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GeoEye, Inc. (NASDAQ:GEOY)

Q3 2009 Earnings Call

November 10, 2009 8:30 am ET

Executives

William Warren – Senior Vice President, General Council

Matthew O’Connell – President, Chief Executive Officer

Joseph Greeves – Chief Financial Officer

William Schuster – Chief Operating Officer

Analysts

Paul Coster – J. P. Morgan

Jeff Evanson – Dougherty & Company

James McIlree – Collins Stewart

Jeff Rath – Canaccord Adams

[Mark Halper – Bluefin]

[Anthony Clairman – Deutsche Bank]

Operator

Welcome to the GeoEye Incorporation third quarter 2009 financial results conference call. Today’s call is being recorded. For opening remarks and introductions I’d like to turn the conference over to Mr. William Warren, Senior Vice President and General Council.

William Warren

Good morning. This is William Warren. Thank you for joining us today as we discuss GeoEye’s third quarter 2009 earnings. Speaking today will be Mr. Matthew O’Connell, Chief Executive Officer and Mr. Joe Greeves, Chief Financial Officer.

Also with us today are Mr. William Schuster, Chief Operating Officer and Mr. Randy Scherago, Vice President of Investor Relations. After our remarks we will take questions from analysts and investors. This call is being recorded.

Before we begin the business portion of this mornings call we would like to inform you that we expect to be making forward-looking statements during today’s call. Statements including words such as believe, anticipate, estimate or expect, conditional statements and statements in the future tense are forward-looking statements.

These forward-looking statements involve known and unknown risks and uncertainties and are based on management’s current views and assumptions regarding future events and operating performance. A number of factors could cause our actual future results to differ materially from our current expectations.

Examples of these factors include but are not limited to conditions in the remote sensing industry, level of government spending, competitive pricing pressures, the level of new commercial imagery orders, production rates for advanced image processing, start up costs or overruns on new contracts and technology and product development risks and uncertainties.

For a discussion of the various factors which could cause our actual performance to differ from our forward-looking statements listeners are encouraged to read the risk factors in our Form 10-K for the fiscal year ended December 31, 2008 which was filed with the SEC on April 2, 2009 and our Form 10-Q for the nine months ended September 30, 2009 which we filed with the SEC on November 9, 2009.

We assume no obligation to publicly update or revise our forward-looking statements. A copy of the prepared script for today’s call will be made available on our website in the investor relations area shortly after this call. We replace that with the final transcript once it is available. You may also listen to an audio replay on our website as well.

At this time I would like to turn the call over to the company’s Chief Executive Officer and President, Matt O’Connell.

Matthew O’Connell

I’d like to thank all the investors and customers listening in on the phone and to our webcast for participating in our third quarter 2009 earnings call.

We’re very pleased with our third quarter results. We experienced strong year over year revenue growth, outstanding operating performance and superior EPS results. The growth we experienced in the quarter and our solid operating results are in large part due to GeoEye-1, the world’s highest resolution commercial imaging satellite and the strong relationships we have with our government and international customer base.

We continue to have excellent visibility into our revenue and earnings and are maintaining and trying to grow a healthy backlog of work with both our government and commercial clients.

On this call we’ll update you on our third quarter financial results, the success of our recent bond offering, our current operations and our new business development. We’ll discuss to the extent we can the U.S. Government’s announced plans regarding the Enhanced View program and their desire to institute this as commercial imagery.

We’ll also discuss the company’s long term goals and update our financial outlook for the remainder of fiscal 2009. After my initial comments, our Chief Financial Joe Greeves will discuss the company’s operating results, financial metrics and how we’ve strengthened our financial team in more detail. Then, I’ll provide a short summary and we’ll take questions from investors.

To get started, we’re very pleased with our strong business fundamentals and we believe we’re well positioned to benefit from future growth in the U.S. Government, international and commercial markets for imagery and information services based on imagery and geographic information.

The company had another quarter of record setting results for the third quarter. Third quarter revenues were $79.9 million or a 123% increase from the $35.8 million we reported for the same period last year. Revenues were up 10% from the second quarter which is a very healthy growth rate in both this current economic environment and also within our industry.

Fully diluted earnings per share were $0.61 above third quarter consensus estimates of $0.43. While we were delighted by this performance, we would note that the quarter reflected higher than expected performance on the revenue side and some one time benefits on the expense side.

In addition, the fourth quarter should reflect some of the investments we’re making to grow our business such as the cost of preparing our bid under the Enhanced View program. Joe will give you more details on all of this.

Now I’d like to describe the highlights of our recent notes offering. At the end of September, we successfully completed a $400 million notes offering. This financing was a very positive event because it laid the foundation for the company’s growth over the next three to five years. Part of the use of funds was to retire our prior notes. As a result, we were able to remove the restrictive covenants in our previous bond indenture.

Those restrictive covenants constrained our access to the debt and equity markets, encumbered our ability to have a bank credit loan and severely restricted our ability to make capital expenditures and to invest to grow our business.

Another positive element of the notes offering is that Moody’s updated our credit rating which helped lower our cost of capital. The $400 million offering gave us the financial flexibility to continue building GeoEye-2 and more important, to turn the satellite’s construction so that we can add capacity on a timeline that we believe coincides with the needs of our customers, particularly our U.S. Government customer.

And of course, we were able to tell our exciting growth story to a wider cross section of the financial industry and expand our investor base, many of whom are on the call today.

With those new to the GeoEye story, and those we missed on the recent road show, I want to quickly review the key demand drivers for our business. The U.S. Government’s demand for commercial satellite imagery will be the biggest driver of our revenue growth for the next three to five years.

U.S. Government agency contracts amounted to 67% of sales from the quarter. We currently supply imagery to 10 U.S. Government agencies. Our single largest customer for satellite imagery collection services is the National Geospatial and Intelligence Agency, often referred to in Washington by its acronym, NGA.

NGA is a Department of Defense combat support agency whose goal is to provide intelligence and support of national security objectives. No other customer accounted for more than 10% of revenues.

We have the highest quality, highest accuracy and highest resolution color imaging satellite available in the global commercial marketplace, so we’re seeing strong demand from numerous government agencies. Demand from the Defense and Intelligence agencies for more high resolution commercial imagery was a theme that was repeated many times at last month’s Geo Intelligence Conference in San Antonio.

Senior officials of the U.S. Government’s Defense and Intel agencies including the Director of National Intelligence said that they plan to increase their reliance on unclassified commercial imagery. This brings us to a quick discussion of the recent extension of our current service level agreement under NGA’s Next View program.

Our largest government contract with the NGA is a service level agreement which many people refer to as an SLA. The service level agreement is a type of contract that provides a predictable level of service to the U.S. Government and a predictable revenue stream for the contractor.

Our current service level agreement calls for the NGA to pay us $12.5 million per month for imagery from GeoEye-1, our satellite that generates most of our revenues under the Next View program. GeoEye-1 was launched in September 2008 and began commercial operations in February of this year.

As part of this service level agreement, we’re measured against a certain number of performance metrics every month. We’re very pleased to report that we met all of NGA’s metrics in July, August, September and October. Because we met all of the metrics during the third quarter and in fact exceeded some, we recognized a little more than $12.5 million per month of imagery revenue from NGA under the SLA portion of the Next View contract.

So our imagery revenue from NGA under the SLA portion of the Next View contract is about $87.1 million for the first nine months of 2009. Joe will go into more detail about the nuances of the NGA contract later.

During the third quarter we negotiated an extension to our service level agreement that will take us through March 31, 2010 with an option for the NGA to extend the agreement through December of next year. We believe a new SLA agreement, under an NGA program called Enhanced View should be in place next spring and that it will supersede our service level agreement and Next View contract.

I’ll discuss this in detail later. But first, I’d like to say a few more words about the recent industry conference in which we participated. As I mentioned, last month we participated in the industry’s largest Geospatial Intelligence Conference which is simply called GEOIN.

I’d like to share with both our new and old investors the words and comments by the Director of National Intelligence, Admiral Dennis Blair, from his keynote speech at the GEOIN conference. We believe they’re a good reflection of our government’s commitment to the commercial satellite imagery industry.

Admiral Blair said, “We are basically committed to a foundational imagery architecture that is balanced that incorporates both government systems and commercial systems and we think it will serve this country very well for many years into the future. As part of our architecture, it’s continuing and in fact increasing our strong reliance on commercial providers and imagery, commercial imagery of various wavelengths as an integral part of our GEOIN support to both policy and action.”

General Bruce Carlson, the Director of the National Reconnaissance Office which manages the nation’s own imagery satellite said this at the same conference. “We work hand in hand with NGA and we’re a great fan of putting commercial imagery into the system. Our national systems are over subscribed every day. Our goal is to fully integrate commercial imagery with our systems so that we can quickly disseminate imagery whenever it’s needed.”

That now brings me to a topic that we’re very excited about, namely NGA’s Enhanced View program. The Enhanced View program is one part of a larger satellite imagery strategy announced last April by the Director of National Intelligence, Admiral Blair, and approved by President Obama.

The plan commonly referred to as the Two Plus Two plan, would serve both the U.S. Military and Intelligence communities. Under the plan, the National Reconnaissance Office would purchase and operate two very advanced, ultra high resolution imaging satellites.

The second part of the Two Plus Two plan calls for the NGA to write imagery data from commercial class satellite operators in an amount equal to the output from two additional commercial satellites. This new multi-year NGA program is called Enhanced View and an award is expected in the spring of 2010.

We are participating in the NGA request for proposal contracting process. This program will allow our government to continue to receive a supply of unclassified, highly accurate satellite imagery from commercial satellite imagery providers. The Enhanced View program will replace the Next View program which could expire at the end of March 2010 unless the NGA exercises their option to extend it.

Public commentary indicates that demand for commercial satellite imagery from the U.S. Government will steadily increase beyond the supply that will be available over the next five to seven years.

Building the satellites that are needed to provide additional capacity requires a long lead time. That brings us to a discussion of the outlook for the GeoEye-2 satellite.

We anticipated the increase in demand for commercial satellite imagery and entered into a contract with ITT Corporation during the third quarter of 2007. So ITT has been working on the camera and camera electronics for GeoEye-2 for two years.

ITT’s work could be used to accelerate the development of GeoEye-2 so that it could be launched in late 2012 and begin commercial operations in 2013. We think the work we did was a good investment and believe we’re well positioned to move quickly when the Enhanced View program contracts are awarded next spring.

We also believe that world wide imagery demand for both surveillance and change monitoring is recession resistant. The capability to observe one’s borders and the countries in other regions of the world is a highly coveted tool as satellite imagery helps many countries and companies around the world monitor infrastructure and their region of influence.

By purchasing our imagery and data, those countries save the costs and avoid the risks of deploying their own space based imagery systems. That brings us to our next topic, international sales.

Our international sales force generated terrific revenue growth compared to the third quarter of last year, up 41.3% as demand in many regions of the world responded favorably to the superior capabilities of GeoEye-1. International revenues were $22 million, or 27.5% of total revenues.

The company’s growing global sales network currently comprises 12 strategic business partners, both government and commercial and more than 100 resellers. In the third quarter we executed an important GeoEye-1 contract with a Middle Eastern country and contract extensions with China, Japan, Singapore and Italy. We have several other contract awards that we can’t disclose for reasons of security and commercial sensitivity.

Now as our long time investors know, we also generate revenues from imagery production. We perform high end value added work for our clients in our St. Louis, Missouri and Thornton, Colorado facilities. The expansions of our St. Louis and Thornton facilities during the third quarter combined with productivity improvements allowed us to reduce our backlog a little.

However, there continues to be growing demand for our products and services. Joe will highlight the financial progress we’re making in the production and services area of our business.

We’re also seeing growth in the commercial business applications that we call Advanced Services. Those are just beginning to emerge. Our Chief Technology Officer, Ryan O’Toole is spearheading our move into Cloud computing and our efforts to give our customers real time access to our large imagery library.

We’re currently beta testing a software platform with NGA so that they can have real time access to our image library. The real time access is being provided as part of an NGA program known as Rapid Dissemination of online Geospatial information. NGA refers to this program by the acronym, RDOG.

After we finish the modules we’re developing for the U.S. Government in early spring, we’ll begin rolling the service out to our commercial customers. In the coming months you’ll hear news from us regarding the obligations we have for the oil and gas industry, the pipeline and utility industries, the international planning industry and the engineering and construction industries.

We’re excited about this emerging technology. It should help us accelerate the growth of our commercial imagery market and reap healthy returns.

Now for the overall industry outlook; as you new investors can probably imagine, it’s not easy to break into the commercial remote sensing business. Competitors are fairly high because you need a license from the U.S. Government, contracts, a fair amount of capital and satellites that can provide the resolutions to the degree we’re already providing.

We have no new American competition anywhere on the horizon in a rapidly expanding market. We’re just beginning to realize substantial revenues in this emerging Geospatial services industry, and as mentioned above, we have many years of strong demand from the U.S. Government ahead of us.

The solid fundamentals of our business model and our recent capital raise have soundly positioned us for growth in both government and commercial markets. Because of our high visibility into revenue and earnings, I want to reiterate again, our revenue and earning per share guidance for the remainder of fiscal 2009.

We are comfortable forecasting revenues in a range of $275 million to $280 million and adjusted EBITDA in a range of $133 million to $137 million. We plan to provide a financial outlook for fiscal 2010 after we report year end results next spring.

It’s too soon to have clear visibility into next year, but a conservative outlook would indicate that we’ll have 2010 revenues in the $310 million to $320 million range. There may be some upside potential in the second half based on some of the investments we’re making, and of course, we’re excited about the prospect of winning an award under Enhanced View.

Given the high demand for our services for the next few years from both government and commercial sectors, we’re confident that our business will continue growing well for the next few years. We invite you to come grow with us.

Now I’ll turn the call over to our Chief Financial Officer, Joe Greeves so he can talk about our third quarter results. After Joe is done, I’ll be back to sum up, and then we’ll take questions.

Joseph Greeves

Good morning everyone. I think the strong third quarter results demonstrate that the company is well positioned for future growth and leadership in the emerging commercial satellite industry. Our financial team is working hard to build a strong financial organization and upgrade our financial systems and controls and I believe the quarter marks another step in the process of re-establishing our credibility with the investment community.

Now to move on to the financial results. The company just recorded record setting revenues for the third quarter of 2009. The third quarter revenues were $79.9 million which represents 123% increase over the $35.8 million reported in the same period last year. For the first nine months of 2009 revenues were $197.9 million, up 86.7% year over year.

The third quarter revenue breakdown includes the following: domestic revenues were $57.9 million and accounted for 72.5% of total revenues. International revenues were $22 million which accounted for the remaining 27.5% of total revenues. Domestic revenues rose by 186% year over year while international revenues rose by 41.3%.

Our imagery revenues of $62.1 million accounted for 77.7% of the quarterly revenues and grew by 149% compared to last year. Our Next View cost share revenues accounted for $6 million or 7.6% of total revenues.

Production and other services revenues were $11.8 million or 14.8% of total revenues and showed a modest increase of 8.3% compared to the prior year, but more importantly, showed a 14.7% sequential increase from the second quarter.

The increase in production services was primarily due to the demand for our value added production services in our Thornton and St. Louis operations. Our production services backlog is currently very strong and we expect these production and services revenues to continue to grow in the future.

However, we did see some effects of economic downturn on our aerial and See Star business in the third quarter. We continue to the aerial and See Star businesses should stabilize and recover as the general economy improves.

In terms of customers, our U.S. Government work amounted to $53.6 million or 67% of revenues, a $129.7 million or 66% of revenues for the first nine months of 2009. Our U.S. Government customers include NGA, Department of Homeland Security, Department of Interior, Department of Defense, and many other agencies. No other customer accounted for more 10% of revenues in the quarter or for the first nine months.

In regards to the NGA service level contract, we recognized $38.1 million of imagery revenue or 48% of our revenues in the third quarter and $87.1 million for the first nine months of 2009. GeoEye-1, our satellite that does most of the work with the NGA’s Next View program, began operations in mid February.

Our current service level agreement contract calls for the NGA to pay us $12.5 million per month for images. However, these monies can vary month to month dependant upon the number of additional imagery requests which could lead to higher payments or can lead to reduced payments dependent upon whether we hit our performance metrics.

Under our service level agreement, the NGA has given us a standing order to collect imagery of a large part of the earth. In addition, the service level agreement gives our government to make special orders. In essence, the NGA could ask us to direct the satellite to take images of hot spots where they determine the need for more sensitive images.

For special order requests above a certain level, we can be awarded additional monies as I mentioned above. In this quarter, we met all the metrics for each month and earned some additional money for providing additional imagery.

Although we are quite pleased with our performance this quarter, we cannot assure you that we will be as successful each quarter going forward.

Now let’s talk about some other financial metrics. One metric of our operation performance is adjusted EBITDA. We define adjusted EBITDA as net income before interest, taxes, depreciation, amortization, non recognition of compensation expense and other unusual items.

Adjusted EBITDA increased by $32.3 million to $45.4 million for the third quarter of 2009 from $12.2 million during the same period of 2008. This strong year over year adjusted EBITDA growth was generated in the third quarter and was attributable to our exceptional revenue growth, expense control and significantly higher depreciation expense associated with the GeoEye-1 satellite.

The adjusted EBITDA margin for the third quarter was 55.7% compared to 34% for the same period last year. We feel comfortable that we can sustain adjusted EBITDA margins in the 50% range for the foreseeable future.

Direct costs for the third quarter of 2009 were $23.8 million and declined as a percentage of revenue to 29.8% from 46.2%. As the revenues grew again this quarter, the company continued to benefit from positive operating leverage. With that said, I need to point out that our satellite insurance expense is $791,000 this quarter was abnormally low due to some one time benefits and will more likely cost $1.5 million per quarter going forward.

On a year over year basis, our other direct costs were down $1.5 million primarily due to a substantial reduction in the amount of imagery we buy from third parties. Although we are always evaluating ways to reduce costs and become more efficient, we continue to believe that our direct costs should range between 30% and 35% of revenues going forward.

Depreciation and amortization expenses rose from $2.2 million last year to $16.3 million this year due to the commencement of operations for the new GeoEye-1 satellite. We began depreciating GeoEye-1 and its related ground station in mid February 2009. GeoEye-1 is being depreciated over its nine year expected life.

We feel comfortable that our depreciation expense and amortization expense should remain in this general range for the foreseeable future.

Sales and general administrative expenses were $12 million or 15.1% of sales in the quarter. As a percentage of revenue this represents a substantial reduction from the 24.1% rate from the third quarter of 2008. These costs have increased as it provides business development and commission costs concurrent with the increased revenue and we have made additional investments in our financial and administrative support operations.

We plan to continue to make investments in our business development sales to support our organization’s plan to help promote future revenue growth. We believe our sales, general administrative expenses as a percentage of revenue should range between 13% and 16% of revenues on a go forward basis.

Income from operations for the third quarter was $27.7 million a healthy increase of $19.3 million from the comparable period of 2008. The operating margin was 34.7% for the third quarter of 2009 compared to 23.5% in the same period in 2008.

Going forward, we continue to believe that 30% is a reasonable target for operating income margin. At that level, we can continue to make investments in our research and development programs, add to our professional service and sales teams, which should allow us to grow the business while still providing strong returns to shareholders.

In the next few quarters, you should see a rise in labor and subcontract expenses associated with the Enhanced View bid and an increased R&D expense. We believe this operating income margin may be subject to quarterly fluctuations.

Interest expense for the quarter was $8.7 million compared to $2.8 million last year. Interest expense primarily increased due to the commencement of GeoEye-1’s operations. The interest cost associated with the development of GeoEye-1 satellite which in the prior year was capitalized in accordance with generally accepted accounting principals, are being expensed now that the satellite is fully operational.

Our effective tax rate for the quarter was 36.4% and 37% for the first nine months before certain discrete items. We believe the company’s effective tax rate for the full year will be approximately 37% before the effect of any discrete items.

Net income for the quarter was $12.5 million or $0.61 per diluted share compared with $31.6 million or $1.57 per diluted share in the third quarter of last year. The net income for the third quarter of 2008 included a one time income tax benefit of $27.8 million.

The number of shares used to make our fully diluted earnings per share calculations for the third quarter was 20,646,000 shares.

Turning to contracted backlog, we have historically had and currently have substantial backlog which provides some assurances regarding future revenue expectations. Our backlog was approximately $320 million as of September 30, 2009, up from $236 million at the end of the year.

Our backlog as of September 30 included $199 million of contracts with the U.S. Government including approximately $79.6 million related specifically to the service level agreement.

Most of our government contracts are funded incrementally on a year over year basis. However, certain foreign governments and commercial customers have signed multi-year contracts.

Now turning to the balance sheet; the balance sheet continues to be strong. The company finished third quarter with $123.6 million in unrestricted cash, $18.9 million in restricted cash, total assets of $812 million, stock holders equity of $257.6 million and long term debt of $248 million.

Accounts receivable at the end of the third quarter were $43.2 million, down from $53 million last quarter. This represents 49 days sales outstanding, DSO’s which are well below our target range of 60 to 70 days outstanding. The third quarter decrease in DSO’s was primarily due to additional focus on collections and prompt payments by domestic and international customers including the NGA.

In terms of capital expenditures, we paid out $61.7 million in the first nine months of 2009. Of this approximately $29.5 million was invested in the new GeoEye-2 program which Matt addressed earlier with the balance primarily funding the GeoEye-1 program and general maintenance expenditures.

Now let’s talk about cash. Unrestricted cash has increased from the beginning of the year by $16.9 million to $123.6 million. The net increase is primarily due to the additional earnings, an increase in deferred revenue and the collection of a large income tax receivable balance somewhat offset by a net increase in capital expenditures and the transfer of $18.9 million to restricted funds.

The proceeds from the recent debt offering were not received until the fourth quarter. As of today, we currently have approximately $225 million in cash on the balance sheet.

As the company continues to generate working capital each quarter, we believe our cash balance will grow substantially and will be used primarily to fund our future capital expenditure programs.

Our head count was 535 employees at the end of the third quarter.

In regards to the notes offering, on October 9, 2009 the company refinanced its outstanding long term debt by closing a $400 million private placement offering of senior secured notes due October 1, 2015 with a 9.625% coupon rate. The 2015 notes were sold at a price equal to 97.262% of their face value with an effective yield of 10.25% before deal expenses.

The 2015 notes are unconditionally guaranteed on a senior secured basis by all existing and future domestic subsidiaries of the company. The net proceeds of the 2015 offering were used to fund the repurchase of $349.5 million of the outstanding principal or approximately 99.8% of the company’s outstanding 2012 notes as part of a tender of these notes which expired on October 8, 2009.

The company has also used a portion of these net proceeds to satisfy the discharge of the remaining $500,000 aggregate principal as well as for corporate general purposes which may include funding a portion of the cost of constructing a new high resolution satellite.

Interest payments of the new $400 million notes will be made semi-annually in arrears on April 1, and October 1 of each year. At any time on or after October 1, 2013, the company may redeem all or part of the 2015 notes at 104.813% of the principal for the subsequent 12 month period and at 100% of the principal on October 1, 2014 and thereafter.

In regards to retirement of the 2012 notes, the company expects to take a one time debt extinguishment charge of approximately $27 million in the fourth quarter to write off remaining unamortized, prepaid financing costs and the premium related to the 2012 notes.

In regards to improving our financial controls, over the past few months we have done quite a bit to enhance our controls over financial reporting and beef up our accounting and financial team. During the quarter, we hired Ramsey Price, our new Vice President of Financial Systems and Sarbanes Oxley compliance. He is overseeing our Sarbanes Oxley compliance program and also working with [Jeannine Macgomery] to improve our financial reporting systems.

We also hired Jim Craig as Vice President to help run our Treasury operations and deal with some of our major financial projects. In addition, we’ve hired a tax director to help manage and improve the quality of our growing tax requirements.

I would also like to reiterate Matt’s guidance earlier and add a little color. We are comfortable with our revenue visibility in the range of $175 million to $280 million for the year with adjusted EBITDA excluding the extinguishment of debt charges in the range of $133 million to $137 million and pro forma earnings per share guidance in the range of $1.30 per share to $1.45 per share before the extinguishment of debt charges.

We will continue to target at 30% operating income margins and 50% adjusted EBITDA margins. Sine we are in a business where revenues from our customers can be lumpy, these margins may vary quarter to quarter and should be considered targets and goals.

Finally I’d like to thank the accounting and finance team for all their hard work to improve the timeliness and accuracy of our financial reporting process. Now I’ll turn the call back to Matt.

Matthew O’Connell

We’re very pleased with our revenues and earnings we just reported. It’s a positive reflection on all the hard work and dedication of our GeoEye employees over the last few years and the support we’ve gotten from you, our investors. We’re excited about our industry and our position.

To sum up, we’re developing products that are more advanced and services and delivery platforms that will provide our customers with timely, accessible and useful location information that they can use to make vital decisions.

You investors will see these new developments in early 2010. Our ability to collect imagery with various satellites and airplanes to produce imagery from a variety of sources and to deliver that imagery and the imagery products through a variety of means, is going to be very helpful as the industry continues to grow and change.

In recent years our industry has evolved from the industrial age to the information age. We used to focus on bending tin and building satellites. Now we’re focused on sending pixels, how we can use the data we collect to help people make important decisions faster and more accurately, and how we can deliver that decision support data faster.

We believe our solid financial position enhanced by our recent notes offering and strong operating cash flow will allow us to continue to invest for future growth. We’re very pleased by the reception of the financial committee to our recent notes offering which we see as an endorsement of our vision for the imagery market.

September was an opportune time to raise money in the market. That enabled us to refinance our debt at a lower fixed rate and will give us more flexibility on how we spend funds. It also puts us in a strong cash position to respond confidently when the NGA issues a formal request for proposals under the Enhanced View program.

Now, I’d like to open the call to financial analysts and investors for questions. For all others, we invite you to stay on the call and listen in. Of course as we discuss further in the call, many of the statements we’ve made and will make during the Q&A period are forward-looking statements subject to risks and uncertainties, and some of our business is related to sensitive U.S. Government programs so that may limit our ability to respond. With that, we’ll take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Paul Coster – J. P. Morgan.

Paul Coster – J. P. Morgan

Can you update us on the status of the IKONOS and Orb View satellites and their useful life in particular?

Matthew O’Connell

I think I’ll turn that over to Bill Schuster since he’s sitting next to me.

William Schuster

With regards to IKONOS, we’ve had a good year. There have been no abnormal events. We don’t see any reason at this time to doubt that it will be around for several more years. GeoEye-1 continues to perform perfectly and we stick with the period over which we’re depreciating for the expected life of nine years.

Paul Coster – J. P. Morgan

As we look out to 2010, your initial thoughts point to 10% to 15% top line growth. Should we think of the growth as being equally distributed across the regional, the domestic intelligence and the production services businesses or will certain segments benefit disproportionately?

Joseph Greeves

In our modeling we try to be conservative. We think that the second half will be stronger as we made some investments. We think the production services will continue to grow. We expect growth in our commercial business, and we expect continued growth in the international business and we’re being conservative in the U.S. Government business.

Paul Coster – J. P. Morgan

The NGA, is there any reason to believe that it will be expanded to include more companies than the incumbents, Vista Global and GeoEye?

Matthew O’Connell

Obviously we look at that hard, but I think that given the sensitivity of that procurement, it’s probably best for us to not comment in any detail on the process they’re running.

Paul Coster – J. P. Morgan

GeoEye, how close are we now to being self funded assuming a late 2012 launch?

Joseph Greeves

We’re not going to get into too much detail on that, but with the funds we raised and our cash flow we are pretty close to being self funded.

Paul Coster – J. P. Morgan

Now that Vista Global’s worldview two is up, the commission is hopefully near the end of this year, what impact do you think that has on pricing for GeoEye-1?

Matthew O’Connell

That’s a good question. By the way, I called Jill as soon as they launched and said congratulations because the important thing about that from an industry perspective is it helps persuade people like the U.S. Government that the commercial industry really is real.

I’m not going to speculate on what it will do to prices. You know the laws of supply and demand. There’s more supply, but at the same time, we know that there’s more demand. The U.S. Government has said there is going to be more demand. So I’m not quite sure how that will all shake out.

Operator

Your next question comes from Jeff Evanson – Dougherty & Company.

Jeff Evanson – Dougherty & Company

I was wondering are you going to start to capitalize some of the interest expense on your debt for the work on the GeoEye-2 satellite.

Joseph Greeves

It looks like we will starting in the fourth quarter. We have about $60 million in that right now and as you saw in the 10-Q the company is being cautious about spending additional capital. But we will now based on the formal process being in place start capitalizing that based upon that amount based on the incremental borrowing rate off the most recent financing we did with the debt.

Jeff Evanson – Dougherty & Company

Should we look at the amount that you’re spending on CapEx as a barometer for how much debt dollars are being allocated to that project and thus the interest on that debt is being capitalized. Is that how I should think about it?

Joseph Greeves

I think what we’d do is use the $60 million debt plus anything else we add to it, multiply that by the incremental borrowing rate and that would be what gets capitalized in any given quarter and obviously there would be some averaging going on there too.

Jeff Evanson – Dougherty & Company

As you are exceeding the SLA $12.5 million per month, are you losing future dollars of that contract or are you adding on dollars to the SLA agreement?

Matthew O’Connell

We’re not losing future dollars, we are adding a little bit.

Jeff Evanson – Dougherty & Company

So this is true upside for these bids?

Matthew O’Connell

I think the way to look at it is if you remember in the first few months of the year we fell short, and what we’re doing is playing a little catch up.

Jeff Evanson – Dougherty & Company

I think it was Joe made a comment about 50% EBITDA margins. Is that what we should be thinking about for a target EBITDA in 2010?

Joseph Greeves

Yes that’s right. From my standpoint, obviously the company in the last two quarters has exceeded the 30% operating income for the company and it’s quite capable of producing higher levels. What I’m doing is being conservative and also giving the company the opportunity to make some investments to expand in R&D fields and expand the sales force so we can capture some of the opportunities in the international space. So the 50% I think is a conservative number, but it’s something we’re comfortable with.

Jeff Evanson – Dougherty & Company

Could you give us an update on where you are in the capacity expansion for your product and services business and when we might start to see revenue ramp there? Obviously NGA is buying a lot inventory. When are we going to see that translate into product and services revenue growth?

Matthew O’Connell

I think that Bill and I will tag team this. As I said in my remarks, Bill finished those expansions in the third quarter and he’s got a plan that will ramp production I would say over the next six months and then you’ll start to see a pick up.

William Schuster

Quarter over quarter the production rate in St. Louis operation has doubled and the rate of increase in our Thornton facility has gone up substantially. The issue is that those numbers that you’re seeing reported are combined. Those numbers are not directly seeing that magnitude of growth. So we are picking up and we are appreciating the benefit of what we’ve invested there in terms of building our production capability.

Joseph Greeves

As I mentioned in my piece, the growth that Bill is mentioning is being offset somewhat by a weaker experience we’re having in the area of the M.J. Harden space.

Jeff Evanson – Dougherty & Company

You’re bearing the cost now but not the benefit and that will ramp over the next six months then?

Joseph Greeves

Yes.

Operator

Your next question comes from James McIlree – Collins Stewart.

James McIlree – Collins Stewart

Could you articulate again the circumstance that you’re looking for to make a decision to accelerate the construction of GeoEye-2?

Matthew O’Connell

As I said in my remarks, we’re going to keep the program going, but in terms of really putting the pedal to the metal, we will wait until there’s an award under the Enhanced View program. As we said in prior calls, we don’t need a replacement satellite until later, but we can bring this program forward if the government wants us to.

So that will be the spring when you hear an announcement, and probably you’ll read about these things in the press as fast as you hear about them from us.

James McIlree – Collins Stewart

Is there a potential risk from delays if there are delays. Is there a risk to the construction of that satellite?

Matthew O’Connell

I don’t think so. Bill’s shaking his head, but we have designed it to be a step forward in terms of technology and performance so we’re kind of ahead of the market. We could slow it down if the government wanted us to for a little while, and I don’t there’s no harm, no foul.

James McIlree – Collins Stewart

I think it was mentioned earlier about vertical markets that you plan to address in 2010. Can you flush that out a little bit, not just the vertical markets but potentially what kind of offerings you would have available.

Matthew O’Connell

We’re really in a development stage with that and haven’t rolled those out. I’d rather hold off and just tell you to stay tuned for coming attractions. The platform is very exciting. I don’t think we can get into a lot of detail on this call, looking down the hall and the table and people are saying let’s just keep that quiet for now. Sorry about that.

James McIlree – Collins Stewart

Is any of that baked into your 2010 I guess I’m going to call it a what if or reasonable expectation?

Matthew O’Connell

No, that conservative outlook I gave you did not include any real growth from the stuff. As I said we expect some upside in the second half of the year based on the investments that we’re making now.

Operator

Your next question comes from Jeff Rath – Canaccord Adams.

Jeff Rath – Canaccord Adams

I’m just going through a bunch of check list items if I can. How should I think about your backlog commentary? You suggested your backlog now stood at $320 million. Do you think of that as revenue that can be drawn down or will be drawn down over the next 12 months giving you essentially 100% revenue visibility? Any color you can give me on how you’re defining your backlog.

Joseph Greeves

Some of that backlog is longer than 12 months and it does not include the cost share which is a substantial number. It’s about $200 million that’s amortized. It’s $6 million per quarter. What that is, is kind of the delta between our bookings and our revenue recognition and I think the point of giving it to you is to give you some comfort that we have pretty decent visibility.

Are you aware of our contracts with the NGA that run now through next March. You’re also aware now that we have some multi-year contracts in the international community which is a substantial piece of that number. And then we have some commercial contracts that also run multi-years.

Jeff Rath – Canaccord Adams

Can you share with us the percentage of that $320 million that is within the 12 months?

Joseph Greeves

I don’t have that available right off the top of my head but I would say it’s probably in the neighborhood of 60%.

Jeff Rath – Canaccord Adams

When I think about your R-Dog offering that you described there, is that factored into your 2010 outlook or how should we think about that?

Matthew O’Connell

R-Dog is as a program, although the expanded services with R-Dog, online services are not yet.

Jeff Rath – Canaccord Adams

Is it something that you think you will be in the market with those expanded services in 2010?

Matthew O’Connell

Oh yes. I think that will turn into some revenue from NGA and then we’ll roll it out to the commercial world. But as I said, the commercial stuff we don’t expect to pick up until second half of next year on the online side.

Jeff Rath – Canaccord Adams

Do you have any update for us on the technical review of the GeoEye-1 glitch that was identified? Have you made a go or no go decision on a fix there? Can you give us any updates?

Matthew O’Connell

I’ll ask Bill to talk about that, but as he said earlier, it’s running like a top.

William Schuster

The analysis which has been fairly extensive including not only review of the data from the satellite but also a number of ground models where we’ve actually built up hardware and tested it, has isolated the likely cause of the problem to a particular area. The good news with respect to the satellite is that it’s a unique circumstance that would not be repeated anywhere else in the satellite.

With regards to a fix, the answer is that we’re operating quite well right now, and we don’t have any plans at this time to make any changes.

Matthew O’Connell

You notice that we’ve signed some new contracts. We’ve collected these millions of square kilometers, so we’re not sure why we would tinker with it. The customers aren’t complaining so it’s not an issue.

Jeff Rath – Canaccord Adams

Obviously it’s operating like a top as you said. Thinking about your GeoEye-2 decision, I understand that it’s subject to a bunch of other discussions there, but what is the fastest that you could build the satellite. When could you realistically be ready for launch? Is it still the earliest you could be out would be late 2012 or is there a scenario under which you could actually deliver incremental capacity sooner?

Matthew O’Connell

I think we ought to stick to the line we’ve been using. Late 2012 would take a lot of effort. We can get there. We are hoping that we’re chosen and that we can provide that to the government. Advancing that a lot, you don’t want to advance things too much because then you incur risk because you’re rushing people on complicated work. I’d say late 2012 is the target that we’re shooting for.

Jeff Rath – Canaccord Adams

As we think about your cash flow characteristics going forward through 2010, can you give us any color on how to think about your cash tax rate? I think we’re getting a better handle on how to model the reported tax rate here going forward, but how should we think about that your cash tax rates going forward?

Joseph Greeves

You’re saying the tax effect on cash?

Jeff Rath – Canaccord Adams

Yes. Essentially we don’t see your tax reporting as clearly so any color you can give us to understand the delta on how much you’re going to report on income taxes and how much you actually will be paying in the coming 12 months.

Joseph Greeves

I don’t have specifics that I can give you but I can give you some general idea. Because of the tax depreciation that the company uses which is referred to as accelerated depreciation for five years of satellite, the taxes are minimized. So effectively, there’s not a lot of tax cash payments being made over the remainder of 2009 or likely in 2010 as a result of that.

That’s really kind of the benefit there. And then also we’re incurring some expenses on the new satellite which might be characterized as R&D which are probably deducted on a more current basis.

So hopefully that gives you some insight.

Operator

Your next question comes from [Mark Halper – Bluefin]

[Mark Halper – Bluefin]

Cash flow was excellent. I was wondering if you could walk through some of the dynamics there because I think you had some tax items in there, but also going forward is there a way to think about your cash flow expectations relative to EBITDA or something given that so much of your revenue comes from deferred but you have very little cash operating costs.

Joseph Greeves

I can give you some general guidance on that front. The company benefited this quarter. Basically we reduced our receivable, prompt payment receivables a little bit higher last quarter, so that was one generation. The second is the company collected a $20 plus million income tax receivable this quarter which added to the cash balance.

And then third, the company received proceeds which ends up being approximately $110 million from the debt financing. So I believe the company will end the year with about $225 million in cash, then in general modeling I believe that the company should produce somewhere in the neighborhood of $75 million to $80 million in cash flow for the year average over the next three years. So that will give you a ball park, and it may be a little more positive after tax.

Operator

Your next question comes from [Anthony Clairman – Deutsche Bank]

[Anthony Clairman – Deutsche Bank]

Given that the bond deal closed after the quarter’s end what was the pro forma cash and given that you raised more than you needed to refinance the existing note, are there any restrictions around the extra cash that was raised as part of the financing?

Joseph Greeves

I think I actually said the company has bout $225 million on a current basis. That’s the way I would characterize the pro forma cash position which if you take the $123 million then add on the $110 million in additional proceeds, I’ve got a pick up interest payment deducted out of that, so as I said I think you’re going to end the quarter with about $225 million, in that ball park.

[Anthony Clairman – Deutsche Bank]

Are there any amounts in that cash balance that are restricted for any reason or is it all unencumbered cash that you can use for any purpose?

Joseph Greeves

Approximately $47.5 million is restricted which was part of the additional amount that we raised in the finance. The restriction is that the company in order to accelerate that or bought out of the escrow, have to be awarded a contract from the NGA related to the next satellite.

[Anthony Clairman – Deutsche Bank]

So as soon as NGA would happen or on that basis, it becomes unrestricted cash that you can use for any purpose, the most likely one being the construction or the completion of the construction.

Joseph Greeves

That’s correct.

[Anthony Clairman – Deutsche Bank]

If I look at your last two quarters of EBITDA and I annualize those, you’re going to be at a leverage number that’s well inside of three times in the not too distant future and it will probably go considerably below that if you in fact fund your next satellite with primarily the excess proceeds from the deal and free cash flow. I’m just wondering if I could get your thoughts on long term how you want this balance sheet to look from a leverage perspective and whether you would consider raising additional debt to fund any of your future construction needs.

Joseph Greeves

Out of the debt agreement we have availability for another $50 million and I think you’re correct that we end up with about three times leverage. So right now we’ll be opportunistic in how we raise funds. Right now for the foreseeable future with the amount of cash we have at the end of the year, I don’t even make any firm commitments on that and I think we’ll be opportunistic the way things play out on how we roll out our capital structure.

Operator

There are no further questions. Mr. O’Connell, I’ll turn it back to you for any additional or closing comments.

Matthew O’Connell

Thank you all for dialing in and taking part in our call. We’re looking forward to talking with you next quarter.

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Source: GeoEye, Inc. Q3 2009 Earnings Call Transcript
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