Hughes Communications Inc., Q4 2007 Earnings Call Transcript

Hughes Communications Inc. (HUGH)

Q4 2007 Earnings Call

March 3, 2008 2:00 pm ET

Executives

Deepak Dutt – VP, Treasurer, IR

Pradman Kaul – President & CEO

Grant Barber – Exec. VP & CFO

Analysts

Matthew Barnet – Jet Capital
[Analyst] – Wachovia

Jennifer Adams – Analyst

James Radcliffe - Analyst

Presentation

Operator

Good day ladies and gentlemen and welcome to the Q4 2007 Hughes Communications earnings conference call. (Operator Instructions) I would now like to turn the call over Mr. Deepak Dutt, Vice President, Treasurer and Investor Relations Officer. Please proceed sir.

Deepak Dutt

Good afternoon everybody and welcome to our fourth quarter 2007 earnings call. Before we begin the call I’d 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 and our Registration Statement on Form S-3 filed on August 8, 2007. In addition to reporting financial results in accordance with generally accepted accounting principals or GAAP, Hughes reviews non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to comparable GAAP results which can be found on our earnings release and our Investor Relations website.

I would now like to introduce the Hughes management team that’s joining today’s call, Pradman Kaul, President and CEO and Grant Barber, Executive Vice President and CFO. Let me turn it over to Pradman who’ll start with a business overview followed by a financial overview by Grant. Pradman will then make closing comments and this will be followed by a question and answer session. Pradman?

Pradman Kaul

Thank you Deepak. Good afternoon and welcome. Hughes Communications Inc. or Hughes, had an outstanding fourth quarter and full year in 2007. With its principal operating subsidiary, Hughes Network Systems LLC or HNS, recording significant growth in revenue, profitability and new orders. HNS’ 2007 revenues increased by 13% over 2006 to $970 million. Of this total, service revenues increased by 22%. As you may recall we have been focusing on growing our service revenues sometimes at the expense of our hardware revenues and this is particularly true in our consumer subscription offering where the hardware is subsidized.

In the same period, operating income grew by 56% and EBITDA by 28%. Net income was $50 million; a growth of almost 161% over 2006. We also had a record year in terms of new orders. We signed new orders of $1.1 billion in ’07 for a growth of 30% over ’06. The growth occurred across all segments and obviously all goes well for our future. The largest order of the year was from Camelot; the national lottery operator in the United Kingdom for over 27,000 sites and 10 years of service. This order had a value of over $150 million.

In addition we signed major orders with a number of enterprise customers all over the world. These included among others the largest bank in India, State Bank of India, Best Western, Sherwin Williams, British Petroleum, Blockbuster, CVS, Harris, Rede Smart in Brazil, Hughes Telematics, [Terrastar], et cetera, et cetera.

Our consumer business also continued to show strong growth. The number of subscribers grew to about 380,000 with the RPU reaching an all time high of $64.00 in the fourth quarter. Churn stated at about 2.3% for the fourth quarter of ’07. All of this is consistent with our planned [SAC] expenditure and our [KU Band] Transponder acquisition plans. We continue to be the largest satellite-based broadband internet access provider to the consumer in the world.

Our international VSAT segment also had strong revenue growth of 25% in the fourth quarter of ’07 over the same quarter in ’06. Driven primarily by our service companies in Europe, India and Brazil. All of these companies are leaders in their markets and are beginning to get the needed critical mass to accelerate their growth both in revenue and margins. New applications and services are being developed for each of these regions and we are hopefully they can be replicated in other markets.

The telecom system segment revenue has also shown significant growth with a 53% growth in ’07 over ’06. This has been fueled by revenues in both the mobile SAT and Telematics businesses. Our strategy of capitalizing on our technology strengths to generate opportunistic business in this segment is working well and we continue to be optimistic about this in the years to come.

I would also like to recap another important event. We entered into an agreement to acquire Helius, a recognized leader in providing IPTV solutions for applications like training, corporate communications and digital signage. We believe this acquisition is an excellent compliment to Hughes’ broadband networking skills and experience and will strengthen our ability to offer value added applications in this space to our enterprise customers. They are already serving major enterprise customers like General Motors, Safeway, JC Penney et cetera and we hope with our global distribution capability to expand their available market significantly.

To summarize, we are very pleased that we have delivered another strong and balanced fourth quarter and full year in ’07. Our tradition of delivering on our business plan continues. Let me now turn it over to Grant and after his presentation 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 excellent quarter and end 2007 in strong financial shape. Our fourth quarter 2007 financial performance shows strong revenue and profitability growth in all operating segments over the same period in 2006. As you recall we present summary information for Hughes Communications Inc. or Hughes, as well as Hughes Network Systems LLC, HNS our principal operating subsidiary.

At Hughes revenues for the fourth quarter of 2007 were $279.7 million, an increase of $36.3 million or 14.9% over the fourth quarter of 2006. Revenue for the year ended December 31, 2007 was $970.6 million, an increase of 13% over the same period of 2006. Operating income for the fourth quarter was $32.4 million, an increase of $9.2 million or 40% over the fourth quarter of last year. For the 12 month period ended December 31, 2007 operating income was $83.6 million, an increase of $31 million or 59% over the same period in 2006. Net income for the fourth quarter of 2007 was $19.9 million or $1.03 per share on a fully diluted basis. This was more than double the corresponding performance in 2006 where net income and EPS were $9.5 million and $0.49 a share respectively.

This improvement reflects the improved profitability of HNS offset by increased corporate costs including our [inaudible] readiness testing. Net income for the full year 2007 was $43.5 million or $2.26 a share again on a fully diluted basis compared to a loss of $39.1 million or $2.43 a share for the comparable period in 2006. Notice we have reviewed on our earlier calls the loss for 2006 included the non-cash income tax charge of $50.3 million in the first quarter of 2006 related to the spin-off. As Hughes Network Systems HNS comprises a significant financial and operational aspect of Hughes I will continue the analysis on the HNS operating subsidiary.

We experienced year over year growth in all of our major reporting segments. The North American VSAT segments revenue of $165.1 million in the fourth quarter of 2007 showed an increase of $10.8 million or 7% above the fourth quarter of 2006. This increase was once again driven by the strong performance in the consumer business which grew by 14% to $87.6 million. The International VSAT segment’s revenue of $76.3 million increased $15.2 million or 25% above the fourth quarter of last year. The Telecom System segment delivered revenue of $38.1 million an increase of $10.3 million or 37% over the fourth quarter of last year. This increase was once again driven by the Mobile Satellite Systems’ revenue as we continue to deliver increased engineering efforts in this business.

Now turning to the full year revenue performance, the North American VSAT segment increased 7.3% to $615.7 million driven once again primarily by the consumer business which grew 13.3% to $331.1 million an increase by approximately 52,400 subscribers throughout the year to approximately 379,900 subscribers in December of 2007. The North American enterprise business had steady revenue growth of 1.1% to $284.6 million. The International VSAT segment revenues increased 11.1% over 2006 to $214.8 million primarily as a result of the growth in our foreign service companies.

The Telecom System segment revenues increased by $48.5 million or 53.3% to $139.5 million in the 12 months ended December, 2007. This increase reflected the strength in the Mobile Satellite Systems business which increased by $54.9 million or 77% over last year. From a hardware and services mix perspective, our fourth quarter growth was driven once again by our services component which was up $35.8 million or 31% above the fourth quarter of 2006 to $150.9 million. For the full year our services revenue were up $97.1 million or 22.1% above the corresponding 12 months of 2006. Hardware revenues in the quarter were $128.6 million inline with the $128.2 million in the same quarter of last year. For the full year hardware revenues were $433 million, an increase of 3.5% over the same period of last year.

The services component continuing the trend we’ve discussed earlier increased from approximately 51% of our overall revenue in the full year 2006 to 55% for the full year of 2007, a reflection of our continued investment and focus on our service organizations. Service margins improved in the fourth quarter to 35.7% of revenue compared to 28.5% in the fourth quarter of ’06. In the fourth quarter this percentage increase was offset by the hardware margins which were 20.6% as compared to 29.4% in the fourth quarter of 2006. On a full year basis, gross margins increased $37.4 million over 2006, an improvement of approximately 1% from 25.7% of revenue last year to 26.6% of revenue this year.

The full year trends were similar with services margins improving from 30% in 2006 to 34% in 2007 and hardware margins reducing from 22% in 2006 to 18% in 2007 reflecting primarily hardware price reductions in the North American consumer market. Operating income for HNS was $34.8 million for the fourth quarter of 2007 or 12% of revenue. This was an increase of $9.8 million and two percentage points over the fourth quarter of 2006 resulting primarily from an increase in gross margin on the higher volume and holding operating expenses two percentage points below the operating expense rate in 2006.

Operating income for HNS for the 12 months ended December, 2007 was $89.8 million, an increase of $32.1 million above the 12 months ended December of 2006. This increase reflects the improved margins on the higher revenues, the inventory provision of $11.9 million recorded in the second quarter of 2006 as we exited the narrow band switching market and the aforementioned containment of operating expenses.

For HNS EBITDA was $46.4 million or 16.6% of revenue in the quarter ended December, 2007 an improvement of $1.2 million over the quarter ended December of 2006. Adjusted EBITDA of $46.4 million was an improvement of $0.5 million over the fourth quarter of 2006 where HNS’ adjusted EBITDA was $45.9 million. EBITDA for HNS for the 12 months ended December, 2007 was $138.8 million or 14.3% of revenue compared to $108.8 million or 12.7% of revenue in the 12 months ended December, 2006. This increase was due primarily to the improvement in the service margins in 2007, the inventory provision in 2006 and the containment of operating expenses are referred to earlier.

Adjusted EBITDA for the 12 months ended December, 2007 was $140 million an increase of $13.9 million compared to the $126.1 million in the 12 months ended December, 2006. As a percentage of revenue adjusted EBITDA for the 12 months ended December 2007 was 14.4% of revenue inline with the 14.7% earned in the same period in 2006.

Moving to Hughes Communications cash and balance sheet we generated net cash from operations of $43.3 million in the quarter which just ended which contributed to the $93.5 million in cash flow from continuing operations in the 12 months ended December, 2007, continuing the trend from last year where we also delivered a similar $90.2 million in cash flow from operations. Capital expenditures for the 12 months ended December 2007 were $248.2 million which includes $190.1 million for SPACEWAY. We ended the quarter and the year with a strong cash and marketable securities position of $151.4 million.

As we outlined in the headlines in our press release HNS revenues increased 13% to $970 million, new orders increased 30% to over $1 billion, net income more than doubled the $50 million and adjusted EBITDA increased to $140 million. In summary our strong operating performance and capital management have provided us with a strong asset base and liquidity position for HNS and HCI.

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

Pradman Kaul

Thank you Grant. At our third quarter earnings call you might recall that we announced that our SPACEWAY satellite was in the process of orbit raising by Boeing. Boeing has completed the step and we are currently performing system testing and expect to start service on SPACEWAY 3 at the end of this quarter. This will begin a new chapter in our company’s history since SPACEWAY 3 is an important component of our business model and it is expected to not only reduce our space segment costs significantly but also open up new opportunities in the enterprise and government space in North America.

We see SPACEWAY as the primary growth engine going forward for our North American businesses both enterprise and consumer. In addition obviously the significantly lower cost of space segment should have a major positive impact on our margins in the next few years. From that perspective 2008 is a transition year with the fixed costs of the satellite operations being offset by the lower recurring space segment costs. And going forward in 2009 and beyond we will start seeing the major positive affect on our margins.

Our international VSAT segment continues to see growth from our three service companies. In other parts of the world we have relationships with some excellent service providers that use our platform. While all our service companies and independent service providers offer IP based connectivity we are beginning to see revenue growth from new applications and services. Our focus in this area is on education, distance learning, lottery services, and other applications that bridge the digital divide in the emerging markets.

In the Mobility area we have developed and in production contracts with many mobile satellite service providers. Deliveries under the new contracts have now started. The first ground based beam forming system for [ICO] has been tested and installed successfully. In addition we’ve announced a broadband maritime offering with Intelsat and an aeronautical broadband system with [Rope 44] for 2 major airlines. With all of these initiatives we will now be able to provide Hughes [inaudible] service to our customers on land, and even if they’re on the moon we can provide these services on land, ocean or in the air.

Finally our Telematics work with Hughes Telematics offers a lot of promise for significant development work and large volume manufacturing contracts in 2009 and beyond for their customers, Chrysler and Mercedes Benz.

With all of these activities going on, I continue to be very optimistic about a bright future for Hughes. Thank you for your time. I’ll now pass the call back to Deepak.

Deepak Dutt

Thank you Pradman. We are now ready to start the Q&A part of the call. In the interest of time we will limit questions to the financial community. 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. Contact information for both is available on our website www.hughes.com.

Question-and-Answer Session

Operator

Your first question comes from Matthew Barnet - Jet Capital

Matthew Barnet – Jet Capital

Hi congratulations on the quarter. I have two questions on your comments. One you spoke about the fixed operating costs of SPACEWAY, can you quantify what you think those would be?

Grant Barber

We haven’t commented exactly on the dollar amount but what we will do as you can see we’re on KU based systems today as we set up new consumers and enterprise on KA we will have equipment that we have to spend in our network operation center plus build gateways for SPACEWAY. And we’ll have ground infrastructure and support costs relating to support those. So in the interim Pradman talked about it being a transition year, where we will have continued costs to support the KU as well as a [inaudible] and cost to support KA until such time as we get up to a critical mass of KA band subscribers.

Matthew Barnet – Jet Capital

And those are kind of one time in nature, are there ongoing to operate a system?

Grant Barber

We could see them typically as a growth CapEx for us so you may have pictured in the past as we add new subs, we typically add capital expenditures for them.

Pradman Kaul

And also you have certain amount of costs to operating the satellite, the telemetry tracking and command and payload control et cetera. Those are recurring costs but they are fixed and as we get more subscribers on SPACEWAY they become trivial. But at the beginning as you have very few subscribers of SPACEWAY, they are higher percentage costs versus our revenues from the space segment.

Matthew Barnet – Jet Capital

And I guess my second question kind of follows up from there. [Viasat] when they announced their satellite initiative they essentially presented a slide which indicated that the uptake of consumers particularly in those areas to the North East et cetera, where there was more need for it was nothing short of phenomenal and essentially [inaudible] the satellite in three to four months. Is there a reason, (a) have you seen their presentation and can you comment on it and (b) is there a reason SPACEWAY’s strategy of marketing would be significantly different than targeting those areas?

Pradman Kaul

No we haven’t, I’ve seen the presentation but we’re not going to comment on their presentation. But no, we believe along with them that the market is robust and our strategy is a national strategy. We distribute through dealers and distributors and our direct sales campaign covers the whole country but we expect the North East to be very strong.

Matthew Barnet – Jet Capital

The data they presented was I think public data so is there a reason you can’t comment on the speed at which Wild Blue and others saw the uptake?

Pradman Kaul

No I think our uptake is going to be very strong and I don’t, you know, I just don’t like to comment on other people’s presentations.

Matthew Barnet – Jet Capital

I guess my comment would be you guys have kind of laid out a strategy for space when a lot of people are left questioning how quickly that uptake would be and it’s a little bit difficult to see either the costs or how quickly you’re planning on adding subscribers.

Pradman Kaul

But as you know we, I think we’ve announced that in the fourth quarter last year we had acquired about 40 some thousand subs and we expect to see that growth in that number of subs so we expect to be acquiring subs at a higher rate than that. You know when we start selling with SPACEWAY in Q2 and Q3, I think we’ll start experiencing what the real rate of growth is. Remember we also always have to balance that with the subscriber acquisition costs that we are willing to spend on acquiring subs. And so we’ll be playing that balancing game as we go forward and see how the market develops.

Matthew Barnet – Jet Capital

Thank you.

Operator

Your next question comes from [Analyst] – Wachovia

[Analyst] – Wachovia

Couple of questions, first of all I guess have you seen any impact from the economy especially on the consumer side with the tick up of your satellite broadband? At least as far as maybe yesterday?

Pradman Kaul

No, so far we’re not seeing any adverse impact. In fact first quarter so far has been relatively strong and we’re worried, but we haven’t seen any impact from the economy yet.

[Analyst] – Wachovia

And that’s the same as well for the enterprise side?

Pradman Kaul

Yes.

[Analyst] – Wachovia

Okay and then the second one is well basically I think from what [Viasat] was telling us during their conference call that Wild Blue pretty much has capacity constraints and it looks like you guys have the consumer broadband market all to yourself and given that I guess, Wild Blue did roughly about 90,000 subs or gross as per quarter and you are currently doing about 40,000, 41,000 I suppose, granted that’s on a limited marketing spend, is there any reason to I guess to believe that you cannot do better than what Wild Blue is doing given that again you have the market all to yourself?

Pradman Kaul

Well let’s see how it develops over the next six to nine months. But I think in the end it’s a function of how much money we want to spend on SAC and the size of the market. I think even while Blue’s numbers you know maybe a month or two they did 25 – 30,000 but I don’t think they consistently did 90,000 a quarter for any period of time.

[Analyst] – Wachovia

Okay got it and then you announced a partnership with EMBARQ, are you thinking of even more partnerships with the [inaudible]?

Pradman Kaul

Yes we are because we’re trying to increase our distribution channels and besides the distribution channels that we have today which is both our direct and indirect sales through dealers and distributors, we are looking to do more deals such as the one we’ve done with EMBARQ.

[Analyst] – Wachovia

Another one is that you have your shelf out there and then I understand that have a lot of, in terms of the shares trading some sort of liquid issue, can you give me the time frame and what kind of instrument or what kind of means are you thinking about here?

Grant Barber

What we file is universal shelf so the time frame on that is three years. So what we had said on the last conference call as well, we’ll continue to watch both the market and our performance inside and we left the shelf with the ability to do equity or debt or a combination thereof. It was really to address our liquidity and provide us with the maximum flexibility.

[Analyst] – Wachovia

And in terms of time frame, is that going to be coinciding with I guess your plan for your next satellite contract?

Grant Barber

Yes, the next satellite was definitely one of the two pieces of the use of proceeds for that and again as I said, we’ll watch the market over the next up to three years to see when the most opportunistic time is.

[Analyst] – Wachovia

Alright so I’m guessing that the other piece is maybe the acquisition of SPACEWAY 1 and/or SPACEWAY 2?

Grant Barber

That’s correct.

[Analyst] – Wachovia

Has there been any progress on that discussion with direct TV?

Pradman Kaul

No, not [inaudible] but I think we’ll, now that the deal with Liberty is complete we’ll ask them whether they’re interested in doing that.

[Analyst] – Wachovia

Alright and then the hardware margin with the price reduction and so on do you think that we are at the level where it’s going to be stable going forward or you think that you still see some margin compression?

Grant Barber

No I think at this point what we’ve echoed this on earlier calls as well, as we continue to watch the pricing to the consumer, the combination of an upfront hardware offer and a monthly recurring services fees and we took action in the last year and a half to reduce that upfront component that they have to pay twice. We think we’re at the level that the market puts us in a competitive position and gives us viable alternative to high speed internet access for the consumers. But I [inaudible] anticipate to see a further degradation in it.

[Analyst] – Wachovia

Okay, thank you very much.

Operator

Your next question comes from Jennifer Adams - Analyst

Jennifer Adams - Analyst

Great, congratulations on the strong quarter. I noticed that it looked like in the fourth quarter SG&A and R&D kicked up a little and I was curious if that was related to marketing for SPACEWAY 3 or other items, if you could just give a little bit more color on that and if we should expect to see increased marketing expense in Q1 or not really until Q2, Q3 when you’re really up and running, thanks a lot.

Grant Barber

Sure, typically the fourth quarter and the first quarter of the calendar years are strong for us on a consumer point of view and those coincide with the quarters where we do an increased selling and marketing effort, commercials, direct mailers, et cetera. And as well the other unique item we had this year as we got into the end of the year was completion of our [inaudible] development, testing, documentation et cetera which should be unique and non-recurring.

Jennifer Adams - Analyst

Great thanks a lot.

Operator

Your next question comes from James Radcliffe – Analyst

James Radcliffe - Analyst

I wanted to talk a bit about with SPACEWAY 3 now deploying how you’re thinking about splitting capacity and capabilities between the commercial and consumer business and I know Pradman you had mentioned before that the nature of the satellite and the onboard switching could enable some new commercial applications, so should we be expecting you to be holding capacity on the satellite for commercial apps or really sort of filling it as demand arises?

Pradman Kaul

No we expect to go after both the enterprise and the consumer business using SPACEWAY 3 and as you just mentioned in the enterprise area we expect that a whole bunch of applications that we couldn’t address with star based networks on KU band that now are open to us to go attack on a competitive basis. So we expect that while a bulk of the satellite will be filled up by consumers just because of the size of the market, we expect the enterprise also to be a big player in this going forward.

James Radcliffe - Analyst

Thank you.

Operator

Thank you ladies and gentlemen that concludes our Q&A session, I’d like to turn the call back over to Deepak.

Deepak Dutt

Thank you everybody for participating in today’s call, much appreciated. Have a good afternoon.

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