Viasat Inc (VSAT) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the ViaSat third quarter fiscal 2005 earnings conference call. My name is Steven and I will be your coordinator for today.

At this time, all participants are in listen-only mode. We will facilitate a question and answer session toward the end of this conference. If at any time during the call you require assistance, please press star followed by 0 and a coordinator will be happy to assist you.

As a reminder this conference is being recorded for replay purposes. I would like to turn the presentation over to the host of today's call, Mr. Mark Dankberg, Chairman and CEO. Please proceed, sir.

Good afternoon, everyone and welcome to ViaSat's earning conference call for our fiscal year 2005 third quarter ended December 31st of 2004. This is Mark Dankberg, Chairman and CEO and I've got Rick Baldridge, President and Chief Operating Officer; Ron Wangerin, Vice President and Chief Financial Officer; and Greg Monahan, Vice President and General Counsel.

Before we start, Greg will read our Safe Harbor Disclosure.

Thanks, Mark.

Portions of this presentation contain projections or other forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events or the future financial performance of the Company. We wish to caution you these statements are only predictions and may differ materially from actual events or results. We refer you to the documents the Company files from time to time with the Securities and Exchange Commission, specifically the Section titled Factors That May Effect Future Performance in the Company's forms 10-K and 10-Q. 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 and others are cautioned not to place undo reliance on these forward looking statements, which speak only as of the date in which they are made. The Company undertakes no obligation to update publicly or revise any forward looking statements. Forward looking statements in this is presentation do not include any impact related to the expensing of stock options under the Financial Accounting Standard Boards Statement 123 R.

Okay. Thanks, Greg.

We will use slides again in the conference call and they can be viewed over the web. I'll be referring to those as we go along. The topics we will cover include our fiscal year '05 third quarter and year-to-date financial results, and a business overview prospective. After that Ron Wangerin will discuss financial results in more detail. Finally I'll update our outlook and financial guidance and talk about our strategic environment and give a quick summary. Then we'll take questions.

So we'll start with third quarter revenues. Sales for the quarter were $88.2 million, which is a new record for us and that's up 23 percent compared to the third quarter of last year. For the 9 months year-to-date we're at $255 million, which is also a new record for us and up 31 percent over last year.

This next slide shows third quarter pro forma earnings compared to last year and year-to-date. In the year ago period, we reached a settlement with Scientific Atlanta regarding our purchase of their satellite business. That one time event had added $3.8 million and $0.14 cents a share to pro forma earnings. Those amounts are shown in gray in the charts. Absent that settlement, pro forma earnings grew from 4.5 million to 6.1 million, which is up 36 percent for the quarter and from $0.16 a share to $0.22 a share, up 38 percent for the quarter. Pro forma earnings exclude only amortization of intangibles due on acquisitions. And we'll provide explicit bridge data from pro forma to GAAP net earnings a little bit later.

Q3 net earnings are shown on this chart and net EPS also with a settlement amount shown in gray. Absent the settlement, Q3 net earnings grew from 3.3 million to $5.2 million or 58 percent and net EPS grew from $0.12 to $0.19 a share, also up 58 percent.

So now looking at the year-to-date numbers, on a 9 month year-to-date basis, pro forma earnings are at record levels and better than last year, even without excluding that one time settlement benefit, which is shown in gray again. Absent the settlement, pro forma earnings are up from 9.1 million to 15.6 million. That's an increase of 71 percent. And from $0.33 a share to $0.56 a share, an increase of 70 percent.

Finally this next slide shows 9 month year-to-date GAAP net earnings, again with a one time benefit in gray. Those are also up year-over-year even including the settlement. But excluding the settlement, GAAP net increased from 5.6 million to 12.5 million, up 123 percent and from $0.21 to $0.45 a share, an increase of 114 percent. So overall, we're really pleased with our earnings performance for the quarter and for the year-to-date.

At this point, I'll cover some of the business issues and highlights. Overall, in terms of revenue, earnings, new orders, and backlog this fiscal year year-to-date is consistent with our plans. Our Government Segment in particular has been very strong in earnings and revenues and exceeded the Commercial Segment in sales. We had an especially strong quarter there at MIDS, a strong start to KG-250 sales, and very good results in our UHF satellite area. In the Commercial Segment, our core VSAT networks and antenna systems areas continue to put up solid results.

But, as we discussed last quarter, overall Commercial Segment earnings continue to be depressed by investments in the SurfBeam DOCSIS consumer satellite network system product. We believe we're making good progress on the technical issues we identified last quarter and continue to see strong demand and new orders. So we believe that those investments are warranted and that we'll have excellent opportunities for strong revenue and earnings growth in the not to distant future, as a result.

New orders continue to be strong for us. New orders have been a clear leading indicator of growth over the last 3 years and it's fantastic to see that continue. We're at $279 million so far this year and we estimate that will fall into a range of somewhere around 400 to maybe as high as 440 million in new orders for this year, as a whole. So obviously that's a big confidence booster for our outlook for next fiscal year.

And actually there are a few other important good points about our recent order activity. The $60 million MIDS JTRS contract is very significant because that's a product development contract and enters us into the broader JTRS radio market, which should be as large or larger than our estimate of MIDS LBT market. I'll talk about the significance of that in a bit, but the main point is that it creates opportunities for us far beyond just a dollar value in the program.

Also we think our recent awards for KG-250 production and new satellite DOCSIS systems are equally significant beyond just the dollar values. We're gaining more confidence that these products will help create and tap into significant market demand.

We have used this next chart for the last few quarters to show our growth in backlog in the context of our quarterly run rate. And you can see that we've maintained a pretty steady record of growing revenues as well as backlog almost every quarter. And we did that again this quarter, as well. Having this kind of backlog helps a lot in being able to anticipate and manage our growth. New orders for us can be very lumpy and we may not increase backlog every quarter, but for now the outlook on an annual basis continues to be bright for growing backlog.

So now we'll turn to some of the main business highlights of the past quarter. Start with the Government business, which was very strong for the quarter. We again set new records for sales and earnings and margins were very good. We did recognize some program cost growth and we made additional investments in information assurance products, but still achieved strong margins in this segment anyway. Revenues and earnings were driven by product sales, especially MIDS, satellite terminals and growth in shipments of our new KG-250 IP encryption product. KG-250 sales grew from about 250 units in our second quarter to almost 500 units in the third quarter. We believe they'll continue to show good quarter-over-quarter growth again this quarter. It is still early in the product's life cycle, so it's hard to tell if shipment rates will continue to grow, but right now the outlook's good. And we also think there could be a network effect from deployed units that might help sustain that demand.

For now we have a competitive price, the margins are good and we're very encouraged by this new business. That's motivating us to increase our investments in this product area, including the KG-250 gigabyte speed IP encryption product. We're also working on prospects for security chips and modules and other embeddable versions.

We also anticipate that our tactical data links areas will have good growth opportunities, driven by the potential to increase shipment rates and the start of a $60 million MIDS JTRS development program, which is a cost reimbursement type contract. Our JTRS development contract is more narrowly focused that other JTRS programs, such as -- it's called Cluster 1 -- but our schedule is shorter and we've already have inquiries from platforms beyond the core MIDS platforms of F/A-18s and F-16s. MIDS JTRS also has potential scope enhancements, which could substantially increase the value of our development contract as well as the resulting market for that product. We expect some of that to begin occurring very soon, probably within the new quarter or so.

Our military satellite business is continuing to perform well, and we hope to reach some agreement soon that could open significant new markets for us later this year.

Turning to our commercial segment, VSAT Networks is the single largest area and it's at record levels for us. We've had excellent growth in our LinkStar IP Broadband VSAT and we've shipped over 39,000 terminals to date. We're starting to market Ku-band's SurfBeam DOCSIS systems and have seen good interest in that. We're work on perfecting our systems and processes to sell and support SurfBeam as successfully as we have LinkStar.

Our VSAT Network Services Group had some real challenges in the last quarter with the series of hurricanes that marched throughout the Atlanta, which is where our primary network hub is. We also had to repoint and re-establish service due to the failure of Intelsat America's 7 satellite. Even though we had very good support from Intelsat, it was still expensive for us. The antenna systems business continues to be solid and is addressing a number of government opportunities as well.

Our U.S. Monolithics business now has the Ka-band transceiver for WildBlue and Telesat in volume production. We've also added to our list of funded development contracts at US Monolithics for defense applications, including adapting our commercial Ka-band technology to military bands such as EHF.

As we discussed last quarter, earnings in our Commercial Segment this quarter were reduced by startup costs in the SurfBeam DOCSIS product. We'll go into more detail later in the financial section, but this impacted our operating margins for the quarter and also had a ripple effect in receivables on our balance sheet. But those affects were expected based on the status last quarter. There's been a lot of progress since that last call. WildBlue and Telesat have been slowly adding Ka-band terminals over their satellite, plus we've been steadily adding performance and operational features to the system. And the pace of technical progress is more predictable than it was.

We have built and shipped a lot of our second generation Gateway equipment. That's been installed in a number of upsides. That improved network performance compared to the first generation and it is also a prerequisite to being able to ship terminals in higher quantities.

We're also growing the number of Ku-band SurfBeam networks and have taken on follow on orders from existing customers for different satellites in new geographic regions. We have new relationships with established internet service providers in at least 2 new international markets. The service providers that have the product are enthusiastic.

The 2 main points to take away from this are -- one, that we believe we are pretty much past the low point in terms of earnings drag on the Commercial Segment and that our confidence is increasing that we're going to get some significant growth in this area, probably in the second half of our next fiscal year.

So at this point, I would like to introduce Ron Wangerin, our CFO, who will discuss the financial data in more detail.

Thanks, Mark. Similar to last quarter, we'll start off with results from operations with the segment perspective first, and then discuss the remaining elements of the P&L, followed by a discussion on the balance sheet and then cash flows. As Mark talked about earlier, we have a lot of

things going well in some of our business areas and some some business areas we continue to make program investments, some discretionary and some in the form program charges. In the Government Segment, revenues for the third quarter were 48.6 million. This is a 46 percent increase over last year. Year-to-date, receives were just under $128 million, which is a 44 percent increase over prior year. Quarterly and year-to-date revenues were reduced by approximately 4.8 million for program charges and investments related to 2 programs in the Government Segment that were experiencing schedule and cost overruns.

In the Commercial Segment, revenues for the quarter were $41 million, which is an increase of almost 5 percent from the prior year. Year-to-date, revenues were over $131 million. This is a 21 percent increase over prior year.

Segment operating earnings -- the Government Segment posted operating earnings of almost $7 million, which represents an increase of almost 80 percent from prior year. The increase is primarily related to year-over-year higher sales of production programs like MIDS and KG-250, which carries higher margins. And the increase was offset by higher selling and general administrative costs due to higher revenue levels and the $4.8 million for program charges and investments related to the 2 programs I discussed previously. Year-to-date segment operating earnings are almost $21 million, which represents a 99 percent increase from prior year. And the increase year-to-date are the same for the quarter.

As mark indicated earlier, the prior year Commercial Segment results included a $6.3 million benefit related to the Scientific Atlanta legal settlement so this skews the comparability year-over-year. Excluding the S.A. settlement impact, in the Commercial Segment despite the increase in revenues year-over-year in the third quarter, segment operating earnings came in lower than prior year at a $78,000 profit. The results were adversely impacted by approximately $44,000 in incremental costs incurred when the Intelsat America 7 satellite failed in December and lower margins in our broadband business. Excluding the affects of the S.A. settlement, year-to-date increases in operating earnings were primarily derived from results in the first quarter.

As we look at the rest of the P&L, for the third quarter and year-to-date, we're seeing very good year-over-year revenue growth. Gross profit was impacted by the previously-described contract charges in the Government Segment and satellite repoint costs. In addition fiscal year 2004 third quarter end year-to-date results include the benefit from the S.A. settlement of $3.2 million recorded at cost of revenues, whereby increasing gross margins. For SG&A, fiscal year 2004 third quarter and year-to-date amounts include a benefit from the S.A. settlement of $3.1 million, whereby lowering SG&A in those periods.

2005 third quarter SG&A remained consistent with other periods for the year, but it is up year-over-year due to higher sales levels. End year-to-date SG&A is also up primarily due to higher sales levels. But I also want to point out that we have expensed approximately $350,000 related to outside costs related to the S & H bid process and over $700,000 year-to-date in outside costs for Sarbanes-Oxley compliance.

R&D was relatively flat year-over-year, but down considerably on a year-to-date basis. We are requiring less company funded R&D due to the higher level of customer funded R&D and since we completed development of the KG-250 in the first quarter. And we expect R&D to increase this quarter.

Quarterly amortization of intangibles is lower for the third quarter and year-over-year due to the completed amortization of certain intangibles. The quarterly amount will remain constant for the next several quarters. Other income and expense reduction reflects lower interest expense and lower debt levels year-over-year. Our income tax provision for the third quarter is pretty involved. As you recall from last conference call, we are recording taxes at an annualized effective tax rate of 33 percent, primarily due to the treatment of R&D tax credits. We told you last quarter that we recognized a cumulative benefit of $650,000 related to the R&D tax law changes, which we did. On top of this benefit, we recorded a benefit of approximately $300,000 related to our fiscal 2004 tax provision versus the 2004 tax returns filed. And we're now estimating an annualized effective tax rate of 22 percent. Prior year quarterly and year-to-date taxes reflect the higher pretax income of $6.3 million from the S.A. settlement, offset by the benefits for R&D tax credits.

All totalled, our net income for the quarter and year-to-date remain strong despite the incurrence of contract charges and other incremental costs we discussed before.

We include this next slide so clearly show the difference between GAAP and non-GAAP or pro forma earnings and per share amounts. Pro forma results only exclude the acquisition related intangibles, net of tax impact. When we turn to the balance sheet, cash and short-term investments decreased by approximately 2.4 million during the quarter and we'll cover that change when with discuss the cash flow statement. As we look at accounts receivable, billed accounts receivable increased quarter-over-quarter, primarily on increased shipments in both of our Government and Commercial Segments and the achievement of program milestones. Day sales outstanding for billed receivables are in the mid-50s, which is significantly below historical levels and down slightly from last quarter.

The main area of management attention is on unbilled receivables. The 3 biggest areas for unbilled receivables are in MIDS programs, SurfBeam programs and Mobile Broadband programs. Together, these 3 areas represent a little over 50 percent of the balance. For the MIDS program it's primarily a function of the progress payment process and the profitability of the program. For each production lot, the balance grows over a 3/4 period and then substantially drops off in the fourth quarter. We saw this with lots 1 through 3 and we're seeing it again with lots 4r and 5. In our fiscal fourth quarter, lot 4 will begin to decline while lot 5 is starting to grow, but we expect to generate cash over the next few quarters in this program area.

For the SurfBeam related programs, we've been discussing for several quarters the delays in achieving program developments milestones, which has resulted in margin reduction, but also delays the ability to convert unbilled receivables to billed. We believe the unbilled balances on these programs has reached peak levels and will be flat in our fourth quarter and then will be substantially worked off over the following 5 or 6 quarters.

For the Mobile Broadband program, we have discussed the delays in shipments to our customers, largely due to market uptake. This quarter we reached agreement with one customer to catch up on their system deliveries and accelerate their cash collection process. We're very pleased with this progress and expect those amounts to be reduced in our fiscal fourth quarter.

The other amounts in unbilled receivables relate to a diverse set of programs and we'll convert those balances to billed receivables as milestones are achieved.

Inventory was up by approximately $5 million quarter-to-quarter. This is primarily related to KG-250 inventories as we begin to ramp up production and consumer and enterprise VSAT equipment. We expect the inventory balance should go down slightly over the next quarter, but could be influenced by end of quarter timing shipment. Goodwill and intangibles were reduced by the quarterly amortization of intangibles. Net property and equipment was down slightly as depreciation outpaced new capital addition. We expect capital expenditures to increase over the next several quarters primarily for facility expansion and to support general business growth. And the reduction in other assets primarily reflects quarterly amortization of capitalized software.

As we look at the liabilities and equities side of the balance sheet, accounts payable continued to increase with our increase in revenues and due to several shipments for product coming in towards the tail end of the quarter. Payment dates to suppliers went down quarter-over-quarter. Advances were up slightly quarter-over-quarter, but reduced significantly from the beginning of the year and reflect progress on a number of contracts. At the end of the quarter, we continue to have no outstanding borrowings leaving our full line of credit available, less Standby LCs.

As you saw in our K filing earlier this week, we executed a new year 3 year $60 million revolving credit agreement even with added liquidity and flexibility and we are very pleased with the agreement. Other current liabilities increased quarter-over-quarter due to increased warranty accruals from shipments of MIDI units, KG-250s and VSAT systems and from 401-K and performance bonus accruals. The continued increase in other long-term liabilities reflect higher warranty accruals from the increased shipment.

As we turn to cash flows, for the quarter we used approximately 1.8 million in cash from operations. Despite the strong net income and non-cash add backs, the increase in receivables and inventory were greater, resulting in the cash usage. In our fiscal fourth quarter, we expect to generate cash from operations of a couple million dollars, mostly due to our profitability, a reduction in inventory, and the decline this receivable balances. However, cash from operations could be adversely impacted by the timing of shipments around quarter end.

Regarding cash from investing activities, our capital expenditures were down slightly compared to normal levels. If you recall, the second quarter was high due to capital investments in our enterprise VSAT business. Year-to-date the conditions are similar to the second quarter -- strong net income and non-cash add backs offset by receivables and inventory growth, resulting in cash usage from operations. But we continue to expand our business at record rates and are not having to use debt to finance it.

Capital expenditures are increasing due to our enterprise VSAT service business expansion. And lastly, we received almost 3.5 million from the issuance of common stock, mostly exercised from stock options.

For the quarter, cash was reduced by about 2.4 million and year-to-date it is down by almost 9.7 million. We expect to generate cash in the aggregate over the next several quarters, maybe not every quarter individually, but we expect to be in a positive position overall.

Next I would like to turn it back to Mark who will talk about our business outlook.

Thanks, Ron.

At this point, I'd like to talk about our outlook for fiscal '05 and also into '06. Fundamentally our continued strong orders and promising pipeline makes it pretty easy to be comfortable with our growth outlook. We anticipate growth in both Commercial and Government Segments and expect to maintain a roughly 50-50 split for the next year or so. Longer term commercial broadband still has more potential for explosive growth.

We believe the outlook we've maintained for this fiscal year as was a whole will turn out to be pretty close. Over the year margins were pressured by investments in SurfBeam DOCSIS, but higher revenues have offset that in terms of EPS. There were some bouncing around in the quarterly tax rates because of the timing of Congress renewing the R&D tax credits, but that pretty much balances out over the full year. So currently we think full year estimates for fiscal year '06 of about $400 million in revenue and $1.00 per share pro forma are reasonable. That represents 25 percent year-over-year growth.

The second half of our fiscal years are generally stronger than the first half and it looks that way for fiscal '06 as well. Q1 of fiscal '06 would be similar to Q3 of fiscal year '05 -- that is what we just completed on an EPS basis. We anticipate year-over-year gains each quarter in fiscal '06. We'll discuss plans again next quarter once we see the value in timing of new awards, since there are some significant items that are still pending. There's potential we could grow revenues more than we currently estimate. We see growth coming in tactical data links, information assurance, VSAT networks and our broadband products. We also have good opportunities in government satellite communications.

Part of next year's plan is to invest part of the margin gains into these same areas. We think that is still consistent with our EPS targets and we'll work to communicate our plans on that throughout the year. The other important point is that it appears that the market forces that are driving our growth in these main areas ought to endure, for at least a few years. So that increases confidence that we can sustain our grow into fiscal year '07 and beyond, even if we aren't yet providing more specific guidance for those areas.

And the other point that I just want to emphasize is that -- on the chart is that our -- we do think we're going to hit that 10 percent top margin target that we've had in the fourth quarter of this fiscal year.

That covers all of the main points I want to make. In summary, we're pretty happy with our performance so far this year. Excluding the legal settlement last year, we set new quarterly records for sales earnings, new orders and backlogs. And we've done the same on a year-to-date basis, even if you don't exclude that settlement.

We've had strong performances from all of our core businesses. We've invested a lot more than we originally planned in our SurfBeam satellite DOCSIS system, but we're making good progress and we think the worst it behind us on that. We've had some unplanned expenses due to Intelsat 7 repoint, expenses due to fitting on the H&S business, when we were doing that and a lot of stocks compliance costs. But overall, we've had a lot of challenges but we've also had some really strong results in our government business that have helped us overcome that.

We've built up receivables more than we wanted, but we expect that to begin resolving this quarter and that should get us back to positive operating cash flow. The big $60 million MIDS JTRS development contract and a fast start to KG-250 sales are good signs for future growth. And our current outlook for the rest of this fiscal year is on plan and we're planning for 25 percent growth in pro forma earnings in our fiscal '06.

So that covers everything. Thanks for listening and at this point, we'll open it up for questions.

(OPERATOR INSTRUCTIONS) Our first question comes from Tom Watts of SG Cowen.

Congratulations on the quarter.

Thanks, Tom.

In terms of -- a couple of issues. One you have a new credit line you negotiated which looks like it's very favorable terms. Any specific uses for that other than financing working capital needs.

No we don't have any specific uses for it. It's just basically a really big safety net.

That's very nice. In terms of taxes for next year, how should we think about the tax rates on that?

Tom, this is Ron. Right now, we're looking at around a 31.5 percent blended rate.

Okay. Just finally, Gilat launched a new line of VSAT products and in this last quarter and reported fairly good numbers yesterday. So they seem to be on a path to recovery. Are you seeing them in the market more? How does their new products compare and do expect a recovered Gilat to have an impact on your commercial side?

One is -- there are 2 big competitors out there that we take seriously. I think -- so of course, we're going to compete as hard as we can. Right now, we're pretty comfortable with our projections for our growth. I don't think that's going to influence our perception of how we'll do. Does that answer your question?

Do you see them as being more active now and are they competing on price at all? Now that they're more solvent, are they not competing as aggressively on price? Any changes in the market conditions? Do you see them in competition?

I would say, there has been price competition. We have not perceived any dramatic differences, I'd say over the last several quarters. I know that in specific markets, we've been competing head to head with H & S and Gilat both on specific projects and we continue -- we win some and we lose some. But I think our growth trends and our perception of where our margins would be -- I don't think we -- we haven't noticed anything in the last quarter or so that would change that.

Tom, they've been pretty aggressive. We didn't think they really slowed down. There may have been some issues in terms of how the market perceived them for awhile, but we didn't really see them slow before. So I think where we do well is where we're addressing customers that fit our products,.

Okay, thanks very much.

Thank Thank you, Tom.

Our next question comes from John Bucher of Harris Nesbitt.

John Bucher. Can you -- the $108 million in new orders for the December quarter, did you break that down between Commercial and Government?

It's about 60 percent and 40 percent Commercial. The main thing we want to point out again is that orders tend to be pretty lumpy and wouldn't put over-emphasis on that breakdown for that particular quarter.

You talked about acceleration in the second half of fiscal '06 with respect to the Commercial side of the business. Besides the Ka-band opportunity, are you also factoring into that some of the internet and potential voice communication connectivity that you might provide to airliners and executive aircraft? And just sort of what trends and how are expecting that particular segment to be shaping up? Thank you.

Yes, I think that we're looking -- we're basically looking at -- one thing is we try to -- we try to pick a probabilistic outlook overall. But I would say that we see -- we have some evidence of stronger growth in the second half of next year for the broadband airborne products, basically the mobile broadband products in general. Does that answer your question on that?

Yes. Is there any change in your outlook for the overall addressable market there? Is it still -- I am guessing that the Ka-band opportunity dwarfs that one right now, in terms of absolutely dollars.

I wouldn't say dwarfs, you know, we're looking at good growth in both, in our broadband area. I think that, just in the -- we're basically working in the mobile broadband area with Boeing connection and we've also been working with (inaudible) SES connection. I think they believe they're making steady progress, primarily in the international market and they're also -- they've also talked about going into the maritime market and making some penetration in general aviation.

We see that stuff continuing to play out. On the SES Americom Airing (ph) front, one of the factors they've been waiting on is SEC license approval for operation in the U.S., which they expect to get pretty soon, probably this current quarter or the next one. And that will open up the general aviation market for them, probably more so in our second half. That's kind of what influences the timing. Did that help?

Yes, thank you very much,.

Thank you.

Our next question comes from David Kestenbaum of IRG.

Thanks a lot. Can you talk about, obviously you expanded the bank facility quite significantly. To follow up on Tom, are you seeing more acquisition opportunities out there? Is that part of the reason and likewise, I'm giving (inaudible).

In terms of our interest in acquisitions, one of the things we said before -- setting aside the H&S thing -- we've said we have interest in (inaudible) acquisitions in specialty areas. And I'd say we've explored a few and we're continuing to explore some that. That could be interesting under the right terms. Those are generally pretty small -- I mean tennish millions, that's kind of ball park for what that might be. I think we're going continue to look at those, where they can help us.

In terms of other company's interest in us -- there's not really much to say about that. We wouldn't comment on rumors. I can say you would think that we could be interesting to other companies, but that's really more up to them then us, I'd say.

Okay can you talk about the DOCSIS customer that you captured this quarter and what the opportunity is in North America.

We have -- there's not 1. We have been winning several DOCSIS contracts. They're pretty much domestic and international, 1 that -- 1 that's been reported on in some places is with SES Americom, so that 1 is out there. That is not the only 1 and we try to coordinate all of our customer leases with our customers, so I would say those are in progress and we'll report on them as we can. But these are all Ku-band ones.

And we will -- but I can tell you ball park, these are -- generally we're looking now for system type orders that are probably ball park 5 to $10 million a piece -- in that range. And each have good prospects to grow significantly depending on the success of our partners and their regions.

Finally, how big that that ComSat Labs NASA opportunity that you disclosed?

It's a multi-phased -- it could be -- I think for us it could be low millions of dollars per space and then more like in the 15ish range, second phase. And that would be a little over a year after a contract started. Plus we have partnerships with other NASA labs which would increase the total value of the contract, but wouldn't necessarily flow through us.

Okay, thanks, a lot.

Thank you, Dave.

Our next question comes from Larry Harris of Oppenheimer.

Yes, thank you, and congratulations on the results for the quarter. Last month, there was, I guess a report in terms of what would be happening in defense spending over the next 5 years and it looked like a lot of the discussion related to the FA-22, and the Navy's programs. But have you seen in the last month or 2, changes in the long-term planning -- the long-term defense planning that may help your business or affect it in some way?

Okay, that's a good question, I'll give you -- this is strictly my view of this, but it's based on a lot of the experience for us in this type of business. We have -- we don't have a lot of businesses that are tied to big high profile platforms like aircraft carriers or new air platforms, in general. We do have program that are tied to some platforms, like we have certainly have some F/A-22, some F-22 business, some JSF business. We have a little bit of business on transformational satellite TSAT program, but the bulk of our business really consists of upgrading existing platforms or putting things into ground units.

And it's not really tied to new platforms, so it may sound a little weird, but actually for us, when big new platforms or huge new strategic programs are deferred, that generally creates more of an opportunity for the types of products that we sell. To upgrade existing platforms in forces like F/A-18s and F-16s and a number of things like that. So we don't really see an adverse affect on us and, as a matter of fact, I think -- I wouldn't quantify it, I'd say conceptually, it probably provides longer legs for some of the products and product families we have now.

Thanks. Great. And just sort of a follow up to John Bucher's question with respect to the airline market, there was some discussion about the FCC perhaps investigating the ability for passengers to make voice calls. Are there any opportunities for you if the FCC were to approve that?

Yes. I think those recent FCC announcements -- there's really 2 different parts to it. One part is really intra-plane communication. For instance one aspect of it covered use of the 802.11 (indiscernible) on the plane for broadband. Another part referred to the potential for voice pico cells on the airplane. And that's a way to collect all the voice calls that people might have on their cell phones on the airplane. But then there would be the issue of how do you get them off of that airplane.

I think the satellite systems that we have now could be used in both of those modes. The 802.11 mode is already being used. Now I think there's another issue about -- might there be alternative ways to get on and off airplanes, for instance, through ground systems. And to the extent that there becomes a broadband ground system, that would be competitive with satellite in some market, but I think that the notion of using pico cells really is not -- that would be an enhancement as far as we would see.

I see, thank you.

Our next question comes from Matt Conn (ph) of Bear Stearns.

Hi. Good afternoon. I have a couple quick questions for you. I notice there's obviously margin pressure that you experienced this quarter. And to what extent was that caused by the situation related to the hurricanes? And also are you not insured for those type of losses?

Okay, one question is that all of the expenses, for instance, related to repoint and the hurricanes. Well, it's on the order of $0.01 to $0.02 a share, all together. We believe--you know we do have applications for insurance.

When it comes to the insurance side, we have filed claims with the insurance company, but rather than hang the costs up and while you're trying to figure out whether settlement or recovery is possible or negotiate with your insurance company a settlement, we chose a more conservative method, expensed them. And then should we recover something, we would go through that at that time and account for the reimbursement at that point.

And also, the LinkStar product is really gaining a lot of traction and there's a huge opportunity internationally. And can you comment on what plans you have to expand internationally. And you know if so, what would the implication be to your margins going forward as you develop and ramp up a sales force and so forth?

One we're working on expanding internationally. And I think that is -- I think that we've had success and that has shown in our results. I don't know want to get too much into competitive situations, but we haven't really -- while we've been strong internationally historically, most of it has been in the mesh market with our Starwire, Skylinx products and now with the LinkWay products and (inaudible).

But being so strong in LinkStar has been a fairly recent phenomenon. We are -- we feel like we're doing well in countries and markets where we've never had a presence before, we -- I don't think you'll see us make any sudden moves where we -- at one point, we have all of a sudden, we have all of these costs that we didn't have before.

We are steadily increasing our sales force and presence in other markets. And I think we're having success there, and that's our objective is to keep our margins -- in the VSAT networks side, we're in the ball park of 10 percent operating margins in that business. Have been doing that pretty steadily and we think that is sustainable and that is really what our objective is -- is to preserve that while we continue to grow.

And one house keeping question and you may have addressed this earlier on. Can you tell us what the operate is margins are by segment this quarter?

Yeah, we had segment slides. Yeah, I'm at computer real quick. But it's roughly around 14 percent in the Government Segment and basically zero in the Commercial Segment because our segment income in the Commercial Segment -- our operating earnings was $78,000 on a base of 41 million.

Okay. Well, thank you very much.

And our next question comes from James Mcilree of Unterberg Towbin.

Hi, this is (inaudible). I had a question about the gross margin. In the past, some of the cost overruns. Is that a one time thing or is everything under control now?

Well, we believe it is under control. We recognize what we think is the impact of the additional cost growth in the period, as required under the accounting rules. And we wouldn't expect to have another recurring event like that within this program. If we did, then we would have been required to recognize it last quarter as well. We think we have recognized the obligation.

And then regarding the gigabyte IP Encryptor, how far away do you think you are from putting one of those out?

It is always hard to tell because we have to get certification, but we think it will be first half of our next fiscal year. That product we -- will have a -- carry a higher average selling price than KG-250 will. But right now, we sort of expect that the market for that is smaller, but we will learn a lot more once the product is out.

Okay. Thanks a lot.

Thank you.

Our next question comes from Steve Mather of Sanders.

Why don't we make this our last question.

Well, thanks. Good quarter. A few quick things. On the expense side, can you just discuss briefly the cost of the facilities expansion. And then secondly, anything on the lease model for VSAT.

And then my final question is a bit broader. The way I think of your commercial opportunities is between 2 things -- the VSAT business versus the SurfBeam business. Would you qualify the VSAT business as a -- the decisions you made a few years ago to go (inaudible) in architecture and (inaudible) as a success that is just going to continue tot grow and bring your bread and butter? And the SurfBeam type business as the opportunity business? Would you frame the commercial side that way?

I'll take -- this is Ron. I'll take the first 2 questions on the capital required for the facilities expansion. We think it is going to begin this quarter. We're starting to break ground.

Was that your question, Steve? Was it capital?

Yes, sir.

And we think it is going to start this quarter and go for the next 4 or 5 quarters. We have 2 different facility expansions. One in the Northern Atlanta area and one here in Carlsbad. It'll cost a couple million dollars between the 2 of them over that roughly 5 quarter period. So it'll be spread, incrementally, over those periods. What we're doing, Steve, is build-to-suit type operations so the fundamental real estate and most of the infrastructure is in our lease -- will be in our lease. And regarding the lease, more so from the expense stand point, we have -- we will have in our queue -- I hate to defer the question, but we will have in our queue. You know, we've signed those leases, we've already updated what we believe the impact will be from an expense stand point, capital-wise in each of those areas. And that will be reflected in our lease table, so it might -- that might be the best place to discuss it.

Okay.

Steve, was your second question about the lease model for VSAT? I know there was one question about SurfBeam versus VSAT and the broadband versus conventional VSAT.

One is -- I'll tell you we are actually very happy with our strategic position in the VSAT market. I think we are really seeing, I'd say 2 kinds of classes of customers. One class, which is generally enterprise accounts -- they are going to buy a certain number of systems and they are very focused on having a solution for their particular problem, which emphasizes things like networking, particular networking features, or security features or particular protocol that they need to support. And a lot of times, those can often go beyond the requirements -- let's say the core specifications for one of the standards like (inaudible) or DOCSIS. And so, with our LinkStar system, we have good abilities to solve those problems and customize solutions to fit particular applications and we keep adding to our library of capabilities. And that has gone really well.

But we also are seeing some sets of customers that want, for instance, DVBRCS open architecture solutions. And obviously, to the biggest direct to home TV providers or ISPs that are looking for large scalable systems, they are very interested in one of these open standards. And generally for the large consumer scaled customers, the SurfBeam DOCSIS system has been the most attractive.

So we feel like we have basically 2 families of products that span that. I think we are doing well with that model. And, I'll take -- our objective is to get steady growth in the project networks portion of VSAT and to keep in play the potential for explosive growth on the consumer, especially during (inaudible). And we are happy with that position. I think there's cross-synergies back and forth that we are benefiting from. And I'd say right now, we are pretty bullish on the prospects.

I hope that answers your question. I think that covers all the questions for today. We thank everybody for your time and attention and we'll look forward to speaking with you again next quarter.

Thanks for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.