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DIGITALGLOBE, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) 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 strategic acquisition of GeoEye, Inc. cannot be fully realized or may take longer to realize than expected; the outcome of pending or threatened litigation; the loss or impairment of any of our satellites; delays in the construction and launch of any of our satellites; delays in implementation of planned ground system and infrastructure enhancements; loss or damage to the content contained in our imagery archives; 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; the costs associated with being a public Company; and other important factors, all as described more fully in our filings with the Securities and Exchange Commission ("SEC"), including our Annual Report on Form 10-K for the year ended December 31, 2012. 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 DigitalGlobe, Inc. ("DigitalGlobe," "Company," "we," "our," or "us") is a leading global provider of commercial high-resolution earth imagery products and services. Sourced from our own advanced satellite constellation, our products and services support a wide variety of uses in a number of fields, including defense, intelligence and homeland security, mapping and analysis, environmental monitoring, oil and gas exploration and infrastructure management. Our principal customers are defense and intelligence as well as civil agencies of governments and providers of location-based services. Additionally, we serve a variety of companies in other industry verticals, such as the 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 from our five high-resolution imaging satellites and managed in our imagery archive, which we refer to as our ImageLibrary. We believe that our ImageLibrary is the largest, most up-to-date and comprehensive archive of high-resolution earth imagery commercially available, containing approximately 3.9 billion square kilometers of imagery, with new imagery added every day. As of March 31, 2013, our collection capacity was approximately 1.2 billion square kilometers of imagery per year or roughly eight times the earth's land surface area. On January 31, 2013, we completed the acquisition of 100% of the outstanding stock of GeoEye, Inc. ("GeoEye"), a leading provider of geospatial intelligence solutions in a stock and cash transaction valued at approximately $1.4 billion. The acquisition of GeoEye increases the scale of our operations, diversifies our customer and product mix, broadens our service offerings, enables us to optimize our satellite orbits and collection of imagery, and strengthens our production and analytics capabilities. The combined company has five operational satellites in orbit, with two satellites nearing end of construction. Refer to Note 4 "Business Acquisitions" to the Unaudited Condensed Consolidated Financial Statements for further discussion. We incurred the following combination related costs in conjunction with the acquisition of GeoEye during the three months ended March 31, 2013: Page 20 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. (in millions) Expensed Capitalized Total Restructuring costs $ 20.3 $ 1.2 $ 21.5 Acquisition costs 20.8 - 20.8 Integration costs 7.9 - 7.9 Debt related costs 17.8 36.6 54.4 Total combination related costs $ 66.8 $ 37.8 $ 104.6 Restructuring costs are costs incurred to realize efficiencies from the acquisition of GeoEye, such as reducing redundant workforce, consolidating facilities and systems, and relocating ground terminals. Capitalized costs relating to restructuring primarily consist of property, equipment and leasehold improvements necessary to consolidate operations. Acquisition costs are costs incurred to effect the acquisition, such as advisory, legal, accounting, consulting and other professional fees. Integration costs consist primarily of professional fees incurred to assist us with system and process improvements associated with integrating operations. Loss on early extinguishment of debt is related to entering into the $550.0 million Senior Secured Term Loan facility and $600.0 million Senior Notes, the proceeds of which were used to refinance our $500.0 million term loan and fund the discharge and redemption of GeoEye's $525.0 million Senior Secured Notes we assumed in the acquisition. The GeoEye acquisition has increased our revenue and assets, as well as diversified our customer base. By optimizing orbits, coordinating scheduling and optimizing collection of imagery, we expect to increase imaging capacity and improve timelines and revisit rates. We expect to reduce capital expenditures as a result of having five operational satellites, of which we intend to only maintain a constellation of three satellites over the longer term, allowing us to delay construction of additional satellites. The combined company has two satellites near end of construction and, following completion of construction testing, will place one of them, GeoEye-2, in storage until such time as incremental capacity or replacement for an existing satellite is required. We currently expect to launch WorldView-3 in the second half of 2014. We anticipate that the full operating expense synergies will be realized primarily within the six quarters following the close of the acquisition. We expect cost savings and efficiencies to come from actions we will take principally with respect to labor cost reductions and operational infrastructure savings. We expect to incur additional severance related restructuring charges of approximately $8.0 million over the next four quarters. We may initiate additional restructuring activities in the future. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates and assumptions. Refer to the accounting policies under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2012, where we discuss our more significant judgments and estimates used in the preparation of the Unaudited Condensed Consolidated Financial Statements. New Accounting Pronouncements See Note 2 "Summary of Significant Accounting Policies" of our Unaudited Condensed Consolidated Financial Statements for a full description of recent accounting pronouncements and our expectation of their impact on our Unaudited Condensed Consolidated Financial Statements. Backlog The following table represents our backlog as of March 31, 2013: Backlog to be recognized (in millions) Next 12 Months Life of Contracts U.S. Government: Enhanced View SLA $ 227.3 $ 2,335.2 Amortization of pre-FOC payments related to NextView 25.5 130.8 Other revenue and value added services 46.9 153.2 Total U.S. Government 299.7 2,619.2 Diversified Commercial: DAP 87.6 181.8 Other Diversified Commercial(1) 110.5 193.6 Total Diversified Commercial 198.1 375.4 Total Backlog $ 497.8 $ 2,994.6 (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 international defense and intelligence, and commercial customers. Page 21 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. "Next 12 months" backlog refers to the period between April 1, 2013 and March 31, 2014. Backlog consists of all contractual commitments, including those under the anticipated ten-year term of the EnhancedView contract, amounts committed under Direct Access Program ("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. The EnhancedView contract is structured as a ten-year term, inclusive of nine annual renewal options that may be exercised by the National Geospatial-Intelligence Agency ("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 only to annual appropriation of funding and the federal budget process, which funding contains an inherent level of uncertainty in the current budget environment. The amortization of pre-FOC payments related to our NextView with NGA will be recognized over the 10.5 years from FOC of WorldView-1. We recognize it ratably over the estimated customer relationship period for which the estimated WorldView-1 satellite useful life is the proxy. 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. Additionally, if the life of WorldView-1 were to be modified, the amortization of deferred revenue would be modified accordingly, either reduced in the event that the life of WorldView-1 is extended, or increased in the event the life of WorldView-1 is reduced. 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 EnhancedView Service Level Agreement Our largest customer is the U.S. Government, which includes our EnhancedView Service Level Agreement ("SLA") with the NGA. The EnhancedView SLA totals $2.8 billion over the term of the contract, payable as $250.0 million per year ($20.8 million monthly) for the first four contract years commencing September 1, 2010, and $300.0 million per year ($25.0 million monthly) for the remaining six years of the contract beginning September 1, 2014. We are required to meet certain service level requirements related to the operational performance of the satellites comprising the WorldView constellation and related ground systems. On July 25, 2011, NGA exercised the first option under the EnhancedView SLA, extending the SLA for the period of September 1, 2011 through August 31, 2012. On July 24, 2012, NGA exercised the second option period under the EnhancedView SLA, extending the SLA for the period of September 1, 2012 through August 31, 2013. We recognize net revenue for the EnhancedView SLA using a proportional performance method. Under this method, net revenue is recognized based on the estimated amount of capacity made available to NGA in any given period compared to the total estimated capacity to be provided over the life of the contract. As increasing levels of capacity are made available to NGA, we recognize SLA revenue in direct proportion to the increased level of capacity made available. The contract requires us to increase the capacity made available to NGA through the addition of our WorldView-3 satellite (scheduled to launch in the second half of 2014) as well as the installation of seven additional remote ground terminals. As of the end of July 2012, we have installed all remote ground terminals required by the EnhancedView SLA. Given the significant amount of constellation capacity that will be made available to NGA once WorldView-3 becomes operational, we anticipate a material increase in net revenue once WorldView-3 reaches full operational capability ("FOC"). Accordingly, when WorldView-3 reaches FOC, we will begin to earn and recognize previously deferred revenue. During the first and second quarters of 2012, DigitalGlobe and NGA agreed to modifications of the EnhancedView Contract that included increasing the amount of capacity made available to NGA and adjustments to the performance penalty (formerly "holdback"). The modifications did not result in a material change to the SLA accounting and we continue to use the proportional performance method of net revenue recognition. The capacity made available to NGA resulted in EnhancedView SLA net revenue as follows: Page 22 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. For the three months ended March 31, (in millions) 2013 2012 Cash received $ 62.5 $ 62.5 EnhancedView SLA net revenue recognized 56.8 44.5 Deferred revenue arising from timing of revenue recognition 5.7 18.0 Deferred revenue arising from timing of payments - 2.1 Deferred revenue represents cash received in advance of revenue recognition. Accordingly, our period-end deferred revenue balance varies based on the timing of revenue recognition and the timing of payments within each period presented. Each monthly SLA payment is subject to a performance penalty ranging from 3% to 10% through February 28, 2013 and 6% thereafter, depending upon our performance against pre-defined SLA performance criteria. If NGA determines that not all of the SLA performance criteria were met in a given month, a performance penalty is assessed for that month. We retain the full monthly cash payment; 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 us to defer recognition of a corresponding net revenue amount until the performance penalty funds are consumed as described above. During the three months ended March 31, 2013 and 2012, respectively, there were no holdbacks for penalties. Results of Operations The following tables summarize our historical results of operations for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 and our expenses as a percentage of revenue for the periods indicated: Three months ended March 31, Change (dollars in millions) 2013 2012 $ Percent Historical results of operations: U.S. Government net revenue $ 77.5 $ 53.7 $ 23.8 44.3 % Diversified Commercial net revenue 50.1 33.3 16.8 50.5 Net revenue 127.6 87.0 40.6 46.7 Cost of revenue excluding depreciation and amortization 40.9 18.0 22.9 127.2 Selling, general and administrative 79.8 29.8 50.0 167.8 Depreciation and amortization 47.3 29.1 18.2 62.5 Restructuring charges 20.3 - 20.3 * (Loss) income from operations (60.7 ) 10.1 (70.8 ) * Loss from early extinguishment of debt (17.8 ) - (17.8 ) * Other income, net 0.3 - 0.3 * Interest expense, net (1.4 ) (3.2 ) 1.8 (56.3 ) (Loss) income before income taxes (79.6 ) 6.9 (86.5 ) * Income tax benefit (expense) 19.0 (3.1 ) 22.1 * Net (loss) income $ (60.6 ) $ 3.8 $ (64.4 ) * * Not meaningful Net Revenue The following tables summarize net revenue and net revenue as a percentage of totals for U.S. Government and Diversified Commercial customers: Three months ended March 31, 2013 2012 Net Revenue as a Percent of Total: U.S. Government 60.7 % 61.7 % Diversified Commercial 39.3 38.3 Total Net Revenue 100.0 % 100.0 % Page 23 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. Total U.S. and international sales were as follows: Three months ended March 31, (dollars in millions) 2013 2012 Net Revenue U.S. $ 90. 8 $ 61.4 International 36. 8 25.6 Total Net Revenue $ 127.6 $ 87.0 The following table summarizes our percentage of direct and reseller and partner sales on a consolidated basis: Three months ended March 31, 2013 2012 Reseller and Direct Sales Direct sales 86.0 % 87.1 % Reseller and partner sales 14.0 12.9 100.0 % 100.0 % Our principal source of revenue is the licensing of our earth imagery products and services to end users and resellers and partners. In connection with the GeoEye acquisition, we have re-evaluated the information used to manage our business and have concluded that we now operate in a single segment, in which we provide imagery, imagery information products and services to customers around the world. The vast majority of our revenue is derived from imagery and imagery information products and services. In order to serve our customers, we use a common infrastructure and technology to collect, process and distribute those imagery products and services to all customers. We have organized our sales leadership and go-to market efforts around two customer bases (i) U.S. Government and (ii) Diversified Commercial. Revenue recognized for services provided to U.S. Government customers consist primarily of the EnhancedView SLA, amortization of pre-FOC payments related to the NextView agreement and other value added services. Diversified Commercial revenue consists of DAP revenue, international defense and intelligence revenue and commercial revenue, including civil governments. 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 suited to 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 requires 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, harbors or airports. U.S. Government Three months ended March 31, (dollars in millions) 2013 2012 U.S. Government Net Revenue: Enhanced View SLA $ 56.8 $ 44.5 Other revenue and value added services 14.3 2.8 Amortization of pre-FOC payments related to NextView 6.4 6.4 Total U.S. Government net revenue $ 77.5 $ 53.7 Reseller and Direct Sales: Direct sales 98.6 % 99.4 % Resellers 1.4 0.6 100.0 % 100.0 % U.S. Government primarily consists of customers who are defense and intelligence agencies of the U.S. Government. 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 and other government agencies. Enhanced View SLA revenue comprised 44.5% and 51.1% of our net revenue for the three months ended March 31, 2013 and 2012, respectively. 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. Other revenue and value added services comprised 11.2% and 3.2% of our net revenue for the three months ended March 31, 2013 and 2012, respectively. Our U.S. Government 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. Page 24 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. Our customers 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 net revenue from customers in the U.S. Government have historically been largely from service level agreements and tasking orders, with a smaller portion from sales of imagery from our ImageLibrary. We sell to the U.S. Government primarily through direct sales, with sales arising from sub-contract relationships to a lesser extent, and expect this trend to continue. Diversified Commercial Net Revenue Three months ended March 31, (dollars in millions) 2013 2012 Diversified Commercial Net Revenue: DAP revenue $ 18.0 $ 12.8 Other Diversified Commercial 32.1 20.5 Total Diversified Commercial net revenue $ 50.1 $ 33.3 Three months ended March 31, 2013 2012 Reseller and Direct Sales: Direct sales 66.5 % 67.3 % Resellers 33.5 32.7 100.0 % 100.0 % Our Diversified 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 through a combination of direct sales and through resellers. 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 of revenue. We have DAP agreements in 10 countries. From our DAP customers, we generated $18.0 million and $12.8 million of net revenues for the three months ended March 31, 2013 and 2012, respectively. Other Diversified Commercial revenue also includes revenue from international civil government, providers of location based services ("LBS"), other industry verticals and from international defense and intelligence customers. Our customers are primarily government agencies, energy, telecommunications, utility and agricultural companies who, like our U.S. Government 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 create or expand their products and services. Customers in our industry verticals are represented by verticals such as financial services, oil and gas, telecommunications, utilities, environmental services and other industry verticals that use our imagery in a wide range of applications. International defense and intelligence consists of customers who are principally defense and intelligence agencies of foreign governments. For the Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012 Net revenue increased $40.6 million, or 46.7%, to $127.6 million for the three months ended March 31, 2013 from $87.0 million for the three months ended March 31, 2012. There was an increase of $23.8 million, or 44.3%, in U.S. Government net revenue to $77.5 million during the three months ended March 31, 2013 from $53.7 million for the three months ended March 31, 2012. This increase was the result of $12.3 million of additional net revenue recognized under the EnhancedView SLA due to increased capacity made available to NGA and an $11.5 million increase in value added services. The increase of $16.8 million, or 50.5%, in Diversified Commercial net revenue to $50.1 million for the three months ended March 31, 2013 from $33.3 million for the three months ended March 31, 2012 was primarily due to having generated two months of net revenue resulting from the acquisition of GeoEye, totaling approximately $13.0 million, in 2013 compared to no such GeoEye net Page 25 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. revenue in 2012. During the three-months ended March 31, 2013 compared to the three months ended March 31, 2012, international civil government revenue increased $5.4 million; other industry verticals increased $3.8 million; LBS revenue increased $2.4 million; and DAP revenue increased $5.2 million. Expenses Three months ended March 31, 2013 2012 Expenses as a percentage of net revenue: Total net revenue 100.0 % 100.0 % Cost of revenue excluding depreciation and amortization 32.1 20.7 Selling, general and administrative 62.5 34.3 Depreciation and amortization 37.1 33.4 Restructuring charges 15.9 - (Loss) income from operations (47.6 ) 11.6 Loss on early extinguishment of debt (13.9 ) - Other income, net 0.2 - Interest expense, net (1.1 ) (3.7 ) (Loss) income before income taxes (62.4 ) 7.9 Income tax benefit (expense) 14.9 (3.5 ) Net (loss) income (47.5 )% 4.4 % Our net revenue is primarily generated by the sale of products and services comprised of imagery from our satellites. Most of the costs of a satellite are related to the pre-operation capital expenditures required to build and launch a satellite. There is not a significant direct relationship between our cost of revenue and changes in our net 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. Cost of Revenue The following table summarizes our cost of revenue: Three months ended March 31, (in millions) 2013 2012 Ground system operation $ 13.6 $ 5.4 Labor related costs 15.5 7.1 Aerial imagery 2.0 2.0 DAP facility costs 3.4 1.5 Other 6.4 2.0 Total costs of revenue $ 40.9 $ 18.0 Cost of revenue increased $22.9 million, or 127.2%, to $40.9 million during the three months ended March 31, 2013 from $18.0 million for the three months ended March 31, 2012. This increase was primarily attributable additional expense resulting from the acquisition of GeoEye consisting of $8.4 million of higher labor related costs, $8.2 million of expense associated with operating additional ground stations and a $4.4 million increase in other costs primarily related to supporting the production and analysis of imagery. We expensed $1.0 million in costs associated with the termination of a contract with a provider of aerial imagery. We expect the amount of future expense derived from aerial imagery to decrease as we have no current plans to purchase additional aerial imagery on an ongoing basis. Page 26 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. Selling, General and Administrative The following table summarizes our selling, general and administrative expenses: Three months ended March 31, (in millions) 2013 2012 Acquisition costs $ 20.8 $ - Labor related costs 32.4 17.4 Professional fees 15.6 4.3 Marketing expenses 0.9 0.6 Software and equipment maintenance costs 2.7 1.9 Satellite insurance 2.8 2.5 Other 4.6 3.1 Total selling, general and administrative $ 79.8 $ 29.8 Selling, general and administrative expenses increased $50.0 million, or 167.8%, to $79.8 million during the three months ended March 31, 2013 from $29.8 million for the three months ended March 31, 2012. We incurred $20.8 million in acquisition costs related to the completion of the acquisition of GeoEye. Labor costs increased $15.0 million primarily as a the result of having incurred two months of labor related to the acquisition of GeoEye compared to no such costs incurred in the prior year. Professional fees increased $11.3 million to support the growth of the business and is primarily associated with combining the two companies. Depreciation and Amortization Depreciation and amortization consists primarily of depreciation of our satellites and other operating assets. Depreciation and amortization increased by $18.2 million, or 62.5%, to $47.3 million for the three months ended March 31, 2013 from $29.1 million for the three months ended March 31, 2012. The increase in expense during the three-month period ended March 31, 2013 was principally attributable to our acquisition of GeoEye and the related property, equipment and intangible assets acquired. In addition, certain of our construction in process projects were put into service during the three months ended March 31, 2013 resulting in increased depreciation. Most significant of these new assets was the infrastructure we activated in the period that integrates our infrastructure more securely to the U.S. Government. The depreciation in the period associated with those assets was $4.4 million, after they were placed into service on January 26, 2013. Future changes in depreciation and amortization could be affected by commissioning of a new satellite, changes in useful life of an existing satellite or introduction of significant new capital assets. We currently plan to optimize the size of our satellite constellation and, following completion of construction and testing, place GeoEye-2 in storage until such time as incremental capacity or a replacement for an existing satellite is required. We anticipate that certain of our restructuring plans, which include reducing or eliminating redundant assets and capacity, will result in accelerated depreciation in the next several quarters, but will reduce depreciation on these assets in the long-term. This reduction in depreciation will be offset by increased depreciation when our WorldView-3 satellite is launched. Restructuring Charges During the quarter ended March 31, 2013, primarily as a result of our acquisition of GeoEye, we initiated a series of restructuring activities intended to realign our infrastructure with demand by our customers so as to optimize our operational efficiency. We recognized restructuring charges of approximately $20.3 million during the three months ended March 31, 2013 and none in the comparable period in 2012. We believe that the restructuring enhances our ability to provide cost-effective customer service offerings, which we anticipate will enable us to retain and expand our existing relationships with customers and attract new business. These restructuring activities primarily consist of reducing redundant workforce, consolidating office and production facilities, consolidating certain ground terminals and systems and other exit costs. Interest Expense, net Interest expense, net of capitalized interest and interest income, decreased by $1.8 million, or 56.3%, to $1.4 million for the three months ended March 31, 2013 from $3.2 million during the three months ended March 31, 2012. This decrease is attributed to approximately 87.9% of our interest being capitalized to capital projects during the three months ended March 31, 2013 as compared to 61.2% during the three months ended March 31, 2012, as well as lower interest cost as a result of refinancing our debt on January 31, 2013. Page 27 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. Based on our capitalization policies, we expect interest expense to decrease due to capitalization of these costs to the construction of our WorldView-3 and GeoEye-2 satellites and other infrastructure. Once GeoEye-2 construction is completed later in 2013, we expect to decrease the amount of interest we capitalize on this satellite, resulting in a higher percentage of interest that is expensed. The amount of interest capitalized related to WorldView-3 will increase as it nears completion and launch. We anticipate expensing substantially all of our interest costs upon the anticipated commissioning of WorldView-3 in the second half of 2014. The costs of our satellites include capitalized interest costs incurred during the construction and development period of the satellite. In addition, capitalized costs of our satellites and related ground systems include internal direct labor costs incurred in their construction. Income Tax (Benefit) Expense Income tax benefit increased by $22.1 million for the three months ended March 31, 2013, to a benefit of $19.0 million from a tax expense of $3.1 million for the three months ended March 31, 2012. The increase in tax benefit is due to having taxable losses during the three months ended March 31, 2013 compared to the taxable income during the three months ended March 31, 2012. For the first quarter ended March 31, 2013, we had an effective overall tax rate of 23.9%. The effective tax rate differed from the statutory federal rate of 35.0% primarily due to state taxes and the effects of non-deductible stock based compensation and discrete items related to the vesting of equity based compensation, 2012 research and development tax credits resulting by tax law changes enacted in January 2013 and significant non-deductible costs related to the acquisition of GeoEye. Balance Sheet Measures Total assets increased $1,646.7 million, or 104.4%, to $3,224.2 million at March 31, 2013 from $1,577.5 million at December 31, 2012. Total assets increased primarily as a result of acquiring the assets of GeoEye totaling $1,129.7 million and goodwill totaling $437.6 million. In addition, property and equipment increased $29.4 million from December 31, 2012 to March 31, 2013 primarily resulting from the costs to build our WorldView-3 and GeoEye 2 satellites and other infrastructure projects offset by depreciation. Other assets increased $31.3 million primarily due to additional deferred financing costs resulting from the refinancing of our long-term debt. Total liabilities increased $827.4 million, or 79.7%, to $1,865.5 million at March 31, 2013 from $1,038.1 million at December 31, 2012. This increase was due to assuming the liabilities of GeoEye totaling $196.1 million and an increase of long-term debt of $662.8 million primarily as a result of the GeoEye acquisition. Liquidity and Capital Resources We believe that the combination of funds currently available to us and funds expected to be generated from operations will be adequate to finance our operations and development activities for the next twelve months. We cannot assure you that the U.S. Government will continue to purchase earth imagery or other services from us at similar levels or similar terms. All of our contracts with the U.S. Government agencies are subject to risks of termination or reduction in scope due to changes in U.S. Government policies and priorities, or reduced Congressional funding level commitments. Pursuant to the contract terms, U.S. Government agencies can terminate, modify or suspend our contracts at any time with or without cause. The U.S. Government accounted for approximately 60.7% of our consolidated revenue for the three months ended March 31, 2013. If the U.S. Government were not to renew or extend our contract at similar levels or similar terms, we believe we would be able to maintain operations at a reduced level with existing cash and cash equivalents for the next twelve months. In summary, our cash flows were: Three months ended March 31, (in millions) 2013 2012Net cash (used in) provided by operating activities $ (27.4 ) $ 68.5 Net cash used in investing activities (593.5 ) (56.0 ) Net cash provided by (used in) financing activities 648.4 (1.2 ) Cash used in operating activities was $27.4 million in the three months ended March 31, 2013 as compared to $68.5 million of cash provided by operating activities in the three months ended March 31, 2012. The $95.9 million decrease in cash provided by operating activities is primarily due to the net loss recognized in 2013 and a net increase in accounts receivable and other current assets. The net loss was due primarily to restructuring and combination related costs totaling $66.8 million in 2013. As a result of our acquisition of GeoEye, we expect to generate increased business volume. We anticipate realizing operating savings within the six quarters following the January 31, 2013 close of the acquisition. We expect these cost savings and efficiencies to come from actions we will take principally with respect to labor cost reductions and infrastructure savings. Page 28 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. Cash used in investing activities was $593.5 million in the three months ended March 31, 2013 as compared to $56.0 million in the three months ended March 31, 2012. The $537.5 million increase in cash used in investing activities was primarily due to cash expenditures for the acquisition of GeoEye, including $596.7 million paid for the discharge and redemption of debt assumed in the acquisition partially offset by net cash received of $76.2 from GeoEye, and higher capital expenditures related to the construction of the WorldView-3 and GeoEye-2 satellites and related infrastructure. We anticipate capital expenditures for the satellites to continue until the completion of GeoEye-2 in 2013 and WorldView-3, which we currently anticipate to be in 2014. In addition, we expect that our cash used in investing activities will increase as a result of capital expenditures associated with infrastructure improvements as we integrate GeoEye's operations with our own. Cash provided by financing activities was $648.4 million in the three months ended March 31, 2013 as compared to $1.2 million of cash used in financing activities in the three months ended March 31, 2012. The $649.6 million increase in cash provided by financing activities was primarily due to $632.2 million in net proceeds from refinancing our debt in connection with the acquisition of GeoEye. In addition, we received $14.6 million in cash proceeds from the exercise of stock options. 2013 Credit Facility In connection with the acquisition of GeoEye on January 31, 2013, we entered into a seven-year $550.0 million Senior Secured Term Loan Facility and a five-year $150.0 million Senior Secured Revolving Credit Facility (collectively the "2013 Credit Facility"). The 2013 Credit Facility requires quarterly principal payments of $1.375 million starting June 30, 2013 with the remaining balance due February 1, 2020. Borrowings under the 2013 Credit Facility bear interest at an adjusted LIBOR rate, plus a 2.75% margin subject to a 1.0% LIBOR floor. The LIBOR margin becomes 2.5% when the ratio of total debt to Adjusted EBITDA is 2.5 or lower. The Senior Secured Term Loan Facility currently bears interest based upon the LIBOR-based rate. The Company will also pay a commitment fee of between 37.5 to 50.0 basis points, payable quarterly, on the average daily unused amount of the revolving credit facility based on our leverage ratio. Our obligations under the 2013 Credit Facility are guaranteed by certain of our existing and future direct and indirect wholly-owned domestic subsidiaries. Our obligations and the obligations of our guarantor subsidiaries under the 2013 Credit Facility are collateralized by substantially all of our assets and the assets of the guarantor subsidiaries. The 2013 Credit Agreement contains affirmative and negative covenants that we believe are usual and customary for a senior secured credit agreement. The negative covenants include, among other things, limitations on asset sales, mergers and acquisitions, indebtedness, liens, dividends, investments and transactions with its affiliates. The 2013 Credit Agreement also requires that the Company comply with a maximum leverage ratio and minimum interest coverage ratio. Senior Notes Also in connection with the acquisition of GeoEye on January 31, 2013, we issued $600.0 million of Senior Notes (the "Senior Notes") which bear interest at 5.25% per year. Interest on the Senior Notes is payable on February 1 and August 1 of each year, beginning on August 1, 2013. The Senior Notes were issued at par and mature on February 1, 2021. We may redeem some or all of the Senior Notes at any time and from time to time on or after February 1, 2017, at the redemption prices set forth in the offering memorandum. The initial redemption price for the Senior Notes is 102.625% of their principal amount plus accrued and unpaid interest to the date of redemption. We may redeem some or all of the Senior Notes at any time prior to February 1, 2017, at a redemption price equal to 100% of their principal amount, plus a "make whole" premium, together with accrued and unpaid interest to the date of redemption. In addition, on or prior to February 1, 2016, we may redeem up to 35% of the principal amount of the Senior Notes using the net cash proceeds from sales of certain types of capital stock at a redemption price equal to 105.250% of the principal amount of the Senior Notes, plus accrued and unpaid interest to the date of redemption, subject to certain other provisions as set forth in the offering memorandum. If a change of control occurs, we must give holders of the Senior Notes an opportunity to sell us their Senior Notes at a purchase price of 101% of the principal amount of such Senior Notes, plus accrued and unpaid interest to the date of purchase. The Senior Notes are senior unsecured obligations, ranking equally in right of payment with all of our existing and future unsecured and unsubordinated indebtedness and senior to our existing and future subordinated indebtedness. The Senior Notes are unconditionally guaranteed, jointly and severally, by all of our existing and certain of our future domestic subsidiaries, including GeoEye and its domestic subsidiaries, which also guarantee our 2013 Credit Facilities. Each guarantor's guarantee ranks pari passu in right of payment with all future senior indebtedness of the guarantor. The Senior Notes have not been registered under the Securities Act of 1933. We have agreed to file an exchange offer registration statement or, under certain circumstances, a shelf registration statement, pursuant to a registration rights agreement. If we fail to comply with certain of our obligations under the registration rights agreement, we will pay additional interest on the Senior Notes. The net proceeds of the 2013 Credit Facility and Senior Notes were used, along with cash on hand, to refinance our 2011 $500.0 million senior secured term loan and $100.0 million senior secured revolving credit facility, to fund the discharge and redemption of GeoEye's $400.0 million 9.625% Senior Secured Notes due 2015 and $125.0 million 8.625% Senior Secured Notes due 2016 assumed in connection with the acquisition, to pay the cash consideration under the merger agreement and to pay fees and expenses related to the transactions. Page 29 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. Contractual Obligations Information regarding long-term debt payments, operating lease payments and contractual obligations is provided in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year ended December 31, 2012. As previously discussed, on January 31, 2013 we entered into a $550.0 million Senior Secured Term Loan Facility and issued $600.0 million of Senior Notes in connection with the acquisition of GeoEye to refinance our outstanding long-term debt, to fund the discharge and redemption of GeoEye's $525.0 million Senior Secured Notes, pay cash consideration and pay fees and expenses related to the transactions. As a result, our contractual obligations for long-term debt and related interest increased materially from the amounts disclosed as of December 31, 2012. As of March 31, 2013, these obligations are as follows: Payments Due by Period Less Than 1-3 4-5 More Than (in millions) Total 1 Year Years Years 5 Years Long-term debt obligations $ 1,150.0 $ 4.1 (2) $ 11.0 $ 11.0 $ 1,123.9 Interest payments on long-term debt(1) 397.9 48.4 105.0 104.4 140.1 Total $ 1,547.9 $ 52.5 $ 116.0 $ 115.4 1,264.0 (1) Represents contractual interest payment obligations on the $550.0 million principal balance of the Company's Senior Secured Term Loan facility and the Company's $600.0 million principal Senior Notes. (2) Represents long-term debt principal payments for the nine-month period ended December 31, 2013. The Senior Secured Term Loan Facility requires quarterly principal payments of $1.375 million starting June 30, 2013 with the remaining balance due February 1, 2020. Interest on adjusted LIBOR based loans is due at the end of each interest period as selected by us, but at least quarterly. Interest on Base Rate loans is due on the last day of each calendar quarter. The interest rate at March 31, 2013 was 3.75%. The Senior Notes bear interest at 5.25% per year with interest payments payable on February 1 and August 1 of each year. We may redeem some or all of the notes at any time after February 1, 2017 at varying redemption prices. The Senior Notes mature on February 1, 2021. Off-Balance Sheet Arrangements, Guaranty and Indemnification Obligations Off-Balance Sheet Arrangements We had no off-balance sheet arrangements as of March 31, 2013. Guaranty and Indemnification Obligations We enter into agreements in the ordinary course of business with resellers and others. Most of these agreements require us to indemnify the other party against third-party claims alleging that one of our products infringes or misappropriates a patent, copyright, trademark, trade secret or other intellectual property right. Certain of these agreements require us to indemnify the other party against claims relating to property damage, personal injury or acts or omissions by us, our employees, agents or representatives. In addition, from time to time we have made guarantees regarding the performance of our systems to our customers. Non-GAAP Disclosures Three months ended March 31, (in millions) 2013 2012 Net (loss) income $ (60.6 ) $ 3.8 Depreciation and amortization 47.3 29.1 Interest expense, net 1.4 3.2 Income tax expense (benefit) (19.0 ) 3.1 EBITDA (30.9 ) 39.2 Loss from early extinguishment of debt 17.8 - Restructuring charges (1) 20.3 - Acquisition costs (1) 20.8 - Integration costs (1) 7.9 - Other (gains) losses (2) (0.3 ) - Adjusted EBITDA $ 35.6 $ 39.2 (1) Restructuring, acquisition and integration costs consist of non-recurring charges related to the combination with GeoEye. (2) Other (gains) losses consists of a gain from our investment in a joint venture. Page 30 of 35 [[Image Removed: LOGO]] -------------------------------------------------------------------------------- Table of Contents DigitalGlobe, Inc. Non-U.S. GAAP Financial Measures EBITDA and Adjusted EBITDA are not recognized terms under U.S. GAAP and may not be defined similarly by other companies. EBITDA and Adjusted EBITDA should not be considered alternatives to net income as indications of financial performance or as alternatives to cash flow from operations as measures of liquidity. There are limitations to using non-U.S. GAAP financial measures, including the difficulty associated with comparing companies in different industries that use similar performance measures whose calculations may differ from ours. EBITDA and Adjusted EBITDA are key measures used in internal operating reports by management and the board of directors to evaluate the performance of our operations and are also used by analysts, investment banks and lenders for the same purpose. In 2013, EBITDA, excluding certain deal costs, is a measure being used as a key element of the company-wide bonus incentive plan. We believe that the elimination of material non-cash, non-operating items enables a more consistent measurement of period to period performance of our operations. In addition, we believe that elimination of these items facilitates comparison of our operating performance to companies in our industry. We believe that EBITDA and Adjusted EBITDA measures are particularly important in a capital intensive industry such as ours, in which our current period depreciation is not a good indication of our current or future period capital expenditures. The cost to construct and launch a satellite and to build the related ground infrastructure may vary greatly from one satellite to another, depending on the satellite's size, type and capabilities. For example, our QuickBird satellite, which we are currently depreciating, cost significantly less than our WorldView-1 and WorldView-2 satellites. Current depreciation expense is not indicative of the net revenue generating potential of the satellite. EBITDA excludes interest income, interest expense and income taxes because these items are associated with our capitalization and tax structures. EBITDA also excludes depreciation and amortization expense because these non-cash expenses reflect the impact of prior capital expenditure decisions which are not indicative of future capital expenditure requirements. Adjusted EBITDA further adjusts EBITDA to exclude the loss on the early extinguishment of debt because this is not related to our primary operations. Additionally, it excludes restructuring costs, acquisition costs, integration costs and the gain from our joint venture as these are non-cash, non-core items. Restructuring costs are costs incurred to realize efficiencies from the acquisition with GeoEye, such as reducing excess workforce, consolidating facilities and systems, and relocating ground terminals. Acquisition costs are costs incurred to effect the acquisition, such as advisory, legal, accounting, consulting and other professional fees. Integration costs consist primarily of professional fees incurred to assist us with system and process improvements associated with integrating operations. Loss on early extinguishment of debt is related to entering into the $700.0 million 2013 Credit Facility and $600.0 million Senior Notes, the proceeds of which were used to refinance our $600.0 million 2011 Senior Secured Credit Facility and fund the discharge and redemption of GeoEye's $525.0 million Senior Secured Notes we assumed in the acquisition. We use EBITDA and Adjusted EBITDA in conjunction with traditional U.S. GAAP operating performance measures as part of our overall assessment of our performance and we do not place undue reliance on measures as our only measures of operating performance. EBITDA and Adjusted EBITDA should not be considered as substitutes for other measures of financial performance reported in accordance with U.S. GAAP. |