Viasat Inc (VSAT) 2004 Q1 法說會逐字稿

Ladies and gentlemen thank you for standing by. Welcome to the ViaSat fiscal year 2004 first-quarter results conference call. During the presentation all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time if you the question (CALLER INSTRUCTIONS). As a reminder, this conference is being recorded Wednesday, August 13th, 2003. I would now like to turn a conference over to Mark Dankberg, President, Chairman, and CEO. Please go ahead, sir.

Thank you. Good afternoon everyone and welcome to ViaSat's earning conference call for our fiscal year 2004 first-quarter ended July 4th, 2003. This is Mark Dankberg, Chairman and Chief Executive Officer. And I have with me Rick Baldrige, our Executive Vice President and Chief Operating Officer; Ron Wayerin, Vice President and Chief Financial Officer; and Greg Monahan, VP and General Counsel. Before we start, Greg will read our Safe Harbor Disclosure.

Thanks Mark. Information contained within this presentation may make projections or other forward-looking statements, regarding future events or the future financial performance of the Company. We wish to caution you that these statements are only predictions and that actual events or results may differ materially. We refer you to the documents the Company files from time-to-time with the Securities and Exchange Commission -- specifically the section entitled factors that may affect future performance in the Company's form 10-K. These documents contain and identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. Stockholders or other readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date on which they are made. The Company undertakes no obligation to update publicly or revise any forward-looking statements.

Thanks Greg. Okay. This quarter we've added slides to our conference call presentation over the Web. So I'll be referring to those as we go along. I also wanted to point out that if you listening over the phone and watching on the Web, the slides will be about 20 seconds behind the telephone audio. If you're listening over the Web, they should be synchronized. The topics we'll cover will include our first-quarter financial results and a summary of the key points there. We had a great quarter for new orders and we'll spend some time discussing that, followed by a summary of the highlights for our business areas. And then Ron will discuss the financial results in more detail. And after that I'll provide an update to our outlook and our financial guidance and then a quick summary.

We reported record revenue again for the second quarter in a row, at $59.3 million. Obviously, the revenue growth is largely a consequence of the backlog we've been building over the last year. This quarter we also so did well with our pass return book and chip products, which showed up the total orders of $102 million. And that contributed to our revenue results. So this starts our fiscal year at an annualized run-rate of over $235 million. Based on order an opportunity floor, we are still planning for sequential growth in sales. So we think this indicates a higher floor for revenue for the year as a whole. We'll go into more detail on the makeup of this quarter's revenue a little later in the call.

This next slide showing our pro forma earnings is my favorite for today. We had a pro forma profit of $1.6 million or 6 cents a share on 26.9 million shares outstanding. For the reasons that we discussed less quarter, this level of result is basically delayed about a quarter from when we first thought we'd reach it. One of the factors we referred to last quarter as contributing to the delay was the expense associated with new business and contract awards. And given the order levels that we're reported now, we think we made the right choice at last quarter. Obviously, this level of earnings, relative to sales, doesn't reflect what we believe our true earnings potential really will be, once we've fully assimilated all the new business we've won. I'll go into this point further when we discuss the outlook for earnings growth later in the call. But for now, I'm really happy about the quarter results. Still, a lot of work to do. But the numbers that our objectives for the quarter. And they create an excellent foundation going forward.

While there were very different profit contributions from the different business areas, each of them to the job of executing to the plans we had set. The strength of our backlog and the investments we made in IT systems last year, should help us more accurately plan and anticipate results. And we're working to validate that. For now, it's really good to have at least one quarter existence proof here.

The GAAP -- the pro forma results exclude only amortization of intangibles due to acquisitions. And last quarter we also said we're aiming to reach profitability on a GAAP basis this quarter. And this slide shows that we did that. Earning $.5 million, or two cents a share, actual net income. So that's something of a milestone as well.

Now, there's a few other key points we'd like to make about the financial results, before we move on to new orders and then the business highlights. The first key point is that while re-establishing profitability is noteworthy, it's also important to look at the results in the context of trends that we've had for the last year. This quarter continues and extends the steady products progress we've been making over the last year, starting with the surge of orders in the June quarter of last year. Once we started absorbing those orders, we've steadily grown revenue sequentially. Although orders can still be very lumpy and timing isn't as predictable as we'd like, things in the aggregate have been consistently improving. We have been generating positive operating cash flow and have been reducing the debt under our revolving credit facility. As we indicated in an 8-K filing we made earlier today, we've amended the facility to increase the ceiling of the credit line to $30 million and have extended the term to September 2004. And it's also worth noting that amendment really reflects the cumulative progress we've made, not just this one quarter's results. So we now have much more maneuvering room on that front. It should be clear that we've made great progress on improving liquidity. And later on, Ron will talk a little more about the prospects for further improvements, even given the rapid growth we're achieving.

The other point here that I think is really important and noteworthy, is that we've made all this financial progress without mortgaging our future. I have always thought that one of the trickiest management issues is to balance three things -- sales, profits, and new orders. It's always possible to improve one at the expense of the others and reaching a good balance isn't easy. Our 100 million dollar bookings for the quarter, combined with steadily growing revenues and an increasing profitability is an indication that I think we're doing pretty well. At that balance we could still do better, but this is pretty good.

Our backlog is at a record level. And at $265 million, is about 40 percent higher than last year's sales. Plus we still have a really promising pipeline of new opportunities. And I'll focus on new orders more in a few minutes. So, looking at the quarterly sales trends -- sequential growth in revenues has been very nice. 59 million and change this quarter we were up just about 50 percent over our low point of three quarters ago. Since a pretty significant amount of our sales is backlog driven, we've got a good shot at continuing this trend for while. There may still be some lumpiness in quarter-over-quarter results, due to contract timing. But we think the trend ought to be good.

Now, this next order trend chart is also pretty nice. But you should interpret it a little bit differently than the revenue trend chart. Orders can be and have been pretty lumpy for us. And it's harder to predict those been revenue which given the long-term nature of our contracts, tends to get smoothed out a little bit more. So even though this chart shows steady sequential growth, it's probably not going to sustain itself smoothly as revenue should. The main point here is that that last year was a record year for us at 260 million in new orders. And last year's first quarter was the biggest contributor at 80 million. So this year's first quarter is up 25 percent from that. And last year, we had a very high winning percentage -- higher than we would have forecasted. We did have a lot of opportunities that were right in our strike zone, though. And we did well on those. This year our pipeline still looks very good. It's quite a bit bigger than the same time last year. So while we still expect quarterly fluctuations on an absolute order values or book-to-bill ratio, we do see good potential to meaningfully beat last year's total. But we don't currently expect this current second-quarter to be necessarily quite as high as this first one was.

Another point to note is balance among the three categories that are shown, which are government, commercial, and broadband projects. So even though it's good to see meaningful broadband contribution again, you can see what a big jump there was in the first quarter relative to the last few quarters. It's important to note that our government in our standard commercial products did very well too. And even with broadband growing, it's not dominating new awards like it did two or three years ago.

Here's another slide on new orders that helps put that in context. There is a lot of information on that chart, but you can see that in fiscal year '01 and '02, the broadband projects made the big -- made up a big percentage of the total orders. And then when Astrolink terminated its contracts, that took a big chunk out of backlog. And it negated a lot of those orders. So, the striking thing about fiscal year '03 was the surge in both government and commercial product orders. Okay. And that's what led us to record levels, with only a small fraction of that total in broadband. So far in this quarter -- just this first quarter -- the government and commercial products are still going strong. And we have added more in broadband than we had all last year. We think this mix which is still represented in our new business pipeline, creates a potential to exceed last year's record in total awards. It probably also seems surprising to a lot of you that we had such high amount of total orders in this first quarter with relatively few press releases describing them. There is two main factors there. One is that the orders were pretty well diversified. There was only one new contract in that $102 million that was valued over $10 million in quarter. All the rest were under 10 million. And second, our customers almost always a contractual rise to approve our press releases. And many may take some time to do that. So we can't always release information as promptly as we would like. Another important point to note is there is still a large -- a pretty good number of large pending contracts out there that are yet to be decided. So, that means, if they do go our way, we can still wrap up another quarter or two as big as this one.

Now, I'm going to move on to our business highlight section. This slide describes -- summarizes the highlights for both are government and commercial business. The government business met its plan in the quarter, including record revenues. We're steadily converting more of the backlog to revenue, especially in the engineering-intensive new funded development contracts. The still added to backlog and have good new targets in the pipeline, including a couple of different variants of the Joint Tactical radio system which are called different clusters. Work (indiscernible) on communications satellite system -- an opportunity where we still could participate in one of the two remaining Mobile User Objective System or MUOS UHF satellite teams. And some good information security opportunities. MIDS is still ramping up delivery of the previously-ordered low-rate initial production, or what's called LRIP units. But the new contract awards have been delayed, primarily due to process and milestone issues, in both domestic and international government customer organizations. Once we transition out of the current LRIP contracts, we expect that MIDS margins are going to improve significantly. We are also performing more funded development contracts now. So while that does increase our below-the-line R&D expenses, gross margins of those funded development programs are generally lower than floor production. There's also more risk in the development process. Although, that's moderated somewhat by the fact that the preponderance of our government development projects are on cost reimbursement type contracts.

So turning to commercial, our VSAT business had a very nice quarter, with strength across the board, in terms of bookings, revenue, program execution, and earnings. One of the two points we made in the press release was that we had received acceptance on 11 different LinkStar networks during the quarter. That's a fantastic program accomplishment. Our VSAT business does carry the smallest backlog of any of our areas. So it's a little more difficult to predict. But this quarter was a big improvement all around. The antenna business had really strong bookings in backlog and some revenue growth. Earnings in this area are low our historical levels. They're pretty much where we expected. But we have plans in place to improve them. And we've got good backlog to execute those plans against. The international KU band DOCSIS contract which that we announced is starting to generate some meaningful revenues, even without having any K band projects onboard yet. There is content for U.S. Monolithics too at the KU band. We're still planning on significant KA band revenues this year, as well. We'll make some more announcements there when we can. We believe that our KU band customer will disclose more of what's going on with that contract this fall. And then, that will be more clear to everyone.

We've also continued to make very good progress with our AirLink Skylink business jet system. We received some additional orders during the quarter. And we have been performing demonstrations and trials that are targeting some new customers. We should see production starting probably at the end of this second quarter, with more in the third quarter and then onward from there. We also continue to be pretty happy with what Boeing is doing with Connection. There's been a lot of publicity regarding the very successful trials with both Lufthansa and British Airways. As well as some significant deployment commitments for international carriers. Boeing is also targeting new international orders this year and has stated that they expect a significant domestic carrier this year. We think that will be a big step. Boeing is also pursuing additional applications that go beyond just Internet access cabin entertainment portion for the airline market. And they're actively exploring other platforms, besides commercial aviation.

So overall, it's starting to look -- it certainly seems like our broadband business kind of bottomed out a while ago and is growing again. And we see positive and improving margins ahead for that area. The other important part of our commercial segment is U.S. Monolithics. And earnings there have been -- this is not new. This is -- they've been pretty negatively impacted because of the long delays in the DOCSIS broadband deployments. At this point, we can see that situation improving, probably around the fourth quarter this year -- the first quarter next year for USM. And their revenues and earnings will ramp with the DOCSIS deployment. But another really important point here is, beyond just that business. USM is gaining some good traction and growing attraction in defense projects. And there are some really good opportunities there. And we've made good progress. And we hope to be able to make some announcements on that in the near future. At this point, we expect USM to enter our next fiscal year at Y '05 profitably. At this point, I would like to introduce Ron Wayngern, our CFO, who's going to discuss our financial data in more detail.

Thanks Mark. A little over a year ago, the Company was in the middle of rebuilding its business base for growth. It started with the large MIDS and second generation modem production orders received at the end of Q1 and continued with the information security and large antenna systems awards in Q2. The balance of the year saw continued orders improvement throughout all of our businesses. The momentum has continued in the first quarter of 2004. I want to point out that this business rebuilding was the product of management diligence to look long-term, target the right markets, and most of all make conscious investments in new technologies and in new business opportunities. Our ability to win new contracts and execute has opened doors -- has openned new doors for the Company as well. The result is a quarter were we continued to grow revenues and earnings, we returned to profitability, and we continue to generate cash for the fourth consecutive quarter. Further, we continue to strengthen our balance sheet, improving several key ratios and improved our liquidity position to our recent amendment to our debt agreement.

I'll start off reviewing the results of operations for Q1 in relation to Q2 -- Q1 of last year and our last fiscal quarter. Next, I'll review key elements of the balance sheet, followed by our cash flow statement. Then I'll highlight the balance sheet improvements. Lastly, I will review our liquidity position and discuss alternative sources of liquidity we continue to evaluate. Now, turning to the P&L. Our Q1 sales increased by $5.6 million or 10 percent over Q4 levels. And 16.4 million or 38 percent over Q1 of last year to a record $59.3 million. For segment purposes, during the quarter, commercial revenues were 31.7 million, while government revenues were 27.5 million. The government revenues represent a new quarterly record. We saw growth in almost all of our government businesses, including tactical data links, information security in networking, UHF SATCOM, and government broadband. In addition, we saw an uptick in sales in the VSAT products and consumer and mobile broadband business areas, following robust orders in the first quarter.

From the sales quality perspective, the growth is a mix of both production and customer-funded development. Gross profit improved over the fourth quarter to 27 percent and was consistent with our expectations to see steady margin improvement. Despite the improvements, though, gross margin was impacted by an increase of 600,000 in inventory reserves recorded in the quarter. When comparing margins to last year -- if you recall in Q1. Last year, was -- last year, margins were aided by a $2.9 million profit benefit, related to MIDS award, received late in Q1 and the resulting accounting treatment. Our margins are dependent on the mix of development and production programs we have in backlog at any given time and our related program performance. SG&A decreased by 800,000, or 7 percent, over Q4, but increased by 1.6 million or 18 percent, over Q1 of last year. The reduction over the fourth quarter is largely due to lower corporate legal and professional services costs. Selling, bid, and proposal costs were essentially flat quarter-over-quarter. The increase in SG&A over fiscal 2003 first-quarter is primarily driven by acruals for 401k match and performance bonuses, offset by lower selling, bid, and proposal costs. Due to our performance last year, we did not accrue for, nor payout 401k match or performance bonuses.

R&D expenditures decreased by 600,000 or 14 percent, from Q4 to 3.7 million and were down $2 million or 35 percent from Q1 last year. The lower R&D levels reflect the recent award of several funded development contracts and transfer of engineers from Company-funded to customer-funded development projects. In addition, we concluded several development projects in Q4 of last year and early Q1 of this year. The substantial reduction in other expense over Q1 of last year reflects a reduced investment in the Amnion (ph ) joint venture of almost 500,000. The income tax benefit was computed using normal statutory rates with an additional benefit from R&D credits which amounted to approximately 600,000 in the quarter.

As we look at the balance sheet, total receivables increased by 4.8 million, largely reflecting an increase in the business volume, partially offset by improved billing and collection processes. We have seen a steady decrease in our unbilled receivables as a percentage of sales over the past four quarters. Further, our DSO improved by another five days to 132 days. Inventory increased in the quarter to 31.6 million. The increase was primarily attributable to our large antenna and VSAT businesses. The VSAT increase reflected a buildup of product that was shipped in July in accordance with contractual schedules. The inventory buildup in our large antenna business follows a very strong orders quarter and material necessary to fulfill such orders. We expect this balance to work down as material is transferred to programs. Despite the increase in material balance, inventory turns improved to almost eight during the quarter. Other current assets increased by almost 3.6 million during the quarter. This increase is a result of a subcontract prepayment on a government program and prepaid rent and insurance, following our changed from a calendar quarter end, to a 52, 53 week year.

The reduction in goodwill and intangibles reflects normal amortization. The reduction in other long-term assets is due to normal amortization of capitalized software costs. The Company recorded no new capitalized software in the quarter. Accounts payable increased in the quarter, consistent with the growth in the business. And collections in advance of revenue increased by 4.3 million in the quarter and reflects continued focus on and improvement of customer terms and the quality of the customers. We continue to pay down our loan in the quarter, reducing the outstanding balance to just below $8 million. The increase in other current liabilities reflects the payment of certain accrued legal and professional expenses offset by increases in warranty reserves and accruals for 401(k) match and performance bonuses.

Next, turning to the cash flows -- during the quarter we generated 4.3 million in cash flows from operations. This was the result of generating net income and the over 5 million in non-cash addbacks from depreciation and amortization. We see these non-cash items increasing over the next several quarters as software amortization and depreciation increases. Having over 5 million in non-cash items charged against operations aids in our ability to generate cash from operations during our growth phase. So for example, if we run it at approximately 5 million in non-cash items per quarter, we might expect around 20 million in non-cash items over the year -- or perhaps even a little higher as it grows.

So, then on a cash basis, our operating earnings are almost 20 million per year higher than they appear on a GAAP basis and almost 12 million per year higher than on a pro forma basis. So our cash flow generation is quite a bit stronger than our earnings might suggest. During the quarter, cash was used to pay down our credit facility by an additional $2 million and brought the balance to below 8 million, which is the lowest level in the last seven quarters. This action, combined with our line increase we completed creates further availability under the line, should the Company need it. Cash was also used in the quarter for capital expenditures which were attributable to test equipment related to new development and production contracts. The Q1 level was less than half of what the past several quarters were, reflecting the completion of our Company's ERP system in Q4 of last year. We expect capital expenditures to increase somewhat in each of the next several quarters to meet the needs of new contracts or as products enter manufacturing stages.

Turning to the balance sheet measures, I wanted to take a moment to reiterate some key points relative to strengthening the balance sheet and the Company's financial position. The Company has been very focused on improving its liquidity position over the past year. The Company is concentrating on generating cash from operations and paying down its line of credit. Over the past four quarters we've generated over 20 million in cash from operations while growing to revenue line almost 50 percent. While the Company grew, the primary working capital accounts of inventory and accounts receivable grew at a much smaller rate. This in-turn improved DSOs and inventory turns. And, while the Company was rebuilding its backlog, it used cash from operations to fund R&D and new business effort. Also, we funded the Company's new ERP system, substantially improving financial and operational visibility and concluded the funding of a significant software development effort. I equate this accomplishment to re-tooling a factory during a recession. When the recession turns around, the Company emerges stronger. ViaSat has been fortunate to rebuild its business backlog and retool the same time. We have emerged a much younger company. We've improved customer quality and have a broader and stronger mix of products and markets we serve.

Next, I wanted to spend a few minutes on our liquidity position. As you saw on the previous slide, we continue to pay down our line during the quarter and create availability. We are also satisfied with the latest amendment to our credit facility we signed, where we increased our line from 20 to $30 million and extended the date to September of 2004. Further, our pricing is lower, reflecting the improved financial condition of the Company. At the end of the quarter, we had in excess of 6 million available on our line of credit. Had the amendment that in-place at quarter-end, we would have had in excess of $16 million available. In addition to our revolving credit facility, the Company is continuing to evaluate both the long-term facility and the public markets including extending our shelf. At the current time, given our financial performance, there is not a sense of urgency and we can make a deliberate decision. Any decision on these facilities would be made after careful of the need for such cash, financial terms, business conditions, and return to shareholders.

This next slide, we have included to clearly showed the difference between GAAP and non-GAAP, or pro forma earnings and per share amounts. As you can see, the only item the Company includes are the effects of acquisition-related intangibles net of tax impact. We have not and do not anticipating in the future to include any operating items as pro forma adjustments. Rather, we have and will include such amounts in operating figures. Next, I'd like to turn it back to Mark, who will talk about our firm business outlook.

Okay, thanks Ron. At this point, I'd like to talk about our outlook for the second quarter and the rest of the fiscal year. So, with respect to guidance, the first point to note is that there's been a lot of dynamics that work over the last few quarters and it's been difficult for us to accurately predict the timing of certain contract awards and then the resulting impact on financial performance. And this is the first quarter in the last several where we believe we've anticipated results well and have enough critical mass so that we could adapt to the environment. So we'd really like another quarter under our belt before we get too detailed on guidance. But we can narrow the range on fiscal year '04 as a whole. We believe that revenue will be probably at least 240 million and probably not more than about 260 million. And we anticipate pro forma earnings for the year, which are fairly consistent with the current analyst estimates. That basically represents about one-quarter slip to the right of the earnings growth we had at one time expected would start in the fourth-quarter fiscal year '03. So while we're still expecting good sequential revenue growth, we think earnings are actually going to go faster than revenue, for the next several quarters until we reach a marginal rate that's more consistent with our historical performance. And that would probably be in the range of about 10 percent of sales -- pre-tax -- on a pro forma basis.

We expect that Q2 earnings will be better than Q1 by a meaningful amount. But we don't want to make any specific promises at this point. And we'd rather err on the side of conservativism right now. But if you figure that we'll do probably at most 10 percent pretax pro forma in the fourth-quarter, then we're kind of in the range of about 3 to 4 percent pro forma pretax this quarter. And then we expect to show earnings growing faster than sales each quarter from here to there -- you can get a reasonable range that we're aiming for. And we expect to approach the 10 percent pretax on a pro forma basis by the end of the fiscal year and carry that forward. Now, given the high level of funded R&D projects we are executing, we've got some maneuvering room to manage our discretionary R&D expenses down to some extent, to help our performance, while we're still having lots of good technology come to market. We are also are trying to avoid passing up the type of growth opportunities that we've been landing, in order to wring another penny or two out of earnings.

This next fact -- this next slide, identifies some of the factors that are influencing how we're narrowing the range and what the timing introductory of our product profit growth ought to be. Some of the -- one thing to notice when talked about the awards is that some of the biggest potential commercial and defense contract awards are still being awarded slower than what we might've expected. In each of these cases, we actually think our underlying competitive position is still good. For instance, the U.S. and international MIDS orders are delayed relative to when our customers thought that they would be making awards. So our estimates were kind of based on their schedule. And in some cases, those schedules have now slipped by several quarters. There's been good progress on DOCSIS broadband, but the launch of TeleSat's (indiscernible) F-2 satellite, which Wild Blue and TeleSat will share, has slipped relative to projections that were out there earlier this year. It's now expected to launch early in calendar 2004. And we've got some really good DoD broadband opportunities. But several of those are also intertwined in larger issues and are delayed. The good news is that even with a all these major delays, we're still winning new business at a really good pace and growing revenue and earnings because of the diversification that we've developed. And also, I think we have done a good job of allocating our resources in real-time to fit the projects that have been awarded, as opposed to having them be idle on others. But there some limits to how we can move all those resources while still preserving our ability to execute in some of these key areas -- or to accommodate other contractual commitments that we've got. So these delays are costing us a little bit in profitability, relative to what we would have earned, given our customers' prior expectations. So that resource allocation issue is a lot of why we're falling more in the middle of the revenue range -- near the lower end of the earnings range for this fiscal year which refers back to that consistency with the current analyst estimates.

This next slide talks about business flux. And it's intended to help illustrate why we're so optimistic about our growth prospects. A lot of the new awards we've received are for funded development contracts that involve production tails -- things that come -- orders that come after the developments are finished. The green arrows at the top of each fiscal year show what new programs we've added into revenues. And then the red arrows at the bottom show where we've had projects our product lines discontinued or decreasing substantially year-over-year. So during our fiscal '02 and '03, we had significant declines, for instance in Astrolink and Wild Blue revenues. And also in the older Scientific Atlanta VSAT product lines that we acquired. But, on the other hand, in fiscal '03 and now in fiscal '04 we've added a number of areas that look to have good long-term growth potential, including the LinkStar and LinkWave VSAT products, the KG250 encryption device, the gigabit ethernet encryption device, some new defense antenna programs, the EBIM defense broadband modem, the SkyLink business jet system connection by Boeing production, the common data link press release program that we put in our press release this morning, and some others. And also, we intend to do better, margin-wise as those products go from development into production.

This next slide, that shows the new product revenue rollouts is intended to be a qualitative example of how the manufacturing of some of these new products and systems might play out over the next few years. It's not intended to show specific numbers or to show values for specific products. But what we want to convey is the idea of the relative values of these different programs and how they might grow over time. And what it shows is that, while these programs are -- represent a relatively small amount of our revenue this fiscal year, they could grow to be a much more significant portion of that overtime. And that -- these programs are basically being funded by our customers for us to develop. And it only -- the other point here is it only basically shows new products that are completing tests or entering the pipeline, starting this year. So, that excludes current standard products like for instance MIDS or antennas or standard VSATs or UHF products. And some of those also have some good growth potential, relative to their current performance. It also excludes non-recurring engineering development sales, new programs that we're going after, that we haven't won yet and engineering services. One way to look at it is that programs that we've won in the last four quarters or so could account for as much as say 30 to 40 percent of the growth that we would like to see over the next several years, depending on how these programs play out. So the point is that not only is the growth that we've had in the last year good, just from a pure financial sense. But we also think it's going to play out in a way that promotes further growth and enhances margins going forward. And another key point I would like to make out of this chart is that the growth is pretty well diversified between commercial and government and then again within each of those areas.

Okay, so now moving to the summary. We should be -- we're very happy with our results for the quarter. We returned to profitability. We have been showing steady improvement in revenues margins and backlog. Our revenues set new records for two quarters in a row. We like the looks of our new business pipeline. Key balance sheet metrics including DSOs, inventory turns, cash flow, and net cash position have been trending nicely. We've significantly improved liquidity over the past year and have remended are revolving debt agreement up to $30 million, it extended through September 2004, and we've earned some better terms on it. The amount of non-cash depreciation charges that are baked into our earnings means that our cash flow will be pretty close to 5 million better than our net earnings on a quarterly basis, as we go forward by the end of this fiscal year. We think that also gives us a lot of maneuvering room to finance our growth. And finally the numbers indicate we're developing a nice balance in our portfolio among defense, standard commercial products, and the newer, higher-risk, higher pay off, broadband SATCOM initiatives. That makes us much less vulnerable to gliches with individual customers than we were a couple of years ago. We know that we've still have got some challenges. And we still need to show good bottom-line results. But we think the numbers for this quarter show we're on the right track. Thanks very much everybody for your time and attention. And now we would like to open it up for questions.

(CALLER INSTRUCTIONS) Tom Weiss, SG Cowen. (ph)

Congratulations Mark on a great quarter. Just a couple of quick things. One, the past two quarters we were looking for contracts from a couple of areas. One is UIA and the other is Netherlands NED (ph). On the UIA front, is that something that you can -- will we know when you get that? Is that something you have already gotten? Or is that something -- will you be able to discuss that when you get it? And also, where are we on the European MIDS front?

The UIA with one is one of those we're working on approval. I mean, that's one way to answer it. So we will disclose the status of that to the extant that we can. There's also a little bit of a -- one of the issues that we sometimes have on security programs has to do with labelling and nomenclature. But we think it will be clear when we discuss it. And we'll try to also do a little -- give a little more information about what it's about now -- it's going. On the -- you're right, there is a European Netherlands MIDS order that a lot of people have been anticipating and just hasn't been made yet. We think we understand what the timing is -- just has to do with the calendar year of the Netherlands government. And there is some new anticipated award date. But we'd just as soon wait to see what happens before we describe it.

Also in encryption product side -- I understand that the KG250 is on the path to approval. Do you still see 40 to $50 million potential in the encryption area?

As a whole, certainly, we're not going to get there instantly. But we're having big growth. It's definitely our fastest -- well that and the defense broadband are the two fastest things we're growing in our defense business this year. And, you know, we're still optimistic. I think we'll hopefully have more to say maybe by around the next conference call.

And then on the new guidance that you're giving on earnings -- it looks like -- you mentioned next quarter higher than this quarter -- the September quarter higher than the June quarter and ramping up. It looks like it's going to be even a little bit more back-load than we have it. Is there anything specific driving sort of the delay in earnings ramp up?

I think it's a little bit cumulative effect of some of the factors that we talked about which are for instance. One that's a factor -- and this -- we had said last quarter that what we'd like to do is see steady progress in our marginal performance. And that is kind of really what we're planning. I think this time we're trying to give a little more insight into how to rollout. I think that's what we're trying to do. From our perspective, it is not materially different than what we envisioned maybe a quarter ago. Some of the factors that are -- if you look at what is going to drive growth in margins over time. Some of the things that we mentioned -- one is, the MIDS orders. And that is basically replacing current or augmenting at first replacing -- eventually -- lower margin production units that are tied to the old LRIP and development contract -- replacing those with newer units that are -- purely reflect the margin production margins. So, that's an important factor. There is timing issues associated with that. And, obviously, those are a little delayed, relative to what we thought maybe six months ago. And then another factor is even though -- I think were making good progress in an overall sense -- adding in some of the Ka band DOCSIS stuff will certainly help improve margins as we go along. Those aren't the only two. But those ones that are conditioned over time. And we're trying to give ourselves maneuvering room to accommodate those.

Also, in terms of your share count, I think you have about 5.5 million options with average srtike in the 14.50 range. As we get in-the-money on those, are we going to see an increase in the share count?

What we use Tom is the treasury method. So as the stock price goes up. And as those things come in-the-money, you will see the some of those show up in the share count over time. It is not -- there is an average number out there, of 14 something. But, as you as you know, there are steps there to get there. So chunks of those options are priced at different values. So it's a combination of time. It's a maturity of the options and it's the strike price.

So there's not any particular traunche rate, that we're likely to see to have a dramatic effect on share count?

No.

Do you have any plans to expense options going forward?

I would say right now, we're not that lead the charge. We'll see what happens. I mean, but we don't -- I don't think we're trying to lead any accounting parades.

Great. Just a final question -- the shift to the 52, 53 week year, anything specific behind that?

No. It just really has a lot to do with our new ERP system -- how we set it up and how we're going to move forward.

Rich Valera, Needham.

Thank you. Congratulations as well on a nice, clean quarter. Mark, there were several programs you mentioned last quarter that could drive you sort of potentially toward the upper end of your guidance range. And you sort of addressed the range. But specifically the programs that you made some reference to like Wild Blue, TeleSat, Astrolink -- which has sort of been dormant for a while now. Could you just comment on your thoughts on those programs? I know the Anneck F2 (ph) is a little delayed. But it still seems you could get business with wild blue or TeleSat potentially before that. So, if you could just comment on those couple of programs. Thanks.

On the Wild Blue and TeleSat we're still planning -- certainly a Wild Blue already had contracts -- already engaged. So that certainly looks optimistic. I think Telesat -- that's a good candidate. There's good prospects that they'll do something pretty similar to Wild Blue. The big issues will be when we can recognize revenues off those contracts. And we would likely expect to get turn ons and to generate some revenues, prior to satellite launches -- prior to service deployment. But, there's a fair amount of revenue that's tied to initial shipments of the units, of course. And that is an important part of the contract. And those are likely to be closer to when service launch will be. We don't mean to speak for them. But it wouldn't be surprising to see that three to six months following the satellite launch, which will put us into the next fiscal year.

Great. And with your new 30 million line there, can you give us a sense of where sort of the pressure point is, with respect to covenants there? And how are they relative to your old covenants? If you could just give us any even just qualitative color on that?

Relative to the previous agreement, we really didn't have any changes in the types of covenants for the increase.

Okay. Great. Could you just give us a sense of where -- (multiple speakers)

But the fact, given the improvements, we definitely have more room now.

Okay. And with respect to your commercial LinkStar products, could you give us any sense if there is anything in the works, in terms of trying to qualify them potentially for military use?

Yes, I think qualify is probably a little stronger word. I think from a defense perspective, when the application of LinkStar and Linkway and eventually even some of the other DOCSIS-type products for defense use -- there's good opportunity there. I think that the defense market -- it depends on how -- one approach they could take is to just adopt the commercial products and standards. And there's interest in that. The other is they could make their own. For instance, that's what we're doing with EBM. There could be some way in which those things emerge. The one thing can tell you now is that we are already making progress there. We hope to have some announcements pretty soon. And it looks pretty promising. It's just kind of a natural migration of those commercial products into defense applications.

John Bucher, Harris Nesbitt

Hi. John Bucher. On the backlog mix. I know you provided the breakdown of orders for the current quarter. I was wondered if you took the backlog in aggregate, and if you were to break it down between engineering services backlog and standard products backlog, perhaps, as it pertains to the military. Could you give an estimated split on that?

John, we have very few what you'd engineering services contracts. But there's been maybe 10 been -- maybe 10 plus million dollars in there with that. So, most of our's are either hardware or development programs that are aimed at hardware.

I meant to include the development in that. I guess I should have said cost plus contracts versus standard products.

I don't have a break out on that -- you mean of the new orders or the backlog?

Of the total backlog.

Mark, do you want to guess at that? I would guess if you just look at -- it's crank them out production -- the crank them out production part -- I'm going to estimate it maybe in the 40-ish percent range of our total backlog 40 or 45 percent. Sometimes it's a little difficult to draw the line. For instance, if we get an order for a new antenna system -- as an example like the Ka band gap filler antennas -- we'll get an order that will include some development -- qualification testing and making a few more of those. And right now, it is little bit difficult to draw a line between well we've made three and now we're in crank them out mode, versus development. So, I'm going to guess if we were to lump -- another example of that would be for instance in this datalink contract that we just announced yesterday which is a pretty significant contract. But it's mostly development, even though there's some protection units there. If you lump all these things kind of together, I'm going to guess we're probably more than half of all the colleagues development programs. That sounds reasonable. That help, John.

Yes very helpful. Could you estimate what the tax rate for modeling purposes would be that we should use for fiscal year '04?

Basically, I would use 40 percent. Plus we're having a benefit of about 600,000 quarter for R&D credits -- R&D tax credits.

Okay. And finally on the -- you mentioned driving towards a 10 percent target operating margin in the fourth quarter. You know, I know you probably hesitate to look much further beyond that. We appreciate the forecast or outlook you've provided there, but do you have sort of like an objective target for consolidated corporatewide operating margin that you're shooting for?

Yes, 10 percent on a pro forma pretax basis is not -- that's not bad for this type of business. I think it's a good target to aim for now. I would say in the past, we have seen that it's higher than that, 11, 12, 13 percent. It's a little bit inversely related to the growth rate. At the times when we were growing more slowly -- I think we had a quarter where we were close to 10 percent on a net basis. Okay. But I think for now I would say we really want to aim for 10. And I think we can get their -- kind of exiting this year, entering next year. And then, once we do that we're going to aim up a little bit. But that's going to mean like 11 or 12 is where we'll aim next. Does that help?

Very helpful. Thank you very much.

James McCleary, C.E. Unterberg Tobin.

(indiscernible) I'm sorry. Thank you. What were the government and commercial operating margins for the quarter?

Sure. The government operating profit was 2.8 million. Commercial had an operating loss of about 500K. And corporate -- about -- operating loss of about 400K. The statement amounts do exclude the amortization of the acquisition.

If you looked at the last quarter of this fiscal year and thought about a revenue split during that quarter and split it into broadband, standard commercial, and the government -- kind of broad-brush, what do you think the split would be?

I think -- first of all, I want to make a little bit -- I'm sorry for the confusion -- I'm going to make a little distinction between government and commercial, in terms of segment and an actual contracts basis. I think that we would end up kind of in the 40 or 45 percent -- maybe 45 percent range in government? Okay. In our government segment. And then all the rest will be in commercial -- in the commercial segment. Okay. But remember, the commercial segment includes -- if we sell, for instance, the the K band antenna system to the government, that's counted as a commercial segment contract -- revenue for us. So if you were to adjust for all that. Things would be pretty much half-and-half -- ballpark, okay. Within the commercial segment, I would say probably 75 to 80 percent -- 75-ish percent -- in that range will be kind of the standard commercial products. I think those numbers -- maybe 40 to 45 on the government at the end of the year.

There's still uncertainty in how this thing -- as part of the benefit of the diversifications that we hope we can manage those -- that's kind of the ranges.

Okay. Great. Finally you -- in answer to an earlier question, you talked about revenue recognition tied to the initial shipment of units and if you are doing work and not recognizing the revenue, what is the accounting treatment for that?

Basically -- first of all, one thing I want to be clear -- I'm not necessarily saying we're going to use shipments on some of those. Because there is a lot -- there's a large project aspect to these initial orders -- I mean it's one big project, okay. But even to the extent that we count some of the initial shipments on a percent complete for the project, we won't actually do things relative to those shipments, until we're pretty close to the deployments. Okay, so for instance we're not going to order materials or start integrating things until we are reasonably close to the actual deployment dates or to when we're going to at least ship units into our customers distribution or whatever they decide to have us send those units. So that's what I was getting at is that revenue's really going to be tied to some extent to cranking some of these things out. That's where a lot of the dollar value of the contracts are. Does that help? I think I got it. Great. Thank you very much. Why don't we take one more question.

Alright, gentlemen. Your last question will come from the line of Kevin Spelman with DVM Asset Management.

Thanks. A few questions. Can you tell me what is actually involved -- what you would define as emerging defense broadband?

What that means? What programs that involves? Okay. One good example is the EBM program. Basically, the government -- EBM, enhanced bandwidth efficient MODEM -- it's basically MODEMs that the government uses for either on government-owned satellites -- right now that would be the DISCA system. It will expand to include the Ka band wideband gap filler system which are nonprofit satellites. And then it also accounts for a lot of the modems -- almost all the modems the government uses when it leases commercial satellite bandwidth, which right now accounts for a very high fraction of all the bandwidth that the government is using, especially in its most active areas. So the intention of EBM is to drive up data rates, because they had more and more high-speed communications. So that's a good example. They also may end up kind of evolving EBM to better reflect the type of networking that their doing or the type of traffic that their handling. So that is one. The whole transformational communications systems program is really a big broadband program from the government perspective. It's a lot like -- say an Astrolink or a SpaceWay, depending on whether they go with a Boeing or a Lockheed. And of course it will integrate elements of, for instance MilStar which has sort of evolved -- have an evolution there into the transformational system. And then there are others that will be more interim types of things as well.

Your business you're doing with the LinkStar and that, is that -- (multiple speakers)

Yes. Basically, they're trying to come up with a plan that evolves things from sort of circuits and trunks into networks. And probably IP the government office, Secretary of Defense for what they call network information infrastructure, has come out with some strong statements saying the government wants to migrate fully to IP.

Now the -- how do I put this. The entity that would be spearheading all this LinkStar and Linkway business for you, as I understand, is approaching multiple different areas that they're proposing these terminals, including what you mentioned before -- the encrypted stuff. And various other applications that would be more widespread. Can you give me a dollar amount as to potential for all of these commercial or VSAT applications to the defense?

It could be big -- it depends. It depends a lot on the way that we get involved. For instance, the least involvement could be that we just shipped indoor units or terminals only. And somebody else integrates them, supports them -- we're just doing a little product shipment. That would be more consistent if we were a commercial VSAT company -- kind of selling to another defense integrator. And what we would like to do -- I think there's some evidence that we'll be able to do this, is take advantage of the fact that we provide a lot of defense satellite networking systems and participate at a higher level, which would means more integration more customization support software integration into network planning and resources -- all that stuff is sort of tied into what we're trying to do in transformational communications. If we do well at that -- then this area could have been very bullish about the information assurance area. This area could turn out to be about as big and grow as fast. But we have to wait for this to ripen a little bit more to see how we are involved. That help?

It didn't give me any numbers but --

It's a little premature.

We can take large ranges.

It could be -- put a ballpark on it -- it could be in the $5 to 10 million revenue if we don't hit a whole lot of stuff on an annual basis, once we get going on that. And if we do well who knows? Maybe it will be a $50 million business area in a couple of years.

That's EBM you are talking about?

No. I'm talking about that whole area. There are some big swingers. It's just difficult to predict. I think a better way to look at it would be to look at the types of announcements we make. And then you can say okay, well in a few quarters, this will grow to be that much.

Did Ron say something about boosting your warranty reserve?

Yes. We did increase our warranty reserves. And that is just a normal product of shipments in the quarter. We did have a fair number of MIDS shipments and second generation modems shipments. And it's been increasing the last several quarters. And as we continue to make shipments and we'll continue to see that rise.

Can you tell us anything -- any update on the Scientific Atlanta lawsuits?

No. I don't really have any comments on that.

Alright. And I see you're hiring engineers to work on MIDS JTRS, a.k.a. the Next Generation MIDS. Can you tell us about that?

Well the -- also the Secretary of Defense has been pretty clear about wanting to migrate all of its radio systems to the Joint Tactical radio system kind of an architecture. And so, one of the things that is being right now -- it's more in the examination study phase is to do that with MIDS.

But are they funding you for that?

Yes, I think we've said before that we're getting kind of -- not necessarily very material amounts. but we're getting funding towards that.

Okay. That's it.

Mark we have one more question that I think we want to take.

Steve Mather, Sanders Morris and Harris.

Thank you. You've already covered a lot of ground, especially with the slides. So, I'll try to be brief. One question is simply one of the larger KA and KU band issues is the cost of the hardware. I wonder, Mark, can you kind of discuss any price points at all of what you -- where you're at or where you think you may be at by next summer?

I think it's hard to predict for next summer. What I have said in the past and I think is still appropriate is that if you look at the -- one thing I think is interesting to look at is what the trajectory was for TV receive only terminals, for instance, DirecTV. When they came out, I believe at retail they were about $800 a piece. And it probably stayed that way for close to one million units. And then, especially when EchoStar entered the market, there was kind of a rapid drop to the $300 range. And things declined from there. But they really took off, when he got into that range.

So a lot of people want to see this get to $300. This being a two-way broadband. We think that's definitely possible. I think it's tied to volume. And I think that the market as a whole will reach that point. Whether or not we're the ones to drive it their faster than it got there with TV. So, I think the big issue is going to be to look at the types of commitments that service providers make in aggregate -- what the different standards are and then we'll just have to see from there. And that I think, obviously, there's a lot more interest now than there was even six or nine months ago. And so there's potential to get there. I don't think you'll see it next year. But it's not out of the question. At least you might see -- depending on how people -- what types of commitments are made -- I don't think you'll see it in that $300 range next year. But maybe a year or two, maybe you could.

Okay, just one other brief point. I think you mentioned you'd be at sales greater than last year's 260.

Orders, I think we said.

Orders, okay. My only question with that is, obviously, when you're in the business that you're in, there's often some delays -- it's somewhat natural. Can you get to 260-plus, even with natural -- or what you might call rational delays? Or do need everything to get to 260?

No. This is not an exact science -- the method that we use. I'm going to tell you two things. One is the method that we use is we look at what all the things are in pipeline and we try to make some estimate of what the chances are that they'll occur at all -- what our chances are of winning. And then we try to come up with some type of weighted statistical value of when they would occur. And so what you -- when we say we think we'll do better than last year's 260 million, that is based on some statistical weighting of the programs and of their timing. That we think is reasonable. The other thing that I would say, though, is -- just to calibrate it, is that we used the same process a year ago, when we were looking at what last year's would be. And right now, applying a similar methodology, the number looks meaningfully bigger. And that's part of what I was trying to convey. That using weighting factors and a method like what we did a year ago, it looks quite a bit bigger -- and a year ago turned into 260. That's sort of why we're saying that.

That's great. Thanks for taking my call.

Thanks a lot for your questions. I think that covers that. And I think that covers all the prepared remarks we had to say. So, thank you all very much for taking the time to attend. And at this point, we'll plan on communicating next at our conference call next quarter. Thanks again. Bye.

Ladies and gentlemen, that does conclude your conference call for today. We thank you for your participation and please ask you to disconnect your lines. (CONFERENCE CALL CONCLUDED)