awards that run to protest at the time of our last earnings call have been resolved in favor of our prime contractors. These programs are being deployed over the third and fourth quarters of 2013. The two awards feature the provisioning of over 350 megahertz of satellite capacity all of which is on network using nine Intelsat satellites providing various regional coverages. The contracts also include use of the IntelsatOne ground infrastructure. Despite the current situation we remain positive on the long-term outlook for this sector and the role of the commercial satellite operators can play in providing cost efficient space base capabilities to the U.S. government.

Moving to operations and fleet management station-kept transponders were flat at 2175 units at the end of the third quarter as was utilization at 78%. There were no significant fleet changes in the quarter. Our most recent fleet investment program concluded earlier this year, our next series of launches or plan to begin in the second half of 2014 when the first of the new satellites providing service to DIRECTV Latin America Intelsat 30 is scheduled to launch with area and space. The launch cycle for the Intelsat Epic program is still on track to commence in the second half of 2015 but the first satellite Intelsat 29e also assigned to Arianespace launcher. In addition to the previously announced Intelsat 33e satellite we’ve confirmed three additional orders of Boeing for Epic-class satellites that will be deployed in the normal course of replacing our 9 series satellites.

One of the most distinctive features of our Epic program is that is fully integrated with our existing global fleet. We will be marketing to the world’s largest installed base on commercial satellite users. The backward compatibility feature provides resilience to our services and positions us to achieve CapEx efficiencies over time. Wrapping up the solid operational performance this quarter generates the free cash flow that drives the positive cycle of delevering that will create equity value. With our Epic program proceeding on schedule and a continued progress on anchor orders for our next generation platform we are executing on our plan to generate organic growth over the longer term.

So with that Mike McDonnell our CFO will provide the financial discussion. Mike?

Michael McDonnell

Thanks, Dave. Looking at revenue by service type our network type was $589 million was up 2% as compared to the prior year quarter. Within on-network revenue transponder services increased $8 million or 2% to $495 million. This increase was primarily driven by media customers buying capacity services for DTH and programming distribution applications. The increase also reflects modest net growth in network services with increases in mobility and enterprise applications offset by declines in transponder services for Africa. Managed services increased by $7 million or 10% to $77 million led by continued demand from network services customers for aeronautical and maritime broadband and wireless backhaul applications. Channel services which are sold exclusively to our network services customer set declined by $5 million. This is in line with our expectations.

Off-network and other revenue decreased $13 million or 17% to $62 million as compared to the third quarter of 2012 primarily due to declines in services for government applications. As we’ve discussed off-network services generally result from situations where the customer is seeking a capability that is not currently available on our fleet such as MSS, other frequencies or sales in hardware. These revenue types generate lower margins than our on-network services. Excluding depreciation and amortization direct cost of revenue were $94 million in the third quarter of 2013 down $9 million from the prior year. The decrease was primarily due to lower cost of MSS and off-network capacity purchased and a decrease in cost of sales for customer hardware partially offset by an increase to $4 million in cost related to a joint venture.

Selling, general and administrative expenses increased $9 million or 20% to $56 million primarily due to a bad debt expense increase of $11 million related to collection challenges with certain customers as Dave highlighted primarily within the Africa and Middle East region. Adjusted EBITDA was $508 million or 78% of revenue essentially unchanged as compared to the third quarter of 2012. Interest expense net was $249 million in the third quarter of 2013, a decrease of $63 million or 20% as compared to the prior year period.

The reduction is primarily a result of our locking in lower interest rates as we reduced and refinanced our debt in 2013. This quarter we recorded a significant tax benefit of $29 million related to foreign tax credits we intend to elect to claim on our U.S. subsidiaries tax returns. These credits are expected to reduce our future tax obligations. Our net income was $88 million or $0.75 of diluted earnings per share.

Moving to cash flow topic, as you will recall we discussed in the second quarter call that we had prepaid substantial accrued interest of $137 million which would have typically been paid in the third quarter. In addition some of the debt refinanced in the second quarter does not have an interest payment due until the first quarter of 2014. As a result cash interest paid in the third quarter was $36 million. Combined, these factors contributed to our solid generation of over $333 million in free cash flow from operations. During the third quarter of 2013, net cash provided by operating activities was $478 million. This includes $23 million and significant customer prepayments received in the third quarter.

Capital expenditures were $144 million resulting in free cash flow from operations of $333 million for the quarter. Our ending cash balance at September 30, 2013 was $404 million. Our enhanced cash flow allows us to continue on our mission of reducing our leverage. As Dave mentioned earlier, subsequent to quarter close we made a $100 million prepayment of Intelsat Jackson secured term loan.

Moving to our business outlook in our capital investment plans. For the past several quarters, we have indicated that sequestration and reduced US government spending could affect our performance. Our previous revenue guidance for the year has been a range of $2.615 billion to $2.64 billion. Given the continuing effects of sequestration and the unfavorable business environment affecting our network services business in Africa, we are revising our 2013 guidance. We now anticipate that we will fall short of the lower end of the range by roughly 1.5%.

Despite the softer revenue outlook, we continue to expect our EBITDA margins to be consistent with recent periods due to favorable mix of our network, government business and discipline with respect to cost control. Our guidance for CapEx and prepayments is unchanged. Capital expenditures for 2013 are expected to range from $600 million to $675 million and from $575 million to $650 million in 2014. For 2015, we anticipate $775 million to $850 million from CapEx. We expect that program is active in 2015 will include the launch of three satellites plus the ongoing cost of five other programs scheduled for launch in 2016 and beyond.

Our prepayment guidance is unchanged and as we noted in the second quarter, is now limited only to significant customer prepayment that are contracted. In 2013, we expect prepayments will range from $100 million to $125 million and in 2014 from $75 million to $100 million. Our prepayment guidance for 2015 is $25 million to $50 million. Please note that the classification of capital expenditure and prepayments between annual periods could be affected by the timing of achievement of contract, satellite manufacturing, launches and other milestones.

That wraps up the financial discussion. We’ll be happy to take your questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Phil Cusick with JPMorgan. Please proceed.

Phil Cusick – JPMorgan

Hi, guys. Thanks. I guess two short ones, one Mike, can you talk about the bad debt and what we should be thinking about that going forward. How does that impact the numbers? And then second on the government business, was there any level of budget flush this quarter? It certainly doesn’t look like it, but do we need to worry about it being down even more sequentially in 4Q? Thank you

Michael McDonnell

Sure. Phil, good morning. I’ll address the bad debt question. I think that when you look at the situation we had in the third quarter, obviously it’s materially higher than what we’ve seen historically we’ve been less than 0.015 of 1% of our revenue base has been impacted by bad debts and I would say that the circumstance that we had in the third quarter is not something as we expect to be typical at all, it’s a limited fixed number of customers, the majority of it did occur in Africa due to the change in dynamics that we have there. We also had one situation where although we are – we’re fully licensed, we were required to take down some services in the Middle East which contributed to about 25% of the bad debt expense that we saw in the quarter. And so, as a result of all that we’ve got a specific number a handful of customers that were going through some workout situations. We are working through those as rapidly as we can throughout the remainder of this year and we’re hopeful to get our bad debt back into the historically well run rate as soon as we possibly can.

David McGlade

So, in terms of government, we need to remember that the comparison to 2012 included some one-offs last year approximately $8 million of one-offs. But in terms of run rate, we continue to see a lack of business activity, so that the pipeline is limited and our customers continue to consolidate their capacity. So, we do see some pressure going forward.

Phil Cusick – JPMorgan

Thanks, Dave.

David McGlade

Thanks.

Operator

Your next question comes from the line of Batya Levi with UBS. Please proceed.

Batya Levi – UBS

Great. Thanks. Just to clarify the revenue guidance again for full year. Within 0.5% of the low end, so that pretty much implies about $640 million for the fourth quarter, maybe government down slightly, but it looks like the channel services decline will accelerate. Can you talk a little bit more what’s driving the faster decline than what you had originally expected because government was still slightly sequentially maybe down a bit, but it’s the network services I think that’s coming off a bit? Any more color on that would be great?

Michael McDonnell

Yeah, Batya it’s Mike speaking. I think when you look at the updated guidance, the low end of the range was $2.615 billion so half a percent is roughly $13 million on our existing revenue base. We pointed to two contributors primarily government and that is due to the ongoing impacts of sequestration and as Dave mentioned in his opening remarks, we are now seeing less visibility than what we had previously and that we point to as a primary contributor.

And then the second is really the situation in Africa. And certainly channels are a portion of that point to point services are a portion of that, that’s been with us for a while. But now what we’re also seeing is due to the rapidly changing environment there as a result of some of the smaller operators and the infiltration of fiber we are seeing price declines which is manifested in the form of some bad debts, it’s contributed to that in the third quarter as well as some impacts on our outlook for revenue and those are really the contributors to the uptake.

Batya Levi – UBS

Okay. Can you also give us an update on the backlog excluding government?

Michael McDonnell

The backlog excluding government is really the majority of the backlog. I think historically the government has been less than 10%, our aggregate backlog and obviously in the environment that we’re sitting in that percentage is more likely to go down and then up. So, the vast majority of our backlog really resides in median network services.

Batya Levi – UBS

Okay. Thanks.

David McGlade

Thank you.

Operator

Your next question comes from the line of Simon Flannery with Morgan Stanley. Please proceed.

David McGlade

Hi, Simon.

Simon Flannery – Morgan Stanley

Hi. Obviously, there is some pricing pressure in Africa. Can you just characterize the kind of supply demand dynamic in some of the other regions? Obviously, there is concern about new capacity coming on over the next couple of years. And then also, Dave, perhaps talk about your interest in M&A? Thanks.

David McGlade

Sure. So, maybe we should start with Africa in terms of supply and demand. The demand is pretty steady. However, because of fiber taking away our point to point business, so that’s the ITS, IPO, managed services and of course the decline of channel, that has consumed some of that. And then the new capacity that’s come in from traditional satellite operators, as it had to be absorbed. Historically we has seen good growth in the region and because of the new capacity that’s come online because of fiber, it’s not being absorbed quickly enough. And the new operators are coming in using price to gain new customers and that is driven down the overall pricing for new business in the market.

Looking across the Board, it’s pretty stable around the world. We’ve seen good increases year-over-year in Asia Pacific, good increases in Latin America and even in the U.S. it’s been stable. So, we actually when we look at the rest of world are pretty positive, we feel good about the performance this year in Continental U.S. And certainly looking at Europe and that’s also been stable, when you exclude the connectivity to Africa. That’s the area where we see the pressure along with the Africa, there might be customers that reside in Africa. So, that’s generally the situation. On the M&A front, we remain focused on being discipline and looking at these opportunities. However if a company sits well within, our coverage footprint and it could add to our capacity for key regions that we think are useful for certain customer applications where we see growth like mobility, like direct-to-home and other media services we certainly could have an interest.

It also would be about what kind of synergies we can achieve from that kind of acquisition. However, well we of course remain focused on delevering the company. So, we want to be sure that we do everything we can to increase free cash flow in the long-term with an acquisition, is that one were to occur. So, we continue to be prudent when we look at opportunities as they present themselves.

Simon Flannery – Morgan Stanley

Great. Thank you.

Michael McDonnell

Thank you.

Operator

Your next question comes from the line of Doug Mitchelson with Deutsche Bank. Please proceed.

Brian Russo – Deutsche Bank

Hi. This is Brian Russo for Doug. I was hoping you could talk about the aeronautical opportunity you see for Intelsat. It seems like there will be a great number of operators both FSS and MSS going after this business, and the competition is likely to be intense. So how do you see this playing out? Is there enough business for everyone, or will there be clear winners and if that is the way you see it, kind of what characteristics you think will help these operators to win? Thanks.

David McGlade

Sure. So, first of all we see aeronautical applications growing over time. And even with what we have today, we’re seeing good growth this year. Unfortunately we don’t have enough capacity to actually fulfill the amount of demand that’s out there. Remember this is a global business, we think it’s a very sustainable business. And the way we have differentiated our services as grew, the Epic capacity that will come online. So, we really do think there will be winners and losers and we feel that we are well positioned to be a winner, one because we’re global and two, because we are so efficient. We will have the high throughput capability that allow us to bring the cost per bid down for our customers so they can remain competitive over time.

Really two global providers of aeronautical capacity, one today is Inmarsat which is narrow band and they hope to bring online more of a broadband offering. And for us we have broadband today through our mobility fabric that be put in place over the last several years. We overlay the Epic fleet with that capacity and add much denser capacity, so better throughput in the high demand roots for aeronautical customers. We are looking at this opportunity on the commercial side as well as the government side and we feel that we are best positioned at all the operators in the world to satisfy demand. So, we’re optimistic about what we can do with the sustainable business.

Brian Russo – Deutsche Bank

Got it. Thanks.

Michael McDonnell

Thank you.

Operator

Your next question comes from the line of Jason Kim with Goldman Sachs. Please proceed.

Jason Kim – Goldman Sachs

Great. Thanks. First question for Mike. Can you remind us the current mix of your on versus off network revenues from the government segment? And in terms of the mix, how much control do you have internally to manage which type of capacity gets impacted from lower revenues?

Michael McDonnell

Sure. So, Jason year-to-date mix is 60% on net, 40% off the third quarter relatively consistent with those percentages. And I think in terms of our ability to manage, I think it’s more a matter, there is not a whole lot of ability to manage it, I think it’s more a matter of what’s out there in terms of customers and it’s all good business obviously the lower margin business does not have any upfront CapEx or investment associated with it it’s very low risk.

So, we take it all, well you have to remember is that the majority of the off network business, in a lot of cases it’s business that really couldn’t beyond net it could be fragments of capacity that we’re aggregating, it could be equipment, it could be our mobile satellite services, those sorts of things that would typically always be off net. So, it’s more a matter of just taking what we can get on both sides because it’s all good business and as it – so has happened throughout the course of this year, the majority of the pressure that we’ve seen on the government business year-to-date has been a little bit more on the off net side.

Jason Kim – Goldman Sachs

Okay. Great. And for Dave if I can ask one more question on the M&A front. You mentioned in your recent conferences that you expect the activity to pick up a little bit in the sector, and I presume that you would much prefer to buy businesses in whole, and I know we’re talking about theoretical scenarios here, but to the extent that you can acquire partial stakes in businesses that may be fairly sizable, is that something that you guys can consider?

David McGlade

It’s not generally something we had an appetite to do. One, because we would like a path to control but frankly controlling our own destiny, achieving operational synergies are extremely important. And by not having full control of the company we aren’t able to achieve all those synergies and really exploit the opportunity fully. So, if there were a very clear path to control, we would never say never but our preference is to buy – in a company in its entirety.

Jason Kim – Goldman Sachs

Great. Thanks for your thoughts.

David McGlade

Thanks, Jason.

Operator

Your next question comes from the line of Joseph Mastrogiovanni with Credit Suisse. Please proceed.

Unidentified Analyst

Hi, it’s actually [indiscernible]. I had then two questions on the government business actually. Firstly, it seems like a lot of the weakness is driven by lower volumes. Also, maybe talk a little bit about what’s going on with the pricing, if you’re seeing pressure on pricing as well? And then on the volume side, I guess some of it is relating to withdrawal of troops from various places, but are there also a component that’s basically just been put on hold, and that could bounce back at some stage. And then the second question is also on government. There has been discussions, I guess, or the government the U.S. government is thinking about how to make their procurement of satellite capacity a bit more efficient. If you can talk a little bit about if there is any progress there, and what you think that could mean for your business? Thanks very much.

David McGlade

Sure. So, on the question about volume and price, we certainly have seen lower volume because of a consolidation in capacity a delay of procurements, et cetera. We have seen some pricing pressure as well as other operators are looking to get a smaller piece or piece of a smaller pie, and also saw some pressures from the protest that occurred. So that is definitely happening on both fronts. In terms of the troop drawdown in Afghanistan we see that occurring going forward to some based on troop welfare and morale applications as well as some command-and-control capabilities that would no longer be required. However, that could be offset in part by Intelligence Surveillance Reconnaissance activities that will occur in Southwest Asia.

So we have to see how that occurs next year, but we had anticipated that Afghanistan would affect our revenues in terms of putting pressure on ourselves that troop drawdown occurs.

In terms of other regions we actually have seen an uptake of new capacity in places like Africa and Asia. Unfortunately we don’t have a lot of capacity to satisfy that demand, but there, it’s certainly and we have seen over time that the U.S. pivot more from the Middle East to Asia-Pacific and places like the Korean Peninsula and the South China Sea. So we think that as a long-term in something that we have to be aware of as well as increased activity in Africa as I mentioned.

In terms of opportunities to capitalize on the U.S. looking to procure capacity more efficiently we certainly see that and we see that as a long-term benefit, because we think we’re more cost effective than the government-owned programs, we have a better track record in terms of providing capacity on time and on budget and we believe by taking advantage of our large global fleet and incrementally procuring capacity on a long-term basis like our media and other customers have done for some time will bring better efficiencies for the U.S. customers, government customers and we look forward to that, we’re seeing some progress certainly with our piece that that have come out and in terms of what we’ve seen on Capitol Hill.

So that’s why we are long-term bullish on the sector because we do see a sea change that occurs out of necessity the large programs that were cost ready are just not available to our customers going forward and we’ve seen a reduction of new project going forward. So we think that bodes well for us long-term.

Unidentified Analyst

Okay, thanks very much.

Michael McDonnell

You’re welcome.

Operator

Your next question come from the line of Bryan Kraft with Evercore. Please proceed.

Bryan Kraft – Evercore Partners

Hi, good morning. Just wanted to ask you about the SATCOM contracts the 350 megahertz, is it about right to assume that’s about $15 million in annual revenue in the government segment and you know, could that be enough to offset any further erosion in that government run rate plus the fourth quarter? Thanks

David McGlade

Sure. So first of all we don’t comment on specific contracts. However, it’s certainly help our on-net business going forward, but I would just say that erosion or some of the other revenues are swapping the growth we’re seeing in the CS2 procurements that we have been successfully winning. So I would just say that it’s an offset and that will probably continue.

Bryan Kraft – Evercore Partners

Okay. And could I ask you just a follow-up I mean, how much of the guidance adjustment is Africa pricing versus government impact?

Michael McDonnell

Yeah Bryan it’s Mike speaking. You know I think it is really not something that we typically quantify real specifically I just kind of referred to what we said which is that you know we’re seeing continued impacts of sequestration that’s you know primarily you know sited that as the primary driver and then you know we also see some impacts from the network services in Africa. So it’s really both I think that we did kind of point a little bit more toward the government, but it’s really both and you know in the end we’re expecting to be within a half a percent of what we provided previously.

Bryan Kraft – Evercore Partners

Okay, thank you.

David McGlade

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Henrik Nyblom with Nomura. Please proceed.

Henrik Nyblom – Nomura

Hi there, guys. Just two very quick questions. The first one on the bad debt expense in Africa and I guess there was some in related to Middle East so, I’m not sure whether that was one single customer or was it several different customers? And related to DoTs and sort of based on the previous question as well what is it really that has happened in Africa this quarter beside this bad debt expense that should have taken you by surprise especially given that you know sound like capacity comes out then we no doubt a few years in advance and some of your competitors have been talking about Africa being an area of problems for now on thus part of two years. So can you just be – bit more specific what is really going on and may be even quantify you know what exposure you actually have to the areas where you expect continued decline?

Michael McDonnell

Yes, so Henrik it’s Mike speaking. You know as I mentioned the majority of the bad debt we saw was in Africa was a handful of customers the other item that I cited which was close to 25% of the impact was actually Europe which was a situation where we’re providing a service that we had a license to provide and the U.S. government required us to take it down and that caused us $2 million, $2.5 million of bad debt expense during the course the quarter.

I think you know the other piece that we’ve seen because obviously the market is moving quickly there is that we have a lot of customers who have you know look to cheaper alternatives and one of the ways that’s manifested is that we’ve had issues with getting them to pay their bills like we have in the past. So we’re working through those situations with those customers, adjusting prices in some instances and looking to you know clean up these workout situations as quickly as we can so that we can restore our bad debt levels to you know where they’ve been historically.

David McGlade

So that IRIB customer is a national programmer in Iran. And as Mike we were required to bring them down by the U.S. state department even though we have license to carry those services. In terms of Africa, we absolutely anticipated all the capacity coming in, we knew who the operators were, we knew what kind of capacity they have and we had worked hard to differentiate our services in the market.

However, as Mike mentioned earlier, at the lower end of the market they were adversely affected by the rapid decline in pricing. So, what happened over the last several months is that the prices dropped and some of our customers who were locked in contracts became uncompetitive in the marketplace. So the smaller ones were most vulnerable to that so some actually went out of business, others to compete needed price concessions and we are actively working with them. So we absolutely anticipated that capacity just like we anticipated the fiber capacity what I guess were surprising with a degree that other operators and some of these large operators use price rather than other capabilities to drive performance on their own assets.

And since we have the largest market share, we were the ones who were affected because we have the customers locked in at pricing that was higher and we have brought up yield in that market for many years now and the new entrants have not that as discipline.

Henrik Nyblom – Nomura

Brilliant, thank you. Very clear.

David McGlade

Thank you.

Operator

Your next question comes from the line of Andrew Spinola with Wells Fargo. Please proceed.

Andrew Spinola – Wells Fargo

Thanks. Could you possibly expand on the African competitive position and specifically whether is this more of a discrete repricing that is going to impact Q4 and that’s going to be new baseline or is this something we should expect to continue to pressure the network services revenue lines throughout 2014?

David McGlade

So let me give a broader view of Africa because that’s an important question. First of all we have some government business there it’s the smallest percentage of all of our customer sets and that pricing is solid. Second part, as we have immediate business there that’s very successful it’s growing and actually grew in Q3 by approximately 4%. And the business that we believe in long-term and can see opportunities that are presenting themselves over time. That really has today that immune from the pricing pressures and there still a high demand for what we offer because these media customers want quality, they want resiliency and we can provide that for them.

Also the large telecom operators and a large mobile operators are all looking for quality as well. And they have large portfolios they operate not only in Africa but other regions and we’re able to leverage our global position with them to mitigate some of these impacts. As I mentioned earlier, it’s really the smallest service providers from the VSAT operators that have more marginal business cases some of them are entrants and they are very susceptible to price changes as they sell some of that capacity from us and the other operators. So if we’re 20% higher say or 30% higher than some of the other pricing then they’re not able to compete effectively.

So what we are focusing on are the large intensive users of capacity and we’re doing all we can to support them because long-term they’re going to be with us. And I think the last point to make is that, this is really a bridge to Epic, because with Epic remember we’re going to get up to 10 times the throughput, 3 to 5 times the capacity the very nature of that technology allows us to bring down the cost per bit, and be more efficient and have a long-term sustainable business for these intensive users of capacity. So we do believe we have the transition customers over the next year and half or so into Epic. But we think we are positioned better than anybody in Africa to satisfy the long-term demand to that region.

Andrew Spinola – Wells Fargo

Thanks, that’s helpful. And, on a similar related note, you know it’s hard enough to notice all of the operator sort of talking pretty optimistically about Latin America, I was just wondering if you would comment on that market in general in terms of sort of demand versus supply when you look at the rollout schedules of other companies and other providers in that space, do you think there is any resemblance to Africa or do you think the applications in the customers are different long-term? Thanks

David McGlade

That’s an excellent question. Look what is consistent is that there are many operators that from a sales and marketing perspective are unsophisticated in our industry. And so that unfortunately is the case it has changed over time for the positive but it still exists. However, the market is very different, the percentage of media customers is much larger, our network services customers are much larger customers is a large telcos and mobile operators that again are very sophisticated like some of the large ones we have in Africa.

And there are much less of those small entrepreneurial service providers than we have in Africa. So we feel that it’s a better position for us long-term not only because of what I just said, but also because of capacity we’re bringing in so let’s not forget. IS30, media satellite project TV virtually sold out. IS31, backup satellite for IS30 virtually sold out for DirecTV Latin America. IS34, already has backlog on it we’ll have significant backlog by the time it launches most of it for media there is also mobility, payload, that mobility payload will have strong demand from again customers with sustainable business. IS29 Epic has capacity in Latin America as well it’s already 20% sold out and have a $1 billion of backlog on it and we see good demand going forward.

So, we think we’re well positioned in that market we think the characteristics are superior to what we see in Africa but at the same time it is absolutely true that new capacity is coming in and could put some pressure on the marketplace that’s why we’re doing everything possible to preempt that environment and work with good, strong, long-term customers that desire, high quality, resiliency that provide as a global operator.

Andrew Spinola – Wells Fargo

That’s very helpful. Thank you very much.

David McGlade

Thank you.

Operator

Your next question comes from the line of Keith Hanauer with Barclays. Please proceed.

Keith Hanauer – Barclays

Hey, good morning and thanks for taking the question. Actually have two and that’s for Dave first off, just on the media side it sounds like the trends there is still pretty strong but I guess I’m curious as we head into the fourth quarter which is a bit of a tougher comp if you think that the 4% to 6% growth we’ve been seen there is actually sustainable with our new capacity coming online?

And then separately just on the cap structure the term loan pay down I guess if you could talk kind of longer-term what you’re thinking is in terms of your de-leveraging strategy you’re already pretty low leverage on a secured basis and kind of the mix going forward paying down the relatively lower coupon term loan as oppose to say like the 8.5s or 7.25s that become callable over the next you know two years and relatively higher coupon could actually benefit your free cash flow a bit more potentially and kind of how you think about that trade-off there?

David McGlade

So this Dave why don’t I take the media, the media question. We certainly see an environment where we are waiting for the new capacity to come online. So remember, we refreshed our media neighborhood in 2011, 2012 and they’re running their course so it is hard to sustain that kind of growth without incremental capacity that the catalyst for growth will absolutely be IS30 that we launch in 2014. Mike, you want to take the other question.

Michael McDonnell

Yeah, so on the second question Keith I would say that the strategy on de-leveraging it’s actually pretty simple, there is really broadly speaking three alternatives that we see that we have one is we can take out the secured debt we can take that at par at any time without penalty and that’s what we did in the early part of the fourth quarter. The second thing we can do which you pointed to one example is to take out debt as it becomes callable the 8.5s happened to be our highest coupon debt and they do become callable but it’s about a year out to put at first call date consumer certainly we can look at taking that out one of it comes callable if we’re willing to pay the premium and reduce the interest expense accordingly. And obviously with higher coupons like that that is you know a bit more interesting than just taking out the secured debt which as you pointed you as is lower coupon. And then I think the third alternative is on an opportunistic basis looking and doing something in the open market. So I think we will look at anything and everything but to the extent that we have excess free cash flow like we found ourself having in the early part of this quarter we look at those three buckets broadly speaking we look at the best alternative and we go with it.

Keith Hanauer – Barclays

Great, thanks very much.

Operator

The next question comes from the line of Andrea Lobo Prabhu with Goldman Sachs. Please proceed.

Andrea Lobo Prabhu – Goldman Sachs

Hi, my question has actually been answered so thank you.

David McGlade

Thank you.

Operator

There are no additional questions this time. I would now like to turn the presentation back over to Mr. David McGlade.

David McGlade

Thank you very much and thanks everyone, our performance this quarter demonstrates the benefits of our diversified business model and our ability to generate the cash flows that would de-lever our business. At the same time we’re executing our business strategy that aligns our customer’s requirement to our next generation fleet, building future revenue growth. Thanks for listening to our call today. We look forward to talking to you soon. Goodbye.

Operator

Ladies and gentlemen that conclude today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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