Hughes Communication CEO Discusses Q3 2010 Results - Earnings Call Transcript

Executives

Deepak Dutt - VP, Treasurer and Investor Relations Officer

Pradman Kaul - President and CEO

Grant Barber - Executive VP and CFO

Analysts

Jennifer Fritzsche – Wells Fargo

James Ratcliffe - Barclays Capital

Chris Quilty - Raymond James & Associates

Larry Harris - C.L. King

Matthew Barnett – Jet Capital

Hughes Communication, Inc. (HUGH) Q3 2010 Earnings Call November 3, 2010 2:00 PM ET

Operator

Good day, ladies and gentleman, and welcome to the Q3 2010 Hughes Communications Incorporated Earnings Conference Call. My name is Tony, and I'll be your coordinator for today. At this time, all participants are in listen only mode. We will conduct a question and answer session towards the end of the conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I would now like to hand the call over to your host for today, Mr. Deepak Dutt, Vice President, Treasurer and Investor Relations Officer. Please proceed.

Deepak Dutt

Thank you, operator, and good morning everybody. Welcome to our third quarter 2010 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 that are subject to risks and uncertainties.

Actual results may differ materially from those contained in these forward-looking statements. And we refer you to 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 to be filed with this press release and our registration statement on Form S-3.

Joining me in today’s call are Pradman Kaul, President and CEO and Grant Barber, Executive Vice President and CFO.

So, let me turn the call over to Pradman.

Pradman Kaul

Thank you, Deepak, and good afternoon. I'd like to start with the main highlights on our performance in the third quarter. First, I’m delighted that we turned in a robust revenue performance in this quarter with a strong resurgence in our enterprise business.

Even more noteworthy is the magnitude of orders we booked in Q3 from the Enterprise businesses; more on this later.

Secondly, the unbroken strength of adjusted EBITDA growth continued this quarter. We delivered an all-time high adjusted EBITDA of $61 million, which represents a growth of 38% over the third quarter of 2009.

Once again, it was driven primarily by strong performance in the consumer business and the margin contribution from our SPACEWAY-base business model being the key driver.

Thirdly, our strategy of providing managed service offerings continues to enhance our competitive positioning, and fuels strong service revenue growth. Our total services revenue grew by an impressive 15% over Q3 ‘09, which corresponds to 18% after excluding revenue from the discontinued contract with Telematics.

Forth, we generated a net $69 million of cash from operating activities, enabling us to end the quarter with a healthy cash and marketable securities position of $222 million; the same position as of the end of Q2 2010, despite significant CapEx in the third quarter on the build out of Jupiter, our new high-throughput Ka-band satellite, currently under construction.

Now, I’d like to give you some highlights of our businesses. Our enterprise business was a clear standout this quarter. You might recall that this part of our business has been somewhat sluggish in the past few quarters, and I’d like to believe this is due primarily to CapEx spending slowdown by our enterprise customers in large part due to the macroeconomic environment.

I’ve also previously convened by cautious optimism of our likely turnaround. I’m delighted that this turnaround appears strong again, and total revenue in this quarter grew by 6% over Q3 ‘09, which corresponds to an even more robust 10% in revenues from the discontinued contract Telematics are excluded.

Even more noteworthy is the magnitude of new orders booked in Q3. We recorded $549 million this quarter, which is a quantum growth of 164% over Q3 ‘09. This includes some very significant orders from large retail chains in North America, as well as leading international enterprises primarily in Brazil and India.

You may also recall that we had previously signed an agreement with Barrett Xplore, Canada’s largest rural broadband service provider, that Barrett will require capacity of Jupiter. Barrett has since confirmed their intention to lease this capacity for a term of 15 years, enabling us to record an order input of $245 million, which represents the least amounts of 15 years and the reservation fee.

All of this has resulted in our Q3 ending order backlog reaching an unprecedented high of just over $1 billion. This backlog does not include all this from the consumer business.

Our consumer business, once again, turned in a solid performance. Total revenues grew by 14% and services revenue grew by 19%.

We had 49,000 gross ads and 13,000 net ads, consumer output increased to $75, close to $71 in Q3 ‘09, and churn improved to 2.2% compared to 2.3% in Q3 ‘09.

We ended the quarter with over 357,000 subscribers on SPACEWAY and 558,000 total subscribers, a 14% growth over Q2 ‘09.

Another landmark event in Q3 was that we were awarded nearly $59 million under the American Recovery and Reinvestment Act of 2009, administered by the Department of Agricultural Rural Utility Service.

The terms of this award include us receiving subsidy of $551 for every qualified subscriber that we activate. We expect that this program will be especially attractive to subscribers in underserved and unserved geographies as providing another avenue for increased growth in our subscriber base.

I’m especially proud that we are the only awardee that was chosen for this service, nationwide, and that we have been awarded nearly 60% of the total amount of awarded to satellite service providers.

You may recall that we took a $44.4 million write down in Q2 ‘09, following the bankruptcy filing by Sea Launch while the deposit that we had paid to Sea Launch.

In Q2 this year, we entered into a settlement agreement where Sea Launch will issue HNS, two credits of $22.2 million each, to be used to defray the cost of two launches if contracted by December 31, 2015.

In addition, as subject to certain conditions, these credits can be transferred to third parties. This could provide us a nice upside for both earnings and cash sometime in the next few years.

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

Grant Barber

Thank you, Pradman, and good afternoon. As Pradman mentioned in his comments, we are pleased to have completed another solid quarter and end the third quarter in strong financial shape.

Our results for the quarter reflect many of the trends that we have discussed on our earlier calls, and we continue to execute on our plans. As a result, I would like to outline the key third quarter highlights and then elaborate on comparisons to the third quarter of last year.

The key financial snapshot for the third quarter highlights that we significantly improved our overall profitability. We delivered revenues that were 6% ahead of the third quarter last year, we earned 61.2 million in adjusted EBITDA, 38% ahead of the third quarter of last year, and positive net income attributable to Hughes stockholders of $10.1 million versus the loss of 2.6 million in the third quarter of last year.

Once again, we close the quarter with a strong cash and marketable security position, up $222 million. At Hughes, revenues for the third quarter of 2010 were $266.3 million, $14.9 million, or 6% above the third quarter of last year. Excluding the Telematics contract, our revenue for the quarter was 10% higher than the third quarter of last year.

Revenues for the first nine months of 2010 were $761.8 million that was $14.4 million or 2% above the first nine months of last year, reflecting the strength in the current quarter just completed.

We continue to deliver strong performance in the consumer business; our largest and fastest growing business group, which generated record revenues of $122.2 million in the third quarter of 2010, 15.1 million or 14% above the same quarter of last year. Multiple factors contributed to this positive result. Substantial growth in the number of subs, targeted higher-priced service plans coincident with higher broadband capacity, improvements in customer retention, as evidenced by a reduction in churn, and more value-added services which yielded higher RPU.

For the quarter, we added 49,000 gross and 13,000 net subscribers. And as of September 30, we achieved a record total base of 558,000 subscribers, 14% higher than the level a year ago.

The North American enterprise business had revenues of $68.4 million, an increase of 1.3 million or 2% above the third quarter of 2009. The international broadband segments revenue of 51.8 million were $4.3 million or 9% above the third quarter of 2009.

We discussed on earlier calls that we had seen positive signs in these two business groups, and that turnaround contributed greatly to the overall performance of the company. Excluding the Telematics revenue in both years, the telecom system segment delivered revenue of $22.4 million, $2.3 million or 11% above the third quarter of 2009. This growth was led by the Mobile Satellite System business revenues, which were up 16% above the revenues of the third quarter of last year.

Service revenues were $202.3 million, an increase of $26 million or 15% above the third quarter of 2009. Hardware revenues in the quarter were $64 million, a decrease of $11.2 million or 15% below the third quarter of 2009.

The service revenues are 76% of our overall revenue, approximately the same percentages as the first half of this year, and up from 70% of revenue in the third quarter of last year. This level is primarily due to the higher revenues from our consumer group due to the growth of our consumer subscriber base, and in part to the election by the customers to utilize the consumer rental program.

The North American and International Enterprise service revenues continue to grow as a result of an increase in our Managed Service business, where a larger percentage of the overall customer revenue reflects lower upfront hardware revenue and increase recurred services revenue.

Gross margins increased 3.2 percentage points to 30.6% of revenue as compared to 27.4% in the same period in 2009. This increase reflected strong growth in the services revenue, which on average delivers higher margins than our hardware business. This continued margin improvement is evidence of the increased profitability of subscribers on SPACEWAY 3 versus those on leased transponders, and continues to improve as we expand our Ka consumer service on the SPACEWAY 3 platform.

Operating expenses for the third quarter of 2010 were $55.9 million, an increase of $2.5 million above the third quarter of last year. This increase reflects higher marketing cost of approximately $3.3 million in our North America operations, as we increased targeted spending for our consumer business, which was instrumental in driving the increased to subscriber gross ads in the quarter.

In addition, we reduced spending in each of our R&D and G&A lines, as we continue to maintain a strong focus on spending constraints and improved earnings.

Operating income was $25.6 million for the third quarter of 2010 or 10% of revenue compared with operating income of $15.6 million or 6% of revenue in the third quarter of last year. Net income attributable to Hughes stockholders for the third quarter of 2010, was $10.1 million or $0.45 a share on a fully diluted basis. And this was a significant turnaround from the loss of $2.6 million or $0.12 per share in the third quarter of last year.

A stable and reconciliation of adjusted EBITDA for Hughes and Hughes Network Systems, LLC, our principal operating subsidiary are attached in 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.

For Hughes, adjusted EBITDA for the third quarter of 2010 was $61.2 million, an increase of $16.9 million or 38% above the same period adjusted EBITDA in 2009, reflecting the improved operating performance of our businesses.

We see adjusted EBITDA as a critical and key measure of our business performance, and are pleased to show an improvement in adjusted EBITDA from 17.6% of revenue in the third quarter of last year to 23% of revenue in the third quarter of 2010.

For the first nine months of 2010, adjusted EBITDA was $156 million, 33% ahead of the first nine months of last year. Also note, on the trailing 12-month basis, adjusted EBITDA for the 12 months ended September 30, 2010, was $212.5 million, and that was 31% ahead of the 12-month end at September 30, 2009.

Moving to Hughes Communications cash and balance sheet, we generated net cash from operations of $69 million in the third quarter bringing our total net cash from operations for the first nine months of this year to $111.8 million. This performance is in line with $110.6 million generated in the first nine months of last year.

Capital expenditures for the third quarter were $66.1 million, slightly above the 63.8 million we averaged in the first two quarters of this year. This CapEx continues to be dominated by payments for our Jupiter satellite, which were $39.3 million in the quarter and 104.8 million in the first nine months of this year.

Looking forward for the fourth quarter of this year, we expect payments for Jupiter of approximately $75 million of which 27 million will be funded by a drawing on the Coface financing recently completed.

As we outlined in the headlines of our press release, for the third quarter we booked new orders of 549 million, revenues of $266 million, and adjusted EBITDA of $61 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. A few words now looking to the near-term future and longer-term strategic initiatives.

I mentioned to you the large consumer backlog of over a billion dollars that we enter the fourth quarter with clearly argues very well for our revenue growth in the near-to-mid terms from our enterprise businesses.

In addition, there are other large opportunities in the pipeline that we’re actively working to close, which I feel very positive about. I expect the consumer business will continue to grow, with an additional push from the ARRA stimulus award.

The consumer business, in fact, on our adjusted EBITDA profitability has been significant to date, and will be ever more pronounced as we continue to activate more subscribers on to SPACEWAY in the near term, and thereafter when we commence service on Jupiter.

Construction of Jupiter, our new high-throughput Ka-band satellite is progressing very well. We signed the launch subject to agreement of our [inaudible] in April, and have completed a number of key satellite construction milestones.

To name a few of the critical design review, while the satellite is completed and subsystem delivery to Space systems around have begun. The communication panels were delivered and their integration is progressing well. Delivery of the bus system subassembly and high-power amplifiers also started in September as planned. The project is on schedule and we expect to launch Jupiter in the first half of 2012.

Finally, we signed last week $115 million loan agreement with BNP Paribas and Societe Generale to provide financing for the launch with very attractive terms, including the interest rate and loan drawdowns.

The loan will be guaranteed by Coface, the French Government’s Export Credit Agency. Loan drawdowns will commenced very shortly.

To recap, Jupiter’s feature is designed to provide over 100 gigabytes of capacity, 10 times greater than SPACEWAY 3, enabling us to augment capacity and expand high-speed services offerings for our North America consumer business.

The capacity of Jupiter is expected to be about 1 ½ to 2 million subs, thus providing the framework of further accelerating our revenue and margin expansion.

As previously discussed, key terms of our agreement of Barrett Xplore to acquire capacity on Jupiter were confirmed recently; that’s reinforcing our plan to extend Ka service to Canadian consumers.

We previously announced a signing of a contract with Avanti Europe to build a ground network infrastructure for their two Ka-band satellite, HYLAS 1 and HYLAS 2.

In addition to providing the gateways and terminals, we have also leased space segment on both satellites for our own service offerings. It is expected that HYLAS 1 and 2 would be able to accommodate approximately 1 million subs in Europe and the Middle East.

So in addition to our current global Ku-service capability in over a hundred countries, we’re now developing an overlapping Ka-band network to provide higher speeds and more attractive economics.

With SPACEWAY, Jupiter and HYLAS, we have a great start by covering the United States, Canada, Europe, and the Middle East. And we intend to provide this capability in other parts of the word through partnerships and joint ventures, and this activity is currently in process and progressing well.

I believe that we will have a Ka-band overlay in many other parts of the world very soon. Hughes has been the leader of this market for over 25 years and I expect that to continue in the future.

Our work with the U.S. and foreign government is also progressing well. We have signed additional contracts with federal agencies, and state and local governments, including a recent award by the U.S. General Services Administration to provide commercial satellite communication services under the GSE and Defense Intelligence System Agencies, Future Concept Services Acquisition Program. The award only serves as a conceptional new program. The offering was created, modified its use existing GSAs schedule 70 contract, to include subscription services and transponder capacity.

Before I conclude, I’d like to address an important point. As you know, thus far, we’ve chosen not to provide guidance on our financial projections. We will continue this practice as it relates to the future. However, we believe that it will be a benefit to our shareholders and investors, if we were to provide longer-term guidance on certain key metrics.

The consumer business has been the key driver of our top-line growth of the past, with our subscriber base growing at a compounded annual growth rate of approximately 19% over the past six- plus years.

Because this market is large with low broadband penetration, we expect this growth to continue at an average of approximately 75,000 net new subscribers per year between now and 2015.

Because it’s growth would primarily be from activations on SPACEWAY and Jupiter, it is expected to provide further expansion in gross and adjusted EBITDA margins.

Taking the above into account, and some of the strategic enterprise initiatives I mentioned earlier, we will be managing the company with the goal of growing total company revenues at a compounded annual growth rate of approximately 10% through 2015 and increasing the adjusted EBITDA margin from 17% in 2009 to the low-to-mid 30% range in 2015.

So in conclusion, I’m delighted with the third quarter performance and believe we are in even better position to continue success and growth in the near and longer term. I’ll turn it over to Deepak now.

Deepak Dutt

Thank you, Pradman. We will now start the question and answer part of the call. If there are any follow-up questions from the financial community, please direct them to me through our investor relations line. Members of the media should contact Judy Blake.

Our contact information for both is available on our website hughes.com. We’ll take a few moments to get the Q&A process started after which the operator will take over and coordinate the session. Tony?

Operator

Ladies and gentlemen, if you would like to ask a question please press star 1. If your question has been answered or you would like to withdraw that question, please press star 2. Questions will be taken in order received. And your first question comes from the line of Jennifer

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Jennifer Fritzsche. Please proceed.

Jennifer Fritzsche – Wells Fargo

Great, thank you. Nice quarter, and thank you very much for that additional guidance, it’s extremely helpful.

Just a few questions. On SPACEWAY 3, you know have just under 360,000 subs, can you talk about what the capacity is? Is it still about ½ a million?

Pradman Kaul

Yeah, I think around 550,000 to 600,000 is what we’re aiming for.

Jennifer Fritzsche – Wells Fargo

Okay. And then on the stimulus, you won – is it 59 million, the award there? Can you talk about how it will be distributed and will you subsidize hardware here?

Pradman Kaul

Yeah. I think in terms of how it will be distributed, it’s the eligibility criteria is based on specific area that the subscriber comes from and there are a whole bunch of criteria the subscribers have to meet to quality for this program. And basically, we install the equipment to them and we will get a subsidy of $551 per subscriber from the government after we finish the installation.

Jennifer Fritzsche – Wells Fargo

Got it, okay. Terrific. And then just one last question. On North America Enterprise business revenue, I know this normally comes out in Q grant, but can – it has been flat and I’m just wondering if this is, are we seeing an uptick here, any trends you can comment on?

Grand Barber

Well, we’ve been down in the first couple of quarters, so this quarter you’ll see a slight increase. We’re up approximately $2 million ahead of where we were in the third quarter. But more importantly to what we put in the press release, and to Pradman’s comment, we’re very encouraged by the magnitude of the orders and the activity that we’ve seen in the Enterprise business that has contributed to our strong backlog position, you know, our recovery in the North American Enterprise, and I mentioned the international as well was up 9%.

So very encouraged with signs we’re seeing initially from those two enterprise units.

Jennifer Fritzsche – Wells Fargo

Perfect. And just one last one. I’m sorry if I missed this, I joined late. RPU was up nicely from the second quarter. Is this just from leasing of hardware or are you seeing an uptick or upgrade for customers moving to the pricier plans?

Grant Barber

Yeah, we’re seeing a combination of things. Clearly, the roughly 2/3s of our consumers that select a rental plan leads to an increase in RPU. We are also seeing increase pickup of our higher price service plans, which are requiring higher bandwidth and obviously higher monthly recurring revenues.

And then thirdly we sell – so value-added services; next-day repairs, maintenance and some tokens that allow people to increase the bandwidth and the download envelope size, and we’re seeing positive upside on all three of those.

Jennifer Fritzsche – Wells Fargo

Terrific. Thank you very much.

Operator

Your next question comes from the line of James Ratcliffe. Please proceed.

James Ratcliffe – Barclays Capital

Good afternoon, guys. Thanks for taking my questions. A couple things. Can you talk a little, in regards to the stimulus; those customers are getting a better deal than is available to the general public. How do you manage marketing to them so you don’t end up getting crossed-marketing messages and end up communicating that offer to people who don’t qualify for it?

Pradman Kaul

Very carefully. The bottom line is, that is something that is very important and we’re working very hard in not confusing the market. But fundamentally, the process says the subscriber signs up for the service and depending on his qualification of the stimulus criteria, we automatically decide, you know, the system automatically decides whether they qualify or not. And if they qualify, they get the stimulus package and if they don’t qualify they’ll get another package, a regular Hughes package which may have some stimulus also, but obviously different than what the government is offering.

James Ratcliffe – Barclays Capital

And secondly, I may have misheard you, but did you say that the Barrett, the whole points of that contract is now part of your backlog number?

Pradman Kaul

Yes. We basically – since we have a firm commitment from Barrett to lease this capacity for 15 years, we have basically booked it into backlog.

James Ratcliffe – Barclays Capital

So can you talk about how the backlog changed Q-on-Q X benefit?

Pradman Kaul

Yeah, Grant’s looking at that number. This way we added $245 million to the backlog. So you subtract 245 from the total number, that will give you the – a billion plus, so that’s what you have to backlog – about 700-plus, excluding [inaudible].

James Ratcliffe – Barclays Capital

Okay.

Pradman Kaul

It was a billion-fifty or something.

James Ratcliffe – Barclays Capital

So it was up Q-on-Q even netting out the Barrett impact?

Pradman Kaul

Absolutely. We had a very good enterprise point.

James Ratcliffe – Barclays Capital

And finally, looking at just the absolute level of your OpEx base, it looks like it came down pretty substantially year on year. Other than just continuing to roll customers Ku transponders, were there other cost elements in there that declined?

Grand Barber

Yeah, the main piece is, as I mentioned on the – in the OpEx, we’re actually up about 2 ½ million in the third quarter over the third quarter of last year, and it was really the targeted advertising in the North American Consumer market, in the selling and marketing, and we were under in initial C in the detail statements when they came out in the R&D and the G&A portion.

So you know, we commented from the last few quarters that we were keeping the lid on your discretionary expenses on all lines, freeing up money to invest in the consumer selling and marketing area and that continues to pay off.

James Ratcliffe – Barclays Capital

And finally, the guidance, long-term guidance was very helpful and back of the envelop looks like it’s kind of implying someone in the range of 500 million EBITDA by 2015, which is a pretty substantial increase. The 75,000 net ads per year number, how much of that sort of growth trend, which you know, seems quite linear and given in the potential size of the unbroadbanded market, it still seems you’re a reasonably small portion of that addressable pie. How much of that growth trend is driven by desire to keep spending in line and limit the amount of money you’re taking into growth, and how much is it just a belief that if you substantially ramped up marketing, got a lot more aggressive, that the yields just wouldn’t be very attractive on that?

Pradman Kaul

Yeah, it’s a combination to clearly, you know, when you look at the market that’s available, all of the market isn’t available this year or next year, you know, people – economic ability, the desire for broadband speeds, we expect over the next five years new people from this market base will be entering the market. So the actual available market per year, we estimate, you know, the 1 million or so new subscribers that will come into the market every year who are ready to buy and ready to put up the money.

So now, if we obviously increase the spending dramatically, we can definitely get more subs, but we are sort of optimizing the subscriber acquisition cost with a number of subs we believe we need to maintain the business and try to find that optimal point.

James Ratcliffe – Barclays Capital

Great. Thank you.

Operator

And your next question comes from the line of Chris Quilty. Please proceed.