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GeoEye, Inc. (NASDAQ:GEOY)

Q2 2008 Earnings Call Transcript

August 13, 2008 11:00 am ET

Executives

William Warren – SVP, General Counsel and Corporate Secretary

Matt O'Connell – President and CEO

Henry Dubois – EVP and CFO

Bill Schuster – COO

Analysts

Paul Coster – JP Morgan

Jeff Evanson – Dougherty & Company

James McIlree – Collins Stewart

Lance Hans [ph] – Lighthead [ph]

Anthony Klarman – Deutsche Bank

Peter Friedland – Soleil

Simon Solacha [ph] – Harbor Side Capital [ph]

Operator

Ladies and gentlemen, thank you for standing by. Welcome to GeoEye Inc.'s second quarter 2008 investor call. At this time, all lines are in a listen-only mode. After the prepared remarks, we will announce the opportunity to receive questions. (Operator instructions) As a reminder, today's call is being recorded.

At this time, I would like to turn the conference over to Mr. William Warren, GeoEye's Senior Vice President and General Counsel.

William Warren

Good morning. This is William Warren. Thank you for joining us today as we discuss GeoEye's second quarter 2008 investor call. Joining me today are Mr. Matt O'Connell, Chief Executive Officer, President, and Director; Mr. Henry Dubois, Executive Vice President and Chief Financial Officer; and Mr. William Schuster, Chief Operating Officer. After our remarks, we will entertain questions. This call is being recorded.

Before we begin the business portion of this morning's call, we would like to inform you that we expect to be making forward-looking statements during today's call. Statements including words such as believe, anticipate or expect, and statements in the future tense are forward-looking statements. These forward-looking statements involve known and unknown risks and uncertainties and are based on management's current views and assumptions regarding future events and operating performance. A number of factors could cause our actual future results to differ materially from our current expectations.

Examples of these factors include, but are not limited to, conditions in the remote sensing industry, level of new commercial imagery orders, production rates for advanced image processing, the level of government spending, competitive pricing pressures, startup costs or overruns on new contracts, technology and product development risks and uncertainties, and the effects of the filing of an application for change of accounting method which we have filed with the IRS.

Listeners are encouraged to read the risk factors in our Form 10-K on file with the Securities and Exchange Commission for a discussion of various factors which could cause our actual performance to differ from our forward-looking statements. We assume no obligation to publicly update or revise our forward-looking statements.

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

Matt O'Connell

Thanks Will. I want to thank you all for taking part in our call. Following our prepared remarks, we'll take your questions.

The main purpose of the call is to report our financial results for the second quarter of 2008, describe our recent financial restatements, and provide an update on our launch. I'll mention some highlights of our performance and our Chief Financial Officer, Henry Dubois, will give you the details of our restatements and financial results. Our Chief Operating Officer, Bill Schuster, will provide an update on the launch.

As we announced yesterday, our launch providers, Boeing and the United Launch Alliance are moving the target launch date for GeoEye-1 from August 22 to September 4. The reasons for the 13-day slip have nothing to do with the GeoEye-1 Satellite which is ready to go.

As Henry will tell you, our operating results for the second quarter were about the same as the results for our first quarter 2008, but that is a 29% decline in revenue from the second quarter last year. Henry will tell you more on that in a second.

We said during our March and May calls that our results might be affected by the decline in orders from our largest customer, the National Geospatial-Intelligence Agency or NGA. Their orders for the first and second quarters were lower than anticipated and as a result, our revenues reflected that. We're in the process of negotiating a service level agreement with NGA. We expect to conclude the negotiations at the launch.

Full certification of the quality of GeoEye-1's imagery by NGA is expected in the late October time frame after we check out all the satellite subsystems. When the service level agreement is finalized, it should even out the peaks and valleys of the government ordering process so that we have a predictable and sustainable revenue stream and the government gets a predictable supply of imagery.

The service level agreement should increase NGA's ability to provide Geospatial-Intelligence to its customers throughout the US government and elsewhere. Our relationship with NGA is strong and they're looking forward to the launch as much as we are.

Some of you have asked why the NGA orders have been lower than expected during the second quarter. We believe that given the delay of GeoEye-1, NGA may have re-allocated imagery orders to our competitor because their NextView satellite was launched last fall and is now operational.

We are confident that once GeoEye-1 is operational, our imagery orders from NGA will substantially increase from current levels. In fact, this week we have received some new orders from NGA for our IKONOS imagery collections over very large land areas. We did have a positive agreement [ph] with NGA in June when we announced new awards totaling $22 million to supply processing services to NGA.

We're happy to announce that our Center for Advanced Geospatial Processing in St. Louis continues to experience strong demand from NGA. So we're increasing the size for our office there by about 50%. We should complete the office's expansion by yearend and then we can start increasing headcount to keep pace with the growth in our business there.

Now, on the financial front. As we disclosed in an 8-K we filed last night, we needed to restate our financials for prior periods. These restatements should not have a big economic impact on the company. Henry will go into more detail on the restatements, but in general, the restatements address the following issues.

First, we concluded our study of the effect of changes in ownership as it relates to our ability to use net operating losses from prior periods under section 382 of the Tax Code. During the course of that study, we realized that we had to make two other changes.

So the second basis for the restatement is that we had to change our policy regarding recognition for tax purposes of the cost-sharing payments we've been receiving from NGA.

The third basis for restatement is that we realized we had over-accrued for imagery purchased from third parties in the second half of 2007.

In the ownership change study, our financial team and our advisors concluded that we had indeed lost most of the NOLs from our reorganization but that we could in fact use more NOLs than they had estimated in the Form 10-K for 2007.

Again, the restatements don't have a big economic impact and we're glad that we can finish the clean up and move forward. We're adding to our financial team and we've already retained a new tax advisor, one of the big four accounting firms.

Now, about the launch. As Bill will tell you, the 13-day slip is not related to either our satellite or to the readiness of the Delta II launch vehicle. The launch provider simply had to find a back-up plan to track telemetry on the rocket itself. Now, the only significant issue Boeing and ULA have left to complete is to re-test of a range-safety antenna on the booster. This retest has been going well and is scheduled for completion on August 16.

Changes in launch schedules are a regrettably routine part of conducting business in space. Commercial space cap [ph] providers like GeoEye often have to deal with scheduled changes dictated to them by the much larger launch providers. The most important thing is to launch safely and successfully. As a senior Air Force official said to me yesterday, it’s better to have a later success than an on-time failure. I would point out however that the US commercial launch business doesn’t produce the economies of scale which could stimulate the investment in infrastructure that could prevent some late-breaking issues like this one that caused delays.

The scarcity of commercial launches is what motivated in part the formation of the United Launch Alliance. We enthusiastically applaud the efforts of entrepreneurs like Elon Musk that tried to develop alternate launch providers so that GeoEye has a choice for future launches. Our country’s access to space is critical for both national security and economic growth. As a business leader in a space-related business enterprise, I hope that the US government will continue to look at how to make the US launch industry more competitive and responsive and will find ways to increase its investment in the launch infrastructure in the United States.

Now, as to the overseas business, we reported on the last call that we have signed two contracts to upgrade affiliated ground stations to receive GeoEye-1 imagery. Since then, we’ve signed a third ground station upgrade contract. Teams are already out doing ground station upgrades in Asia and the Middle East. Other potential customers and our other established affiliates continue to show strong interest, but as we said before they’re going to wait until after launch to enter into binding agreements.

Our fastest growing market in the developing economies continues to be China. China is still a relatively small buyer compared to our long-time affiliates, but the market is huge and our market share continues to grow very rapidly. In July, we attended an international conference on remote sensing and mapping in Beijing. While we were there, we signed a memorandum of understanding with our Chinese distributor for IKONOS for them to sell GeoEye-1 imagery in China as well.

We’re also experiencing strong growth in demand in Russia and to a lesser extent, India. Two weeks ago, we hosted a conference for our global resellers. More than 90 people representing 14 countries attended three days of presentations by members of our staff. They are all looking forward to the launch of GeoEye-1 and they loved the new archive search tools I’m going to tell you about in a minute.

We’ve made significant improvements to our brand awareness and our online capabilities. We substantially upgraded our search capability by licensing Google Earth's enterprise application and an enterprise application from a leading provider of mapping software called ESRI. The package of tools we assembled provides our customers fast, fluid online access to our immense imagery archive. We’ve also done a dramatic redesign of our corporate website and gotten very favorable feedback from customers and resellers. And our sales for the online segment continue to grow. We expect to expand our sales in the online segment even more after the launch of GeoEye-1 and we’ll tell you more about that after launch.

On May 29, our imagery embedded in a videogame premiered at the Louvre in Paris. The review said that the quality of the imagery had a terrific realism. The game was developed for Ubisoft, one of the world’s largest videogame companies, and it will be released early next year.

In an effort to look to the future beyond launch, we recently hired a Chief Technology Officer named Brian O’Toole [ph]. Brian’s experience in systems integration and solution development as well as his entrepreneurial success building and selling a small solutions business will be a great asset as we build GeoEye. Having someone focused on our strategy for advanced geospatial and location-based technologies will ensure that we continue to be a market leader.

Another post-launch item to discuss is our GeoEye-2 program. Work on the program has continued. A number of you have asked if the rumors about the US government starting a program which might involve building its own broad area and mapping satellites could affect our plan to build GeoEye-2. We've read many of the same press reports as you and the program which is referred to the press as BASIC or Broad Area Satellite Imagery Collection is one that we monitor closely. We haven’t been formally notified by the US government that any official decision has been made to proceed with the program.

We have heard that various concepts remain under consideration like integrating commercial imagery capabilities into the larger US government architecture, increased US government purchases of commercial imagery, and procurement by the US government of imaging satellites that have the same capabilities as GeoEye-1 and GeoEye-2.

We are limited in what we can say about our customers so we won’t comment directly on this particular program, but I’ll repeat what I’ve said for years. The private sector can always do things cheaper and faster than the government. So to the extent that the government cares about schedule and cost, then it doesn’t make sense for them to build their own mapping satellites. It’s also worth noting that a US government decision to own and operate its own commercial-like capability would be inconsistent with two presidential policies on commercial remote sensing.

Having said that, we have other customers on the international front and even on the domestic commercial front who want to have more capacity and they’ve indicated they might be willing to prepay for imagery. That could mean an attractive alternative for everyone involved. So we’re factoring all that in as we think about how and when to finance GeoEye-2.

We also realized that we had to work harder at communicating with our investors. Henry and I have spent a lot of time on the phone with our investors and with analysts since the last quarterly call. In addition, we've visited with investors, with investment bankers, and with analysts in New York and Boston and we’ve spoken at investor conferences in New York and Washington. We’re picking up more analyst coverage too. Four firms now cover us, and we’re going to keep trying to improve our communications with our investors.

Now, I'll turn the call over to our CFO, Henry Dubois, so he can report our second quarter financial results and the restatements.

Henry Dubois

Thank you, Matt. Before we go into the second quarter operating results, I would like to discuss the restatements for 2005, 2006, and 2007 and the first quarter of 2008 we identified in the Form 8-K we filed last night. There were three reasons for these restatements. One, the tax treatment of the cost-share payments from NGA for the development, construction, and commissioning of GeoEye-1; two, completion of our ownership change study; and three, correction for an over-accrual of the cost of imagery purchased from third parties in 2007.

I want to emphasize upfront economically and from a cash standpoint, our tax liabilities have not significantly changed from our last investor call. Let me provide you with detailed information. First, I’ll talk about the income tax exposure on the cost-share payments from NGA. As you are aware, we’ve been receiving cost-share payments from NGA for the development, construction, and commissioning of GeoEye-1. As of June 30, 2008, we have received $194 million of a total expected amount of $237 million.

The method we were using to recognize these payments for income tax purposes was the same as the method we have been using and will continue to use to recognize for financial reporting purposes. We have plans to recognize these payments over a seven-year period following the commissioning of the GeoEye-1 satellite for both financial reporting and tax purposes. This remains the appropriate method for financial reporting.

However, after a detailed review of all of our tax positions, we have determined that these payments should have been recognized as income for tax purposes in the year that we were entitled to receive the payments. Thus, we should have had taxes payable on these amounts over the periods from 2004 through 2008.

The total income tax on the $194 million that we had received by June 30, 2008 from NGA would have been approximately $102 million. This is the same amount that would have been due on these receipts as in depreciation costs associated with GeoEye-1 over the deferred seven-year period that we were originally expecting to pay the income taxes on.

I should point out a notable difference. If we had correctly recognized the cost-share payments as taxable income when they were invoiced, there would not have been any corresponding costs and deductions against the taxable income recognized for the cost-share payments.

I would also point out that because our financial books were not recognized and in fact will not recognize the income from the cost-share payments until later years, our financial books would have reflected a tax effect of this timing difference between tax income and financial reporting income as a deferred tax asset.

Accordingly, the amount paid would have been recorder in our deferred tax asset account to be reduced eventually to zero over the period of time that the company will record the income for financial reporting purposes. The deferred tax asset is the equivalent of prepaying $102 million of taxes on taxable income that will be recognized at a later date for financial reporting purposes.

As we work through our analysis, we calculate that due to the fact that the company had not paid this tax, we would have been subject to interest and penalties on the unpaid amounts if we had not notified the IRS of the situation as I’ll explain in a moment.

The total of these penalty and interest amounts would have been approximately $35 million through June 30, 2008, but we believe our notification to the IRS should eliminate them.

After we have realized we should treat the payments differently for tax purposes, we filed an application with the IRS on August 8, 2008 to change our tax accounting method for these payments.

We now plan to recognize the payments for tax purposes over the next four years starting in 2008 rather than the seven years we anticipated. The amount of tax liabilities on these payments is anticipated to remain the same as it has always been barring any change in corporate tax rates in the coming years. However, with the change in the tax accounting method, the timing of the recognition of the income for tax purposes has changed. The income is anticipated to be recognized for tax purposes over four years rather than seven years.

Of course, the amount of actual income taxes we will pay over the next four years will be based on the calculations of our annual taxable income, which will include three primary components. First, for 2008, the recognition into taxable income of the cost-share payments invoiced in 2008; second, for each year 2008 to 2011, the recognition into taxable income of one fourth of the prior cost-share payments; and third, our taxable income from operations after taking into account associated expenses including accelerated depreciation for tax purposes.

Because of the significant tax deductions that are anticipated over the next few years starting in 2008 from the accelerated tax depreciation of GeoEye-1, we believe that the tax deductions for depreciation will negate the effect of the increase in taxable income from the cost-share payments.

This method of reflecting the cost-share payments resulted in a deferred tax asset and the corresponding tax liabilities each in the amount of approximately $102 million. The deferred tax asset and the corresponding tax liabilities will offset each other on our balance sheet and be reduced to zero as we recognize the cost-share payments for tax purposes and book purposes, and depreciate GeoEye-1.

In addition, as a result of the filing for the change in accounting and tax accounting method last week, we believe that we have been able to obtain protection from IRS audit on this point and relieved from the tax-related interest and penalties related to this matter.

Thus, we would expect to reverse up to $35 million of interest and penalties in the third quarter of 2008 as they would no longer be due. This reversal will result in an increase to our 2008 net income by the amount of expense that would have been incurred prior to 2008, namely by approximately $31 million.

Since this is the reversal of a tax accrual, the total of the $31 million will, for financial reporting purposes, be included in net income and this amount is not taxable.

Regarding the ownership change study, as you know, when we filed our 2007 financial statements earlier this year, we indicated that we were undertaking an analysis of our shareholder base and its changes to determine whether or not we have a change in ownership as it is interpreted under the Section 382 of the IRS Code. That section relates the use of net operating losses from prior periods to offset current income.

At that time, we estimated that we had had a change of ownership at the end of March 2005, plus eliminating all net operating losses that pre-dated March 31, 2005. We did a thorough study with help from outside experts and significant research on the actual dates of share transfers.

The study and data indicate that we did in fact have a change of ownership, but based on the specific information relating to the shared transfers, the ownership change for Section 382 purposes occurred on November 16, 2004, not March 31, 2005. The difference between these two dates allows us to utilize the net operating losses that were generated during the four months from November 16, 2004 to March 31, 2005 to offset current income.

During that period, we generated approximately $12.8 million of losses. Thus, we are able to reduce our tax liability for 2007 by approximately $4.3 million from the amount we recorded in the 10-K for 2007.

Now, to address the reduction in the cost of imagery purchased from third parties. During the second quarter, we undertook an internal review of the accounts of the imagery purchased from third parties and determined that we had over-accrued approximately $3 million of expenses associated with purchasing imagery to satisfy our customer needs. As you may recall, on occasion, we need to purchase individual IKONOS teams from our regional distributors to meet the needs of one of our direct customers.

In 2007, we originally had expensed through actual purchase and accruals $6.4 million of purchased imagery. As a result of this internal review, we determined that we had over-accrued $1.7 million in the third quarter and $1.3 million in the fourth quarter for these expenses. Thus, while we have reported we have purchased $6.4 million of imagery, the internal review confirmed that we'd only purchased $3.4 million.

I know that this is complicated especially the tax related items. In summary, our tax liabilities have not significantly changed from prior expectations. We are confident that we've put these issues behind us as we move into the GeoEye-1 era.

Now, I will go onto our second quarter operating results, GeoEye-1 program cost, and cash position. Revenue for the second quarter of 2008 was lower than the second quarter of 2007. We generated $34.2 million of revenue in the second quarter of 2008 versus $48.3 million in 2007, a decrease of $14.1 million or roughly 29% below last year. The primary reason for this reduction was the issue related to the timing of NGA orders we mentioned during our first quarter investor call.

In the second quarter of 2008, the imagery and production services we delivered to NGA decreased $16 million compared to the same period in 2007. We believe these results are from NGA waiting to receive products from GeoEye-1 when it becomes operational in the next few months. This reduction was partially offset by increased revenues of $1.1 million in SeaStar revenue and $0.5 million increase from our M.J. Harden operations.

On a year-to-date basis for 2008, we have generated $68.6 million of revenue compared to $85 million for 2007. Again, the primary reason for this reduction has been the issue related to the timing of NGA orders which resulted in the $20.6 million decrease of orders from NGA. This decrease was partially offset by $800,000 in ground station equipment sales, $1 million dollar in SeaStar revenue and $2.2 million in M.J. Harden operations. As we have said before, we believe the NGA ordering issue will be resolved soon and should not be an issue once we have GeoEye-1 in operation later this year.

Our income from operations in the second quarter of 2008 was $5.3 million compared to $25.7 million in 2007. The primary reason for this decline in income from operations was due to the NGA imagery orders issues previously discussed, as well as some increased costs incurred as we prepare for the upcoming launch of GeoEye-1.

For 2008, year-to-date income from operations was $11 million compared to income from operations of $36.8 million for 2007. The main contributing factor for this decrease was the NGA imagery order decrease. Our second quarter net income for 2008 was $2.4 million compared to $11.2 million in the second quarter of 2007 as restated. The decrease in net income in the second quarter of 2008 was due to the NGA order timing issue and the increasing costs related to the preparations for the launch of GeoEye-1, partly offset by a reduction in the provision for income tax in 2008 given the change in tax accounting method that has been applied for.

On a year-to-date basis, our net income for 2008 was $3.4 million compared to a loss of $2.4 million for 2007 as restated. The difference between the two is the result of the netting effects of the NGA timing issue. The loss of the OV-3 satellite in 2007, the increased cost related to the preparations for the launch of GeoEye-1, and a reduction of provision for income tax in 2008 given the tax accounting method application.

Overall, our cash balance as of June 30 was $221.5 million. The GeoEye-1 program continues to remain fully funded. To date, we have expended approximately $420 million of the $502 million program, most of which has been capitalized. The $421 million of expenses includes payments of $370 million and accrued but not yet paid amounts to contractors of $43 million.

On a cash basis, there is $124 million remaining to be paid under the GeoEye-1 program. This includes the previously mentioned $43 million accrued but not yet paid expenses and $81 million consisting of amounts to our contracts for milestones not yet completed, insurance premiums, interest free cap lines [ph], and remaining unused contingency.

To cover these expenses, we have $221.5 of cash on our balance sheet and $43.5 million of remaining NGA milestone payments as of June 30. Thus, we have $265 million of cash from these sources which provides a significant cushion. In addition, we have access to the cash flow generated from our operations.

Regarding GeoEye-1, I'd like to discuss our insurance program for a moment. As we've previously reported, we secured $270 million in both total and partial loss insurance for GeoEye-1 with premiums totaling $38 million.

As we‘ve also discussed in prior calls, we were looking to purchase additional insurance if it was available. We’re pleased to report that in early August, we purchased an additional $50 million of total loss only insurance. The premium in this additional insurance placement totaled $6.1 million, so we now have $320 million of total coverage.

Now, I’m going to turn the call over to our COO, Bill Schuster.

Bill Schuster

Thanks, Henry. First, I want to give you more information on the launch of GeoEye-1. As Matt said, United Launch Alliance needs extra days to allow for the positioning of the resources to support receipt of telemetry from the Delta II rocket after launch.

The primary US military aircraft for doing this job recently became unavailable due to unexpected maintenance issues. This required ULA to seek an alternative plan for capturing telemetry data after the rocket goes beyond the range of land-based tracking station that follows the rocket’s initial flight.

ULA is now going to use a ship to track the telemetry. Mobile telemetry either by aircraft or ship is required to receive the downlink of the telemetry through second-stage engine cut off. This Telemetry enables ULA to continually monitor engine performance and other launch vehicle dynamics. ULA has assured us that this alternative means for receiving telemetry will be in place to support the September 4 launch.

As a result of this, ULA has asked the 30th Space Wing at Vandenberg Air Force Base for permission to launch on September 4. We expect to hear soon if the launch range can support a launch on that new target date. We have every reason to expect an affirmative answer.

The Delta II booster's first and second stages are currently stacked on the launch pad. The only significant issue ULA has left to complete is the retest of a range safety antenna on the booster. This retest has been going well and is scheduled for completion by August 16.

The GeoEye-1 satellite has successfully completed all of its pre launch check-outs prior to being mated with the booster. The satellite is ready and waiting to be lifted and placed on top of the booster to complete preparations for the planned September 4 launch.

We will launch. When we do, launch will occur in the afternoon at approximately 2.50 PM Eastern Time. After launch, it'll take a few hours to know we’ve reached the proper orbit and to determine the satellite’s status. So, there will be no announcement from the company after launch until we have that all-important first contact with GeoEye-1.

The Delta II rocket has a success rate of better than 98.5% and the last 82 consecutive Delta II missions have been successful. In addition, General Dynamics and ITT each have 100% mission success rates for their satellites and cameras. Our internal team has been busy rehearsing for launch and operations of GeoEye-1. All of that makes us very confident of a successful launch, deployment, and transition to operations.

Anyone will be able to watch the launch live on the Internet by going to our corporate Web site at GeoEye.com. After launch, we’ll test and calibrate each of the satellite subsystems. It’s like a shake-down cruise. We plan to turn on the camera around two weeks after launch. We expect to deliver some sample imagery to NGA and possibly other customers in the late September time frame and make some imagery publicly available around the same time. Finally, we expect to achieve full certification of the quality of the imagery by NGA in the late October time frame.

Now, despite our excitement about GeoEye-1, we can’t forget about IKONOS. We just got some good news with respect to IKONOS. Last month, Lockheed Martin completed a new life-expectancy study. They found no impending life-limiting issues and they now estimate that the satellite can achieve a ten-year life span. This means it will likely continue to operate through next year, if not longer.

Now, I’ll turn the call back to Matt.

Matt O'Connell

Thanks, Henry. Thanks, Bill. Last time we talked, we gave you a heads up that it would take a while to get launched and to solve the NGA order issues. As you’ve heard, we’re very close to launching GeoEye-1 and to finalizing a service level agreement that will make our order flow from NGA more predictable.

We’re putting some issues behind us and you have to remember that our industry is exciting and growing fast. GeoEye-1 will be the world’s highest resolution commercial satellite. Satellite imagery has migrated from the world of intelligence to the world of commerce and we’re on the front end of that trend.

Our technology married with the benefits of GPS, fast Internet connectivity, and generally favorable laws and policies will move the needle in ways we can’t even imagine. Remember, it was only in 1996 that the first map was sent over something called the Internet, and in 2004, Google bought Keyhole, a small intelligence community backed startup to form Google Earth, which has since revolutionized how we look at our planet. We and our 450 employees are proud to be part of this exciting industry.

Now, we know that some of you have expressed interest in asking questions. We’ll take your questions now, understanding that some of the questions may involve proprietary, commercially sensitive information, and that may limit our ability to respond. Thanks again for joining the call.

Back to the operator.

Question-and-Answer Session

Operator

(Operator instructions) And we’ll take our first question from Paul Coster of JP Morgan.

Paul Coster – JP Morgan

Well, first of all, can I just check that you can hear me?

Matt O'Connell

Yes, we can.

Paul Coster – JP Morgan

Okay, good. The NGA mix for your program, BASIC, and many other data points suggest that this is an early-staged industry where demand is outstripping supply and I’m sure you agree with that. But, how can we reconcile that with the fact that the NGA revenues are kind of fully short at the moment? Surely they’re desperate for any imagery from any source at the moment. Can you just help us to understand that quandary?

Matt O'Connell

Sure, Paul. I’ll take it first and then I can let the others join in. First of all, I will remind you that our client’s name is the National Geospatial-Intelligence Agency, an intelligence agency, they don't like to hear themselves talked about in public, so I’ll be somewhat restrained in what I say. There is overall more demand than there is supply. At the same time, NGA is going to a transition from a period where it had the ClearView program before to the NextView program. That transition involves a lot of internal changes.

Combined with that is the fact that with GeoEye-1, obviously, they paid for half of the satellite, they get a very good rate on the imagery they buy under that satellite, and the pixels under that satellite are better than even the pixels that IKONOS produces and IKONOS is a world leader. So when WorldView-1 launched, it appears that NGA may have taken some of the orders that otherwise we might have gotten and ported over them over to Worldview-1. We think that’s temporary and we think that when GeoEye-1 launches, that needle will swing back. I think you’re right though that there is a lot of demand. I think this is a temporary situation.

Paul Coster – JP Morgan

Much of the capacity that you have on IKONOS is already allocated to regional affiliates. What is the firm’s philosophy regarding allocation of capacity to those third parties with respect to GeoEye-1?

Matt O'Connell

Well, that’s actually a nice question to deal with, Paul, because our business is kind of like – one analyst compared it the primetime TV. Northeast Asia and the Middle East are completely sold out. In fact, there’s a waiting line for time there. If we had more capacity in both areas, we could sell that. So, as GeoEye-1 comes on stream, we’re going to balance orders. I think most of the government customers that we sell to including the US government will want GeoEye-1 because it will be the best in the world and it will be color. And that’s, in a way, helpful to us because that frees up capacity.

I alluded to China before and it’s not too often that you sit in a meeting with a customer who’s most frequent complaint is they want more capacity and they want it right now and they’ll pay for it and they have the money. So, we’re looking forward to having more capacity in our peak areas. We also, once we have GeoEye-1 up there, can do more speculative collects. The speculative collects will help us develop new products and services like monitoring services that we're actively looking at for a couple clients.

As you know, not only is IKONOS capacity constrained, Paul, but we do have to treat it a little tenderly because it’s getting on in years and we want to make sure that it continues to collect so that we can have a constellation. So, we do minimize our speculative collects with IKONOS. Getting GeoEye-1 up there is going to be such a massive mapping machine that we can do more speculative things with that and that will really help us develop some of the products and services that are on hold pending its launch.

Paul Coster – JP Morgan

I realize you are not in a position to issue guidance at the moment, too many variables, but are there a range of analyst forecasts out there now for calendar year ‘09. Are you comfortable with those forecasts?

Matt O'Connell

I can let Henry address that, but you hit the nail on the head, Paul, when you said that we don’t generally provide guidance. Henry?

Henry Dubois

I think I would echo Matt on that, I mean, you’re all kind of falling into a similar source of range, but as you know, Paul, we don’t provide guidance at the moment.

Paul Coster – JP Morgan

My last question then, Henry, is state and local government is feeling the squeeze at the moment. Are you seeing any change in buying behavior on part of those customers and for that matter, what percentage of your revenues can be attributed to that end customer?

Henry Dubois

Paul, as we’ve always discussed, our general revenue flows are roughly about 50% US government and about 35% international foreign governments, and the remaining 15% our domestic commercial and other businesses. State and local governments would be a subset of that 15%, not – less than half of that 15%. I would expect it to be fairly – we are anticipating that we may have some follow up there and we’re taking steps to see what we can do about it.

Matt O'Connell

Yes, we’re doing what any good manager would do, Paul. As we look out, we read the journal, and we talk to people in the state municipalities. We just went to a conference that was I would say 50% state and local people. And as we heard them talking about their budget issues, we then went and talked to, for instance, our M.J. Harden people and said why don’t you orient more toward the Department of Homeland Security and FEMA for your '09 planning than for state and local?

State and local has been a very good source of revenue for those guys. M.J. Harden is a small piece of our business, but they just did have the best second quarter of their history. But looking forward, like you, we are cognizant of the fact that the state and local guys are going to be – probably coming up short and we think that Homeland Security and FEMA is probably a better place to focus some of our domestic activities.

Paul Coster – JP Morgan

Thank you for taking my questions.

Henry Dubois

Thank you for the questions. Next question?

Operator

Our next question comes from Jeff Evanson of Dougherty & Company.

Jeff Evanson – Dougherty & Company

Good morning gentlemen, thanks for taking my questions.

Matt O'Connell

Thanks for asking them, Jeff.

Jeff Evanson – Dougherty & Company

Matt, I guess what I would like to know initially is what are the types of things you’re looking for and when do you expect to see these things that will give you more visibility on your plans for GeoEye-2?

Matt O'Connell

Well we’d love to have clarity on what the US government is going to do with its’ rumored program. I’m not going to get too much into the business of reading tea leaves in Washington, but since this is an election year and since committing dollars in election year is often tough, that seems to us to pose some hurdles to the people who might want to go ahead with that program. We are formulating plans around that – you heard before that we are aware of other pockets of capital that might be interested in capacity that’s the guys we’re going out and looking for those pockets of capital, and if we can line up the right number of people who want to pre-commit for imagery, we’ll steam ahead with that plan and then will go to the government and say, "Hey, look, this is our program, this is what we are investing with our partners on GeoEye-2 and do you want to come along?" And then we’ll negotiate the deal with them.

Jeff Evanson – Dougherty & Company

So these potential pre-commitments, are those being woven into your discussions around resigning for GeoEye-1?

Matt O'Connell

No, that’s really a GeoEye-2 issue. Remember that all of this, Jeff, is in the 2012 and then on time frame, so we've got a full line of discussions going on right now on GeoEye-1 because people are eagerly waiting for that. They all want bragging rights in their jurisdiction to say they've got the best and we’re going to keep that going. There are a couple of specific people who’ve talked about looking past that phase and that those are the people we are talking about GeoEye-2.

Jeff Evanson – Dougherty & Company

All right. So generally, the GeoEye-1 and GeoEye-2 discussions with international customers are two-track discussions?

Matt O'Connell

Yes.

Jeff Evanson – Dougherty & Company

Okay.

Matt O'Connell

Additive if you will.

Jeff Evanson – Dougherty & Company

The new orders you mentioned on IKONOS. As you kind of talked around, if I should consider those orders basic mapping type orders or are those related to recent geopolitical events that may have popped up in the news media?

Matt O'Connell

Well, I'll let Bill get into the details to the extent he can, but I think you can – as you know Jeff, whenever there is a geopolitical thing, without talking about any specific territory, you can assume that we're taking pictures. Bill, can you give him any more color on the orders?

Bill Schuster

Yes, the orders that Matt was referring to represented a fairly large area of a mapping nature to go off and collect part of their strategic mapping effort. Other things that you alluded to, we certainly were asked to, but from an area of square kilometer perspective didn't come anywhere close to this large area that Matt was referring to.

Jeff Evanson – Dougherty & Company

Okay. And then Matt, by my calculations, if I go back out NGA, it looks to me like revenues grew about 10% year-over-year. I was wondering if you could speak to – if there was balanced strength between international customers and commercial or if one was stronger than the other on a year-over-year basis.

Matt O'Connell

I'll turn that over to Henry.

Henry Dubois

Jeff, as I discussed in the main part of my conversation, we had some increased revenue in some of our products and services businesses, both in the stuff that we are doing in St. Louis as well as our SeaStar products and our MJ Harden operations. Those products and services picked up some of the shortfall on NGA.

Jeff Evanson – Dougherty & Company

Okay. Could you give us the breakout, Henry, between imagery and production revenue?

Henry Dubois

We'll be getting that when we file the 10-Q shortly.

Jeff Evanson – Dougherty & Company

Okay. We can hold off on that. How much direct cost did you have related to the repurchased imagery in the quarter?

Henry Dubois

We'll put that down, all that will be in the 10-Q but it's roughly on par with what we actually purchased last year, roughly about $1.25 million.

Jeff Evanson – Dougherty & Company

Okay. Can you share with us depreciation and amortization in Q2?

Henry Dubois

We will get all that stuff sent with the 10-Q when we get it filed shortly.

Matt O'Connell

Yes. Jeff, we regret that we don't have those kinds of details. We wanted to have everything filed by today but, as you can imagine with all of the restatements, it's taking our team a little while to get through all that.

Jeff Evanson – Dougherty & Company

Okay, and then my last question, how much of your demand in the quarter could you attribute to specific events like the Burma cyclone, the Chinese earthquake or the Olympics? Can you speak to that at all?

Bill Schuster

We had some preparation work associated with the Olympics and we certainly covered other events, but again the size of those efforts from a square kilometer point of view pale in comparison to the overall mapping where NGA's efforts are aimed at mapping the Earth – entire Earth.

Matt O'Connell

Yes, our steady-state business is more significant than the spot order business. I guess that's another way to put it.

Jeff Evanson – Dougherty & Company

Sure. But you did get some get some lift from the spot order business in the quarter, I take it, although de minimis? Is that what you are saying?

Bill Schuster

I would answer it slightly differently and that is that we were asked to support all of those events and we did.

Matt O'Connell

Yes, and Jeff actually that question ties us back to earlier question. I look forward to having GeoEye-1 available because when I was in Beijing, one of the questions was can’t you give us more imagery of the Olympics site. We gave the Chinese what we could but we're pretty well committed in that part of the world.

Jeff Evanson – Dougherty & Company

Understood. Okay. Great. Thanks a lot guys.

Matt O'Connell

Thank you.

Operator

Our next question comes from James McIlree of Collins Stewart.

James McIlree – Collins Stewart

Thank you. Good morning. I think you mentioned that the IKONOS satellite has now been life expectancy through 2009. Didn't the K say it was 2010?

Matt O'Connell

We have been stating it at 2010 and I think what we're looking at is the difference between the life expectancy at a probability rating of about 80% versus a probability closer to 65% to 70%. If we were to lower the probability, we would get a longer life.

James McIlree – Collins Stewart

Longer than 2010?

Matt O'Connell

What we did in the study is we took a look at what would be the likely things that could get you based on some physics at various periods of time and what we have now done is a result of this last study said that there are no known phenomenon that would take you out in a deterministic way through year ten. It's not to say that you might not have a problem; what it says is, you don’t run out of gas in year ten and you don’t – that will be a simple example and you don’t have other things that would be known to occur with ten year's worth of accumulated life.

James McIlree – Collins Stewart

Okay. And Henry, is anything on the tax issue for the NGA prepayments, does that change any cash tax payments that you’ll need to make between now and let's call it the end of ’09?

Henry Dubois

What we’re anticipating is that we would end up recognizing some of the cost-share payments as well as the – the cost-share payments we received in 2008 plus roughly one-quarter of the $194 million in 2008. That would be about $93 million of cost-share payments in this year’s taxable income tax return. We would anticipate, assuming we have the satellite launched and commissioned as we’re planning to, including some components completed by September 30, be able to offset that additional $93 million of taxable income with the accelerated depreciation that we would get off of the satellite program. So the answer is, on our current plan, no, we don’t expect to have any difference.

James McIlree – Collins Stewart

But is there any cash tax payments that you need to make for the prior three where you didn’t?

Henry Dubois

Relating to the 382 study –

James McIlree – Collins Stewart

No, on the prepayments.

Henry Dubois

On the prepayments, the remaining balance will then – we’ll recognize another 25% of the $194 million in 2009, a third 25% in 2010 and the fourth in 2011 which would then be offset by the depreciation that we will be recognizing on from GeoEye-1.

James McIlree – Collins Stewart

Maybe I’m just asking it inelegantly but, for ‘05, ‘06, ‘07, for tax purposes, you should have recognized income. And I’m wondering if now you have to make a cash catch-up tax payment for the prior years.

Henry Dubois

No, we don’t. As a result of the IRS application for the tax accounting method change, we get to recognize that four – the total amounts that we should have recognized over the next four years. That's part of the – that’s governed by the IRS tax procedures.

James McIlree – Collins Stewart

Okay.

Henry Dubois

But it just gets moved out.

James McIlree – Collins Stewart

Okay. Bill, could you just address what kind of issues would prevent the 30th wing from not allowing the September 4 launch and then what’s the back-up if the range safety antenna doesn’t retest properly?

Bill Schuster

Let’s see. With respect to giving the launch range, it’s basically an issue of deconflicting and because we don’t have a 100% visibility into everything going on at the range, but we do have a lot of visibility, we believe that the date is available and we expect in the very immediate future to be hearing that they have accepted it. But it would be a conflict in which case they would juggle the conflict. They would move something a day or two. There was an activity that was tying up the range, 3, 4, or 5 of September. That activity was moved out last night. So there’s no – as far as we know, there should no longer be a conflict and we anticipate that that will be freed up. With regards to the range safety antenna, the answer is, it is a mandatory flight item and they will have to go do what’s necessary to get it to pass its tests.

James McIlree – Collins Stewart

So the risks of that not passing its tests could then cause another delay in the launch date?

Bill Schuster

That’s theoretically possible. However, the testing is going exceptionally well and currently, all of its environmental tests were completed yesterday and right now – and it was functionally tested to make sure that in the course of those environmental tests that nothing bad transpired. It’s currently on its way back to the manufacturer where they’re going to compare its performance – its pre-test performance to its now post-test performance on all the parameters and assuming that that happens without issue, they’re done. And that will occur before the end of this week.

James McIlree – Collins Stewart

Okay. So let’s assume the best that September 4 is approved and that range safety antenna is fine. Do you announce about those things that both items have now been checked off?

Matt O'Connell

We haven’t planned to because it’s kind of normal business, but we can if you want. I think we’re just going to steam toward launch. We might – would we put out our press release guys when we put the satellite on the rocket? I think that’s what we’d probably do James.

James McIlree – Collins Stewart

Okay.

Bill Schuster

And actually all of that should happen at around the same time

Matt O'Connell

Yes, I think I mean –

Bill Schuster

By sometime next week we should be in the position to be able to speak to all three of those and maybe we’d pick that opportunity to wrap all three into one.

Matt O'Connell

Now what we would do, James, I mean the rocket is literally standing up, the boosters are strapped on. It’s on the path; it ain’t going anywhere. So the most exciting thing is when you take your capsule which is currently – I mean our satellite is sitting in the capsule ready to go, it’s bagged up and when we put that physically on top of the rocket, we’d probably put an announcement out then.

James McIlree – Collins Stewart

And my last one, Matt, you spoke a little bit about the online and the search tools. Could you elaborate a little bit on that and may be frame it in terms of what revenues you’re generating from that now or what would you would hope to generate?

Matt O'Connell

Well, I’ll be happy to frame it for you again. We don’t give guidance but I would say that the tools that we’ve developed are really exciting for a number of reasons. One, they help our customers reach right into our archive and see whatever they want and they do it in an incredibly elegant and efficient way. When we presented at South West to our resource, the guy presenting got spontaneous applause from people all around the world. We were then featured in this industry conference. There was a video in the opening section which was attended by thousands and again, we got some applause there because it’s just such an elegant solution. That will make it easier for customers to see what’s in our stuff and compare it to what they have in their own archives, some of them have actually said they’d like to license our tools and use it to manage their own archives which is sort of a nice, new little line of business.

As to the revenue that we generate from online, that has not been a material item for us and actually if you look at digital World's S1 [ph], it’s not material for them too. We don’t think in the near term that online will be a material line of business for us in the SEC sense. However, we do expect to have some healthy growth in that and we’ll come back to you after launch and give you more details on that.

James McIlree – Collins Stewart

Thank you and good luck on the launch.

Matt O'Connell

Thanks.

Operator

Our next question comes from Lance Hans [ph] of Lighthead [ph].

Lance Hans – Lighthead

Hey guys, thanks. All my questions have been answered, thank you.

Matt O'Connell

Okay, thanks, Lance. The best question we’ve gotten. Go ahead.

Operator

Our next question comes from Anthony Klarman of Deutsche Bank

Anthony Klarman – Deutsche Bank

Thanks. Two questions here. First, I just want to reconfirm that none of the changes that you've seen in volumes from the NGA currently have anything to do with what’s already been committed as part of their contract that they signed with GeoEye-1; I think that it was like $190 million or so of revenue over the first I think six-quarter period after check out?

Matt O'Connell

Well, I mean Bill can talk about how that contract has been modified Anthony. First of all, thanks for the question. We do still have a contract with them, that original commitment remains in place except to the extent that we’ve already drawn in onset commitment by supplying imagery to them with IKONOS right now. But, no, they haven’t decreased the overall commitment other than what they have already spent with us, if that’s what you’re asking?

Anthony Klarman – Deutsche Bank

Right, I guess and my point was, I think there were some earlier commentary or maybe even something in the release that indicated that they might have sourced some imaging from one of your competitors whose bird was up already, that would not at all replace imaging that they were due to purchase from you as part of GeoEye-1.

Bill Schuster

Imaging is an ongoing activity, and so from the time we launch, at the very least the contract will be out six quarters after that and that’s the nature of the discussion that we’re in with them on the SLA, so it basically just moved out with the launch of the satellite.

Anthony Klarman – Deutsche Bank

Yes,

Bill Schuster

There's just so many pictures, enough to take and then if it’s taken, then you don’t get to take it. I mean, the imagery is done over and over again because you need to maintain currency of what your holdings are.

Henry Dubois

Anthony, what you're talking about is the $197 million on a post-launch basis. But we have discussed in the past how we’ve been utilizing some of that money to supply them over the last year and a half or so with imagery offered by IKONOS but, no, that is not going to somebody else.

Anthony Klarman – Deutsche Bank

Right.

Matt O'Connell

And also, Anthony, when we announced that amendment that let us access those post-launch dollars, pre-launch as we face delays and we wanted to have funding for IKONOS sales, we did mention that as we did the amendment NGA asked for and we happily gave them the right to amend the contract to increase the amount of funding. They call it topping up; they got the right to top up the contract later if they want to. It’s good news.

Anthony Klarman – Deutsche Bank

Right. And with respect to GeoEye-2, how much money has been spent on that to this point? I know that you’d spent some initial dollars sort of I think investigating the opportunity and talking to some of the potential partners that you would have in the construction of that satellite.

Henry Dubois

Anthony, as we have said in prior things, it's not a material number at this point. It's well below the covenant levels that we have of $15 million a year.

Anthony Klarman – Deutsche Bank

Okay. In terms of, I guess, how you would look at that going forward, the call date on the debt has extended out obviously quite a bit given the delay relative to the initial timing that was set in the bonding indentures, how would you sort of envision – I guess, number one, how much of the cash that, Henry, that you spoke about inside the restrictive group versus outside? And how would you imagine on encumbering some of those limitations that are in there in terms of your ability to spend on GeoEye-2 to the extent that you get off satisfactory answers that Matt laid out in terms of what you'd be looking to really push ahead with that satellite?

Henry Dubois

That analysis is something that we're all looking at as we go down the path of GeoEye-2 in terms of getting the business side and then looking at the overall structure as to how we would do that? Obviously, we need to make sure and do it within conformity to the covenants we have on the existing floating rate notes and yes, with a launch delay from now – with August 22, I think the non-call provision was actually about January 6. Now we're about January 20 give or take. And regarding the restricted and non-restricted subsidiary cash, we'll be getting that out in the Q as well.

Anthony Klarman – Deutsche Bank

Okay. Thanks. Good luck with everything.

Matt O'Connell

Thanks, Anthony.

Operator

Our next question comes from Peter Friedland of Soleil.

Peter Friedland – Soleil

Hi. Quick question, I know you guys don't provide guidance but just thinking about the next couple of quarters, what we should see as far as revenue progressions? Is it fair to say that Q3 should look similar to Q2 and Q1, and then you should see some level of ramp in Q4 assuming a successful launch?

Henry Dubois

Peter, this is Henry. As Matt was saying, we're in the process of negotiating the service level agreement and we believe that we'll probably take that thing to get in place before we are able to truly solve the full order – NGA order timing issue.

Matt O'Connell

And I think in our comments before, Peter, what we said was we'll get that SLA finished and we'll probably put out an announcement when we sign that thing but even after we sign it, I wouldn't be surprised. I don't want to yield any ground on negotiations right now but I could easily see NGA saying, they'll sign it before they certify the quality of the imagery on GeoEye-1 but that's why in my remarks and Bill's remarks, we both talked about the timing of NGA's formal certification that they accept the quality of the imagery of GeoEye-1. That's the late October timeframe, so without providing guidance, I think we can say that you can apply your own logic and say that we may get this SLA, we may announce this SLA, but the routine and we expect increased amounts of payments probably won't kick in until they have formally accepted the imagery. I think that may help you without giving guidance.

Peter Friedland – Soleil

Great. Thanks. And then one more thing just on the tax line, is there a placeholder tax rate that we can use for the rest of '08 and for '09?

Henry Dubois

We've been using about the 39.5% tax rate's what I would suggest. (inaudible) about it.

Peter Friedland – Soleil

Great. Thank you.

Operator

One more question from Simon Solacha [ph] of Harbor Side [ph] Capital Management.

Simon Solacha – Harbor Side Capital

Hey guys. Thanks for taking my question. These are few quick ones. I don't want to take too much time on this call. My first one is related to the antenna test, it's on August 16 you said?

Bill Schuster

Yes.

Simon Solacha – Harbor Side Capital

Okay. And between then and the proposed launch date, are there any other things that have to happen?

Bill Schuster

Well, there's a lots of routine things that we'd like to happen, like for example, fueling the rocket. We've already been through the pre-test to make sure that there are no leaks in the tanks, in the valves, and stuff like that but you can't keep liquid oxygen in the rocket because it boils off, so those steps take place much closer to launch. There are a few other prep procedures, for example, putting the satellite on top of the rocket, then putting the paring over the satellite, and then arming all of the various separation joints, so there's thousand of things that take place. The issue with the antenna was that that was extraordinary in the sense that we had to get that thing tested.

Simon Solacha – Harbor Side Capital

Okay.

Bill Schuster

As opposed to the normal flow of getting a rocket ready.

Matt O'Connell

And just one thing to add to that, Simon, is that the antenna test by the way, it isn't just us, this is the whole industry so –

Simon Solacha – Harbor Side Capital

Right. I understand. And then the one other question under that, we talked about the probability of launch, do you have like a sense of probability for the antenna that’s going through just fine? Is it again similar to most things in the industry of 982, 973 [ph]?

Bill Schuster

Let me be qualitative and say that I think it’s very, very high.

Simon Solacha – Harbor Side Capital

Okay.

Bill Schuster

It has been through all the stressful environments where it’s been pushed beyond its normal limits. And after that, it was functionally tested. It was x-rayed. It was examined very carefully and everything appeared to be right. What we’re going to do now is just compare the pre-test numbers with the post-test numbers and we have every reason to expect that they should be within the design tolerance that they have and so we’re pretty optimistic that things are going to look good.

Simon Solacha – Harbor Side Capital

Okay, great. And I actually had most of my other questions answered, I guess, the only thing I have is more common in terms of press release that that would be helpful if you guys would be able to do that in terms of those (inaudible) approving the date and finalizing it.

Matt O'Connell

Okay. We’ll do that Simon.

Simon Solacha – Harbor Side Capital

Great, thank you. All right, you all take care.

Matt O'Connell

Thanks, Simon.

Operator

We have another question from Jeff Evanson of Dougherty & Company.

Jeff Evanson – Dougherty & Company

Thanks, gentlemen. First let me say, I want to congratulate you on the quality of this conference call. It was very well-handled and went much better than last quarter. So thank you for your preparation for that.

Matt O'Connell

Thank you, Jeff.

Jeff Evanson – Dougherty & Company

I guess, I’d like to get just some clarity around when you think the 10-Q will be available, Henry? I’m sorry to pin you down but what do you think?

Henry Dubois

I would expect within the next couple of days.

Jeff Evanson – Dougherty & Company

Okay. And then I just want to hear it from you guys, the material weakness that was identified. Have you resolved that and how long will we see that discussed in the SEC filings?

Henry Dubois

I believe you need to discuss material weaknesses through the next audit cycle. So we would see it at least going into the 10-K. We have addressed that by bringing on additional resources, both externally as well as internally.

Jeff Evanson – Dougherty & Company

Okay. My last question, I’m still having just a little bit of a tough time understanding these penalties and interests that you’re accruing for, but you won’t have to pay. Am I stating that correctly? Was there a filing that should have occurred in the past or was there an incorrect filing around this treatment of the cost-sharing revenue or help me understand?

Henry Dubois

Jeff, our prior tax returns had been assuming that we’ll be able to recognize the cost-share payments in the same process, in the same methodology as we are recognizing it for our financial reporting purposes; in other words, over a seven-year period post launching and we’ve been filing our tax returns that way. We’ve determined that that was an incorrect method and as a result of identifying that over the recent past, with the help of our new tax advisers, we filed with the IRS an application for a change of accounting method for tax purposes for these cost-share payments. As a result of that filing, we get audit protection and we get relief from the penalty and interest protection. That is where we have been going on in place right now. We’re in – we do our – we’re processing it through and as a result of that, we believe we are free from the penalty and interest.

Matt O'Connell

Yes, Jeff, it confused me too when I first heard about it, but the way I heard it explained was when you self – the IRS like to people to self-report and they’ll forgive you from the penalties and interests. So you have to book it as though it was in there in the past, so you have comparable periods, but at the same time it’s going to come out in the third quarter because it’s going to get reversed. So for the quarter just ended, it has to go in and then the quarter coming up, we expect it will come out based on the advice we’re getting from our new tax advisor.

Henry Dubois

What it is, it assumes as of June 30 as we have that liability even though we didn’t. We didn't know, we made the application last week and as a result of that application last week, that’s what gives us the relief; however, we have to file our financial statements as of June 30, 2008.

Jeff Evanson – Dougherty & Company

Great. I got it. So the last follow-up on that. So the $2.4 million discussed related to Q2, that is not present in the financials you put out in the press release, correct?

Henry Dubois

It actually is present in those financials. It’s in the tax provision but it gets netted out against multiple other things. We are finding our taxes are way more complicated than we ever anticipated.

Matt O'Connell

And that’s why we made the change we talked about earlier.

Jeff Evanson – Dougherty & Company

Well, I see that you accrued for financial purposes at almost 40% which is what we expected for an effective tax rate and that included an extra $2.4 million?

Henry Dubois

When you do your taxes, you have to look at it on a full-year basis with estimated income and how that’s all playing out. We’re now getting into some fairly complex tax accounting. I’d be happy to discuss it later.

Jeff Evanson – Dougherty & Company

Well, it’s not my favorite subject, so I’d suggest we continue to model at 39% to 40% on a go-forward basis?

Henry Dubois

That is correct.

Jeff Evanson – Dougherty & Company

Okay, thank you. Thanks guys.

Matt O'Connell

Thank you, Jeff. Other questions?

Operator

We have no further questions on the phone at this time.

Matt O'Connell

Well, if there are no further questions, we want to thank you all for your patience. We’re looking forward to launch and to putting all the restatements behind us, and to signing that SLA. So thanks again for your patience; we’ll talk to you next quarter.

Operator

And ladies and gentlemen, this does conclude today's conference. Thank you for your participation and you may disconnect at this time.

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