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DGI > SEC Filings for DGI > Form 10-K on 29-Feb-2012All Recent SEC Filings

Show all filings for DIGITALGLOBE INC

Form 10-K for DIGITALGLOBE INC


29-Feb-2012

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a leading global provider of commercial high-resolution earth imagery products and services. Our products and services support a wide variety of uses, including defense, intelligence and homeland security applications, mapping and analysis, environmental monitoring, oil and gas exploration, and infrastructure management. Our principal customers are governments, including U.S. and foreign defense and intelligence, and civil agencies and providers of location-based services (LBS). Additionally we serve a wide variety of companies in other vertical markets, such as energy, telecommunications, utility, forestry, mining, environmental and agricultural industries. The imagery that forms the foundation of our products and services is collected daily via our three high-resolution imaging satellites and managed in our content archive, which we refer to as our


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ImageLibrary. We believe our ImageLibrary is the largest, most up-to-date and comprehensive archive of high-resolution earth imagery commercially available, containing more than 2.0 billion square kilometers of imagery, with new imagery added every day. As of December 31, 2011, our collection capacity was approximately 910 million square kilometers of imagery per year or roughly six times the earth's land surface area and offers intraday revisit around the globe.

Revision of Previously Issued Financial Statements

In connection with the preparation of the Company's consolidated financial statements for the year ended December 31, 2011, errors were identified primarily relating to the year ended December 31, 2010 and the first three quarters of the year ended December 31, 2011. These errors were primarily related to the Company's accounting for the Direct Access Program ("DAP"), as described below. The Company has assessed the impact of these errors on each period involved, in accordance with the SEC's Staff Accounting Bulletin No. 99, and has determined that the impact of the errors was not material, both individually and in the aggregate, to all previously issued financial statements. While the Company has also determined that the cumulative effect of correcting the errors in the fourth quarter of the year ended December 31, 2011 would not be material to the 2011 consolidated financial statements, the Company has elected to revise its previously issued financial statements to facilitate comparisons among periods. As part of its revision, the Company has determined to reverse immaterial out-of-period adjustments that were previously recorded in the Company's 2011 quarterly periods and to reflect those adjustments as corrections to the periods in which the errors originated.

The following is a description of the nature and the amount of the errors relating to the year ended December 31, 2010 (see Note 16 of the Notes to the Consolidated Financial Statements for the impact on the 2010 and 2011 quarterly financial information):

In three of the Company's four current DAP customer contracts, the up-front payments contractually negotiated for the Facility were less than the actual third-party costs to manufacture the Facility. As each of the three Facilities was brought into service, it was the Company's accounting policy to amortize both the deferred revenue and deferred contracts costs over the estimated customer relationship periods, which periods are consistent with the estimated remaining useful life of the satellite being accessed. However, the Company has concluded that this accounting policy was in error and that it should have been recognizing the deferred contract costs in excess of the deferred revenues (for each individual customer) over the related initial contract period. The impact of this error is an increase in cost of revenue of $1.5 million.

Certain costs for two DAP customers were previously netted against the related revenue. However, the Company concluded that this was an error as the Company acts as the principal in these arrangements. The cost and revenue should have been recorded on a gross basis, with the effect being an increase in both revenue and cost of revenue of $1.1 million.

The Company incorrectly capitalized interest related to the construction of its direct access facilities and other discrete projects. The impact of this error is an increase to interest expense of $0.8 million.

The Company previously recognized maintenance revenue for one DAP customer over a one-year period. However, the Company concluded that this was an error and that the revenue should have been recognized over the customer relationship period. The impact of this error is to reduce revenue by $0.5 million.

The Company incorrectly calculated certain DAP access minutes. The impact of this error is to reduce revenue by $0.3 million.

The Company has also corrected other immaterial errors including (i) over- or under-capitalization of certain internal and external costs, (ii) the accounting for stock compensation, including under capitalization of stock compensation for certain assets under construction, (iii) the effects of properly reconciling certain accrued liability accounts, and (iv) the classification of payments received for a sales type lease from operating to investing cash flows.


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Products and Services

We offer earth imagery products and services that are comprised of imagery from our three high-resolution satellite constellation as well as aerial and satellite imagery that we acquire from third party suppliers. We process our imagery to varying levels according to our customers' specifications and deliver our products using the distribution methods that best suit our customers' needs. Customers can purchase satellite or aerial images that are archived in our ImageLibrary, or by placing custom orders, which require tasking of our satellites, for a specific area of interest, or as a bundle of imagery and data for a region or type of location, such as cities, ports and harbors or airports. For example, our Global Basemap product features comprehensive color imagery of the Earth's surface that is refreshed on a routine basis and is delivered to customers according to geographic need.

Our ImageLibrary currently houses what we believe to be the most comprehensive, up-to-date, high-resolution archive of commercial earth imagery in the world. It is a collection of substantially all imagery acquired by our QuickBird, WorldView-1 and WorldView-2 satellites, whether tasked for a specific customer or collected on a speculative basis, as well as aerial imagery and other satellite imagery we have purchased to supplement our satellite imagery. We collect and store hundreds of thousands of high-resolution imagery scenes covering over 2.0 billion square kilometers in the ImageLibrary. Approximately 54.5% of our revenue, excluding the NGA SLA, is generated from purchases from our ImageLibrary.

Customers specify how they want the imagery content that they are purchasing from us to be produced. We deliver our satellite imagery content at three processing levels: (i) basic imagery with the least amount of processing;
(ii) standard imagery with radiometric and geometric correction; and
(iii) ortho-rectified imagery with radiometric, geometric, and topographic correction. Radiometric correction enables images to appear uniformly illuminated with the right level of brightness. Geometric correction allows a user to identify the latitudinal, longitudinal and altitudinal location of any point in an image. Topographic correction accounts for terrain and projects images onto the earth as they would be seen by the human eye. All of our aerial imagery is delivered as ortho-rectified imagery.

We also use enhanced processing to produce mosaic and stereo imagery products. The mosaic process takes multiple imagery scenes, collected at different times and dates, and merges them into a single seamless imagery product. We use specialized collection and enhanced processing to produce stereo imagery products. Stereo imagery products consist of two images collected from two different viewpoints along the satellite orbit track that are produced as basic products, but can be viewed in stereo (3D) using specialized software. Stereo imagery products are used for the creation of digital elevation maps, for the more accurate creation of 3D maps and flight simulations.

We offer a range of on- and off-line distribution options designed to enable customers to easily access and integrate our imagery into their business operations and applications. Delivery options include desktop software applications, web services that provide for direct on-line access to our ImageLibrary, File Transfer Protocol (FTP), and physical media such as CD, DVD, and hard drive.

We offer an additional distribution option through our Direct Access Program (DAP) that allows certain customers, approved by the U.S. government, to task and download data directly from our WorldView-1 and WorldView-2 satellites within their regional area of interest. DAP is designed to meet the enhanced information and operational security needs of a select and limited number of defense and intelligence customers and certain commercial customers. To date, we have signed five customer contracts for our DAP, four of whom have been operational since the second half of 2010. The fifth customer is currently expected to come online in the first half of 2012.

We sell our products and services through a combination of direct and indirect channels, a global network of resellers, strategic partners, direct enterprise sales and web services. We generated 38.3% of our revenue through direct sales and 61.7% of our revenue from our reseller and partner network.


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Significant Customer

In September 2003, we entered into the NextView agreement with the National Geospatial-Intelligence Agency (NGA) under which we agreed to provide a minimum of $531.0 million of imagery products and services from our WorldView-1 satellite. Of this amount, $266.0 million was received between September 2003 and November 2007, the date WorldView-1 became operational, and was used to offset the construction costs of the satellite. The remaining $265.0 million commitment was to be received upon the delivery of imagery once WorldView-1 achieved full operational capability (FOC). In January 2008, we amended the NextView agreement from image-based ordering to a service level agreement (SLA) and increased the amount we received under the NextView agreement from $265.0 million to $311.0 million (NextView SLA). On June 25, 2009, the NextView SLA agreement was further amended to extend the term from July 31, 2009 through March 31, 2010 in consideration for payment of an additional $100.0 million, payable at $12.5 million per month during the extended term. On February 9, 2010 the NextView agreement was amended to provide NGA with an option to extend the agreement for three months on the same terms from April 1, 2010 to June 30, 2010 and six additional options each for a one month period with the last option term expiring on December 31, 2010. On March 11, 2010, NGA exercised the option to extend through June 30, 2010. On June 8, 2010, NGA exercised its first monthly option to extend through July 31, 2010, and on July 13, 2010 exercised its second monthly option to extend through August 31, 2010. The NextView SLA expired August 31, 2010.

On August 6, 2010, we entered into the EnhancedView contract with NGA. The SLA portion of the EnhancedView contract, (EnhancedView SLA) has an effective date of September 1, 2010, commencing upon the expiration of the NextView SLA. The EnhancedView contract has a ten year term, inclusive of nine one-year options exercisable by NGA, and is subject to Congressional appropriations and the federal budget process, and the right of NGA to terminate or suspend the contract at any time.

For a discussion of the risk associated with our government contracts, see Risk Factors in Part 1, Item 1A.

The EnhancedView SLA portion of the award is sized at $2.8 billion over the term of the contract assuming NGA exercises all of its options and we perform as specified; $250.0 million annually, or $20.8 million per month, for the first four contract years, commencing September 1, 2010, with an increase to $300.0 million annually, or $25.0 million per month, for the remaining six years of the contract term. The award also provides for up to $750.0 million for value added products, infrastructure enhancements and other services, including the option for NGA to require us to lower the altitude of WorldView-2 to an altitude of 496 km at any time after September 1, 2013. We will be required to meet certain service level requirements related to the operational performance of the satellites comprising the WorldView constellation and related ground systems. To support requirements under this agreement, we have begun the procurement and construction of our next satellite, WorldView-3, as well as certain other infrastructure improvements.

We recognize revenue for the $2.8 billion in services to be provided under the EnhancedView SLA using a proportional performance method based upon the estimated capacity of our constellation made available to NGA compared to the total capacity to be provided over the life of the contract. The contract requires us to increase capacity of the constellation through the installation of additional remote ground terminals, which communicate directly with our satellites, as well as the addition of an entirely new satellite, WorldView-3. Our WorldView-3 satellite is expected to be ready for launch in mid 2014. As capacity is added to our constellation, we recognize revenue in direct proportion to the amount of incremental capacity that is made available to NGA. Commencing in September 2010, we recognized approximately $12.5 million of revenue monthly through August 31, 2011, under the EnhancedView SLA. As of September 1, 2011, we increased the capacity of the constellation made available to NGA and are now recognizing approximately $14.1 million per month under the EnhancedView SLA. For the year ended December 31, 2011, we recognized approximately $157.0 million of revenue and recorded $94.6 million of deferred revenue related to the EnhancedView SLA contract. As of December 31, 2011, there was $119.4 million in total deferred revenue from the inception of the EnhancedView SLA. Given the significant amount of constellation capacity expected to be generated by WorldView-3 satellite and the increasing percentage of capacity that NGA will acquire from us once WorldView-3 satellite becomes operational, we anticipate a material increase in revenue once WorldView-3 satellite reaches FOC.


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Under the EnhancedView SLA, and assuming all option years under the agreement are exercised and funded, we will receive a consistent, monthly non-refundable cash payment of approximately $20.8 million from NGA during the first four years of the EnhancedView contract, with an increase to $25.0 million per month in years five through ten. Each month is subject to a holdback, up to 10% of the monthly payment scheduled, depending upon our performance against pre-defined criteria. If we have been certified as having performed all requirements in the agreement each month, no holdback will be applied to that month. If funds are held back, we retain the cash, however, those funds can be applied to future products and services or will fund a pro-rated extension beyond the current contract period. Accordingly, all amounts held back will cause us to defer recognition of a corresponding revenue amount until such additional products or services have been provided. From September 1, 2010 to December 31, 2010, we satisfied all performance criteria under the agreement, and therefore had no holdback applied for the period. During the year ended December 31, 2011, there was $0.2 million of holdback, which occurred during the first quarter of 2011, all of which has been applied to other products and recognized as revenue as of December 31, 2011.

Revenue

Our principal source of revenue is the licensing of our earth imagery products and services to end users and resellers and partners.

We conduct our business through two segments: (i) defense and intelligence; and
(ii) commercial. We have organized our business into these two segments because we believe that customers in these two groups are functionally similar in terms of their areas of focus and purchasing habits. Our imagery products and services are comprised of imagery that we process to varying levels according to the customer's specifications. We deliver our products and services using the distribution method that best suits our customers' needs. Customers can purchase satellite or aerial images that are archived in our ImageLibrary. Customers can also order imagery content by placing custom orders, which require tasking of our satellites, for a specific area of interest, or as a bundle of imagery and data for a region or type of location, such as cities, ports and harbors or airports.

                                                Year ended December 31,
                                                          2010
                                            2009        Revised        2011
                                                    ($ in millions)
           Revenue
           Defense and intelligence        $ 231.0      $  252.4      $ 261.4
           Commercial                         50.9          70.1         78.1

           Total Revenue                   $ 281.9      $  322.5      $ 339.5

           Revenue as a percent of total
           Defense and intelligence           81.9 %        78.3 %       77.0 %
           Commercial                         18.1          21.7         23.0

           Total Revenue                     100.0 %       100.0 %      100.0 %

Total U.S. and foreign sales were as follows:

                                         Year ended December 31,
                                                   2010
                                      2009       Revised       2011
                                              (in millions)
                    Revenue
                    U.S.            $  232.7     $  227.8     $ 228.3
                    Foreign             49.2         94.7       111.2

                    Total Revenue   $  281.9     $  322.5     $ 339.5


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Defense and Intelligence Revenue

Our defense and intelligence segment consists of customers who are principally defense and intelligence agencies of U.S. or foreign governments. The U.S. government, through NGA, purchases our imagery products and services on behalf of various entities within the U.S. government, including the military commands and other government agencies. We also sell to other U.S. defense and intelligence customers including defense and intelligence contractors who provide an additional outlet for our imagery by providing value-added services with our imagery to deliver a final end product to a customer.

Our defense and intelligence customers focus on image quality, including resolution, frequency of area revisit and coverage, as well as ensuring availability of a certain amount of our capacity as they integrate our products and services into their operational planning. Our customers in this segment typically operate under contracts with purchase commitments, through which we receive monthly or quarterly payments in exchange for delivering specific orders to the customer. Our revenue from our defense and intelligence customers has historically been largely from tasking orders, with a smaller portion from sales of imagery from our ImageLibrary. We believe this trend will continue. We sell to our defense and intelligence customers both directly and through resellers.

Only one DAP customer had been commissioned in 2009. By the second half of 2010, we commissioned four of our current DAP customers' ground terminals and began generating revenue from providing satellite access time to these customers. These four DAP customers generated revenue for the entire year of 2011. The fifth DAP customer is currently expected to come online in the first half of 2012.

We earn revenue from sales of the DAP facility hardware and software, as well as service fees to access our satellite constellation. The revenues to access our satellite constellation are recognized over time based on minutes of actual usage. The revenues and costs associated with the sales of a DAP facility are deferred until we commission into operation the ground terminal and can provide contractually specified access to our operational satellites. The revenues and costs are then recognized ratably over the customer relationship period, which is based on the estimated useful life of the satellite being accessed, except when deferred contract costs are in excess of deferred revenues, in which case the excess costs are recognized over the initial contract period. If more than one satellite is used, the satellite with the longest remaining useful life is used as the basis for the amortization.

                                                                 Year ended December 31,
                                                                           2010
                                                           2009          Revised          2011
                                                                      (in millions)
Defense and intelligence revenue
U.S. and Canada revenue
NGA SLA                                                   $ 150.6        $  150.3        $ 157.0
Other revenue and value added services                       38.2            29.7           23.4
Amortization of pre-FOC payments related to NextView         25.5            25.5           25.5

Total U.S. and Canada revenue                             $ 214.3        $  205.5        $ 205.9

International revenue, excluding Canada                   $  16.1        $   12.2        $   8.4
DAP revenue                                                   0.6            34.7           47.1

Total international revenue, excluding Canada             $  16.7        $   46.9        $  55.5

Total defense and intelligence revenue                    $ 231.0        $  252.4        $ 261.4

Revenue as a Percent of Total
U.S. and Canada                                              92.8 %          81.4 %         78.8 %
International, excluding Canada                               7.2 %          18.6 %         21.2 %

                                                            100.0 %         100.0 %        100.0 %
Reseller and Direct Sales
Direct Sales                                                 96.7 %          98.2 %         98.4 %
Resellers                                                     3.3 %           1.8 %          1.6 %

                                                            100.0 %         100.0 %        100.0 %


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Commercial Revenue

Our commercial segment consists of both traditional and location based services customers. Our traditional customers are primarily civil government agencies, and energy, telecommunications, utility and agricultural companies who, like our defense and intelligence customers, use our content for mapping, monitoring, analysis and planning activities. Providers of LBS, include internet portals, connected devices, and digital mapmakers, who use our imagery products and services to expand their products and services. Customers in other industry verticals are represented by financial services, oil and gas, telecommunications, utilities, environmental services and other industry verticals who use our imagery in a wide range of applications.

Our commercial customers are located throughout the world. They purchase our products and services on an as-needed basis, or through multi-year contracts, depending on the solution that best suits their application. We sell to these customers directly and through resellers.

For the twelve months ended December 31, 2011, we generated approximately 21.9% of our commercial revenue from paid tasking and 78.1% from our ImageLibrary.

For the years ended December 31, 2009, 2010 and 2011, our top five commercial customers accounted for 56.1%, 46.3% and 43.5% of our commercial revenue. We believe that we will have additional growth opportunities internationally especially in countries with rapidly developing economies, such as Brazil, China and Russia, and, as a result, we expect that long-term sales growth in our commercial segment will be higher outside of the United States.

                                                 Year ended December 31,
                                                           2010
                                             2009         Revised        2011
                                                      (in millions)
           Commercial Revenue
           Americas                        $   23.6      $    32.5      $ 32.9
           International                       27.3           37.6        45.2

           Total commercial revenue        $   50.9      $    70.1      $ 78.1

           Revenue as a Percent of Total
           Americas revenue                    46.4 %         46.4 %      42.1 %
           International revenue               53.6 %         53.6 %      57.9 %
           Reseller and Direct Sales
           Direct sales                        43.4 %         42.4 %      38.3 %
           Resellers                           56.6 %         57.6 %      61.7 %

Expenses

Most of our revenue is generated by the sale of products and services comprised of imagery from our QuickBird, WorldView-1 and WorldView-2 satellites. Given that most of the costs of a satellite are related to the pre-operation capital expenditures required to build and launch a satellite, there is no significant direct relationship between our cost of revenue and changes in our revenue. Our cost of revenue consists primarily of the cost of personnel, as well as the cost of operations directly associated with operating our satellites, retrieving information from the satellites, and processing the data retrieved. Costs of acquiring aerial imagery from third-parties are capitalized and amortized on an accelerated basis as a cost of revenue.

Our selling, general and administrative expenses consist primarily of labor, benefits, travel, rent, insurance, utilities, telecommunications and related overhead costs, third-party consultant payments, sales commissions and marketing expenses. Our total selling, general and administrative expenses have been increasing in recent years, and we expect the increase in costs to continue, as we expand our sales and administrative resources to enable our revenue growth and increase capacity for product sales and distribution.


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The increase in selling, general and administrative expenses may be offset in future years by the capitalization of labor costs incurred in the development of new assets, especially during the construction of a new satellite. With the initiation of WorldView-3 satellite and other capital investments related to the . . .

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