Viasat Inc (VSAT) 2011 Q1 法說會逐字稿

Welcome to ViaSat's fiscal year 2011 first quarter earnings conference call. Your host for today's call is Mark Dankberg, Chairman and CEO. You may proceed Mr. Dankberg.

Okay. Thanks. Good afternoon, everybody, and welcome to ViaSat's earnings conference call for our first quarter of fiscal year 2011. I'm Mark Dankberg, Chairman and CEO, and I have got with me Rick Baldridge, our President and Chief Operating Officer; Ron Wangerin, our Vice President and Chief Financial Officer; and Keven Lippert, our General Counsel. Before we start, Keven will provide the Safe Harbor disclosure.

Thanks, Mark. Before we get started I would like to remind you that the discussion today will contain forward-looking statements. We would like to caution you that actual results may differ materially from those projected in these statements. The risk factors that could cause actual results to differ are discussed in our SEC filings including our most recent reports on Form 10-K and Form 10-Q. Copies are available from the SEC or from our website. With that said, let me turn it back over to Mark.

Okay. We'll be referring to slides that are available over the web, and we'll start with the top of our financial summary for our fiscal 2011 first quarter. I'll discuss the major highlights as well as an overview of our business segments, and after that Ron will discuss financial results in more detail, and then finally I'll update our outlook for the fiscal year and summarize things and then we'll take questions.

First quarter results are summarized in this chart. We had good year-over-year growth in revenues and orders due to the WildBlue acquisition as well as good EBITDA and cash flow. But overall earnings were impacted by cost growth in a fixed price government satellite development program. That reduced our GAAP and non-GAAP diluted earnings per share this quarter by $0.12 a share.

We had performance and schedule issues and probably overcompensated in an effort to correct them. We're not perfect, but it has been a long time since we have had cost growth of this magnitude, and it is not representative of our culture of financial performance. Government Satcom is a big and it's a fast-growing area almost tripling in size over the last three years, and it has been very profitable even including the expense recorded this quarter.

We have taken a number of steps to add key resources at all levels to this area, including an executive management, program management and a chief engineer from other areas. At this point we believe the issue is behind us and should not have material impact on future earnings and revenue. Otherwise financial results were pretty consistent with our plans. We'll give more detail later in the call.

For this quarter and the next few, we're dealing with interest expenses and dilution from a three year satellite network build-out, and we won't see the benefits of that 'til next year other than WildBlue's current results which are good, but they are growth constrained because of satellite bandwidth. Looking at the highlights, you notice the timing for orders, especially government orders, has been a key issue. It has been a key issue throughout the defense industry for about a year or so, but there are prospects for that to change for us in the relatively near term, as a number of program award decisions are anticipated to be made soon. We will address these in the business area discussions in a few minutes.

Obviously the timing of customer orders is beyond our control. We work to balance cost containment against our expectations of our likely win rate. If our success rate on the pending award decisions is similar to what we have experienced in the past then this will be quite a strong year for new orders. In a nutshell we believe there are growth catalysts for each of our three business segments. They would be along the following lines.

For Government Systems, the pending award decisions near term and longer term will likely be affected by market forces emphasizing procurement cost containment, creating a more receptive environment for our lower cost products to replace more expensive alternatives or programs of record. That would be in the areas such as the Joint Tactical Radio System program, JTRS; in Tactical Data Links; in airborne intel, surveillance and reconnaissance missions; situational awareness; and military broadband satellite networks and services.

Also there are urgent new needs in cyber security creating demand for new products and services that are well suited to our skills and product portfolio. Especially encrypting data-at-rest on hard drives, what are called non-crypto controlled items for network encryption, and new capabilities in mobile security and network protection. In commercial satellite networks, our growth would be driven by new international satellite projects that are expected to begin over about the next year, the launch of several new Ka band satellites that are scheduled beginning at the start of calendar year 2011, and potentially by subsidies from US government broadband stimulus which are currently scheduled to be announced the week of September 6th.

In the Satellite Services segment introduction of new network and information technology infrastructure which will enable new and more attractive services on our existing satellites, should happen later this fiscal year. And that will be followed by even more advanced services on ViaSat-1 which are planned to be introduced in the second quarter of our next fiscal year, plus we also have a potential for broadband stimulus to benefit this area as well. Our mobile broadband business is growing steadily from a small base, and we believe there's increasing market awareness that more cost-effective Ku band and Ka band networks are going to capture the lion's share of bandwidth intensive mobile satellites revenues from the L band in the future.

We think we're in a good position in that portion of the market, and it should benefit as well from the new Ka band launches that are scheduled for next year. Of course our business outlook got a big boost with the Blue Force Tracking 2 win that we had just after the end of the first quarter, and that adds about $38 million in second quarter orders, and at about $477 million it's the second largest IDIQ contract we have ever won after the MIDS LVT terminals. So given that overall context, I'll discuss the some of the highlights for each of our segments.

In Government Systems, Government Satellite Networking has become our biggest defense business and has very good growth potential. There's really strong demand for airborne intel, surveillance and reconnaissance; ground broadband systems and situational awareness networks, including our recent Blue Force Tracking 2 production and deployment contract. At this time we anticipate significant near-term program award opportunities in this business area for broadband satellite ground networks. We also anticipate opportunities to expand the market for the Blue Force Tracking system to other applications beyond the initial delivery order contract valued at about $477 million for the FBCB2 program. One example of potential market is MTS, or the Movement Tracking System.

The Tactical Data Links business has been relatively flat for the last two years. We have established an early-leading position for production of the MIDS Joint Tactical Radio System variant which begins the US market transition from the MIDS low-volume terminals. There has been increased interest in MIDS Joint Tactical Radio System, or MIDS J, as the avionics community has become more aware of its production status and its functional capabilities. We anticipate that production volumes will build gradually.

We have delivered the first units of our Small Tactical Terminal, or STT, for NFA certification on the security part and customer testing. The STT initially combines a low-cost Link 16 capability with a UHF line-of-sight radio module supplied by Harris. The STT is being considered by a number of platforms that were otherwise planning for the Joint Tactical Radio System AMF, or Airborne and Maritime version, a small airborne form factor radio.

The STT is much, much lower cost and it's available on a much earlier schedule. There is good potential for meaningful orders this year. The business model we are aiming for is similar to the one Harris achieved with its early-entry Falcon JTRS compliant ground radio.

Our Information Assurance business has also been relatively flat to slightly down over the last two years largely due to lower production orders for tactical network encryption products. It appears the Army accumulated more units than were needed and that led to lower orders over about the last year or so, but we believe that our share of the market has been growing. We have seen increased ordering activity recently after some Army procurement organizational changes, and recent Defense Supplemental Bill passages are also expected to result in higher order flow.

We have a new smaller version of the KG-250 now available for order that is expected to be in production in our fiscal fourth quarter, which we'd anticipate would be the strongest quarter this year for that particular area. The new version has been anticipated for a while and we believe will tap into some pent up demand.

We also recently acquired the Stonewood Group, a small UK company with a position in data-at-rest encryption markets product segment for classified secret and sensitive but unclassified markets. That should strengthen our leading position for these media encryption devices which to date has been focused on the higher value though smaller top secret market.

We see budget containment as a central theme in DoD procurement. We believe that creates opportunities for our cost-effective products in each of these segments. Key opportunities for us include these lower-cost JTRS radios, modifications of our existing JTRS products to reduce development costs and/or risks in the multi-billion-dollar AMF and/or GMR JTRS programs, increased adoption of our lower cost Blue Force Tracking situational awareness networks and products, and growing adoption of our commercial satellite broadband and Airborne ISR, or intel, surveillance and reconnaissance products and services. The urgent need for cyber security products and capabilities in multiple areas is creating new market opportunities that we believe are well suited to us, and we have been invited to submit a number of proposals to key customers.

In our Commercial Networks, our Antenna Systems business has been the most profitable and fastest growing piece of that satellite network segment. Business in that unit has been broad-based, including Ka band, gateways and teleports, mobile broadband antennas, defense applications, and our traditional earth sensing and imaging ground terminals. The outlook for our Commercial Satellite Networks business remains good.

ViaSat has been a leading provider of conventional Ku band fixed satellite services products, but as the market begins migrating to much more cost effective Ka band solutions we believe our competitive position becomes even stronger. As an example, we have got a picture on this page of Ka band evolution to our VR-12, Ku (sic -- see slide 8) band mobile broadband antenna which we use on both defense and commercial airborne and a few other ground platforms as well. This Ka band version is planned to be tested on both defense and commercial satellites this year showing what is possible with these powerful new satellites.

As we mentioned in prior quarters, our Ka band consumer terminal business is inhibited for the next couple of quarters by several factors including limitations of capacity on existing [Wobbly] and Telesat satellites in the areas with the highest demand, our acquisition of WildBlue which means that we no longer recognize revenue for sales of terminal equipment that are leased by WildBlue branded retail customers and the timing of the launch of the upcoming Ka band satellites, KA-Sat in Europe, ViaSat-1 here in North America, and Yahsat 1B in the Middle East. In the interim, revenues are tied to infrastructure and production startup for the new satellite projects we just mentioned.

Catalysts for revenue and earnings growth in this area include the potential to win one or more additional new international satellite projects such as the one for the Australian national broadband network, the impending launch of Ka-Sat which will be about the start of the next calendar year and the potential to win broadband stimulus funds which could increase the sales of our Ka band SurfBeam terminals to WildBlue distribution partners and/or subsidize purchases of equipment for WildBlue retail customers. Also at the end of last week, the RASCOM replacement satellite was successfully launched. We provide their ground networking equipment for telephony and some forms of cellular backhaul connectivity throughout Africa.

Our Satellite Services segment was very profitable this quarter as the WildBlue business is performing according to plan or better. Our main initiatives with WildBlue have been to ease off on subscribers in the beams with the most current customers to improve service quality compared to when we acquired the company. We're working on network infrastructure upgrades and preparing for the integration of the next-generation SurfBeam 2 ground network on all the satellites and the launch of ViaSat-1.

Total subscriber count has reduced by about a percentage point or two. ARPU has held relatively constant as has churn and cash flow is good. We expect modest subscriber growth from this point through the end of this calendar year.

We reached an important milestone with the ViaSat-1 satellite when we completed payload performance testing and the satellite was placed into the thermal vacuum test chamber. The payload performance and the satellite capacity remains within expectations. The satellite launch is now expected a little bit later than originally scheduled, but still consistent with beginning service in the second quarter of calendar year '11, as we discussed in our last call.

Both WildBlue and its distribution partners submitted good proposals for the Rural Utilities Services broadband stimulus grants. The government has said it intends to award approximately about $100 million and just recently stated that winners would be announced the week of September 6th. WildBlue submitted proposals with DIRECTV, Dish, and the National Rural Telecom Cooperative as co-applicants, and also some of our distributors submitted their own proposals using the WildBlue service. So if we and/or our distributors are selected, we believe that would have a favorable impact on WildBlue subscriber growth as well as network equipment sales.

Also our ArcLight mobile broadband businesses continue to grow. We have got about 800 commercial planes and ships on the network and we are seeing steady progress. As described in the previous slide, we're working on extending ArcLight to government and commercial Ka band satellites, too. So at this point, Ron will go into more detail on the financial data.

Thanks, Mark. We'll begin with a segment discussion followed by further P&L discussions, our non-GAAP measures, the balance sheet and then cash flows.

Our Government Systems segment revenues were down about 4% in the quarter, year-over-year. The reductions are primarily related to lower information assurance and Tactical Data Link product sales which have been impacted by delayed awards due to the timing of government funding for a number of our customers. These reductions were offset by higher sales of Government Satcom systems. Operating earning for the quarter were down substantially, primarily due to the $8.5 million increase in our estimated cost for our Government Satcom program previously discussed, as well as higher selling, bid and proposal costs incurred when compared to the prior year, which reflects an expanded sales funnel.

Our Commercial Network segment revenues were down almost $18 million or 28% in the first quarter year-over-year. The reduction was primarily due to lower enterprise VSAT sales as well as lower consumer broadband product sales and lower mobile satellite networking development sales. These reductions were offset by higher Antenna Systems sales. Our operating results in the Commercial segment yielded a loss in the quarter versus a profit in Q1 of last year.

The year-over-year difference is principally due to lower earnings contribution from the lower sales as well as higher R&D costs, principally for our SurfBeam 2 system. These were offset by lower selling and new business support costs.

Our backlog in the Commercial Network segment contains several lower-margin development programs for our SurfBeam 2system. As we obtain follow on programs and orders for customer premise equipment for the satellites that are scheduled to launch in the next 12 to 18 months, we expect our operating margins will improve.

For Satellite Services the revenue increase for the quarter year-over-year was attributable to the addition of WildBlue and from higher global mobile broadband services. Operating earnings results were also positively impacted by the WildBlue acquisition and reaching scale in the mobile broadband business where there are sufficient customers on the network to generate earnings.

As we turn to the rest of the P&L, amortization of intangibles is higher due to the acquisition of WildBlue in our fiscal third quarter last year. Other expenses is essentially interest expense from our senior notes and line of credit that is not capitalized. We expect the amount to be reduced sequentially each quarter as the capital on our satellite and other long-term assets under construction increases, and will also depend on our total debt outstanding.

Our income tax provision for the first quarter reflects an annual tax rate of approximately 37%, which is significantly higher than the 26% tax rate in the first quarter of last fiscal year. The higher tax rate for the three months ended July 2 reflects the December 31st, 2009, expiration of the Federal Research and Development tax credit. The estimated effective tax rate is different from the expected statutory rate primarily due to State Research and Development tax credits.

In looking at non-GAAP metrics, non-GAAP reconciliations includes both earnings per share and adjusted EBITDA information. Non-GAAP earnings per share exclude stock-based compensation expenses, acquisition related expenses, and the amortization of acquisition related intangibles. All net of income tax effects.

Our diluted share count increased substantially for the first quarter year-over-year, principally due to the 4.3 million shares issued in connection with the WildBlue acquisition in December 2009, the 3.2 million shares we issued in an equity offering in March of this year, and about 1.2 million shares from the exercise of stock options and vesting of restricted stock units over the past 12 months.

Last quarter we added adjusted EBITDA and we believe this is an important measure since we are a public debt issuer and for [initiary] comparison. Our adjusted EBITDA of $37.6 million was impacted by the $8.5 million program cost growth, but nonetheless represented a nice improvement year-over-year.

In looking at the balance sheet. While the balance sheet contracted a little in the quarter, it was primarily due to the paydown of $30 million on our revolver which reduced cash and debt. Our accounts receivable position continues to improve with our day sales outstanding at historic lows. Inventory is increasing largely due to a higher mix of sales coming from mature products and near term forecasted demand. The balance is a little higher than we want, and we expect it to come down some over the next two quarters.

We continue to make progress on the ViaSat-1 satellite which is reflected in the $28 million change in the quarter. Also we're starting to incur costs related to the ViaSat-1 Gateway Infrastructure and Network Center, so other PP&E investments are also increasing. Our total capital outlays through ViaSat-1 in-service date continues to track to previous communications. The only real significant change in liabilities was the reduction in the revolver, and we currently have approximately $230 million of availability under our revolving line of credit.

Turning to cash flows, we had a good start to the fiscal years from cash flow generation perspective. We generated almost $39 million in cash from operations. We used the cash to fund capital expenditures primarily for the ViaSat-1 satellite and related ground and network infrastructure equipment, and to pay down some of the outstanding amount on our revolving line of credit. At this point, our previous communications for ViaSat-1 capital expenditures and cash flow generations from operations remain intact. Now I'll turn it back to Mark who will discuss our outlook.

Thanks, Ron. We believe our financial outlook for the balance of this year is consistent with our prior plans. Award timing could be something of a wild card. Government contract awards have been slow, defense industry-wide, but we're pretty optimistic that a number of awards for programs we have been working are closer at hand. Longer term we like our competitive positioning and the prospects for the particular market segments we address.

The international satellite opportunities are as unpredictable as the government business in terms of timing, and of course some of those might not be awarded at all. And we don't really consider those to be quite as imminent as the government opportunities. Still there appears to be increasing interest in and demand for Ka band broadband systems overall, and we're quite happy with our competitive positioning in that area.

In aggregate, we believe we're well positioned for a number of relatively near-term significant opportunities, and if our win rate on those is similar to what it has been in the recent past in comparable situations, we believe our new awards for the year could be better than originally planned. The initial $38 million delivery order on BFT 2 contract occurred in our second quarter, and it's obviously an important and favorable factor in our view of our total awards outlook for the current quarter and our year as a whole.

In addition, if we and/or our distributors capture a reasonable portion of the RUS satellite broadband stimulus grants that would help accelerate subscriber adds for WildBlue prior to the launch of ViaSat-1 beyond what we are currently expecting. It could also directly or indirectly increase commercial satellite networks' equipment revenue later this year up through the launch of ViaSat-1.

And then the impact from the changes we made in our capital structure late last year, the bond and the additional equity offering, and the delay in extending the R&D tax credit should be factored into any models for our earnings. Our annualized tax rate would be approximately 37% without the credit or 26% with it.

So to summarize, let's take a quick inventory of what is going on across our business. In our first quarter earnings were impacted by a pretty unusual fixed-price program cost growth, as we saw possible new orders, especially defense, suffered continued delays. But early in the second quarter we won the Blue Force Tracking 2 competition with an IDIQ contract ceiling of about $477 million, our second largest ever.

So what do you make of all that? We look at the rhythms and timing of each of our businesses.

Government Satellite has been a big growth engine for us, about tripling in revenue from fiscal year 2007 through fiscal year 2010. It appears that it will be our fastest grower again this year, with a good shot at better than 25% year-over-year revenue growth, driven by clear and likely enduring demand for airborne intel, surveillance and reconnaissance, situational awareness and broadband applications. That area was actually our slowest defense grower for several years before that while we established our position in advance of the market demands. While we don't see 25% growth there indefinitely, we believe we're well positioned in an important area building on a track record of innovation, operational success and cost-effective products.

But meanwhile, our Tactical Data Links and Information Assurance businesses have flattened over the last three years, sort of like Satcom was before it grew. But we see both areas as fundamentally very sound with good growth opportunities and high entry barriers. Our competitive position has improved quite measurably in each of those areas.

NSA reduced the number of its high assurance internet protocol encryption suppliers for the last version upgrade from three down to two which includes us, and our market share of unit sales is up relative to the competition. We have got a leading position in the data-at-rest encryption market, which we believe is going to benefit as more comprehensive policies to improve government cyber security are defined and implemented. The overall level of urgency for cyber security in general, and information assurance as a key part of that solution, is only beginning to be felt.

Our share of production awards for MIDS J is significantly higher, much earlier in the program life cycle than it was for the LVT version. MIDS J is just now establishing its position in the overall joint tactical radio system market as a lower cost, lower risk product at a time when cost and risk are more important in defense acquisition thinking than they have been in about a decade or more.

The upshot of this, combined with the growing backlog of slowly occurring, but pretty likely nonetheless contract award decisions, helps create a sense of optimism about new contract awards. Our BFT 2 win enforces that. It's always difficult to replace an incumbent in a risk averse DoD environment, but a compelling value proposition at a time of intense cost pressure has a better chance now than it did when DoD acquisition budgets were flush.

Meanwhile our commercial networking products were also flat to down. That's because we and our customers have a relatively low supply of the low cost bandwidth needed to fuel product sales. Fortunately the cure for that is nearing as new satellite launches create opportunity for sustained growth in Europe, the US, Canada, and the Middle East starting early next year.

While the lead time on these projects is long and sometimes frustrating, it also means that we can have a significant competitive advantage in Ka band equipment markets driven by similar lead times for other systems. That kind of market advantage is what makes us optimistic about our position in capturing new Ka band networking projects that are appearing. With that as backdrop, we look forward to talking to you all next quarter for the next update on how these events play out. And at this point, I think we'll open it up for questions.

(Operator Instructions). Our first question comes from Rich Valera.

Thanks. Good afternoon, gentlemen. Just on the order front. Last quarter you had said you had the prospects for potentially having a positive book-to-bill for the year. And it sounds like timing vagaries aside that you think your order outlook might be a little better. So is it fair to say you still think you can see a positive overall book-to-bill for the year?

Yes, that's fair.

Great. Then with respect to the growth of your various segments. Just looking at the government segment sounds like Government Satellite you are quite optimistic on the growth there and maybe a little bit less so on the near term growth for Data Links and Encryption. But overall it sounds like you put them together, you would expect that business to grow this year from a revenue standpoint. Is that a fair assumption?

Yes, that's true.

Great. Then on the $8.5 million loss. Just wanted to clarify if this is the same program you had called out last quarter. I think last quarter you mentioned you'd taken a total of $7 million of losses on the program. Is this the same one?

Yes.

I guess it begs the question what gives you the confidence this is it. It seems like this was third loss that you had booked on this. Have you reached some milestone that gives you some conviction that you have put the bulk of these delays behind you?

Yes, it is just based on where we are in the program, and that we are going into the final testing phase of it, so that coupled with the progress we made on testing, that's basically what it is.

Great. And just one more with respect to your outlook. Last quarter you talked about adjusted EBITDA in the ballpark of $200 million for the year. Is that still an operative number to think about?

We still think it's achievable. I mean, there's a lot of pluses and minuses, but we still think it is an achievable range.

Great. And just one final one if I could on the BFT2 program, obviously a big win for you there. Can you talk about the delivery time frame you expect for that first $38 million award, and I guess as sort of a follow on when you might expect to get your next award in that program?

We expect in the two-thirds range over the balance of the fiscal year of that $38 million. There's components to getting it through tests and then some initial production units, and so we think it's a good program, well staffed and we're off to a good start.

Then with regards to other orders I think it just depends on the customer's timing, and how we progress through the testing phase.

Great. I'll yield the floor, thank you.

Thanks.

Thanks, Rich.

Our next question comes from Michael French.

Good afternoon, gentlemen.

Hi, Mike.

I was just going to follow up on Blue Force Tracking 2. Obviously your competitor put out a press release that said they intended to challenge the award. Have you heard anything else on that? Because it seemed that the press release might not have been based on accurate information.

No, we haven't heard anything yet.

And so the schedule you just laid out assumes that there's no challenge that's upheld, obviously?

Yes, sure.

Okay. And then a question on the ViaSat-1 payload testing. Now that you have got it assembled and have been able to test it, has there been any change to the anticipated throughput, i.e., the 100-plus gigabits a second?

No. We spent a lot of time on that and got a lot of detailed characterization, and no, we're comfortable with the performance that it will do what we expect.

Okay. Very good. Thank you.

Thanks, Mike.

Thanks.

Our next question comes from Mike Crawford.

Thanks. Regarding the Blue Force tracking. When do you expect to see an RFP for the mobile tracking system, and how would you characterize your prospects of winning that network?

The government is going through an evaluation process. They went through an RFI to get inputs for other alternatives. I think their desire for looking at other alternatives is sort of driven by two things.

One is they wanted to get away from proprietary solutions, and I think they wanted something more cost effective. Our BFT 2 program deals with those two issues. I think there's, obviously, benefits to commonality, so I think we have got a good shot at it.

But we'll learn more when they go through a more formal RFP process. I think we should see something over the course of the next year or so for that next step.

Okay. Thank you. And then you commented on the launch window for ViaSat-1. So I mean, would you expect that to be now more of like a March/April thing or what?

Last time we talked about a launch middle to end of Q1 and in service Q2, and now we're probably more across the line into early Q2 for the launch, but service would still be in the second quarter as well.

Okay. Thank you. And then maybe a final broader question on cyber security. Exactly what strength would you say you have besides data-at-rest, but for data-on-the-move between military and/or commercial networks?

The cyber security initiative is going to cover a bunch of different areas, but some of the areas are things like detection, so that is trying to understand what is going on in your network. That is an area we haven't traditionally been involved in, but because existing intrusion detection systems are so inadequate, I guess is the way to put it, people are looking at a lot more -- a lot much broader range of technical approaches to that one.

Also there is a lot of interest in things they call like filters or other ideas of separating different levels of networks or separating networks from each other. That is also an area we have got some background in. And there will be, I will bet, a bunch of new areas in mobility, especially around mobility of personal electronic devices. Those are some of the areas that I know we have got a lot of interest in things that we're doing.

Okay. Thank you.

Thanks.

Our next question comes from Chris Quilty.

Question for you regarding the Commercial Networks business. You have had real good order flow coming into the quarter here, and a pretty good backlog running in that business segment. And if I remember correctly, you should have some big infrastructure deployments with your partners, both Yahsat, and Eutelsat.

So would you expect a sequential rebound on a go-forward basis through the balance of the year in that business? Or is it primarily just reflecting the downturn in terminal requirements?

I think the current quarter what you saw was reflecting a downturn in terminal requirements and some softness on the enterprise networks. We've said before that the development efforts that we have in there for Yahsat, Eutelsat -- these initial development efforts are fairly low margin, they have a bunch of MRE embedded in those contracts.

So yes, that should pick up as we begin to deploy those networks, but we think it will really begin to pick up as we begin to deploy the CPE in those systems which will be later this year.

Okay. So that was your statement earlier that you have got some low-margin backlog in the Commercial Networks, earlier?

No, on those initial infrastructure projects, yes.

Okay. And yet, I think almost immediately after you said that you expected operating margins overall for the Company to trend up --

Yes.

-- in spite of that? For all the other things happening in the Government segment and the Satellite Services?

Yes. In that segment later this year, like I said, as we begin to deploy the CPE and then we hopefully are going to win more projects than we currently have in the backlog. And the incremental projects should be at higher margins.

And when do you expect to commercially release the SurfBeam 2 modem?

That will go with Eutelsat following the launch of their satellite and, obviously, we're doing testing on that now. That will be the first of the next generation deployments.

But one of the other things we're looking to do is to deploy it on our own network on the existing satellites. That would be Wobbly [One] and Telesat satellite. That will help improve the services. It's more efficient, offer higher speeds, and better responsiveness, and those will both be about the same time probably early first quarter calendar 2011.

Okay. Got you. So the big news in the industry on Friday, Inmarsat announcing their I-5 satellite program, three big Ka band global footprint satellite, obviously a great endorsement of your Ka band strategy. But how do you view their implementation of that, which is obviously very different than your business model and your satellite construction, as either an opportunity, a risk or just totally neutral?

So, one, I think it certainly is an endorsement of the Ka band strategy for global mobile, which is one of the things we have been saying and working towards. Inmarsat is a really good company. We work with them a lot. We would like to work with them on that. For instance they'll provide bandwidth for a lot of the Blue Force Tracking applications.

But I think what you've got to look at is that there's really a couple of different themes in this broadband mobile. One is globalness. And Inmarsat really embodies that already with their L band system and they're recognized as truly global. It is something that we in KVH have worked to create at Ku band. So one is the globalness value proposition which Inmarsat clearly looks to deal with.

But the other one is a local value proposition which is really a speeds and bandwidth pricing. I think one of the things you can tell is that the existing Ku band, maritime and aviation and energy markets, all these mobile applications, came into being because customers value that local aspect as well as the global part.

So if you fast forward ahead a few years, I think you'll see the same thing. What we feel like is satellites like ViaSat-1 and KaSat and Yahsat which have much, much higher capacity will continue to do well on the local part, and what we would like to see is that becomes integrated with this global value proposition. It would make a pretty cool global seamless one. We'll have to see how that all plays out. But I think that gives a sense of what the different value proposition are in the areas and how Inmarsat could play in that.

Great. Thank you.

Thanks, Chris.

Our next question comes from Jim McIlree.

Great. Thank you. Can you help me understand the quarter-to-quarter decline in commercial revenues? Was that driven by the commercial VSAT business?

Yes, primarily. Yes.

Okay. And the subscriber decline in what used to be called -- or in the WildBlue operations? I think, Mark, you said that was planned, but probably modest growth from here, or is it another planned decline and then modest grow from there?

No, the way I put it is there are a few factors going on. One is what is going on in growth additions; what is going on in churn.

I would say our growth additions are where we expected. The churn also sort of where we expected. What accounted for the decline was that in the areas that have the most subscribers, those are the really high-demand beams, where we inherited a pretty big number of subscribers in those beams.

We chose not to take more gross adds to replace churn in those beams to try to bring the service level up a little bit, and that's what has happened and that accounts -- that is basically the only what I would say material change at all in WildBlue business.

Now from here we think that it is at a good level, and we have got some things that we'll be introducing that will improve the service quality even if the subscriber accounts hold the same or go back up a little bit, and we expect to make progress on the low demand beams as well. So that's why we said that we expect things to start progressing up from where they are now.

The only thing I would say is that may not happen month over month or necessarily next quarter over this quarter. But over the next few quarters.

Yes, that's our plan between now and the launch of the ViaSat-1 satellite.

Right.

The one fact that could make that, say, significantly better than what I just described would be the broadband stimulus program, which would probably have a favorable impact on the outlook there because of equipment subsidies.

Right. Okay. And I just want to make sure I have the time line of the launches correct, you are looking for a ViaSat-1 launch in early Q2, I think you said?

Yes.

Okay. And then it sounds like if everything goes according to plan then it would be kind of a late Q2 bring it into service.

Yes.

Calendar.

Right. Calendar Q2 is correct. Okay. And then KaSat, you are expecting sometime around the end of this year and then if all goes according to plan maybe a couple months after that to be in service.

Yes. And you would have to talk to Eutelsat to get the exact dates, but that's our understanding. It is kind of the end of this year. End of this calendar year.

Okay. Terrific. That's helpful. And I'll re-queue. Thank you.

Okay. Thanks, Jim.

(Operator Instructions). Our next question comes from Michael Ciarmoli.

Hey, good afternoon, guys. Thanks for taking my question. Can you just provide an update? You're talking about potential awards and potential --- I guess your pipeline, maybe the update, just a status on the in-flight connectivity market. It's like, I guess we're already seeing some bottlenecks with the air to ground connectivity service.

What's in the cards there for Ka band? I've heard some buzz about it, and do you have anything specifically in the pipeline?

Yes. Sometimes it takes patience. What we've been -- our thesis is that it is about bandwidth. Air to ground system has worked well. As you add more and more airplanes and subscribers, the amount of bandwidth that you have gets stretched farther, shared more. And I think it is noticeable that it doesn't work the way it did when the first service was first launched, and there is still the bulk of the airplanes scheduled to come on. I think that that is highlighting this issue about bandwidth.

We have existing Ku band services. Those Ku band services work well. We have been using them for business jets. I think there was a window probably earlier in the 2000s, when Ku band probably fit the utilization profile for bandwidth better. I think from where we are now and especially looking forward, it's not so clear Ku bands economics are very enduring. If you look at a pretty big capital buildout in terms of equipping airplanes with that, not so clear that's a good bet.

Ka band, if you can drive bandwidth cost down substantially -- and that's the whole thesis of ViaSat-1 and KaSat and the Yahsat satellite -- I think that has long legs, a decade or more, and so I would say we're getting growing awareness of that. We're seeing early adopters who are looking to test that, both on the commercial and the government side, and I'd say we are optimistic about it.

I think it's a little hard to come up with a timeline, but you look at all the market forces, I mean set aside competitive forces, just look at market forces, and I think they are all driving in that direction.

Okay. And would your play on that, would it be the goal to maybe partner or cultivate strategic relationships with some of the existing providers, or even some of the avionics providers, the Panasonics and Telus's of the world who are providing those IFE systems?

I would say we are looking at a variety of approaches. Those range from managing the service ourselves, which we do with our Yonder service now, so that would be the most go-it-alone strategy, to partnering with any of a set of people that could help bring that to market or operate it, or provide bandwidth in other parts of the world.

I would say we're generally pretty flexible in how we go about it, and it will depend on the situation, I would say, is the way we would want to play it.

Okay. Fair enough, and then just two quick ones on the BFT and MTS. Was it strictly, I guess, cost? Was cost a determining factor? Or was there anything else? Your decision to build and launch a satellite did that play any role in the DoD's decision looking at their need to potentially switch vendors, and maybe just a lower total cost of ownership down the road? Or did ViaSat-1 not play a role at all?

I don't think ViaSat-1 played a role. I think the government when they envisioned the BFT 2 program, they had certain objectives. High on that list were higher performance, lower cost, and achieving more open network standard. I think those were three of their objectives.

All of their program objectives eventually are captured in their evaluation criteria, and I think that's what they used was the evaluation criteria between the competitors, and price being one of those evaluation criteria. I think that's what it came down to.

Okay. And then on MTS are you guys going at that alone or are you partnered with a larger contractor?

Right now, as I mentioned before, they are really in an RFI stage. I think they will use the RFI inputs to come up with an RFP, and if the RFP is at all like the Blue Force Tracking system, and has a similar scope of work, then we would go after that ourselves. It may involve satellite bandwidth or other aspects in which case then we'd partner. So we'll just have to see what the RFP says.

Okay. Perfect. Thanks, guys.

Thank you.

Our next question comes from Jim McIlree.

Okay. Thanks. The program that you had the charge on this quarter?

Yes.

Let's say that it --- well, let me ask it this way, does it complete this year? Or is it scheduled to complete this year?

Essentially.

And then what happens? Does it go into production, or at that point a production decision is made?

It would go into production.

Yes. It would go into production. Yes. We expect a decision for that, Jim.

Okay. So that would be -- is that production ramp part of your expectation for fiscal 2011, or is that more of a fiscal 2012 ramp?

It is really de minimis when you look out for the remainder of this year.

So it would be more next year.

Right.

Yes.

Okay. Great. And I just want to make sure I understand the comments that you made, Ron, regarding the commercial development contracts with low margins that are in backlog. You are talking about the development part of those, of that equipment, correct? Or are you also saying that when you go into production, you are going to have low margins on that as well?

No, it's the development phase.

Yes, and the development is associated with the original, the initial network infrastructure deployment.

Correct.

All right.

So that doesn't speak at all to any follow-ons for new network infrastructure.

Spares.

Or for the user terminal equipment.

Right. And years and years ago when you were first starting out with the supplying equipment to WildBlue there was lingering margin pressures, because the initial development contract was linked to the initial production. Is that a similar scenario this time, so that these developments are going to linger?

No.

Okay.

And we have a few terminals delivered under that initial thing, but no.

Yes, so when we get these contracts, the contracts were largely infrastructure, and a few tens of thousands each of terminals. So those first few tens of thousands of terminals would be bundled in, but all the following production contracts would be separate.

Okay. And then lastly, relative to pricing the service on ViaSat-1, have you changed your thinking at all about pricing, either up or down?

We're going through our service plans, and I think that the main thing we're looking at is -- well, I would say a couple things, one is expanding the dynamic range of services. Right now, for instance, WildBlue has retail service plans at $50, $60, and $80. We're looking at expanding that dynamic range which would involve creating service plans say at lower prices and also at higher prices as well as probably keeping those price points, and we may diddle with some of the parameters in those interim ones, but it will be pretty close to what we talked about in the past, I would say.

Does that help at all? We've been talking about 2, 4, and 8 megabit-per-second plans covering that $50 to $80 range. And certainly cover at least that 2, 4, and 8 megabit range, but we might go down market a little bit, up market a little bit and we might expand the dynamic range a little bit.

Right. Okay. And is that across the constellation, or are you just talking about ViaSat-1?

So now things are a little bit more complicated because of the broadband stimulus program. In the broadband stimulus program there are different flavors of applications. There is nationwide and regional, and then the regions that they use are -- don't necessarily line up with the regional coverage of ViaSat-1.

And because we look at it as a fairly important thing -- that is part of what is causing us to make some adjustments to our plans. In some cases you'll see things that are uniquely ViaSat-1; in some you'll see national plans that are a little bit of a blend. And that's complicating it a little bit, but overall value proposition on ViaSat-1 hasn't really changed.

Yes. That's helpful.

Did that confuse things more, or did that help a little bit?

No, that's what I was looking for.

Okay.

Distribution partners on ViaSat-1. Is there -- what is the expectation on timing of formal signings with those guys?

So I'm not sure that there will be -- let me just call it formal signing, because we have these distribution relationships that we can easily extend to the new satellite, and I think and it will more along those lines. So the things that we're doing now with our distribution partners are more along the lines of lining up these plans, lining up the information systems that go with rolling out those plans.

And one of the good things is the broadband stimulus was a little bit of an external forcing factor there in terms of helping to start bringing things together. So I would say I think we don't necessarily expect sort of a dramatic demarcation line, what we expect is just an evolution, where we will start introducing new plans, and then you'll see our distribution partners adopting those plans as well.

Okay. All right. I was thinking it was more like a drop-dead date and then you had to resign up some (multiple speakers) partners.

Not anything like that. No.

Okay. Great. Thank you.

Thanks, Jim.

Our next question comes from Ron Epstein.

I think that's the last --

Okay. Yes.

Yes. Good afternoon, guys. Just a quick question on WildBlue, what do you expect the subscribers to be at the end of the year? Is it going a little slower than you thought? Can you give us some color around that?

What we said was we thought we might have flat to modest year-over-year growth, and we started with around 420,000 to 425,000 subscribers. I think, as I mentioned, we were at about 415,000 at the end of the quarter. I think that will get back up where we were, maybe a little bit ahead of that. Absent the stimulus program. With the stimulus program we have the opportunity to do that.

Okay. And why did it pull back some?

I described earlier the effect is we've had a churn rate, which I've described as fairly constant, fairly consistent in the beams that we inherited when we acquired the company that have the highest demand. There were very high concentrations of subscribers, so we chose in those beams not to replace the subscribers that churned off, because we felt it would improve service quality, and that is what has happened. That is the effect.

Okay. Great. Thank you.

Okay. Thanks. One more.

Okay.

Last question.

Our next question comes from Rich Valera.

Thanks. Just a quick follow-up on operating margin. If you back out the charge you guys took this quarter, your op margins would have been pretty impressive. I came up with around 13.5%.

I am just wondering how valid that is as a baseline; like if there were any unusual benefits in the quarter. And then I guess we obviously have to factor in as well as the work through of those lower margin commercial development programs as we move through the year. So just wondering if you can give us any color on where you think op margins trend relative to that 1Q baseline if you were to back out that charge?

There weren't really any special onetime benefits on that side. So if you adjust the Government margins as you said, or add back the program charge, the Government margins were pretty good, consistent with historical. We talked about where the Commercial margins are and then you look at the Satellite Service margins.

I would say the Satellite Service margins are an artifact of where we are relative to sub count, and as we grow you have commission expenses and things like that come into play that end up being period costs that could reduce your operating expense. So given the fact that we had some reduction in the sub count overall, you wouldn't incur those, and therefore, it becomes more profitable. So it really becomes a weighting on the Satellite Service side.

As Mark said about subscriber growth over the balance of the year, we expect modest growth from where we are now, and therefore the results in the Satellite Service segment, probably going to be a little bit better than we planned, but trending down from where they are at the end of the first quarter.

Okay. That's helpful. Thank you.

All righty.

Okay.

Okay, that's it. Thanks a lot everybody for tuning in and listening. Appreciate all the questions, and we'll talk again next quarter.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone have a great day.

Thanks, you too.