Maxar Technologies Inc.
Q3 2018 Earnings Call Transcript

Published: 31 Oct 2018

[Operator:]

Welcome to Maxar Technologies’ Q3 2018 Conference Call. We would like to remind you that part of today's discussions, including responses to various questions, may contain forward-looking statements which represent the company's estimates, future plans, objectives and expected performance as of today's date. These statements are based on current assumptions that the company believes are reasonable, but are subject to a wide range of uncertainties and risks that could actually result to differ materially from the forward-looking information. You are referred to the advisory regarding forward-looking statements contained in the second quarter earnings news release and in the company's most recent Management's Discussion and Analysis and Annual Information Form, which are available under the company's SEDAR profile at www.sedar.com, under the company’s EDGAR profile at www.sec.gov or on the company’s website at www.maxar.com. As we begin the discussion, we ask that you refer to the accompanying slides for today’s call that can be found on company’s website under Investor, Events & Presentation, Q3 2018 Event Details. I would like to turn the discussion over to Mr. Howard Lance. Please go ahead, sir.

[Howard Lance:]

Good morning, everyone. And welcome to our call to review third quarter results and key accomplishments across the company. I would like to begin this morning by welcoming our new Chief Financial Officer, Biggs Porter. Biggs joined the company in August as CFO after distinguished careers for Tenet Healthcare, Raytheon, and Northrop Grumman. His knowledge in the aerospace and defense industry and the prior public company’s CFO experience will be instrumental in shaping our future strategies and execution plans. Excluding the GEO communications satellite line of business, there’s been a decline for a number of quarters, Maxar continued to make solid progress and build momentum to establish a long-term profitable growth trend in the rest of the business. I want to once again thank the entire Maxar team for their continued focus on delivering positive results. Now, if you can please turn to Slide 2 of the accompanied presentation. I want to begin today’s discussion by taking a view to the bigger Maxar perspective and remind you, we combined four leading space brands across the value chain into one company, creating the commercial leader in the new space economy. Our capabilities in optical and radar imaging, geospatial services, and AI, satellite design and manufacturing and space infrastructure will be highly sought after as the new space economy continues to develop and evolve. Maxar is very well-positioned to grow by leveraging end-to-end solutions, and accelerating innovation. Key enablers of our financial success will be strong expected end market demand, a proven operating model and management team, and execution of the specific strategies we’ve put in place to drive growth across all of our segments. We believe this path will result in sustainable earnings growth and cash generation, allowing for significant de-leveraging of our balance sheet and providing attractive returns for our shareholders. Please turn to Slide 3. Imagery and Services growth is our first strategic pillar. Imagery segment revenue was up 6% year-to-date and margins remained strong, all consistent with our Investor Day outlook earlier this year. The recent transition of EnhancedView contract to the NRO, the exercise of the year 8th option, the new award of funding to improve interoperability with US government customers, 2019 funding for the Global EGD program and the recent new contracts and product announcements in the commercial and international defense markets suggest sustained growth looks very achievable in this segment. In the Services segment year-to-date revenue is flat with last year, but this is due to lower subcontractor revenue pass-through and the transition of a couple of key contract vehicles, but we had a great Q3. We won two task orders on the new $900 million Janus Geography IDIQ contract. We also signed multiple classified contracts that together amounted to an incremental $180 million of award value over the program life. This momentum suggests the return to growth in this segment is on the horizon. The second strategic pillar is returning to growth in Space Systems. We all know that the wind down of the multiyear RCM radar satellite project in Canada and the continued weakness in the GEO Comsat market have create significant revenue headwinds. While total segment revenue was down year-to-date, our combined US government commercial Smallsat and MDA revenue is up 17% year-to-date. Largest synergies represent our third strategic pillar. We continue to execute well in this area and believe we are on track to achieve 60 million to 120 million run rate synergies by the end of 2019. Improving cash flows as a priority to delever is our fourth strategic pillar. Adjusted cash from operations is up significantly year-to-date, and we expect to generate $300 million to $400 million in 2018, consistent with our Investor Day outlook. Beyond the WorldView Legion construction period of 2018 to 2020, capital expenditures are expected to decline significantly, allowing for a large increase in free cash flows, debt reduction and delivering. We remain keenly focused on cash generation from a variety of sources, including working capital improvements, orbital receivables securitization and asset sales, including real estate. Please turn to Slide 4. At the end of August we announced the transition of the EnhancedView commercial imagery contract from the National Geospatial-Intelligence Agency or NGA to the National Reconnaissance Office or NRO. NRO will now manage the contract and its successors moving forward. At the same time, the NRO has renamed the contract EnhancedView Follow-On, the exercise option year 8th contract that includes US government fiscal year 2019 funding of $300 million. I’m pleased to advise that contract transition occurred seamlessly and we continue to provide our commercial high-resolution imagery to the US government in the same terms as previously. But in addition NRO awarded Maxar a new contract. This is a multiyear contract to fund development of an enhanced cloud-based infrastructure which will improve integration and the interoperability with US government customers. Also, the NGA put $44 million of funding in place for year seven of our Global EGD program. This provides daily access of high-resolution imagery to the Department of Defense. These key milestones clearly indicate that our relationship with the US government is on very solid footing and the prospects exist for continued growth and increased collaboration going forward. But don’t take my word for it. Take a look at the statements from Betty Sapp the Director of NRO that is shown on the right portion of this slide, and I quote “Commercial imagery is an increasingly important part of satisfying both existing and emerging security and intelligence challenges. The award of the EVFO is an important first step in the NRO strategy of embracing commercial imagery as a key element of our current overhead architecture and a critical and integral element of our future overhead architecture.” Clearly a very positive and resounding support for Maxar's future relationship. We are very proud to support our customers and the thousands of men and women in uniform that benefit from the mission of both NRO and NGA. With that, I’ll turn to Slide 5. Market trends at the US and international government levels remain very positive, there’s grown budgets to fund increased space investments. The global threat environment is persistent and that's driving higher spending levels in key areas that we can address. All of our business segments will benefit from the trends noted on this slide. The legacy GEO Comsat market of courses is exception and it remains weak with industry orders at the lowest level in recent history. Severity and persistence of this market downturn led to announce the pursuit of strategic alternatives towards the GEO product line at the end of July. We are in active discussions and continue to expect to announce a definitive direction for this business by the end of the year. With that, I will turn to Slide 6 to review the key highlights from Q3. We announced earlier this month that we've advanced the process of domesticating the company to the United States, effective in January 2018, subject of course to a favorable shareholder vote on November 16th and other customary conditions. As you know, this represents a critical milestone for Maxar and will further advance our efforts to sustain and compete previous government contracts. We believe it will accelerate our growth trajectory and better align our corporate structure with our business strategy. In Imagery, I already discussed the solid progress with US government, including the year seven renewal for Global EGD. This is our online service and supports 250,000 warfighters, first responders, analysts and civilian government users with access to current satellite imagery and geospatial intelligence to inform their mission planning, disaster response and situational awareness. DARPA selected the company to build a new platform called the geospatial cloud analytics hub to enable military, intelligence end users to leverage machine learning to extract insights at scale and make critical decisions. Also worth noting that the hub content includes our RADARSAT-2 data and processing tools to help detect features and changes faster and more accurately. NASA ordered Maxar’s Sole-Source contract for commercial electro-optical and radar satellite imagery. NASA funded researchers who will use this data to advance science and application development objectives,to understand and explore earth, improve lives and safeguard our future. Both of these wins are examples of synergies between DigitalGlobe and MDA who are increasingly collaborating across the Maxar imagery ecosystem. In the commercial markets we signed a significant contract during the quarter for large named tech company, further demonstrating our leading position with this set of customers. We also signed a strategic contract with General Motors as we made gains in the automotive segment, an area we expect to be a growth driver for our imagery business over the next several years. Turning to Space Systems, our momentum with the US government also continued. SSL was selected by NASA for two separate programs to develop vital space craft technologies including on-orbit robotics and high-powered electric propulsion. We’re also making progress with US DoD. We were awarded a contract to provide the Air Force with antenna prototypes for future secure satellite communications and the contract to develop a prototype concept to address requirements for detecting and tracking missile threats for the US Missile Defense Agency. And most significant we were awarded a $750 million IDIQ contract vehicle, called Small Spacecraft Prototyping Engineering, Development and Integration from the DoD’s Space Rapid Capabilities Office. This program will acquire commercially developed solutions for small to medium sized spacecrafts and related systems. This is one of the large opportunities that we outlined at our Investor Day earlier this year. We believe all of these awards are proof points that our strategy to address US government’s spacecraft market is indeed gaining traction, also examples of how the MDA DigitalGlobe merger is delivering synergies. SSL is going to partner on the latest award which Radiant will study and develop next generation systems for ISR missions. We’re very pleased to hear that the Canadian government announced the selection of Lockheed Martin as the preferred bidder for the Canadian Surface Combatant program. MDA is a leading member of the Lockheed team focused on electronic warfare and communication systems. This is another large opportunities that you'll recall we outlined at our Investor Day earlier this year. We will expect to begin receiving orders some time in 2019 of course assuming Lockheed is successful in getting their prime contract in place. I am also pleased to report that MDA has now successfully completed development of the three satellites that are part of the RADARSAT Constellation Mission or RCM and we shipped the satellites to Vandenberg Air Force Base in California for a launch by SpaceX in the February 2019 timeframe. We are very proud to have led this important program for the benefit of the government and citizens of Canada. In Services, we won multiple large awards during the quarter as I’ve already mentioned and we now have renewed momentum in this segment. We will develop special communications and collection technologies and rapidly prototype and deploy machine learning and crowd-sourcing capabilities to help analysts quickly process large volumes of remote-sensing data, allowing them to understand global patterns of life and enabling broad areas of search. Overall, I believe it was a very successful quarter in delivering on our strategic priorities and creating future momentum for Maxar. With that, I am going to stop and hand things over to Biggs Porter for a more detailed review of financial performance during the quarter.

[Biggs Porter:]

Thank you, Howard. And good morning, everyone. It’s pleasure joining my inaugural call with Maxar. I’m excited to be here and look forward to spending more time with our shareholders in the months and quarters ahead. Before I get started this morning I want to point out that it’s been customary this year, I will be comparing our 2018 quarterly results to pro forma results from prior periods as if the merger between MDA and DigitalGlobe was completed in Q1 2017. We believe this provides greater insight to the operations and financial health of the company by comparing the 2017 actuals which of course did not included DigitalGlobe. Please turn to Slide 7 where we present year-over-year comparisons for the third quarter. Total company revenues declined 10% year-over-year in the quarter as continued growth in inventory was more than offset by declines in the Services and Space Systems segments with the latter impacted since 2015 as a step down in industry award values for GEO contracts; the effect of which continues to fall through our revenue line. We also experienced as expected a lower level of planned activity on RCM project for the Canadian government. It’s worth taking a moment to point out that the Services decline did not have an impact on the bottom-line because the decline was in low margin pass-through subcontract revenue. Also strong bookings in the quarter in the Services segment are a good leading indicator of future growth opportunity. Adjusted consolidated EBITDA margins declined 470 basis points year-over-year, of which 140 basis points driven by the timing of investment tax credits realized in the quarter versus third quarter of 2017. The remaining 330 basis points decline was driven by Space Systems or an increase in estimated cost to complete programs as a result of supply chain issues experienced during the third quarter 2018 as well as impacts to lower volume on our Palo Alto facility, including lower productivity and overhead absorption. In addition to gain from recovery of liquidated damages which occurred during 2017 exhibited a decrease in EBITDA on a comparative basis. Adjusted EPS was $0.75 versus $1.28 a year ago driven by lower volume and margins in part offset by lower depreciation and amortization as well as lower tax rate. IFRS EPS was a loss of $7.31 versus a gain of $0.34 in the third quarter of 2017, driven largely by the $384 million in non-cash impairment and inventory obsolescence charges related the GEO Comsat business. As Howard mentioned earlier, the current state of this market, together with other factors, necessitated an analysis of the carrying value of the GEO Comsat assets on our balance sheet. This led to an impairment loss of $346 million related to property, plant and equipment of intangible assets and an inventory obsolescence reserve of $38 million during this quarter. Please note that we did not incur a goodwill impairment in the quarter related to the GEO Comsat business as this test is done at the segment levels which also includes company’s, US government and commercial Smallsat and MDA businesses, all of which have strong market and income expectations. Please turn to Slide 8. Year-to-date revenues have declined 6.3% year-over-year driven by Space Systems where the GEO Comsat business is down 27%. Excluding GEO, the remainder of our businesses have grown 4.4% year-to-date. As a side note, the numbers we’re showing for revenue and income excluding GEO, do not income any of the inter-company sales to GEO and related income. So those would be addictive if the business was separated and those sales effectively became third-party sales. Adjusted EBITDA margins have declined 90 basis points year-to-date verses 2017, again driven by Space Systems and lower ITCs recognized thus far in the year. Adjusted EPS was $3.44 through the third quarter compared to $3.69 over the same period in 2017. On an IFRS basis, we posted a loss of $7.29 year-to-date versus a gain on $0.98 in 2017, again the major driver of decline was the impairment and inventory charges I mentioned earlier. Book-to-bill year-to-date is 0.75 to 1 removing the quarterly drawdown of the 10 year EnhancedView contract with the US government in the Imagery segment. Here again the Space Systems GOE concept business has been a significant drag. Excluding the backlog burn with this product line and the EV contract, our book-to-bill has been roughly 1 to 1 year-to-date. Imagery segment revenues were up 4% year-over-year driven by demand from international defense and intelligence and commercial customers. Adjusted EBITDA margins for this segment were flat year-over-year as benefits from synergies were offset by a mix in the quarter. Year-to-date revenues were up 6% and margins have expanded over 100 basis points given higher volumes and realized merger synergies. Please turn to Slide 10. Space Systems experienced 12% year-over-year revenue decline in Q3, as growth in our US government and commercial Smallsat businesses was more than offset by the decline in the GEO Comsat business and the Canadian RCM radar satellite program. This quarter was also negatively impacted by a significant increase in estimated costs to complete program on the GEO Comsat, as a result of supply chain issues and delays experienced during the third quarter of 2018 as well as impacts of lower volume at our Palo Alto factory which resulted in lower overhead absorption. An increase in estimated cost to complete directly impacts revenue, as revenues are recognized over time under the cost-to-cost method. GEO revenues were down 31% year-over-year in the quarter while the rest of the segment was up 13%. Year-to-date revenues declined by 10% for the segment overall but are up by strong double-digit percentage growth when excluding the GEO Comsat business, suggesting there’s solid growth across the rest of the business, even when excluding WorldView Legion constellation build that flows through this segment. Adjusted EBITDA margins declined 7.2% -- declined to 7.2% from 20.5% a year ago, driven largely by the cost issues and GEO Comsat that I just mentioned, a recovery of liquidated damages that occurred in 2017 and did not repeat in 2018, as well as timing issues related to the recognition of tax credits. Year-to-date margins were also lower for some of our regions. Please turn to Slide 11. Our Services business posted a 14% decline versus third quarter 2017 driven by contract transitions with the US government and lower volume levels recognized on subcontract awards. Latter however helped drive margins 210 basis points higher year-over-year to 15% and revenues generated with high subcontractor mix to lower margins. Year-to-date both revenues and margins are roughly flat. Going forward this segment continue to have the strong pipeline across its capability set and we expect it to be persistent contributor to long-term growth particularly as it begins to benefit from new programs and new products in Q4. Please turn to Slide 12. The company generated $92 million in adjusted operating cash flow in Q3, up nicely over the preceding two quarters and the corresponding period of prior year. As in the past, we’ll continue to have fluctuations in quarterly cash flows. We’ll provide a view of the last seven quarters of performance, which refigures a more wholesome view of recent trends. As a reminder, we define adjusted cash flow as operating cash flow less interest and plus or minus the effects of orbital receivables, securitizations, and also excludes integration costs. Reconciliation of these items can be found on the appendix of the accompanying slides we’re using during this call. During the quarter, we generated $29 million of free cash flow. Going forward we will continue to have a keen focus on working capital and other drivers of cash generation and we’ve a number of opportunities on that front. Please turn to Slide 13, we finished the quarter with our consolidated net debt of 3.1 billion essentially flat with Q2. Our leverage ratios however increased modestly and ended the quarter with 4.3 given lower levels of trailing 12 months of EBITDA, again result the weakness in the Space Systems segment. That said we’re well within our covenants and we expect we can bring an additional cash through either the sale of the GEO Comsat business or the modernization of its real estate and additional orbital receivables and securitization. Investment in the WorldView Legion constellation will continue for two more years at which we will be positioned to have much greater free cash flows to delever. I can assure you the management team remains fully committed to paying down debt levels. Please turn to Slide 14, turning to guidance. Total company revenues are now expected to decline roughly 6.5% for 2017, from a lower expected outlook for GEO Com and the company's Space Systems and Services segment. Services outlook has been impacted by contract transitions with US government and lower volume levels recognized on subcontractor work. This will recover as we go through the remainder of the year and should be momentary. Segment EBITDA margins are now expected to grow roughly 32% and have been impacted by lower volumes and higher costs in the Space Systems segment. Adjusted EPS is now expected to be in a range of $4.05 and $4.10, and has been impacted by the profit outlook for the Space Systems segment and the outlook for slightly higher corporate expenses also in part by lower effective tax rate. There has been no change in the company's outlook for adjusted cash flow from operations. Additional securitization is what would move us up towards the higher end of the range. We’ve decreased our outlook on capital expenditures to a range from 300 million to 315 million. Turning to give full guidance for 2019. At this time, this is a pending resolution of GEO business line, however, to give you some idea of how the rest of the company should be viewed, I will give you some color. As we’ve disclosed today the GEO Comsat business line comprises roughly 50% of the Space Systems’ revenue this year and about 30% of consolidated revenue, all at a low effective margin rate. The rest of the company is growing 3% to 4% this year and is expected to generate EBITDA margin this year on IFRS basis of roughly 39%. Going into next year, we expect revenue to grow 4% to 5% again for the business ex-GEO Comsat. Ex GEO, from an aggregate margin rate perspective, we'll have to absorb some headwinds from conversion to GAAP. However, we expect synergies and other variables to absorb most if not all of those headwinds. We will be a little more specific by segment in our fourth quarter call where we could fully isolate continuing business based on where a construct evolves for the resolution of the GEO business which we expect to have clarity on by year end. I’d like to quickly update you on US domestication which will require the company in a transition to US GAAP. We laid out these details with a circular related to the upcoming share vote, but I thought it might be useful for listeners to have a recap presented to them here. As we discussed in the past, primary accounting changes have to do with two items, the recognition of investment tax credits and the capitalization of development costs. Under IFRS, ITC are recognized as reduction in cost rather than incremented income taxes which has the effect of increasing EBITDA compared to GAAP as the latter recognized as ITCs has a reduction in taxes. Also on our GAAP we won’t be able to capitalize on cost development and overhead which will result in higher in-period expenses going forward. That said, these development expenses will substantially decline as the vast majority of these related to GEO. Cash flow is not affected by any of these items and our credit facility covenants are based on IFRS. As you can see in the circular it was an offset from lower pension expense under GAAP also ITCs have no impact to the bottom-line as geographically they simply moved down to the tax line on the income statement. With that, I’ll stop and hand the call back over to Howard for some further remarks.

[Howard Lance:]

Thanks, Biggs. Let’s turn to our final slide 15 for a quick recap and takeaway. We’re effectively executing against each of our four strategic pillars. When combined with the fact that our core markets and businesses are growing that we have strong momentum with the US government and we’ve a great pipeline of new business opportunities, we believe we have a recipe to create improved long-term shareholder value. Over the next several quarters we expect to significantly reduce or eliminate many of the perceived risks that are depressing our share price. These include completing US domestication and transitioning to US GAAP accounting, extending the EnhancedView Follow-On imagery contract, meeting our operating cash flow and free cash flow commitments, growing our US government space business, and resolving GEO Com business issues that have been negatively impacting revenue, earnings and cash flows. With that, I’ll ask the operator to come back on the line so we can take your questions.

[Operator:]

Thank you. Ladies and gentlemen, we’ll now begin the question-and-answer session. [Operator Instructions] And your first question is from Steve Arthur from RBC Capital Markets. Please go ahead.

[Steve Arthur:]

Just a couple of questions. First off, related to the -- your current thinking on the review of the GEO business. Just wondering if you can elaborate any more -- offer any more color on the items under consideration, what's looking most interesting? And as well, what kind of drag, if you can say, was the GEO business on earnings and cash flow in the quarter?

[Howard Lance:]

Steve, I can’t be specific but I can tell you we’re in a number of discussions and our primary path remains to sell the business. So we’ve multiple interested parties. We're in discussions and we’re still hopeful to have an answer that we can announce between now and the end of the year. With regard to the specifics of the GEO Comsat business, I think for the first time and on one of the slides we have broken out for you the business ex-GEO, so that will give you a sense between the reported numbers and the numbers we’ve identified. There’s a little bit of inter-company sales as you know between our MDA company which is providing subsystems for SSL, so those are not factored in. But you can see that it’s very low profitability on a year-to-date basis, much lower than in the prior year on a year-to-date basis. And when you exclude the impact of orbital receivable income even on an IFRS basis, this product line is making very, very little money.

[Biggs Porter:]

And really the decline in GEO is what drives the variance year-over-year for the Space Systems segment.

[Steve Arthur:]

Great, understood. Secondly, just on the WorldView Legion program, just curious of how development is proceeding there and any changes to the CapEx outlook? I think initially we talked about $600 million, so just wondering if that has moved up or down in any way and how that kind of the spread through ‘18, ‘19, ‘20?

[Howard Lance:]

The progresses and the program Steve is on schedule. It will span ‘18, ‘19 and ‘20 with 2019 having the highest CapEx on that one program over the three years. We are on schedule. We expect to finish the program and launch in two separate launches in early 2021, which will put us on-orbit and time to provide full continuity should we have any issues with end of life on the existing WorldView 1 and WorldView 2 satellite. Again those are engineering projections. We don't expect those will go out and service immediately but our plan is to ensure all of our customers’ continuity and collection capability.

[Steve Arthur:]

And just final one. Just on orbital receivable securitization there. That option has been available for some time, but we haven't in the trigger pulled so far this year. Just curious what conditions you're looking for to use that option? Or if you expect to?

[Howard Lance:]

Well, I think in the quarter, we’ve securitized around 18 million of those orbitals and we are working on additional securitization in Q4. We can't assure the timing on that but should it occur as Biggs said in his prepared remarks, that's what will help propel us toward the higher end of our operating cash flow guidance range that we provided. We did securitization most recently I think in 2016 toward the end of the year. And again, as you know, this allows essentially pulling forward of these receivables that -- while they stretch out over the entire operating life of the satellite, we are typically pulling forward some portion of three to four years worth of receivables. So this is something that can come back to the market, do every couple of years.

[Operator:]

Thank you. Your next question comes from Richard Tse from National Bank Financial. Please go ahead.

[Richard Tse:]

I was wondering you would have a book-to-bill you can provide us for the Imagery and Services segments?

[Howard Lance:]

I think we said that when you take out GEO Comsat and then you take out the fact that with the EnhancedView contract every quarter, backlog goes down. So you take those two things out on a year-to-date basis which would cover Imagery, Services as well as our MDA and SSL business outside of GEO, it’s little above one-to-one. And we don’t include unfunded government backlog in that. So I’d say from my view that’s a really conservative way to track backlog. We had a very good quarter. I talked about a number of new program wins across both Imagery, Services and Space Systems outside of GEO. That’s what’s going to drive this company going forward, Richard. So we're very pleased with the momentum during the quarter reflected in the current quarter results but bodes well for the future. I think what I would emphasize is the large program pipeline that we talked about back in March at Investor Day that those programs are starting to come through, the Canadian Combatant Surface program, a big ship program in Canada. We won a major IDIQ contract award at SSL. We have been waiting to get this hunting license if you will. This is a $750 million contract ceiling and we were one of only three awardees under that program. So that’s a strong positive. Of course, we already talked about last quarter the Janus Geography program for Services. So we’re making real progress working down that list, and we’ve a few others over the coming quarters that we expect to be awarded. And I am very optimistic on the future growth potential of the company.

[Richard Tse:]

And the other question I had was with respect to the supply chain issues referred to in the quarter. I was wondering if you could maybe elaborate that a little bit?

[Howard Lance:]

Well we’ve got three things that are kind of going against us. We’ve been talking about a couple of them for a while in the Palo Alto factory because of the lower volumes. Of course as you get shrinking volumes you got lower overhead absorption. We can cut costs and take some of those costs out but not as fast as the decline in the revenue and the new orders. Second is our labor pool, while we try and match that with the production volume, it’s certainly less productive as you have fewer satellites in the factory. So we've been talking about those two items for a while. What hit us this quarter has to do with some significant supplier delivery and quality issues that have had the effect of creating rework and extending the delivery on some of the satellites by a few weeks or in some cases a few months. And so under percent completion accounting not only is all of that increasing our cost base, but it’s stretching out the programs. And so we’ve to adjust the cost to-date which in some cases causes you to take both the negative revenue and the negative profit yet in the quarter. So that the world under a percent completion accounting and the new item in the quarter had to do with a primarily one supplier issue but it was for components that were almost on every single satellite that we had to rework.

[Richard Tse:]

So should the read be that you’re through those issues now and we shouldn’t expect those to occur again going forward here?

[Howard Lance:]

Yes. I think we’re mostly through the supplier quality delivery delay issues. We might see a little bit more in the fourth quarter but we will continue to struggle with profitability on the programs in backlog because of labor productivity and absorption and we’re talking about now a market this year that may have as few as six or seven awards in a market that short three years ago had 25 or more awards. So this is really pretty unprecedented. We’re managing through the best we can and I want to really compliment the management team and the resiliency of the workforce, I know these are tough times. But people are very much focused on their mission of continuing to build and launch high quality satellites.

[Operator:]

Thank you. Your next question comes from Tim with TD. Please go ahead.

[Tim James:]

I was just wondering if you could little bit about your positioning in the Smallsat market for both the earth observation and communication satellite purposes within the Space Systems segment?

[Howard Lance:]

Well a couple things that we can just remind you about. First of all, on the communication side, the largest program under pursuit is the Telesat LEO constellation. As you know we are teaming with Thales Alenia Space and our team was selected as one of two companies to receive funding during about a nine month or so risk reduction phase. So we’re in the middle of that, things are going well and we expect to complete that work by say mid next year. And presuming always on track with Telesat we are expecting to down select at that time to a supplier. We’ve talked about the potential of that program being upwards of $3 billion over a multiyear period as you build and deploy the system and our work share in our teaming agreement with Thales Alenia and it was around 50% plus or minus a few points. So we’re very positive and continue to work on that. In the commercial Smallsat market, there continue to be on a number of startups they are getting funding and we are involved in the funnel on all of those constellations. So there's commercial work. There is international earth observation opportunities as we look at international governments that are looking to expand their imagery capabilities, some of those would utilize our Legion platform. We talked about the Legion-X program, which is where we propose an end-to-end solution to an international government for them to procure a Legion satellite for us to operate that satellite and that provides various kinds of analytics and then share in the revenues with the customer in this case providing all the funding for the program. So this is a real uplift. We continue to have one in our sites within the next couple of quarters and multiple ones in the pipeline for 2019 and ‘20. And then lastly I would just talk a little bit more about the IDIQ contract that we won at SSL government. We have been making great progress at SSL in moving up the stack from studies now to designing prototypes for future US government constellations. This now gives us a contract vehicle to pursue that and it was a very positive step in the quarter. So it’s nothing but really strong progress across these businesses unfortunately overshadowed by GEO.

[Tim James:]

And then just one further question, the 2019 revenue growth indications and I realized it’s preliminary that you’ve provided, suggests lower growth than you provided at the Investor Day for a five-year time horizon. So I realized we’re looking at five years there. But that would suggest to me accelerating revenue growth beyond 2019, I think even if you remove the unexpected weakness in the GEO Comsat market that we’ve seen this year. What’s going to drive that improving or accelerating revenue growth as we get beyond 2019?

[Howard Lance:]

I think it’s primarily Tim going to be driven by Space Systems. At this point we’re coming off of tough comparables with our MDA company because of the wind down of the RCM business. As that winds down and the year-over-year comparables kind of go to zero and then you put on top the growth programs that Mike Greenley and his team are driving, most notably continued growth in our satellite subsystems business, growth in robotics both from our Brampton operations, as well as our operations with the acquisition of Neptec, and then on top of that the great news with the Canadian Combatant Ship program, you’re going to see accelerating growth there. At SSL outside of GEO, I’ve really talked about the pipeline of things that are going to be awarded and that we’re working on. And today we’re winning studies of $1 million. Those are going to turn into prototypes we hope of $10 million and at some point of constellations of 100s of millions of dollars. So that’s why you would expect that to continue to accelerate. Having said that, this isn’t our final word on guidance for ‘19; but we do want to say we believe it’s going to be improved over this year. We think that’s a very positive statement. We will have more color around the specifics once we understand whether GEO is in or out and to what extent. But we think there's room solid room for optimism around top-line prospects going forward.

[Tim James:]

Just one quick clarification and it’s, is RCM still drag on revenue growth in ‘19? I was thinking that ‘18 had sort of ramped down so much that its impact on growth in ‘19 would be relatively immaterial but is it still in fact a bit of a drag next year?

[Howard Lance:]

Yes. So it will be a drag because we’re working on the program this year because the launch has slipped about a quarter, we’ll have a little bit of revenue next year at that launch milestone but not a lot. So, RCM year-over-year will be a negative. That will offset we think by some growth programs, as well as by the revenue from the Neptec acquisition. So -- but MDA is definitely bottoming and that was the whole picture we were trying to describe back at Investor Day that you’re reaching a point where the whole company ought to be reaching this kind of bottom point and we ought to be looking forward to positive growth momentum and the EBITDA and cash flows that will come along with that.

[Operator:]

Thank you. Your next question is from Thanos from BMO. Please go ahead.

[Thanos Moschopoulos:]

Just to clarify an accounting point. If you have contracts in GEO that are expected to lose money over the life of the contract, would you recognize the losses over that life upfront and then recognize the contract with zero margin going forward or will the losses be recognized on a go forward basis?

[Biggs Porter:]

Any time you have a contract, is that a loss you recognize at that point in time. Is that your question? It’s not something you’d defer it to the future.

[Thanos Moschopoulos:]

So just to clarify then based on your prior commentary, it sounds like GEO Comsat had maybe a negative 40 million impact in the quarter. Would that be a right ballpark?

[Biggs Porter:]

It’s a little -- it’s probably a little on the high side. But if you look at as I said Space Systems variance last year and this year, it’s actually driven by GEO Comsat, so it’s significant.

[Howard Lance:]

It’s significantly negative. I think we can certainly say that Thanos and our goal here was to provide a little more transparency and clarity around those numbers but we have had some programs slip from small margin to a loss and you take the whole accumulated loss in the current quarter under percent completion accounting. So it exacerbates the quarter. And again we say this every quarter but we would encourage investors to look at trends rather than at one quarter activity because these programs do move around. But I’ve said now for a few quarters that we are now trending in GEO toward a loss, we’re trending and now having the impact on pretty significant negative cash flows and as we move from IFRS to GAAP that will worsen somewhat because of the impact of capitalized R&D. So this is part of the explanation of what's going on in the quarter.

[Thanos Moschopoulos:]

I guess one thing I want to clarify is, if we take your 2018 EBITDA guidance, it would seem it’d be in the ballpark of 4.75 times leverage at December 31st, which is what the covenant drops to at June 30, ‘19. So maybe help us get comfort on that? I guess the mitigating factors would be the asset sales that you're evaluating and then the fact that there will be some EBITDA improvements based on the revenue growth that you’re talking about next year?

[Biggs Porter:]

Yes. So I guess first thing to remind everybody is that the covenants -- the bank covenants have a different definition on what you get off the financial statements. And as I said and we’ve said before it’s based on IFRS. But consistent with what you are just projecting, I think you got to look at what I said about margins this year and growth in revenues -- put it together somewhat this way. We said that 2019 margins under GAAP should be roughly in line or close to 2018 margin rates under IFRS. So if they are constant GAAP versus IFRS that means it really would be expanding under IFRS, then you got to apply not just margin rate expansion under IFRS, but also the revenue growth and that’s going to take you to EBITDA growth. And then as you say we have proceeds from assets sales, additional securitizations, orbitals and proceeds potentially from GEO resolution either in the sale of business or monetization of its real estate.

[Howard Lance:]

So all of those factors together put us in a -- we think a continuing solid and steady position. That’s the way I would think of it.

[Thanos Moschopoulos:]

And maybe just one last one from me. It’s my understanding that the RCM launch was a delayed due to scheduling issues with SpaceX. Is there any revenue EBITDA or cash flow timing impact associated with the launch delay?

[Howard Lance:]

Yes and that’s reflected in our current guidance. It was both some revenue and EBITDA impact from that delay moving from Q4 to we hope Q1 of next year.

[Operator:]

Thank you. Your next question is from Stephanie at CIBC. Please go ahead.

[Stephanie Price:]

It looks like CapEx guidance has been reduced somewhat for the year. Can you talk about this and whether you’re delaying expenditures or what’s going on with that?

[Biggs Porter:]

We’re doing our best to manage cash flow. Every program is in an additional level of scrutiny with regard to its need and justification and returns. We have raised our notional hurdle rate and are only investing in those capital programs which are either essential as maintenance replacements, or associated with driving growth in the business going forward. So there’s just a whole lot more focus on it.

[Stephanie Price:]

Alright. So we shouldn’t assume the difference has any thing to do with the Legion constellation?

[Biggs Porter:]

No, the Legion constellation is essentially on track. We haven't made any substantial reductions in that for 2018 compared to what we expected back in March.

[Stephanie Price:]

And then on the Services business, the revenue guidance came down. Can you talk a bit more about the factors behind that reduction? I know you mentioned them in the prepared remarks but can you go into a bit more detail?

[Biggs Porter:]

So the reductions, there was just a lower pass-through kind of revenue, so it’s a subcontractor revenue that doesn’t have a significant margin associated with it. So if you will, the contract could maybe gone direct to those subcontractors or it may just had in other cases not occurred in the quarter at all. But in any event it does have a bottom-line impact. So EBITDA is unaffected while revenues went down on a quarter-over-quarter basis, so it’s really kind of non-event from an economic standpoint. But as we said once you let -- when you look at all the orders funded non-funded that have been brought into services in the quarter, they’re in really good position going forward and we do expect that business to grow and be one of the contributors to next year’s revenue growth in addition to Space Systems that Howard was talking about earlier and Imagery growing too. We’re -- we feel very good about the position of that business and this was not an economic event.

[Stephanie Price:]

And just finally from me, on the EnhancedView contract renewal. Now that it’s housed in the NRO, can you give us a bit of an update on the contract renewal process there and timing?

[Howard Lance:]

We’ve said a couple of times Stephanie that we would expect to hear about the contract extension at a minimum a year in advance. So that would be July of 2019 but the move to the NRO as we also said previously has allowed us to engage in discussions and those discussions are underway. I can't comment any further on it other than I'm feeling very good about how we are perceived by the customer, the value we are delivering to the customer and their mission. And I think that’s evidenced by not just the renewal of contracts year eight, not just by the renewal of your seven and Global EGD but by the new awards helping us to upgrade the infrastructure to increasing cloud-based content for the customer as well as obviously the words of the director as relates to the importance of commercial imagery as part of the overall national architecture. So we’re feeling very positive that as we have said before, and we believe that we will continue to be the primary partner for commercial imagery and see an extension in the EnhancedView contract.

[Operator:]

Thank you. Your next question is from Paul from Scotia Capital. Please go ahead.

[Paul Steep:]

Howard or I guess Biggs, could you talk a little bit with Space Systems just the cost base, what’s the flexibility be there to return margins to double-digit levels in [29] maybe with or without GEO? Thank you.

[Biggs Porter:]

I think without GEO, we would say pretty strongly we will have excellent Space Systems margins. The margins for the rest of the business are solid. It’s the margins for GEO which now have gotten to such a low level and there is still such a large amount of revenue there as a big set of that’s 50% of the segment revenue. So if you're making no margin on 50% of the revenue that will give you a sense of what you're making on the rest of the business and it’s solid.

[Operator:]

Thank you. And your next question is from Robert from Credit Suisse. Please go ahead.

[Robert Spingarn:]

I don’t have a great connection, so I’m here with Audrey as well and we both have a couple of questions, we will try to be quick. At a high level Howard, you’ve been ramping up the past couple of years as you joined the business there’s been a significant amount of change, the end markets haven't been particularly cooperative and the expectations and the strategy have moved around a bit. So I do feel compelled after reading through today's release and reviewing what you’ve had to say. 0ow would you calibrate your confidence in your outlook today from a trend perspective versus let's say at the Investor Day?

[Howard Lance:]

I think my confidence ex-GEO is equal or greater than the confidence six months ago. So the issue and the unpredictable nature of the outlook has all been tied to the GEO business. If you go back to Investor Day and you look at our guidance, even starting from late February into Q4 outlook, we are hitting on all cylinders more or less as a total company ex-GEO. So I feel that both the outlook is as good or better. We’re taking off some of these big program wins which we talked about in March and we are meeting within plus or minus a couple of percent, all of the expectations that we laid out. So it's been very frustrating of course not having visibility on GEO and having that cloud the overall reported results of the company. So that’s my view.

[Robert Spingarn:]

But is it unfair to say I mean we just talked about what’s going on with Services revenues. There still seem to be some areas where visibility just isn’t that strong. On the other hand you’ve better margin there. So I am just trying to gauge what your level of visibility into these businesses is -- for somewhat desperate businesses is as they come together to form one?

[Howard Lance:]

Well I think Services in my view Rob is, it’s an anomaly, it’s one quarter. We’re not a $4 billion Services business, so we can have a major contract transition from one agency to the other, have happened during this quarter and instead of the past quarters coming to us and passing through with virtually no margin they went direct to the other subcontractor. So that’s going to happen from time-to-time. The Services has been and will continue to be a growth business. But it’s not our most profitable business. So I wouldn’t place all the spotlight on that. If I were tracking I would pay a lot of attention of course to our biggest profit and cash flow generator which is the Imagery business, it is performing exactly as we expected during the year and I think has a building momentum. So we feel very positive about that. And while we’re in early days of turning around the rest of the Space Systems business to a big growth and profit contributor, the progress we're making that I noted during the call thus far whether it is a Canadian Ship program, the $750 million IDIQ contract for SSL or other programs, I think those are all pretty much coming along as we expected. So if you could carve out in your mind, GEO, the rest of the business I think is pretty much performing as expected and the outlook has improved. And lastly to comment on cash flow, we provided the cash flow guidance on the basis of a certain amount of EBITDA back in March. We’re well short of that EBITDA because of GEO. But we’re still on track with our operating cash flow guidance and our free cash flow guidance. That says something about ….

[Robert Spingarn:]

I was going to say -- that segways right into my next question with Mr. Biggs. Forgive me, but you do have -- you’re set up here for a pretty big fourth quarter and cash flow, I guess that's typical but I wanted to ask Biggs if he could do two things. One, speak to the puts and takes that we should be looking for in this big fourth quarter, so something to set -- we can set expectations? And then separately Biggs you’ve not been there that long either just about a quarter. I wanted to ask to what extent you've had your chance to do your deep dive and maybe reset any kind of expectations above and beyond the charge that we saw today in GEO, do you still plan to do some kind of significant review that could result in some changes because that already happened in these results?

[Biggs Porter:]

There’s no plan for me to do anything beyond what we’ve looked at this quarter. I mean quarter it’s my obligation to look at everything and make sure that we’re doing everything all right, whether it’s in accordance with IFRS or in accordance with GAAP. So that just will never change and that’s not something that is optional. But we did everything that we should do this quarter. We looked at it harder and I think we of course didn’t stand behind that from a standpoint of believing that we captured what was supposed to be captured. The -- going back to your first question on the working capital and the cash flows, you pointed out there been some seasonal history here. We’re looking at working capital improvements, driven by a combination of milestone, the patterns of expected customer payments just as they’ve occurred in the past. Also, interest is also seasonal under our credit agreement. We have four quarters of interest payments in the year but the way they work out, the first quarter ends up been heavy and the fourth quarter light on interest payments. So that’s a contributor. And then as Howard already mentioned, what really cerates the upside and ability for us to drive higher in the range would be getting additional securitizations done.

[Robert Spingarn:]

Okay, thank you for that. I think Audrey's got one too.

[Audrey Preston:]

Hi. This is Audrey. So with the understanding that you’re still evaluating multiple alternatives for the GEO business, if we can just calibrate kind of a worst case scenario here and you have to line then Palo Alto on an organic basis, how much credit cost on a cash basis?

[Howard Lance:]

I don’t want to speculate Audrey other than to say that something we’ve said before which is that we believe any shutdown costs would be lower than the value of the real estate assets such that even in the shutdown mode which we don’t expect to undertake but if we did it would still be positive cash flow. Beyond that, I can’t really comment any further because we don't have any more specifics.

[Howard Lance:]

Okay, thank you very much. I think with that operator we will end the call. Thank you all for joining us. And we look forward to talking to you again next quarter.

[Operator:]

Thank you, ladies and gentlemen, that concludes today's conference call. We thank you for participating and we ask that you please disconnect your lines.