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DGI > SEC Filings for DGI > Form 10-Q on 31-Oct-2012All Recent SEC Filings

Show all filings for DIGITALGLOBE, INC.

Form 10-Q for DIGITALGLOBE, INC.


31-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained herein and other of our reports, filings, and public announcements may contain or incorporate forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "could," "intends," "target," "projects," "contemplates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of these terms or other similar words, although not all forward-looking statements contain these words.

Any forward-looking statements are based upon our historical performance and on our current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us that the future plans, estimates or expectations will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions. A number of important factors could cause our actual results or performance to differ materially from those indicated by such forward looking statements, including: the loss, reduction or change in terms of any of our primary contracts; the availability of government funding for our products and services both domestically and internationally; changes in government and customer priorities and requirements (including cost-cutting initiatives, the potential deferral of awards, terminations or reduction of expenditures to respond to the priorities of congress and the administration, or budgetary cuts resulting from congressional committee recommendations or automatic sequestration under the Budget Control Act of 2011); the risk that the anticipated benefits and synergies from the proposed strategic combination of the Company and GeoEye, cannot be fully realized or may take longer to realize than expected and the risk that a condition to closing of the proposed strategic combination may not be satisfied; the outcome of pending or threatened litigation; the loss or impairment of our satellites; delays in the construction and launch of WorldView-3; delays in implementation of planned ground system and infrastructure enhancements; loss or damage to the content contained in our ImageLibrary; interruption or failure of our ground system and other infrastructure, decrease in demand for our imagery products and services; increased competition that may reduce our market share or cause us to lower our prices; our failure to obtain or maintain required regulatory approvals and licenses; changes in U.S. foreign law or regulation that may limit our ability to distribute our imagery products and services; and other important factors, all as described more fully in our filings with the SEC, including our Annual Report on Form 10-K.

We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. Readers are cautioned not to place undue reliance on any of these forward looking statements.

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. Additionally we serve a wide variety of companies in other industry vertical markets, such as financial services, 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 imagery archive, which we refer to as our 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 2.6 billion square kilometers of imagery, with the capacity to add approximately 2.9 million square kilometers of imagery every day. As of September 30, 2012, our collection capacity was nearly one billion square kilometers of imagery per year or roughly seven times the earth's land surface area and offers intraday revisit around the globe.

Proposed Merger

On July 22, 2012, DigitalGlobe entered into an Agreement and Plan of Merger (the "Merger Agreement") with GeoEye, Inc. ("GeoEye"), 20/20 Acquisition Sub, Inc., a Delaware corporation and a wholly owned subsidiary of DigitalGlobe, and WorldView, LLC, a Delaware limited liability company and a wholly owned subsidiary of DigitalGlobe. Under the terms of the Merger Agreement, GeoEye common stockholders will have the right to elect to receive either: (i) 1.137 shares of DigitalGlobe common stock and $4.10 in cash, (ii) 100% of the consideration in cash ($20.27 per share) or, (iii) 100% of the consideration in stock (1.425 shares of DigitalGlobe common stock), for each share of GeoEye common stock they own, with the amount of cash and stock subject to proration depending upon the elections of GeoEye common stockholders, such that the aggregate consideration mix reflects the ratio of 1.137 shares of DigitalGlobe common stock and $4.10 in cash per share of GeoEye common stock. Accordingly, the aggregate consideration pursuant to the Merger Agreement is a fixed amount of shares and cash. DigitalGlobe expects to issue approximately 26.0 million shares of common stock and pay $93.9 million to GeoEye's common stockholders.

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In addition, each issued and outstanding share of the 80,000 shares of Series A convertible preferred stock of GeoEye will be converted into: (i) one share of a newly-designated Series A convertible preferred stock of DigitalGlobe, and
(ii) $4.10 in cash for each share of GeoEye common stock into which such share of GeoEye Series A preferred stock is convertible. As a result, DigitalGlobe expects to pay $11.0 million in cash to GeoEye's Series A convertible preferred stockholders. Upon completion of the transaction, DigitalGlobe stockholders are currently expected to own approximately 64% and GeoEye stockholders are currently expected to own approximately 36% of the combined company.

The transactions contemplated pursuant to the Merger Agreement (the "Merger") will be accounted for under the acquisition method of accounting. Total Merger-related transaction costs expected to be incurred by the Company are estimated to be approximately $40.2 million including legal, accounting, advisory fees and fairness opinions and integration consulting fees, but excluding any fees associated with refinancing the debt of the combined company. In connection with the transactions contemplated by the Merger Agreement, DigitalGlobe has obtained a commitment for a $1.2 billion credit facility from Morgan Stanley Senior Funding, Inc., The Bank of Tokyo-Mitsubishi UFJ, Ltd, J.P. Morgan Securities LLC, JPMorgan Chase Bank, N.A. and Citigroup Global Markets Inc.

The transaction, which is expected to be completed in the fourth quarter of 2012 or the first quarter of 2013, is subject to the satisfaction of customary closing conditions, including the receipt of requisite regulatory approvals and approval from DigitalGlobe and GeoEye stockholders.

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 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 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 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 of the errors (see Note 3 of the Notes to the Unaudited Condensed Consolidated Financial Statements for the impact on the 2011 quarterly financial information):

In three of the Company's 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.

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.

The Company incorrectly capitalized interest related to the construction of its direct access facilities and other discrete projects.

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 Company incorrectly calculated certain DAP access minutes.

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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DigitalGlobe, Inc.

Products and Services

We offer earth imagery products and services that are comprised of imagery from our three high-resolution satellite constellations as well as aerial 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 have collected and stored millions of high-resolution imagery scenes covering over 2.6 billion square kilometers in the ImageLibrary. For the nine months ended of 2012, approximately 50% of our revenue, excluding the National Geospatial-Intelligence Agency ("NGA") Service Level Agreements ("SLA"), is generated from purchases from our ImageLibrary.

Customers specify how they want the imagery that they are purchasing from us to be produced. We deliver our satellite imagery 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 using specialized software. Stereo imagery products are used for the creation of digital elevation maps, for the more accurate and life like creation of stereo maps that can be used in flight simulations, environmental analysis and other consumer end products.

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, and physical media such as hard drives.

We offer an additional distribution option through our 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. The 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 six customer contracts for our DAP, four of whom have been operational since the second half of 2010. We began providing services to our fifth DAP customer during the first quarter of 2012. We signed a contract with our sixth customer in the third quarter 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.

The following table summarizes our percentage of direct sales and reseller and partner sales:

                                          Three months ended September 30,                   Nine months ended September 30,
                                                                     2011                                               2011
(in millions)                             2012                      Revised                  2012                      Revised
Direct sales                                    86.5 %                     84.9 %                  86.7 %                     86.9 %
Reseller and partner sales                      13.5                       15.1                    13.3                       13.1

100.0 % 100.0 % 100.0 % 100.0 %

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DigitalGlobe, Inc.

Backlog

The following table represents our backlog as of September 30, 2012:



                                                            Backlog to be recognized
(in millions)                                     Next 12 Months             Life of Contracts
EnhancedView SLA                                 $          232.9           $           2,503.5
DAP                                                          47.9                         158.7
Amortization of pre-full operational
capability ("FOC") payments related to
NextView                                                     25.5                         143.6
Other  (1)                                                   59.9                         204.8

Total Backlog                                    $          366.2           $           3,010.6

(1) Other consists of firm orders, minimum commitments under signed customer contracts, remaining amounts under pre-paid subscriptions, firm fixed price reimbursement and funded and unfunded task orders from U.S. and International defense and intelligence and commercial customers.

Backlog consists of all contractual commitments, including those under the anticipated ten year term of EnhancedView, amounts committed under DAP agreements, firm orders, remaining pre-paid subscriptions and task orders from our government customers. Our backlog also includes amounts of obligated funding on indefinite delivery/indefinite quantity ("IDIQ") contracts on which we participate for products and services that we believe we are qualified to provide.

EnhancedView has a ten-year term, inclusive of nine annual renewal options that may be exercised by NGA. Although NGA may terminate the contract at any time and is not obligated to exercise any of the remaining eight option years, we include the full remaining term in backlog, because we believe it is NGA's intention to exercise the remaining options, subject to annual appropriation of funding and the federal budget process, which funding contains an inherent level of uncertainty in the current budget environment.

The pre-FOC balance will be recognized over the 10.5 years from the launch of WorldView-1. We recognize it ratably over the estimated satellite life, but the recognition of this revenue has no effect on our ability to generate additional revenue from the usage of our satellite and therefore should not be considered a reduction in our capacity to generate additional sales.

Although backlog reflects business that is considered to be firm, terminations, amendments or cancellations may occur which could result in a reduction in our total backlog. In addition, failure to receive task orders under IDIQ contracts could also result in a reduction in our total backlog. Any such terminations, amendments or cancellations of contractual commitments, or failure to receive task orders under IDIQ contracts may also negatively impact the timing of our realization of backlog.

Significant Customer

On August 6, 2010, we entered into EnhancedView with the NGA. The EnhancedView SLA has an effective date of September 1, 2010. EnhancedView 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. On July 24, 2012, NGA exercised the second option period under the EnhancedView SLA to extend the EnhancedView SLA for the period of September 1, 2012 through August 31, 2013.

The EnhancedView SLA 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 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. The infrastructure improvements include the addition of seven remote ground terminals that enable us to communicate more frequently with our satellites that has an additional benefit of increasing our imaging download capacity, and the addition of certain infrastructure that integrates our imagery delivery systems more closely with the U.S. government.

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. As of July 2012, we have installed all remote ground terminals in accordance with EnhancedView. During the first and

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second quarters of 2012, the Company and NGA agreed to modifications of EnhancedView that included increasing the amount of capacity made available to NGA and adjustments to the performance penalty (formerly "holdback"). The modification did not result in a material change to the SLA accounting. We will continue to use the proportional performance method of revenue recognition. Our WorldView-3 satellite is currently 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. As of September 1, 2012, we increased the capacity of the constellation made available to NGA and are now recognizing approximately $18.9 million in revenue per month under the EnhancedView SLA. For the nine months ended September 30, 2012, we recognized approximately $144.5 million of revenue, and recorded $47.7 million of deferred revenue related to the EnhancedView SLA contract. As of September 30, 2012, there was $167.8 million in total deferred revenue from the inception of the EnhancedView SLA. Given the significant amount of constellation capacity expected to be generated by the WorldView-3 satellite and the increasing percentage of capacity that NGA will acquire from us once our WorldView-3 satellite becomes operational, we anticipate a material increase in revenue once WorldView-3 satellite reaches FOC. The expected increase in revenue will reflect the cash received from NGA plus amortization of deferred revenue.

Under the EnhancedView SLA, assuming all option years under the agreement are exercised and funded, and that future systems and satellites are operational according to our current plan, we will receive a monthly non-refundable cash payment of approximately $20.8 million from NGA during the first four years of EnhancedView, which began on September 1, 2010, with an increase to $25.0 million per month in years five through ten, beginning in September 2014. Each monthly payment is subject to a performance penalty, ranging from 3% to 10% through February 28, 2013 and 6% thereafter, depending upon the Company's performance against pre-defined SLA performance criteria. If NGA determines that we have performed all SLA performance criteria in the agreement each month, no performance penalty will be applied to that month. If the Company incurs a performance penalty due to NGA's assessment that not all performance criteria have been met, a penalty is incurred. The Company retains the cash; however, the penalty amount will be applied to mutually agreeable future products and services, or to a pro-rated extension beyond the current contract period. Accordingly, all penalty amounts will cause the Company to defer recognition of a corresponding revenue amount until the performance penalty funds are consumed as described above. For the three months ended September 30, 2012 and 2011, there were no performance penalties. For the three months ended June 30, 2012, we had a penalty of $0.2 million which was consumed by NGA during the third quarter of 2012. For the three months ending March 31, 2011, we had a penalty of $0.2 million which was consumed by NGA during the second quarter of 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.

                                             Three months ended September 30,                   Nine months ended September 30,
                                                                        2011                                               2011
(in millions)                                2012                      Revised                  2012                      Revised
Revenue:
Defense and intelligence                $          81.1            $          65.3         $         230.9            $         191.4
Commercial                                         26.1                       16.6                    65.1                       50.4

Total Revenue                           $         107.2            $          81.9         $         296.0            $         241.8

Revenue as a Percent of Total:
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