Conference Call Highlights

Management drops potential bombshell about GeoEye-1 malfunction

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

• GeoEye-1 Problem: COO Bill Schuster, when reading from a prepared statement, stated that last week the company found a potential problem with GeoEye-1’s imagery collections.

He further explained that the satellite has several different imagery collection profiles, and that the problem seems to be present with only one profile and not the others, as determined by the company and the maker of the camera, ITT Corp. (NYSE: ITT).

In this affected profile, part of the image lacks color, but the black and white imagery is unaffected.

The issue doesn’t affect resolution or accuracy.

He further stated that it is too early to tell what is causing this issue, or the specific remedies that may apply.

Further, he stated that there was little or no impact for the company as it pertained to their SLA with the NGA.

They are still looking into whether these issues might affect some of the selected needs of some of their other customers.

The COO also stated that they are unsure how this will affect their collections capabilities going forward, if at all, and that they are currently operating the satellite in a way that completely avoids the issue.

On the Q&A portion of the call, an analyst asked if this problem with GeoEye-1 was causing any capacity constraints, and the COO stated that what the company has had to do was eliminate the operating mode that is causing the issue, and that they’ve been unable to automate and optimize those operations, but that they are quickly overcoming those limitations.

He further answered that he didn’t feel that this problem would have any affect on their large area collections capabilities that specifically apply to the SLA with the NGA.

When pressed further and asked if this was a software or hardware issue, or a combination of both, the COO said that they are still trying to determine which it is, however he DOES NOT SUSPECT THAT IT IS A SOFTWARE ISSUE.

My Take: Let’s start here before delving into anything else on the conference call.

As we saw today, the market didn’t stick around to find out what the true extent of this “problem” might be, and it definitely makes me nervous as well.

One of the primary risk factors for owning shares of GeoEye or any other satellite company (DigitalGlobe owners beware), is that their only source of revenue is hurtling through space at incredible speeds, with little ability to recalibrate or fix problems should they arise.

We already saw that when GeoEye-1 was launched and initially calibrated, this process also ran into problems, and delayed the final check out of GeoEye-1 by months.

The fact that GeoEye is now facing another issue, albeit one that so far isn’t affecting revenues too much at this point, makes me nervous and calls into question the investing thesis in GeoEye depending on the extent of the problem.

For instance, if this problem continues to be minor in nature, and is readily fixable, then we can use the weakness in the stock price to increase our position.

If however, this problem is an extension of, or an outcropping of earlier problems, then we could be looking at additional downside, and possibly an entire loss in certain aspects of GeoEye-1’s capabilities.

What scared me the most though was that the COO stated clearly that he didn’t think it was a software issue!

If it was, that would be good news in that the software issues could be addressed over time, and probably corrected.

I’m not a satellite expert, but I would think that any issue having to do with hardware would be next to impossible to fix unless they are directly tied to software that can be manipulated to correct the hardware issue.

I don’t want to jump to conclusions at this point, but we need to hear more out of the company on this issue to the extent of how much it will affect GeoEye, what can be done to rectify the situation, and what long term affects this will have on future contracts and orders.

From what I understood on the call, and follow up questions on the subject, it feels to me that the issue is most likely a long term one, and one that will affect imagery collection going forward for certain customers and certain of their needs, but not affect GeoEye’s SLA contract, or the majority of their contracts since the problem was only recently detected for what seems to be very niche imagery needs by only a few customers.

I’ll be watching this very closely.

• CEO Discusses SLA With NGA: CEO Matt O’Connell spoke about how GeoEye didn’t ramp up their full capacity for their Service Level Agreement (SLA) with the National Geospatial-Intelligence Agency for $12.5 million per month, until April, so Q1’s results contain very little actual revenue dedicated to this agreement.

He further went on to say that if GeoEye does not deliver the agreed upon amount of imagery, the NGA can impose a penalty of up to 10%, but that as of April, they not only fulfilled this capacity, but did so well within the time frame specified for the month of April.

Concerning the SLA, he further went on to say that the current agreement with the NGA expires at the end of November, but that the NGA is looking to extend that agreement through June of 2010 or longer.

The terms of next year’s extension haven’t been finalized yet.

My Take: It was further clarified on the call, that the “penalty” really isn’t a penalty at all, but rather, a delay and deferment of revenues.

So for example, if GeoEye doesn’t supply the NGA with the agreed upon imagery for a certain time frame, then that portion of revenue gets pushed back to the end of the contract and tacked on at the end, up to 10%.

So far, that hasn’t been a problem though as GeoEye seems to be up to date with their imagery collection demand for the NGA even with the problems encountered by GeoEye-1.

In addition, the extension of this agreement for another year is great news for GeoEye’s revenue and predictability.

• U.S Government Expansion of Commercial Satellite Imagery Purchases/GeoEye-2: The CEO then touched on the recent news that the U.S. government recently decided and issued a press release stating that they were going to rely on commercial imagery providers more in the coming years.

He went on to say that GeoEye is positive on the announcement, and looks forward to hearing more specifics of the plan.

He further stated that they believed that this increase in use of commercial providers like GeoEye and DigitalGlobe, while far away in the past, appears to be much closer to fruition now.

Management also stated the fact that they believe that even with the capacity of GeoEye and DigitalGlobe, there is currently not enough capacity to satisfy the government, and thus the reason that GeoEye has continued to invest in construction and efforts to further their GeoEye-2 satellite program.

To that end, they are focusing their efforts towards having GeoEye-2 ready for launch in the 2012 time frame when they expect demand to really pick up.

He also stated that GeoEye has already invested about $43 million over the last year or so in the camera and other items associated with GeoEye-2, which will have the capacity, should the government allow it, to capture imagery at a resolution of ¼ meter, or about 10 inches, which would put this satellite head and shoulders above any other commercial satellite available today.

Finally, as far as capital expenditures for GeoEye-2, management talked about first feeling out demand, and then making sure that they have an “anchor” customer and/or support from the U.S. government before they devote any further resources to the GeoEye-2 project.

My Take: Management stated that GeoEye has enough capital on hand to make it through this quarter without tapping into the equity markets, and that by the 3rd quarter of the year, they will know more in terms of how they will continue to finance GeoEye-2’s construction and build out, which might involve some combination of debt and equity.

Like I’ve said before, there will come a time when the company will take on either more debt, or dilute shareholders in order to fund their next satellite launch.

• GeoEye’s International Business: While discussing GeoEye’s international business, the CEO noted that while the NGA is GeoEye’s single largest customer, international business continues to account for nearly half their revenue.

He further stated that GeoEye had recently met with several of their overseas customers and were told how impressed and happy they were with GeoEye-1’s imagery. (This was probably before GeoEye-1’s problems!)

GeoEye will look to expand their international presence throughout the year by brokering more deals, and passing muster with several international regulations so that by the 3rd quarter of 2009, they expect to build this market out further and reap even more revenue.

Finally, the CEO touched again as he did in GeoEye’s last conference call, about GeoEye’s new imagery business model that allows them more income, freedom, and rights to the imagery they collect, all which will lead to a much smoother revenue stream and margin picture.

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

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

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

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

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

• Products and Services Business: The CEO touched on the value added work that GeoEye does with the imagery that they receive, which by the way, is done on imagery from any source, not just GeoEye’s imagery from their satellites.

Management also noted that they are still increasing capacity at their production facilities, which will in turn increase revenue in the future, and will be hiring about 120 additional employees throughout 2009 for these and other purposes at the company.

These production services differentiate GeoEye from other providers, especially DigitalGlobe, in that they can do complex imagery manipulation that allows customers to see more with the images they have.

• CEO stated that Google’s (NASDAQ: GOOG) agreement with GeoEye states that Google has to purchase all the imagery that GeoEye-1 takes, regardless of what it is.
• DigitalGlobe IPO Discussion: The CEO spoke briefly about how DigitalGlobe’s IPO will positively affect the entire sector and industry of geospatial mapping, and specifically, for the market of GeoEye’s stock as it will bring added attention both in the financial world, as well as media coverage.

So whats’ the bottom line?…

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