TMCnet News
IRIDIUM COMMUNICATIONS INC. - 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 discussion along with our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed on March 4, 2014 with the Securities and Exchange Commission, or the SEC, as well as our condensed consolidated financial statements included in this Form 10-Q. This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Such forward-looking statements include those that express plans, anticipation, intent, contingencies, goals, targets or future development or otherwise are not statements of historical fact. Without limiting the foregoing, the words "believe," "anticipate," "plan," "expect," "intend" and similar expressions are intended to identify forward-looking statements. These forward-looking statements are based on our current expectations and projections about future events, and they are subject to risks and uncertainties, known and unknown, that could cause actual results and developments to differ materially from those expressed or implied in such statements. The important factors discussed under the caption "Risk Factors" in our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2014 filed on May 1, 2014, could cause actual results to differ materially from those indicated by forward-looking statements made herein. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Overview of Our Business We are engaged primarily in providing mobile voice and data communications services using a constellation of orbiting satellites. We are the second largest provider of satellite-based mobile voice and data communications services based on revenue, and the only commercial provider of communications services offering 100% global coverage. Our satellite network provides communications services to regions of the world where wireless or wireline networks do not exist or are impaired, including extremely remote or rural land areas, airways, open oceans, the polar regions and regions where the telecommunications infrastructure has been affected by political conflicts or natural disasters. We provide voice and data communications services to businesses, the U.S. and foreign governments, non-governmental organizations and commercial end-users. We provide these services using our constellation of in-orbit satellites and related ground infrastructure, including a primary commercial gateway. We utilize an interlinked, mesh architecture to route traffic across the satellite constellation using radio frequency crosslinks. This unique architecture minimizes the need for ground facilities to support the constellation, which facilitates the global reach of our services and allows us to offer services in countries and regions where we have no physical presence. We sell our products and services to commercial end-users through a wholesale distribution network, encompassing more than 70 service providers, more than 185 value-added resellers, or VARs, and 55 value-added manufacturers, who either sell directly to the end-user or indirectly through other service providers, VARs or dealers. These distributors often integrate our products and services with other complementary hardware and software and have developed a broad suite of applications for our products and services targeting specific vertical markets. At June 30, 2014, we had approximately 705,000 billable subscribers worldwide, an increase of 9% from approximately 647,000 billable subscribers at June 30, 2013. We have a diverse customer base, with end users in the following lines of business: land-based handset; machine-to-machine, or M2M; maritime; aviation; and government. We recognize revenue from both the sale of equipment and the provision of services. We expect a higher proportion of our future revenue will be derived from service revenue than in the past. Revenues from providing voice and data service historically have generated higher gross margins than sales of subscriber equipment. We are currently devoting a substantial part of our resources to develop Iridium NEXT, our next-generation satellite constellation, and on hardware and software upgrades to our ground infrastructure in preparation for Iridium NEXT, the development of new product and service offerings, upgrades to our current services, and upgrades to our information technology systems. We estimate the aggregate costs associated with the design, build and launch of Iridium NEXT and related infrastructure upgrades through 2017 to be approximately $3 billion. Our funding plan for these costs includes the substantial majority of the funds available under our $1.8 billion loan facility, or the Credit Facility, together with cash and marketable securities on hand, and internally generated cash flows, including potential cash flows from hosted payloads and Iridium PRIMESM. The remaining portion of the Credit Facility not used to develop Iridium NEXT is utilized for capitalized interest and COFACE insurance premiums paid to COFACE, the French export credit agency that insures the Credit Facility. As discussed below in "Liquidity and Capital Resources," we were in compliance with all our financial covenants as of June 30, 2014 and believe that our liquidity sources will provide sufficient funds for us to meet our liquidity requirements for at least the next twelve months. As of July 31, 2014, we had borrowed a total of $1,089.5 million under the Credit Facility. For more information about our sources of funding, refer to "Liquidity and Capital Resources" below. 16 Recent Developments Amendment and Restatement of the Credit Facility In May 2014, we entered into a supplemental agreement, or the Supplemental Agreement, with the Lenders under the Credit Facility, to amend and restate the Credit Facility. The Supplemental Agreement includes revised financial covenant levels. The Supplemental Agreement also delays, until 2017, a portion of the contributions that we had been scheduled to make during 2014, 2015 and 2016 to the debt service reserve account that we are required to maintain under the Credit Facility. The Credit Facility delays $22 million of our 2014 contributions, $22 million of our 2015 contributions and $32 million of our expected 2016 contributions, for a total of $76 million. As of March 31, 2014, prior to the execution of the Supplemental Agreement, the minimum required cash reserve balance was $94.5 million. As of June 30, 2014, after the execution of the Supplemental Agreement, the minimum required cash reserve balance was reduced to $83.5 million. As a result of this reduction, $11.0 million was released from restricted cash during the three months ended June 30, 2014. The Supplemental Agreement required us to raise at least $217.5 million through the sale of equity securities by July 31, 2014, with net proceeds of at least $200.0 million, in order for the amendment to become effective. The supplemental agreement allowed us to raise up to $150.0 million of the total in convertible preferred equity, with the remainder to be raised through sales of our common equity. There were no other conditions to the effectiveness of the Supplemental Agreement. The condition was satisfied on May 14, 2014 upon the closing of the sale of our common stock and Series B Cumulative Perpetual Convertible Preferred Stock, or Series B Preferred Stock. Common Stock - Offerings In May 2014, we issued 7,692,308 shares of our common stock in a registered direct public offering to certain investment funds affiliated with Baron Capital Group Inc., or Baron, at a price of $6.50 per share for aggregate gross proceeds of $50.0 million. We received proceeds of $49.9 million from the sale of the common stock to Baron, net of offering costs of $0.1 million. The settlement date of the offering was May 5, 2014. Under the stock purchase agreement entered into with Baron, Baron was entitled to receive additional shares if, during the 90-day period following the date of the stock purchase agreement, we issued or sold securities below specified prices. As a result of our public offering of common stock and our public offering of Series B Preferred Stock, described below, we are obligated to deliver 504,413 additional shares of common stock to Baron. The shares will be issued on or about August 6, 2014. Additionally, on May 14, 2014, we issued 8,483,608 shares of our common stock in an underwritten public offering, including 1,106,558 shares of common stock upon the underwriters' election to exercise their overallotment option in full. The sale price to the underwriter, equal to $6.10 per share, reflected an aggregate underwriting discount of $2.6 million. We received proceeds of $49.0 million, which were net of the $2.6 million underwriting discount and $0.2 million of offering costs. Series B Cumulative Convertible Perpetual Preferred Stock Offering In May 2014, we issued 500,000 shares of our 6.75% Series B Preferred Stock in an underwritten public offering at a price to the public of $250 per share. The purchase price that we received, equal to $242.50 per share, reflected an underwriting discount of $7.50 per share. We received proceeds of $120.8 million from the sale of the Series B Preferred Stock which were net of the $3.8 million underwriter discount and $0.4 million of offering costs. Holders of Series B Preferred Stock are entitled to receive cumulative cash dividends when, as and if declared from, and including, the date of original issue at a rate of 6.75% per annum of the $250 liquidation preference per share (equivalent to an annual rate of $16.875 per share). Dividends on our Series B Preferred Stock will be payable quarterly in arrears, beginning on September 15, 2014. The Series B Preferred Stock does not have a stated maturity date and is not subject to any sinking fund or mandatory redemption provisions. The Series B Preferred Stock ranks senior to our common stock and pari passu with respect to our Series A Preferred Stock with respect to dividend rights and rights upon our voluntary or involuntary liquidation, dissolution or winding-up. Holders of Series B Preferred Stock generally have no voting rights except for limited voting rights if we fail to pay dividends for six or more quarterly periods (whether or not consecutive) and in other specified circumstances. Holders of Series B Preferred Stock may convert some or all of their outstanding Series B Preferred Stock initially at a conversion rate of 33.456 shares of common stock per $250 liquidation preference, which is equivalent to an initial conversion price of approximately $7.47 per share of common stock, subject to adjustment in certain events. Except as otherwise provided, the Series B Preferred Stock will be convertible only into shares of our common stock. 17 On or after May 15, 2019, we may, at our option, convert some or all of the Series B Preferred Stock into the number of shares of common stock that are issuable at the then-applicable conversion rate, subject to specified conditions. On or prior to May 15, 2019, in the event of certain specified fundamental changes, holders of the Series B Preferred Stock will have the right to convert some or all of their shares of Series B Preferred Stock into the greater of (i) a number of shares of our common stock as subject to adjustment plus the make-whole premium, if any, and (ii) a number of shares of our common stock equal to the lesser of (a) the liquidation preference divided by the market value of the our common stock on the effective date of such fundamental change and (b) 81.9672 (subject to adjustment). In certain circumstances, we may elect to cash settle any conversions in connection with a fundamental change. We intend to use the proceeds from the common stock and Series B Preferred Stock offerings for general corporate purposes, which may include capital expenditures, including development and deployment of the Iridium NEXT system, working capital and general and administrative expenses. Material Trends and Uncertainties Our industry and customer base has historically grown as a result of: • demand for remote and reliable mobile communications services; • increased demand for communications services by disaster and relief agencies, and emergency first responders; • a broad wholesale distribution network with access to diverse and geographically dispersed niche markets; • a growing number of new products and services and related applications; • improved data transmission speeds for mobile satellite service offerings; • regulatory mandates requiring the use of mobile satellite services; • a general reduction in prices of mobile satellite services and subscriber equipment; and • geographic market expansion through the ability to offer our services in additional countries. Nonetheless, we face a number of challenges and uncertainties in operating our business, including: • our ability to develop Iridium NEXT and related ground infrastructure, and to develop new and innovative products and services for Iridium NEXT; • our ability to access the Credit Facility to meet our future capital requirements for the design, build and launch of the Iridium NEXT satellites; • our ability to generate sufficient internal cash flows, including potential cash flows from hosted payloads and Iridium PRIME, to fund a portion of the costs associated with Iridium NEXT and support ongoing business; • Aireon LLC's ability to successfully develop and market its space-based automatic dependent surveillance-broadcast, or ADS-B, global aviation monitoring service to be carried as a hosted payload on the Iridium NEXT system; • Aireon's ability to raise sufficient funds to pay hosting fees to us; • our ability to maintain the health, capacity, control and level of service of our existing satellite network through the transition to Iridium NEXT; • changes in general economic, business and industry conditions; • our reliance on a single primary commercial gateway and a primary satellite network operations center; • competition from other mobile satellite service providers and, to a lesser extent, from the expansion of terrestrial-based cellular phone systems and related pricing pressures; • market acceptance of our products; • regulatory requirements in existing and new geographic markets; • rapid and significant technological changes in the telecommunications industry; • reliance on our wholesale distribution network to market and sell our products, services and applications effectively; • reliance on single-source suppliers for some of the components required in the manufacture of our end-user subscriber equipment and our ability to purchase parts that are periodically subject to shortages resulting from surges in demand, natural disasters or other events; and 18 • reliance on a few significant customers for a substantial portion of our revenue, as a result of which the loss or decline in business with any of these customers may negatively impact our revenue and collectability of related accounts receivable. Comparison of Our Results of Operations for the Three Months Ended June 30, 2014 and 2013 Three Months Ended June 30, % of Total % of Total Change ($ in thousands) 2014 Revenue 2013 Revenue Dollars Percent Revenue: Services $ 76,217 74 % $ 71,401 75 % $ 4,816 7 % Subscriber equipment 20,333 20 % 19,815 21 % 518 3 % Engineering and support services 5,971 6 % 3,468 4 % 2,503 72 % Total revenue 102,521 100 % 94,684 100 % 7,837 8 % Operating expenses: Cost of services (exclusive of depreciation and amortization) 16,730 16 % 14,206 15 % 2,524 18 % Cost of subscriber equipment 13,268 13 % 12,893 14 % 375 3 % Research and development 4,645 5 % 1,741 2 % 2,904 167 % Selling, general and administrative 18,493 18 % 18,399 19 % 94 1 % Depreciation and amortization 19,672 19 % 18,597 20 % 1,075 6 % Total operating expenses 72,808 71 % 65,836 70 % 6,972 11 % Operating income 29,713 29 % 28,848 30 % 865 3 % Other income (expense): Interest income, net 725 1 % 641 1 % 84 13 % Undrawn credit facility fees (1,460 ) (1 )% (2,020 ) (2 )% 560 (28 )% Other expense, net (3,789 ) (4 )% (869 ) (1 )% (2,920 ) 336 % Total other expense (4,524 ) (4 )% (2,248 ) (2 )% (2,276 ) 101 % Income before income taxes 25,189 25 % 26,600 28 % (1,411 ) (5 )% Provision for income taxes (10,170 ) (10 )% (11,187 ) (12 )% 1,017 (9 )% Net income $ 15,019 15 % $ 15,413 16 % $ (394 ) (3 )% 19 Revenue Total revenue increased 8% to $102.5 million for the three months ended June 30, 2014 compared to $94.7 million for the three months ended June 30, 2013. This increase in revenue was primarily due to an increase in service revenue, driven by a 9% year-over-year increase in commercial billable subscribers and an increase in prepaid revenue resulting from the change in our prepaid airtime policy. Also contributing to the increase in total revenue was an increase in government-sponsored engineering and support service contracts and an increase in government service revenue. Commercial Service Revenue Three Months Ended June 30, 2014 June 30, 2013 Change (Revenue in millions and subscribers in thousands) Billable Billable Billable Revenue Subscribers (1) ARPU (2) Revenue Subscribers (1) ARPU (2) Revenue Subscribers ARPU Commercial voice and data $ 45.7 352 $ 44 $ 44.7 343 $ 44 $ 1.0 9 $ - Commercial M2M data 14.5 298 17 12.3 253 17 2.2 45 - Total Commercial $ 60.2 650 $ 57.0 596 $ 3.2 54 (1) Billable subscriber numbers shown are at the end of the respective period. (2) Average monthly revenue per unit, or ARPU, is calculated by dividing revenue in the respective period by the average of the number of billable subscribers at the beginning of the period and the number of billable subscribers at the end of the period and then dividing the result by the number of months in the period. Commercial voice and data revenue increased due to a higher number of subscribers and the change in our prepaid airtime policy, which became effective at the end of 2013. Commercial M2M data revenue growth was driven principally by an 18% increase in billable subscribers. We anticipate continued growth in billable commercial subscribers for the remainder of 2014. Government Service Revenue Three Months Ended June 30, 2014 June 30, 2013 Change (Revenue in millions and subscribers in thousands) Billable Billable Billable Revenue Subscribers (1) Revenue Subscribers (1) Revenue Subscribers Government service revenue $ 16.0 55 $ 14.4 51 $ 1.6 4 (1) Billable subscriber numbers shown are at the end of the respective period. We provide Iridium airtime and airtime support to U.S. government and other authorized customers pursuant to a five-year Enhanced Mobile Satellite Services, or EMSS, contract managed by the Defense Information Systems Agency which we executed in October 2013. The EMSS contract replaced our previous EMSS contract which we originally entered into in April 2008. Under the terms of this new agreement, authorized customers utilize Iridium airtime services, provided through the U.S. Department of Defense's, or DoD's, dedicated gateway. These services include unlimited global secure and unsecure voice, low and high-speed data, paging, and Distributed Tactical Communications System, or DTCS, services for an unlimited number of DoD and other federal subscribers. DTCS is a service that provides beyond-line-of-sight, push-to-talk tactical radio service for user-defined groups. The fixed-price rates in each of the five contract years, which run from October 22 through the following October 21, are $64 million and $72 million in years one and two, respectively, and $88 million in each ofthe years three through five. Government service revenues for the three months ended June 30, 2014 increased to $16.0 million from $14.4 million in the prior year period as a result of the new EMSS contract. Under this contract, revenue is a fixed monthly amount and is no longer based on subscribers or usage, allowing an unlimited number of users access to existing services. As we continue to innovate and better meet the needs of our customers, additional services not contemplated under the new EMSS contract may be provided in future periods at an amount mutually agreed upon by both parties. We anticipate government service revenue for the full year 2014 will exceed full year 2013 government service revenue. 20 Subscriber Equipment Revenue Subscriber equipment revenue increased 3%, or $0.5 million, for the three months ended June 30, 2014 compared to the prior year period. This increase was primarily due to higher unit sales of L-Band transceivers and M2M devices, somewhat offset by targeted lower pricing on these products designed to achieve the higher volumes we experienced. We anticipate subscriber equipment revenue for the full year 2014 to exceed full year 2013 due to higher overall unit sales. Engineering and Support Service Revenue Three Months Ended June 30, 2014 June 30, 2013 Change (In millions) Government $ 5.5 $ 2.8 $ 2.7 Commercial 0.5 0.7 (0.2 ) Total $ 6.0 $ 3.5 $ 2.5 Engineering and support service revenue increased by $2.5 million for the three months ended June 30, 2014 compared to the prior year period due to the execution of government-sponsored contracts during the second half of 2013 related to the DoD's gateway modernization efforts as we transition to Iridium NEXT capabilities. We anticipate an increase in the scope of work for government contracts in 2014 resulting in overall growth in engineering and support service revenue compared to 2013. Operating Expenses Cost of Services (exclusive of depreciation and amortization) Cost of services (exclusive of depreciation and amortization) includes the cost of network engineering and operations staff, including contractors, software maintenance, product support services and cost of services for government and commercial engineering and support service revenue. Cost of services (exclusive of depreciation and amortization) increased $2.5 million, or 18%, for the three months ended June 30, 2014 from the prior year period primarily due to an increase in scope of work for government-sponsored contracts and related costs. Cost of Subscriber Equipment Cost of subscriber equipment includes the direct costs of equipment sold, which consist of manufacturing costs, allocation of overhead, and warranty costs. Cost of subscriber equipment increased by $0.4 million, or 3%, for the three months ended June 30, 2014 compared to the prior year period. This increase was primarily due to the increase in unit sales as described above. In addition, the cost per unit for the Iridium Pilot® terminals increased over the comparative period as we implemented product quality improvements. Partially offsetting these increases was a $1.9 million decline in the warranty provision for our Iridium Pilot terminals compared to the prior year period. Research and Development Research and development expenses increased by $2.9 million, or 167%, for the three months ended June 30, 2014 compared to the prior year period due to Iridium NEXT projects including development costs associated with enabling faster data speeds on our terminal equipment. Depreciation and Amortization Depreciation and amortization expense increased by $1.1 million, or 6%, for the three months ended June 30, 2014 compared to the prior year period due to additions to property and equipment for ground infrastructure compatible with Iridium NEXT. 21 Other Income (Expense) Undrawn Credit Facility Fees Commitment fees on the undrawn portion of the Credit Facility were $1.5 million for the three months ended June 30, 2014 compared to $2.0 million for the prior year period. The decrease of the commitment fee is directly proportional to the increase in the amounts borrowed under the Credit Facility as we continue to finance the development of Iridium NEXT. Other Expense, Net Other expense, net, was $3.8 million for the three months ended June 30, 2014 compared to $0.9 million for the prior year period. This change primarily resulted from our share of the loss from our investment in Aireon LLC. Aireon is accounted for as an equity method investment within our financial statements, and our investment is included within other assets on our accompanying condensed consolidated balance sheet. As of June 30, 2014, due to our cumulative recognition of our share of Aireon's reported losses, our investment balance in Aireon was zero. To the extent that Aireon continues to incur losses, we will suspend recognition of these losses on our condensed consolidated statement of operations until such time that future Aireon income exceeds cumulative accrued preferred dividends and accumulated suspended losses. Provision for Income Taxes For the three months ended June 30, 2014, our income tax provision was $10.2 million compared to $11.2 million for the prior year period. The decrease in the income tax provision and rate is primarily a result of lower tax expense in the current period compared to the previous period for valuation allowance on certain state net operating losses. The valuation allowance serves to appropriately reflect the realizability of the state net operating loss carryforward deferred tax asset. As our current estimates change in future periods, the impact on the deferred tax assets and liabilities may change correspondingly. Net Income Net income was $15.0 million for the three months ended June 30, 2014, a decrease of $0.4 million from the prior year period. This decrease in net income was driven by a $2.9 million increase in research and development costs primarily for Iridium NEXT projects, a $2.9 million increase in other expenses related to our share of the loss from our investment in Aireon, and a $1.1 million increase in depreciation expense due to additions to property and equipment for ground infrastructure compatible with Iridium NEXT. These decreases to net income were partially offset by a $4.8 million increase in service revenue due to increased commercial billable subscribers and the favorable impact of the new EMSS contract, and a $1.1 million decrease in our provision for income taxes due to the estimated realizability of our state net operating loss carryforwards. 22 Comparison of Our Results of Operations for the Six Months Ended June 30, 2014 and 2013 Six Months Ended June 30, % of Total % of Total Change ($ in thousands) 2014 Revenue 2013 Revenue Dollars Percent Revenue: Services $ 149,647 75 % $ 140,188 76 % $ 9,459 7 % Subscriber equipment 40,490 20 % 37,146 20 % 3,344 9 % Engineering and support services 10,416 5 % 6,539 4 % 3,877 59 % Total revenue 200,553 100 % 183,873 100 % 16,680 9 % Operating expenses: Cost of services (exclusive of depreciation and amortization) 30,933 15 % 28,682 16 % 2,251 8 % Cost of subscriber equipment 27,180 14 % 24,013 13 % 3,167 13 % Research and development 6,766 3 % 3,400 2 % 3,366 99 % Selling, general and administrative 37,679 19 % 36,764 20 % 915 2 % Depreciation and amortization 39,938 20 % 36,828 20 % 3,110 8 %Total operating expenses 142,496 71 % 129,687 71 % 12,809 10 % Operating income 58,057 29 % 54,186 29 % 3,871 7 % Other income (expense): Interest income, net 1,362 1 % 1,278 1 % 84 7 % Undrawn credit facility fees (2,959 ) (2 )% (4,116 ) (2 )% 1,157 (28 )% Other expense, net (4,139 ) (2 )% (2,265 ) (1 )% (1,874 ) 83 % Total other expense (5,736 ) (3 )% (5,103 ) (2 )% (633 ) 12 % Income before income taxes 52,321 26 % 49,083 27 % 3,238 7 % Provision for income taxes (20,759 ) (10 )% (18,736 ) (10 )% (2,023 ) 11 % Net income $ 31,562 16 % $ 30,347 17 % $ 1,215 4 % Revenue Total revenue increased 9% to $200.6 million for the six months ended June 30, 2014 compared to $183.9 million for the six months ended June 30, 2013. This increase in revenue was primarily due to an increase in service revenue, driven by a 9% year-over-year increase in commercial billable subscribers and an increase in government service revenue. Also contributing to the increase in total revenue was an increase in subscriber equipment sales due to increased unit sales and an increase in government-sponsored engineering and support contracts. 23 Commercial Service Revenue Six Months Ended June 30, 2014 June 30, 2013 Change (Revenue in millions and subscribers in thousands) Billable Billable Billable Revenue Subscribers (1) ARPU (2) Revenue Subscribers (1) ARPU (2) Revenue Subscribers ARPU Commercial voice and data $ 89.6 352 $ 43 $ 87.1 343 $ 43 $ 2.5 9 $ - Commercial M2M data 28.0 298 16 23.6 253 16 4.4 45 - Total Commercial $ 117.6 650 $ 110.7 596 $ 6.9 54 (1) Billable subscriber numbers shown are at the end of the respective period. (2) Average monthly revenue per unit, or ARPU, is calculated by dividing revenue in the respective period by the average of the number of billable subscribers at the beginning of the period and the number of billable subscribers at the end of the period and then dividing the result by the number of months in the period. Commercial voice and data revenue increased due to a higher number of subscribers and the change in our prepaid airtime policy, which became effective at the end of 2013. Commercial M2M data revenue growth was driven principally by an 18% increase in billable subscribers. Government Service Revenue Six Months Ended June 30, 2014 June 30, 2013 Change (Revenue in millions and subscribers in thousands) Billable Billable Billable Revenue Subscribers (1) Revenue Subscribers (1) Revenue Subscribers Government service revenue $ 32.0 55 $ 29.5 51 $ 2.5 4 (1) Billable subscriber numbers shown are at the end of the respective period. Government service revenues for the six months ended June 30, 2014 increased to $32.0 million from $29.5 million in the prior year period as a result of the execution of the new EMSS contract. Under this contract, revenue is a fixed monthly amount and is no longer based on subscribers or usage, allowing an unlimited number of users access to existing services. Subscriber Equipment Revenue Subscriber equipment revenue increased 9%, or $3.3 million, for the six months ended June 30, 2014 compared to the prior year period. This increase was primarily due to higher unit sales of L-Band transceivers and M2M devices, somewhat offset by targeted lower pricing on these products designed to achieve the higher volumes we experienced. Engineering and Support Service Revenue Six Months Ended June 30, 2014 June 30, 2013 Change (In millions) Government $ 9.4 $ 5.3 $ 4.1 Commercial 1.0 1.2 (0.2 ) Total $ 10.4 $ 6.5 $ 3.9 Engineering and support service revenue increased by $3.9 million for the six months ended June 30, 2014 compared to the prior year period due to the execution of government-sponsored contracts during the second half of 2013 related to the DoD's gateway modernization efforts as we transition to Iridium NEXT capabilities. 24 Operating Expenses Cost of Services (exclusive of depreciation and amortization) Cost of services (exclusive of depreciation and amortization) increased $2.3 million, or 8%, for the six months ended June 30, 2014 from the prior year period primarily due to an increase in scope of work for government-sponsored contracts and related costs. Cost of Subscriber Equipment Cost of subscriber equipment increased by $3.2 million, or 13%, for the six months ended June 30, 2014 compared to the prior year period. This increase was primarily due to the increase in unit sales as described above. In addition, the cost per unit for the Iridium Pilot® terminals increased over the comparative period as we implemented product quality improvements. Partially offsetting these increases was a $1.9 million decline in the warranty provision for our Iridium Pilot terminals compared to the prior year period. Research and Development Research and development expenses increased by $3.4 million, or 99%, for the six months ended June 30, 2014 compared to the prior year period due to Iridium NEXT projects including development costs associated with enabling faster data speeds on our terminal equipment. Depreciation and Amortization Depreciation and amortization expense increased by $3.1 million, or 8%, for the six months ended June 30, 2014 compared to the prior year period primarily due to additions to property and equipment for ground infrastructure compatiblewith Iridium NEXT. Other Income (Expense) Undrawn Credit Facility Fees Commitment fees on the undrawn portion of the Credit Facility were $3.0 million for the six months ended June 30, 2014 compared to $4.1 million for the prior year period. The decrease of the commitment fee is directly proportional to the increase in the amounts borrowed under the Credit Facility as we continue to finance the development of Iridium NEXT. Other Expense, Net Other expense, net, was $4.1 million for the six months ended June 30, 2014 compared to $2.3 million for the prior year period. This change primarily resulted from our share of the loss from our equity method investment in Aireon. Provision for Income Taxes For the six months ended June 30, 2014, our income tax provision was $20.8 million compared to $18.7 million for the prior year period. The increase in the rate and income tax provision is primarily related to the increase in our income before income taxes partially offset by lower tax expense in the current period compared to the prior year period for valuation allowance on certain state net operating losses. The valuation allowance serves to appropriately reflect the realizability of the state net operating loss carryforward deferred tax asset. As our current estimates change in future periods, the impact on the deferred tax assets and liabilities may change correspondingly. Net Income Net income was $31.6 million for the six months ended June 30, 2014, an increase of $1.2 million from the prior year period. This increase in net income was driven by a $9.5 million increase in service revenue due to increased commercial billable subscribers and the favorable impact of the new EMSS contract, a $3.9 million increase in engineering and support services revenue due to the execution of new government-sponsored contracts, and a $1.2 million decrease commitment fees on the undrawn portion of the Credit Facility. These increases to net income were partially offset by a $3.4 million increase in research and development costs primarily for Iridium NEXT projects, a $2.3 million increase in costs of services related to the increase in scope of work for government-sponsored contracts, a $3.1 million increase in depreciation expense due to additions to property and equipment for ground infrastructure compatible with Iridium NEXT, a $1.9 million increase in other expenses primarily related to our share of the loss from our investment in Aireon, and a $2.0 million increase in our provision for income taxes. 25 Liquidity and Capital Resources As of June 30, 2014, our total cash and cash equivalents balance was $336.3 million, and our marketable securities balance was $164.2 million. Our principal sources of liquidity are cash, cash equivalents and marketable securities, internally generated cash flows, and the Credit Facility. Our principal liquidity requirements are to meet capital expenditure needs, principally the design, build and launch of Iridium NEXT, as well as for working capital, research and development expenses, and dividends payable on our Series A Preferred Stock and Series B Preferred Stock. We estimate the aggregate costs associated with the design, build and launch of Iridium NEXT and related infrastructure upgrades through 2017 to be approximately $3 billion. Our funding plan for these costs includes the substantial majority of the funds available under our Credit Facility, together with cash and marketable securities on hand, and internally generated cash flows, including potential cash flows from hosted payloads and Iridium PRIME. We currently use the Credit Facility to pay 85% of each invoice we receive from Thales Alenia Space France, or Thales, under their contract for the development and construction of our Iridium NEXT satellites, with the remaining 15% funded from cash, cash equivalents and marketable securities on hand. We also utilize the Credit Facility to fund a portion of the interest under the Credit Facility and COFACE insurance premiums. Once the Credit Facility is fully drawn, we expect to pay 100% of each invoice we receive from Thales and all interest on the Credit Facility from cash and marketable securities on hand, and internally generated cash flows, including potential cash flows from hosted payloads and Iridium PRIME. We believe that our liquidity sources will provide sufficient funds for us to meet our liquidity requirements for at least the next 12 months. The Credit Facility contains borrowing restrictions, including financial performance covenants and covenants relating to hosted payloads, and there can be no assurance that we will be able to continue to borrow funds under the Credit Facility. There can also be no assurance that our internally generated cash flows, including those from hosted payloads on our Iridium NEXT satellites, will meet our current expectations. If we do not generate sufficient cash flows, or if the cost of implementing Iridium NEXT or the other elements of our business plan are higher than anticipated, we may need further external funding. Our ability to obtain additional funding may be adversely affected by a number of factors, including global economic conditions, and we cannot assure you that we will be able to obtain such funding on reasonable terms or at all. If we are not able to secure such funding in a timely manner, our ability to maintain our network, to design, build and launch Iridium NEXT and related ground infrastructure, products and services, and to pursue additional growth opportunities will be impaired, and we would likely need to delay some elements of our Iridium NEXT development. Our liquidity and our ability to fund our liquidity requirements are also dependent on our future financial performance, which is subject to general economic, financial, regulatory and other factors that are beyond our control. Holders of Series A Preferred Stock are entitled to receive cumulative cash dividends at an annual rate of $7.00 per share. Dividends are payable quarterly in arrears on each March 15, June 15, September 15 and December 15. For each full quarter that the Series A Preferred Stock is outstanding, and assuming that no shares of Series A Preferred Stock have been converted into shares of our common stock, we would be required to pay cash dividends of $1.75 million. We expect that we will satisfy dividend requirements, if and when declared, from internally generated cash flows. Holders of Series B Preferred Stock are entitled to receive cumulative cash dividends at an annual rate of $16.875 per share. Dividends are payable quarterly in arrears on each March 15, June 15, September 15 and December 15, beginning September 15, 2014. For each full quarter that the Series B Preferred Stock is outstanding, and assuming that no shares of Series B Preferred Stock have been converted into shares of our common stock, we would be required to pay cash dividends of $2.1 million. We expect that we will satisfy dividend requirements, if and when declared, from internally generated cash flows. As of June 30, 2014, we had borrowed a total of $1,084.4 million under the Credit Facility. The unused portion of the Credit Facility as of June 30, 2014 was $715.6 million. Under the terms of the Credit Facility, a minimum cash reserve for debt service of $83.5 million as of June 30, 2014 was maintained and classified as restricted cash on the accompanying condensed consolidated balance sheet. This minimum cash reserve requirement will increase over the term of the Credit Facility to $189.0 million in 2017. For more information about our cash reserves, see "Recent Developments-Amendment and Restatement of the Credit Facility" above. In addition to the minimum debt service levels, financial covenants under the Credit Facility, as amended and restated in May 2014, include: · an available cash balance of at least $25 million; · a debt-to-equity ratio, which is calculated as the ratio of total net debt to the aggregate of total net debt and total stockholders' equity, of no more than 0.7 to 1, measured each June 30 and December 31; · specified maximum levels of annual capital expenditures (excluding expenditures on the construction of Iridium NEXT satellites) through the year ending December 31, 2024; 26 · specified minimum levels of consolidated operational earnings before interest, taxes, depreciation and amortization, or operational EBITDA, for the 12-month periods ending each December 31 and June 30 through December 31, 2017; · specified minimum cash flow requirements from customers who have hosted payloads on our satellites during the 12-month periods ending each December 31 and June 30, beginning June 30, 2016 and ending on December 31, 2017; · a debt service coverage ratio, measured during the repayment period, of not less than 1 to 1.5; and · specified maximum leverage levels during the repayment period that decline from a ratio of 4.73 to 1 for the twelve months ending June 30, 2018 to a ratio of 2.36 to 1 for the twelve months ending December 31, 2024. Our available cash balance, as defined by the Credit Facility, was $386.1 million as of June 30, 2014. Our debt-to-equity ratio was 0.39 to 1 as of June 30, 2014. We were in compliance with the operational EBITDA covenant set forth above as of June 30, 2014. We were also in compliance with the annual capital expenditure covenants set forth above as of December 31, 2013, the last point at which they were measured. The covenants regarding capital expenditures, operational EBITDA and hosted payload cash flows are calculated in connection with a measurement, which we refer to as available cure amount, that is derived using a complex calculation based on overall cash flows, as adjusted by numerous measures specified in the Credit Facility. In a period in which our capital expenditures exceed, or our operational EBITDA or hosted payload cash flows falls short of, the amount specified in the respective covenant, we would be permitted to allocate available cure amount, if any, to prevent a breach of the applicable covenant. As of June 30, 2014, we had no available cure amount, though none was required to maintain compliance with the covenants. We note that available cure amount, due to the complexity of its calculation, has fluctuated significantly from one measurement period to the next, and we expect that it will continue to do so. The covenants also place limitations on our ability and that of our subsidiaries to carry out mergers and acquisitions, dispose of assets, grant security interests, declare, make or pay dividends, enter into transactions with affiliates, fund payments under the full scale development contract, or FSD, with Thales Alenia Space France from our own resources, incur additional indebtedness, or make loans, guarantees or indemnities. If we are not in compliance with the financial covenants under the Credit Facility, after any opportunity to cure such non-compliance, or we otherwise experience an event of default under the Credit Facility, the lenders may require repayment in full of all principal and interest outstanding under the Credit Facility. It is unlikely we would have adequate funds to repay such amounts prior to the scheduled maturity of the Credit Facility. If we fail to repay such amounts, the lenders may foreclose on the assets we have pledged under the Credit Facility, which include substantially all of our assets and those of our domestic subsidiaries. Cash Flows The following table summarizes our cash flows: Six Months Ended June 30, 2014 2013 Change (in thousands) Cash provided by operating activities $ 91,197 $ 100,262 $ (9,065 ) Cash used in investing activities $ (195,806 ) $ (236,088 ) $ 40,282 Cash provided by financing activities $ 254,595 $ 78,256 $ 176,339 Cash Flows from Operating Activities Net cash provided by operating activities for the six months ended June 30, 2014 decreased by $9.1 million from the prior year period. This decrease was principally due to the timing of cash collections for customer-related receivables, primarily driven by our increase in equipment sales. Cash Flows from Investing Activities Net cash used in investing activities for the six months ended June 30, 2014 decreased by $40.3 million compared to the prior year period primarily due to a $43.6 million decrease in capital expenditures primarily related to IridiumNEXT. 27 Cash Flows from Financing Activities Net cash provided by financing activities for the six months ended June 30, 2014 increased by $176.3 million from the prior year period primarily due to receipt of net proceeds of $219.7 million from the sale of our common stock and Series B Preferred Stock during the second quarter of 2014. This increase was partially offset by a $56.5 million decrease in borrowings under the Credit Facility.Off-Balance Sheet Arrangements We do not currently have any off-balance sheet arrangements, as such term is defined in Item 303(a)(4)(ii) of the SEC's Regulation S-K, that have or are reasonably likely to have a material current or future effect on our financial condition, results of operations, liquidity or capital resources. Seasonality Our results of operations have been subject to seasonal usage changes for commercial customers, and we expect that our results will be affected by similar seasonality effects in the future. March through October are typically the peak months for commercial voice services revenue and related subscriber equipment sales. Commercial M2M revenue has been less subject to seasonal usage changes, and revenue from our new fixed-price U.S. government contract will not be subject to seasonal fluctuations. Recent Accounting Developments On May 28, 2014, the Financial Accounting Standards Board and the International Accounting Standards Board jointly issued a comprehensive new revenue recognition standard, Accounting Standards Update No. 2014-09 Revenue from Contracts with Customers or ASU 2014-09, that will supersede nearly all existing revenue recognition guidance under U.S. GAAP. ASU 2014-09 requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for public entities for annual and interim periods beginning after December 15, 2016. Early adoption is not permitted. ASU 2014-09 becomes effective for us in the first quarter of fiscal 2017. We have not yet selected a transition method, and we are currently evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. |