Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Executives

Daniel Friedmann - President & CEO

Anil Wirasekara - EVP & CFO

Analysts

Steve Arthur - RBC Capital Markets

Thanos Moschopoulos - BMO Capital Markets

Scott Penner - TD Securities

Stephanie Price - CIBC

Paul Steep - Scotiabank

Sera Kim - GMP Securities

Steven Li - Raymond James

Nikhil Thadani - National Bank

Catharine Sterritt - Scotia Capital

Naser Iqbal - Salman Partners

Cabot Henderson - Hudson Bay Capital

Richard Tse - Cormark Securities

Blair Abernethy - Stifel Nicolaus

MacDonald, Dettwiler and Associates Ltd. (OTCPK:MDDWF) Transformational US Acquisition Conference Call June 27, 2012 8:30 AM ET

Operator

Good morning. My name is Sarah and I will be your conference operator today. At this time, I would like to welcome everyone to the MacDonald, Dettwiler and Associates Limited announcement. (Operator Instructions) Thank you.

A number of statements that will be made on this conference call constitute forward-looking statements and information within the meaning of applicable security laws which reflect the current view of MacDonald, Dettwiler and Associates Limited, the Company or MDA with respect to future events and financial performance.

Forward-looking statements generally can be identified by the use of forward-looking terminology such as may, will, would, could, should, expect, intend, estimate, anticipate, plan, foresee, believe, or continue or the negative of such terms or variations of them or similar terminology. Such forward-looking statements are based on MDA’s current expectations, estimates, projections and assumptions made in light of its experience and perception of historical trends.

Forward-looking statements are subject to risks and uncertainties many of which are beyond MDA’s control and effects of which can be difficult to predict. MDA’s actual results of operations could differ materially from historical results or current expectation.

With regard to MDA’s proposed acquisition of Space Systems/Loral, Incorporated, SS/L, there can be no assurance that MDA will realize the anticipated benefits or results due to a variety of factors. For specific risk factors pertaining to MDA’s proposed acquisition of SS/L please refer to the news release distributed yesterday June 26, 2012 which also provides the specific disclaimer for forward-looking statements and information discussed on this conference call.

In addition, you are referred to the risk factors described in MDA’s most recent Annual Management Discussion and analyst Annual Information Form and other documents on file with the Canadian Securities Regulatory Authorities available at SEDAR, www.sedar.com or www.mdacorporation.com. All such factors should be considered carefully, as well as other uncertainties and potential events, and the inherent uncertainty of forward-looking statements, when making decisions with respect to MDA.

The forward-looking statements and information made on this conference call represents MDA’s views only as of today’s date. All such statements are made pursuant to the Safe Harbor provisions of applicable Canadian and US security laws. MDA disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, other than required by law, rule or regulation. You should not place undue reliance on forward-looking statements.

Mr. Friedmann, you may begin your conference.

Daniel Friedmann

Thank you, Sarah. Good morning ladies and gentlemen and thank you for joining us on this call. With me is Anil Wirasekara, our Chief Financial Officer. We have exciting news to talk to you about this morning.

Last night we announced that we will acquire Space Systems/Loral as part of a highly accretive transaction. This is a true game changer for MDA; one that meets many of our key strategic objectives in a single move. I am going to start today with a review of the transaction and the significant benefits we’ll realize through this combination. Anil will review the financial aspects and then we will open the line to answer your questions. We will be using a PowerPoint presentation during our discussion. If you have not had a chance to access this presentation, please go to MDA’s website, mdacorporation.com and under the Investor tab, there should be a link provided for you to view the presentation.

As we announced in our press release last night, we have signed a definitive agreement to acquire 100% of Space Systems/Loral for $875 million. Space Systems/Loral or SS/L is a global leader in commercial communication satellite. Combined with our market leading strengths in essential information, this transaction transforms MDA into a unique, global communication and information company with a strong commercial focus.

Post-acquisition, more than two-thirds of our revenues will come from the commercial market. This compares with just under one-third currently. The transaction also gives us critical mass in the United States, one of the world’s largest markets for our capabilities. Importantly, the new business maintains and increases our focus on essential end user needs. In this case by enabling Internet, mobile, broadcast and other core communication services.

Keep in mind that the benefits of the transaction are not in the future. It will provide immediate benefits including strong accretion for our shareholders. Anil will provide more detail on that in just a few moments, but first let me take a look at Space Systems/Loral.

SS/L is the world's leading supplier of commercial communication satellites. It has more GEO stationary satellite capability in orbit today than any other supplier and has delivered more than 240 satellites over its 50 year history. That makes SS/L not just the largest, but also one of the worlds most experienced providers of commercial communication infrastructure.

The company has been very successful in building large international base of well-established customers and these are strong relationships evidenced by the fact that over 80% of SS/L’s revenues comes from repeat customers. I want to emphasize that this company has long, solid track record and in 2011 it achieved about $1.1 billion in revenues and as of March 31st, it had a backlog of about $2 billion giving us good visibility on future performance.

We are also pleased that SS/L’s existing management team and employees will be working with us. Led by John Celli, the SS/L has exceptional depth and expertise. Members of the management team have on average 35 years of industry experience including more than 22 at SS/L itself. They are absolutely proven team. Culturally, we are very compatible. Both companies are engineering oriented, commercial internationally and generally work on a fixed price basis.

At this point, I would like to show an existing SS/L video that tells you a little bit about the company, its products and competitive strength and then I will continue. We are not using satellite technology so there is a delay.

[Video Presentation]

Okay, I hope that gives you a little idea for many of you that have been to our Montreal facility and may recognize similar equipment and rooms.

And moving onto slide five, let's now take a look at SS/L's market and competitive position. Space Systems/Loral business is fueled by some of today's most compelling consumer communication needs. Satellites been able to cost efficient delivery of television, radio, internet, voice communications and communications on the move. Billions of people around the world depend on these services.

As demand for these services grow the world needs more and higher power satellites supporting, particularly the types that SS/L specializes in. Currently, there are about 300 satellites in orbit, but more are needed as people in developing countries increase the use of communication devices and governments recognize the cost benefits of using commercial bandwidth for their own communication needs.

Keep in mind that this space infrastructure also needs to be regularly replaced as satellites have a typical life span of 15 years. All of this and defense a very healthy market for commercial communication solutions, one that is largely detached from government’s spending decisions and fueled by essential consumer needs.

When you stop and consider the full range of end user services that are supported by communication satellite infrastructure you see why we view this as an essential communication business. In many parts of the world including India, the Middle East, Eastern Europe, large parts of Asia, satellite is the only way that populations are able to access television, internet and communications.

Even in countries like Canada and the US that have well developed ground infrastructures, there's still a large demand for satellite supported communications in mobile and remote applications as well as TV. SS/L has built very strong relationships with the companies that supply services to the people around the world.

Looking at the graph on slide seven, you see that the world’s top 22 operators account for the vast majority of satellites in orbit today. SS/L has existing relationships with 80% of these operators, companies like [Infosat], EchoStar, Sirius, Teleset, DirectTV and in most cases these relationships span several years and often decades and involve many satellites. This gives SS/L a powerful incumbency advantage when these customers procure new infrastructure.

SS/L already understands the customers' technical and business needs and has established track record of performance and trust with them. The advantage becomes evident when you look at their market share. Among all the world’s commercial communication satellites awards between 2007 and 2012 MDA, SS/L won more than any other competitors about 30%. And the success rate was even higher in the high powered segment of the market where SS/L won close to half of all the satellite contracts awarded. They are an established global market leader.

As we said at the outset, one of the compelling features of this transaction is that it establishes critical mass for us in the United States, a long-term goal for our company. Not only will this give us access to the US market for SS/L’s products but it will also finally open the door for our traditional business in surveillance, intelligence and robotics.

As part of our new US business, we are gaining an exceptionally stable and experienced workforce. SS/L has made a significant investment in hiring and training the best engineers and technicians in the industry. During our due diligence we assessed the capabilities of SS/L's people and facilities evaluating not just the current set of products but also their ability to diversify into new space applications.

We found that their workforce has a large and established base of core capabilities required to design, build, test and operate a wide variety of space missions. Over 2,700 of SS/L’s 3,200 employees are space engineers and technicians and they have the skill sets required to help us expand MDA’s traditional business to new customers.

In addition, we’re gaining an impressive physical facility with the addition of SS/L’s huge campus in Palo Alto, California. This facility comprises over 1.3 million square feet and has everything required to produce diverse complex and large satellites and systems.

In summary, the combination of MDA and SS/L ultimately achieves three of our major strategic objectives in one step. We immediately become a leader in the global commercial communications market.

We established critical mass in the US which will enable us to move business, new businesses in this market. And thirdly, as we were [during] the products era, the majority of our revenues will be back to being from commercial customers rather than government sources.

Achieving these three objectives will obviously mean change and growth. MDA’s revenues and earnings will become more diversified especially geographically and the majority of our revenues will be underpinned by essential societal needs.

However, other aspects of our business will remain the same. MDA and SS/L’s heritage of innovation and operational excellence will not change. These are core strengths of both companies. I am a part of what makes us a good cultural fit.

Our balance sheet and financial flexibility to undertake further organic and M&A growth remains strong, we will continue our focus on delivering value and service to our customer and of course, our world class operations in Canada will continue. Essentially, we are still be MDA, but larger, stronger and in a much better position for future growth and success.

At this point, I will turn the presentation over to Anil to talk about the transaction benefits and the financial results. Anil?

Anil Wirasekara

Thank you, Dan and good morning ladies and gentlemen. I will start by providing you with the overview of the transaction. The purchase price as stated in our press release was $875 million for a 100% of all the outstanding units of Space Systems/Loral.

The transaction has been structured to include a tax step up of approximately $120 million. This step up allows MDA to amortize a substantial portion of the purchase price over approximately 15 year period, thus creating a very valuable tax asset or a tax shield with a very high level of certainty that we have on a net present value basis estimated at a $120 million.

Some of you may remember, this is very similar to the tax asset that was created in our MSB transaction many years ago. We will also as a result of this transaction acquire a very significant real estate from that presently headquarters SS/L in Palo Alto. This real estate is valued at a $101 million and is a separate part of the overall transaction.

We have financed this transaction with approximately $260 million of existing MDA cash we have on our balance sheet. We have entered into a land note from Loral Space & Communications a parent company of SS/L for a $101 million which we will pay over three years that has a coupon of 1% and we will draw down approximately $500 million on a new credit facility of $1.1 billion that has been fully committed and underwritten by the Royal Bank of Canada.

The transaction as Dan has mentioned previously would be immediately accretive to our earnings per share. The combined 2011 pro forma operating EBITDAs of the two companies amount to $345 million combined 2011 pro forma operating EPS has increased by about 60% to $5.94.

We continue to maintain a very prudent leverage and we've estimated that to be about 2.2 times EBITDA a little less out of the GAAP but once you have factor in the land note and some other transactions related expenses we estimate at the highest level out of the GAAP to be 2.2 times considering that our covenants about 3.5 times. The acquisition has a significant ROI and ROIC significantly exceeds MDA's cost of capital.

The transaction requires regulatory approval as does most transactions of this nature. We expect to close in Q3, Q4 2012 once we have received all the regulatory approvals.

Going to the next chart which provides you with some idea as to how we looked at the business when we applied it and it provides the different components of the purchase price. So you can look at this either from left to right or from right to left and we have a purchase price of $870 million and then we have different value components that we have attributed to arriving at this purchase price.

As I have talked about earlier, we have a tax step up which we have valued at $120 million that's a very valuable asset that we have generated as part of this transaction and the second component is what we call orbital incentives. This is a very interesting item and is quite common in the satellite business where the satellite provider in this case SS/L participates in the success of the program or project or satellite that they are building.

The participation is generally up to about 10% to 15% of the contract value and is made over the construction period. This participation also includes a return and this return is recovered over the orbit, on orbit life of the satellite which is generally 15 years. This creates a very valuable and liquid asset on the balance sheet. As of March 31st, the balance sheet date of the transaction, the risk adjusted net present value of this participation or investment amounted to $337 million.

As part of the transaction, we also acquired the outstanding pension obligations of Space Systems/Loral. We had to value this liability and the after tax or the tax effect that book value of the pension liability at the March 31st, 2012 amounted to a $132 million. When you add and subtract the different components of value drivers of our purchase price we get to a business value of $550 million for this business.

On the next chart we have put down some pro forma numbers that show the 2011 actual financials before and after giving effect to this transaction. On the revenue side the status quo was $761 million of MDA revenue, on a pro forma basis it’s 1.857 billion.

The next thing we look at operating EPS, the status quo was $3.69 per share MDA’s operating EPS for 2011. When we combine it with SS/L’s operation after giving adjustment to financing this transaction and after adjusting for the substantial issue or bid that we did in 2011 on the assumption that it was done at the beginning of the year, the pro forma EPS increases to $5.94 almost 60% or greater than 60% increase in our operating EPS.

Our operating EBITDA goes from $194 million to $345 million for 2011. And our backlog as of 31s December -- once again, these are 31st December numbers. Our backlog goes up from $805 million to $2.2 billion.

Getting onto the next charts on the next page, we've tried to segment our revenues by both sector and geography. The total revenue -- on the left-hand side, the total revenue has been segmented by commercial communications, surveillance and intelligence, and advanced technology based on our status quo, our numbers as of 2011. And on the right-hand side is the pro forma numbers after combining SS/L.

And you can see the difference. The commercial communications have significantly increased and is about two-thirds or greater than the company from a fairly substantial part. It was about one-third previously and now it's about two-thirds. The surveillance and intelligence, which was the old heritage business of MDA, is still a fairly significant part but now substantially smaller than our commercial communications business.

And the advanced technology, which is kind of an R&D engine of the company, still contributes a fairly significant amount. Very new segment of businesses before and after by geography, we still have an outstanding mix of geographical distribution of our revenues and our customers. The status quo for MDA, we had significant business in Canada and the U.S., a big footprint in Europe and somewhat smaller footprint in Australasia and the Middle East.

Post transaction, the geographical distribution is significantly more impressive with North America or the United States really becoming the largest component, followed closely by Europe, Canada, and Australasia and the Middle East. Canada still is a very significant component of our business, but we are more balanced today post the transaction than before.

Going onto our next chart, which is also an interesting way to look at the business of MDA pre- and post-transaction. On the left-hand side, pre-transaction, we had the status quo of our contracts. We tried to segment this business by the value of our contracts. And if you see, the blue is contracts that are less than $50 million in revenue, and the gold has contracts that are greater than $50 million in revenue.

The status quo that is MDA today had almost two-thirds of our contracts less than $50 million and one-third of our contracts greater than $50 million. Post-transaction the whole trend reverses, where approximately $75 million of all contracts operated by MDA or the combined business is in excess of $50 million and about a third or 20% to 25% is less than $50 million, thus eliminating great volatility in our annual revenues.

That's kind of the financial presentation that I have. And I will now hand it back to Dan to provide a summary.

Daniel Friedmann

Thanks Anil. In summary, we are excited about our plans to put SS/L and MDA together. We are bringing together two complementary market leaders to create a truly unique, global communication and information company. In the process, we are realizing our long-term objective of gaining a stronger presence in the United States market and significantly increasing our focus on the commercial market.

Post-transaction, the majority of our revenues will come from commercial sources. We believe the combination of SS/L's world-class commercial communication expertise and our own strength in essential information solutions will not only benefit existing customers but will provide exiting new opportunities for growth. As Anil highlighted, the transaction is immediately accretive and provides an excellent return on capital employed.

It also leaves us well positioned financially to pursue additional growth opportunities and M&A in our pipeline. From every perspective, we believe this is a right move for MDA, for our customers, for our employees, and for our shareholders. We are transforming the company into a unique and major player in the global market, and laying the groundwork for continued growth and success.

That ends our formal presentation and I'll now ask Sarah to please open the line to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steve Arthur, RBC Capital Markets. Your line is now open.

Steve Arthur - RBC Capital Markets

Yes, thank you very much. Dan just wanted to follow-up on a couple of your last comments there and trying to form a picture of these new businesses as they come together, looking ahead both in terms of revenue and margins. I guess first on revenue opportunities, if you look at the respective growth rates of MDA traditionally and SS/L, in the new business, are you looking at something like the same order of magnitude in growth or are there cross-selling opportunities or other things that can take that growth rate potentially higher?

Daniel Friedmann

Yeah. So of course, it can go higher because there are a number of synergies that are fundamentally all revenue and growth synergies. They are in several levels. The two most important levels is, first, in the communications market. As you know, our particular growth at MDA in the last couple of years has been driven significantly by our success in the communications sector, which has grown to be a significant part of our company.

Our strategy in that sector as MDA, given that we were coming from a small beginning, has been to focus on what SS/L calls the captive market, that is those countries which have their own local prime contractors and are looking for pieces of the solution; whereas SS/L, of course, focuses on the main commercial market where people are buying a turnkey solution.

So we are complimentary in the business that we are pursuing. However, MDA is still a small player in the captive market with very strong competitors and have already received email from customers this morning about how much the strength is our own capability in the communications market. So between the two of us, we are going to strengthen each other. MDA has much more systems' expertise that will help SS/L also in that marketplace.

Separately from that, I think we're all aware that MDA's capabilities in our traditional robotics and surveillance and intelligence business have a very, very large demand in the United States, a demand that we have just not been able to access. Historically, we've done design work there. We've done work as part of international cooperation within Canada and the U.S.

But fundamentally when the big programs go forward, we get sent home. And we now have an incredible capability in the United States to pursue that business, which we believe is very large. Despite government funding, it's still a huge pool of money. So those are the two major events that will drive revenue growth above and beyond both companies' baseline plan.

Steve Arthur - RBC Capital Markets

Okay, that was very helpful. I think you've answered this but on the flipside, in terms of margins, if we look at what SS/L has been doing over the past year call it, is that a typical or an expected margin level going forward or are there things you can do there to up the margin levels?

Daniel Friedmann

Well, if you look at SS/L, you have to take the last few years and average them out; the same with MDA. We have businesses in MDA that have the same margins as the business SS/L has. We have businesses and they have larger margins. Some of our synergistic businesses that I just discussed will have better margins.

In the end, when you put the two companies together and you do it all, we will have double-digit margins. We will have probably the world-leading fixed-price base company in this sector. And this is an era where people want that kind of contracting. So we will be -- that's why I say we're going to be absolutely unique and a global company.

Steve Arthur - RBC Capital Markets

Okay, and final question, just in terms of the Loral customers, have you had a chance to speak with them yet and what are their perspectives? Are there any risks to them or are there opportunities within those customers do you think further?

Daniel Friedmann

I personally had a chance to speak to some of the top customers yesterday evening. This transaction is well received. People see that we're complementary. People see that MDA is in this business for the long-term. People see that there's joint growth opportunities that will help the customer set because many of these customers want to have hosted payloads to reduce their costs. Many of those hosted payloads come from government customers. It's been very well received.

Operator

Your next question comes from Thanos Moschopoulos of BMO Capital Markets. Your line is now open.

Thanos Moschopoulos - BMO Capital Markets

Hi, good morning and congratulations on the transaction. Can you comment a bit further on the revenue outlook for Space Systems/Loral, so even in the absence of synergies as they look at their business, it seems like their backlog is up pretty strongly year-over-year. So would it be safe to assume that going forward we should expect similar revenue rate 2011, if not stronger, as they deliver on that higher backlog?

Daniel Friedmann

Absolutely. This business has strong visibility. As we said, there are like 22 or so providers out there. Loral has existing relationships with 80% of them, has a targeted plan to get into the rest that we have reviewed. These providers have long-term plans. About a third of procurements in any given year are replacement of infrastructure procurements. So those are pretty obvious, so everybody can predict when they die -- those satellites die and they need to be replaced.

And we have reviewed very strong pipeline for the next couple of years with every opportunity having a name, customer, a target satellite, a target use. And they have a strong pipeline. They had very good growth over a number of years. Got to kind of a new level now and they're poised for the next step-up in '14 and '15; very good prospects.

Thanos Moschopoulos - BMO Capital Markets

Okay, and then can you comment on potential cost synergies? Is there an opportunity to bring in some of the work that Space Systems had did in some contract, for example, or any other obvious cost savings that you'd highlight?

Daniel Friedmann

This is fundamentally a revenue synergy story. There's nowhere where we can save costs. However, both companies put a fair amount of work outside, and we believe there'll be some of that kept inside now as a result of us being together. But it's a minor event compared to the real reason.

Thanos Moschopoulos - BMO Capital Markets

Okay, and then can you comment on how you plan to manage the integration risk? Is the plan for the Space Systems' management team to stay onboard part of the transaction?

Daniel Friedmann

Absolutely. This team is amazing and a very strong team and very committed to the business, they love the business, just like us. We are culturally very compatible. We do things very similarly in terms of managing fixed-price contracts, managing the cost and schedule; accounting-wise we are almost identical. It's just like going home.

So there is no integration; you know this company is coming along. It works today very well. It does things almost identically to the way we do them. We see totally eye-to-eye. We will layer course the synergy group on top to try and grab the new business that neither of us are going after today, but other than that it's going to be business as usual for both of us. And as you know we have retained our complete products management team at MDA, so we have the capacity to handle $1 billion type acquisition within our existing corporate staff.

Operator

Your next question comes from Scott Penner of TD Securities. Your line is now open.

Scott Penner - TD Securities

Thanks guys. Can you just I guess give a quick overview of any additional regulatory considerations that maybe involved in closing this transaction?

Daniel Friedmann

I mean you have the normal standard regulatory issues that you got to deal with in a transaction like this, Scott. You got to go through what they call CFIUS which is the equivalent of our Investment Canada Review. You have got to go through some of the defense reviews; even though this business, this company does not do any significant government work or classified work, 99% of it is commercial, but you still have to go through those reviews and we will work through the process diligently and methodically and we got to go through Hart-Scott-Rodino, so we got to file a competition bureau even though MDA does not have participated in this kind of business in the US, we got to do that. So we got to work those reviews over the next several weeks and participate in the process and hopefully have this thing done in the next Q3, Q4 timeframe as I have mentioned.

Scott Penner - TD Securities

And Dan what do you expected that, you mentioned some of the growth synergies and some of the aspects of that; what is the timing on some of these; immediately you can go out and bid and secure business in some of these areas you have been locked a bit or shut out of or is it going to take some time?

Daniel Friedmann

You know that and yes to both; I mean the opportunities are quite in front of us in the communication sector for example and I think I mentioned in our quarterly call last time that MDA has been pursuing the US programs for on-orbit servicing and we believe we are being successful in those, although there has been no official announcements yet, but we think we have got a good proposal in there.

And traditionally what happens is we win the design phase of those programs, but we do not win the construction phase because we are unable to carry it out in the US. As I mentioned in my remarks, we have evaluated that we will, so to be able to do so, if its required after we win the design phase that the work to be done in the US, we will be able to do so and instead of running our technology and everything going to another company it will stay with us and we will do that.

That program is supposed to be awarded in the coming weeks and we are now been told that another RFP coming out in late summer; we know there is NASA RFP coming out that we have been pursuing for a long time. So in those areas that we are already bidding, we are already acting with customers and the synergy is going to be fairly mediate.

In other areas where we have not been active because we simply could not bid unless we were in this stage, already at the bidding stage; it will take us longer to develop that, but we've already worked through the kinds of people and facilities that are required and the kinds of things we have to put together and that’s all there. Of course, we have to wait till things close to do all that, but we will be spending the next few months planning all that out in detail.

Scott Penner - TD Securities

Sure. Anil can you just help me with your adjusted EBITDA for your pro-forma calculation for SS/L; I know the SS/L business looks like it’s $137 million in EBITDA last year and did $10 million for the first quarter. So I am just trying to figure out how you got to $153 million?

Anil Wirasekara

As I said there are two components; there is revenues or income that is generated by the business and then there is income that is generated through the participation of their orbital incentives. So the value of that for 2012 if you read through the Loral communication financial statement works out $14 million. And as part of this transaction, we are buying back investment that they have made in those orbital incentives. So when you add the two together it works out to a $150 plus million.

Scott Penner - TD Securities

Okay. Is that $14 million, when they gave guidance for 8% to 10% margins over 2012 and 2013, did they include that orbital incentive amount?

Anil Wirasekara

I have no ideal; got to ask them. I didn't provided that guidance; but I don't know how they calculate this.

Operator

Your next question comes from Stephanie Price, CIBC. Your line is now open.

Stephanie Price - CIBC

Just going back to the question about SS/L and Q1 margins that were very weak, can you kind of give us a feel for what you think margins are going to be like in the near-term; is this an issue that’s going to continue; I think there was a cost overrun on the project?

Daniel Friedmann

No, what you saw was a couple of one-time effects. If you look over the long term history, their margins are pretty consistent, so if you look at the ‘09, ’10, ’11 averages that is good and margins going forward look very similar to the past.

Stephanie Price - CIBC

Okay.

Anil Wirasekara

So if you read the commentary Stephanie you can see that there were some significant one-time events both on the investment side as well as on the R&D side, as well as some technical issues that they had to deal with on the satellite program.

Stephanie Price - CIBC

Yeah, I guess that was my question that $12 million whether that was going to be recurring or was actually fixed….

Anil Wirasekara

If you look at the history, if you look at the previous 20 quarters, you don’t get it. So, these things do happen in these kinds of businesses and you have these anomalies that happen, that need to get fixed. So this is an unusual item that they decided to take in the first quarter of 2012.

Stephanie Price - CIBC

Okay. Anil can you talk a bit more about the tax rate that we should be expecting post the acquisition just given these tax shields that you have been talking about?

Anil Wirasekara

Yeah, the tax works two ways, so one from a consolidated P&L income statement standpoint I think that it’s difficult to say exactly, but the low 20s would be an appropriate number. That’s what we are using in our modeling; 23%, 24% would be appropriate. And on a cash flow basis, on a cash tax basis, it would be in the low teens, so we estimate that the net effect of cash taxes would be in the 11% to 12% range.

Stephanie Price - CIBC

Okay. And just finally, on your antenna and from your component business, do you think you’re going to see some impact from the acquisition just given that you’re now competing with some of your clients in those businesses?

Daniel Friedmann

You know, that’s always possible. Of course, we have been competing with our clients quite heavily in the last year and a half in some procurements. We maintain a very clear, separation today within the businesses and we’ll do so in the future to protect client confidentiality and we work very hard. Our component and our antenna business being available to everybody in the world including SS/Loral in the past and in the future and some of their competitors, so it’s some of our competitors.

So we hope that as always proven to be the case in this market, we all recognize that we have very specific components that we all built, that we buy from each other. We buy from our competitors. SS/L buys from their competitor and these components which are at a third-tier level and yet still create a unique and differentiating offering at the first-tier level. So we have the right processes and we’re going to manage to not have an impact, but it is a risk.

Operator

Your next question comes from Paul Steep of Scotiabank. Your line is now open.

Paul Steep - Scotiabank

Just one quick question. In terms of Loral, obviously there is existing agreements, but beyond this I didn't hear any mention of it, is that a longer term agreement in terms of Telesat guys from the next generation of those satellites that they would sort of like default go with SS/L as part of this agreement?

Anil Wirasekara

No there is no you know you'd expect because both companies are owned by the same people that there would have been a big agreement, but no, they dealt with the thing in a good competitive business way and Telesat procures from where they consider to be the right people which has been SS/L and we hope will be SS/L in the future. But each one of those procurements is hard earned and we plan to continue to earn by doing hard work and give them a good service.

Operator

Your next question comes from Sera Kim of GMP Securities. Your line is now open.

Sera Kim - GMP Securities

Hi. I just have a couple of questions left out. Just referring back to the earlier question you mention that competing with customers could be a risk, I'm just wondering what is the trade-off of integrating your own components versus what you might lose if you're competing with your customers now? I am just wondering if you can provide a little bit more color on that?

Daniel Friedmann

Yeah, nobody asked me about the upside, there is also upside. On balance we think there is more upside than downside of the net gain.

Sera Kim - GMP Securities

Okay. Okay great. And just in terms of the credit facility, are you going to provide, with the – I mean terms are -- well leveraged ratio you have to maintain, EBITDA – like that of the staff covenants?

Anil Wirasekara

Yeah I mean the requirement is 3.5 times, the flexibility to go half a turn more if you're going to an acquisition. So we got plenty of space, plenty of room for growth and as you know we generate so much of cash in this business, you know the free cash is very significant. So you know we have the opportunity to pay this thing down you know very rapidly.

Operator

Your next question comes from Steven Li, Raymond James. Your line is now open.

Steven Li - Raymond James

Thank you. Just a couple of questions Dan, historically has the [COM] side of market being impacted by the overall economy climate are you detecting any slowdown?

Daniel Friedmann

You know that there has been some impact but it's usually pretty small, these are essential services to a large degree and even where they are not people consider them that way. So the operator sometimes if the landing market are tough might delay procurements six months, a year but when you average it out over a number of years you just don’t notice any impact including one there has been a significant slowdown in terms of the current situation we believe that both MDA and SS/L are kind of high point in terms of bits and procurements going on right now I mean it is good as it has been.

Steven Li - Raymond James

Okay great and about the backlog that gives you a short-term visibility what situation of that is it about two years?

Daniel Friedmann

Yeah, that’s typical as you know from MDA's business that typical contract is two to three years. So there are contracts in the backlog of course that we are finishing next week and there are contracts in the backlog that were booked this year and we have another 2.5 years to run in both companies.

Steven Li - Raymond James

Anil just a clarification on one of Scott’s questions. So in terms of the accounting going forward the orbital receivables that you would be collecting so it would be accounted as EBITDA for the combined company?

Anil Wirasekara

Well, there are two components right. The orbital receivables come in two components; one component has already been recognized in revenue so that will flow right through the balance sheet. The orbital receivables is all represented in cash. A significant component of the revenue associated with the orbital receivables or the orbital incentives has already been recognized and that component will flow through the balance sheet. The unrecognized component will flow through the income statement and yes it will be in our view a component of revenue or component of income and will be accounted accordingly.

Steven Li - Raymond James

And on how much depreciation and how much amortization is coming over from SS/L?

Anil Wirasekara

Well, as you know when you do business combinations you've got to zero base all this. Today about half of the amortization works out to approximately $35 million, $32 million to $35 million of depreciation and amortization a year.

On top of that we think that there will be another $15 million to $18 million of purchase price amortization as a result of this transaction which is really good with amortization and when I talked to you about the accretion and I talked to you about the combined EPS number of $5.96 I believe that includes all the purchase price amortization in that.

We haven't pro forma that out because it’s a little uncertain right now. We have sat down with our accountants and estimated what the goodwill will be as that will be generated as a result of this transaction and how much that amortization will be and we have booked that as a component, as a pro forma adjustment in the numbers. So it includes that doesn't exclude that.

Operator

Your next question comes from Nikhil Thadani of National Bank. Your line is now open.

Nikhil Thadani - National Bank

I was wondering if you could comment about the combined pipeline for SS/L and MDA. I believe SS/L won about three orders in Q1. You won the one order this Sunday gone by. So what is the combined pipeline look like? Are we still looking like about half a dozen little ones out there that you are working on right now or is it significantly larger?

Daniel Friedmann

Well, there's our pipeline which I mentioned half a dozen, the half a dozen in our pipeline you saw a very key win for us in Israel this week. Of course that creates another pipeline because that was in AMOS-6 and there's AMOS-7 and so on going forward and we are now well positioned for that. And just the rest of our opportunities we have lost one that was the lowest probability one in the pipeline and then there's several other opportunities in our pipeline going forward as we've spoken before.

Those are all as I mentioned before like in captive countries where they are buying locally with a component or typically a payload coming from us that's completely separate from another pipeline which is where SS/L plays and their pipeline is pages long literally. This is a completely different scale of business and our business in communications. They are the top supplier. So their pipeline is pages long.

Nikhil Thadani - National Bank

Right, okay so given your capacity in Montreal and given SS/L's capacity, do you anticipate having to add capacity or any kind of CapEx to sort of to keep up the demand because it sounded like SS/L was looking to step up CapEx through 2013 or does Montreal sort of absorb some of that going forward.

Daniel Friedmann

As you know we’ve just added significant capacity into Montreal and we are happy with that capacity in terms of what we foresee including synergies. SS/L themselves is in the midst of a step up in terms of their production capacity and yes they do have an out of the usual capital expenditure in the next 18 months, in the last 12 months as they move to kind of a new revenue level in the ‘14, ‘15 timeframe. So we don’t anticipate adding new capacity because both MDA and SS/L now currently are adding capacity as we speak.

Operator

Your next question comes from Andrew Reitknecht of Scotia Capital. Your line is now open.

Catharine Sterritt - Scotia Capital

Yes, it's Catharine Sterritt of Scotia Capital. Just to go back to the orbital incentives just $337 million net present value is that entirely the amount on the balance sheet for the recognized receivables and then in addition to that those just flow into EBITDA for the unrecognized?

Anil Wirasekara

That’s correct. And it’s not only net present value it’s risk adjusted, so when you decide how much to put on your balance you got to not only net present value the return or the receivable or the participation investment, you also got to adjust it for risk and the risk is there are two types of risk. One risk is the performance risk, you got to determine based on historical data, what the performance issues are and how much of this will be eliminated because of performance issues and the second one is [credit] risks. So there is a very extensive calculation that goes, that is reviewed by their auditors that have historical trends and that's the value that is put on their balance sheet.

Catharine Sterritt - Scotia Capital

So can you give us some color for 2011? What was the actual cash that float in on the orbital incentives for SS/L from both crystallizing the cash that the receivable on the balance sheet as well as the EBITDA because it sounds as if the cash flow is considerably higher?

Anil Wirasekara

For 2011, it was about $14 million that was unrecognized and the recognized component I believe was in the $60 million to $70 million but I have to clarify that and get back to you.

Operator

Your next question comes from Naser Iqbal of Salman Partners. Your line is now open.

Naser Iqbal - Salman Partners

I will try to keep my question short. It's been a long call. Dan, just when looking at the revenues by contract value like prior and pro forma, you know, now you’re going to have more contracts in excess of 50. I guess, previously it was, in a difficult environment when you had contract, when you had a business that was built on smaller contracts. Then in some ways that was more sustainable in a difficult environment. Do you think now that it flips over that it exposes some kind of volatility or risks?

Daniel Friedmann

No. That’s why we put the graph there. We think this dramatically reduces our volatility I mean if you look at our company today, we get about half of our revenue from kind of a regular diet of things, lots of contracts ranging from very small to tens of millions. And then we get another chunk of the revenue coming from very, very few large contracts. And to the extent that one of those doesn't happen it's a major event that we are witnessing today with the RCM situation which is you know causing lots of issues for us everywhere and staffing facilities, you name it.

Now all of a sudden, we will have 20, 25 of those contracts around and to the extent that one of them hiccups or one of them gets delayed, it's almost not going to be noticeable and so this has been another major strategic objective for us you know more financially that we can have half of our revenue coming from two contracts like we did today, basically the communications contract and the one that's going away.

So we think this really stabilizes our company. Now geographically there are issues because the contracts are in different places. We still have the geographic issue, but in terms of what you will see as a combined financial result. This makes our company much more stable than currently.

Naser Iqbal - Salman Partners

Okay, now that's great. And Anil just maybe, understanding the interest cost on the debt that is going to come on, will the $100 million in the, I guess land whatever…

Anil Wirasekara

Note.

Naser Iqbal - Salman Partners

Note. Will that be at 1% and the 500 is going to be at whatever normal interest rate?

Anil Wirasekara

That's correct.

Naser Iqbal - Salman Partners

Okay, okay. And so from a pro-forma 2013, if you are modeling the tax rate, the 23% to 24% is for MDA is a fair number?

Anil Wirasekara

You lost me. Can you repeat that, please?

Naser Iqbal - Salman Partners

For MDA in 2013, assuming that this contract closes -- the acquisition closes this year, so for 2013 MDA, for the whole company, tax rate is 23% to 24%?

Anil Wirasekara

That's correct.

Operator

Your next question comes from Cabot Henderson of Hudson Bay Capital. Your line is now open.

Cabot Henderson - Hudson Bay Capital

Thank you and congratulations on the transaction. I was just calling because on the Loral press release they talked about cash dividends being paid to Loral. How does that work in calculation for the transaction?

Anil Wirasekara

What I understand has happened is over the past several year there has been -- SS/L has earned a significant amount of income, and this income has been trapped within SS/L and retained by SS/L. And as a result of this transaction, that cash or the earnings of SS/L, the retained earnings of SS/L up to 31st March will be dividended out to its parent, its retained earnings up to that day, that's the amount.

Cabot Henderson - Hudson Bay Capital

Okay. So the $5.8 million that they estimate per month, that is effectively just the cash that is being earned at SS/L?

Anil Wirasekara

Well, that's a different thing. So they had two -- one was the $112 million, which was going to be dividended out as a result of the transaction, which is kind of cash that has been trapped in SS/L over the past several years. That will be dividended out. Then you have the earnings of SS/L from signing to closing.

And what we have arranged as part of this transaction is that we will split the money between SS/L and the parent going forward on a monthly basis. So if you take -- if you assume that this is going to close in six months' time, SS/L will have -- the parent will take half the earnings of the company and the balance will be retained within SS/L as an equity pickup.

Cabot Henderson - Hudson Bay Capital

Okay. So -- and then that is a fixed 50% split between?

Anil Wirasekara

It's close -- it's 49.4% or 51.6%. It's close to 50%. It's in dollar amounts because there are taxes involved. So you've got to factor in the taxes that go in.

Operator

Your next question comes from Richard Tse of Cormark Securities. Your line is now open.

Richard Tse - Cormark Securities

Yeah, thanks. Dan; just wanted to get a bit of color on how this transaction came about. So where they in a process or did you guys pursue them? If you can give us a bit of background on that, it would be great.

Daniel Friedmann

In interest of what they were after, I'm still not totally sure, you will have to ask them, but it's been clear that they have been evaluating a number of strategic options, including spinning the company out. It's pretty clear to us from our activity in the marketplace that there were other bidders that were trying to acquire the company, not just ourselves.

So I think they had a kind of sale process going on. They had a spin-off process going on. And eventually, I guess they picked the best value for their shareholders and the process got going in earnest over the last month or two. In terms of MDA, I have been to visit every significant U.S. corporations to try and do a deal in the last two years, and this is one of them on the list.

Richard Tse - Cormark Securities

Okay. And then, I guess related, so how long was the diligence period? And I guess to what extent did you have to go through all the contract? Because there was the question earlier and I started reading through the last quarterly result for SS/L, Loral, and they had a couple of contracts that are sort of offside. Did you guys have a chance that their through with their contacts and feel pretty comfortable on that or where does that stand?

Daniel Friedmann

Yes, we've gone through reductive contracts, but by and large they are contracts. And then, we've gone back in confirmatory due diligence after we got an exclusive to look at more specifics. We've gone through all the estimates to complete on their contracts or through with our world-class guys that we have in Montreal. We've gone through all how that's accounted, all the risk budgets, all of those things. We have done our own analysis of what that backlog looks like in terms of risk and EACs and all those things, and we're satisfied with them.

Anil Wirasekara

Just to add to that Richard, some of these write-offs are investments that they call. It was done with their knowledge. This was not something that came up. They were -- these were kind of -- some of these were like investments that they made in R&D and business development during the year.

Operator

Your next question comes from Scott Penner from TD Securities. Your line is now open.

Scott Penner - TD Securities

Thanks. Pretty much all the questions were answered. Just one quick one, now that I think of it, Dan, does this change any of your feelings around maybe staffing up or down in some of the businesses that you were restrained with being a Canadian-only company?

Daniel Friedmann

No, it doesn't change that immediately. But of course, we are now able to go after other businesses. We still have to close the transaction. It'll take a few months. But as we look forward in the next couple of years, we believe that the revenue synergies will mean higher staffing in the U.S. and in Canada. But that is a couple of year or so away until we start seeing those effects.

Operator

Your next question comes from Blair Abernethy of Stifel Nicolaus. Your line is now open.

Blair Abernethy - Stifel Nicolaus

Thanks and congratulations, guys. Just one quick question here, Dan, on the combined product portfolio as you look at it and you look to leverage some of your more unique technologies, is there -- in your mind, overtime, is there a margin expansion opportunity for the SS/L business?

Daniel Friedmann

There may or may not be. Our margin situation is so dependent on the amount of value-added in any particular contract. If you really look at our value-added margin on both companies, it's pretty similar. The question is do you have a launch, do you have a whole pile of pass-throughs. That's what changes it a lot. So I don't see -- I see lots of opportunities to add more value and to increase things. But to predict where that will go is very difficult.

If we're able to succeed on a significant robotic bid in the United States and we do only the robot, well yeah, there'll be big margin expansion. If we do the whole mission, no, because we'll have to buy all kinds of component. So it's really going to be a mix thing. We look at the thing as a return on investment, as a cash flow, rather than percentages and sales. And therefore, we look at it as increased EPS for our invested dollar.

Blair Abernethy - Stifel Nicolaus

Okay, great. And then just a follow-up to that, any positive or negative impacts on your supplier relationships?

Daniel Friedmann

We don't expect any negative impact. It should be neutral to positive.

Operator

Your next question comes from Sera Kim of GMP Securities. Your line is now open.

Sera Kim - GMP Securities

Oh, hi, just a couple of follow-up questions. Given that integration is low and you've got flexibility in the balance sheet, what are your thoughts on additional acquisitions? I know in the past you've talked about tuck-in type deals. What's your thoughts on that now?

Daniel Friedmann

We continue with the same thoughts. We have been working our pipeline for about a year and a half. I mentioned that our pipeline was looking good at the last call. It still looks good. Of course, one of the big items moved luckily in the acquisition direction. We continue our focus on trying to expand even more now frankly in our surveillance and intelligence sector because we have footprint in the United States.

We have opportunities there. And we also have opportunities in our service business, especially in the oil and gas area. And we continue to be active. We worked very hard at getting a credit facility that you've seen, plus an extra accordion of 250 on top to maintain the flexibility, to act as these opportunities come through. So we're active.

Sera Kim - GMP Securities

Great. And just last question, are all 3,200 employees at Space Systems/Loral staying, and are there lock-up agreements in place for the senior guys?

Daniel Friedmann

Yeah. Space Systems/Loral, like us, goes up and down in employment all the time. But yeah, there's nothing as result of this transaction that's changing anything. There are no lock-up agreements with anybody there or here. In the knowledge business, people are free to make their choice and lock-up agreements are just a license to print money at the wrong time, as you've seen in other companies.

So we attract people because the work is great, because our customers are fantastic to work with. And their reaction -- I'm on my way to Loral to speak -- to SS/L to speak to all the employees later on today. But of course, I've spoken at length with their senior management team. They love their jobs. They want to keep doing that. They like the synergy with MDA.

They've been there for a while. There's no reason for anybody to go anywhere. And we have participation on the value of the company, which is going to be new to them. So it should be positive for everybody.

Operator

Your next question comes from Nikhil Thadani, National Bank. Your line is now open.

Nikhil Thadani - National Bank

Just a quick housekeeping question guys, is there a break fee associated with the transaction?

Anil Wirasekara

No.

Operator

(Operator Instructions) There are no further questions queued up at this time.

Daniel Friedmann

Okay, thank you very much for listening to us at short notice, and at least for those in the West, early in the morning. And if you have any further questions, we'll be around later on today. Anil will be here a little longer than I because I'm flying south, and I'll be back on Friday. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: MacDonald, Dettwiler and Associates CEO Announces Transformational US Acquisition Conference (Transcript)
This Transcript
All Transcripts