Things were as expected Wednesday, which is to say rather lackluster, as GeoEye, Inc. (NASDAQ: GEOY), a provider of space-based and aerial imagery and geospatial information, reported its fiscal 3rd quarter 2008 earnings on Tuesday, and updated the status of GeoEye-1.
While I wrote previously that I did not expect the Q3 earnings to be anything special (they weren’t), GeoEye did update the status of GeoEye-1 on the call, and why it has taken longer than expected for the full checkout and imagery certification so that GeoEye can begin selling imagery to its customers.
What follows is a summary of GeoEye’s earnings announcement and conference call, and what you need to know if you own, or are thinking of owning the stock.
New to the GeoEye story?
GeoEye provides space-based, and aerial imagery and geospatial information through high-resolution and low-resolution imagery, imagery-derived products, and image processing services to customers worldwide.
This capability benefits a broad array of industries including national defense and intelligence, online mapping, state and local governments, environmental monitoring and land use management, oil and gas, utilities, disaster management, insurance and others.
- Read my initial buy recommendation here.
- or listen to my EXCLUSIVE interview with GeoEye’s management team here.
I’ll break down this report into 4 parts:
- Hit Me With The Numbers: Sales, Earnings: All Down, I’ll Explain
- Other Business Highlights: Solid cash reserves, honing in on Service Level Agreement (NYSE:SLA) with NGA
- Conference Call Highlights: GeoEye-1 close to being fully certified and operational
- Bottom Line: GeoEye is Still a Go
Hit Me With Some Numbers
Sales, Profit Down as Expected
Here are some of GeoEye’s earnings highlights (growth from previous year’s Q3/analyst’s estimates where applicable):
- Quarterly sales of $35.9 million (down 33%, from $53.8 million in the prior year/vs. $34.87 million projected by analysts)
- Quarterly operating income of $8.3 million (down 65%, from $23.8 million in the prior year)
- Quarterly net income of $6.0 million, or $0.27 per diluted share (down 79.3%, from $22.0 million, or $1.21 per diluted share in prior year/vs. $.12 per share projected by analysts)
- Gross margin of 49.9% (down from 64.4% from prior year, but up from 43.5% in Q2/2008)
- Operating margin of 23.1% (down from 47.9% from prior year, but up from 15.4% in Q2/2008)
- Net margin of 16.8% (down from 40.9% from prior year, but up from 7.0% in Q2/2008)
My Take: GeoEye’s quarterly sales actually weren’t that bad, especially when put into context and losing orders from the National Geospatial-Intelligence Agency (NGA) that were given to GeoEye’s only competitor, DigitalGlobe (NYSE: DGI), as a result of the delayed launch and checkout of GeoEye-1.
At any rate, GeoEye’s margins were higher as a result of a better mix of products, namely selling more imagery as opposed to their “Production and Other” segment which manipulates the imagery and has higher expenses associated with it.
Like I said before, I don’t really care about what GeoEye has done in the past, and in about 1 more month, we can look solidly to the future and into 2009, as GeoEye begins selling imagery from GeoEye-1, which I’ll have more details on below.
Other Business Highlights
Solid Cash Reserves for Construction of GeoEye-2
- GeoEye is currently finishing the calibration and checkout phase of GeoEye-1 and expects to start commercial operations with GeoEye-1 next month. (More below.)
- GeoEye is currently in negotiations with the National Geospatial-Intelligence Agency (NGA) regarding the establishment of a Service Level Agreement (SLA) that the they believe will streamline the order flow from NGA. The Company expects to sign this agreement shortly.
- GeoEye’s cash and short term investments balance was $149.9 million at Sept. 30, 2008, as compared to $234.3 million at Dec. 31, 2007.
- This balance, coupled with the remaining milestone payments from NGA of $11.6 million, provides more than sufficient cash to fund the amounts due to complete the GeoEye-1 program.
- As of September 30, 2008, GeoEye has expended approximately $471 million of the $502 million for the launch, build-out and insurance on GeoEye-1.
- The remaining $31 million represents final amounts to contractors not yet incurred, interest to be capitalized during the commissioning phase and contingencies.
- GeoEye does not provide forward guidance, which I like.
My Take: There was nothing shocking or untoward in GeoEye’s earnings release other than the fact that they again had to delay their 10-Q filing as a result of some accounting errors, which would not materially affect their revenue or profits.
They assured investors that they have taken steps to correct this problem (more below), and from now on, all accounting should be streamlined and free from further restatements and adjustments.
I’ll talk more about it in a minute, but GeoEye ended the quarter with a nice cash hoard, which they will be using to start the construction and build out of their NEXT satellite, GeoEye-2.
Yep, you always have to be looking ahead since it takes 3-4 years to build out and launch one of these birds.
Finally, as I’ll also discuss below, GeoEye will be entering into a Service Level Agreement (SLA) with the NGA which will vastly improve their order flow and streamline their revenues and profits from quarter to quarter.
Conference Call Highlights
GeoEye-1 Ready to Go, SLA Being Negotiated
The following are the highlights from GeoEye’s analyst conference call:
- Update on GeoEye-1 Calibration Issues: The satellite is working well and they are delighted by the imagery. On October 8th they released the first GeoEye-1 image of the Kutztown University in Pennsylvania.
In answer to the obvious question why Kutztown, the CEO stated that it really was GeoEye’s first image, and that they literally opened the camera door and that’s what they saw. Since then, they have released other equally stunning images, which are posted on GeoEye’s website.
Management stated later in the call that the calibration and checkout have taken somewhat longer than expected.
They further stated that they knew that a 45 day checkout period was aggressive, but now a little more than two months since launch, they are seeing the kind of success that they wanted to attain sooner.
Management stated that the hardware is performing flawlessly, but they have had several software issues almost exclusively related to the attitude control system that have been the major reason why checkout has taken longer than expected.
These internal issues were not readily discoverable in testing on the ground.
Further, management says that they have worked their way through each of these issues and they won’t have any impact on future GeoEye-1 operations or life expectancy.
Finally, GeoEye said that they are confident that they will be able to work through any remaining issues and start full commercial operations in December.
My Take: I knew something wasn’t quite right and that the calibration and checkout were taking much longer than expected.
Add this to the long list of delays that have plagued GeoEye-1’s launch from the start.
The good news is that GeoEye has been working hard on these issues, and better for us and them, none of them are irreparable to the point of rendering GeoEye-1 non-operational.
GeoEye is targeting delivery of their imagery in December, which is about 1 month later than I had projected, but should still lead to significant revenue and profit increases for the last month of 2008, and then explode in 2009.
This is all part of the risk of owning a stock like this. We are dealing with very sensitive pieces of equipment that are fragile and are going to be held to a very high and exacting standard. Any malfunction, slip-up, or nuance that throws that off will destroy our investment thesis.
- NGA Service Level Agreement (SLA): The CEO stated that as they said in their last call, they didn’t expect to solve the NGA order issues and obtain a service level agreement until after the launch of GeoEye-1 at the earliest, and checkout at the latest.
He further clarified that they are in the final stages of negotiating the SLA.
This agreement should even out the peaks and valleys of the NGA’s image ordering process so that GeoEye can get a predictable revenue stream and the government can get a predictable supply of imagery.
The CEO then stated that they where pleased to see what the Director of the NGA, Vice Admiral Robert Murrett said about GeoEye at a round-table in Washington.
He said: “the point that people need to not lose sight off is what a huge chunk of our mission capabilities is comprised by the commercial remote sensing industry, and how we have them programmed and embedded in our architecture in ways that are irreversible for many, many years of the future.”
My Take: This is good news for us going forward as it will essentially lock in the NGA for longer term orders with GeoEye and in turn smooth out their revenue fluctuations, and allow them to better plan their next satellite build out and launch with the steady stream of revenue and supposedly cash flow, that this deal will generate.
- On the postponement/cancellation of the BASIC program: The CEO commented that the Broad Area Space-Based Imagery Collection (BASIC) program has been put on hold by congress until some additional studies are done early next year.
He stated that no one knows what those studies will conclude.
The BASIC program would have directly competed with GeoEye in that the U.S. government would have launched 2 of their own satellites by 2012 to provide commercial-type imagery to the U.S. government.
The CEO further went on to say that GeoEye was proud to support the U.S. government’s collection system and that they believe they can satisfy even more of the government’s imagery and mapping requirements.
My Take: The CEO went on to say that if the government did decide to go ahead with the BASIC program, which you can read all about here, GeoEye would be a full supporter of the program.
It sounded like a little cover-your-butt speak, in that it seems that GeoEye is trying to stay on the government’s good side so as not to elicit the potential for the go-ahead of the BASIC program, and remain their good graces.
A smart move by all accounts I’m sure.
Like I wrote about before, this delay or possible deletion of the program, is good news for GeoEye, and might eventually lead to the abandonment of the BASIC program.
My guess is that part of the “studies” that the government will be doing in the next year or so to determine whether they want to proceed with the program, will depend partially, if not fully, on how well GeoEye and their only U.S. competitor DigitalGlobe (NYSE: DGI) can service the NGA’s imagery needs.
I’m sure the government will keep a close eye on how fast they receive promised imagery, if they had to wait longer than what is determined reasonable, and if GeoEye is putting other clients, namely Google (NASDAQ: GOOG), ahead of the government.
I don’t think that will happen since GeoEye knows where their bread is buttered, but we shall see.
- Deal with Google: The CEO reiterated that GeoEye-1’s imagery will be exclusive to Google for use on Google Earth and Google Maps.
He further stated that they are “delighted by the partnership”, and that in addition to Google paying for their GeoEye-1 inventory, GeoEye actually in turn paid Google to help them develop a program for searching imagery archives.
They are marketing that new search capability to several of their international clients, who are interested in it because it’s terrific way for them to search both GeoEye’s archives and their own.
My Take: One appealing aspect to this deal is that, although there won’t be material revenue from these deals in the overall financial picture, there will be a steady source of recurring revenue and a natural tendency for a higher profile which can lead to more deals with other companies.
The Google partnership already lead to the first request for GeoEye to supply imagery to other providers and acted as a bridge that introduced the possibilities of GeoEye’s imagery to a more diverse market.
- GeoEye’s recently announced deal with Telespazio: The CEO stated that with regards to GeoEye’s commercial regional affiliates, they’ve mentioned before that they plan to transition commercial affiliates away from buying minutes of direct access to the satellite, to buying square kilometers of imagery.
That plan achieved a major success last month with the execution of a multi-million dollar, multi-year agreement with Telespazio for the European and North African region.
Telespazio, a Finmeccanica/Thales company, will produce, market and sell Earth imagery and related products and services from GeoEye’s newest high-resolution satellite, GeoEye-1, to customers in Europe and North Africa.
Telespazio’s GeoEye-1 exclusive imagery sales rights begin as soon as GeoEye-1 becomes operational.
Beginning in 2009, Telespazio will also have access to the IKONOS satellite and collect, produce, market and sell Earth imagery and related products to customers in Europe and North Africa.
You can read more about this agreement here.
The CEO further commented that they were excited about Telespazio’s ability to provide value-added services from throughout Europe and that Telespazio has committed to a guaranteed annual minimum payment for the satellite imagery inventory that GeoEye-1 will provide.
Finally, the CEO stated that revenue from this deal should start to be realized during the first half of 2009 and will be one more element that makes GeoEye’s revenue more predictable over the long-term.
My Take: As we can see, GeoEye-1 has already begun to reap some powerful rewards for GeoEye. This will only continue as more and more providers, foreign governments, and other contractors look to GeoEye to supply them with the highest resolution commercial imagery available today.
- Status of GeoEye-2: The CEO updated the status of GeoEye’s next generation satellite that has already been commissioned, and that ITT (NYSE: ITT) has received the glass for the primary mirror, has assembled the mirror and has ordered parts for the assembling of the camera electronics.
These are long lead-time items.
The next step, is for GeoEye to choose a vendor to build the satellite itself.
The CEO stated that this could happen at the end of this year or early next year, and that from that point it will take about three years until launch, which puts launch in the 2012 time-frame.
As for how much money they will need, management stated that as of right now, they don’t need financing for the new satellite in the short-term, and that they can pay for the development of the satellite via their free cash flow.
Over the next six months they will continue to monitor the demand from government, international, and commercial customers, and determine how they will proceed with the expenses for this satellite as time goes on.
My Take: This is good news to hear. It looks like we will have a runway of about 4-6 months or so whereby GeoEye will not need to leverage more debt, dilute shareholders, or have to tap into the equity markets in this current environment.
What happens beyond then will all be determined by the revenue ramp that GeoEye-1 provides, and how much of that cash flow GeoEye is able to drop to plow back into the construction of their new satellite.
- Earnings/Tax Restatements: Concerning the various earnings and revenue restatements that GeoEye has had lately, the CEO commented that the restatements didn’t have a big economic impact on the company, although they regret that they happened at all.
He also stated: “I guess the simplest explanation as to why they occurred is that we grew too fast for our financial system.”
Further, he stated that they have hired a new controller in Jeanine Montgomery, and they have a new auditor in KPMG and a new tax adviser.
Finally he stated that they are still uncovering some small issues that need to be cleaned up and they will continue to beef up their system so that they don’t have anymore discrepancies, even minor ones.
My Take: GeoEye has delayed their 10-Q filing by about 5 days to give them some more time to work on these issues and make sure their numbers are right.
Like management stated in the call, there is nothing in these restatements or delays that will affect GeoEye’s balance sheet, financials, or other metrics of substance, but it is worth noting that hopefully GeoEye has gotten their internal controls in order and we’ve seen the last of these issues.
- On GeoEye’s production business: CEO Matt O’Connell said that they were going to expand their production staff in their Thornton office significantly to keep up with the demand in their airport mapping database business. They are also going to increase their office space in St. Louis by 50%.
In both expansions, the CEO noted, the cost is far outweighed by increases in GeoEye’s production capacity, which is a good source of revenue and also a great competitive factor, since no other satellite imagery operator does the value-added production on the level that GeoEye does.
- Satellite imagery demand from developing countries: Management stated that they continue to see strong demand in developing countries for their satellite imagery, and that Russia seems to be catching China as the developing nation with the fastest growing demand, but that they are both exciting markets.
Investing Thesis Remains the Same
It now appears that the hard part is over.
Those scared to put new capital to work in shares of GeoEye for fear of a launch failure, or some other mishap related to GeoEye-1 can rest easy, take a deep breath, and scrounge around their pockets for some money to invest in this great company.
I don’t know if you’ve looked lately, but GeoEye has vastly outperformed the market in the last 6 months or so, and will continue to do so from here on out.
For those looking for somewhere to put their money that does not depend on customer spending, the economy, or global economic forces, look no further than GeoEye.
This is truly a recession proof business as most of GeoEye’s revenues are derived from the U.S. government, and will continue to be regardless of what is going on around us, as the need for imagery to secure borders and monitor the earth will not be cut from any budget.
This is especially true in light of the fact that the the U.S. government, through the NGA, just paid 50% of the cost for the build, launch and insurance, on GeoEye-1.
You don’t spend $250 million and then not support the product you produced and violate presidential mandates.
On top of that, GeoEye is expanding their offerings and adding more customers and service level providers, like their deal with Telespazio in which they sell their imagery to others, and then are also still free to sell that imagery over and over again to anyone they see fit.
This is a stark contrast to how they used to do business whereby the service providers owned the rights to the imagery, and GeoEye would have to PAY the providers to use it and sell it again!
Stupid, I know.
At any rate, that is being rectified as we speak, and from here on out, GeoEye’s revenues, profits and free cash flow will explode as they enter into more and more markets and expand their reach and capabilities now that they have a constellation of satellites: OrbView-2, IKONOS and GeoEye-1.
With IKONOS having a life span estimated to run into 2010, and possibly beyond, GeoEye can now effectively provide more imagery to more customers and cover more of the Earth’s surface far quicker than they used to.
Add to that the fact that GeoEye-1 is the highest resolution commercial imagery satellite available on planet earth today, and you can see that demand will become insatiable.
Couple all of that with a bargain basement stock price (GeoEye’s market cap is BELOW the very value of GeoEye-1!), and once the year-over-year comparisons start flowing starting in 2009, the stock price will follow suit in short order.
I’ve been pounding the table for GeoEye for a long time now.
Nothing has changed.
Now even the risk averse can get into the stock with less trepidation knowing that the BASIC program has been delayed/canceled, GeoEye-1 is about to deliver useful and certified imagery and GeoEye is signing deals left and right to expand their product offerings and increase their coverage and revenue generating capabilities.
All you have to do is take a look at this quarter’s financials, which were still impressive, even with the sharp decline in orders from the NGA to see how a ramp up in sales will drop right to the bottom line.
You do the math and determine: what will those numbers look like once GeoEye begins to ramp up that revenue?
The hard part is over, now the fun begins.