Q2 2008 Hughes Communications Inc Earnings Call Transcript

Hughes Communications Inc. (HUGH)

Q2 2008 Earnings Call

August 7, 2008 11 am EST

Executives

Pradman Kaul, president and CEO

Grant A. Barber - CFO

Depot Dutt, Vice President, Treasurer and Investor Relations Officer

Analysts

James Radcliff - Laymen Brothers

Chris Quilty - Raymond Janks and Associates

Gat Malak -Goldman-Sachs

Jennifer Adams - Calanen

Presentation

Operator

I’ll be your coordinator for today. (Operator Instructions)

I would now like to turn the presentation over to Mr. Depot Dutt, Vice President, Treasurer and Investor Relations Officer. Please Proceed.

Mr. Depock Dutt

Thank you operator, and good morning everybody.

Welcome to our 2^nd quarter 2008 earnings call. Before we begin I want 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 risk and uncertainties. Actual results my differ materially from those contained in these forward looking statements and may refer to the documents we file from time to time with the FCC, specifically our annual reports on 10K, our quarterly reports of 10Q, our periodic 8k filings and our registration statements on Form S3.

In addition to reporting financial results in accordance with generally accepted accounting principles of GAAP, used reports of non- GAAP financial results. Investors are encouraged to review the reconciliation of these non GAAP financial measures with comparable GAAP results which can be found on our earnings release and on our investor relations website.

I would now like to introduce the Hughs management team that is joining to this call. Mr. Pradman Kaul, President and CEO and Grant Barber, Executive Vice President and CEO.

We will start with a business overview by Pradman. That will be followed by a financial overview by Grant. Pradman will then come back with some closing comments, after which we will have a Q and A session.

So let me turn this call over to Pradman now.

Pradman Kaul

Thank you Depock, and good morning to all of you.

I am delighted to report that Hughes had an outstanding 2^nd quarter in 2008, recording strong growth in revenue, AVIDA, and new orders. Hughes revenues increased by 13% in Q2 08 over Q2 07 to $266 million a new record for 2^nd quarter revenue.

Service revenues increased by 15%, as a result of our continued focus on growing our service businesses. In the same period adjusted AVIDA grew by an impressive 22% to $38 million also a new 2^nd quarter record. We also had a record 2^nd quarter in terms of order bookings. We booked new orders of $333 million in the 2^nd quarter for a growth of 51% over the 2^nd quarter of 2007.

It’s gratifying to note that this new order performance was strong across all our business segments and has raised our form backlog from the non-consumer parts of our business to an all time high of $869 million. As you may recall, we do not book any orders or backlog for our consumer businesses even though we generally have 24 month service commitments from our subscribers.

This strong backlog gives us great visibility and predictability of our revenues in the coming quarters and has positioned us very well for the second half of 2008.

In North America, our consumer business continued it’s tradition of solid performance in all aspects of the business. The number of gross adds was 37,000 subs, which represents a 21% growth over Q2 07, and the met adds increased by an even stronger 32% in the same period.

As you know, this is the season of business for us with Q1 and Q4 being our strongest quarters followed by Q3 and Q2. For the record, our gross adds in Q2 of 2007 were approximately 30,000. From an operational perspective, the ARPU went up to $66 compared to $62 in the second Quarter of 2007. Our strategy of offering new services and upgrades is obviously working and augurs well for the future.

This resulted in the consumer services revenue increasing by a strong 23% in the 2^nd Quarter of 2008 over the 2^nd Quarter of 2007.

All in all a strong share for the consumer business. We believe this growth will continue and that spacemen will help drive this growth and we continue to be the largest satellite base brought by an internet access provider in the world. The non-American enterprise business also had a good quarter in new orders and the backlog has gone up nicely. Most of our news orders came for services which will be translated into revenue all the next few years. We will slightly lower in revenues this quarter because of two hardware upgrade orders that slipped out of the quarter. However, we had some interesting new order bookings in this segment. Blockbuster renewed their service contract for two more years for an order booking of $12 million. In addition, Barrett, BP Amical, Galaxy Broadband, Maltrip and American General Finance bought additional services this quarter worth approximately $20 million.

We also are beginning to see good results in our U.S. Government business resulting from our earlier wins of the SATCOM2 contact. This quarter, we were selected by the social security administration to provide a video and distance learning network for 1,650 branches. The initial ordering put for the year is $4 million but this contact could bought up to $40 million over the next five years. This combined with our win last quarter of the government education training network means that Hughes has won both of the big SATCOM2 service deals that have been contracted so far. We see the segment as being an important part of our enterprise business as it gives us an opportunity to leverage our commercial technology and service capability for the various agencies of the U.S. Government.

Our international enterprise group was the other standout in the second quarter with revenue growth of 43% and operating income growth of 52% over the second quarter of 2007. Our European service subsidiary contributed a significant part of this growth, primarily through successful rollout of the Camelot lottery project. Lottery terminals are being installed at an impressive rate of 200 per day and approximately 13 thousand terminals have been installed to date. As we’ve indicated in the past, we’ve been working hard to attain critical mass in our three international service companies.

This quarter, the revenues of HNS Europe were up by 120% and HughsDo Brazil will drop by 36% over the second quarter of 2007.

We continued with a strong new order, input performance in this segment also, including contracts with the African Development Bank, which was a three-year service deal, BP Abimata in Indonesia, Telemar in Brazil, STL Alogic providers - Spain, Afsat in Kenya, etc. In addition, we signed agreements with a company in India Srei for 17,000 VSATs to reinstall in rural kiosks in India over the next two years. This brings our kiosk backlog to approximately 30,000 to be installed over the next two years. These kiosks will be used to provide government-to-consumer services, interactive distance learning and internet access. It’s an outstanding example of the new and exciting applications -that are products and services- are enabling in emerging markets.

The telephone system segment also had a good quarter. The highlight will be ordering for all $100 million to design and implement Global Star’s next generation radio access network. The programs for our existing mobile satellite customers are also proceeding well. A significant milestone this quarter was the successful integration of our ground-based beam-forming systems with the recently-launched Iko satellite, probably one of the most challenging technology jobs we’ve done in the recent past. Our vote for Hughs Telematocs continued at a good phase with a schedule to start delivering or product sometime late next year. Turning to Space Ray, many of you’ll recall that we launched commercial service on Spaceway 3 satellites on April 3^rd. The strategy being; to activate all our new consumer subs onto Spaceway. I am happy to report that as of now, approximately 27,000 sub have been activated on Spaceway. Feedback from customer experience has been very positive, and I'll come back with more comments on this subject after Grant's comments.

In summary, we are very pleased with our strong performance in Q2, which has not been a strong quarter historically for all of our businesses because of seasonality; but the diversity of our business has clearly contributed to the stronger overall performance this quarter. Let me now turn it over to Grant.

Grant A. Barber

Thank you Pradman and good morning. As Pradman mentioned in his comments we are pleased to have completed another excellent quarter and we end Q2 in strong financial shape. The financial performance of Q2 2008 showed strong revenue and profitability growth in all operating segments over the same period in 2007. At Hughs, revenues for the second quarter of 2008 were $265.6 million, an increase of of $31.3 million or 13% over Q2 2007. We experienced year over year growth in all of our reporting segments The North American's VSAT's revenue of $161 million in Q2 2008 showed $10.5 million or 7% over Q2 2007. This increase was once again driven by strong performance in the consumer business which grew by 16% to $93.3 million. Our North American Network and Service Business was $67.9 million, a decline of $2.6 million, or 4% over Q2 2007. This primarily reflected delays in a couple of hardware upgrades by a couple of existing enterprise customers.

The international VSAT segment of $65.5 million increased $19.5 million or 40% over Q2 2007. The telecom systems segment delivered revenue of $38.8 million, an increase of 4% over Q2 2007, this increase was driven by the microwave businesses. From a services hardware mix perspective, our second quarter growth was driven by increases in both components. Our services component was up $19.9 million or 15% above Q2 2007 to $149.3 million. Hardware revenues in the quarter were $116.4 million and increase of $11.4 million or 11% above Q2 2007. The services component continuing the trend we discussed on previous calls increased from 55% of overall revenue in Q2 to 56% in the second quarter of 2008, a reflection of our consumer business growth in both subscriber count and ARPU and continued investment and focus in our global service organizations.

Gross Margins for the second quarter of 2008 were 25% of revenue a decrease of 1.5 percentage points from the second quarter of last year. This overall decline was entirely attributed to the depreciation charges related to Spaceway 3. As you will recall, we started commercial service on Spaceway 3 in April 2008, and as a result we began depreciating the satellite and related items. The depreciable value is approximately $380 million with an estimated life of 15 years yielding a quarterly depreciation charge of $5.4 million. Prior to this charge gross margins improved by approximately 1% above Q2 2007, again reflecting a stronger mix of service revenue. Operating income for Hughs was $16.1 million for Q2 2008, or 6% of revenue SG&A remained at 16% of revenue in line with our prior year. R&D increased by $3 million in the quarter over Q2 2007, primarily due to additional discretionary investments in our Hughsnet and Spaceway projects, and from our Helius subsidiary that we acquired in February of this year.

Net income for Q2 was $1.8 million or 9 cents a share on a fully diluted basis, This compares with an increase of with an income of $9.6 million or 50 cents a share in Q2 of 2007. This decline of 7.8 million dollars or 41 cents per share is more than made up for by the depreciation in interest charges starting in April 2008 with the launch of service on Spaceway 3. These two items make up $9 million of costs, or 45 cents per share.

A table in reconciliation of both the adjusted net income and adjusted EBITDA 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. Adjusted net income has been adjusted for the long term cash incentive retention program in 2008, and the equity incentive compensation charges in both 2008 and 2007.

Non-GAAP adjusted net income for Q2 of 2008 was $3.9 million compared to $10.6 million in Q2 of 2007. This decline reflects the improved volume and gross margin offset by increased depreciation, R&D spending and the interest expenses previously discussed. Adjusted EBITDA was $37.6 million, or 14% of revenue in Q2 of 2008, an increase in 22% or $6.7 million over Q2 of 2007. Again, this increase was primarily due to the increased margins and prudent control of operating costs.

Turning to the first half performance, we are pleased to report that revenues for the first half of 2008 were 5$03 million, an increase of $46 million, or 10% over the first half of 2007. This increase was almost entirely driven by the higher services revenue that increased $49 million or 20% above the first half of 2007. From a business segment perspective, growth in our consumer business was $24 million or 15% above the first half of 2007. Our international business grew by $21 million, or 23% above the first half of 2007. Our Telecom systems segment increased $9 million or 14% above the first half of 2007. These increased were partially offset by our North American enterprise business which declined $8 million or 6% below the first half of 2007.

Gross margins increased $15 million, reflecting the volume increase and improved margins of almost a full percentage point above the first half of 2007, reflecting the improved profitability in our services businesses. Operating expenses which include SG&A and R&D increased at 21% of revenue versus 18% in the first half of 2007. As we commented in the last quarter's call, the main component of this increase was a $9 million charge related to a one-time retention program in connection to the April 22^nd 2005 transaction between Direct TV and Sky Terra. Increased domestic selling, advertising and customer service costs of approximately $2 million to support our growth and approximately $3 million of operating expenses at our new Helius subsidiary acquired earlier this year.

The net income for the first half of the year was $2.5 million, which is $10 million below the first half of last year, reflecting primarily the improved operating performance offset by the $9.2 million long term retention program and the 9 million dollar depreciation and interest charges as discussed earlier. Adjusted EBITDA for the first half of 2008 was $67 million, an increase of $11 million or 19% above the first half of last year. Moving to the cash and balance sheet; we generated net cash from operations of $14 million in the first half of 2008, with a net usage of $4 million in Q2. Capital expenditures for Q2 were $24.6 million which includes $12.1 million for Spaceway. In Q2 we completed our public offering whereby we sold 2 million shares of our common stock and provided net proceeds of $93 million and we ended the quarter with a cash and marketable securities position of $191 million.

As we outlined in the headlines of the press release for Q2, we booked new orders of $333 million, a 51% increase over Q2 of last year. Revenues increased 13% to a record $266 million, and adjusted EBITDA increased 22% to $38 million. In summary, we continued to execute on our plan and delivered strong operating performance in capital management. At this time I'd like to turn the call back to Pradman for further comments.

Pradman Kaul

With the launch of commercial service on Spaceway 3, you may recall that the last Q1 earning score when we announced that our strategy was to begin activating new consumers subs initially from the East Coast and then go Westward so that by the end of May we would cover the whole country. I am delighted to report that this strategy has been executed successfully and we now have over 27,000 subscribers on Spaceway that have deployed all over the country.

We also recently announced speed enhancements to the pre-existing subscriber plans with no increase in price and also announced three brand new elite plans with download speeds of up to five megabites per second. These new plans provide an unprecedented range of speeds that will cater to the complete range of consumer needs. In addition, we also announced last week an exciting new private networking solution for small and medium businesses with Spaceway. This feature will, for the first time, use the Mesh capability that Spaceway 3 has. Hughsnet private networks provides enterprise grade security and performance at a price that's more affordable than Terrestrial abilities including MPLS and internet based BPN solutions.

We expect that this complete sweep of offerings will result in an expansion of our enterprise market. Our first Enterprise customer is expected to become operational Spaceway in the third quarter. We continue to see Spaceway as the primary group engine group going forward for our North American businesses both Enterprise and consumer. In addition, the significantly lower cost of the space segment should have a major positive impact on our margin in the next few years. From that perspective, 2008 is a transition year, with a fixed cost of the satellite operation be offset by the most space segment recurring costs.

Obviously going forward in 2009 and beyond, we will start seeing the major positive effect on our margins. We've also made significant progress in the decision for procurement of our next satellite for our capacity requirements beyond Spaceway Three and expect to sign the contract for the satellite by the end of Q3. In conclusion, all our business have been firing on all cylinders and I'm more optimistic than I've ever been about the future for Hughs. Also, before I close, let me take a moment to pass on our sinsere thanks and appreciation to our existing and new share holders who participated in our equity offering in May and made it such a success. Your faith and confidence in us is much appreciated. Now I'd like to hand it over to Depot.

Depot Dutt

Ok. We will start the question and answer part of the call. If there are any questions from the financial community please direct them to me separately as a follow up through the investor relations outline. Obviously you are welcome to sign on and we will address that on the conference call as well. Members of the media should contact Judy Blake separately and her contact information is available on our website, hughs.com. We take a few moments get the Q&A process started after which the Operator will take over and coordinate the session.

Question and Answer

Operator

Thank you. Ladies and Gentlemen, if you would like to ask a question, please press "star" followed by one on your touchtone phone. If you question has been answered and you wish to withdraw the question, press "star" two. So please, press "star" one to begin and stand by for audio questions.

Your first question comes from Mr. James Radcliff with Laymen Brothers (4.09). Please proceed.

James Radcliff - Laymen Brothers

Morning Gentelmen. I have several questions for you starting with the, on the Enterprise side. In the international, how much impact did currency in the Euro and real have on the your revenue growth?

Grant A. Barber - CFO

James, it's Grant. How are you?

James Radcliff - Laymen Brothers

Great, how are you?

Grant A. Barber - CFO

Currency both in Q1 and Q2 we had strength in Q1 in the Euro, in Brazil and India, the other two areas, where the local services are in local dollars. The rest of our international business for us we sell direct from the US outside of those three entities and they are primarily in US currency. So the impact of both Q1 and Q2 was less than 1% of our revenue on the topline and then since they have local currency costs as well to support, the services operation, the currency impact on the operating income.

James Radcliff - Laymen Brothers

Couple others. On the Spaceway Capex, was that $14 million for two Q or for the first half of the year?

Grant A. Barber - CFO

We were $12 million for Q2.

James Radcliff - Laymen Brothers

Q2, ok, great. And

Unidentified Management Speaker

final payment to Boeing of $10 million dollars. That's a big piece of it.

James Radcliff - Laymen Brothers

Got it, ok. And on the speed increases, taking all the plans off, is that for existing customers as well or just for new home Pro customers?

Pradman Kaul, president and CEO

No, this would be primarily people with the Spaceway terminal, so it's essentially for all the new customers.

James Radcliff - Laymen Brothers

Ah. So this isn't going to result in any slower bleed off of the links capacity.

Pradman Kaul, president and CEO

No.

James Radcliff - Laymen Brothers

Alright, thank you very much.

OPERATOR

Your next question comes from the line of Chris Quilty with Raymond Janks and Associates Please proceed.

Chris Quilty - Raymond Janks and Associates

Good morning Gentlemen. Congratulations on the results. I know you're not inclined to give guidance, but could you give us a sense of what your general expectations are for the Spaceway service and it's impact on your gross ads on a go forth basis and, along with that, what specific marketing programs have you initiated since the Spaceway service to try and accelerate the customer ads.

Pradman Kaul, president and CEO

Hi Chris. Yes. You know we're obviously very excited about what Spaceway can do to enhance the growth in the consumer business end. As I mentioned earlier I know your pair off. The first thing we did was change all our existing plans and give our customers for the same price more bits. So for example, our base plan under our previous approach used to give our customer 700 kilobits, for the same $60 or $59.95, we increased that to one megabit. And the next plan, which was at one megabit for $70, we increased the bits to 1.2 megabits and so on.

And then also in the last week we announced these elite plans, which will give the customer the capability to really go to get speeds of two megabits, three megabits, and five megabits. So we're finding a reasonable amount of excitement in the market there, where you know people would never be able to get five megabits from a satellite. Right? There's no other such plan available anywhere in the world. So the first step we've taken is basically give our customers more bits for the same price and improve customer satisfaction, everyone wants faster and faster speed and give them options for more bandwidth that they never had before. We continue to look at other plans and other enhancements that we can do to our service offerings and I think over the next six months hopefully you will see some more stuff that we're going to be doing all trying to one improve customer satisfaction, and two, increase the growth rate of our subscribers and increase our ARPUs, all three of them being important elements.

Chris Quilty - Raymond Janks and Associates

OK in a specific question for you, I missed the exact number. I think you said you had 20 thousand 300 new Spaceway subs?

Pradman Kaul, president and CEO

27,000 to date.

Chris Quilty - Raymond Janks and Associates

27?

Pradman Kaul, president and CEO

Yes

Chris Quilty - Raymond Janks and Associates

Ok. So if I'm one of the, call it 370,000 other Hughs subscribers, I bought KU band equipment six months ago and I see that I can now get at the base plan 40% better download speed, I call up Hughs, and I say, ok, I want those faster speeds. The guy has already paid equipment, he's already on a two year contract. How do you mange that process? Are you going to make him pay an entire new hardware, sign a new contract and obviously that process would actually increase the churn in the newer term to the degree that you get customers switching over.

Pradman Kaul, president and CEO

Well, the first thing is that if the guy wants one megabit, he doesn’t have to change his equipment, but he just goes to the next level plan on the KU band. He goes from $50 to $70 and he gets the same one megabit that he would if he had the other plan.

Chris Quilty - Raymond Janks and Associates

But he sees the advertisement saying we just increased at this base rate plan. How come I'm not getting it?

Pradman Kaul, president and CEO

No, I understand. I was just saying there are two alternatives. One is the alternative where he just pays $10 a month more and gets the one megabit speed. The second alternative is for him to switch to Spaceway like you suggested and upgrade his terminal to the Spaceway terminal and go on to the new plan. Now, clearly today, we haven't yet introduced any upgrade plans that would take care of and give the customer some keeper cheaper way to upgrade from KU to KA and that’s certainly one of the enhancements and new plans that is under consideration on being reviewed right now, and I think on the next three, four months, we will start introducing some more options to get our existing customers to upgrade.

Chris Quilty - Raymond Janks and Associates

The general idea would be you can pay $10 a month more for that speed or do a one-time 120 dollar payment for new hardware if you want to give them a one-year ROI, and you reup for another two years; that type of scenario?

Pradman Kaul, president and CEO

I don’t know whether the amount is $120, we certainly haven’t….

Chris Quilty - Raymond Janks and Associates

(interruption) No, I’m just throwing that out.

Pradman Kaul, president and CEO

However, the concept will be something similar to that.

Chris Quilty - Raymond Janks and Associates

Ok.

This brings me back to the turn rate question not a huge deal, but your turn was up sequentially from 2.17 to 2.31 and modestly up from a year ago, period. Did anything in particular in the quarter lead to that?

Pradman Kaul, president and CEO

Yes, we’d to believe we finalized that very carefully, and there’s a bunch of little things but nothing significant but probably the trend, the slight increase that we see is primarily coming from where we see people just not being able to able; some payment defaulters but it’s too small to take any significant conclusion from that.

Chris Quilty - Raymond Janks and Associates

Okay. The announcement that you made on the increased bits caught several weeks ago are you getting any indications that you’re picking up, while blue customers or some of those guys still are locked down on your contracts that you’re just not going to see an impact?

Pradman Kaul, president and CEO

I don’t think we’ve got any confirmation that they’re wild blue customers by any means, but certainly we’re seeing a lot of positive feedback from our customers and in fact, the earlier question on churn that you were saying, we give people 30 days to get out of their contract if they’re unhappy in the first 30 days, which is part of our churn number, and we found a reasonable decline in the churn in the first 30 days or the last 2 months. This tells you that the customer satisfaction space ray was much higher than it was in the traditional KU-BAND customer and it’s primarily due to the fact that they’re getting more bits.

Chris Quilty - Raymond Janks and Associates

Okay. A question for Grant the proceeds from the secondary, can you remind us of how and when you’re going to deploy that and what sort of cash rate we should model or interest rate on the cash?

Grant A. Barber

Right now, obviously, we have all the $93 million in our cash. We have -like we mentioned in the last call initiative discussions with suppliers to build our next generation satellite- and we expect to conclude on those this quarter to be safe, and typically it’s a 3.5-year build plan with milestone payments including a deposit upfront and then, typically, quarterly payments through the 3.5 years, with the largest of those being the launch any insurance that are paid towards that latter part.

Chris Quilty - Raymond Janks and Associates

The plan would be to just to hold back cash and a cash account not paid downturn in the near term?

Grant A. Barber

There’s no intent to pay down either of our term loans or the bonds.

Chris Quilty - Raymond Janks and Associates

Great. I’ll circle back with other questions.

Chris Quilty - Raymond Janks and Associates

Okay, thanks.

Operator

Your next question comes from the line of Gat Malak with Goldman SacksPlease proceed.

Gat Malak -Goldman-Sachs

Hey, good morning. Thanks for taking a question. Just first on the mid-sized business seems like one of the major advantages of SpaceWay, just wondering how you’re selling this is this the same shells force that’s selling enterprise channels or do you need new types of distribution to target these mid-sized businesses?

Pradman Kaul, president and CEO

Bo, we definitely need a new type of distribution and, in fact, we’ve set up a separate organization as far as backing this small and medium-business market. It’s a mix of consumer skills and consumer know-how in terms of the wires that we are using etc. and some direct capability, so now if you look at a non-American sales organization we have a large enterprise which is all direct within small and medium-business enterprise, which is a combination of direct and resellers, and then the last role -of course- is the consumer which is primarily all direct through our dealers and agents.

Gat Malak -Goldman-Sachs

Ok that's helpful, thanks. I just wanted to ask you a couple of questions on RLECS, haven been increasingly talking about giving expansion; their broadband [014] recently. I know that Barb talked about using some smart coils to expand the distance into world markets so that it can provide DSL. We just talked about what part of your churn has to do with our life expansion in the past. How that proportion has changed over time, and what your expectations are?

Pradman Kaul

You know, we certainly haven't seen any significant pluses or minuses from the RLECS. The numbers are just not big enough to radar our screen yet. I think we're trying from a long-term strategy, to develop partnerships with some of the RLECS so that they could be a sales agent or a reseller for selling our services in India, but they don't have coverage with DSL. We have seen some interest there, I think we signed an agreement which we announced previously which gets active in September or October and they are talking to 4 or 5 other RLECS. We are hoping they will compliment the sales agent/dealer kind of reselling capabilities.

Gat Malak -Goldman-Sachs

Is there any idea on the proportion of the churn that comes from our work expansion?

Pradman Kaul

Negligible. They would come up in the list, items for churns that we see.

Gat Malak -Goldman-Sachs

So that your biggest items for churn are when people move and disatisfaction with the service?

Pradman Kaul

Yes, and which is to say, they don't want to pay the $60 a month for broadband services.

Gat Malak -Goldman-Sachs

Again, on the new satellite, I was just wondering if you're looking at the possibility of having less on-board processing, maybe the cost of the next satellite could be lower than it was on space way 3.

Pradman Kaul

We're looking at the next satellite, primarily focusing on what is the optimum design for the consumer business. Do you remember when we did Spaceway, one of the reasons we picked an onboard switch was we were focusing on the mesh traffic requirements that the enterprise markets would see. This goes way back in 1998. So now we're at consumer businesses is really the real space segment hog that we have to feed. They are designed to operate quite different, and the answer is yes, we have switching and processing on board but, still be a very powerful big satellite with a lot bits and a lot of capacity.

Gat Malak -Goldman-Sachs

Ok thanks

Operator

The next question up online is from Mrs. Jennifer Adams with the Calanen Company.

Jennifer Adams - Calanen

Congratulations on the good quarter. I have a quick few questions. Working at hardware margins what kind of growth margins were up a little bit from the first quarter and up from what we expected. If you give a little favor of what caused that improvement in hardware margins. The second question I know the global start contract was one of the big deals you announced this quarter. If you could just give us a little favor on how that $100 million will be paid out, what milestones you have to hit and how we can expect to see that this money is being paid out. Thanks a lot.

Grant A. Barber - CFO

Sure. On hardware margins, obviously we're pleased with the performance on hardware. It's made of a mix the enterprise business which is slightly better year over year domestically. The international hardware margins continue to improve for as we're able to keep our prices and continue to drive down on hardware cost we experienced through last year and continue to do that through this year as well. There is slight reaction on the consumer hardware side, just reflecting the reduced, if you recall, we dropped our priced on the upfront programs for the consumer about $100 in May of last year and that impacts the year over your hardware negatively, but it's been more than offset by the enterprise and the international hardware programs we have.

Pradman Kaul

Unfortunately is the NDA's requirements of the contract don't allow us to just close the details of the payment terms but fundamentally, it's the 3-year programs and milestone payments are structured in a manner we get, have cash neutral as we grow during the whole program.

Jennifer Adams - Calanen

Ok so your call….

Pradman Kaul

That's fairly close we go by milestone by milestone and we don't expect to have any significant exposure.

Jennifer Adams - Calanen

There is s certain point in the contract that we'll be seeing process?

Pradman Kaul

Yeah, we'll have a profitable a new contract, like all our business.

Jennifer Adams - Calanen

Right, but do you have any flavor, would you have deliver a certain number of units? Is there any way to talk about when it might hit break-even?

Pradman Kaul

We both got the accounting method we use in here is basically on a cost basis so we book margins on every dollar of cost that we incur and you recognize revenues based on that cost plus the margin that the cost to complete the project.

Grant A. Barber

It is very similar with all of our mobilesat contracts, with most of the engineering development and effort, they are multiple year contracts, 3-4 years development fields with milestone billings and payments and cost plus basis. We track the profitability every quarter in each one of our projects.

Jennifer Adams - Calanen

Ok thanks for that clarification.

Grant A. Barber

Thank you.

Operator

We have a question from the line of Chris Quarthy from Bran & James and Associates, please proceed.

Chris Quarthy - Bran & James

(unclear).and which was specific advertising and promotion items that you're dealing, anything different per say, or more aggressing on the consumer marketing end for this space-way service.

Pradman Kaul

Yeah, here continually evolved way of things, we test different methods, we see what does, what does work. But I think this year the big difference was, we got a little more aggressive on our commercials and so we'll advertising more for television, primarily on both directv and dish, and we'll continue to do that. We're also doing a lot of direct mails, very targeted direct mailing to people and zip codes where we know there is not DSL cable. I think you're about to see, or you will see in the next 30 days a new commercial for our promos that we're developing and we think will create some more response from the potential subscribers. So yes, that constantly evolves.

Chris Quarthy - Bran & James

And we continue to work with the dealer channels to see what they need to help with and assist them with the process whether it's collateral, optics or material or a slightly different offer for them to use to their customer.

Grant A. Barber

Got you. In another follow up problem you had mentioned when talking about the North American enterprise business in terms of the new contract you had signed you also mentioned that one of the successes was selling new services to existing customers, is that digital signage disaster recovery or is there something totally different?

Pradman Kaul

There's a lot of stuff, the important thing to remember is even though our revenues and enterprises are lower, and our auto-input and our backlog in North American enterprises have gone up. The reason is the more and more of our orders are coming for services as opposed to pure hardware. Those orders for services take years to convert to revenues, because they usually are 2-5 years as opposed to the hardware orders that you book very quickly because you deliver the hardware. So I think new types of services, more renewals, existing customers etc..are all part of the social security order of mentioned of all services. There's new video distance learning network security administrations, and others like that we see; but it is a very encouraging train in the long term, because we're building up our backlog in the enterprise video for the next two or three years, albeit because of the loss of hardware revenues and it's causing a slight degeneration when you compare to the previous quarter of last year.

Chris Quarthy - Bran & James

Ok, and final question here on the new satellite contract. A. Is there anyone other but than Boeing that has the onboard switching capabilities that is going to be part of space way 4 that you could chose as a alternative supplier and B. Is this going to be a 500 gigabyte satellite?

Pradman Kaul

Maybe that wasn't very clear as I mentioned a few minutes ago. Because these satellites are focused on the consumer requirements the need for on-board switching is not there, because the consumer doesn't have a mesh requirement, so we're most likely will end up with a new satellite and not having an on-board search.

Chris Quarthy - Bran & James

Ok.

Pradman Kaul

The answer to your question is yes, there is going to be a satellite with a large capacity.

Chris Quarthy - Bran & James

A lot eh?

Pradman Kaul

Yes.

Chris Quarthy - Bran & James

Thank you. Got it.

Operator

Just to remind you, if anyone would like to ask a question, please press # followed by 1 on your touchtone telephone.

Grant A. Barber

Ok, it looks like there are no more questions, so at this point, I want to thank everyone for taking the time to listen to our conference call and asking the questions. Thank you.

Operator

This concludes our presentation, you may now disconnect. Have a good day.

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