Viasat Inc (VSAT) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the ViaSat fiscal year 2013 second quarter earnings, call. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

As a reminder this call may be recorded. I would now like to introduce your host for today's conference, Mr. Mark Dankberg, Chairman and CEO. You may begin.

Okay, thanks. Good afternoon, everybody, and welcome to ViaSat's earnings call for our second quarter fiscal year 2013.

I'm Mark Dankberg, Chairman and CEO. I have got with me Rick Baldridge, our President and Chief Operating Officer; Shawn Duffy, our interim CFO Vice President and -- our interim CFO and Vice President and Chief Accounting Officer; and Keven Lippert, our General Counsel.

So, before we start, Keven will provide our safe harbor disclosure.

Thanks, Mark.

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

With that, back to you, Mark.

Okay. Thanks, Keven. We will be referring to slides, as usual, and they are available over the web. I will start with some highlights and a top level business overview, and then after that Shawn will discuss our financial results. And then I will give more depth on each of our business segments, and then we will take some questions.

So, our second quarter was pretty exciting across the board, and I'll touch on some of the highlights here. We did really well on new orders, over $540 million this quarter, on top of a strong first quarter, too. So, year-to-date we are at about $880 million in new orders and we've built a backlog of close to $1 billion. The single largest order in the second quarter was for the Australian National Broadband Network satellite ground system, but awards were good across the board.

Those strong new orders on top of pretty solid orders last year is fueling a growth spurt for us. Revenues are up over 25% year-over-year for both the quarter and year-to-date. As we've been expecting, the growth in revenue, combined with steady gains in Exede broadband subscribers is driving steady growth in our adjusted EBITDA, too. Sequential adjusted EBITDA increased $15 million compared to the first quarter of this year. And adjusted EBITDA is up year-over-year, as earnings growth starts overcoming the fixed costs that we incurred for the ViaSat-1 network expansion.

We had about 150,000 subscribers on ViaSat-1 at the end of the second quarter, which is just about six months after we had the whole footprint lit up on the satellite. Plus, we continue to, make good progress in all the adjacent markets we envision for the satellite, too.

So, we'll take a quick look at the highlights in each of our business segments. We are making steady progress in building up the ViaSat-1 Exede subscriber base. Gross adds and net adds both gained sequentially compared to the first quarter, and look very good in the context of broadband industry subscriber growth in total.

We'll talk about that point further in the call. ARPU is up significantly on the new subscribers, rising 8% year-over-year when blended over the entire subscriber base. Overall subscriber unit economics are pretty much in line with our objectives. We are continuing to build confidence that we are addressing a much larger market than just the unserved, and that we can provide a level of speed and responsiveness that is sustainable.

We are continuing to develop and refine our approach to identify and attract subscribers who are likely to find the most value in our high-speed service. As I mentioned, ARPU continues to trend very positively. And in total, we think that, given our current growth trajectory and considering all the factors and market applications underway, we can earn the returns we envisioned when we began the ViaSat-1 project. The Commercial Networks business continues to grow fast. Revenues grew 35% year-over-year, and we believe the very significant Australian National Broadband Network contract substantiates our market-leading position in the satellite broadband space.

We are continuing to invest significantly in new satellite broadband technologies, both space and ground, that capitalize on our competitive position and the advantages of our satellite technology. Adjusted EBITDA in that segment grew significantly in the quarter. And finally, the Government segment had a very strong quarter, driven by a combination of sustained growth in our mobile broadband products and services, and growth in other areas that have been seeing extended delays in government order activity. Operating profits in the segment increased 70% year-over-year this quarter. We believe our Government business is benefiting from our success in unconventional projects that deliver mission-critical capabilities that aren't really being addressed effectively by bigger budget programs of record.

Now, I'll introduce Shawn Duffy, who is our interim CFO, and she will present an overview of our financial results.

Thanks, Mark.

Well, Q2 was marked by good progress financially for us. As Mark mentioned, we achieved records in the quarter for both orders and revenue. This resulted in a 27% growth in revenue year-over-year. As we discussed last quarter, Q1 was a low point for us on the adjusted EBITDA front, as we launched our Exede satellite service. Overall the wight of the fixed startup costs and new subscriber acquisition costs outweigh the incremental revenues from our initial launch subscribers.

As we have continued to grow our Exede subscriber base and increased revenues each quarter, we have generated some upward momentum in Q2, bringing adjusted EBITDA to $44.6 million. So overall, we are pretty pleased with where our second-quarter landed, and some of our key performance indicators are shaping up the year nicely. In looking at our results here to date, we have also been very pleased with our order flow for the year. The $880 million in new orders for the year has helped drive our revenues up 25% over last year and generated a record backlog of $966 million.

Overall, we have had some very significant wins with our Q1 Cap contract in Saudi Arabia, followed by the Yanko contract in Q2. Those wins, coupled with strong flows into our situational awareness in government mobile broadband programs in this uncertain DOD spending environment has started to solidify our near-term outlook. Year-to-date adjusted EBITDA, which carries the weight of the first quarter Exede service launch effects, is almost about even with prior-year results, coming in at $74 million versus $75 million last year.

So, as we move to the P&L as a whole, our Q2 revenue growth to $283 million was the driver in helping us close the gap on the operating margin impacts of our Exede satellite service launch activity. But we are not quite there. So, overall our operating results reflected a $1 million loss in Q2. Although we are still in the early phases of our Exede subscriber ramp activity, our operating margins rebounded by about $13 million from Q1 due to our increasing Exede sub base and very good growth from our Government segment contributing an additional $10 million.

We continue to invest in research and development activities, both space and ground, as we look to adjacent market opportunities and maintain our leadership position in the satellite broadband market. Recently we have been fairly successful in leveraging our investments in Ka-band to drive global opportunities and positioning, so we expect investments in this area will continue.

Our year-over-year interest expense continues to be higher than prior periods due to the additional $275 million in senior notes we issued in February of this year, coupled with the capitalized interest effects in 2012 as we completed construction of ViaSat-1.

We also initiated a refinancing in late September of our 2009 bond. Market conditions and the Company's performance and position came together and presented an opportunity to refinance a portion of our existing bonds at an attractive rate. This refinancing provides a reduction in our annual cash interest expense by $3.8 million, as well, as extending the maturity of our entire bond portfolio to 2020.

As a result of these refi activities, we will be recording a one-time extinguishment charge of about $27 million in Q3, which is driven by cash payments to the current holders to tender and call the existing debt obligations and a write-off of about $7 million in debt issuance costs and amortized on discounts associated with the old notes. So on balance, with the $10.5 million in premium we were able to achieve in the refi, we have secured an effective rate of about 6.4%, which is down significantly from 9% on the old note.

And, finally, our income tax effects year-over-year are quite different due to our lower pretax income and the effects of the Federal R&D tax benefit. In fiscal 2012 we recorded three quarters of Federal R&D tax credit benefit while fiscal year 2013 reflects no benefit due to the expired legislation. In short, the Federal R&D tax credit expired on December 31, 2011, and it has not renewed. So, given the Fed R&D status and forecasted pretax losses for the year on a GAAP basis, our expected effective tax rate is coming in around 40%.

So let's take a look at some cash flow activities and our balance sheet at the end of the quarter. Our operating cash generation has been pretty strong this year, growing to $42.1 million, which is up almost 80% from the same time last year. The key factors here have been good adjusted EBITDA performance coupled with balanced management of AR and inventory during a high growth period for us.

However, we are reinvesting cash and capital to grow our Exede subscriber base, spending about $43 million in additional consumer premise equipment and we are continuing to grow our investment in government and commercial global networking solutions as the demands for advanced satellite services in these markets expand. So, on balance, our cash investment are showing up on the balance sheet in relation to the areas of our business that are growing.

So let's dive a little deeper into our Q2 results by looking into our segments. Mark is going to talk about the segments a bit more, but at a summary level, the results across the board were fairly strong. Revenues were up in all segments, and we had good adjusted EBITDA growth in both our Government and Commercial segments, which combined were up $13.5 million or 60% year-over-year. On our satellite service segment side, revenues are growing nicely, as we leverage the compounding benefit of each new subscriber net add.

For the quarter, revenues were up $11.9 million to last year and our ending sub count came in around $429,000, which has surpassed any historical levels. Our mix of gross adds still was skewed towards the Retail side of the Business at about 63% with the remaining 37% coming from Wholesale. This shift in mix is continuing to drive ARPU which grew again quarter-over-quarter to 47.96%. Adjusted EBITDA came in at around $8.7 million for the service segment. It is down about $8 million from prior year, as we still carry the full weight of our ViaSat-1 fixed costs, but the gap is narrowing pretty significantly each and every quarter.

So, I'll turn it back to Mark who will show you how our progress is paying off, as well as provide some other market and segment update.

Okay, thanks, Shawn.

So I'll go on into a little more depth for what's going on in each of the business segments. We'll start with the satellite services. The theme there is steady progress. We're making good progress and refining our approach based on what we learn. In a minute, I'll show you some really interesting data on how we 're doing in the broadband market as a whole, which lends some context to the subscriber growth data. Were still making sequential improvement in gross and net adds. Unit economics continue to be in line with our plans.

As expected, last quarter was the bottom for us in terms of earnings in this segment. In this quarter, we turned about $8 million of revenue growth into about $5 million of adjusted EBITDA gain. The chart at the bottom of this page shows how our subscriber base and adjusted EBITDA have trended over the last six quarters, and it can give you a sense of the rate of growth that is associated with current trends and subscriber additions. Adjusted EBITDA margin will fluctuate from period to period primarily as a result of marketing initiatives that generally we believe will trend in line with our models.

ARPU continues to trend up driven by the stronger market position of the service and a higher retail mix. We are steadily overcoming the fixed cost increase of the ViaSat-1 network expansion based on the unit subscriber economics. Data continues to substantiate that we are drawing from the underserved, as well as the unserved broadband customer base, which suggests that we have a market opportunity that is far larger than the capacity of ViaSat-1 and the Echo satellite.

Our subscriber metrics for the Exede service shows some steady growth relative to our first fiscal quarter. Installs grew to about 71,000. The number of migrations of existing legacy subscribers onto the new Exede services declined slightly so that meant a greater share of the installs went towards new gross adds. In the second quarter, retail adds continued to be significantly greater than wholesale. The shift toward retail subscribers continued to yield growth in blended ARPU for our subscriber base. The churn rate from the second quarter was pretty similar to the first quarter.

We've got two specific initiatives underway that we believe will help drive the churn rate more towards what we've achieved in the past. That would be improving the legacy service and increasing awareness of the new Exede options. The churn rate really had been driven by legacy subscriber base. Net adds showed sequential improvement again in the second quarter. We have a number of activities underway that we believe create opportunities to increase quarterly net adds, including adding new value, added features to the service, continuing to improve our go to market plans, and more active promotions with satellite TV.

In the next couple of charts, though, we will show that, in the overall scheme of things, that we're doing pretty well in net subscriber growth compared to the broadband market in general and that the current growth trajectory is pretty consistent with our original investment targets for ViaSat-1 when all factors are considered.

So this chart gives some overall industry context for the growth rate for our consumer Internet services. The data is from the Leichtman Research Group, and it shows net broadband subscriber growth for all the major cable and telephone companies, as well as for ViaSat for our second calendar quarter. That's the June quarter, and that's the latest quarter for which all of these industry results are available.

As national broadband penetration has increased over the last several years, the rate of industry growth as a whole has slowed considerably. In the June quarter, net broadband adds for the industry group that's shown here, which accounts for the vast majority of total broadband subscribers, was less than 0.5%, or about 250,000 net adds out of a base of about 80 million. In contrast, we grow about 5% in the June quarter, so we added 20,000 net based on at that time a base of 385,000. So, that was in the June quarter.

None of the major cable or telephone companies grew by more than about 1%. That's true pretty much independent of size, even for the several ISPs on this chart that have around the same number of subscribers that we have. The telephone companies as a whole actually lost net subscribers. The higher speed fiber services like fiber to the home, fiber to the node, U-verse, FiOS, those grew. But those gains were more than offset by a loss of lower speed ADSL customers.

In general, subscribers switched away from lower-cost, lower speed services to higher speed, higher-priced ones that deliver better value in a more megabits per dollar of subscription cost sense. Those trends are good for us as our research shows that Exede is a very good value compared to alternatives in terms of megabit per second per dollar.

While Leichtman Group hasn't yet, published comparable data for the September quarter, we do know results for the large providers. Comcast, which accounted for the majority of industry adds in the June quarter, grew by about 1.5% in the September quarter. Time Warner cable grew by a little less than 1%. And AT&T and Verizon both showed the same trend in the September quarter as they did in the June quarter, where migration to higher speed, higher-priced fiber services increased, but with losses in the DSL customer base yielding a net decrease in total subs.

ViaSat grew by over 5% in the September quarter again. So in this context, our rate of sub growth is very good. Just after the end of our second-quarter, HNS brought their ViaSat-1 look-alike satellite into service. It's been in service now for a little over a month, and that's probably too soon to draw definitive conclusions about the long-term competitive dynamics. But, based on what we've observed so far, we believe that our growth prospects, given this competition, are still consistent with what they seemed to be before the Jupiter launch and that we can still make improvements in subscriber additions compared to what we've experienced so far.

So, that leads to the next key question, which is, even if we are growing faster than the industry as a whole, is that growth rate good enough to provide the return on capital we were aiming for when we started the ViaSat-1 project almost five years ago? So, to answer that question, we really like this chart from a Sanford Bernstein Research report on the voice, video, and data markets in the United States.

Telecom is very capital intensive, and the chart shows the range of return on invested capital for wireline, wireless, cable, and satellite service providers in their respective markets. Obviously, not all providers compete in all the markets. But it's easy to see the attraction of the satellite business -- satellite television video business compared to other transmission media.

Essentially, satellite TV provides a competitive video service with higher return on investment capital than any other. We think the root source of competitive advantage for satellite is that it can provide a comparable service with much lower capital cost per home passed and capital cost per home served. And that's pretty much exactly what we're aiming for with our Exede broadband service, a competitive high-speed Internet service for the un- and under-served market at relatively low capital costs per potential and actual subs.

Ultimately our return on capital is driven by several key factors, the net subscriber ramp rate, our ARPU, reflecting pricing and market position in retail wholesale mix, and the cost of acquiring and keeping subscribers, plus, the performance of adjacent markets like in-flight Wi-Fi or defense.

While for competitive reasons, we won't give exact numbers, what we are aiming for were returns that are sort of in the cable and satellite range that are shown in this chart. There have been significant events since we started the project in 2008. Satellite construction was delayed for over nine months. HNS bought a look-alike satellite from SSL. EchoStar then acquired HNS. The delay in launch made it harder to preserve our legacy subscribers.

On the other hand, we have been more retail centric, which raised our ARPU significantly. We have shown good success in appealing to the underserved market, which increases our target market substantially. And there seem to be clear industry trend toward higher speed and higher prices at better dollars per megabit per second, and those play well for us. Our unit economics have been pretty much in line with our plans, and we've had good success in key adjacent markets for mobile services that meet higher grade of service and yield better returns on the bandwidth.

The upshot of all these affects is that today, just over a year post launch, we anticipate returns on capital that are in line with our goals when we started five years a go. Those returns were in between the cable and satellite companies. We believe we've retired a lot of risk, and our current borrowing costs reflect that. But we think that as we scale the business, enabled by targeting a larger market, we can start to see prospects that are closer to the satellite TV space. One of the key enablers would be a series of new satellites that provide even better economic returns then ViaSat-1, and we will talk about that in a few minutes when we update you on ViaSat-2.

Now I'll switch to our Government segment, and that had a fantastic quarter, as you can see from the data on this chart. Year-over-year revenue increased by almost 25%. Operating earnings grew from $14 million to $24 million, up about 70%, and adjusted EBITDA grew from almost $21 million to about $31 million, or just over 50%.

Second-quarter orders were $174 million, which represents a book to bill for the Government segment of almost 135%. So, we added significantly to our backlog. And you can see that year-over-year, the services portion of our Government business grew from about $17 million to about $45 million or over 160%. As we have pointed out before, our Government business can be pretty lumpy, driven by the timing of government contracting activities and budget uncertainties.

But this quarter loss of things lined up in our favor. Some of the performance this quarter is due to realization of revenues and earnings that were delayed from prior periods. But the strong order flow is indicative of underlying strength and growth prospects. Some of the key growth drivers are continued success in our Government global mobile broadband business, initial deployments and bandwidth services for Blue Force tracking, as well as good performance and satellite modem and terminal products, tactical data links, and secured networks.

Results were also very good in the Commercial Networks business. Revenue grew from about $64 million to $86 million on a year-over-year basis, up almost 35%. Adjusted EBITDA more than doubled from $1.8 million to $4.8 million. We've been very successful in capturing the most significant Ka-band broadband ground networking infrastructure programs in the world. The Australian National Broadband Network project is an excellent example. We believe the number and scale of projects we're doing here creates meaningful competitive advantages. The chart at the bottom shows data that was compiled by Akamai for average Internet speeds on each continent. And then we compared that to the Exede 12 plan offered on ViaSat-1.

We think delivering reliable speed at a good value is clearly a source of competitive advantage in most all global fixed broadband markets. While we realize there are many areas that are well served in most countries, there is much less cable infrastructure than there is in the US, and we think satellite can compete very well in underserved markets that are more dependent on ADSL and mobile wireless. But a key gating item in each market is to identify a go-to-market strategy that promotes satellite as a better choice than those terrestrial solutions, instead of just as last resort that has to be priced at the bottom of the market.

That is still a controversial and often contentious value proposition in most of the world. So it will take some time to realize the potential there. Meanwhile, our success in both Government and Commercial satellite services is driven by pushing the state-of-the-art in networking technology, and this business segment contains the engineering resources that do that R&D. We've been encouraged by the prospects for a number of areas, including advanced consumer broadband features, in-flight Wi-Fi, satellite news gathering, live online event streaming and others.

So, we're continuing to invest more. We also feel that we are certainly providing the benefits of achieving industry-leading results in satellite bandwidth economics. So, we continue to invest there, too. Those investments show up in this segment, and we are still showing a modest operating loss for the segment, although smaller on a year-to-year basis.

We believe the investments will be worthwhile. So, that gives an overview of the business segments. We think the big surge in new orders, the associated backlog, the steady growth of the Consumer business and overall program performance mean we have the ingredients for sustained growth over the next few years. The trick is in balancing the strategic and tactical use, so we will end a little time on our thinking here.

In the satellite services segment, we are steadily gaining experience and competence in understanding how our high-speed service plays in the underserved markets. While nobody wants to fill up the satellite faster than we do, we want to take advantage of our available capacity and bandwidth to refine and perfect understanding that will scale to multiple satellites and create an enduring business that can achieve the types of return on invested capital the Satellite TV business has in the broadcast market.

So that's where we've been aiming, and the data is encouraging. A year post launch, it looks less like were tapping into pent-up demand in the unserved market and it looks more like we have a real and much larger opportunity including the underserved market. Pretty much each quarter we are trying new and different market research and tests to better understand how to identify, reach and capture those customers that are the best long-term fit for our service. We believe we are making good progress and learning a lot fast, much of which we just couldn't have learned about actually being in service.

We are very focused on unit economics that build value. We are gaining traction in the adjacent markets, and we have got our sights set on achieving cash flow break even in the satellite segment around the end of this fiscal year. All things considered, we believe we are on a trajectory to earn the returns we aimed at almost five years ago, and that we are doing well in the context of the overall US fixed broadband market.

Our Government Systems business continues to perform really well in a very, very challenging environment. If seems that the tightening budgets are making government customers much more price conscious and willing to try new things, which is good for us compared to the larger defense primes. The value of good Intel, surveillance and reconnaissance data and the ability to communicate and disseminated it is recognized. We have unique capabilities to offer, and we believe that is reflected in our results.

We also think that we have barely scratched the surface of what's possible with satellites such as ViaSat-1, so there's good long-term growth opportunities. In the short term, we're not going to be able to reproduce quarters like this every period, but we think it's becoming more clear that we can grow revenue and earnings on a year-over-year basis this year and next fiscal year, and target doing so on a continuing basis.

We think our unconventional approaches will play well in a time of constrained programs of record. Likewise, our commercial business is benefiting from a leadership position in Ka broadband. Our backlog creates confidence, but it's important to note that we believe much of our competitive advantage comes from our leadership position with the ViaSat-1 satellite.

So, we're working hard on extending that leadership position with ViaSat-2. We're still working on finalizing a ViaSat-2 procurement contract. Were choosing from two very competitive options. But those options should enable us to achieve our strategic objectives of improving bandwidth economics, reaching the entire United States, and extending into some important new geographies and markets. We anticipate will be under contract this quarter. We believe we have the capital resources in place, and we will talk more about ViaSat-2 when we announce that procurement contract.

So that completes our prepared remarks. Before we take questions, I also wanted to talk for a minute about our first ViaSat analyst day, which is scheduled for November 29. We think it will be really worthwhile, allowing us to go into much greater depth on markets and strategies than we can on these quarterly calls. We'll have more data and insight on the overall consumer broadband market and the factors that are driving and helping our competitive positioning. Plus we will be able to give greater depth on our government and commercial adjacent broadband satellite markets.

So that's it. And now I'll open it up for questions.

Thank you. (Operator Instructions)

Mike Crawford, B. Riley & Co.

On the Exede adds, what percent of the subscribers you signed up came from underserved or DSL markets?

Again, it's kind of in the mid 30s %. About where we've been before.

And when do you expect that DirecTV agency deal to kick in full strength?

That will be this month. Actually, that's when it will start. It hasn't started at all yet.

Okay, thank you. Then regarding -- back to DSL, is there any risk to your model you see with the vectoring technology that can potentially dramatically improve DSL speed. At maybe a low economic cost to carriers?

Vectoring technology has gotten a little bit of play or something. Actually, I don't think it's relevant to our market at all. What vectoring pretty much does is it reduces crosstalk for DSL lines that are in close proximity where that turns out to be the limiting factor. For the market that were going after generally the limiting factor for DSL is loop length. So it's not that the loops are close together, which is what the vectoring does, it is that the lines are really long. And vectoring really doesn't do anything for that. So, we still don't see anything on the horizon that changes the overall outlook for DSL, and I think if you look at how the telephone companies are behaving, it doesn't look like they do, either.

Okay, thanks. And then just the last question, switching gears to the mobile broadband. That's a little confusing with you still branding that service as Yonder. Is that going to be branded Exede, and I think at one point that was your fastest growing business. I don't know if that's still the case, and maybe if you could comment on what the approximate level of revenue you are getting from mobile broadband today.

So for us, mobile broadband comes in multiple flavors. They main ones that we have going now are at KU band, and they used our spread spectrum technology that we called ArcLight, and that's basically what we've called our Yonder services, ArcLight technology solutions over KU band satellites.

The two -- the main flavors of that are the government business, that's the global mobile broadband business, and the largest part of the services piece of our Government segment revenue is really due to that service. That's the single largest piece of that. The other pieces that we have for Yonder are Business Jets and a revenue share that we have in the maritime market where we partner with KVH.

Those two are probably maybe half the size of the Government business together. Then the part that -- one of the parts that also looks promising, and this is the part that we will be branding Exede right away, is the Ka-band part that will be on commercial aircraft. And that's what we will be doing with JetBlue and United, pretty much starting in calendar 2013. Our plan is to use the Exede brand-name when we can use high capacity Ka band satellites and deliver an experience that is like the Exede home experience.

So, we won't be branding the KU band stuff as Exede, because we can't really provide the same economics and performance. So, we will preserve the Yonder name. But, overall, what we will be aiming to do, and this will take years, is to eventually be able to use all Ka-band on those markets on a global basis.

Thank you very much.

Rich Valera, Needham and Company.

I just want to get us out of how you're thinking about the gross sub adds per quarter. You talked before about targets, a medium term target of 90,000 to 100,000. I think you were around 71,000 this quarter. And, given your commentary on the last call where you had seen a pretty good pickup in the month of June, would have probably expected a bigger gross install uptick than the 5,000 we saw. So just trying to figure out what is going on there on the gross installs, and is the 90,000 to 100,000 still the active target over the next quarter or so.

Well, I don't think it's that over the next quarter. We are --one of the things we're doing is constantly researching and trying to find out what's going on in the market. And so we -- when we gave out those targets of 90,000 to 100,000, it was based on what we had historically achieved, or what Wild Blue had historically achieved working with both DISH and DirecTV as distributors.

So now we're in the market. We've been in the market for nine months. And we're just trying to assess both what we can do and how what we are doing compares to the market as a whole. If we were to -- once we get sort of more towards the blended disconnect rate or churn rate that we expect, if we were doing 100 -- just to put things in perspective, if we were doing 100,000 adds a quarter, today, we would probably account for 25% to 30% of all the net adds in the broadband industry as a whole.

So that looks pretty ambitious. I don't -- we don't think we will get there in the next quarter or two. And to put things in perspective, that would mean us as a service provider with let's say 0.5 million out of 80 million total broadband subs would be getting 30% out of say, 300,000 or 325,000 total net adds in the industry. What I'll tell you that make that look more formidable.

On the other hand, when we look at what's going on in the market, we think there is room for improvement for what were doing. So, that's what we're working on, and I would say there are still things that could help us get there. But we're just not going to -- we don't think we're going to say we're going to do that next quarter or the quarter after. We're just going to see what happens in the market and report on it.

Is it fair to say you expect sequential growth in that gross sub add number?

It looks like it so far. It's hard to tell. We were off to a pretty good start this quarter. I think we'll just have to see quarter-over-quarter. But I think the things -- what we're finding is that the value proposition seems to be there in the underserved market. We think that the reasons that subscribers are buying, are the reasons that we intended, which is that we offer a really good value and speed in megabits per second per dollar and that the speed level we are offering is the right range that people are attracted to that.

And I Would say that what we are finding now more than anything is that our adds are sort of proportional to the effectiveness of our marketing spend. That's kind of what we're finding. And so were trying to perfect that. One thing we could do is just throw a ton of money at it, but that would sort of screw up our unit economics. So what we're trying to do is do it more thoughtfully and purposefully, and we're learning a lot on how to optimize that.

We are trying things in different markets. And what we feel like is, it's going well. It's sort of the way we look at it. So we're not -- I guess what I was trying to say is we are trying to not just focus on the absolute numbers, but on the unit economics the returns we will generate and the reasons that we're getting the subscribers.

This is Rick, Rich. Another I'll add to that remark is that last quarter we reminded you guys that as Jupiter entered the market here, that we could see some pressure from them coming into the market for a quarter or two. We didn't think it would affect us overall. It doesn't change the answer. But we could see some near-term pressure, and we really don't know yet. They're just getting started. It's early to tell. But overall, I'd say were trying to look at sort of the strategic environment. That's more what we were trying to comment on.

Understood. And just trying to understand the sequential increase in service revenue. If you just take the addition of net subscribers that you got and kind of take the average subscriber base for the quarter times your ARPU, you get a significantly smaller sequential revenue increase than what you reflected. I'm trying to understand what's the other component there.

There's clearly sort of a service which is sort of average subs time your ARPU, but there's got to be some other underlying I guess maybe hardware component there that I'm not understanding. Just to -- I'm trying to understand how I can model that going forward, because that increase, like I said, was bigger than I would've expected.

I think one of the things you have to account for, Rich, this is Rick again, it the subs that came on in the last quarter weren't all reflected in the previous quarters. So as this builds on itself, so you've got to go back into last quarter and reflect those subs, plus there is some -- there is incremental margin for some of the equipment sales from revenue because you have to buy the equipment.

But not -- it's insignificant. What we cited here is blended ARPU, and so the incremental ARPU of the subscribers that we are getting is much higher than the blended ARPU. That's one of the factors that is helping us to achieve the results that we aim for. Our ARPU on the new subscriber is like 20%, 25% higher than we originally modeled.

And the ones we are losing in terms of disconnects are more off the low end.

Low end, yes.

Okay. I'll have to take a look at that. And then going back into last quarter, you had talked about replacing what you call the sales only call center, and that had caused some disruption. I just wanted if you would provide an update on that. How is that new one working out? Is it working as expected?

Yes. Basically there are a couple of objectives that we had. One was we thought that we could improve the economics. We were paying double, twice, for some of the marketing spend that we were getting in the way that we went through a particular sales only deal. Or the other factor was that we felt we were not getting access to all the data that we could.

What we found is that both of those things worked out well. The economics have improved, so that helps us, and we're getting access to more data, which is helping us be effective. That -- it actually worked out well. We did that early in the September quarter.

We had some glitches for several weeks, glitches meaning we went backward -- we took a step backward for a little while, and then we recovered what we had set out to do. And that kind of thing, those kinds of steps that were taken away from the way we used to do business, I think I think that we're going to try to do continually over the next several quarters.

Got you. Just one final one of I could. Obviously a great quarter in the government business, and you kind of acknowledged in your prepared remarks that you had some -- a lot of things go your way. Can you give us any sense of how you're thinking about this step business for this year? I mean it's obviously a little tough to model when you get that level of volatility, but any way you could kind of help us think about that business on a full year basis or sequential basis would be quite helpful. Thanks.

I think, Rich, there was definitely a catch up in the quarter. As Mark mentioned earlier. Shawn, chime in here, too, if you have some additional comments. So, there was some stuff that had slid from previous quarters into the quarter which caused a blip. So, I would go back to the previous quarters and, given our growth that we projected, draw a smoother line.

Okay.

I think when you look at it on a full year-over-year basis, and the past we've been talking about 10%-ish growth. We didn't quite get that last year, but some of that was really was sort of deferred to this year. I think this is a catch-up year for us. That kind of growth on a sustained basis would be good.

Okay. That's helpful. Thank you.

Yair Reiner, Oppenheimer & Company.

It looks like the rate at which you are adding subscribers is may be, all things considered, a little bit slower than you had originally forecast. Given that, would make sense to maybe see how sub trends go for a couple of quarters before signing a contract for ViaSat-2? It looks like at the current rate it is going to take you quite a few years to fill up your current capacity.

One it is a good point. And obviously, we are being very thoughtful about what we do on ViaSat-2. If you look at the rate that we have been in business on ViaSat-1, the whole footprint for about six months. We're about 150,000 subs on ViaSat-1. So I think we talked about filling up the satellite to 1 million subscribers in the three to four your range.

That's very consistent with that, sort of more on the faster end than that. The other factor is that the satellite doesn't fill up uniformly. Some markets fill up faster than others. You want to reinforce those. So those things sort of say it is time -- certainly time to bring ViaSat-2 contract into place.

The other thing is I think people should look at the revenue contribution, which is really the product of the ARPU and the ramp rate. And when you factor in the substantially higher ARPUs that we're getting, that basically even without the adjacent markets, which are shaping up well for us, the returns look good. And so that, we're encouraged. We look at the following satellite as a way to extend what we're doing.

To cover all our fixed costs and the cash flow [inter rating] within a year after launch is very successful.

If you could talk about right now your costs, it looks like quarter-on-quarter your costs came down quite a bit in terms of your period costs. Can you talk about the factors there? It seems like your understanding some of the period costs a little bit better.

I'd say, are you referring to the satellite service, in particular?

Yes.

So what I would say is we're going to see some fluctuations in period to period. One of the things that we've been looking to do on the unit economics is be able to turn revenue growth into ARPU, we wanted -- one of the things that we wanted to make sure that people understood that. And just as I was saying for this quarter, for the September quarter on a sequential basis, we turned about $8 million of revenue growth into about $5 million of incremental ARPU, a little over 60%. And that's pretty well in line with what we're aiming at. I think will do better as we scale and get more economies of scale. But that's pretty good. There's really not anything grossly unusual about the quarter in terms of our spend.

And just one more if I could. You talked quite a bit in this call about the underserved market. Some of the stats out there suggest that the unserved market is really big. Why haven't you focused more on that given that it seems to be -- would have seemed to have been a ripe opportunity and perhaps there might be some sort of pent-up demand, as you mentioned earlier.

This is one of the things that we've dealt with were addressed for quite a while. What we think is the unserved market represents -- a lot of estimates in the 7 million to 10 million home range. We think that's a good market, but the underserved market is probably three to four times bigger than that. And that's a much more attractive market for us.

We also believe that if you run a business that's predicated on selling to people that have no choice, that you don't really develop all of the skills and tools you'd want to effectively address that 30 to 40 -- 30 million-ish market of underserved people. So we pretty much bit the bullet at the beginning and said hey, we're going to position this thing to address the larger market. And a lot of that was to deal with this question that you asked earlier about ViaSat-2

If we were dealing with a total market of seven million or eight million, we are dividing that among two service providers, you look at what the penetration which rate would be for that market, you say okay, maybe we should get one or two more satellites. You'd position those in places that address those unserved markets. But it's not at all obvious they you can just say now I'm going to take that and go after the underserved.

We think we're learning a lot of skills both in marketing, customer service, number of areas, and we're also learning a lot about geography, and why people choose our service. So that's what we had our eye on, and that's why we keep talking about where our subscribers are coming from, what it cost to get them, what the value proposition is, our ability to keep them, what customer satisfaction is? And I think that involve a lot of learning in our services organization, which I think is going well.

But we don't really look at it is a step one, you get the unserved and then you just say okay, now I'm going to morph immediately into the underserved. I think there's a lot of issues associated with doing that. So were trying to do it holistically to start.

Okay, thank you.

Chris Quilty, Raymond James.

First a clarification, Mark, I understand branding the JetBlue service with Exede, but from an accounting perspective, do those revenues still fall within -- do they fall in satellite services or government networks in terms of your breakdown of product and service revenues?

I can answer that for you. This is Shawn. So, the product side of developing onboard equipment shows up in our Commercial side of the business. And then as we launch the service, that will come into our satellite service area.

The retiring air time revenues.

Yes.

Okay, fair enough. And initial shipments of hardware, or should some service actually be turned on in the fourth quarter?

Services won't be turned on in the fourth quarter. What we are doing is we're really working now on the FAA's flight worthiness certifications. Those are sort of the gating item to revenue and initial aircraft being in service in the first quarter.

Okay. And a follow-up on Rich's question about the average ARPU for the quarter. I ran the same calculation as him and came up with $60 million of revenue, and you reported $67 million. So is it fair to assume that from the beginning of the quarter to the end of the quarter your ARPU moved up significantly to account for that incremental revenue?

You can't just take the new subs you add in the quarter current quarter. You have to take the previous quarter ending subs and average the new ones in at the new ARPU level, and then there were some product shipments. There were some product sales in the quarter in that business. And that's growing. As an absolute value, reducing as a percentage but as an absolute value of $2 million, also.

Just to be clear, what happens is you sort of go back to the prior quarter figure out what the midpoint is for that quarter. You'd have to add revenue based on that, and then you do the same thing on a cumulative basis. But the other thing is to make sure you sort of model in this effect of, on a churn basis, remember, in the older days, we were largely wholesale. Now we're largely retail. The wholesale ARPUs before were in the low 20s. Now retail ARPUs are above 50. So, we're replacing at a pretty high rate lower revenue subscribers with newer revenues subscribers. It's pulling up the blended ARPU, but the incremental ARPU is quite a bit higher than that.

Okay. And how about just amongst new Exede customers are you seeing a lift in the ARPU now that you're enforcing the fact of people moving up from basic to improved plans?

I'd say that it's a modest effect at this point. What I would say is, and this may sound a little bit silly, but really the purpose of the fair access policy isn't to drive revenue. I think in order for us to compete well in the unserved -- in the underserved market, what we really are trying to do is offer a good value. So, if we have tricks that drive up revenue that don't make it a good value, that's not a good outcome for us. So the real purpose of it is to preserve the integrity of the service and try to match people to the right plans.

So I don't think were going to see a really big lift there. But we'll see the effects of it, and it sort of helps us achieve the network performance that we're trying to achieve, make sure we get the unit economics that we are trying to achieve.

And the other thing, since we introduced in this past quarter our unlimited overnight FAP free zone. So that gives people an opportunity to consume a bunch more bandwidth off-peak hours without raising their bill. And people perceive that as a good value, as well.

So, will be trying to do things that sort of preserve ARPU in a range that is competitive. And this is one of the things will go into more depth on in the analyst days. How we look at revenue, how we gauge the value of our service. But the idea is not to drive revenue up to really high levels but to remain competitive and preserve network integrity.

And I may have missed it, did you give the mix of subs coming on ViaSat-1 wholesale versus retail?

We've been pretty consistently around two thirds retail, one third wholesale.

Okay. And just a clarification from the language earlier around the rate of net adds and hitting that 90,000 to 100,000. It sounds like we should back off over the next several quarters perhaps with the entry of Hughes back into the market, the rate at which you're picking up. Is that a fair assumption and perhaps push out a couple of quarters when we get to sort of that run rate net adds?

I don't know. What we did is over 70,000 installs in this quarter -- in the September quarter. The December quarter, we have multiple effects going on, including DirecTV will start during the course of this quarter, so that will probably have some impact. DISH Net went live. That had some live impact, and we're still providing wholesale subscribers to DISH Net. Use is in the market. So that's providing some diversion, as well.

I think that personally, what I think that is to the extent that the Usenet services and the DISH Net services are the same as ours, and reinforce the value proposition of satellite in a sort of a dollars per megabit per second basis, that ultimately that's not bad for us. But all those things are going to take a little while to play out.

So, what we find is I think that our growth in installs will really depend a lot on the way we market, which is not surprising at the end of the day. It is sort of how effective are we at marketing. And so what we're doing is going about that we believe in strategic and deliberate way, that I think actually gives us a good shot at getting to that target. I just don't want people to be sitting around every quarter going oh, did you do 90,000 this quarter? Because I think what we are really trying to figure out is how do we get there, what does the business look like at that point? And what are the economics when we're at the point that we're at now, which are actually pretty good.

And speaking of DISH, at what point should we know whether we're going to get a renewal on the contract, and will you come out one way or another when that negotiation and contract is renewed or not?

We haven't made announcement about that yet. What I would say is I think things will continue with DISH for a while. How about that?

Okay. And final question, the government business, I think you had some record EBIT margins in the segment. What's a better normalized margin to assume?

In the Government business?

Yes.

It's like I said earlier, Chris, I think I would draw a smoother line between what you've expected for the year from our previous quarter until what we had modeled for the overall year. We just had catch-up for the quarter. And although the margins aren't substantially different, we had good margins in the quarter, but it was really driven by revenue.

But if you look at our historical margins in the Government business, I think that those are -- we've been able to over reasonably long periods of time sustain pretty consistent performance. We don't see that changing.

Sort of low to mid teens?

Yes.

Great. Thank you, guys.

(Operator Instructions)

Why don't we just take one more.

Tim Quillin, Stephens Incorporated.

With regards to DISH Net, are there any particular beams that you would service as opposed to Hughes, or how is that business going to be split up between the two underlying providers?

We have right now this sort of very funny situation where the Hughes satellite looks pretty much exactly like ours. They have coverage and capabilities and plans that look just like ours in places that we have ours. I think that that is a little bit of an artifact of the way we acquired our first satellite and probably won't occur again. But it probably will be that we for the next couple of years.

So that means that DISH will really sort of exercise their judgment and discretion about how they divide them up. And so far we have a good relationship with DISH. Obviously, there's going to be multiple factors that they will put in there, but I think we have a good relationship with DISH, and I think they are treating us fairly, pretty fairly. And I'd see that continuing for the foreseeable future.

Would you expect a change in the wholesale retail mix in the current quarter?

I would say DISH, when you bring DISH Net on, DISH Net is a pretty powerful brand. DISH brings on 0.75 million gross adds a quarter. So, they can definitely move the needle. We know that. I think We'll just have to see. It just depends on how aggressive they remain in selling it and how they divide up the business. But it's possible that could skew us in the short term a little more wholesale.

And then we'll have to see what happens with DirecTV. DirecTV, our agreement is an agency one, and that is retail. And that one hasn't kicked in yet. So, I think what we're trying to do is make sure we have a good understanding of the long-term competitive dynamics. And it's very hard to say what's going to happen in a quarter when things are changing, moving around internally in the quarter. It will take of two or three quarters I'd say to sort out all these effects on an ongoing basis.

Right.

But overall, I think this is one of the things that we're trying to focus on is sort of why do people buy this service, what represents a good value, what are the ways in which they do that, and how does the marketing campaigns of each channel blend together to form a whole? And it's still pretty early to tell, but we think we're learning a lot about is sort of what the overall growth rate is in the market and the churn rate within the players in the market, and we think we can sustain or improve the rate at which we're going. And the revenues that were generating doing that.

Right. In terms of the -- you talked about the return on invested capital assumptions, which are above cable I think, and below satellite television, would that be at the current pace of net adds? Would that ROIC still be attainable?

Yes, so basically, the way I described it is in the range of the cable industry, plus or minus, could be up. And then aiming more for the satellite industry as a whole as we go for the scale, which is one of the reasons we're aiming for this larger underserved market. And then what we said was, so when we started the business five years ago, we had a spreadsheet, basically, forecast that said here is where we get at ARPU, here's what we can get subscribers, here's how big the market is, all these things. And when you played all those things, we got a return on invested capital that looked like that range that we were talking about.

Now here we are a lot later, and we know what the actual rates are, we know what the actual ARPUs are, and we know that we had delays in the satellite construction. So, we put all those things in, and then we project out from where we are now, and like I said, if we were to go kind of at the rates that we're at now, blending all these things in, the return on invested capital, all factors considered, taking into account all these markets and factors would be in the range of what we thought it was at the beginning. So, I think that's a good outcome. And that range, that's a good range. I mean, that's the kind of range that you say wow, knowing what I do now, would I go back and start that project, I'd say, yes, sure.

Is there a difference between the churn rates between wholesale and retail right now?

Yes, there is. Right now the churn rate differential is really more about the legacy network than it is about the Exede network. The Exede network, the new subscriber churn rates are fine. They are right in line. What I would say is the issue that we've had on churn on the legacy network, a lot of it has to do with wholesale base, because we don't own or touch those subscribers as much. And so that problem will sort itself out over time.

And then lastly, in your press release you talked about a wholesale agreement to provide coverage in Northern Mexico, presumably with ViaSat-1, but maybe can you talk about that and if it's meaningful in terms of the percent of capacity it might consume. And then you alluded to ViaSat-2potentially targeting new geographies, as well. And I am wondering if you can kind of fill us in on what you're thinking there.

Talk about, first on the legacy stuff and the existing satellites into Mexico. We think that there's underlying root competitive advantages for satellite that should play in multiple markets. And we're looking for ways to prove that -- test that and prove it. And some of that we will do ourselves, some we will do with partners. This is one that we are working with partners on. We'll see how that goes.

I would say in the longer run what we would like to do is create additional satellite capacity that gives us options, sort of free options to test, either expanding existing products into new geographic markets or trying new projects in new geographic markets. And I think we will do that in a pretty prudent way, but we can't really talk about what those geographies will be and what the services will be yet. But I think we will once we have more insight into -- or we've established the contract -- the satellite procurement contracts. Then it will be more appropriate to talk about that.

Okay. Thank you.

Thank you. I'm not showing any further questions in the queue.

Okay, good. So there is a lot going on, a lot of discussion, and we really appreciate everybody's time and interest. Once again, we really like to encourage people to think about attending our analyst day at the end of the month, where we'll have an opportunity to go into a lot more depth on issues that were touched on in some of these questions. Until then, I look forward to talking to you all next quarter. Thanks, again.

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