UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
| | |
þ | | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2008
or
| | |
o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-33015
GEOEYE, INC.
(Exact name of registrant as specified in its charter)
| | |
Delaware | | 20-2759725 |
(State or other jurisdiction of | | (I.R.S. Employer |
incorporation or organization) | | Identification No.) |
21700 Atlantic Boulevard
Dulles, VA 20166
(Address of principal executive offices) (Zip Code)
(703) 480-7500
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filero | | Accelerated filerþ | | Non-accelerated filer o (Do not check if a smaller reporting company) | | Smaller reporting companyo |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ
The number of shares outstanding of Common Stock, par value $0.01, as of September 3, 2008, was 17,998,573 shares.
TABLE OF CONTENTS
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| | Page | |
PART 1. Financial Information | | | 3 | |
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Item 1. Financial Statements | | | 3 | |
Condensed Consolidated Statements of Operations (unaudited) — Three Months and Six Months Ended June 30, 2008 and 2007 | | | 3 | |
Condensed Consolidated Balance Sheets (unaudited) — June 30, 2008 and December 31, 2007 | | | 4 | |
Condensed Consolidated Statements of Cash Flows (unaudited) — Six Months ended June 30, 2008 and 2007 | | | 5 | |
Notes to Condensed Consolidated Financial Statements (unaudited) | | | 6 | |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | | | 22 | |
Item 3. Quantitative and Qualitative Disclosures About Market Risk | | | 29 | |
Item 4. Controls and Procedures | | | 29 | |
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PART 2. Other Information | | | 30 | |
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| | | 30 | |
Item 1. Legal Proceedings | | | 30 | |
Item 1A. Risk Factors | | | 30 | |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | | | 30 | |
Item 3. Defaults Upon Senior Securities | | | 30 | |
Item 4. Submission of Matters to a Vote of Security Holders | | | 30 | |
Item 5. Other Information | | | 30 | |
Item 6. Exhibits | | | 30 | |
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Signatures | | | 31 | |
2
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements.
GEOEYE, INC.
Condensed Consolidated Statements of Operations
(Unaudited; in thousands, except share and per share data)
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | | Six Months Ended | |
| | June 30, | | | June 30, | |
| | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| | | | | | (As restated) | | | | | | | (As restated) | |
Revenues | | $ | 34,219 | | | $ | 48,254 | | | $ | 68,621 | | | $ | 85,050 | |
Direct expenses | | | 19,335 | | | | 15,162 | | | | 39,095 | | | | 34,272 | |
| | | | | | | | | | | | |
Gross profit | | | 14,884 | | | | 33,092 | | | | 29,526 | | | | 50,778 | |
Selling, general and administrative expenses | | | 9,604 | | | | 7,385 | | | | 18,544 | | | | 13,979 | |
Net (gain) loss on satellite | | | (9 | ) | | | — | | | | 1,141 | | | | 36,053 | |
| | | | | | | | | | | | |
Income from operations | | | 5,289 | | | | 25,707 | | | | 9,841 | | | | 746 | |
Interest expense, net | | | 1,366 | | | | 1,897 | | | | 2,449 | | | | 5,119 | |
Unrealized (gain) loss on derivative instrument | | | (97 | ) | | | (839 | ) | | | 1,668 | | | | 999 | |
| | | | | | | | | | | | |
Income (loss) before provision for income taxes | | | 4,020 | | | | 24,649 | | | | 5,724 | | | | (5,372 | ) |
Provision (benefit) for income taxes | | | 3,635 | | | | 13,030 | | | | 6,349 | | | | 4,935 | |
| | | | | | | | | | | | |
Net income (loss) | | $ | 385 | | | $ | 11,619 | | | | (625 | ) | | $ | (10,307 | ) |
| | | | | | | | | | | | |
Earnings per common share — basic | | $ | 0.02 | | | $ | 0.66 | | | $ | (0.03 | ) | | $ | (0.59 | ) |
Earnings per common share — diluted | | $ | 0.02 | | | $ | 0.61 | | | $ | (0.03 | ) | | $ | (0.59 | ) |
See accompanying Notes to Condensed Consolidated Financial Statements.
3
GEOEYE, INC.
Condensed Consolidated Balance Sheets
(Unaudited; in thousands, except share data)
| | | | | | | | |
| | June 30, | | | December 31, | |
| | 2008 | | | 2007 | |
ASSETS | | | | | | | | |
Current assets: | | | | | | | | |
Cash and cash equivalents | | $ | 221,498 | | | $ | 234,324 | |
Receivables net of allowances of $342 and $738, respectively | | | 27,845 | | | | 44,517 | |
Other current assets | | | 11,320 | | | | 6,419 | |
| | | | | | |
Total current assets | | | 260,663 | | | | 285,260 | |
Property, plant and equipment, at cost, less accumulated depreciation of $14,654 and $11,817, respectively | | | 97,396 | | | | 88,418 | |
Satellites and related rights, at cost, less accumulated depreciation and amortization of $12,219 and $10,311, respectively | | | 368,423 | | | | 346,267 | |
Goodwill | | | 32,612 | | | | 32,612 | |
Intangible assets | | | 15,702 | | | | 17,068 | |
Other non-current assets | | | 14,096 | | | | 16,653 | |
Deferred tax asset | | | 78,721 | | | | 78,721 | |
| | | | | | |
Total assets | | $ | 867,613 | | | $ | 864,999 | |
| | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | |
| | | | | | | | |
Current liabilities: | | | | | | | | |
Accounts payable and accrued expenses | | $ | 23,665 | | | $ | 17,684 | |
Amounts payable to subcontractors | | | 42,818 | | | | 55,967 | |
Accrued interest payable | | | 17,188 | | | | 17,292 | |
Current portion of deferred revenue | | | 13,823 | | | | 9,499 | |
Income tax payable | | | 32,816 | | | | 32,911 | |
| | | | | | |
Total current liabilities | | | 130,310 | | | | 133,353 | |
| | | | | | | | |
Long-term debt | | | 247,145 | | | | 246,789 | |
Deferred revenue, net of current portion | | | 193,860 | | | | 193,860 | |
Non-current income tax reserve | | | 97,152 | | | | 93,081 | |
| | | | | | |
Total liabilities | | | 668,467 | | | | 667,083 | |
| | | | | | | | |
Commitments and contingencies Stockholders’ equity: | | | | | | | | |
Common stock, par value $0.01; 50,000,000 shares authorized; 17,997,441 shares and 17,868,153 issued and outstanding at June 30, 2008 and December 31, 2007, respectively | | | 180 | | | | 179 | |
Additional paid-in capital | | | 201,792 | | | | 199,938 | |
Accumulated deficit | | | (2,826 | ) | | | (2,201 | ) |
| | | | | | |
Total stockholders’ equity | | | 199,146 | | | | 197,916 | |
| | | | | | |
Total liabilities and stockholders’ equity | | $ | 867,613 | | | $ | 864,999 | |
| | | | | | |
See accompanying Notes to Condensed Consolidated Financial Statements.
4
GEOEYE, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited; in thousands, except share data)
| | | | | | | | |
| | Six Months Ended | |
| | June 30, | |
| | | | | | As Restated | |
| | 2008 | | | 2007 | |
Cash flows from operating activities: | | | | | | | | |
Net income (loss) | | $ | (625 | ) | | $ | (10,307 | ) |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | |
Depreciation and amortization | | | 4,792 | | | | 10,329 | |
Amortization of intangible assets | | | 1,321 | | | | — | |
Loss on impairment of satellite | | | 1,141 | | | | 36,053 | |
Loss on disposal of fixed assets | | | — | | | | 55 | |
Amortization of debt discount and issuance costs | | | 1,061 | | | | 2,062 | |
Unrealized loss on derivative instrument | | | 1,668 | | | | 1,838 | |
Stock compensation expense | | | 261 | | | | 947 | |
Deferred income taxes | | | — | | | | (4,580 | ) |
Changes in assets and liabilities, net of effect of acquisitions: | | | | | | | | |
Accounts receivable and other current assets | | | 16,671 | | | | (35,149 | ) |
Other assets | | | (4,716 | ) | | | (1,410 | ) |
Accounts payable and accrued expenses | | | 4,734 | | | | (161 | ) |
Income tax payable | | | (95 | ) | | | — | |
Non-current income tax reserve | | | 4,071 | | | | 8,086 | |
Deferred revenue, net | | | 4,325 | | | | 7,098 | |
| | | | | | |
Net cash provided by operating activities | | | 34,609 | | | | 14,861 | |
Cash flows from investing activities: | | | | | | | | |
Capital expenditures | | | (49,029 | ) | | | (28,157 | ) |
Payment for business acquisition, net of cash acquired | | | — | | | | (8,747 | ) |
| | | | | | |
Net cash used in investing activities | | | (49,029 | ) | | | (36,904 | ) |
Cash flows from financing activities: | | | | | | | | |
Repayment of long-term debt | | | — | | | | (15,443 | ) |
Issuance of common stock | | | 1,594 | | | | 360 | |
| | | | | | |
Net cash provided by (used in) financing activities | | | 1,594 | | | | (15,083 | ) |
| | | | | | |
Net (decrease) in cash and cash equivalents | | | (12,826 | ) | | | (37,126 | ) |
Cash and cash equivalents, beginning of period | | | 234,324 | | | | 199,684 | |
| | | | | | |
Cash and cash equivalents, end of period | | $ | 221,498 | | | $ | 162,558 | |
| | | | | | |
Supplemental cash flow information: | | | | | | | | |
Interest paid | | $ | 17,188 | | | $ | 17,402 | |
| | | | | | |
Taxes paid | | | 2,332 | | | | 1,195 | |
| | | | | | |
Non-cash items: | | | | | | | | |
Capital expenditures | | $ | (13,149 | ) | | $ | (16,166 | ) |
Amounts payable to subcontractors | | | 13,149 | | | | 16,166 | |
See accompanying Notes to Condensed Consolidated Financial Statements.
5
GEOEYE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
(Unaudited)
(1) Basis of Presentation
In the opinion of management, the accompanying unaudited interim condensed consolidated financial information reflects all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the information. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted following the instructions, rules and regulations prescribed by the Securities and Exchange Commission (“SEC”). Although management believes that the disclosures provided are adequate to make the information presented not misleading, you should read these unaudited interim consolidated financial statements in conjunction with the audited financial statements and associated footnotes for the year ended December 31, 2007, which are included in our Form 10-K/A filed with the SEC. Operating results for the six months ended June 30, 2008 are not necessarily indicative of the results that may be expected for the full year.
(2) Restatement
The Company and the Audit Committee of the Board of Directors of GeoEye, Inc. (the “Company”) concluded on August 6, 2008 that the Company should restate its financial statements and other financial information for the three month period ended March 31, 2007 and the six month period ended June 30, 2007 for the following reason: The Company completed a detailed study analyzing its tax accounting methods in which the Company discovered that it had not correctly included in taxable income cost-share payments received from the U.S. Government under the NextView program. As a result, the Company must include previously unrecorded expenses for interest and penalties on unpaid taxes which will lower net income for those periods and create a deferred tax asset and corresponding liability on the balance sheet for both the unpaid taxes and accrued but not paid interest and penalties on the unpaid taxes. However, the Company filed an application for change in method of accounting with the Internal Revenue Service (“IRS”) on August 8, 2008 which management believes will eliminate all of the tax interest and penalties. As a result, management expects that the financial impact of these corrections will be reversed in the third quarter of 2008. Management believes that reversal will result in an increase in net income for the third quarter of 2008 equal to the reduction in net income in previous periods. Management believes a second result of this accounting method change is a change in the timing of the payment of taxes on the cost-sharing payments, as we recognize the payments over four years for income tax purposes and over seven years for book purposes.
The Company filed an application for change in method of accounting with the IRS on August 8, 2008. As a result of the application filed with the IRS, as of the date of this filing, management believes the uncertain tax positions have been resolved. However, we were required to restate our financial statements for each period to correctly show the appropriate accounting treatment. Management expects that the financial impacts of these corrections will be reversed in the third quarter of 2008. Reversal of the tax expense in the third quarter of 2008 is expected to cause an increase in net income by $29.5 million. Thus, while this restatement reduces net income in the periods referenced, the Company expects that net income in the third quarter of 2008 should increase by the aggregate amount of the reduction in prior periods.
The net effect to the tax provision for the cost share adjustment was a $11.8 million provision or $0.62 per diluted share for the three months ended June 30, 2007 and a $3.5 million tax provision or $0.20 per diluted share for the six month period ended June 30, 2007. The Company also recalculated its effective tax rate for the three and six month periods ended June 30, 2007 as 38.6%. The application of interest and penalties on this effective tax rate resulted in a $13.0 million and $4.9 million provision for these periods, respectively.
In addition, our cash flow statements have been adjusted to reclassify the capitalized interest and other working capital items from operating cash flow into investing activities. While this does not change the overall cash flow analysis, it increases operating cash flow and decreases investing cash flow by $11.6 million for the six months ended June 30, 2007.
(3) Significant Accounting Policies
Basis of Consolidation
The consolidated financial statements include the accounts of wholly-owned subsidiaries which the Company controls. All intercompany transactions and balances have been eliminated in consolidation.
6
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in its financial statements and accompanying notes. Actual results could differ from these estimates.
Revenue Recognition
The Company’s principal source of revenue is the sale of satellite and aerial imagery and imagery-related products and solutions to customers, value-added resellers and distributors. Such sales often require us to provide imagery over the term of multi-year sales contracts under “take-or-pay” arrangements whereby customers pay for access time regardless of usage. Accordingly, we recognize revenues on such imagery contracts on a straight-line basis over the delivery term of the contract. Otherwise we record revenues based on the delivery of imagery products to our customer. Deferred revenue represents receipts in advance of the delivery of imagery, imagery-related products and solutions and is generally recognized as a current liability. We also derive revenues from maintenance of certain ground stations for our customers, which we account for under the straight-line method. Revenues for other services are recognized as services are performed.
Revenue is recognized on contracts to provide imagery processing services using the units-of-delivery method, a modification of the percentage of completion method whereby revenue is recognized based on the contract price of units of a basic production product delivered during a period. Revenues recognized in advance of becoming billable are recorded as unbilled receivables. Such amounts generally do not become billable until after the products have been completed and delivered. To the extent that estimated costs of completion are adjusted, revenue and profit recognized from a particular contract will be affected in the period of the adjustment. Anticipated contract losses are recognized as they become known.
A significant portion of the Company’s revenues are generated through contracts with the U.S. Government. U.S. Government agencies may terminate or suspend their contracts at any time, with or without cause, or may change their policies, priorities or funding levels by reducing agency or program budgets or by imposing budgetary constraints. If a U.S. Government agency terminates or suspends any of its contracts with the Company or changes its policies, priorities, or funding levels, these actions would have a material adverse effect on the business, financial condition and results of operations. Imagery contracts with international customers generally are not cancelable.
For contracts consisting of multiple elements, the Company identifies these elements and considers whether the delivered item(s) has value to the customer on a standalone basis, whether there is objective and reliable evidence of the fair value of the undelivered item(s) and, if the arrangement includes a general right of return relative to the delivered item(s), delivery of performance of the undelivered item(s) considered probable and substantially in the Company’s control.
Allowances for doubtful accounts receivable balances are recorded when circumstances indicate that collection is doubtful for particular accounts receivable or as a general reserve for all accounts receivable. Management estimates such allowances based on historical evidence such as amounts that are subject to risk. Accounts receivable are written off if reasonable collection efforts are not successful.
Satellites and Related Rights
The IKONOS satellite was acquired in January 2006, and as of June 30, 2008, is fully depreciated. At acquisition, the satellite was assigned an estimated useful life of 2.5 years. Based upon a recent study, we anticipate that IKONOS will remain operational until the 2010 time frame. The OrbView-2 satellite was launched in 1997 and is fully depreciated. The Company has completed the construction and pre-launch testing of GeoEye-1, its next generation, high-resolution imagery satellite, which is currently planned for launch on September 6, 2008. We are also in the initial stages of constructing a second next generation, high-resolution imagery satellite, GeoEye-2. Costs associated with the construction of both GeoEye-1 and GeoEye-2 satellites and the related ground system are capitalized when incurred. Amortization of the capitalized costs begins when the assets are placed in service. Capitalized costs include interest costs associated with construction in accordance with SFAS No. 34, “Capitalization of Interest Cost.” Capitalized costs also include the cost of any applicable launch insurance. The Company began capitalizing interest costs associated with the debt incurred for the construction of the GeoEye-1 satellite and related ground segment and system assets in the third quarter of 2005. The capitalized interest is recorded as part of the historical cost of those assets and will be amortized over the assets’ useful lives when placed into service. Capitalized interest totaled approximately $61.0 million as of June 30, 2008 for the construction of GeoEye-1 and the related ground system assets.
7
Stock-based Compensation
Effective January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payments,” and related Securities and Exchange Commission rules included in Staff Accounting Bulletin No. 107 on a modified prospective basis. SFAS No. 123(R) requires stock options and other share-based payments made to employees to be accounted for as compensation expense and recorded at fair value, and to reflect the related tax benefit received upon exercise of the options in the statement of cash flows as a financing activity inflow rather than an adjustment of operating activity. The Company uses the Black-Scholes option pricing model to estimate the fair value of stock options granted subsequent to the date of adoption of SFAS No. 123(R).
The Company’s Employee Stock Incentive Plan provides for the grant of various types of stock-based incentive awards, including stock options, restricted stock and other stock-based grants. The types and mix of stock-based incentive awards are evaluated on an ongoing basis and may vary based on management’s overall strategy regarding compensation, including consideration of the impact of expensing stock option awards on the Company’s results of operations subsequent to the adoption of SFAS No. 123(R).
Derivative Instruments and Hedging Activities
The Company uses derivative financial instruments to manage its exposure to fluctuations in interest rates on its long-term debt. The Company does not hold or issue derivative financial instruments for trading or speculative purposes. The Company accounts for its derivative financial instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. Under SFAS No. 133, all derivatives are recorded on the balance sheet as assets or liabilities and measured at fair value. Changes in the fair value of the Company’s existing derivative financial instrument are recorded in net earnings. In February 2008, we entered into a $250 million interest rate cap agreement that is intended to protect us from rises in interest rates by limiting our interest rate exposure to the three-month LIBOR rate, with a cap of four percent. The cap is effective July 1, 2008 and terminates January 1, 2010. We paid $0.5 million to obtain this cap.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 establishes a framework for measuring fair value under GAAP and will be applied to existing accounting and disclosure requirements in GAAP that are based on fair value. SFAS 157 does not require any new fair value measurements. SFAS 157 emphasizes a “market-based” as opposed to an “entity-specific” measurement perspective, establishes a hierarchy of fair value measurement methods and expands disclosure requirements about fair value measurements including methods and assumptions and the impact on earnings. On February 12, 2008, the FASB issued Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157,” which delayed the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008.
SFAS 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
The net amount of financial assets and liabilities recorded at fair value at June 30, 2008 totaled $0.8 million and were related to our derivative financial instruments. We determined the fair values of these financial instruments using Level 2 inputs. The fair values of the derivative financial instruments are obtained from third party broker quotes. These Level 2 fair values are routinely corroborated on a quarterly basis with observable market-based inputs. We are currently assessing the impact of SFAS 157 for nonfinancial assets and nonfinancial liabilities on our consolidated financial position and results of operations.
On February 15, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115.” Under this statement, the Company may elect to report financial instruments and certain other items at fair value on a contract-by-contract basis with changes in value reported in earnings. This election is irrevocable. SFAS 159 provides an opportunity to mitigate volatility in reported earnings that is caused by measuring hedged assets and liabilities that were previously required to use a different accounting method than the related hedging contracts when the complex provisions of hedge accounting under SFAS 133 are not met. SFAS 159 is effective for years beginning after November 15, 2007. We elected not to adopt the fair value option included in SFAS 159.
8
In December 2007, the FASB issued SFAS No. 141(R) (revised 2007), “Business Combinations.” SFAS 141R replaces SFAS 141 and establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree. SFAS 141(R) also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This statement is effective for fiscal years beginning after December 15, 2008. The impact of the adoption of SFAS 141(R) will depend on future acquisitions as there will be no impact on our existing financial position and results of operations.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51.” SFAS 160 establishes new accounting for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective in the first quarter of 2009. We do not expect the adoption of SFAS 160 to have a material impact on our results of operations, financial condition or cash flows.
In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.” SFAS 161 expands quarterly and annual disclosure requirements in SFAS 133 about an entity’s derivative instruments and hedging activities. SFAS 161 is effective for fiscal years beginning after November 15, 2008. The Company is currently assessing the impact of SFAS 161 on its consolidated financial position and results of operations.
(4) NextView Contract
The U.S. Government, through the National Geospatial-Intelligence Agency (“NGA”), announced in March 2003 that it intended to support the continued development of the commercial satellite imagery industry by sharing the costs for the engineering, construction and launch of the next generation of imagery satellites. This program is known as NextView. On September 30, 2004, NGA announced that the Company had been awarded a contract under the NextView program. Under this program, the Company is the prime contractor constructing the GeoEye-1 satellite. The Company estimates its total project cost (including financing and launch insurance costs) to bring the GeoEye-1 satellite into service will be approximately $502 million. Under the NextView contract, NGA will support the project with a cost share totaling approximately $237 million spread out over the course of the project and subject to various milestones. As of June 30, 2008, NGA had paid the Company $193.9 million. The Company is deferring recognition of the cost share amounts as revenue until GeoEye-1 is put into service and then will recognize revenue on a straight-line basis over the imagery delivery term of the program, which the Company believes will ultimately approximate the expected seven-year life of the satellite for financial reporting purposes. Total capitalized costs of the GeoEye-1 satellite and related ground systems incurred were $421.1 million as of June 30, 2008. Approximately $42.8 million of this amount was payable to subcontractors at June 30, 2008.
The NextView contract also provides for NGA to order approximately $197 million of imagery products beginning February 1, 2007 and continuing until six quarters after GeoEye-1 goes into service. In February 2007, the Company and NGA executed the initial task order under the NextView contract whereby NGA agreed to purchase $54 million of imagery products from the Company’s existing satellites for the period from February 1, 2007 to December 31, 2007; all of the imagery under this task order was delivered to NGA by September 30, 2007. In November 2007, we entered into a new $60 million task order with NGA for the continued delivery of products from November 2007 to the commissioning of GeoEye-1, which at that time was anticipated to occur in July, 2008 after an April 2008 launch. As of June 30, 2008, the Company has received approved task orders from NGA for $49.7 million of the $60 million target discussed in November 2007. Of the $49.7 million of approved orders, we have delivered approximately $25.3 million of which $5.4 million was delivered under this task order in the second quarter of 2008. Overall, the Company has experienced a shortfall in imagery orders from NGA throughout the first six months of 2008. We believe the NGA ordering issue will resolve itself over the coming months as we conclude negotiations of a Service Level Agreement (SLA) with NGA that would streamline the order placement and delivery processes between NGA and the Company. We believe this SLA should be in place by the time we commence GeoEye-1 operations later this year.
The NextView contract, as modified, and the SLA we are currently negotiating provide the ability for the Company to use either of the high resolution spacecraft in the constellation to collect any assigned target as long as the chosen satellite meets the technical specifications of that target. Based on NGA’s public announcement of ongoing support requirements, the Company expects NGA to continue to purchase our imagery products following expiration of the initial 18-month period covered by the contract. The Company anticipates that NGA will account for a significant portion of the imagery-taking capacity during this period, with the remaining capacity available to generate commercial sales, sales to international ground station customers and on-line search engine customers.
9
We continue to make progress toward launch of the GeoEye-1 satellite. In early July 2008, a satellite Mission Readiness Review was completed, satisfying a milestone under the contract with NGA. During that review, we verified that the performance of the satellite meets our pre-defined requirements and that there were no hardware issues detected that would require resolution prior to launch. There are still some actions to be completed before launch, including finalizing all of the satellite documentation, but no major issues were detected. As a result of completing this milestone, we invoiced NGA for the $30 million attributable to the milestone and received this payment in early August 2008. Additionally, United Launch Alliance held a Pre-Vehicle on Stand review to assess the status of the launch vehicle program and to determine readiness of whether to begin the process of assembling our Delta 2 vehicle on the launch pad or not. As a result of the review, United Launch Alliance determined that the satellite is ready and assembly of the Delta 2 rocket began on July 3, 2008. After successfully passing these key milestone reviews, the satellite was shipped on July 9, 2008 to Vandenberg Air Force Base and arrived safely on July 10, 2008. GeoEye-1 is now in its final preparation stages for its launch which is currently planned for September 6, 2008.
In September 2007, we purchased $220 million of launch plus first year on-orbit insurance coverage and $50 million of launch plus three-year on-orbit coverage for the GeoEye-1 satellite to be paid in the event of a launch failure or if on-orbit anomalies prevent the satellite from being placed into service. The premiums to be paid to the underwriters by the Company total approximately $41.5 million. As of June 30, 2008, we paid $2.2 million of the insurance premium. An additional $33.8 million of the insurance premiums was paid on July 17, 2008. The remaining $5.5 million will be paid in two equal installments on the first and second anniversaries of GeoEye-1’s launch date. The portion of the premiums associated with the insurance covering launch and check-out will be capitalized as part of the satellite’s cost and depreciated over the estimated seven year life while the portion of the premium attributable to on-orbit insurance will be expensed in the year to which the coverage relates.
In August 2008, in accordance with our previously stated intent, we sought additional insurance. We purchased an additional $50 million of launch plus first year on-orbit insurance to be paid in the event of a total loss of the satellite. The premiums paid to the underwriters in August were approximately $6.1 million. The portion of the premiums associated with covering the launch and check-out will be capitalized as part of the satellite’s cost and depreciated over the estimated seven year life while the portion of the premium attributable to on-orbit insurance will be expensed in the year to which the coverage relates.
(5) Loss of OrbView-3 Satellite
On March 4, 2007, the Company’s OrbView-3 satellite began to experience technical problems which affected its image quality. On April 23, 2007, we announced that the satellite had been declared permanently out of service due to an electronic system failure within the camera. The Company recorded a loss of $36.1 million in the first quarter of 2007. The OrbView-3 satellite was insured for $40.0 million. The Company submitted an insurance claim on June 8, 2007 and received the full proceeds during the third quarter of 2007.
We had a post-launch on-orbit milestone payment obligation with Orbital Sciences in connection with the ongoing performance of our OrbView-3 satellite whereby annual post-launch on-orbit payments in maximum amounts of up to $1.275 million were scheduled to be made on each of the three remaining anniversaries of the acceptance of the OrbView-3 system in 2007, 2008 and 2009, for a total possible maximum obligation of $3.825 million. This obligation was written off in the first quarter of 2007 in conjunction with the loss of the OrbView-3 satellite. Orbital Sciences subsequently asserted that a prorated portion of the 2007 on-orbit incentive payment was payable, which we disputed through an arbitration process. On April 22, 2008, the arbitrator decided in favor of Orbital Sciences and in April 2008, we paid Orbital Sciences $1.1 million which included accrued interest. This amount was recorded in the first quarter of 2008.
(6) MJ Harden Acquisition
On March 15, 2007, we acquired MJ Harden Associates, Inc. through a stock purchase of all of the outstanding stock of MJ Harden’s sole owner, i5, Inc. MJ Harden is a provider of both digital electro-optical and LiDAR imagery and location-based information solutions. With this acquisition, GeoEye has access to MJ Harden’s digital aerial imagery capture capability, photogrammetry services, mobile and geographic information system technology and implementation services, field data collection and other related services that provide customers with asset-mapping and corridor management solutions. Customers include oil and gas pipeline companies, utilities, engineering firms, developers and federal, state and local government agencies, among others. MJ Harden is located in Mission, Kansas, and has approximately 60 employees.
A fair market valuation of the purchased MJ Harden assets was completed in 2007, resulting in a $2.2 million allocation of costs to intangible assets. Those intangible assets will be subject to amortization over the assigned lives of six and ten years. The remaining excess of cost over fair value of the net assets of $4.1 million was allocated to acquired goodwill and is not subject to amortization. The accompanying consolidated statement of operations includes the operating results of MJ Harden from the date of acquisition.
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(7) Other Comprehensive Income
For the three and six months ended June 30, 2008 and 2007, respectively, there were no material differences between net income as reported and comprehensive income.
(8) Earnings per Common Share
The computations of basic and diluted loss per common share were as follows for the three and six months ended June 30, 2008 and 2007, respectively (in thousands, except share data):
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | | Six Months Ended | |
| | June 30, | | | June 30, | |
| | | | | | As Restated | | | | | | | As Restated | |
| | 2008 | | | 2007 | | | 2008 | | | 2007 | |
Numerator for basic and diluted earnings per common share: | | | | | | | | | | | | | | | | |
Earnings (loss) available to common stockholders | | $ | 385 | | | $ | 11,619 | | | $ | (625 | ) | | $ | (10,307 | ) |
| | | | | | | | | | | | |
Denominator for basic and diluted earnings per common share: | | | | | | | | | | | | | | | | |
Average number of common shares outstanding for basic computations | | | 17,993,466 | | | | 17,611,016 | | | | 17,945,894 | | | | 17,550,658 | |
Dilutive effect of warrants | | | 1,763,942 | | | | 1,464,485 | | | | — | (a) | | | — | (a) |
Dilutive effect of stock options | | | 142,861 | | | | 81,478 | | | | — | | | | — | |
Dilutive effect of restricted stock units | | | — | | | | — | | | | — | | | | — | |
Dilutive effect of director stock units | | | 46,684 | | | | 52 | | | | — | | | | — | |
| | | | | | | | | | | | |
Average number of common shares outstanding for diluted computations | | | 19,946,953 | | | | 19,157,031 | | | | 17,945,894 | (a) | | | 17,550,658 | (a) |
Earnings per common share — basic (b) | | $ | 0.02 | | | $ | 0.66 | | | $ | (0.03 | ) | | $ | (0.59 | ) |
| | | | | | | | | | | | |
Earnings per common share — diluted (b) | | $ | 0.02 | | | $ | 0.61 | | | $ | (0.03 | ) | | $ | (0.59 | ) |
| | | | | | | | | | | | |
| | |
(a) | | All warrants, stock options and stock units were anti-dilutive for the six months ended June 30, 2007 and June 30, 2008 because the Company incurred a loss in that period. |
(b) | | Refer to Note 2 to the Condensed Consolidated Financial Statements for the impact of the restatement on earnings per common share. |
(9) Long Term Debt
On June 29, 2005, we issued $250 million aggregate principal amount of Senior Secured Floating Rate Notes due 2012 (the “Notes”). The Notes were offered in a private placement to certain qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933. The purpose of the offering was to contribute the proceeds to the capital of its wholly-owned subsidiary. ORBIMAGE Inc., to be used for construction costs for the GeoEye-1 satellite, to mandatorily redeem all of the outstanding Senior Subordinated Notes of ORBIMAGE Inc. that were to mature in 2008 and for general working capital purposes. The Notes were issued at a discount of two percent of total principal. Consequently, we received $245 million of cash proceeds at closing. Approximately $8.9 million was used to pay certain transaction-related expenses. We recorded a loss of approximately $2.7 million relating to the early extinguishment of the Senior Subordinated Notes during 2005. In June 2006, we filed a registration statement with the SEC under Form S-3, which enabled the holders to exchange the Notes for publicly registered Notes with substantially identical terms.
Under the instruments governing the Notes, we are prohibited from paying dividends until the principal amount of all such Notes have been repaid. Prior to August 15, 2007, we had the ability to redeem all or part of the Notes at any time on or after July 1, 2008, provided the GeoEye-1 launch took place on or prior to August 15, 2007. With the delay of the launch into 2008, we may redeem the Notes at any time after July 1, 2008 plus the number of days that will have elapsed from February 15, 2007 to the launch of GeoEye-1. If the launch takes place as currently planned, the Notes could be redeemed beginning in January 2010. The Notes may be redeemed at 104 percent of par for the first twelve-month period, at 102 percent of par for the next twelve-month period, and at par thereafter.
The Notes bear interest at a rate per annum, reset semi-annually, equal to the greater of six-month LIBOR or three percent, plus a margin of 9.5 percent. We entered into an interest rate swap arrangement in June 2005 pursuant to which the effective interest rate under the Notes has been fixed at 13.75 percent through July 1, 2008. In February 2008, we entered into a $250 million interest rate cap agreement that is intended to protect us from rises in interest rates by limiting our interest rate exposure to the three-month LIBOR rate plus four percent. The cap is effective July 1, 2008 and terminates January 1, 2010. We paid $0.5 million to obtain this cap.
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The Company began capitalizing interest costs associated with the debt incurred for the construction of the GeoEye-1 satellite and related ground segment and system assets in the third quarter of 2005. The capitalized interest is recorded as part of the historical cost of those assets and will be amortized over the assets’ useful lives when placed into service. Capitalized interest totaled $42.0 million at September 30, 2007.
(10) Income Taxes
The Company recorded a provision for income taxes of $3.6 million for the second quarter of 2008 and $6.3 million for the six months ended June 30, 2008. The Company recorded a provision for income taxes of $13.0 million for the second quarter of 2007 and $4.9 million for the six months ending June 30, 2007. The tax provision was calculated using the Company’s estimated effective tax rate of 39.8% for 2008 and 38.6% for 2007 prior to the application of penalties and interest related to the cost share payments.
The Company recently completed a detailed study analyzing its tax accounting methods, and the Company discovered that it had not correctly included in taxable income the $194 million cost-share payments received from the U.S. Government under the NextView program. As a result, the Company must include previously unrecorded expenses for interest and penalties on unpaid taxes which will lower net income for those periods. These penalties and interest amount to $8 thousand in 2005, $11.5 million in 2006, $14 million in 2007 and $2.0 million in the first quarter and 2.0 million in the second quarter of 2008. However, the Company filed an application for change in method of accounting with the Internal Revenue Service (“IRS”) on August 8, 2008 which management believes will eliminate all of the tax interest and penalties. This new accounting method for cost-share payments is to recognize the payments for tax purposes at the time the Company is entitled to receive them. As a result of the Company’s application filed with the IRS, payments for the past due amounts will be made over the next four years, starting in third quarter 2008, which is the standard practice when a company applies for a change in accounting method. The amount of tax liability on these payments remains the same as it has always been. However, with the change in accounting method, the timing has changed.
Also as a result of the filing, management expects that the cumulative financial impact of these corrections for tax interest and penalties will be reversed in the third quarter of 2008. That reversal will result in an increase in net income for the third quarter of 2008 of $29.5 million, including $2.0 million of tax related expenses recorded in both the first quarter and the second quarter of 2008, respectively.
The Company completed a detailed study regarding the application of Section 382 of the Internal Revenue Code of 1986 (“Section 382”) on ownership changes. Application of the findings of this study resulted in a decrease in income tax expense and related tax liabilities from the amounts reported on the Company’s Report on Form 10-K for the year ended December 31, 2007 because the previously identified ownership change occurred earlier than previously reported and thus eliminated fewer net operating losses. The decrease in income tax expense related to the NOL issue is offset by the income tax expense associated with the cost share payments as described in Note 2.
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) effective January 1, 2007. FIN 48 provides a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the Company has taken or expects to take on a tax return.
The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is no longer subject to U.S. tax examinations for years before 2004. State jurisdictions that remain subject to the examination range of 2004 to 2007 are Colorado and Virginia. The Company recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.
(11) Stock Incentive Plans
The Company’s employee stock incentive plans provide for the grant of various types of stock-based incentive awards, including stock options, restricted stock and other stock-based grants. The types and mix of stock-based incentive awards are evaluated on an ongoing basis and may vary based on management’s overall strategy regarding compensation. All grants or awards made under the plans are governed by written agreements between the Company and the participants.
Stock Options
Stock option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant; those option awards generally vest based on 4 - 5 years of continuous service and have 8 to 10-year contractual terms. The Company recognized expense associated with stock-based compensation of approximately $0.2 million in the second quarter of 2008 and $0.3 million year to date 2008 which reduced both earnings per basic and diluted share by $0.01 for both periods. Stock-based compensation expense for the second quarter in 2007 was $0.6 million and $0.9 million year to date 2007, which reduced both basic and diluted shares by $0.03 and $0.05, respectively. These costs are included in selling, general and administrative expenses in the
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accompanying consolidated statement of operations. The cash received from the exercise of options and the related tax benefit realized for the tax deductions from exercise of the share-based payment arrangements were not material.
The fair value of each option granted has been estimated as of the date of grant using the Black-Scholes option pricing model using the following assumptions:
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | June 30, | | June 30, |
| | 2008 | | 2007 | | 2008 | | 2007 |
Volatility | | 56.36% | | 52.35% | | 51.0% - 75.0% | | 52.35% - 63.87% |
Dividend yield | | 0.0% | | 0.0% | | 0.0% | | 0.0% |
Risk-free interest rate | | 3.35% | | 4.54% - 4.96% | | 3.35% - 4.09% | | 4.34% - 4.70% |
Expected average life | | 7.39 years | | 5.25 - 6.24 years | | 7.39 years | | 5.25 - 6.24 years |
Exercise price per option | | $17.28 | | $18.00 - $18.11 | | $17.28 - $30.45 | | $18.00 - $18.11 |
This model utilizes certain information, such as the interest rate on a risk-free security maturing generally at the same time as the expected life of the option being valued, and requires certain assumptions, such as the expected amount of time the option will be outstanding until it is exercised or it expires, to calculate the fair value per share of options issued. Expected volatilities are based on historical volatility of the Company’s stock. The risk free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
On January 3, 2008, the Company issued 12,136 deferred stock units (“DSUs”) to its non-employee directors. These DSUs vest in two installments: at six months after grant and at 12 months after grant. These DSUs will be settled in shares of the Company’s common stock six months after the non-employee director’s separation from Board service. DSUs are included in the Company’s diluted earnings per share calculations.
(12) Industry Segments and Major Customers
The Company operates in two industry segments: Imagery and Production and Other Services. The business segments have been organized based on the nature of the products and services offered. In the following tables of financial data, the total of the operating results of these industry segments, inclusive of allocations of indirect and SG&A expenses, is reconciled to the corresponding consolidated amount.
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | | Six Months Ended | |
| | June 30, | | | June 30, | |
| | 2008 | | | 2007 | | | 2008 | | | 2007 | |
Net sales | | | | | | | | | | | | | | | | |
Imagery | | $ | 22,614 | | | $ | 36,559 | | | $ | 46,181 | | | $ | 65,206 | |
Production and Other Services | | | 11,605 | | | | 11,695 | | | | 22,440 | | | | 19,844 | |
| | | | | | | | | | | | |
Total net sales | | $ | 34,219 | | | $ | 48,254 | | | $ | 68,621 | | | $ | 85,050 | |
| | | | | | | | | | | | |
Operating profit (loss) | | | | | | | | | | | | | | | | |
Imagery | | | 5,483 | | | | 21,553 | | | | 8,874 | | | $ | (8,129 | ) |
Production and Other Services | | | (194 | ) | | | 4,154 | | | | 967 | | | | 8,875 | |
| | | | | | | | | | | | |
Total operating profit (loss) | | $ | 5,289 | | | $ | 25,707 | | | $ | 9,841 | | | $ | 746 | |
| | | | | | | | | | | | |
Selling, general and administrative costs are allocated to industry segments based upon the proportion of direct costs incurred for each segment. During the second quarter of 2007, this allocation changed as a result of the absence of depreciation expense for the OrbView-3 satellite and from the outlay of costs associated with source material for new value-added production initiatives, resulting in additional costs being allocated to the Production and Other segment.
The U.S. Government is the Company’s largest customer. The Company recognized revenue related to the U.S. Government of approximately $11.8 million for the second quarter of 2008, which represents 35 percent of total revenues for the current quarter and $25.3 million or 37 percent of total year to date revenue for 2008. Total revenues from the U.S. Government for the corresponding quarter of 2007 were $28.5 million, which represents 59 percent of total revenues for that period and $46.9 million or 55 percent of total year to date revenue for 2007.
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(13) Financial Information of Guarantor Subsidiary
The Senior Secured Floating Rate Notes issued by the Company are guaranteed by ORBIMAGE Inc., its wholly-owned subsidiary. The Company does not have any independent assets or operations other than its ownership in all of the capital stock of ORBIMAGE Inc., the subsidiary guarantor of the Notes, and the capital stock of its other non-guarantor subsidiaries. Since inception, all of the Company’s operations were conducted through its wholly-owned subsidiaries. ORBIMAGE Inc.’s guarantee of the Notes is full and unconditional. There are no significant restrictions on the ability of the Company to obtain funds from ORBIMAGE Inc. by dividend or loan. There are also no significant restrictions on the ability of ORBIMAGE Inc. to obtain funds from the Company by dividend or loan.
The following condensed consolidating financial information for the Company presents the financial information of the Company, the guarantor subsidiaries and the non-guarantor subsidiaries based on the Company’s understanding of the Securities and Exchange Commission’s interpretation and application of Rule 3-10 under the Securities and Exchange Commission’s Regulation S-X. In this presentation, GeoEye, Inc. consists of the parent company’s operations. Guarantor subsidiaries and non-guarantor subsidiaries of the Company are reported on an equity basis. The financial information may not necessarily be indicative of results of operations or financial position had the guarantor subsidiaries or non-guarantor subsidiaries operated as independent entities.
Adjustments noted in Note 2 affect the Parent’s Statement of Operations, Balance Sheet and Cash Flows for the cost share payment tax liabilities as stated in Note 2. The effective tax rate impact was updated to the Parent and subsidiaries upon these restatements. The reclassifications in the Statements of Cash Flows impact only the guarantor subsidiaries.
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GEOEYE, INC.
Condensed Consolidating Statement of Operations
Three Months Ended June 30, 2008
(Unaudited; in thousands)
| | | | | | | | | | | | | | | | | | | | |
| | Unconsolidated | | | | | | | |
| | | | | | | | | | Non- | | | | | | | |
| | | | | | Guarantor | | | Guarantor | | | | | | | |
| | Parent | | | Subsidiary | | | Subsidiaries | | | Eliminations | | | Consolidated | |
Revenues | | $ | — | | | $ | 12,811 | | | $ | 26,413 | | | $ | (5,005 | ) | | $ | 34,219 | |
Direct expenses | | | — | | | | 10,745 | | | | 13,595 | | | | (5,005 | ) | | | 19,335 | |
| | | | | | | | | | | | | | | |
Gross profit | | | — | | | | 2,066 | | | | 12,818 | | | | — | | | | 14,884 | |
Selling, general and administrative expenses | | | — | | | | 2,012 | | | | 7,592 | | | | — | | | | 9,604 | |
Gain on impairment of satellite | | | — | | | | (9 | ) | | | — | | | | — | | | | (9 | ) |
| | | | | | | | | | | | | | | |
Income from operations | | | — | | | | 63 | | | | 5,226 | | | | — | | | | 5,289 | |
Interest expense (income), net | | | 2,983 | | | | (1,129 | ) | | | (488 | ) | | | — | | | | 1,366 | |
Unrealized gain on derivative instrument | | | (97 | ) | | | — | | | | — | | | | — | | | | (97 | ) |
Equity in earnings of subsidiaries | | | (2,123 | ) | | | — | | | | — | | | | 2,123 | | | | — | |
| | | | | | | | | | | | | | | |
Income (loss) before provision for income taxes | | | (763 | ) | | | 1,192 | | | | 5,714 | | | | (2,122 | ) | | | 4,020 | |
Provision (benefit) for income taxes | | | (1,148 | ) | | | 2,509 | | | | 2.274 | | | | — | | | | 3,635 | |
| | | | | | | | | | | | | | | |
Net income (loss) | | $ | 385 | | | $ | (1,317 | ) | | $ | 3,440 | | | $ | (2,122 | ) | | $ | 385 | |
| | | | | | | | | | | | | | | |
15
GEOEYE, INC.
Condensed Consolidating Statement of Operations
Three Months Ended June 30, 2007
(Unaudited; in thousands)
(As restated)
| | | | | | | | | | | | | | | | | | | | |
| | Unconsolidated | | | | | | | |
| | | | | | | | | | Non- | | | | | | | |
| | | | | | Guarantor | | | Guarantor | | | | | | | |
| | Parent | | | Subsidiary | | | Subsidiaries | | | Eliminations | | | Consolidated | |
Revenues | | $ | — | | | $ | 36,313 | | | $ | 37,892 | | | $ | (25,951 | ) | | $ | 48,254 | |
Direct expenses | | | — | | | | 29,502 | | | | 11,611 | | | | (25,951 | ) | | | 15,162 | |
| | | | | | | | | | | | | | | |
Gross profit | | | — | | | | 6,811 | | | | 26,281 | | | | — | | | | 33,092 | |
Selling, general and administrative expenses | | | — | | | | 444 | | | | 6,941 | | | | — | | | | 7,385 | |
| | | | | | | | | | | | | | | |
Income from operations | | | — | | | | 6,367 | | | | 19,340 | | | | — | | | | 25,707 | |
Interest expense (income), net | | | 3,197 | | | | (1,074 | ) | | | (226 | ) | | | — | | | | 1,897 | |
Gain on derivative instrument | | | (839 | ) | | | — | | | | — | | | | | | | | (839 | ) |
Equity in earnings of subsidiaries | | | (13,066 | ) | | | — | | | | — | | | | 13,066 | | | | — | |
| | | | | | | | | | | | | | | |
Income (loss) before provision for income taxes | | | 10,708 | | | | 7,441 | | | | 19,566 | | | | (13,066 | ) | | | 24,649 | |
Provision (benefit) for income taxes | | | (911 | )(a) | | | 6,381 | (a) | | | 7,560 | (a) | | | — | | | | 13,030 | |
| | | | | | | | | | | | | | | |
Net income (loss) | | $ | 11,619 | | | $ | 1,060 | | | $ | 12,006 | | | $ | (13,066 | ) | | $ | 11,619 | |
| | | | | | | | | | | | | | | |
| | |
(a) | | The provision for income taxes and net income have been adjusted by ($1,622), $6,381 and $7,046 for the parent, guarantor subsidiary, and non-guarantor subsidiaries respectively. |
16
GEOEYE, INC.
Condensed Consolidating Statement of Operations
Six Months Ended June 30, 2008
(Unaudited; in thousands)
| | | | | | | | | | | | | | | | | | | | |
| | Unconsolidated | | | | | | | |
| | | | | | | | | | Non- | | | | | | | |
| | | | | | Guarantor | | | Guarantor | | | | | | | |
| | Parent | | | Subsidiary | | | Subsidiaries | | | Eliminations | | | Consolidated | |
Revenues | | $ | — | | | $ | 26,349 | | | $ | 52,449 | | | $ | (10,177 | ) | | $ | 68,621 | |
Direct expenses | | | — | | | | 21,306 | | | | 27,966 | | | | (10,177 | ) | | | 39,095 | |
| | | | | | | | | | | | | | | |
Gross profit | | | — | | | | 5,043 | | | | 24,483 | | | | — | | | | 29,526 | |
Selling, general and administrative expenses | | | — | | | | 3,610 | | | | 14,934 | | | | — | | | | 18,544 | |
Loss on impairment of satellite | | | | | | | 1,141 | | | | | | | | | | | | 1,141 | |
| | | | | | | | | | | | | | | |
Income from operations | | | — | | | | 292 | | | | 9,549 | | | | — | | | | 9,841 | |
Interest expense (income), net | | | 5,840 | | | | (2,903 | ) | | | (488 | ) | | | — | | | | 2,449 | |
Unrealized loss on derivative instrument | | | 1,668 | | | | — | | | | — | | | | | | | | 1,668 | |
Equity in earnings of subsidiaries | | | (3,895 | ) | | | — | | | | — | | | | 3,895 | | | | — | |
| | | | | | | | | | | | | | | |
Income (loss) before provision for income taxes | | | (3,613 | ) | | | 3,195 | | | | 10,037 | | | | (3,895 | ) | | | 5,724 | |
Provision (benefit) for income taxes | | | (2,988 | ) | | | 5,342 | | | | 3,995 | | | | — | | | | 6,349 | |
| | | | | | | | | | | | | | | |
Net income (loss) | | $ | (625 | ) | | $ | (2,147 | ) | | $ | 6,042 | | | $ | (3,895 | ) | | $ | (625 | ) |
| | | | | | | | | | | | | | | |
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GEOEYE, INC.
Condensed Consolidating Statement of Operations
Six Months Ended June 30, 2007
(Unaudited; in thousands)
(As restated)
| | | | | | | | | | | | | | | | | | | | |
| | Unconsolidated | | | | | | | |
| | | | | | | | | | Non- | | | | | | | |
| | | | | | Guarantor | | | Guarantor | | | | | | | |
| | Parent | | | Subsidiary | | | Subsidiaries | | | Eliminations | | | Consolidated | |
Revenues | | $ | — | | | $ | 43,207 | | | $ | 67,839 | | | $ | (25,996 | ) | | $ | 85,050 | |
Direct expenses | | | — | | | | 38,323 | | | | 21,945 | | | | (25,996 | ) | | | 34,272 | |
| | | | | | | | | | | | | | | |
Gross profit | | | — | | | | 4,884 | | | | 45,894 | | | | — | | | | 50,778 | |
Selling, general and administrative expenses | | | — | | | | 3,964 | | | | 10,015 | | | | — | | | | 13,979 | |
Loss on impairment of satellite | | | — | | | | 36,053 | | | | — | | | | — | | | | 36,053 | |
| | | | | | | | | | | | | | | |
Income from operations | | | — | | | | (35,133 | ) | | | 35,879 | | | | — | | | | 746 | |
Interest expense (income), net | | | 6,321 | | | | (2,358 | ) | | | 1,156 | | | | — | | | | 5,119 | |
Unrealized loss on derivative instrument | | | 999 | | | | — | | | | — | | | | — | | | | 999 | |
Equity in earnings of subsidiaries | | | 5,817 | | | | — | | | | — | | | | (5,817 | ) | | | — | |
| | | | | | | | | | | | | | | |
Income (loss) before provision for income taxes | | | (13,137 | ) | | | (32,775 | ) | | | 34,723 | | | | 5,817 | | | | (5,372 | ) |
Provision (benefit) for income taxes | | | (2,830 | )(a) | | | (5,652 | )(a) | | | 13,417 | (a) | | | — | | | | 4,935 | |
| | | | | | | | | | | | | | | |
Net income (loss) | | $ | (10,307 | ) | | $ | (27,123 | ) | | $ | 21,306 | | | $ | 5,817 | | | $ | (10,307 | ) |
| | | | | | | | | | | | | | | |
| | |
(a) | | The provision for income taxes and net income have been adjusted by $(3,745), $(5,652) and $12,903 for the parent, guarantor subsidiary, and non-guarantor subsidiaries respectively. |
18
GEOEYE, INC.
Condensed Consolidating Balance Sheet
June 30, 2008
(Unaudited; in thousands)
| | | | | | | | | | | | | | | | | | | | |
| | Unconsolidated | | | | | | | |
| | | | | | | | | | Non- | | | | | | | |
| | | | | | Guarantor | | | Guarantor | | | | | | | |
| | Parent | | | Subsidiary | | | Subsidiaries | | | Eliminations | | | Consolidated | |
ASSETS | | | | | |
Current assets: | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 20,387 | | | $ | 84,514 | | | $ | 116,597 | | | $ | — | | | $ | 221,498 | |
Receivables, net | | | — | | | | 13,530 | | | | 14,315 | | | | — | | | | 27,845 | |
Amounts due from related parties | | | 3 | | | | 11,086 | | | | 2,833 | | | | (2,602 | ) | | | 11,320 | |
Other current assets | | | 182,099 | | | | — | | | | — | | | | (182,099 | ) | | | — | |
| | | | | | | | | | | | | | | |
Total current assets | | | 202,489 | | | | 109,130 | | | | 133,745 | | | | (184,701 | ) | | | 260,663 | |
Property, plant and equipment, net | | | — | | | | 82,169 | | | | 15,227 | | | | — | | | | 97,396 | |
Satellites and related rights, net | | | — | | | | 368,423 | | | | — | | | | — | | | | 368,423 | |
Investment in subsidiaries | | | 261,672 | | | | — | | | | — | | | | (261,672 | ) | | | — | |
Goodwill | | | — | | | | 28,490 | | | | 4,122 | | | | — | | | | 32,612 | |
Intangible assets | | | — | | | | 50 | | | | 15,652 | | | | — | | | | 15,702 | |
Other non-current assets | | | 12,020 | | | | 76 | | | | 2,000 | | | | — | | | | 14,096 | |
Deferred tax asset | | | — | | | | 78,721 | | | | — | | | | — | | | | 78,721 | |
| | | | | | | | | | | | | | | |
Total assets | | $ | 476,181 | | | $ | 667,059 | | | $ | 170,746 | | | $ | (446,373 | ) | | $ | 867,613 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | |
Current liabilities: | | | | | | | | | | | | | | | | | | | | |
Accounts payable and accrued expenses | | $ | 1 | | | $ | 14,218 | | | $ | 12,048 | | | | (2,602 | ) | | $ | 23,665 | |
Amounts payable to related parties | | | — | | | | 106,593 | | | | 75,506 | | | | (182,099 | ) | | | — | |
Amounts payable to subcontractors | | | — | | | | 42,818 | | | | — | | | | — | | | | 42,818 | |
Accrued interest payable | | | 17,188 | | | | — | | | | — | | | | — | | | | 17,188 | |
Current portion of deferred revenue | | | — | | | | 6,224 | | | | 7,599 | | | | — | | | | 13,823 | |
Income tax payable | | | 12,701 | | | | 20,115 | | | | — | | | | — | | | | 32,816 | |
Other payables | | | — | | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | |
Total current liabilities | | | 29,890 | | | | 189,968 | | | | 95,153 | | | | (184,701 | ) | | | 130,310 | |
Long-term debt | | | 247,145 | | | | — | | | | — | | | | — | | | | 247,145 | |
Non-current income tax reserve | | | — | | | | 97,152 | | | | — | | | | — | | | | 97,152 | |
Deferred revenue, net of current portion | | | — | | | | 193,860 | | | | — | | | | — | | | | 193,860 | |
| | | | | | | | | | | | | | | |
Total liabilities | | | 277,035 | | | | 480,980 | | | | 95,153 | | | | (184,701 | ) | | | 668,467 | |
Stockholders’ equity | | | 199,146 | | | | 186,079 | | | | 75,593 | | | | (261,672 | ) | | | 199,146 | |
| | | | | | | | | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 476,181 | | | $ | 667,059 | | | $ | 170,746 | | | $ | (446,373 | ) | | $ | 867,613 | |
| | | | | | | | | | | | | | | |
19
GEOEYE, INC.
Consolidating Balance Sheet
December 31, 2007
(As restated)
| | | | | | | | | | | | | | | | | | | | |
| | Unconsolidated | | | | | | | |
| | | | | | | | | | Non- | | | | | | | |
| | | | | | Guarantor | | | Guarantor | | | | | | | |
| | Parent | | | Subsidiary | | | Subsidiaries | | | Eliminations | | | Consolidated | |
ASSETS
|
Current assets: | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 38,645 | | | $ | 116,821 | | | $ | 78,858 | | | $ | — | | | $ | 234,324 | |
Receivables, net | | | — | | | | 33,007 | | | | 11,510 | | | | — | | | | 44,517 | |
Amounts due from related parties | | | 150,996 | | | | — | | | | — | | | | (150,996 | ) | | | — | |
Other current assets | | | 3 | | | | 7,784 | | | | 3,836 | | | | (5,204 | ) | | | 6,419 | |
| | | | | | | | | | | | | | | |
Total current assets | | | 189,644 | | | | 157,612 | | | | 94,204 | | | | (156,200 | ) | | | 285,260 | |
Property, plant and equipment, net | | | — | | | | 73,804 | | | | 14,614 | | | | — | | | | 88,418 | |
Satellites and related rights, net | | | — | | | | 344,359 | | | | 1,908 | | | | — | | | | 346,267 | |
Investment in subsidiaries | | | 257,776 | | | | — | | | | — | | | | (257,776 | ) | | | — | |
Goodwill | | | — | | | | 28,490 | | | | 4,122 | | | | — | | | | 32,612 | |
Intangible assets | | | — | | | | 91 | | | | 16,977 | | | | — | | | | 17,068 | |
Other non-current assets | | | 14,576 | | | | 77 | | | | 2,000 | | | | — | | | | 16,653 | |
Deferred tax asset | | | — | | | | 78,721 | | | | — | | | | — | | | | 78,721 | |
| | | | | | | | | | | | | | | |
Total assets | | $ | 461,996 | (a) | | $ | 683,154 | (a) | | $ | 133,825 | (a) | | $ | (413,976 | ) | | $ | 864,999 | |
| | | | | | | | | | | | | | | |
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
Current liabilities: | | | | | | | | | | | | | | | | | | | | |
Accounts payable and accrued expenses | | $ | — | | | $ | 11,598 | | | $ | 11,290 | | | $ | (5,204 | ) | | $ | 17,684 | |
Amounts payable to related parties | | | — | | | | 105,038 | | | | 45,959 | | | | (150,997 | ) | | | — | |
Amounts payable to subcontractors | | | — | | | | 55,967 | | | | — | | | | — | | | | 55,967 | |
Accrued interest payable | | | 17,292 | | | | — | | | | — | | | | — | | | | 17,292 | |
Current portion of deferred revenue | | | — | | | | 2,474 | | | | 7,025 | | | | — | | | | 9,499 | |
Income tax payable | | | — | | | | 32,911 | | | | — | | | | — | | | | 32,911 | |
| | | | | | | | | | | | | | | |
Total current liabilities | | | 17,292 | | | | 207,988 | | | | 64,274 | | | | (156,201 | ) | | | 133,353 | |
Long-term debt | | | 246,788 | | | | — | | | | — | | | | 1 | | | | 246,789 | |
Deferred revenue, net of current portion | | | — | | | | 193,860 | | | | — | | | | — | | | | 193,860 | |
Non-current income tax reserve | | | — | | | | 93,081 | | | | — | | | | — | | | | 93,081 | |
| | | | | | | | | | | | | | | |
Total liabilities | | | 264,080 | (a) | | | 494,929 | (a) | | | 64,274 | (a) | | | (156,200 | ) | | | 667,083 | |
Stockholders’ equity | | | 197,916 | (a) | | | 188,225 | (a) | | | 69,551 | (a) | | | (257,776 | ) | | | 197,916 | |
| | | | | | | | | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 461,996 | | | $ | 683,154 | | | $ | 133,825 | | | $ | (413,976 | ) | | $ | 864,999 | |
| | | | | | | | | | | | | | | |
| | |
(a) | | Total assets were adjusted by $(47,967), $78,721, $0 and $44,291 for the parent guarantor subsidiary, non-guarantor subsidiaries, and eliminations, respectively. Total liabilities were adjusted by $(28,960), $152,911, $25,746 and $(55,645) for the parent, guarantor subsidiary, non-guarantor subsidiaries and eliminations, respectively. Total stockholders equity was adjusted by $(19,007), $(74,190), $(25,746) and $99,936 for the parent guarantor subsidiary, non-guarantor subsidiaries, and eliminations, respectively. |
20
GEOEYE, INC.
Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2008
(Unaudited; in thousands)
| | | | | | | | | | | | | | | | | | | | |
| | Unconsolidated | | | | | | | |
| | | | | | | | | | Non- | | | | | | | |
| | | | | | Guarantor | | | Guarantor | | | | | | | |
| | Parent | | | Subsidiary | | | Subsidiaries | | | Eliminations | | | Consolidated | |
Net cash provided by (used in) operating activities | | $ | (19,852 | ) | | $ | 15,135 | | | $ | 39,326 | | | $ | — | | | $ | 34,609 | |
Cash flows from investing activities: | | | | | | | | | | | | | | | | | | | | |
Capital expenditures | | | — | | | | (47,442 | ) | | | (1,587 | ) | | | — | | | | (49,029 | ) |
| | | | | | | | | | | | | | | |
Net cash used in investing activities | | | — | | | | (47,442 | ) | | | (1,587 | ) | | | — | | | | (49,029 | ) |
Cash flows from financing activities: | | | | | | | | | | | | | | | | | | | | |
Issuance of common stock | | | 1,594 | | | | — | | | | — | | | | — | | | | 1,594 | |
| | | | | | | | | | | | | | | |
Net cash provided by financing activities | | | 1,594 | | | | — | | | | — | | | | — | | | | 1,594 | |
| | | | | | | | | | | | | | | |
Net (decrease) increase in cash and cash equivalents | | | (18,258 | ) | | | (32,307 | ) | | | 37,739 | | | | — | | | | (12,826 | ) |
Cash and cash equivalents, beginning of period | | | 38,645 | | | | 116,821 | | | | 78,858 | | | | — | | | | 234,324 | |
| | | | | | | | | | | | | | | |
Cash and cash equivalents, end of period | | $ | 20,387 | | | $ | 84,514 | | | $ | 116,597 | | | $ | — | | | $ | 221,498 | |
| | | | | | | | | | | | | | | |
21
GEOEYE, INC.
Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2007
(Unaudited; in thousands)
| | | | | | | | | | | | | | | | | | | | |
| | Unconsolidated | | | | | | | |
| | | | | | | | | | Non- | | | | | | | |
| | | | | | Guarantor | | | Guarantor | | | | | | | |
| | Parent | | | Subsidiary | | | Subsidiaries | | | Eliminations | | | Consolidated | |
Net cash provided by (used in) operating activities | | $ | 892 | | | $ | (4,201 | ) | | $ | 18,170 | | | $ | — | | | $ | 14,861 | |
Cash flows from investing activities: | | | | | | | | | | | | | | | | | | | | |
Capital expenditures | | | — | | | | (25,463 | ) | | | (2,694 | ) | | | — | | | | (28,157 | ) |
Payment for business acquisitions, net of cash acquired | | | — | | | | — | | | | (8,747 | ) | | | — | | | | (8,747 | ) |
| | | | | | | | | | | | | | | |
Net cash used in investing activities | | | — | | | | (25,463 | ) | | | (11,441 | ) | | | — | | | | (36,904 | ) |
Cash flows from financing activities: | | | | | | | | | | | | | | | | | | | | |
Repayment of long-term debt | | | — | | | | — | | | | (15,443 | ) | | | — | | | | (15,443 | ) |
Issuance of common stock | | | 360 | | | | — | | | | — | | | | — | | | | 360 | |
| | | | | | | | | | | | | | | |
Net cash provided by (used in) financing activities | | | 360 | | | | — | | | | (15,443 | ) | | | — | | | | (15,083 | ) |
| | | | | | | | | | | | | | | |
Net increase (decrease) in cash and cash equivalents | | | 1,252 | | | | (29,664 | ) | | | (8,714 | ) | | | — | | | | (37,126 | ) |
Cash and cash equivalents, beginning of period | | | 55,056 | | | | 105,056 | | | | 39,572 | | | | — | | | | 199,684 | |
| | | | | | | | | | | | | | | |
Cash and cash equivalents, end of period | | $ | 56,308 | | | $ | 75,392 | | | $ | 30,858 | | | $ | — | | | $ | 162,558 | |
| | | | | | | | | | | | | | | |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
On August 6, 2008, we concluded that the Company should restate its financial statements for the quarter ended September 31,2007, the year ended December 31, 2007 and for the quarter ended March 31, 2008. These restatements should not have a big economic impact on the Company. There were three reasons for the restatements. The first reason affects periods in 2007, the quarter ended March 31, 2008 and the six months ended June 30, 2008. The second and third reasons only affected periods in 2007.
(1) The Company completed a detailed study analyzing its tax accounting methods in which the Company discovered that it had not correctly included in taxable income cost-share payments received from the U.S. Government under the NextView program. As a result, the Company must include previously unrecorded expenses for interest and penalties on unpaid taxes which will lower net income for those periods and create a deferred tax asset and corresponding liability on the balance sheet. However, the Company filed an application for change in method of accounting with the Internal Revenue Service (“IRS”) on August 8, 2008 which management believes will eliminate all of the tax interest and penalties. As a result, management expects that the financial impact of these interest and penalties will be reversed in the third quarter of 2008. Management believes that reversal will result in an increase in net income for the third quarter of 2008 equal to the reduction in net income in previous periods. Management believes a second result of this accounting method change is a change in the timing of the payment of taxes on the cost-sharing payments, as in the liquidity section.
(2) The Company completed a detailed study regarding the application of Section 382 of the Internal Revenue Code of 1986 (“Section 382”) on ownership changes. Application of the findings of this study resulted in a decrease in income tax expense and related tax liabilities from the amounts reported on the Company’s Report on Form 10-K for the year ended December 31, 2007 because the previously identified ownership change occurred earlier than previously reported and thus eliminated fewer net operating losses. This item does not affect the periods in this Form 10-Q.
(3) In connection with an internal review, the Company identified a decrease in direct expenses in 2007 due to an overstatement of the cost of imagery purchased from third parties associated with imagery sales in 2007. This item does not affect the periods in this Form 10-Q.
In addition, our cash flow statements have been adjusted to reclassify the capitalized interest and other working capital items from operating cash flow into investing activities. While this does not change the overall cash flow analysis, it increases operating cash flow and decreases investing cash flow by $11.6 million for the six months ended June 30, 2007.
For a discussion of the restatement adjustments and the background leading to the adjustments, see Note 2 of the condensed financial statement, all amounts in this Form 10-Q affected by the restatement adjustments reflect such amounts as restated.
OVERVIEW
GeoEye, Inc. (“GeoEye” or the “Company”), together with its consolidated subsidiaries, provides geospatial information, imagery and solutions for the national security community, strategic partners, resellers and commercial customers to help them better map, measure and monitor the world. Geospatial information is geographic information that can be used to identify a particular location’s spatial relationship to other locations.
22
We operate a constellation of Earth imaging satellites and mapping aircraft which collect, process, and distribute digital imagery of the Earth’s surface, atmosphere and weather conditions and have an international network of ground stations, a robust imagery archive, and advanced location-based imagery processing capabilities. We maintain image processing and production centers at our headquarters in Dulles, Virginia and our facilities in Thornton, Colorado and Mission, Kansas. Our advanced image processing and location-based information technology development and production center in St. Louis, Missouri is a world-renowned center for innovation in the industry. Our satellite system also includes a U.S. ground system, including four ground stations owned or leased by the Company, to operate the satellites and to collect, process, and distribute imagery from the satellites.
We acquired the IKONOS satellite in January 2006 upon our purchase of the operating assets of Space Imaging LLC (“Space Imaging”), and we have a license to operate and control the OrbView-2 satellite. We acquired mapping aircraft in March 2007 upon our purchase of MJ Harden & Associates, Inc. (“MJ Harden”). The construction and pre-launch testing of our next-generation, high-resolution imagery satellite, designated as GeoEye-1, has been successfully completed. On July 10, 2008, GeoEye-1 arrived at Vandenberg Air Force Base in California and preparations continue for its planned launch on September 6, 2008.
Our principal sources of revenue are the sale of satellite imagery to and the processing and production of imagery and location-based information for customers, regional distributors and value-added resellers. We have entered into several long-term sales contracts to provide imagery products and solutions, and in certain circumstances, we will be entitled to receive contractual payments in advance of product delivery. Our direct expenses include the costs of operating the satellites, airplanes and ground systems, as well as costs to perform value-added processing services and construction costs related to distributor-owned ground stations. Labor expenses and depreciation represent the largest component of our direct expenses.
NextView Program.The U.S. Government, through the National Geospatial-Intelligence Agency (“NGA”), announced in 2003 that it intended to support the continued development of the commercial satellite imagery industry through contracts to support the engineering, construction and launch of the next generation of imagery satellites by two providers. This program is known as NextView. On September 30, 2004, NGA awarded the Company a contract as the second provider under the NextView program. As part of the contract, we have been, as prime contractor, constructing a new satellite, GeoEye-1 and have completed all satellite development. As of August 11, 2008, the satellite is at the Payload Processing Facility at Vandenberg Air Force Base and is ready for launch. We estimate the total project cost (including financing and launch insurance costs) to bring the GeoEye-1 satellite into service will be approximately $502 million. We have spent approximately $421.1 million under the program through June 30, 2008. Remaining expenditures under the program principally consist of milestone payments to our subcontractors, launch and on-orbit insurance premiums and capitalized interest. NGA is supporting the project with a cost share totaling approximately $237 million spread out over the course of the project and subject to various milestones. Through June 30, 2008, we have received $193.9 million of milestone payments from NGA.
In September 2007, we purchased $220 million of launch plus first year on-orbit insurance coverage and $50 million of launch plus three-year on-orbit coverage for the GeoEye-1 satellite to be paid in the event of a launch failure or on-orbit anomalies which prevent the satellite from being placed into service. The premiums to be paid to the underwriters by the Company total approximately $41.5 million. As of June 30, 2008, we paid $2.2 million of the insurance premium. An additional $33.8 million of the insurance premiums was paid on July 17, 2008. The remaining $5.5 million will be paid in two equal installments on the first and second anniversary of GeoEye-1’s launch date. The portion of the premiums associated with the insurance covering launch and check-out will be capitalized as part of the satellite’s cost and depreciated over the estimated seven year life while the portion of the premium attributable to on-orbit insurance will be expensed in the year to which the coverage relates.
In accordance with our previously stated intent, in August 2008, we purchased an additional $50 million of launch plus first year on-orbit insurance to be paid in the event of a total loss of the satellite. The premiums paid to the underwriters in August were approximately $6.1 million. The portion of the premiums associated with covering the launch and check-out will be capitalized as part of the satellite’s cost and and depreciated over the estimated seven year life while the portion of the premium attributable to on-orbit insurance will be expensed in the year to which the coverage relates.
We continue to make progress toward launch of the GeoEye-1 satellite. In early July 2008, a satellite Mission Readiness Review was completed. During that review, we verified that the performance of the satellite meets our pre-defined requirements and that there were no hardware issues detected that would require resolution prior to launch. There are still some actions to be completed before launch, including finalizing all of the satellite documentation, however, no major issues were detected. Additionally, United Launch Alliance held a Pre-Vehicle on Stand review to assess the status of the launch vehicle and to determine whether to begin the process of assembling our Delta 2 vehicle on the launch pad. As a result of the review, United Launch Alliance determined that the satellite is
23
ready and assembly of the Delta 2 rocket began on July 3, 2008. After successfully passing these key milestone reviews, the satellite was shipped on July 9, 2008 to Vandenberg Air Force Base and arrived safely on July 10, 2008. GeoEye-1 is now in its final preparation stages for its launch which is planned for September 6, 2008.
We believe that when it is launched and placed into service, GeoEye-1 will be the most modern, high-capacity, high-resolution commercial imaging satellite in the world. GeoEye-1 is designed for 0.41 meter (16 inch) resolution panchromatic (black and white) images, and 1.65 meter resolution multi-spectral (color) images, with the capability to take black and white images of up to 700,000 square kilometers of the earth’s surface every day at 1.0 meter resolution or better, or over 255 million square kilometers per year, or combined panchromatic and multi-spectral images of up to 350,000 square kilometers of the earth’s surface every day at 1.0 meter resolution or better, or over 127 million square kilometers per year. GeoEye-1 and IKONOS, operating together, will collect up to 500,000 square kilometers of the earth’s surface every day at 1.0 meter resolution or better in black and white and color.
The NextView contract also provides for NGA to order approximately $197 million of imagery products beginning February 1, 2007 and continuing until six quarters after GeoEye-1 goes into service. In February 2007, the Company and NGA executed the initial task order under the NextView contract whereby NGA agreed to purchase $54 million of imagery products from the Company’s existing satellites for the period from February 1, 2007 to December 31, 2007. All of the imagery under this task order was delivered to NGA by September 30, 2007. In November 2007, we entered into a new $60 million task order with NGA for the continued delivery of products from November 2007 to the commissioning of GeoEye-1, which at that time was anticipated to occur in July 2008 after an April 2008 launch. As of June 30, 2008, the Company has received approved task orders from NGA for $49.7 million of the $60 million target discussed in November 2007. Of the $49.7 million of approved orders, we have delivered approximately $25.3 million of which $5.4 million was delivered under this task order in the second quarter of 2008. Overall, the Company has experienced a shortfall in imagery orders from NGA throughout the first six months of 2008. We believe the NGA ordering issue will resolve itself over the coming months as we conclude negotiations of a Service Level Agreement (SLA) with NGA that would streamline the order placement and delivery processes between NGA and the Company. We believe this SLA should be in place by the time we commence GeoEye-1 operations for NGA later this year.
Once the GeoEye-1 satellite is placed into service, NGA will have the first right to order images from a significant portion of the satellite’s imagery-taking capacity, with the remainder available for commercial and state and foreign government sales by the Company. GeoEye-1 is intended to have a design life of seven years and sufficient fuel to operate for up to two additional years. Based on NGA’s public announcement of expected ongoing support, we expect NGA to continue to purchase our imagery products following expiration of the NextView contract.
GeoEye-2 Satellite.In October 2007, we announced that we had entered into a contract with ITT Corporation to begin work on the camera for our next earth imaging satellite to be named GeoEye-2. This is the first step in a phased development process for an advanced, third-generation satellite. GeoEye-2 will be of the same general class as GeoEye-1, but will benefit from some improvements in capability. We expect to contract with a satellite builder in late 2008, although the timing may vary depending on our perception of the market potential, especially the potential interest from the U.S. Government. We would expect to launch the satellite approximately three to four years after work begins on that contract. We will evaluate our options for financing the construction of GeoEye-2 in conjunction with its selection of the satellite builder. Total capitalized costs for GeoEye-2 were approximately $15.7 million as of June 30, 2008.
RESULTS OF OPERATIONS
The condensed financial information presented herein is unaudited.
Revenues. Total revenues for the Company were $34.2 million and $48.3 million for the three months ended June 30, 2008 and 2007, respectively and $68.6 million and $85.1 million for the six months ended June 30, 2008 and 2007, respectively. Revenue decreases in both periods compared were primarily attributable to a reduction of imagery and production services delivered to NGA, our largest customer.
The $14.1 million decrease in revenue in the second quarter of 2008 versus 2007 was attributable to a $16.0 million decrease in delivered imagery and production services to NGA which management believes is due to the delay in launch of GeoEye-1, which was offset by a $1.1 million increase in SeaStar revenue and $0.5 million increase of commercial production and services revenue from our MJ Harden operations. On a year to date comparison, total revenues decreased by $16.5 million for the six months ended June 30, 2008 versus 2007. Our deliveries of imagery and production services to NGA decreased by $20.6 million, which was partially offset by an $0.8 million increase from equipment sales relating to ground station upgrades, $1.0 million of increased SeaStar buoy sales and $2.2 million increase from our MJ Harden operations. MJ Harden is a provider of digital aerial imagery and location-based information solutions which we acquired in March 2007.
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Direct Expenses. Direct expenses include the costs of operating and depreciating our satellites and related ground systems, as well as construction and on-going maintenance costs related to distributor-owned ground stations. Labor expenses are the largest component of direct expenses. Direct expenses were $19.3 million and $15.2 million for the three months ended June 30, 2008 and 2007, respectively and $39.1 million and $34.3 million for the six months ended June 30, 2008 and 2007, respectively.
The $4.1 million increase in direct expenses for the second quarter of 2008 is attributable to $1.5 million of increased headcount and labor costs as we prepare to launch our GeoEye-1 satellite, a $1.0 million increase in production costs relating to an NGA order and an increase of $1.2 million for purchased imagery from our regional affiliates. The $4.8 million of increased direct expenses on a year to date basis includes $1.0 million of direct expenses associated with our MJ Harden operations, which we acquired in March 2007, $2.7 million of increased headcount and labor costs as we prepare to launch our GeoEye-1 satellite, $1.3 million increase in production costs relating to an NGA order, the completion of a ground station upgrade for an international customer in 2008 for $1.3 million, $0.9 million in additional SeaStar costs attributable to the buoy sales and net increases in purchased imagery of $2.9 million. These year to date increases were offset by the absence of $5.3 million of depreciation expense resulting from the write-off of the OrbView-3 satellite and related assets during March 2007 as discussed below.
Selling, General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses include the costs of marketing, advertising, promotion and other selling expenses, as well as the costs of the finance, administrative and general management functions of the Company. SG&A expenses were $9.6 million and $7.4 million for the three months ended June 30, 2008 and 2007, respectively and $18.5 million and $14.0 million for the six months ended June 30, 2008 and 2007, respectively. This $2.2 million increase for the three months ended and $4.5 million increase for the six months ended is attributable to increased headcount as we prepare to launch our GeoEye-1 satellite in September 2008 and increases in sales and marketing and other support-related activities, particularly with regard to labor, commissions, travel and bid and proposal activities. These activities have increased in preparation of the upcoming GeoEye-1 launch.
Loss on Impairment of Satellite.On March 4, 2007, the Company’s OrbView-3 satellite began to experience technical problems which affected its image quality. On April 23, 2007, we announced that the satellite had been declared permanently out of service due to an electronic system failure within the camera. We recorded a loss of $36.1 million in the first quarter of 2007. The OrbView-3 satellite was insured for $40.0 million. The Company submitted an insurance claim on June 8, 2007 and received the full proceeds during the third quarter of 2007.
We had a post-launch on-orbit milestone payment obligation with Orbital Sciences in connection with the ongoing performance of our OrbView-3 satellite whereby annual post-launch on-orbit payments in maximum amounts of up to $1.275 million were scheduled to be made on each of the three remaining anniversaries of the acceptance of the OrbView-3 system in 2007, 2008 and 2009, for a total possible maximum obligation of $3.825 million. This obligation was written off in the first quarter of 2007 in conjunction with the loss of the OrbView-3 satellite. Orbital Sciences subsequently asserted that a prorated portion of the 2007 on-orbit incentive payment was payable, which we disputed through an arbitration process. On April 22, 2008, the arbitrator decided in favor of Orbital Sciences and in April, 2008, we paid Orbital Sciences $1.1 million which included accrued interest. This amount was recorded in the first quarter of 2008.
Interest Expense, net. We recorded net interest expense of approximately $1.4 and $1.9 million in both three month periods ending June 30, 2008 and 2007, respectively. Net interest expense for the six months ended June 30, 2008 and 2007 was $2.5 million and $5.1 million, respectively. As presented in the table below, the majority of interest expense incurred for these periods pertained to interest expense associated with the Company’s $250 million Senior Secured Floating Rate Notes due 2012 (the “Notes”). Interest expense incurred on these Notes includes amortized prepaid financing costs and amortization of debt discount and excludes capitalized interest expense associated with the construction of the GeoEye-1 satellite and related ground systems. The composition of interest costs incurred on the Notes is as follows (dollars in thousands):
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | June 30, | | June 30, |
| | 2008 | | 2007 | | 2008 | | 2007 |
Interest expense | | $ | 3,099 | | | $ | 3,604 | | | $ | 6,177 | | | $ | 7,383 | |
Capitalized interest | | | 6,377 | | | | 5,874 | | | | 12,672 | | | | 11,572 | |
Total interest costs on Notes | | $ | 9,476 | | | $ | 9,478 | | | $ | 18,849 | | | $ | 18,955 | |
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Total interest expense incurred on the Notes for both three months ended June 30, 2008 and 2007 was $9.5 million. The Company also recorded interest income of $1.2 million and $1.7 million for the three months ended June 30, 2008 and 2007, respectively, which offset interest expense. Total interest expense incurred on the Notes was $18.9 million and $19.0 million for the six months ended June 30, 2008 and 2007, respectively. In addition, as more fully described in the Liquidity and Capital Resources section below, in February 2007 we repaid the remaining $15.4 million principal balance of loans incurred to finance the Space Imaging acquisition in January 2006. Interest expense related to these loans was $1.4 million inclusive of amortization of prepaid financing costs. The Company recorded interest income of $1.2 million and $1.7 million for the three months ended June 30, 2008 and 2007, respectively and $3.2 million and $3.7 million for the six month periods ended June 30, 2008 and 2007, respectively, offsetting interest expense in those periods.
Unrealized Loss on Derivative Instrument. In February 2008, we entered into a $250 million interest rate cap agreement that is intended to protect us from rises in interest rates by limiting our interest rate exposure to the three-month LIBOR rate, with a cap of four percent. The cap is effective July 1, 2008 and terminates January 1, 2010. We paid $0.5 million to obtain this cap. Our previous interest rate swap agreement, which the Company entered into in June 2005, terminated as of June 30, 2008. In June 2005, the Company entered into an interest rate swap agreement, which effectively maintained a fixed interest rate of 13.75% on our $250 million of long-term debt during that period.
Although the interest rate swap and rate cap agreements provide the Company with an economic hedge against interest rate risk, the Company is applying “mark to market” accounting, the effect of which is the inclusion in net income of any increases or decreases in the fair value of derivative instruments previously designated as hedges during the periods in which such increases or decreases in their fair values occurred. We recorded unrealized gains on these derivative instruments of $0.1 million and $0.8 million for the three month periods ended June 30, 2008 and June 30, 2007, respectively. We recorded unrealized losses on these derivative instruments of $1.7 million and $1.0 million for the six month periods ended June 30, 2008 and 2007, respectively.
Provision for Income Taxes. The Company recorded a provision for income taxes of $3.6 million for the second quarter of 2008 and $6.4 million for the six months ended June 30, 2008. The tax provision was calculated using the Company’s estimated effective tax rate of 39.8% prior to the application of penalties and interest related to the cost share payments. The Company recorded a provision for income taxes of $13.0 million for the second quarter of 2007 and $4.9 million for the six months ended June 30, 2007. The tax provision was calculated using the Company's effective tax rate of 38.6% prior to the application of penalties and interest relating to the cost-share payments.
Backlog. Total negotiated backlog was $267.0 million at June 30, 2008 and $237.7 million at December 31, 2007. This amount includes NGA’s expected remaining milestone payments of $43.5 million related to GeoEye-1 construction costs. As of July 10, 2008, we successfully completed the Mission Readiness milestone and invoiced NGA for $30.0 million of the remaining $43.5 million. These amounts include both funded backlog (unfilled firm orders for our products and services for which funding has been both authorized and appropriated by the customer) and unfunded backlog (firm orders for which funding has not yet been appropriated). Negotiated backlog does not include unexercised options or task orders to be issued under indefinite-delivery/indefinite quantity (“IDIQ”) type contracts. Total funded backlog was $135.5 million at June 30, 2008 and $139.7 million at December 31, 2007. NGA’s share of GeoEye-1 construction costs of up to $237.4 million will be recognized as revenue on a straight-line basis over the expected imagery delivery term of the program, which we expect to be equivalent to the useful life of GeoEye-1, once GeoEye-1 is placed into service. Customer contracts are generally for terms of one to four years, and the customers have options to renew.
LIQUIDITY AND CAPITAL RESOURCES
We believe that we currently have sufficient resources to meet our operating requirements through the next twelve months, and that our cash balances and the reserve under the NextView program are more than sufficient to sustain the program through the launch of the GeoEye-1 satellite, which is currently planned for launch on September 4, 2008. However, our ability to continue to be profitable and generate positive cash flow through our operations beyond that period is dependent on the continued expansion of commercial services, adequate customer acceptance of our products and services and numerous other factors.
Net cash provided by operating activities was $34.6 million and $14.9 million for the six months ended June 30, 2008 and June 30, 2007, respectively.
Net cash used in investing activities was $49.0 million and $36.9 million for the six months ended June 30, 2008 and 2007, respectively. Capital expenditures were $12.1 million more in the current six month period compared to the similar period in the prior year due mostly to increased cash outflows for expenditures related to the construction of GeoEye-1 and its related ground system assets. In addition, during the six month period of 2007, the Company used $8.7 million of cash to purchase the MJ Harden operations and acquire a 4.9 percent ownership interest in SPADAC, Inc.
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Net cash provided by financing activities was $1.6 million for the six months ended June 30, 2008 and were associated with issuances of common stock related to stock option exercises. Net cash used in financing activities was $15.1 million for the six months ended June 30, 2007. As discussed above, we repaid the remaining $15.4 million balance on the debt that had been incurred to purchase the Space Imaging operations during the first quarter of 2007.
On June 30, 2008, we had $221.5 million of cash and cash equivalents from our combined operations. At that date, our total long-term debt consists of $250 million of Senior Secured Floating Rate Notes, net of unamortized discount of $2.9 million. Our debt-to-total capital ratio (debt/debt plus equity), net of unamortized discounts, was approximately 53 percent at June 30, 2008 as compared to 61 percent a year ago. Our stockholders’ equity was $199.1 million at June 30, 2008.
Under the instruments governing the Notes, we are prohibited from paying dividends until the principal amount of all such Notes have been repaid. We may redeem the Notes at any time after July 1, 2008 plus the number of days that will have elapsed from February 15, 2007 to the launch of GeoEye-1. If the planned September 4, 2008 launch occurs, the Notes could be redeemed beginning in January 2010. The Notes may be redeemed at 104 percent of par for the first twelve-month period, at 102 percent of par for the next twelve-month period, and at par thereafter.
The Notes bear interest at a rate per annum, reset semi-annually, equal to the greater of six-month LIBOR or three percent, plus a margin of 9.5 percent. As stated previously, in February 2008, we entered into a $250 million interest rate cap agreement that is intended to protect us from rises in interest rates after the expiration of our interest rate swap by limiting our interest rate exposure to the three-month LIBOR rate, with a cap of four percent. The cap is effective July 1, 2008 and terminates January 1, 2010. We paid $0.5 million to obtain this cap and as of June 30, 2008, the interest rate cap agreement’s fair value was adjusted to $0.7 million.
Approximately $42.8 million of our cash balance at June 30, 2008 is committed for payments to subcontractors under the NextView program. Our performance under the NextView contract will require GeoEye to make additional capital expenditures to complete the launch of the GeoEye-1 satellite. Total funding of the Company’s operations and obligations under the NextView contract requires approximately $265 million, most of which has been incurred. We have funded our non-NextView capital expenditures and cash flows from operating activities using cash on hand and revenues from existing contracts. We have repaid the indebtedness incurred to finance the Space Imaging acquisition with the operating cash flows of the acquired business.
The Company has reevaluated its tax accounting method for the cost share payments received from NGA for the design, construction and commissioning of GeoEye-1. Originally, the Company believed it was appropriate to recognize for tax purposes the cost-share payments over a 7-year period following the commissioning of GeoEye-1, which is the method that will be used to recognize the cost-share payments for financial reporting purposes. Upon reevaluation, however, the Company has determined that these payments should have been recognized, for tax purposes, as income in the year that the Company was entitled to receive them. After this determination, the Company made an application with the IRS on August 8, 2008 to change its accounting method for these payments and will now recognize the payments, for tax purposes, over the next four years, starting in third quarter 2008. The amount of tax liability on these payments remains the same as it has always been. However, with the change in accounting method, the timing has changed. This will result in higher than previously anticipated taxable income in the four year period starting with 2008 but should be offset by the accelerated depreciation of GeoEye-1 in those same years, upon successful launch and operation. The related liability has been placed on the balance sheet with a corresponding offset to a deferred tax asset. The liability and the deferred tax asset will correspondingly decline over time to zero, as the timing differences diminish.
The amount of actual income taxes we will pay over the next four years will be based on the calculations of our annual taxable income, which will include three primary components: 1) for 2008, the recognition into taxable income of the cost share payments invoiced in 2008; 2) for each year 2008 to 2011, the recognition into taxable income of one-fourth of the prior cost share payments; and 3) our other taxable income from operations after taking into account associated expenses including accelerated depreciation for tax purposes. Because of the significant tax deductions that are anticipated over the next few years starting in 2008 from the accelerated tax depreciation of GeoEye-l, we believe that the tax deductions for depreciation will negate the effect of the increase in taxable income from the cost share payments.
In October 2007, we announced that we had entered into a contract with ITT Corporation to begin work on the camera for our next earth imaging satellite, GeoEye-2. This is the first step in a phased development process for an advanced, third-generation satellite. GeoEye-2 will be of the same general class as GeoEye-1, but will benefit from some improvements in capability. We expect to contract with a satellite builder in 2008 although the timing may vary depending on our perception of the market potential, especially the potential interest from the U.S. Government. We would expect to launch the satellite approximately three to four years after work begins on that contract. We will evaluate our options for financing the construction of GeoEye-2 in conjunction with its selection of the satellite builder.
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CRITICAL ACCOUNTING POLICIES
The foregoing discussion of our financial condition and results of operations is based on the consolidated financial statements included in this Form 10-Q, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and the related disclosures of contingencies. We base these estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
During the quarter ended June 30, 2008, there were no significant changes to the critical accounting policies we disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K/A for the year ended December 31, 2007.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 establishes a framework for measuring fair value under GAAP and will be applied to existing accounting and disclosure requirements in GAAP that are based on fair value. SFAS 157 does not require any new fair value measurements. SFAS 157 emphasizes a “market-based” as opposed to an “entity-specific” measurement perspective, establishes a hierarchy of fair value measurement methods and expands disclosure requirements about fair value measurements including methods and assumptions and the impact on earnings. On February 12, 2008, the FASB issued Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157,” which delayed the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008.
SFAS 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
The net amount of assets and liabilities recorded at fair value at June 30, 2008 totaled $0.8 million and were related to our derivative financial instruments. We determined the fair values of these financial instruments using Level 2 inputs. The fair values of the derivative financial instruments are obtained from third party broker quotes. These Level 2 fair values are routinely corroborated on a quarterly basis with observable market-based inputs. We are currently assessing the impact of SFAS 157 for nonfinancial assets and nonfinancial liabilities on our consolidated financial position and results of operations.
On February 15, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115.” Under this statement, the Company may elect to report financial instruments and certain other items at fair value on a contract-by-contract basis with changes in value reported in earnings. This election is irrevocable. SFAS 159 provides an opportunity to mitigate volatility in reported earnings that is caused by measuring hedged assets and liabilities that were previously required to use a different accounting method than the related hedging contracts when the complex provisions of hedge accounting under SFAS 133 are not met. SFAS 159 is effective for years beginning after November 15, 2007. The adoption of SFAS 159 did not have a material impact on our results of operations, financial condition or cash flows.
In December 2007, the FASB issued SFAS No. 141(R) (revised 2007), “Business Combinations.” SFAS 141R replaces SFAS 141 and establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree. SFAS 141R also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This statement is effective for fiscal years beginning after December 15, 2008. The impact of the adoption of SFAS 141(R) will depend on future acquisitions as there will be no impact on our existing financial position and results of operations.
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In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51.” SFAS 160 establishes new accounting for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective in the first quarter of 2009. We do not expect the adoption of SFAS 160 to have a material impact on our results of operations, financial condition or cash flows.
In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.” SFAS 161 expands quarterly and annual disclosure requirements in SFAS 133 about an entity’s derivative instruments and hedging activities. SFAS 161 is effective for fiscal years beginning after November 15, 2008. The Company is currently assessing the impact of SFAS 161 on its consolidated financial position and results of operations.
Item 3. Quantitative and Qualitative Disclosure of Market Risk
The Company’s primary exposure to market risk relates to interest rates. The financial instruments which are subject to interest rate risk principally are limited to floating rate long-term debt. These notes are subject to interest rate fluctuation because the interest rate is reset semiannually for the term of the notes. A 100 basis point increase in market interest rates on the notes would result in an annual increase in the Company’s interest expense of approximately $2.5 million. The Company is using an interest rate swap to mitigate its interest rate exposure with respect to the $250 million of Floating Rate Notes.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its periodic filings with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to its management, including its principal executive officer, principal financial officer and principal accounting officer, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to use its judgment in evaluating the cost to benefit relationship of possible controls and procedures.
The Company routinely reviews its system of internal controls over financial reporting and makes changes to its processes and systems to improve controls and increase efficiency, while ensuring that it maintains an effective internal control environment. Based on that evaluation, the Company’s principal executive officer, principal financial officer and principal accounting officer concluded that the Company’s disclosure controls and procedures were ineffective in providing reasonable assurance that information required to be disclosed in the reports the Company files or submits under the Exchange Act is recorded, processed, summarized and reported as and when required and that such information is accumulated and communicated to management in a manner that allows timely decisions regarding required disclosure. After giving effect to the restatements referred to above, and subject to the Statements below regarding the Company’s inability to maintain effective controls over income tax reporting, the Company’s management has concluded that the financial statements included in this Form 10-Q fairly present in all material respects the Company’s financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles.
There have been no significant changes in the Company’s internal controls over financial reporting during the most recently completed fiscal quarter that materially affected, or are reasonably likely to materially affect, its internal controls over financial reporting. In connection with the preparation of our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2007, our management, in consultation with the Board of Directors, concluded that the Company did not maintain effective controls over the income tax reporting under SFAS No. 109, “Accounting for Income Taxes,” in 2007 with regard to the calculation of the provision for income taxes and utilization of net operating loss (“NOL”) carryforwards.
During the 2007 year-end procedures for calculating the annual income tax provision, the Company reassessed the application of the pre-reorganization NOLs against 2007 taxable income with regard to a change of control as defined in Section 382. This assessment resulted in the loss of pre-reorganization NOLs to offset current taxable income as a result of a November 16, 2004 change in control. This material weakness resulted in the restatement of the Company's consolidated financial statements for the quarter ended September 30, 2007 and the years ended December 31, 2007, 2006 and 2005, respectively, to correct income tax expense.
Subsequent to April 2, 2008, the Company identified a material misstatement in its annual and quarterly financial statements for 2005, 2006 and 2007, requiring restatement of these financial statements. In July, the Company completed a detailed study analyzing its tax accounting methods in which the Company discovered that it had not correctly included in taxable income cost-share payments received from the U.S. Government under the NextView program. As a result, the Company identified a control failure from the lack of tax expertise and must include previously unrecorded expenses for interest and penalties on unpaid taxes which will lower net income for those periods and create a deferred tax asset and corresponding liability on the balance sheet.
In addition, the Company failed to maintain effective controls to review and reconcile the expenses and related liability accounts associated with purchased imagery sales. As a result and in connection with an internal review, the Company identified a decrease in direct expenses in 2007 due to an overstatement of third party purchased imagery costs associated with imagery sales in 2007.
Accordingly, management determined that these control deficiencies constitute material weaknesses. As a result of the assessment performed and the material weaknesses noted, management concluded that the Company's internal control over financial reporting was not effective as of December 31, 2007. The Company continues to invest significant effort and resources to eliminate these deficiencies in internal controls, and will continue to do so throughout 2008.
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Accordingly, management determined that these control deficiencies constitute material weaknesses. As a result of the assessment performed and the material weaknesses noted, management concluded that the Company’s internal control over financial reporting was not effective as of June 30, 2008. The Company continues to invest significant effort and resources to eliminate these deficiencies in internal controls, and will continue to do so throughout 2008.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In the normal course of business, we are party to various lawsuits, legal proceedings and claims arising out of our business. We cannot predict the outcome of these lawsuits, legal proceedings and claims with certainty. Nevertheless, we believe that the outcome of any existing or known threatened proceedings, even if determined adversely, should not have a material adverse effect on our business, financial condition or results of operations.
Item 1A. Risk Factors
We do not believe that there have been any material changes to the risk factors previously disclosed in our 2007 Form 10-K/A.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
(a) Exhibits
| | |
Exhibit 31.1 | | Rule 13a-14(a) Certification of Matthew M. O’Connell |
| | |
Exhibit 31.2 | | Rule 13a-14(a) Certification of Henry E. Dubois |
| | |
Exhibit 32.1 | | Certification Pursuant to 18 U.S.C. Section 1350 of Matthew M. O’Connell |
| | |
Exhibit 32.2 | | Certification Pursuant to 18 U.S.C. Section 1350 of Henry E. Dubois |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | | |
| | |
| GeoEye, Inc. | |
| (Registrant) | |
| | |
|
Date: September 5, 2008
| | | | |
| | |
| /s/ MATTHEW M. O’CONNELL | |
| Matthew M. O’Connell | |
| President and Chief Executive Officer | |
|
| | |
| /s/ HENRY E. DUBOIS | |
| Henry E. Dubois | |
| Executive Vice President and Chief Financial Officer | |
|
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