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DigitalGlobe, Inc. (NYSE:DGI)

Q4 2013 Earnings Conference Call

February 26, 2014 11:00 AM ET

Executives

David Banks – IR

Jeffrey Tarr – President and CEO

Yancey Spruill – EVP, CFO and Treasurer

Analysts

Andrea James – Dougherty & Company LLC

Peter Appert – Piper Jaffray & Co.

Howard Rubel – Jefferies & Co.

Chris Quilty – Raymond James

Mark Strauss – JPMorgan

Jim McIlree – Chardan Capital

Operator

Good day ladies and gentlemen and welcome to the DigitalGlobe Fourth Quarter 2013 Earnings Conference Call. All participants are in a listen-only mode until the question-and-answer session begins following the presentation.

(Operator Instructions). Today’s call is being recorded and is also being broadcast live over the Internet at www.digitalglobe.com.

In addition, there are supplemental materials that will be referenced in today’s call available at the company’s website. To access those materials, please go to the Investor Relations section of the company’s website at www.digitalglobe.com.

I will now turn the call over to David Banks, Investor Relations for DigitalGlobe.

David Banks

Thank you, Ashley. Good morning everyone and thanks for joining our call today. With me on the call are Jeff Tarr, President Chief and Executive Officer; and Yancey Spruill, Chief Financial Officer.

Our remarks today will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended. Any forward-looking statements are based upon our historical performance and our current plans, estimates and expectations. We may make forward-looking statements about, among other matters, revenue and revenue growth, adjusted EBITDA and adjusted EBITDA margin, earnings per share, cash flow, sales pipelines and strategic initiatives.

Inclusion of this forward-looking information should not be regarded as representation by us that we will achieve future plans, estimates or expectations. Such forward-looking statements are subject to various risks and uncertainties and assumptions. A number of important factors could cause our actual results or performance to differ materially from those indicated by such forward-looking statements. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect occurrence of unanticipated events.

Please refer to our earnings release, which can be found at our website at www.digitalglobe.com, for a discussion of these risk factors. You should also refer to our earnings release for an explanation of the non-GAAP financial measures discussed during this call and for a reconciliation of those measures to the nearest applicable GAAP measures. These non-GAAP measures are indicators that management uses to provide additional, meaningful comparisons between current results and prior reported results, and as a basis for planning and forecasting for future periods.

For your convenience, we have posted slides on the Investor Relations section of our website at www.digitalglobe.com to give you an overview of the information we will cover today. During the Q&A session, please limit your questions to one plus a follow-up and then re-enter the queue if you have other follow up questions. With that, I’ll turn the call over to Jeff.

Jeffrey Tarr

Thanks, David. Good morning. Thank you all for joining us for today’s discussion of our fourth quarter and full year results.

2013 was a transformative year for DigitalGlobe. We exited the year as substantially larger and more capable company. We brought together two industry leaders, removed more than $100 million of operating cost and made great strides in completing the world’s two most capable commercial earth observation satellites, one which will be launched later this year and another which will be launched when needed.

By any measure we are the technology and industry leader, well positioned to deliver long-term profitable growth and free cash flow generation and realize our vision as the indispensable source of information about our changing planet.

Today, I plan to discuss our integration successes; update you on our 2013 full year and Q4 results; provide a preview of 2014; and take some time to discuss our acquisition of Spatial Energy. I’ll then hand it over to Yancey, who will provide more details with regard to our financial performance and update our guidance.

Starting first with the integration, our team made great strides combining what were once two fierce competitors into one integrated company with one common culture, built around a unifying purpose, vision and values. Through the course of the year we also integrated numerous duplicative systems, improved our operations and expanded our capabilities. In the process, we removed nearly $130 million of annualized cost from the business, including more than $100 million of operating expense and $26 million of financing costs.

We exceeded our original target of $100 million in operating expense reductions and we achieved it fully seven months early. Moreover we’ve determined that there is even more synergy than we originally anticipated, and today are raising our target by an additional $20 million.

The focus of our integration efforts in 2013 was on cost reduction. That cost reduction has now driven three straight quarters of strong sequential EBITDA margin expansion. With a fourth quarter adjusted EBITDA margin of $49, up nearly 900 basis points sequentially, we are well positioned to achieve our original commitment of $50 EBITDA margin upon completion of our 18-month integration effort.

In 2014, our integration work will focus primarily on customer experience and growth. We expect the work we complete in 2014 to produce the incremental $20 million of cost savings, but more importantly to create a seamless customer experience and enhance our ability to scale to achieve our $1 billion revenue growth aspiration. Examples of this next phase of our integration program include consolidation of our order entry and collection planning systems.

Let me now turn from the update on our successful integration to my second topic, our Q4 and 2013 results. We grew revenue by 35% in the fourth quarter and 45% for the full year. We grew our U.S. Government business by 29% in the fourth quarter and 38% for the full year.

A key contributor to our recent growth has been Global EGD. Our significant investment in creating this breakthrough platform to process and deliver imagery in near real time is changing the way customers across the U. S. government access and use imagery. In recent months we’ve seen rapid acceleration of adoption and usage and intend to apply this capability to deliver even more value to our largest customer.

We grew our direct access business by 113% in the fourth quarter and by 86% for the full year, surpassing the $100 million annual revenue mark. We achieved this fourth quarter result in spite of the fact that our newest customer didn’t come on line until the middle of Q1.

Taken together our U. S. Government and Direct Access businesses are of great importance. Both are attractive, growing revenue streams that, combined, represent 75% of our revenue base, are highly recurring in nature and exhibit strong renewal rates. While we were pleased with our results in these two areas we were disappointed in the performance of our Diversified Commercial revenue beyond our Direct Access business, and we are taking steps to get this area back on a strong growth trajectory.

On our fourth quarter call, we acknowledged revenue risk, but the shortfall was larger than expected. Our international civil governments business, which is concentrated in emerging markets and is largely project-based accounted for nearly all of the weakness. Civil government budgets became unexpectedly constrained due to macroeconomic and political factors, including a stronger U.S. dollar that rendered our products more expensive in certain local currencies.

While most of that revenue remains in our pipeline and some is now included in our backlog, we didn’t close enough business in time to deliver commercial growth in the quarter. We also saw increased competition in a small part of our business characterized by lower resolution, lower accuracy offerings.

Purchasers of this type of imagery tend to be more transactional in nature and often come to us through non-exclusive resellers. While we intend to continue to compete in this segment primarily using Ikonos and Quickbird, our top priority will continue to be with customers who value our superior resolution, accuracy and spectral diversity combined with our image processing, mining and analytics.

Reinforcing this strategy, we were encouraged by a number of key wins with customers who value our superior resolution and accuracy, including a major multi-year agriculture monitoring program with the European Commission. This deal is expected to generate several million dollars of revenue annually over each of the next four years. Our superior 50 centimeter native resolution, accuracy and collection capability were key differentiators behind the win and allowed us to command a meaningful premium over competitors.

I’m also pleased to announce that this week, we signed a multi-year renewal with Google, a strategically important customer in our LBS customer group. We also signed emerging market deals in India and another in the Middle East and added others to our pipeline, lending confidence to our view that current emerging market challenges are temporary.

Going forward we will capitalize on our superior resolution, accuracy and spectral diversity to re-accelerate our sales cycle and get our diversified commercial business back on a strong growth trajectory. Specific near-term actions include stronger marketing and value propositions; new products as discussed in our recent investor day including Advanced Country Coverage, Global EGD, Geospatial Big Data offerings and Analytics; stepped up efforts to secure permission from U.S. Government regulators to sell our 30 cm imagery; leveraging the first generation satellites in our fleet, Quickbird and Ikonos, Ikonos rather to compete more aggressively with the comparable 70-centimeter satellites in our competitors’ fleet; and where reseller performance is lacking, pursuit of alternative routes to market.

To this end we have completed the acquisition of Spatial Energy, a value-added reseller with a strong position in the oil and gas vertical. More on that later.

I’d now like to move on from 2013 and Q4 to the next topic and preview some of what we see as we look ahead to the balance of 2014. With regard to our outlook we expect 2014 revenue growth in the mid-single digit range. Longer term our growth aspirations are higher. While emerging markets may well continue as a headwind in our commercial business in the near term, we remain confident in the underlying demand for our services in this customer group.

More importantly, we expect our growth to get a substantial boost beginning in late 2014 with the step up in our EnhancedView SLA, with further acceleration in 2015 as we more fully commercialize WorldView-3, which is on track for a mid-August launch. Resolution restriction relief will create new opportunities for both our existing constellation and GeoEye-2. Acquisitions like Spatial Energy and new product offerings in the realm of Geospatial Big Data and Analytics that we shared at investor day will further advance our progress towards our $1 billion revenue milestone.

As for our bottom line, our synergy savings have positioned us well to deliver EBITDA margins of at least 50% and free cash flow margins of at least 20% by the fourth quarter of 2014. These all important metrics should be further enhanced with continued top line growth in 2015 and beyond.

Finally I’d like to share a few more details on our acquisition of Spatial Energy. Spatial Energy is the leading provider of satellite imagery, radar, aerial imagery and approximately 50 other geospatial data sets that run through a sophisticated on-demand platform geared specifically to the energy industry. Their customers, which include 12 of the top 20 oil and gas majors around the world, use Spatial Energy’s offerings primarily to support exploration-related activities.

We see a number of key strategic benefits. Spatial Energy will position us much closer to end customers in the important oil and gas vertical, one of the very largest end markets for information. It will be accretive to our diversified commercial growth. In addition to the opportunity to add new oil and gas accounts around the world, we expect to grow existing accounts by using our analytics, emerging Geospatial Big Data and other capabilities to deliver more value.

We are delighted to welcome the Spatial Energy team to DigitalGlobe and look forward to working with them to serve our new customers in this important vertical market.

With that, let me turn it over to Yancey.

Yancey Spruill

Thanks Jeff. We truly transformed our business in 2013! We combined two similarly sized organizations and asset platforms and delivered significant sequential margin improvement, driven by outperformance on the integration and revenue growth.

Achieving this level of cost take-out early is a testament to our 2013 strategy that focused on delivering the integration. It positions us well to continue driving margin expansion during 2014 as we return our business to at least 50% adjusted EBITDA margins in Q4 of this year.

As Jeff noted, we exceeded our original synergy target of $100 million of operating expense savings, and have targeted an additional $20 million of savings we expect to achieve by the end of the third quarter of this year. We remain on track to complete our integration effort, complete construction on our two satellites, and generate significant free-cash flow in Q4 of 2014 and beyond.

We are very pleased to exceed our Q4 adjusted EBITDA target despite lower than expected revenue. Revenue for the quarter was $169.7 million, up 35% year-over-year. Pro forma revenue growth was 3.2% compared with last year’s Q4 pro forma revenue of $164.4 million.

U.S. Government revenue in the quarter was $97.1 million, up 29% compared with Q4 2012 and 10% pro forma. Included in that revenue is $56.8 million from our EnhancedView Service Level Agreement or SLA, flat compared with Q4, 2012. Our SLA revenue is expected to increase when we begin delivering higher volumes of imagery anticipated to be in Q4 following the launch and commissioning of WorldView-3.

U.S. government value-added services was a significant driver of our growth in the quarter, and at $33.9 million was nearly three times the $12.3 million in revenue we generated in Q4, 2012, and up 35% pro forma. Growth was driven by Global EGD, as our platform delivered at scale for the first full quarter, as we met expanding customer requirements on this important service.

Value added services revenue within our insight and analytics group was impacted by the government shutdown, as we had noted was possible on our third quarter call. Diversified Commercial revenue was $72.6 million in the quarter, up 45% on a reported basis, but down 4.6% pro forma.

Within Diversified Commercial, Direct Access revenue was strong at $28.5 million, up 113% compared with Q4, 2012, and 27% pro forma. Growth was driven by increased usage from existing customers and by the one-time purchase of other services by one of our larger DAP customers.

We delivered revenue of $44.1 million in Diversified Commercial outside of DAP, up 20% year over year on a reported basis, but down 18% pro forma. As Jeff noted, delayed closings on certain international civil government opportunities in Q4, particularly in emerging markets drove most of the year-over-year revenue weakness. Most of those Q4 revenue opportunities remain either in our 2014 pipeline or have moved to our backlog. Our next 12-month revenue backlog increased 20.5% to $506 million.

In Q4, we generated $82.7 million of adjusted EBITDA, a margin of 48.7%, up 890 basis points sequentially, and once again reflective of the leverage in our business as we realize the benefit from synergies. Note, adjusted EBITDA excluded $9.2 million of integration related expenses.

Through the end of Q4 we have exceeded our initially projected $100 million in total annualized operating expense savings from the combination, and are now increasing our synergy target to $120 million. We realized approximately $25 million of benefit from operating synergies in Q4, and expect to realize the full $120 million run-rate in Q4 of this year. As a reminder, the refinancing we completed just prior to the GeoEye acquisition created significant annual synergies on top of the operating expense savings as interest costs were reduced by approximately $26 million per year.

Depreciation and Amortization was $59.1 million in the quarter, up $31 million year-over-year. About 87% of the increase reflects a full quarter of depreciation from acquired assets and the balance from infrastructure we placed into service to more closely integrate our operations with NGA earlier this year.

Net interest expense was de minimis in the quarter, reflecting capitalization of substantially all of the $13 million in quarterly interest on our debt. We expect to capitalize interest at these levels in the first half of this year. After that, interest expense will ramp up as GeoEye-2 is completed and placed into storage, and we launch and commission WorldView-3. By the end of 2014, we expect to expense most of our interest.

Our effective tax rate for the year was 35.4%. This annual effective tax rate resulted in an income tax benefit of $600,000 for the fourth quarter. We estimate an approximate 38% effective tax rate for 2014, and we do not expect to pay material cash taxes this year or for at least two years beyond 2014. We achieved profitability this quarter, with net income of $13.6 million available to our common shareholders.

In 2013, Restructuring and integration-related spending totaled $91.9 million of which approximately $69.3 million were expensed and $22.6 million were capitalized. Our net use-of-cash in the quarter totaled $27.2 million, driven by timing of receipts from the U.S. Government and a payment to our GeoEye-2 vendor associated with the renegotiation of our launch vehicle and satellite contracts. CapEx in Q4 was $75.5 million.

Now for our 2014 outlook. In 2014, we expect revenue in the range of $630 million to $660 million, an adjusted EBITDA margin of approximately 43%, and to return to positive free cash flow. At the midpoint of our guidance we assume we begin recognizing revenue for the SLA on November 15th, which reflects $25 million less revenue than prior models, which assumed a September 1st step up in the SLA revenue.

Given the very high incremental contribution margin for the SLA revenue, the impact on 2014 adjusted EBITDA margins is roughly 200 basis points. For reference, as you model revenue progression for the year, please keep in mind that we had a $9 million catch up in Global EGD as the system ramped to full capacity in Q3, 2013, creating a challenging growth comparison this year.

Importantly, the expected $50 million annual increase in cash payments associated with the SLA step up begin September 1st. The annual payments will increase to $25 million per month or $300 million per year. We expect to generate 47% of our revenue in the first half and 53% in the second half, with quarterly revenue percentages expected to be in line with our historical averages, with the exception of Q3, which will be slightly lower, related to the year-over-year item just mentioned.

We expect to realize adjusted EBITDA margins for the year of approximately 43%, and margins of at least 50% in Q4, back to our long term target. Our increase in expected integration-related savings will require approximately $65 million of additional spending in 2014, with integration-related spending to be complete in the third quarter. We expect to expense approximately half of integration-related spending, with the balance to be capitalized.

We expect to achieve free-cash flow as a percentage of revenue, or free cash flow margin, for the year of approximately 5%. We expect free cash flow to be slightly positive to slightly negative in the first three quarters depending upon timing of CapEx, and then be at least 20% in Q4, in line with our longer term target. We expect our cap-ex for the year to be approximately $170 million, with the vast majority to be spent by the end of the third quarter.

With that, I will now turn the call back to Jeff.

Jeffrey Tarr

As we move beyond 2013, a year defined by a truly transformative integration, there is much to look forward to in the year ahead. We will deliver a full year of our $100 million of operating cost take out, and remove another $20 million from the run rate by this year’s fourth quarter. We will launch the world’s most advanced commercial imaging satellite in the history of our industry with 30 centimeter resolution and short-wave infrared. With the foresight of leaders in Washington we will be given the opportunity to commercialize our superior resolution.

We will bring new Geospatial Big Data and analytic offerings to market. We will grow current customers and win new ones across all customer verticals. We will realize the potential of our acquisition of Spatial Energy and other acquisitions yet to close. And with the completion of our combination and capital investment associated with WorldView-3 and GeoEye-2, we will begin generating robust free cash flow that will fuel continued creation of shareowner value.

All of this will be possible because of the relentless commitment of our DigitalGlobe team members to our customers and our purpose. By enabling our customers to see the earth clearly and in new ways we help them make our world a better place. It is this commitment that moves us closer each day to achieving our vision of becoming the indispensable source of information about our changing planet.

With that, operator, let’s please open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Andrea James of Dougherty & Company. Your line is open.

Andrea James – Dougherty & Company LLC

Hi, thank you for taking my questions. Well guys at the analyst day in November you’ve guided to long term average growth of about 10% and I guess I didn’t hear you saying at the time also by the way 2014 is going to be significantly south of that longer term average. The question as you know why not rein expectations at that point and did something in the business change between now that sort of surprised you on 2014?

Jeffrey Tarr

Yes thanks Andrea. There were two factors that caused the revenue challenge in the quarter. So let me talk about that and then bridge over to your second question which is the more future looking one.

These two factors were slippage of international government business in emerging markets and new competition for our transactional business which is at the very low end of our market constitutes the total about 5%, 6% of our total business. In terms of what we saw at the time because you asked about November and how we were seeing the future there were these two factors came into play. So if you look at our emerging market business those issues came on suddenly for us and others and in an area where much of our business is project based and concentrated in Q4.

As for the transactional business that business is conducted primarily through non-exclusive resellers, they are small transactions exactly how they found and therefore by the very nature have limited visibility. As we look forward and think about our long-term growth targets which we still feel are intact, there are two main factors. Number one as Yancey talked about the timing of the launch. This accounts for $25 million of revenue that came out of our revenue guidance essentially, that $25 million will still be receive as cash, it just won’t be recognized as revenue in the year.

And then secondly as we put our guides together we’ve assumed that it takes time for emerging markets to recover and it takes time for us to address that competition at the very low end of our transactional business. Offsetting this we’ve identified $20 million of cost savings associated with the integration so while our 2014 revenues are somewhat below long-term targets our EBITDA and cash flow generation should be strong and more in line with how we seen the year progressing.

Andrea James – Dougherty & Company LLC

It is helpful. And then you said your – the satellite launch timing cost you $25 million in revenue recognition on the government side but how much of the timing affect the commercial business I mean I think of I guess you had revenue down by about $50 million and I am trying to figure out how much of that is just modeling into soon when the shortwave infrared and the added capacity actually contributes your revenue.

So the question is when does the next satellite launch really start contributing to revenue in a meaningful way?

Jeffrey Tarr

I think that you are correct in that assumption that with the shift in the launch timing and the availability of imagery to customers that also pushes out the commercial business. And you should also assume that availability of shortwave infrared lags availability of four band – of first four bands of the imagery.

Andrea James – Dougherty & Company LLC

What pushed out the launch timing?

Jeffrey Tarr

Well, the satellite itself has been on track but there are factors associated with launch timing that are beyond our control, including the availability of the launch windows. There is one place where we launch the satellites and so that ends up being somewhat dependent on what other launches are planned for that location it’s also availability of crews. So the crews are often shifted between East Coast and West Coast. So there is some complexity here that’s beyond our control.

Andrea James – Dougherty & Company LLC

You cited the first time you were here, was any of the tied to the solar storms in January I know that punched a lot of satellite launches out?

Jeffrey Tarr

Not that I am aware of, did it effect the manifest I wouldn’t know but certainly with the available – with our satellites availability to launch now.

Andrea James – Dougherty & Company LLC

And finally the CapEx of $170 million is a bit higher than you’re expecting, can you just talk about what’s going on, on the CapEx on 2014?

Yancey Spruill

Hi Andrea it’s Yancey I think one item that is new today we’re taking up synergy estimates by $20 million incrementally and the spend to go get that is about $65 million half of that will be expensed as integration of restructuring cost and the other half about $32 million is CapEx. And so if you net that off of the $170 million that’s roughly just below $140 million.

The balance of the most vast majority of the remaining CapEx is tied to the satellites about $80 million tied it will be three satellites including a third of that insurance payments and then the balance just to close out GeoEye-2. We did modify our contract with Lockheed on GeoEye-2 in Q4. We’ve made out significant payments to them in Q4 but we also have some additional testing and other work that we are doing to get that satellite in a condition that it meets our spects and that accounts for some additional spending as well.

But I think the principle item on $32 million of CapEx tied to the additional integration in savings is probably the biggest delta that we announced today.

Operator

Thank you. Our next question comes from Peter Appert of Piper Jaffray. Your line is open.

Peter Appert – Piper Jaffray & Co.

Thanks. So Jeff the guidance for 2014 suggests that the weakness in the commercial channel is not just about timing of closing deals. So can you expand on that – are you seeing some things in terms of the other industry verticals or the location based services that makes you more cautious in terms of the ability to scale commercial business?

Jeffrey Tarr

So the factors are Peter the ones that I pointed out. So emerging markets. And that is in Q4 it was about timing we did lose a lot of business to a few projects that were cancelled. There were some projects that shifted to Q3 – Q1 rather some of which are closed, some of which are still in the pipeline.

Keeping in mind that some of these markets, the imagery season is primarily a fourth quarter, late third quarter event and so we won’t know about some of those deals till late when the budget got squeezed they didn’t – some of them didn’t just slipped one quarter they slipped four quarters. And like the rest of the world we need to see some stability in recovery with government budgets in emerging markets to really feel good about that particular part of our business.

The demand is still there and our competitive advantage with those customers is still there. So we feel good long term even though there is a short-term challenge. Within other verticals that is where most of the transactional business sets. Transactional business cuts across most of the verticals but its concentrated there.

It truly is what it sounds like $10,000, $15,000 $20,000 one-time transactions for imagery, more price sensitive so impacted by as we said competition, impacted by some pricing issues currency issues in emerging markets as well to some extent. Our plans there entail sales and marketing, doing a better job of segmenting our customers those who value the higher resolution versus those in that transactional segment, that don’t and then finding new ways of adding value and getting closer to our customers, but just through the acquisition of Spatial Energy.

But we’ve assumed that that takes several quarters to recover much as we assume the emerging markets take several quarters to recover.

Peter Appert – Piper Jaffray & Co.

By ‘15 you can get back to north of 10% growth in the commercial channel?

Jeffrey Tarr

Yeah, without breaking down the business segment-by-segment we feel very good about 2015. If we think about 2015 we’ll have a full year of WorldView-3, with Shortwave infrared, we will have made tremendous growth I believe into the oil and gas vertical and potentially into some other verticals through other acquisitions in our pipeline, should things play our way in that part of our business.

We have new products such as the Geo-Spatial big data product and analytics product that we showed at Investor Day that aren’t contributing to revenue today but reasonably should start to contribute by the time we get to 2015. And we have our integration we’ve made great progress on the integration. We’ve made tremendous progress on the cost side of the integration. We have more work to do to bring the systems together that allow us to utilize the full potential of the integration from a revenue perspective and we expect that to be behind us and opportunity going into the end of this year in 2015.

Peter Appert – Piper Jaffray & Co.

Last thing, the resolution restriction relief what’s the timeframe on that?

Jeffrey Tarr

Yeah and that’s another one which I just didn’t mention in the list. Right now it’s top of mind for everyone. We filed for resolution restriction relief in May. Our government stakeholders across multiple agencies have been actively engaged in reviewing the application. We feel very strongly that relief enabling us to sell our full capability with regard to resolution is important for the long term health of the industrial base and so we think logic is on our side we are working with our government stakeholders, they are doing their jobs and we are hopeful that logic prevails here and that we get the relief that we need to compete fully with our foreign competitors.

Peter Appert – Piper Jaffray & Co.

No timeframe specifically you can talk about?

Jeffrey Tarr

You know it’s impossible to speculate on the timeframe. Other than we are coming up on the one year anniversary of our application, so hopefully that creates some sense of urgency.

Operator

Thank you. Our next question comes from Howard Rubel Jr. of Jefferies. Your line is open.

Howard Rubel – Jefferies & Co.

Okay, thank you very much. Couple of things, first Yancey maybe you could if you could add a little bit of color as to what sort of costs you can take out with all of this incremental restructuring and how does it help the business run more efficiently?

Yancey Spruill

Well couple of points. The first $100 million, the breakdown was about 50-50 people and then infrastructure. This next $20 million of incremental synergies is going to be around making the customer experience better so it’s going to be about more technology, it’s going to be about a better infrastructure and opportunities we see to rationalize that and combine systems even further. It’s going to be about elimination and reduction of contractors and then procurement savings.

We made some progress in 2013 on some procurement on the combined company but that’s a meaningful opportunity for us, so that will be the next $20 million. It can be a lot more about technology and procurement and contractor a lot less of it and people than we had in 2013.

Howard Rubel – Jefferies & Co.

And things like professional fees does that like go away in a big way when you talk about contractors?

Yancey Spruill

Well, we have a lot of IT. There’s a big IT effort as it relates to the combination we also have some satellite development and other activity so we are just going to rationalize that. And then you know other IT infrastructure to make us even more efficient in serving customers and then we are going to get procurement savings by really squeezing on how we spend our money with the vendors.

Howard Rubel – Jefferies & Co.

And then on EGD great run rate again in the fourth quarter even with sequester. Why – how do you sort of see that I mean this is part of the GeoEye combination one plus one gets two plus a lot more. Do you see that business holding it roughly at this level or is there some downward pressure to it?

Jeffrey Tarr

It’s global EGD which was the new platform that we have been building over the last several years. It’s now offering at scale. It allows us to process virtually on the fly the enormous volume of imagery that we capture and what we call our daily take or our daily collections and make it available typically within couple of hours of collection to U.S. government customers around the world.

So it really is a very compelling offering. We are seeing a very substantial and see the curves are exponential in nature on both adoption and usage of this platform and the potential for us to add more value to this platform is very substantial. So we feel really good about it. I would say at the midpoint of our guidance we are assuming that it remains funded at its current level into the next fiscal year which impacts the tail end of our year and that’s our going in assumption.

Howard Rubel – Jefferies & Co.

So Jeff if I kind of understand its right I mean that would sort of imply $120 million for that line item, roughly order magnitude not rough order magnitude is not unreasonable?

Jeffrey Tarr

You know that Yancey I will let you go into detail but that contract is more in the $50 million to $55 million range in terms of the cash that we receive so why don’t you talk about how the revenue recognition…

Yancey Spruill

So I think the run rate revenue you see in Q4 is certainly what we see in the first half and for a big part of Q3 and then there is some amortization as well as the cash that Jeff referred to that’s driving EGD revenues. We got the systems up to capacity last year and then in the second half of the year we assume it’s renewed but that amortization will be slightly lower and so we’ll be starting to recognize revenue more closely to the cash rate, little bit higher than the cash rate but closer to that than we are today.

Jeffrey Tarr

Now let me wrap with just couple of additional thoughts on that. We continue to innovate in this area, the opportunity to continue to save tax payer’s money while delivering higher quality of service against faster timelines compared to previous ways of doing this kind of work is very substantial and we are focused on continuing to innovate and deliver. We have actually seen in recent months smaller opportunities come our way to do just that and we’ll stay focused on this through the year and beyond.

Yancey Spruill

One additional comment to get to your number Howard we do have US government analytics and other value added services that would get you closer to that sort of a number that you just mentioned. It’s not just all EGD we do, we do other production, services and then obviously we have the insight in analytics revenue stream that we contribute into that value added bucket.

Operator

Thank you. Our next question comes from Chris Quilty of Raymond James. Your line is open.

Chris Quilty – Raymond James

Thank you. Just a follow up on some of the transactional price competition, it’s your understanding that most of that price competition being driven by the [HD] satellite or is it more related to you know international government owned medium resolution satellites and internalizing the capability.

Jeffrey Tarr

It’s the former you know we have [native] satellites as you know we have 70-centimeter satellites at their best resolution they’re being re-sampled and marketed. At 50-centimeter even though they are native 70 so there is a very substantial different between native 70 and our native 50 or better but to the transactional customer who is coming in often through a resale of what we just focused on just trying to get that small ten thousand transaction done, he more susceptible to a price pressure, more susceptible to confusion in the marketplace about the differences between native 50 and re-sampled 50.

Those are issues that don’t play a significant factor with our larger customers the bigger projects the ongoing relationships but in the transactional part of our business we have some work to do to clarify our value proposition.

One of the things that we have done is launched a new product offering that is a 70-centimeter product offering. It is superior in terms of graphic quality and accuracy to our competition at a competitive price point and yet differentiated from our true 50-centimeter or higher resolution native offering. So more to do here work to be done. We believe ultimately we will be successful in turning that part of our business too but we have allowed ourselves for few quarters in our guidance to get there.

Chris Quilty – Raymond James

And again is most of that imagery the transactional imagery content that’s coming off the old Quickbird Ikonos or is it some of it just coming off the newer satellites?

Jeffrey Tarr

Great question from Quickbird and Ikonos that’s where we compete on tasking for 70-centimeter because these satellites you know while they are 13 years old are superior satellites to what others are talking about today but the other opportunity is actually taking our 50-centimeter imagery and sampling that in a way, processing that in a way that it gives a higher quality 70-centimeter product differentiated from our native 50. And so we are doing both.

I want to emphasize at this part of our business is about 5% to 6% of our total revenue concentrated in other verticals it’s still a good size business but it I wanted to give you a sense of how much of our business is impacted by the lower resolution competition?

Chris Quilty – Raymond James

And just when you look at the end market I mean 5% to 6% today. Is that a just on an absolute basis is it a growth business over time? Or is that a part of the market that you think will stay flat or decrease?

Jeffrey Tarr

Well you know it is like all of our business we believe that there is growth opportunity there, in many cases there is additional value added by value added resellers to that product. And so there is growth potential there, has it been a big contributor to our growth, no but could it be a big contributor to our growth in the future, certainly.

Chris Quilty – Raymond James

Okay and finally on the acquisition can you just give us a little background on what your relationship was prior to the acquisition and just give us a sense of what it’s going to take operationally to integrate their software and platforms with yours?

Jeffrey Tarr

I will give you little history the team that started Spatial Energy actually one start works for DigitalGlobe, left the company about eight years ago to start Spatial Energy. And the company’s resellers of ours are focused on the oil & gas vertical, they add value they have a part of their business is a subscription platform that we think has great potential for growth within both oil & gas are potentially like other verticals like mining over time. Part of their business is also just a transactional business reselling imagery including outside light imagery, imagery from others radar, aerial.

And we excited about the potential small, this year it relative to our total business. About $1 million to $3 million of revenue in any given quarter but we believe that longer term potential 2015 and beyond as we add value to the platform as we uniquely do with our geospatial big data and larger constellation there is a huge opportunity here. Oil & gas is a gigantic vertical for information.

Operator

Thank you. Our next question comes from Jason Gursky of Citi. Your line is open.

Unidentified Analyst

Hi good morning everyone. I wanted to talk a little bit about U.S. government behavior specifically on value add and kind of like this some of the budget comments I mean that defense – made the other day and as well your SLA negotiation how you feel about that heading into the summer?

Jeffrey Tarr

Our SLA is in solid in well position we deliver great value to the U.S. government and I think you recently hear our you heard you saw in our release not our release but our script that we did signs amendment to the SLA which reaffirms the commitments to the step up starting September 1st. We feel very good about that and that’s not something we worry about a lot here we focused on how we can deliver more value to tax payers everyday meet and exceed their expectations and we believe by continuing to do that we are at great shape.

The Global-EGD that is one way we are working with our customer to much sure that there is adequate funding in next fiscal year as we seeing we are delivering grate value there and focused on delivering more value to customers. And there is a portion of our business about $40 million of revenue that’s analytics highly concentrated with U.S. government multiple contracts does enter more contracts and we feel there good there also about the value that we are delivering and how that’s differentiated from our competitors in that part of our business given our access to constellation and our unique analytics geospatial big data and capability.

So overall our view in the U.S. government is very positive and we think we have a unique and compelling value preposition that should position us well.

Unidentified Analyst

Okay great thanks and you can tell by voice it’s actually John [inaudible] here. And quick follow up at the investor day you guys talked a little bit about 25% free cash flow margin 2015. Is that something you still think is possible?

Jeffrey Tarr

What you should read into this is we are not giving 2015 guidance today but we haven’t changed our long term view that the long term view on EBITDA margin free cash flow margin long term growth our ability to achieve a billion in revenue all of that is unchanged. You know we saw in Q4 and what we are saying in the first part of we may see in the first part of 2014 is isolated to factors that we think are primarily short term in nature and we work strong.

Unidentified Analyst

Great thank you very much.

Operator

Thank you. Our next question comes from Paul Coster of JPMorgan. Your line is open.

Mark Strauss – JPMorgan

Yeah good morning. This is Mark Strauss on for Paul thanks for taking our questions. And I think the most important questions already been asked, but just quickly on the Google contract. I am just curious if the renewal included in an incremental both times as far as analytics or anything like that or if it’s just a kind of an extension?

Jeffrey Tarr

I wish I could share more we are grateful that Google has allowed us to disclose that we’ve signed this agreement with them but beyond that I am just not at liberty to go beyond it.

Mark Strauss – JPMorgan

Okay. And then with spatial can you talk about how much their historic revenue came from reselling your imagery versus other suppliers? And what will that relationship look like going forward will they still be allowed to work with other vendors?

Yancey Spruill

Hey, this is Yancey in Jeff’s just comment in that we should see about $1 million to $3 million of revenue per quarter, included in that is the netting effect of the fact that we were selling imagery to them that they would result. So but little bit over half of the revenues it comes from that type of sale and it’s not growing as fast as the subscription platform whether integrating the 50 or more that with layers that Jeff referenced in the script and in that I think that covers it.

Mark Strauss – JPMorgan

Make sense okay thanks guys.

Operator

Thank you our next question comes from Jim McIlree of Chardan Capital. Your line is open.

Jim McIlree – Chardan Capital

Yeah thanks good morning. I just want to make sure I haven’t straight it sounds like diversified commercial is flat to flattish in 2014 do I have that right?

Jeffrey Tarr

You have that right at the mid-point of our guidance.

Jim McIlree – Chardan Capital

Okay that’s it for me, thanks a lot.

Operator

Thank you. Looks like we have a follow up from Andrea James of Dougherty & Company. Your line is open.

Andrea James – Dougherty & Company LLC

Hi guys I was wondering if you could give us a way to give confidence that there is a growing market for the higher resolution offering. It seems like there is a lot of puts and takes in 2014 and it might this guides with going on when your commercial business. Could you strip up the satellite launch timing and the stuff like that? I mean do you have portions of the business that are growing 10%, 15% much faster than the company average? Thank you.

Jeffrey Tarr

There is a difference between looking at the business as long term trajectory and taking the snap shot of the quarter. We clearly have a headwind from emerging markets in our civil government business that impacted Q4 and we anticipate it may take several quarters to work through. We haven’t seen significant revenue losses there we’ve seen the couple of contracts go away or get differed indefinitely.

But mostly we’ve seen that revenues slept and that’s mostly project based. In our transactional business we’ve seen somewhat competitive loss small part of our business and we intent to claw that back through better marketing and sales efforts in that part of our business again relatively small part of our business 5% to 6%.

As you look longer term we are all great about the gross potential and the growth that we are seeing. Our defense and intelligence business and this is both domestically and internationally this is the part of our business that truly values our superior resolution and accuracy in capacity and central diversity is willing to pay for it and some growing business.

We are still a relatively small percentage of the spend of most of our large defense and intelligence customers spending on overhead architecture geospatial big data and analytics that represents substantial potential. WorldView-3 will bring forward new capability that’s never been available commercially that’s a growth opportunity. Products in our pipeline which aren’t generating revenue today obviously just put in the pipeline we feel very good about their potential for 2015.

And with Spatial Energy we now happen to have gotten a solid foothold in what is one of the very largest markets for information in the world. And what’s interesting about that information market is the work flow of most professionals in oil and gas starts with a map or an image, what a great place to be. So we feel very good about the growth of our business and appreciate the question.

Andrea James – Dougherty & Company LLC

And then putting the camera on the International Space Station and another guy they are talking about video of the earth – a lot about those capabilities and where they bump up against you? Thank you.

Jeffrey Tarr

Sure. First of all low resolution satellite imagery isn’t a new. We believe that the market is moving towards higher resolution, higher accuracy, greater spectral diversity and not just in the satellite imagery side of the business but also in geospatial big data and analytics. The higher the resolution the more spectral diversity the more data and the more data the more robust analytic work can be done across a wider range of applications.

So we believe where we are and where we are going is where the ultimate customer demand is and is going. In terms of the capabilities if you look at what we’ve got today, we believe that we can deliver today and are generating revenue today from what others talking about doing three years from today. We already have three times revisit per day given the large size of our constellation and capacity of these satellites with WorldView-3 that will step up to more than four times revisit per day again greater spectral diversity.

And we did something called multi-frame it’s not just about video multi-frame is not as many frames per second as video but when we think about government and business applications we believe that with the multi-frame capability that we have today we can answer virtually all of the questions that one could answer with a few more frames per second.

So we feel very good about what we’ve got, where we’re going. We believe we are the technological leader and intend to maintain that technological lead.

Andrea James – Dougherty & Company LLC

Thank you.

Operator

Thank you. I am not showing any further questions in queue I’d like to turn the call back over to Jeff for any further remarks.

Jeffrey Tarr

Terrific. I want to thank all of you for joining us today. We look forward to seeing many of you in person in coming weeks. And in the meantime if you have got any follow-up questions at all please reach out to our Investor Relations team. Thanks very much.

Operator

Ladies and gentlemen thanks for participating in today’s conference. This concludes today’s program, you may now disconnect. Everyone have a great day.

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