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ECHOSTAR CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following management's discussion and analysis of our financial condition and results of operations together with the condensed consolidated financial statements and notes to our financial statements included elsewhere in this quarterly report. This management's discussion and analysis is intended to help provide an understanding of our financial condition, changes in our financial condition and our results of operations and contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in our Annual Report on Form 10-K for the year ended December 31, 2012 under the caption "Item 1A. Risk Factors." EXECUTIVE SUMMARY EchoStar Corporation (together with its subsidiaries is referred to as "EchoStar," the "Company," "we," "us" and/or "our") is a global provider of satellite operations, video delivery solutions, and broadband satellite technologies and services for home and office, delivering innovative network technologies, managed services, and solutions for enterprises and governments. We currently operate in three business segments: the EchoStar Technologies segment, the Hughes segment, and the EchoStar Satellite Services segment. EchoStar Technologies Segment Our EchoStar Technologies segment designs, develops and distributes digital set-top boxes and related products and technology, including our Slingbox "placeshifting" technology, primarily for satellite TV service providers, telecommunication and international cable companies and, with respect to Slingboxes, directly to consumers via retail outlets. Slingbox "placeshifting" technology can be used by consumers to watch and control their home digital video and audio content via a broadband Internet connection. A substantial majority of our digital set-top boxes are sold to DISH Network Corporation and its subsidiaries ("DISH Network"), but we also sell digital set-top boxes to Bell TV in Canada, Dish Mexico, S. de R.L. de C.V. ("Dish Mexico") in Mexico and other international customers. Our EchoStar Technologies segment also provides digital broadcast operations including satellite uplinking/downlinking, transmission services, signal processing, conditional access management and other services primarily to DISH Network. We depend on DISH Network for a substantial portion of our EchoStar Technologies segment revenue and we expect that DISH Network will continue to be the primary source of revenue for our EchoStar Technologies segment. Therefore, our results of operations are, and will be closely linked to the performance of DISH Network's pay-TV service. In January 2012, we entered into a receiver agreement with DISH Network (the "2012 Receiver Agreement"), expiring on December 31, 2014, pursuant to which DISH Network has the right, but not the obligation, to purchase digital set-top boxes, related accessories and other equipment from us either: (i) at cost (decreasing as we reduce cost and increasing as our costs increase) plus a dollar mark-up which will depend upon the cost of the product subject to a collar on our mark-up; or (ii) at cost plus a fixed margin, which will depend on the nature of the equipment purchased. Under the 2012 Receiver Agreement, our margins will be increased if we are able to reduce the costs of our digital set-top boxes and our margins will be decreased if these costs increase. While we also expect to sell equipment to other customers, the number of potential new customers for our EchoStar Technologies segment is small and may be limited as prospective customers that have been competitors of DISH Network may continue to view us as a competitor due to our common ownership with DISH Network. We believe that our best opportunities for developing potential new customers for our EchoStar Technologies segment over the near term lie in international markets, including joint ventures. Thus, our efforts in expanding our digital set-top box business are focused on international markets and we are not actively seeking set-top box opportunities with United States cable operators. Over the years, we have noticed an increase in new market entrants that offer low cost set- 32 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued top boxes, including set-top boxes that are modeled after our products or products of our principal competitors. The entry of these new competitors may result in pricing pressure in international markets that we hope to enter. If market prices in international markets are substantially reduced by such new entrants, it may be difficult for us to make profitable sales in international markets. As a result, our ability to generate revenue and income growth in future periods depends greatly on our success in entering the international markets. We continue to focus on building and strengthening our brand recognition by providing unique and technologically advanced features and products, including Internet delivery of video content, whole-home HD DVR receivers and MPEG-4 digital compression technology, to our customers. Our success depends heavily on our ability to bring advanced technologies to market to keep pace with our competitors. The margins we earn on sales are determined largely through periodic negotiations that could result in pricing reflecting, among other things, the digital set-top boxes and other equipment that best meet our customers' current sales and marketing priorities, the product and service alternatives available from other equipment suppliers, and our ability to respond to customer requirements and to differentiate ourselves from other equipment suppliers on bases other than pricing. Our ability to sustain or increase profitability will also depend in large part on our ability to control or reduce our costs of producing digital set-top boxes. The market for our digital set-top boxes, like other electronic products, has been characterized by regular reductions in selling prices and production costs. Therefore, we will likely be required to reduce production costs to maintain the margins we earn on digital set-top boxes and the profitability of our EchoStar Technologies segment. However, our ability to reduce production costs may be limited by, among other things, economic conditions and a shortage of available parts and may lead to inflated pricing. If we do not compete effectively, demand for our products could decline, our gross margins could decrease, we could lose market share, our revenues and earnings may decline and our growth prospects could be diminished. Hughes Segment Our Hughes segment is a global provider of broadband satellite technologies and services for home and office, delivering innovative network technologies, managed services, and solutions for enterprises and governments. The Hughes segment uses its two owned satellites, SPACEWAY 3 and EchoStar XVII, and additional satellite capacity acquired from multiple third-party providers to provide satellite broadband Internet access to North American consumers, which we refer to as the consumer market, and broadband network services and systems to the domestic and international enterprise markets. Our Hughes segment also provides managed services to large enterprises and networking systems solutions to customers for mobile satellite and wireless backhaul systems. We incorporate advances in technology to reduce costs and to increase the functionality and reliability of our products and services. Through the usage of advanced spectrally efficient modulation and coding methodologies, such as DVB-S2 and proprietary software web acceleration and compression techniques, we continue to improve the efficiency of our networks. We invest in technologies to enhance our system and network management capabilities, specifically our managed services for enterprises. We also continue to invest in next generation technologies that can be applied to our future products and services. Beginning in October 2012, we introduced HughesNet Gen4 broadband Internet services to our customers in North America on EchoStar XVII, which was launched in July 2012. In October 2012, we entered into a distribution agreement (the "Distribution Agreement") with dishNET Satellite Broadband L.L.C ("dishNET"), a wholly-owned subsidiary of DISH Network, pursuant to which dishNET has the right, but not the obligation, to market, sell and distribute the Hughes satellite Internet service (the "Hughes service"). dishNET pays us a monthly per subscriber wholesale service fee for the Hughes service based upon a subscriber's service level and beginning January 1, 2014, certain volume subscription thresholds. The Distribution Agreement also provides that dishNET has the right, but not the obligation, to purchase certain broadband equipment from us to support the sale of its service. The Distribution Agreement has a five year term with automatic renewal for successive one year terms unless terminated by either party with a written notice at least 180 days before the expiration of the then-current term. Upon expiration or termination of the Distribution Agreement, the parties will continue to provide the Hughes service to the then-current dishNET subscribers pursuant to the terms and conditions of the Distribution Agreement. 33 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued As of March 31, 2013 and December 31, 2012, our Hughes segment had approximately 692,000 and 636,000 subscribers, respectively. These subscribers include subscriptions with HughesNet services, through retail, wholesale and small/medium enterprise service channels. Not included in the subscriber totals above were approximately 28,000 and 23,000 subscribers as of March 31, 2013 and December 31, 2012, respectively, receiving services through third-parties who have capacity arrangements with us. Subscribers reported in previous periods included those receiving services through third-parties who have capacity arrangements with us and have been adjusted in this report to exclude such arrangements. As of March 31, 2013 and December 31, 2012, we had $1.034 billion and $1.063 billion, respectively, of contracted revenue backlog. We define Hughes revenue backlog as our expected future revenue under customer contracts that are non-cancelable, excluding agreements with customers in our consumer market. We continue our efforts in growing our consumer revenue, which depends on our success in adding new subscribers on our Hughes segment's satellite networks. Accordingly, we may need to adjust our service offerings in response to the offerings of our competitors, including ViaSat Communications, Inc. In addition, we focus on expanding our enterprise business, both domestically and internationally. However, the growth of the enterprise business relies heavily on global economic conditions. EchoStar Satellite Services Segment Our EchoStar Satellite Services segment operates its business using ten of its owned and leased in-orbit satellites, including EchoStar XVI launched in November 2012. We lease capacity on a full-time and occasional-use basis primarily to DISH Network, and secondarily to Dish Mexico, United States government service providers, state agencies, Internet service providers, broadcast news organizations, programmers and private enterprise customers. We continue to pursue expanding our business offerings by providing value added services such as telemetry, tracking and control services to third parties. However, there can be no assurance that we will be able to effectively compete against our competitors due to their significant resources and operating history. We depend on DISH Network for a significant portion of the revenue for our EchoStar Satellite Services segment and we expect that DISH Network will continue to be the primary source of revenue for our EchoStar Satellite Services segment. Therefore, our results of operations are and will be closely linked to the performance of DISH Network's pay-TV service as well as changes in DISH Network's satellite capacity requirements. In November 2012, we launched EchoStar XVI, which is fully leased to DISH Network beginning in the first quarter of 2013, for the delivery of direct-to-home ("DTH") broadcast services to DISH Network customers in the United States. Any termination or reduction in the services we provide to DISH Network would increase excess capacity on our satellites and require that we aggressively pursue alternative sources of revenue for this segment. Possible adverse effects on the EchoStar Technologies segment from DISH Network's possible decline in gross subscriber additions are not expected to materially impact the revenue generated within the EchoStar Satellite Services segment in the near term. As of March 31, 2013 and December 31, 2012, our EchoStar Satellite Services segment had contracted revenue backlog attributable to satellites currently in orbit of approximately $1.386 billion and $1.440 billion, respectively. While we also expect to provide services to other customers, the number of potential new customers for our EchoStar Satellite Services segment is small and may be limited as prospective customers that have been competitors of DISH Network may continue to view us as a competitor due to our common ownership with DISH Network. Our ability to expand revenues in the EchoStar Satellite Services segment will likely require that we displace incumbent suppliers that generally have well established business models and often benefit from long-term contracts with their customers. As a result, to grow our EchoStar Satellite Services segment we may need to develop or otherwise acquire access to new satellite-delivered services so that we may offer differentiated services to prospective customers. However, there can be no assurance that we would be able to develop or otherwise acquire access to such differentiated services or develop the sales and marketing expertise necessary to sell such services profitably. 34 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued In addition, as our satellite fleet ages, we will be required to evaluate replacement alternatives such as acquiring, leasing or constructing additional satellites, with or without customer commitments for capacity, which may require us to seek additional financing. However, there can be no assurance that such financing will be available to fund any such replacement alternatives on terms that would be attractive to us or at all. New Business Opportunities We are exploring opportunities to selectively pursue partnerships, joint ventures and strategic acquisition opportunities, domestically and internationally. We believe that investments in these types of opportunities, such as the Brazil DTH market, may allow us to increase our existing market share, expand into new markets, broaden our portfolio of products and intellectual property, and strengthen our relationships with our customers. With our extensive experience in designing, developing, and distributing digital set-top boxes and related products, we can leverage the broader adoption of advanced technologies within set-top boxes to create opportunities for us. We believe that DTH satellite and broadband services are particularly well-suited for countries without extensive telecommunications and cable infrastructure, and we intend to continue to seek new investments and customer relationships with international DTH satellite service and broadband service providers. Our available satellite capacity provides us, in certain cases, with the ability to initiate new services quickly. EXPLANATION OF KEY METRICS AND OTHER ITEMS Equipment revenue - DISH Network. "Equipment revenue - DISH Network" primarily includes sales of digital set-top boxes and related components, including Slingboxes and related hardware products, and sales of satellite broadband equipment and related equipment, primarily related to the Hughes service, to DISH Network. Equipment revenue - other. "Equipment revenue - other" primarily includes sales of digital set-top boxes and related components to Bell TV, Dish Mexico and other domestic and international customers, including sales of Slingboxes and related hardware products and sales of broadband equipment and networks to customers in our enterprise and consumer markets. Services and other revenue - DISH Network. "Services and other revenue - DISH Network" primarily includes revenue associated with satellite and transponder leasing, satellite uplinking/downlinking, signal processing, conditional access management, telemetry, tracking and control, development of web-based applications for set-top boxes, professional services, facilities rental revenue and other services provided to DISH Network. Beginning in October 2012, "Services and other revenue - DISH Network" also includes subscriber wholesale service fees for the Hughes service sold to dishNET. Services and other revenue - other. "Services and other revenue - other" primarily includes the sales of enterprise and consumer broadband services, as well as maintenance and other contracted services. "Services and other revenue - other" also includes revenue associated with satellite and transponder leasing, satellite uplinking/downlinking and other services provided to customers other than DISH Network. Cost of sales - equipment. "Cost of sales - equipment" principally includes costs associated with digital set-top boxes and related components sold to DISH Network, Bell TV, Dish Mexico and other domestic and international customers, including costs associated with Slingboxes and related hardware products. "Cost of sales - equipment" also includes the cost of broadband equipment and networks sold to customers in our enterprise, consumer markets, and to DISH Network. 35 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Cost of sales - services and other. "Cost of sales - services and other" primarily includes the cost of broadband services provided to our enterprise customers, consumer customers, and to DISH Network, as well as the cost of providing maintenance and other contracted services. "Cost of sales - services and other" also includes the costs associated with satellite and transponder leasing, satellite uplinking/downlinking, signal processing, conditional access management, telemetry, tracking and control, development of web-based applications for set-top boxes, professional services, facilities rental revenue and other services provided to our customers, including DISH Network. Research and development expenses. "Research and development expenses" primarily includes costs associated with the design and development of products to support future growth by reducing costs and providing new technology and innovations to our customers. Selling, general and administrative expenses. "Selling, general and administrative expenses" primarily includes selling and marketing costs and employee-related costs associated with administrative services (i.e., information systems, human resources and other services), including stock-based compensation expense. It also includes professional fees (i.e., legal, information systems and accounting services) and other items associated with facilities and administrative services provided by DISH Network and other third parties. Interest income. "Interest income" primarily includes interest earned on our cash, cash equivalents and marketable investment securities, including accretion on debt securities. Interest expense, net of amounts capitalized. "Interest expense, net of amounts capitalized" primarily includes interest expense associated with the Notes, capital lease obligations (net of capitalized interest), other debt and amortization of debt issuance costs. Realized gains on marketable investment securities and other investments. "Realized gains on marketable investment securities and other investments" primarily includes gains on the sale or exchange of investments and "other-than-temporary" impairments of marketable and other investment securities. Other, net. "Other, net" primarily includes transaction costs related to acquisitions and dividends received from our marketable investment securities. Earnings before interest, taxes, depreciation and amortization ("EBITDA"). EBITDA is defined as "Net income attributable to EchoStar" plus "Interest expense, net of amounts capitalized" net of "Interest income," "Income tax benefit, net" and "Depreciation and amortization." EBITDA is not a measure determined in accordance with accounting principles generally accepted in the United States ("GAAP"). This "non-GAAP measure" is reconciled to "Net income attributable to EchoStar" in our discussion of "Results of Operations" below. EBITDA should not be considered a substitute for operating income, net income or any other measure determined in accordance with GAAP. Conceptually, EBITDA measures the amount of income generated each period that could be used to service debt, pay taxes and fund capital expenditures. EBITDA should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. EBITDA is used by our management as a measure of operating efficiency and overall financial performance for benchmarking against our peers and competitors. Management believes EBITDA provides meaningful supplemental information regarding liquidity and the underlying operating performance of our business. Management also believes that EBITDA is useful to investors because it is frequently used by securities analysts, investors, and other interested parties to evaluate companies in our industry. Subscribers. Subscribers include subscriptions with HughesNet services, through retail, wholesale and small/medium enterprise service channels. 36 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued RESULTS OF OPERATIONS Three Months Ended March 31, 2013 Compared to the Three Months Ended March 31, 2012. As of or For the Three Months Ended March 31, Variance Statements of Operations Data 2013 2012 Amount % (Dollars in thousands) Revenue: Equipment revenue - DISH Network $ 308,875 $ 237,365 $ 71,510 30.1 Equipment revenue - other 102,090 157,347 (55,257 ) (35.1 ) Services and other revenue - DISH Network 139,925 126,658 13,267 10.5 Services and other revenue - other 244,564 243,410 1,154 0.5 Total revenue 795,454 764,780 30,674 4.0 Costs and Expenses: Cost of sales - equipment 353,855 337,166 16,689 4.9 % of Total equipment revenue 86.1 % 85.4 % Cost of sales - services and other 179,294 167,830 11,464 6.8 % of Total services and other revenue 46.6 % 45.4 % Selling, general and administrative expenses (including DISH Network) 94,176 98,934 (4,758 ) (4.8 ) % of Total revenue 11.8 % 12.9 % Research and development expenses 17,494 17,350 144 0.8 % of Total revenue 2.2 % 2.3 % Depreciation and amortization 126,699 114,090 12,609 11.1 Total costs and expenses 771,518 735,370 36,148 4.9 Operating income 23,936 29,410 (5,474 ) (18.6 ) Other Income (Expense): Interest income 1,977 2,879 (902 ) (31.3 ) Interest expense, net of amounts capitalized (49,100 ) (38,621 ) (10,479 ) 27.1 Realized gains on marketable investment securities and other investments (including reclassification of realized gains on available-for-sale securities out of accumulated other comprehensive income of $16,530 and $127,995, respectively 19,463 127,995 (108,532 ) (84.8 ) Equity in earnings (losses) of unconsolidated affiliates, net (3,905 ) 4,185 (8,090 ) * Other, net 5,481 348 5,133 * Total other income (expense), net (26,084 ) 96,786 (122,870 ) * Income (loss) before income taxes (2,148 ) 126,196 (128,344 ) * Income tax benefit, net 5,646 305 5,341 * Net income 3,498 126,501 (123,003 ) (97.2 ) Less: Net income (loss) attributable to noncontrolling interests 40 (87 ) 127 * Net income attributable to EchoStar $ 3,458 $ 126,588 $ (123,130 ) (97.3 ) Other Data: EBITDA $ 171,634 $ 276,115 $ (104,481 ) (37.8 ) Subscribers (1) 692,000 608,000 84,000 13.8 -------------------------------------------------------------------------------- *Percentage is not meaningful. (1) Excluded 28,000 and 26,000 subscribers as of March 31, 2013 and 2012, respectively, receiving services through third-parties who have capacity arrangements with us. 37 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Equipment revenue - DISH Network. "Equipment revenue - DISH Network" totaled $309 million during the three months ended March 31, 2013, an increase of $72 million or 30.1%, compared to the same period in 2012. The increase was primarily due to higher sales of set-top boxes and related accessories. See Note 14 in the Notes to our Condensed Consolidated Financial Statements for further discussion. Equipment revenue - other. "Equipment revenue - other" totaled $102 million during the three months ended March 31, 2013, a decrease of $55 million or 35.1%, compared to the same period in 2012. The decrease was attributable to lower sales of set-top boxes and related accessories of $42 million to Bell TV and $3 million to our international customers, primarily due to a decline in the number of units sold and average revenue per unit. The decrease in "Equipment revenue - other" was also due to lower sales of $4 million of broadband equipment and networks to customers in the enterprise market provided by our Hughes segment. Services and other revenue - DISH Network. "Services and other revenue - DISH Network" totaled $140 million during the three months ended March 31, 2013, an increase of $13 million or 10.5%, compared to the same period in 2012. The increase was primarily due to higher revenue earned from the sales of broadband services generated by our Hughes segment and additional services relating to the development of web-based applications for set-top boxes as well as uplink services provided by our EchoStar Technologies segment. See Note 14 in the Notes to our Condensed Consolidated Financial Statements for further discussion. Services and other revenue - other. "Services and other revenue - other" totaled $245 million during the three months ended March 31, 2013, an increase of $1 million or 0.5%, compared to the same period in 2012. The increase was primarily attributable to higher sales of broadband services to customers in the enterprise market provided by our Hughes segment. Cost of sales - equipment. "Cost of sales - equipment" totaled $354 million during the three months ended March 31, 2013, an increase of $17 million or 4.9%, compared to the same period in 2012. The increase was primarily due to higher costs of $62 million resulting from higher sales of set-top boxes and related accessories to DISH Network. The increase in "Cost of sales - equipment" was partially offset by lower costs of $38 million, primarily relating to a decrease in sales of set-top boxes and related accessories to Bell TV and our international customers. "Cost of sales - equipment" represented 86.1% and 85.4% of total equipment revenue for the three months ended March 31, 2013 and 2012, respectively. Cost of sales - services and other. "Cost of sales - services and other" totaled $179 million during the three months ended March 31, 2013, an increase of $11 million or 6.8%, compared to the same period in 2012. The increase was due to corresponding increases in costs of $11 million and $5 million resulting from higher services revenue generated by our EchoStar Technologies segment and our Hughes segment, respectively. The increase in "Cost of sales - services and other" was partially offset by a decrease in cost of sales of $4 million, primarily due to the termination of our satellite lease agreement with DISH Network for EchoStar I in July 2012. See Note 14 in the Notes to our Condensed Consolidated Financial Statements for further discussion of our agreements with DISH Network. "Cost of sales - services and other" represented 46.6% and 45.4% of total services and other revenue for the three months ended March 31, 2013 and 2012, respectively. Selling, general and administrative expenses. "Selling, general and administrative expenses" totaled $94 million during the three months ended March 31, 2013, a decrease of $5 million or 4.8%, compared to the same period in 2012. The decrease was mainly due to lower administrative expenses incurred associated with third-party professional services and administrative services provided to us by DISH Network. See Note 14 in the Notes to our Condensed Consolidated Financial Statements for further discussion of our agreements with DISH Network. The decrease in "Selling, general and administrative expenses" was partially offset by higher marketing and advertising expenses incurred by our Hughes segment. "Selling, general and administrative expenses" represented 11.8% and 12.9% of total revenue for the three months ended March 31, 2013 and 2012, respectively. 38 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Depreciation and amortization. "Depreciation and amortization" expense totaled $127 million during the three months ended March 31, 2013, an increase of $13 million or 11.1%, compared to the same period in 2012. The increase was primarily related to depreciation expense of $15 million on EchoStar XVII and EchoStar XVI, which were placed into service in October 2012 and January 2013, respectively. In addition, the increase in "Depreciation and amortization" expense was also partly due to higher depreciation expense of $4 million associated with customer rental equipment in our Hughes segment. The increases in "Depreciation and amortization" expense were partially offset by lower depreciation expense of $5 million on EchoStar VI, which was fully depreciated in August 2012. Interest expense, net of amounts capitalized. "Interest expense, net of amounts capitalized" totaled $49 million during the three months ended March 31, 2013, an increase of $10 million or 27.1%, compared to the same period in 2012. The increase was due to lower capitalization of interest expense of $11 million associated with EchoStar XVII and EchoStar XVI as they were placed into service in October 2012 and January 2013, respectively. Realized gains on marketable investment securities and other investments. "Realized gains on marketable investment securities and other investments" totaled $19 million during the three months ended March 31, 2013, a decrease of $109 million or 84.8%, compared to the same period in 2012. The decrease was related to higher gains of $109 million recognized on sales of marketable investment securities and other investments during the first quarter of 2012. Earnings before interest, taxes, depreciation and amortization. EBITDA was $172 million during the three months ended March 31, 2013, a decrease of $105 million or 37.8%, compared to the same period in 2012. The decrease was primarily due to higher gains of $109 million recognized from the sale of marketable investment securities and other investments during the first quarter 2012. The following table reconciles EBITDA to the accompanying financial statements. For the Three Months Ended March 31, Variance 2013 2012 Amount % (In thousands) EBITDA $ 171,634 $ 276,115 $ (104,481 ) (37.8 ) Interest expense, net (47,123 ) (35,742 ) (11,381 ) 31.8 Income tax benefit, net 5,646 305 5,341 * Depreciation and amortization (126,699 ) (114,090 ) (12,609 ) 11.1Net income attributable to EchoStar $ 3,458 $ 126,588 $ (123,130 ) (97.3 ) -------------------------------------------------------------------------------- *Percentage is not meaningful Income tax benefit, net. Income tax benefit, net totaled $5.6 million during the three months ended March 31, 2013, an increase of $5.3 million, compared to $0.3 million benefit in the same period in 2012. Our effective income tax benefit rate was 262.8% for the three months ended March 31, 2013 compared to 0.2% for the same period in 2012. The change in our effective tax rate was primarily related to the release of valuation allowances associated with our capital investments and reinstatement of the research and experimentation tax credit for 2012 and 2013, as enacted by the American Taxpayer Relief Act on January 2, 2013. Net income attributable to EchoStar. "Net income attributable to EchoStar" was $3 million during the three months ended March 31, 2013, a decrease of $123 million or 97.3%, compared to the same period in 2012. The decrease was primarily attributable to lower: (i) gains of $109 million recognized from the sale of marketable investment securities and other investments; (ii) capitalization of interest expense of $11 million associated with our EchoStar XVII and EchoStar XVI satellites, which were placed into service in October 2012 and January 2013, respectively; and (iii) earnings of $8 million from our investments accounted for under the equity method of accounting. The reductions in "Net income attributable to EchoStar" was partially offset by a $7 million gain recognized as a result of an anomaly associated with AMC-16, one of our capital leased satellites. 39 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued LIQUIDITY AND CAPITAL RESOURCES Cash, Cash Equivalents and Current Marketable Investment Securities We consider all liquid investments purchased within 90 days of their maturity to be cash equivalents. See "Item 3. - Quantitative and Qualitative Disclosures about Market Risk" for further discussion regarding our marketable investment securities. As of March 31, 2013, our cash, cash equivalents and current marketable investment securities totaled $1.527 billion compared to $1.548 billion as of December 31, 2012, a decrease of $21 million. This decrease in cash, cash equivalents and current marketable investment securities was primarily driven by capital expenditures of $73 million, partially offset by cash generated from operations of $50 million for the three months ended March 31, 2013. We have investments in various debt and equity instruments including corporate bonds, corporate equity securities, government bonds, and variable rate demand notes ("VRDNs"). VRDNs are long-term floating rate municipal bonds with embedded put options that allow the bondholder to sell the security at par plus accrued interest. All of the put options are secured by a pledged liquidity source. Our VRDN portfolio is comprised of investments in municipalities and corporations, which are backed by financial institutions or other highly rated companies that serve as the pledged liquidity source. While they are classified as marketable investment securities, the put option allows VRDNs to be liquidated generally on the same day or on a five business day settlement basis. As of March 31, 2013 and December 31, 2012, we held VRDNs, within our current marketable investment securities portfolio, with fair values of $65 million and $66 million, respectively. The following discussion highlights our cash flow activities for the three months ended March 31, 2013. Cash flows from operating activities. We typically reinvest the cash flows from operating activities in our business. For the three months ended March 31, 2013, we reported net cash inflows from operating activities of $50 million, a decrease of $29 million, compared to the same period in 2012. The decrease was primarily attributable to lower net income of $123 million adjusted to exclude: (i) "Depreciation and amortization;" (ii) "Realized gains on marketable investment securities and other investments;" (iii) "Equity in losses (earnings) of unconsolidated affiliates, net;" (iv) "Deferred tax benefit;" and (v) "Other, net." In addition, net cash inflows was reduced by $22 million resulting from changes in operating assets and liabilities related to timing differences between the incurrence of expense and cash payments. Cash flows from investing activities. Our investing activities generally include purchases and sales of marketable investment securities, capital expenditures, and strategic investments. For the three months ended March 31, 2013, we reported net cash outflows from investing activities of $43 million, a decrease of $5 million compared to the same period in 2012. The decrease was primarily related to a reduction in capital expenditures of $41 million, which was partially offset by lower proceeds of $38 million from net sales of marketable investment securities. Cash flows from financing activities. Our financing activities generally include net proceeds related to the issuance of long-term debt, cash used for the repurchase, and redemption or payment of long-term debt and capital lease obligations. For the three months ended March 31, 2013, we reported net cash outflows from financing activities of $1 million, a decrease of $15 million, compared to the same period in 2012. The decrease was primarily due to higher proceeds of $19 million received from Class A common stock option exercises and stock issued under our Employee Stock Purchase Plan, which was partially offset by higher repayments of long-term debt of $4 million. Contractual Obligations As of March 31, 2013, our remaining satellite-related obligations were approximately $1.1 billion. Our satellite-related obligations include, among other things, costs related to our capital leased satellites, transponder service agreements, multiple launch contracts, in-orbit incentives as well as the design and construction of EchoStar XIX. 40 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Off-Balance Sheet Arrangements Other than the transactions below, we generally do not engage in off-balance sheet financing activities or use derivative financial instruments for hedge accounting or speculative purposes. As of March 31, 2013, we had $49 million of letters of credit and insurance bonds. Of this amount, $8 million was secured by restricted cash; $15 million related to insurance bonds; and $26 million was issued under credit arrangements available to our foreign subsidiaries. Certain letters of credit issued by our foreign subsidiaries are secured by their assets. As of March 31, 2013, we had foreign currency forward contracts with a notional value of $15 million in place to partially mitigate foreign currency exchange risk, of which $8 million related to forecasted collections on a Mexican peso denominated revenue contract. From time to time, we may enter into foreign currency forward contracts, or take other measures, to mitigate risks associated with foreign currency denominated assets, liabilities, commitments and anticipated foreign currency transactions. Satellite Insurance We generally do not carry insurance for any of the in-orbit satellites that we use because we believe that the premium costs are uneconomical relative to the risk of satellite failure. However, pursuant to the terms of the agreements governing certain portions of our indebtedness, we are required, subject to certain limitations on coverage, to maintain launch and in-orbit insurance for SPACEWAY 3, EchoStar XVI and EchoStar XVII. The loss of a satellite or other satellite malfunctions or anomalies could have a material adverse effect on our financial performance which we may not be able to mitigate by using available capacity on other satellites. There can be no assurance that we can recover critical transmission capacity in the event one or more of our in-orbit satellites were to fail. In addition, the loss of a satellite or other satellite malfunctions or anomalies could affect our ability to comply with Federal Communications Commission and other regulatory obligations and our ability to fund the construction or acquisition of replacement satellites for our in-orbit fleet in a timely fashion, or at all. Future Capital Requirements We primarily rely on our existing cash and marketable investment securities balances, as well as cash flow generated through our operations to fund our investment needs. Since we currently depend on DISH Network for a substantial portion of our revenue, our cash flow from operations depends heavily on its needs for equipment and services. To the extent that DISH Network's gross subscriber additions decrease or DISH Network experiences a net loss of subscribers, sales of our digital set-top boxes and related components to DISH Network may further decline, which in turn could have a further material adverse effect on our financial position and results of operations. As of March 31, 2013, our remaining obligations related to EchoStar XVI, EchoStar XVII, EchoStar XIX and the launch contract with Arianespace, SA totaled $591 million. There can be no assurance that we will have positive cash flows from operations. Furthermore, if we experience negative cash flows, our existing cash and marketable investment securities balances may be reduced. We have a significant amount of outstanding indebtedness. As of March 31, 2013, our total indebtedness was $2.463 billion, of which $461 million related to satellite capital lease obligations. Our liquidity requirements will be significant, primarily due to our debt service requirements. In addition, our future capital expenditures are likely to increase if we make additional investments in infrastructure necessary to support and expand our business, or if we decide to purchase one or more additional satellites. Other aspects of our business operations may also require additional capital. We periodically evaluate various strategic initiatives, the pursuit of which also could require us to raise significant additional capital. 41 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Satellites As our satellite fleet ages, we will be required to evaluate replacement alternatives such as acquiring, leasing or constructing additional satellites, with or without customer commitments for capacity. We also may construct or lease additional satellites in the future to provide satellite services at additional orbital locations or to improve the quality of our satellite services. Stock Repurchases Pursuant to a stock repurchase plan approved by our Board of Directors, we are authorized to repurchase up to $500 million of our outstanding shares of Class A common stock through and including December 31, 2013. As of March 31, 2013, we have not made any repurchase of outstanding shares of our Class A common stock under this plan. Seasonality For our EchoStar Technologies and EchoStar Satellite Services segments, we are affected by seasonality to the extent it impacts our customers. Our customers in the pay-TV industry, including DISH Network, our largest customer, typically experience seasonality. Historically, the first half of the year generally produces fewer new subscribers for the pay-TV industry than the second half of the year. However, we cannot provide assurance that this will continue in the future. For our Hughes segment, like many communications infrastructure equipment vendors, a higher amount of our hardware revenues occur in the second half of the year due to our customers' annual procurement and budget cycles. Large enterprises and operators often allocate their capital expenditure budgets at the beginning of their fiscal year (which often coincides with the calendar year). The typical sales cycle for large complex system procurements is 6 to 12 months, which often results in the customer expenditure occurring towards the end of the year. Customers often seek to expend the budgeted funds prior to the end of the year and the next budget cycle. Inflation Inflation has not materially affected our operations during the past three years. We believe that our ability to increase the prices charged for our products and services in future periods will depend primarily on competitive pressures or contractual terms. |