Viasat, Inc.
Q1 2017 Earnings Call Transcript

Published: 10 Aug 2016

[Operator:]

Welcome to the ViaSat's FY 2017 First Quarter Earnings Conference Call. Your host for today's call is Mark Dankberg, Chairman and CEO. You may proceed, Mr. Dankberg.

[Mark D. Dankberg:]

Okay. Thanks. Good afternoon, everybody, and thanks for joining our earnings conference call for our first fiscal quarter of 2017. So, I'm Mark Dankberg, Chairman and CEO. And I've got with me here, Rick Baldridge, our President, Chief Operating Officer; Shawn Duffy, our Chief Financial Officer; Keven Lippert, our General Counsel; and Bruce Dirks, our Treasurer. And before we start, Keven will provide our Safe Harbor disclosure.

[Keven K. Lippert:]

Thanks, Mark. As you know, this discussion will contain forward-looking statements. This is a reminder that factors could cause actual results to differ materially. Additional information concerning these factors is contained in our SEC filings including our most recent reports on Form 10-K and Form 10-Q. Copies are available from the SEC or from our website. With that said, back to you, Mark.

[Mark D. Dankberg:]

Okay. So, we'll be referring to slides that are available over the web. And I'll start with some highlights and a top level business overview and after that, Shawn will go through the consolidated and segment level financial results. And in this quarter, we thought we'd spend a little time reviewing how we think about our R&D investments in satellite broadband productivity, and give some color about how that productivity manifests itself in our key broadband services businesses, including an update on the R&D status on ViaSat-2 and ViaSat-3. And then, we will review our outlook and take questions. So, our first quarter was a pretty good start for the year. Overall, revenue was up 5% year-over-year, new orders were up 10% and Adjusted EBITDA grew 3%, all compared to the same quarter last year. As we said last quarter, we had significant growth in R&D spending in our commercial network segment on ViaSat-3 and success based commercial airborne Supplemental Type Certificates, or STCs. As a reminder, we are expensing the preflight payload engineering activities on the ViaSat-3 satellite as an artifact of building the payloads internally. Absent that growth in R&D expenses, Adjusted EBITDA companywide would have grown 16% year-over-year, and op earnings even more than that. Our Satellite Services segment was especially strong. ARPU increased 8% year-over-year due to a combination of packaging attractive higher bandwidth, higher-speed service plans, and increasing attachment rates on a growing portfolio of value-added services. Subscriber count was relatively flat. Sat costs have been trending down on a per subscriber basis. Commercial aircraft in-service is growing, and that led to a 32% year-over-year increase in Adjusted EBITDA in the Satellite Services segment. Overall, we continue to see strong demand for Satellite Services in target markets and later on, I'll go into more depth on our longer-term thinking on how we drive profitable growth there, leveraging ViaSat-2 and beyond. Our Government segment also had very good results. Adjusted EBITDA and operating earnings for the first quarter increased 13% year-over-year on flat revenue, though with a higher proportion of services than last year. Overall, our Government business seems well positioned for growth in revenues, orders and earnings due to favorable outlooks in satellite mobility services, Tactical Data Links, and some recently certified additions to our network security appliances portfolio. Government customers have been initially procuring satellite mobility terminals and then have been following that with the ongoing services contracts. And as those are executed, that helps provide visibility to our growth trajectory there. The handheld Link 16 radio that's shown on the slide is a good example of the way we've been growing our Government business. We've had end users support to develop a product that has strong market flow, even without there being in a program of record for it. A lot of our growth in the Government segment, including in mobility, has come from creating unique and growing markets for products and services that aren't served by the DoD acquisitions. We're very pleased and excited by two very significant aeronautical mobile contracts with American Airlines and the U.S. Government senior leadership fleet, including Air Force One. Obviously, those are really high profile customers, and we believe winning those awards speaks volumes about the market recognition of the quality and economics of services on our satellite networks. But even more importantly, they are strong endorsements of our very simple yet highly differentiated approach to satellite broadband infrastructure. So, on that note, Shawn will give some more detail on the financial results. And then I'll come back and give some more color on that differentiated broadband infrastructure topic.

[Shawn Lynn Duffy:]

Thanks, Mark. As Mark just highlighted, the Satellite Services and Government Systems segment drove the overall increase in Adjusted EBITDA, more than offsetting declines in Commercial Networks. Specifically, revenues were up 15% in Satellite Services and flat in Government Systems, yet Adjusted EBITDA was up 32% and 13%, respectively, in each of these segments. Once again, we reached record recurring Adjusted EBITDA of $72 million in Satellite Services, with EBITDA margin topping 47%, which is a 300 basis point increase sequentially from FY 2016 Q4 and a 600 basis point increase year-over-year. And I'll talk a little more about what drove those increases in a little bit. In Government Systems, our Adjusted EBITDA grew on flat revenue. This reflects the growth of our higher margin service offerings, as a scale (5

[Mark D. Dankberg:]

Okay. Thanks, Shawn. So this next slide makes a relatively simple point but it's one that's really important to understanding our thinking about ViaSat's businesses and how we build competitive advantage. The charts are a reminder that broadband users keep demanding higher speeds and more bandwidth and that the revenues or ARPUs that service providers can earn from their users isn't growing as fast as the speeds and volumes. So service providers with stronger competitive positions like cable companies competing mostly with DSL have been able to earn ARPU gains, but customers still continue to get better and better values in terms of megabits per second per subscription dollar or gigabytes of consumption per dollar. In markets with greater competitive intensity like, say, cellular services, ARPUs could actually decrease even while speeds and volumes are increasing. So this race to deliver more output with the same or less capital input is essentially the definition of productivity and that's what we're going to focus on. The up-chart is a service providers with infrastructure, productivity advantages are going to do better than those with lower productivity. So cable, hybrid fiber coax networks, improve speeds and volumes more efficiently than copper or telephone plan (13

[Operator:]

Thank you. And our first question comes from the line of Rich Valera from Needham & Company. Your line is now open.

[Richard Valera:]

Thank you. I appreciate the color on the pre-and post ViaSat-2 with the different businesses, Mark. Just wondering if you thought that migration might become a factor again post launch of ViaSat-2 as they were when you initially launched ViaSat-1?

[Mark D. Dankberg:]

Yes, we do. We listed that as one of the factors. I think that it's going to be much less of a factor than it was with ViaSat-1. For the main reason that the difference in the satellite productivity is narrower than it was between WildBlue-1 and in ViaSat-1. So they were looking at like a 10x, 20x increase in productivity and this is more or like double or maybe a little better than that. So there will be some but we think it ought to be more manageable based on the way we defined the services.

[Richard Valera:]

Okay. Is there any way we could think about that? I think you peaked at like 60K a year in the first year of that transition, so sort of a significant factor less than that is how we should think about it when we think about the first year...?

[Mark D. Dankberg:]

I think the way I'd think about it is one of the ways and we talked about this a couple of quarters ago is think about it as we improve the productivity, we can use some of that bandwidth gain to improve the surface as one of the big factor and then another part to improve our margins. So think of it as if we gave it all to our customers we'd have half the customers per unit bandwidth. If we kept it off ourselves we would have double the customers in total per satellite and we'll be in between. So what it really will mean is that the yield on ViaStat-1 will go down a little bit, but will grow subscribers on ViaStat-2 at a faster rate. And because a lot of the terminals are, I think, the terminals are capable of – a lot of the terminals are capable of the services that we offer, ViaStat-2 we won't have the SAT costs associated with the migrations that we did before. So that's a big benefit for us. So when we model migrations, think of it's a little more sort of normalizing productivity than it is stack expenses as it was last time. There will still be stack expenses associated with it but those will be moderated.

[Richard Valera:]

Got it.

[Mark D. Dankberg:]

Does that make sense?

[Richard Valera:]

Yeah, that does. Just wanted to get your sense on how your message is resonating in the market. You presented a pretty compelling picture there of the relative bandwidth/cost benefit that you have versus pretty much anything else out there in the market and it seems like even in terms of the worst-case ViaStat-1 you are at least 10x better than pretty much anything else out there and then you can close up to kind of 100x. So when you present this to your prospective in-flight connectivity customers, how is this resonating or are they sort of getting it? And what would be the pushback they would have? I mean, it seems if they're looking at that it would be kind of a no-brainer to go with the guys, to go with the guy with sort 100x sort of bandwidth cost advantage, but what are some of the things you are sort of hearing and how is that resonating in the marketplace?

[Mark D. Dankberg:]

So one thing – I mean, one thing that anybody can observe is just look at the language that is now around, what's going on in the airplanes, right? I mean, people are always talking about oh, we need 100 megabits per second per airplane, right or 200 megabits per second per airplane. So people are, one is, you are seeing an acknowledgment that the demand for bandwidth is going to be a lot higher than it was. So that's a good thing. I think another thing that you're seeing is more people talking about the things that drive bandwidth consumption, which is video streaming as an example, right, that you can see (38

[Richard Valera:]

Got it.

[Mark D. Dankberg:]

I mean you are covering this space too. So I think you can weigh yourself on (41

[Richard Valera:]

Fair enough. I appreciate that color. That was helpful, Mark. Thank you.

[Mark D. Dankberg:]

Thanks, Rich.

[Operator:]

And our next question comes from line of Andrew DeGasperi from Macquarie. Your line is now open. Andrew DeGasperi - Macquarie Capital (USA), Inc. Thanks. Macquarie. First question, can you maybe clarify for us, what the FCC Spectrum Frontiers order impact is to ViaSat-2 or ViaSat-3 potentially in the 28 gigahertz band?

[Mark D. Dankberg:]

Yeah. We obviously follow that. We paid a lot of attention to that. We have been probably the leading proponent of spectrum sharing in the satellite industry. I think that put us in kind of a leadership position and – in the discussions around that. And also, we've been probably ahead of the curve in taking advantage of spectrum sharing in that 28 gigahertz band. So at the end, I think that the statements that the FCC made around what their intentions were are good for 5G and for the satellite industry. They acknowledged the issues around grandfathering the teleport gateways for existing satellite systems, including for ViaSat-1 and ViaSat-2, and there are provisions for many thousands of new gateways throughout the U.S. for ViaSat-3 and beyond, using that 28 gigahertz spectrum band. The FCC also acknowledged that there was need for further study to deal with both the local interference levels associated with those gateways and the aggregate interference that may arise from 5G use of the 28 gigahertz band on the spacecraft itself. So I think we believe that there is a framework in place for a good outcome. There's still a lot of work to be done. Overall, we think the outcome is good and consistent with our plans. Andrew DeGasperi - Macquarie Capital (USA), Inc. Great. And if you could just remind us what the backlog is currently on your commercial aircraft. I've seen that you keep adding planes, but where you essentially adding these from? Are they existing customers that, they are just giving you more aircraft or are there new fleets coming online? Can you maybe just comment on that?

[Mark D. Dankberg:]

Yeah. We have – we are basically primarily adding aircraft from the fleets that we currently have, so that is adding aircraft for JetBlue – for instance, JetBlue completed its regional expansion. JetBlue has also talked about adding planes to its fleet. We've been adding to the United fleet, Virgin America, and EL AL, and then we have the single biggest lump of backlog is the American Airlines 737 MAX award. Andrew DeGasperi - Macquarie Capital (USA), Inc. If we think about the rest of the year, till ViaSat-2 goes up in (44

[Mark D. Dankberg:]

I'd say – maybe not quite at the levels that we've been at in the last quarter, probably going down a little bit from that, based on what the current situation is. That could change, but I would say for the next couple of quarters or so, I'd think about it in those terms. Andrew DeGasperi - Macquarie Capital (USA), Inc. Got it. And last question for me, retail business, based on dishNET numbers, it seems that your retail business more than made up for the weakness in wholesale. Can you maybe tell us what you're doing differently there?

[Mark D. Dankberg:]

I don't think – I think we're doing the things that we've described over the last year or so. I think we've got – we are very happy with our retail distribution network. I think we've expanded that. I think that the plans that we're offering are good, they are more attractive. I think we're just grinding it out. I think we're getting operationally pretty good, and I think those are all good factors, pending the launch of ViaSat-2. Andrew DeGasperi - Macquarie Capital (USA), Inc. Got it. Thank you.

[Operator:]

And our next question comes from the line of Mike Crawford from B. Riley. Your line is now open.

[Mike Crawford:]

Thank you. Can you give an update on the status of your JVs that you're forming with Eutelsat?

[Mark D. Dankberg:]

Okay. Yeah. I think last – was it last – week before, they had their earnings conference call and that was one of the topics there, and I think our view of it is just like theirs, that we've got good top level agreement between us. There's a pretty fair amount of detail to go through to reach closure on the agreements. We don't see anything that's jumping out as threatening that, but there is work to do. I think they said, and we've kind of agreed, that probably this year is a reasonable target for completing it. Also, one thing I would like to point out, which is good in the meantime, is that we're cooperating with them on helping to think about the KA-SAT services. And one point we mentioned is that we now have our first joint European aircraft on KA-SAT, with EL AL. So that's exciting, and I think it's good progress.

[Mike Crawford:]

Just one more question in that regard is that, Eutelsat sold its majority stake in this maritime service provider. So, does that mean that you will be able to service the maritime market with Eutelsat with one of the JVs?

[Mark D. Dankberg:]

So the mobility services is definitely one of the targets in the JV. So that would be through KA-SAT and through the next-generation satellite. And I think we're a really good mobility partner. I think we would have to talk – you would have to ask Eutelsat what their overall plans are in serving that market, but I don't think that's – I'm not sure I'd read too much into that one particular issue.

[Mike Crawford:]

Okay. And if I could just turn back to this productivity issue, Mark, one thing you stated in this call, I believe you said ViaSat-2 will more than triple effective network capacity for, I guess, airborne mobility?

[Mark D. Dankberg:]

Yeah. If you think of ViaSat-1 having unit capacity of one and ViaSat-2 has double that capacity then, between the two of them, that makes three and that's – that triple the total capacity.

[Mike Crawford:]

I thought you were referencing the more flexible beam architecture?

[Mark D. Dankberg:]

No, I don't want to be ambiguous about that. Basically, what we've talked about is double the throughput. So that means we've got a lot more illuminated gigahertz on ViaStat-2 then on ViaStat-1. We've gone through this in the past. The infrastructure cost is like 20% to 25% higher so the total throughput must be more than double in order to get double the bandwidth economics and we have not counted flexibility as part of that. It is just raw bandwidth. Now we think that flexibility and portability is going to increase the yield on the satellite but we haven't factored that into that number.

[Richard A. Baldridge:]

The other thing is, this is Rick, with the increased coverage, I think they will have more time of the aircraft that are flying more time within the coverage area and so that's going to be a factor as well.

[Mark D. Dankberg:]

. I think one of the things I said also is we think there's upside to our current numbers so we will report on that as some of the elements of that fall into place. But right now we're sort of, we think we are sort of doing well compared to what our original target was because the capacity numbers are holding and the capital costs are at the low end of the range.

[Mike Crawford:]

Thank you. And then just to try to be absolutely clear on this. So with the Ku-Band satellite that one (50

[Mark D. Dankberg:]

What you look at is illuminated, you look at illuminated gigahertz and there was a time, maybe they are not advertising it so much, but there is a time when you can look on the web and you can find the illuminated gigahertz for each of the satellites and then you divide that among the beams and it's not necessarily uniformly allocated among the beams, but it gives you a sense of order magnitude of the amount of gigahertz that you have to work with in each of these beams and then from there what you do is you just turn that into how many bits per second per hertz you can get and that's a function of the link budget. The antenna on an airplane is a factor, but it's basically it's a two-way link budget, so you have to look at, you can improve with the bigger antenna, you can improve the downlink portion of the link budget a little bit, but that's not the total link budget. You have to put that in context of the total link budget, and it's 20%, 30% increase in capacity relative to a smaller antenna. So you can make bigger and bigger antennas and you can get a little bit more gain and a little bit more throughput, but you're not going to go from 1.5 bits per second or 2 bits per second to 4 bits per second, you might go from 1.5 bits per second or 2 bits per second or 1.8 bits per second or 2.4 bits per second or something along those range. That's what you get. The rest of the stuff, things like compression, those are pretty much available to those people we think we have really good compression technology. A big part of that has to do with the way content is distributed by media companies. So there is domestic compression that are driven by end to end encryption that are available to any ISP. So our point is there's not a lot of maneuvering room, and it is sort of like we say which is like bandwidth productivity is kind of the destiny of these systems.

[Mike Crawford:]

Okay. Thank you. And then just switching to Commercial Networks, you are talking about some opportunities to grow even though the types of gateways and architectures you are building and designing for yourself are different from what others seem to be considering unless that's changing. So is this more of a modem type opportunity with nbn and potentially others or what is it specifically that you are targeting for potential growth in Commercial Networks given the way that your business has shifted?

[Mark D. Dankberg:]

Yes. One of the decision that we had to make was whether we wanted to build network infrastructure for sort of garden-variety "High Throughput Satellites" or whether we wanted to invest in those things that would drive productivity. And what we've chosen to do is to invest in things that would drive productivity. I think if we were only in the business of building and selling products that would be a tough decision, but when we are in the business of selling services and we have these enormous productivity gains that justifies the R&D investments that makes it an easy choice. So what we're doing is we're really building ground infrastructure for satellite networks that are using our unique technologies and we haven't seen any other operators really go for those. So nbn was a good opportunity for us because they used basically ViaSat-1 technology. I mean, what they want to is the ViaSat-1 in their market and KSAT was the same way. So those are good fits for us, but we're not investing in that type of infrastructure anymore. So we don't really model selling infrastructure going forward as a standalone product. What we are seeing, though, more and more are outside of satellite operators saying well, I think about this productivity issue. We would like to be on your side. And so, we are seeing more opportunities for things where in specific regions operators would partner with us building on our network infrastructure Eutelsat and KSAT, I mean, that's a really good example of that. So some of that might lead to network and infrastructure sales like, for instance, what we did with XCI on ViaSat-2. We have other opportunities for infrastructure product sales, but they are more based on our own sub satellites and on partnerships.

[Mike Crawford:]

Okay. And thank you. And then final question relates to Government Systems where you have STT in this BATS terminal that represents potentially quite large program that as you mentioned came in not through normal program or record. Are there other opportunities like that like, say, what that Information Assurance products that you're targeting right now?

[Mark D. Dankberg:]

Yes. Definitely. More and more we're seeing sort of a disconnect between the procurement system and what users want. And so that's what we're aiming for, especially things that are adjacent to or variances stuff we already do. So a great example of that is the STT terminal, which started out as basically as a R&D program with us with some customer support but then turned into the program of record for Apache helicopters and the others, quite a big market for helicopters both domestically and internationally and other small form factors for that. Our handheld really good sign. Recently, it was given radio designators by DoD which is indicative of its desire to turn that into essentially a new program of record for that type of application and we see more of those not only in the Tactical Data Links and security space but also in the satellite space. So that – I think that's a big part of why our revenues are still growing and we're sort of diverging from some of the other big defense aerospace command and control communications companies.

[Mike Crawford:]

Okay. Thank you.

[Operator:]

And our next question comes from the line of ...

[Mark D. Dankberg:]

Okay, one more.

[Operator:]

And our next question comes from the line of Andrew Spinola from Wells Fargo. Your line is now open.

[Andrew C. Spinola:]

Thanks. Mark. I wanted to ask you about, on slide 10, and I'm looking at the coverage maps of ViaSat-1 versus your competitors. The one thing that's clear to me is that you've obviously concentrated your capacity with ViaSat-1 over the United States while your competitors have opted for a lot more coverage. And I'm wondering, as you opt for a lot more coverage with ViaSat-2 and ViaSat-3 why won't you suffer the same or similar productivity declines that your competitors have with the existing satellites or will you?

[Mark D. Dankberg:]

Yep, so that's a really good question. So there is really two factors. One is the total illuminated gigahertz that we will have with our satellite is much, much larger than the total illuminated gigahertz for those other ones. So if you look, if you go through and do some research you will see that the total illuminated gigahertz with those three others ranges from 5 gigahertz or 6 gigahertz to maybe 10 gigahertz or 12 gigahertz. ViaSat-1 was 100 and ViaSat-2 is quite a bit more than that and ViaSat-3 is a way more than that. So one is the illuminated gigahertz and that's really the factor that we have focused on and by illuminated gigahertz what I mean is take the bandwidth per beam, multiply that by the number of beams and you will get a total – it called total illuminated gigahertz. So number one is that's a really important metric of total productivity over the entire footprint. But the other really big factor is the one that Mike Crawford was sort of bringing up, which is this flexibility. And so, one thing that would be nice with the satellite and this is what we do with ViaSat-2 is you could say, hey, well the U.S. market, in fact, Wi-Fi is way bigger than all the rest of those coverage areas, how that if we move all of those illuminated gigahertz into the U.S. market. That would be really good if that's where the demand is and none of those other satellites have the ability to do that. That's a really important thing that we are doing on ViaSat-2 where we have a very big footprint. We cover Latin America down to South America, we cover the Atlantic Ocean, we cover the Caribbean, but if we wanted to we could bring all that bandwidth back into the U.S. So that doesn't increase the illuminated gigahertz, but it makes it a lot more useful when different market develop at different rates. So we think those are the two really big advantages that we have.

[Andrew C. Spinola:]

Got it. And I just wanted to ask one quick follow-up. You mentioned the maritime market is something that might be interesting to you longer-term and it's kind of a unique market given the predominance of L-Band and the strength of one competitor. And I'm just wondering, it seems like that ViaSat sort of likes to target areas that can be disruptive and have markets that have characteristics that would lend themselves towards being disrupted. And just wondering if you have a similar thought process about the maritime market and if that's one of the reasons why you think that's an opportunity.

[Mark D. Dankberg:]

Yep, exactly. So the thing that's really interesting about the maritime market now is lots and lots of ships, tens of thousands of ships in total, but not very much bandwidth is used. All right. So the bandwidth per ship is not that high. And essentially what a lot of those ships are paying for is the ability to be connected if they need to be, but they're not really using a lot of bandwidth because there's not a lot of bandwidth to be had. At the other extreme of the market, there is a small number of ships with very, very large bandwidth demands, and for those, it doesn't mean that they'd have to cancel their L-Band subscription, they could still use that for safety and emergency communications but they have very high bandwidth needs, because they have a lot of passengers or they have a big crew or they have an exploration mission that requires collection of enormous amounts of data. So those are the ends of the market that we're going after, a small number of ships with very large bandwidth requirements because that's where we think most of the money is and that's what we're going to target.

[Andrew C. Spinola:]

Got it. Thank you.

[Mark D. Dankberg:]

Okay. So I think that cover – my voice is gone – that covers a lot of the questions. So I think that will be it for this afternoon. Thanks a lot, everybody, for joining our call. Look forward to talking to you next quarter.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a wonderful day.