GeoEye: Price Jumps as Company Hits Its Stride

Apr. 6.09 | About: GeoEye, Inc. (GEOY)

GeoEye LogoGeoEye, Inc. (NASDAQ: GEOY), a provider of space-based and aerial imagery and geospatial information, is finally coming into focus much like the company’s flagship satellite, GeoEye-1

The company reported its fiscal 4th quarter and full year 2008 earnings, and with the report and subsequent analyst conference call, soothed investor’s fears and gave a small preview of the earnings and revenue driver that GeoEye has become now that they are firing on all cylinders.

My investment thesis has played out beautifully with GeoEye, with a great deal more good news still to come.

But with shares up about 50% in the last few weeks, should you be adding to your position or holding for now?

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.

GeoEye operates in what in essence is a duopoly with only one other U.S. competitor, DigitalGlobe (NYSE: DGI), and just recently launched and certified their latest satellite, GeoEye-1, which is the most accurate and detailed commercial imagery satellite available today.

Want more?

  • Read my latest earnings preview here.
  • OR: read my latest 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: Expanding Workforce, SLA with NGA Extended
  • Conference Call Highlights: GeoEye Starting to Finally Meet Expectations
  • 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 Q4 and full year/analyst’s estimates where applicable):

  • Q4/2008 sales of $40.7 million (down 6.7%, from $43.6 million in the prior year/vs. $34.9 million projected by analysts)
  • Q4/2008 operating income of $3.65 million (down 76.9%, from $16.0 million in the prior year)
  • Q4/2008 net loss of (-$3.6) million, or (-$0.20) per diluted share (down from $6.97 million, or $.42 per diluted share in prior year/vs. $.00 per share projected by analysts)
  • Q4/2008 Gross margin of 46.7% (down from 55.2% from prior year, but up from 43.5% in Q2/2008, and down from 49.9% in Q3/2008)
  • Q4/2008 Operating margin of 9.0% (down from 36.7% from prior year, down from 15.4% in Q2/2008, and 23.1% in Q3/2008)
  • Q4/2008 Net margin of -8.9% (down from 16% from prior year, down from 7.0% in Q2/2008, and 16.8% in Q3/2008)
  • Full Year 2008 sales of $146.7 million (down 19.8%, from $183.0 million in the prior year/vs. $139.9 million projected by analysts)
  • Full Year 2008 operating income of $22.8 million (down 71.2%, from $79.2 million in the prior year)
  • Full Year 2008 net income of $26.6 million, or $1.36 per diluted share (down 6.7% from $28.5 million, or $1.44 per diluted share in prior year/vs. $.42 per share projected by analysts)
  • Full Year 2008 Gross margin of 48.0% (down from 64.7% from prior year)
  • Full Year 2008 Operating margin of 15.5% (down from 43.3% from prior year)
  • Full Year 2008 Net margin of 18.2% (up from 15.5% from prior year)

My Take: The numbers certainly weren’t great, which was expected because of the delayed launch and check out of GeoEye-1.

In addition, there was a large discrepancy that you’ll notice on the net income line.

GeoEye showed a net income of $26.6 million for the full year 2008 time period, which grossly inflated their earnings per share figure to $1.36 per share.

These are phantom earnings as they were purely as a result of a one-time income-tax benefit resulting from the reversal of charges recorded in 2007.

This change resulted from the reversal of the accrued tax penalties and interest for the cost-share payments under the NextView program with the National Geospatial-Intelligence Agency.

If you back that out of the equation, you get a net-real earnings of about break-even for the year, or $.00 per share in earnings.

Obviously as we all know by now, these numbers didn’t affect the stock price, and aren’t what analysts are looking for anyway.

We all knew that both the top line and bottom line would be bad because of the continued delays in GeoEye-1 launch and check out, so all we care about is what’s going to happen from here on out.

Other Business Highlights

Expanding Workforce, SLA with NGA Extended

  • GeoEye is currently in negotiations with the National Geospatial-Intelligence Agency (NGA) regarding the establishment of a Service Level Agreement (SLA) extension through June of 2010. The current SLA was set to expire at the end of 2009.
  • GeoEye’s cash and short-term investments balance was $110.5 million at December 31, 2008, as compared to $234.3 million at December 31, 2007. The decrease from the 2007 cash balance primarily reflects payments made to complete the GeoEye-1 program and income taxes paid related to the GeoEye-1 cost-share payments.
  • GeoEye is currently evaluating options for financing GeoEye-2 (more below)
  • The fourth quarter revenue decrease was partially offset by increased revenue from the sale of ground station upgrades of $7.2 million. These are 1-time in nature.
  • GeoEye will be greatly expanding their staff by approximately 120 or more. (see below)
  • MJ Harden division had a good year and revenues grew by 46 percent over the preceding year.
  • GeoEye expanded this division by purchasing a new aircraft and camera (more below)

My Take: I’ll be expanding on many of these points in the conference call section below, but needless to say, aside from the overall revenue and earnings shortfall as a result of GeoEye-1 delays, GeoEye overall is headed in the right direction, and has many good things to talk about.

One thing that investors probably noticed was that the stock spiked upward when on the conference call CEO Matt O’Connell talked about the NGA wishing to extend their SLA with GeoEye well into 2010, instead of the agreement ending at the end of 2009.

This is huge news as it means that GeoEye now has about 1 1/2 more years of predictable, steady revenue from their largest customer. Although the new negotiations are yet to take place, the price that GeoEye will charge the NGA will most likely be similar in scope to what they are getting now.

Conference Call Highlights

GeoEye Starting to Finally Meet Expectations

The following are the highlights from GeoEye’s analyst conference call:

  • NGA Looks to Extend Service Level Agreement (SLA): The CEO stated in prepared comments that GeoEye was told two days ago that the NGA intends to execute a contract modification extending GeoEye’s Service Level Agreement through June 30, 2010, with options to extend further.

The current contract was set to expire later this year.

Management stated that the terms should remain the same through the end of this year, and then they will have to negotiate new terms for the first half of next year.

My Take: This was huge news as far as Wall Street was concerned and caused a large spike in GeoEye’s stock price which never let up.

We can all see that having your largest customer committed to keeping you in business for the foreseeable future is a very good thing.

More than that, GeoEye will be able to rely on these consistent revenues and analysts can all breath a sigh of relief when looking at GeoEye’s long term prospects as a company and stock.

Out of everything discussed on their conference call, this was the biggest news by far.

  • CEO Commenting on GeoEye’s Poor Investor Relations: The CEO addressed the obvious of GeoEye not communicating with investors properly over the last few months.

He stated that they realize that they’ve got to do a better job with their financial filings and overall communication with investors.

There’s a few ways that management proposed doing this.

First GeoEye will hire a new CFO.

GeoEye has been conducting a CFO search with the help of a leading recruiting firm and hope to complete the process shortly.

The second was that they are also looking to expand their investor relations capability to better handle the media exposure and Wall Street in general.

The CEO also stated that GeoEye’s 10-K was late because as the company worked on it, they discovered discrepancies and they had to make sure that they started 2009 with the most accurate set of financials possible.

As a result of those discrepancies GeoEye also had to restate earnings, as I’ve discussed before.

None of the restatements has a material effect on the company’s bottom line, they were merely small accounting errors that accumulated over time.

My Take: Talk about too little too late…where was this the last 6 months or so?

It appeared that GeoEye had turned the corner when it came to investor relations and communication with Wall Street, but the last few months has been a very serious step back for the company.

I’ll be monitoring this closely, and to be fair, GeoEye has been forthcoming with their recent press releases and communications over the last several weeks, so let’s see if this continues and has any teeth.

  • GeoEye’s Current Deal With Google: The CEO elaborated on GeoEye’s increasing sales in their various channels, such as their energy sector channel, which includes oil and gas, which is their second biggest vertical and their fastest growing commercial sector outside of the on-line mapping community.

The CEO then talked about their highest profile North American customer Google (NASDAQ: GOOG) and reminded us how their logo was on GeoEye-1’s rocket, and mentioned GeoEye’s GeoEye-1 image of the inauguration that garnered them increased media exposure.

In early February, GeoEye made their first GeoEye-1 deliveries to Google, and although IKONOS imagery began appearing on Google Earth about a year ago, they expect GeoEye-1 imagery to start showing up there in increasing amounts over the coming months.

Google will not be tasking the satellite directly but will instead order archived imagery.

My Take: We all know that this agreement has brought a lot of publicity to both Google and GeoEye, and is good for the company in many respects.

However, I want to reiterate that as far as the bottom line, Google does not contribute, nor will they contribute, significantly to GeoEye’s revenues throughout their agreement as it stands now.

But overall, this is a good agreement for GeoEye and keeps them at the forefront of public awareness and investors love that.

  • Deal with Overseas Vendors: The CEO went over some of the recent deals that GeoEye has made with overseas vendors and reiterated that the deals that they have in place are far superior to previous deals under their IKONOS satellite.

In essence, GeoEye now has a significant amount of the imaging capacity for GeoEye-1 over a given area, regardless of their territorial agreements with these resellers.

What this means is that as opposed to their IKONOS satellite in the past, GeoEye can now use the time that GeoEye-1 is traveling over a certain area to collect other imagery, not just what that resell partner or government affiliate wanted them to collect, thus increasing the value to the company, as well as coverage area.

In addition, for the most part, GeoEye now retains the rights to the actual images and can sell imagery worldwide, outside of territories where the company granted exclusive territorial sales rights to qualified channel partners.

You can read more about GeoEye’s agreement with Telespazio here.

You can read more about GeoEye’s recently announced deals with 3 other partners here.

My Take: This is just reiterating what we have already known.

In essence, GeoEye-1 is a huge leap forward for GeoEye not just in capabilities, but more so in its ability to generate revenue, earnings, and higher margins for the company on more favorable terms.

The company has way more leverage now than they ever did with IKONOS which they inherited from Space Imaging, and have the capability to not waste the coverage of GeoEye-1 on simple tasks when they can instead have the satellite multi-tasking so to speak, over a given coverage area.

  • GeoEye-2 Discussion: When talking about GeoEye-2, GeoEye’s as-yet-to-be-manufactured next generation satellite, the CFO stated in prepared remarks that GeoEye’s cash balance will be affected by the pace with which GeoEye proceeds with GeoEye-2.

He further stated that the timing of the GeoEye-2 program will depend on the company’s perception of the market potential, especially the potential interest from the U.S. Government.

In addition, given the significant capital required to build GeoEye-2 and the current state of the financial markets, the timing will depend on GeoEye’s ability to raise the necessary capital on terms which they deem acceptable.

As of December 31, 2008, total capitalized costs for GeoEye-2 were $29.9 million.

My Take: This is a significant update from before when GeoEye was proceeding as planned with GeoEye-2 and were going to begin looking at creative financing options in the first half of 2009 to try and get work started on this satellite since the lead time is so long (4 years), that eventually demand as well as the capital markets will allow GeoEye to capitalize on the growing need for commercial satellite imagery.

I am OK with GeoEye holding off on plans to finance this operation now, at least until they can get financing on attractive terms, WITHOUT diluting shareholders significantly, which is a big risk as we get closer to the actual build out and contracting of GeoEye-2.

Keep in mind that the money will need to come from somewhere, and as of now, GeoEye already has $250 million in debt on their balance sheets from GeoEye-1, so it’s not a good idea to look for ways to increase that debt load until the company can at least pay down some of their old debt, or roll the new debt with the old and continue the build out of GeoEye-2.

Additionally, now that GeoEye-1 is operational, interest expense will increase because the interest on GeoEye’s $250 million outstanding debt related to the GeoEye-1 program will no longer be capitalized

We’ll see how this plays out, but be forewarned that the day is coming when GeoEye will need to come up with the cash for GeoEye-2.

  • GeoEye Expanding Workforce: Management stated that over the course of the year, GeoEye will be adding more staff and significantly increasing their expenses in this area.

This includes 100 operational staff, which will provide for an expansion of GeoEye’s rapidly growing production services, and provide support for operating and information systems and maintenance of all the company’s operations.

Additionally, during the course of the year, GeoEye anticipates adding up to 20 new employees in other functions within SG&A, including, sales and marketing, accounting, and business development.

My Take: I’m not too happy about increased expenses, but with the matching increase in revenue and profit, I think that GeoEye can handle the added burden, and in the grand scheme of things, the added staff will allow the company to service more customers, which in turn will also lead to higher revenues and increased efficiency, and allow them to expand their reach and service capabilities and truly become a best-in-breed company.

  • GeoEye Expanding MJ Harden Division: The CEO spoke briefly about GeoEye’s MJ Harden division, stating that the division had a good year and revenues grew by 46% over the preceding year.

He then elaborated by saying that GeoEye recently bought a new aircraft along with a second advanced Digital Mapping Camera which will be fully operational within a week.

He also said that MJ Harden had to turn away work last year and that the new airplane and camera will help them collect more imagery so they can take on more work.

My Take: This one’s a no-brainer.

Even though the MJ Harden division is a small part of GeoEye’s revenue, and its margins are also lower, turning away business that is profitable is never a wise thing to do, and further diversifies GeoEye in a way that their largest competitor DigitalGlobe does not.

From end-to-end, and top to bottom, GeoEye offers a complete suite of services to their customers that DigitalGlobe simply cannot match.

  • Parting Thoughts on Executive Compensation: As an homage to the recent executive compensation news that has been making the rounds, GeoEye’s prepared statements went out of their way to talk about how, as a result of the delay in GeoEye-1’s launch and check out, no GeoEye officers – no vice presidents or above - received any bonus in any form for their 2008 performance.

The CEO further went on the clarify that while all of senior management did not get bonuses, we may have seen some management recently receive shares.

These shares were part of the bonuses granted in 2006 that only vested after the check out of GeoEye-1, and were not new awards.

Bottom Line

Investing Thesis Remains the Same

The good news was doled out in copious amounts this week by GeoEye.

We had everything from the filing of their 10-K, which by the way was broken down in ways that no 10-K before it had been, as well as the earnings call that soothed investor’s fears about the company, stock, and future of the business.

I look up and see GeoEye’s stock now trading in the mid $20’s.

I certainly hope that over the last year or so that I have been recommending the stock, at prices from $16-$22, that investors at least bought a small amount for the riskier part of their portfolio.

If you did, you have been well rewarded, but that’s not even the best part.

The best part is that we are seeing our investment thesis play out.

Was it timely? No.

Was it perfect? No.

Did it happen the way that I thought it would? No again.

But the bottom line is that all the original reasons that I had for investing in GeoEye came to fruition.

Let’s go over those in order:

  • Successful launch of GeoEye-1 (Check!)
  • Successful check out of GeoEye-1 (Check!)
  • Successful calibration and image approval from the NGA for GeoEye-1 (Check!)
  • Increased order demand and future revenue as a result (Check!)

Sure, it all happened on a later time line than I had hoped, but that’s the intricate beauty of long term investing.

This is why we have an advantage over Wall Street.

While others were panicking over the continued delays in launching GeoEye-1, the continued delays in calibration and check out, and the continued delays and lack of response within the company to the investing community, you had ample opportunity to snag shares at significant discounts to where they are now.

There’s two more important points that I want to go over as it pertains to GeoEye’s stock at this point in time:

  • GeoEye’s shares will continue to be volatile: This is both good news and bad news depending on your perspective.

It’s obvious good news if you’ve been waiting in the weeds for all of this to play out before you invested in the company as shares are likely to vacillate up and down and likely present you with another decent buying opportunity.

It’s obvious bad news for current shareholders who might get a bit nervous of the “sell on the news” mantra as well as the overall volatility that will plague the market for time to come.

  • Regrettably, I have to slightly lower my recommendation: This is hard for me to do, but as a result of GeoEye’s share price run-up over the last few days, I have lowered GeoEye from a STONG BUY, to merely a BUY.

This doesn’t necessarily mean I am not telling you to purchase shares.

Quite the contrary.

I am merely reiterating the fact that with the recent share run up, as well as the catalysts that have been “used up” so to speak, we are likely to get less chance to make as large of a gain on purchasing shares at these levels (although I still advocate buying shares), than we had when shares were below $20.

The bottom line:

This is when the fun starts.

You know how they say that we feel the pain of bad news, or a down day in our portfolio, way more than an up day?

Well, that saying doesn’t apply to me.

I feel completely satisfied and pleased that my diligence, research and faith have paid off in a classic buy-and-hold strategy.

The best part?

We still have more to go.

Remember that GeoEye just announced an extension of their SLA with the NGA through June of 2010 with options to renew further past that date.

In addition, with 2 years of flattish to down revenue, lower margins, and lower profit numbers, as the revenue from GeoEye-1 starts flowing through in the coming months, comps from past quarters will easily be beat, and the stock will garner even more attention on Wall Street and continue its march upwards.

If you bought GeoEye at much lower levels, say below $18 per share, you might consider taking a little off the table, but I would not want to see you miss out on the next leg up.

GeoEye continues to be a buy, and a core portfolio holding as the investment thesis continues to play out.