Viasat Inc (VSAT) 2013 Q3 法說會逐字稿

Welcome to ViaSat's fiscal year 2013 third-quarter earnings conference call. Your host for today's call is Mark Dankberg, Chairman and CEO. You may proceed, Mr. Dankberg.

Thanks. Good afternoon, everybody, and welcome to our earnings conference call. I am Mark Dankberg. I'm Chairman and CEO. I have with me, this afternoon, Rick Baldridge, our President and Chief Operating Officer; Shawn Duffy, our Chief Accounting Officer and Interim CFO; and Keven Lippert, our General Counsel. Before we start, Keven will provide our Safe Harbor Disclosure.

Thanks, Mark.

As you know, this discussion contains forward-looking statements. This is a reminder that 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 10-K and Form 10-Q. Copies are available from the SEC or from our website. That's it. Back to you, Mark.

Thanks, Keven. We will be referring to slides that are available on the web. I will start with some highlights from the top-level overview; and then after that, Shawn will discuss our financial results, and then I will go into more depth on each of the businesses, and we will take questions.

Our third quarter was good across all the segments, and we are pretty happy with what we have seen as the underlying reasons. We had record gross and net adds in our domestic broadband business, and we ended the quarter with just about 467,000 subscribers, up from about 429,000 last quarter, and from one year ago, when we were at about 377,000. About 216,000 of the subscribers are on the ViaSat-1 satellite. It was a good quarter. We continued to learn a lot about our value proposition and how best to project it, and we are continuing to build confidence in our strategic view of the market opportunity.

Revenues companywide were up 40% year over year, with the fastest growth in our government and satellite services segments. Adjusted EBITDA companywide was up 31% year-over-year and it was up 9% sequentially. As we will discuss later, strong subscriber growth in our Exede business, somewhat tempered the sequential growth, due to the fact that we have to expense certain of the subscriber acquisition costs. Finally, total new orders of $266 million allowed us to maintain a very good backlog of just about $1 billion.

Now, we can take a quick look at the highlights in each of our business segments. In satellite services, we had an excellent quarter with steady gains in installations, gross adds, and net adds. Most of the increase was through retail, with wholesale gross adds pretty flat compared to last quarter. As we expected, ARPU continues to trend up due to the wholesale-to-retail mix shift, and it gained about 8% compared to last year's quarter. Overall, churn is trending down; but actually, it was lower than we expected this quarter, and we will talk about that later in the call. Overall subscriber unit economics continue to be in the range [we're aiming], and this quarter resulted in a sequential adjusted EBITDA gain of about 27% in that services segment. We feel like we are learning a lot, pretty steadily, about how best to position Exede in the broadband market across all our retail partners, including of course, with DirecTV, who began working with us this past quarter.

Our commercial networks segment is maintaining its momentum, with revenues up 26% year-over-year and another positive quarter of adjusted EBITDA. We achieved an important milestone just after quarter end when we shipped our 500,000 Surfbeam 2 satellite terminal. Our government segment had another very strong quarter, driven by continued growth in our mobile broadband products and services, as well as the command and control and tactical satellite segment business units. Adjusted EBITDA was up 77% year over year and 13% sequentially. New orders were strong again, even given all the uncertainty in the defense environment.

With that as an overview, I will introduce Shawn Duffy now, who is our Interim CFO, and she will go into more detail on our financial results.

Thanks, Mark.

Q3 was marked by another quarter of strong financial progress and growth. Our new orders flow was good, coming in at $266 million, and with 40% revenue growth year-over-year, we achieved a new record for quarterly revenues at $286 million. Adjusted EBITDA also grew year-over-year and sequentially to $48 million in the third quarter. Considering the impact new subscriber acquisition costs can have on our results as our gross add ramp rate accelerates, we were pleased with our continued growth and adjusted EBITDA momentum.

Let's turn to our results here today. Our third quarter was marked by another big milestone as we pushed over $1 billion in new orders year to date. We have experienced strong order flow into both our commercial and government segments, including a $52 million follow-on broadband airborne satcom service contract award for a US government customer in the third quarter. Overall, our $1.1 billion in new orders has helped drive our revenues up 30%, year-over-year, to $811 million. So, we are closing out our third quarter with $939 million of backlog, which provides a good position as we head into the fourth quarter and the continuing uncertain DoD budgetary environment.

Our year-to-date adjusted EBITDA also saw a nice increase of 9%, which reflects another quarter of strong performance from our government segment, as well as quarter-over-quarter growth in our satellite service segment, as our Exede customer base grows.

Moving to the P&L as a whole, our third quarter reflects a few notable events financially. We grew revenues to $286 million, fueled by increases in both products and service revenues, which grew by 35% and 47%, respectively. Overall, we are making strong strides in top-line growth, as our Exede subscriber gross adds strive upward and our subscriber revenue base, as a whole, grows. This growth, coupled with another quarter of strong performance in our government segment, overcame the incremental cost of performing another 77,500 subscriber installations in Q3. On a whole, we were able to generate quarterly income from operations for the first time this year, coming in at $1.3 million for the third quarter. Overall, we are pretty pleased with our third-quarter operating performance.

Our investments in research and development activities, both in space and ground networking solutions continues. We are focused on addressing adjacent market opportunities and driving advancement in consumer broadband tools and solutions. As we see opportunities and customer interest in leveraging advanced Ka-band capabilities globally persist, we expect to continue to make targeted investments in those areas.

Moving to other third-quarter key items, in October we completed the refinance of our 8.875% $275 million notes at a significantly lower interest rate. These refinance activities generated a one-time debt extinguishment charge of $27 million. $7 million being non-cash, which is reflected in our Q3 results. I am going to discuss the details of the transaction a little bit more later to provide some insight on the overall deal economics and the financial benefits we secured. Our year-over-year interest expenses continue to be higher than prior periods due to the additional $275 million in senior notes we issued in February of last year, coupled with the capitalized interest effects occurring in 2012, as we completed construction of ViaSat-1.

Finally, our income tax effects, year over year are quite different due to lower pre-tax income and the effects of the Federal R&D tax benefit. In fiscal 2012, we recorded three quarters of Federal R&D tax credit benefits, while fiscal year 2013 reflects no benefit, due to the expired legislation as of our third-quarter end on September 28. In short, the Federal R&D tax credit expired on December 31, 2011 and was not renewed until January 2 of 2013. Had the R&D credit legislation been put into effect into our third quarter, we would have recorded an additional tax benefit of approximately $8 million, resulting from the cumulative effect of the legislation being retroactively reinstated to December 31, 2011.

Let's take a look at some of our cash flow and balance sheet activities at the quarter end. Our operating cash generation for the first nine months was about $49 million, and that includes $20 million of cash payments made to extinguish our 8.875% senior notes. When considering those activities, our overall cash performance has been pretty strong this year. Our key success factors have been good adjusted EBITDA performance, growing sequentially each quarter of fiscal year '13, combined with focused management of operating assets and liabilities.

As you can see on the above chart, our investments in customer premise equipment continues to grow, as we drive our Exede subscriber ramp rates up, overall, expanding our consumer satellite Internet subscriber base. Year to date, we have invested about $69 million in this area, and we expect those investments to continue. Additionally, we are investing in network expansion equipment and support structure for our government and commercial mobility customers, as demand for these on-the-move solutions grow. These success-based type capital investments are showing up on the balance sheet in the areas that support our growth objectives.

Before we turn to segment performance, I would like to give a bit more detail on our bond refi activities discussed earlier. As an overview, we initiated refinancing activities late in September 2012, due to market conditions that, coupled with the Company's performance and position, presented attractive interest-rate opportunities. We completed the transaction in October and effectively refinanced our $275 million senior notes, due 2016, at substantially lower interest rates.

These original notes were issued at a 1.24% discount, bearing interest at 8.875%, which equated to an annual effective rate of over 9%, excluding issuance costs. Our new $300 million notes were issued as an add-on to our existing 6.875% notes issued last February and were price at a 3.5% premium. So, we were able to drive down our annual effective interest rate to 6.29%. We were also able to reduce our annual cash interest payments by $3.8 million, extend the maturity on the notes by four years to 2020, improve our covenant package, and reduce our annual interest expense by $5.4 million, including the amortization of costs incurred to issue the new debt. Overall, a pretty attractive opportunity, and we were please with the value we were able to secure.

Let's turn to our segments and look into our third-quarter operating performance a little deeper. Mark is going to talk about the segments some more later, but overall, the results across the board were pretty good and reflect some of the dynamics we were expecting. Revenues across the segments were up year over year. Our government segment had another extraordinary quarter, with revenues of $146 million, a 54% increase over last year. We know that driving this rate of revenue growth in a constrained government environment is going to be challenging; and while we push forward with balanced expectations, we are very pleased with our government segment performance and record revenue quarter. With respect to adjusted EBITDA, both government systems and commercial networks segments experienced increases year over year. Which, combined, were up $17 million, or 91%, which clearly marked the strong revenue performance this quarter.

From our satellite service segment, we are starting to see very good revenue growth, rising 29% from last year to $72 million for the third quarter. The scale effects of our subscriber base, which has now reached 467,000 subscribers, is providing a strong cash flow and fueling additional subscriber adds. In fact, at these sub counts, we have reached a level of sustainment, by which the related revenues are able to support the entire network and related recurring costs.

Over the past couple quarters, we have made significant investments in driving brand awareness and ramping subscriber growth. While these activities put pressure on near-term results, they are beginning to pay off as evidenced by our subscriber ramp, and we expect investments in these areas will continue, as we drive our subscriber base upwards.

Our mix of gross adds is still weighted towards the retail side, which is continuing to drive ARPU, growing again, quarter over quarter, to $49.07 on a weighted per-sub basis. On a whole, satellite service's adjusted EBITDA came in around $11 million, which is down $6 million year over year, but is sequentially up to Q2 by over $2 million, despite the increased subscriber adds and related acquisition-cost impacts.

With that, I will turn it back over to Mark, and he can provide some additional market and segment updates.

Okay, thanks, Shawn.

I will go into more depth on what is going on in each segment, starting with satellite service. The theme there is, continues to be, steady progress. We had another quarter of sequential improvement in installs, gross adds, and net adds. The unit economics are still in the right ballpark, and we are still growing adjusted EBITDA on a quarter-over-quarter basis.

The upper left-hand corner shows that our revenues are up, as Shawn mentioned, about 29% year over year, but the year-over-year earnings are still down because of the fixed costs of the ViaSat network -- ViaSat-1 network startup and our new subscriber acquisition costs. But, the chart at the bottom shows how our subscriber base and our adjusted EBITDA have trended over the last seven quarters. We anticipate that this is going to be the last quarter where we have got negative year-over-year comparisons. We were quite happy with the trend.

ARPU also continues to trend up, mostly due to a higher retail mix. Our wholesale adds for the quarter were pretty steady compared to the second quarter, which is pretty much what we were expecting as Dish began ramping up its dishNET branded service. We continue to have a good relationship with Dish, but it is not yet clear how much longer we will continue to add new dishNET subscribers.

From a retail perspective, we are after, what we call, a Goldilocks strategy of market segmentation. If we were just addressing the unserved market, we could probably raise our prices and still capture many of the same customers that have no other choice. But, as we have said, when we see an opportunity for a much bigger market, where we can attract targeted subscribers with access to slower speed, DSL, or mobile wireless, or web and cable networks. We are pretty systematically refining our skills and our services to attract, serve, and retain those customers.

Last quarter, we and DirecTV began testing bundles of Exede with DirecTV video. Early results are encouraging, and that reflects there are lots of customers who like to buy bundles. In this last quarter, especially, we increased our sales and marketing spending and showed that we can grow faster within our targeted unit economics. But, we are putting a lot of effort into interpreting and understanding all of the dynamics behind that to find a just-right approach that lets us grow faster, while still continuing to learn and refine who our best potential customers are, how best to attract them, and to be able to understand when they are, or when they are not, buying our service for the right reasons. We are finding that, under some circumstances, it is quite possible to acquire terrestrial customers who like our speed and our price, but aren't really good fits for the service as it currently is offered.

In the long run, we think being methodical and deliberate is going to be the best way to gauge how big our market can ultimately be, and how to scale it to that point economically. We continue to be excited by our progress. Adjusted EBITDA margins will likely fluctuate from period to period as a result of specific marketing tests and initiatives and the costs associated with those. As Shawn mentioned before, we have also now overcome the fixed-cost increase of the ViaSat-1 network expansion, based on our current unit subscriber economics. Finally, it still appears that given the way the satellite services are currently position, there is plenty of demand for two ViaSat-1 satellites and that our methodical approach to growth can both yield the economic results we like and allow us to gain the market insight that we can use to compete effectively in the presence of terrestrial alternatives.

This page shows some of the detail on our subscriber metrics. Installations continued to rise to about 77,500 in the third quarter, while migrations continued to subside on both an absolute and a percentage basis. For competitive reasons, we are no longer separating our wholesale and retail adds. We clearly skewing more retail, including a meaningful portion via our relationship with DirecTV.

Net adds increased somewhat disproportionately from the prior quarter because of growth in gross adds and on lower-than-anticipated disconnects reported from our wholesale channel. That effect is seen in our fiscal year '13 third-quarter monthly churn data that is in that lower right-hand corner chart. So, we think we might see somewhat higher reported wholesale churn in the next quarter to make up for that.

As anticipated, we are seeing churn trend down in our retail channel. 2% average monthly churns are a pretty reasonable near-term target for us. As we stated earlier, ARPU is continuing to trend upward, primarily due to the increasing retail mix. The second half of the calendar year, that we just finished, is traditionally stronger than the first half for Internet subscriber growth, so we have to factor that into our expectations for our fourth quarter.

One of the important strategic decisions we made shortly before we launched our service was to create the new Exede brand, rather than just use the existing legacy WildBlue brand. Although that impacted our early subscriber growth ramp, we believe we are beginning to see some of the benefits of having done that.

One advantage is that potential new customers can differentiate our performance results with the new network, instead of having those results diluted by the legacy results on the older lower-capacity satellites. It is kind of like distinguishing a fiber-based service from DSL from the same telephone company, or distinguishing LTE versus third-generation wireless from the same wireless company. As an example of what that means, in the lower right-hand corner of this chart, we are showing a screen shot from a website, called testmy.net, which is a speed-test site, and what they do is post accumulated speed-test results that random users do on their website, and they sort them by the ISP that they are testing. On that list, ViaSat is currently listed by testmy.net as one of the top-10 fastest ISPs in the United States for download speeds, so that's pretty cool.

The new brand also allows us to establish a new voice for the service and our approach to communicating with the market. So, we're still learning and experimenting, but late last year, we introduced two commercials to roughly 40 markets, primarily in our ViaSat-1 coverage area. We have had quite positive feedback from both commercials, and we have seen a good correlation of this mass-market approach and increases in our Exede website traffic, our call-center volume, and also in general social media buzz.

Finally, we have got a number of other initiatives to support our retail dealers and our agent networks, such as pre-approved advertising materials that tie into these themes and the visuals of our commercials and the branding campaign. We anticipate that we will also be able to tie some of our related satellite broadband services, such as in-flight Wi-Fi, into our Exede marketing campaign. Our data suggests that our branding and marketing and promotion efforts are cost-effectively contributing to our total retail subscriber growth.

We will move on to our commercial business. We are pleased with the continued progress shown on our Q3 results there, too. Revenue grew from $54 million to $69 million year over year, which is a 26% increase. Adjusted EBITDA improved by $2.6 million from the prior quarter, and we have achieved nearly $11 million in adjusted EBITDA year to date in this segment. There is going to continue to be quarter-to-quarter fluctuation in product and service sales, but our strong backlog, as we've shown in this chart, lends a pretty good measure of stability and confidence to this business.

We see good opportunities to grow our business with existing customers that have Ka-band satellites, to increase our opportunities in mobile broadband market, and to build on our strong competitive position for new Ka-band satellites and follow-ons. New orders associated with new satellites are pretty lumpy and stretch over multi-year periods, and you can sort of see that in the backlog now. We may increase our R&D investments in this segment as we see opportunities in our fixed and mobile broadband products and services markets.

Our government segment had another record quarter on the heels of record results last quarter. New orders, revenue, and EBITDA were all up materially from the prior period. We continue to receive new and follow-on orders across multiple product lines and services, including broadband airborne satellite services, ground and airborne satellite terminals, Blue Force Tracking product and services, MIDS and JTRS, and cyber security. The robust order activity contributed to sustaining a strong backlog, which lends confidence to our long-term prospects in this segment. Mobile broadband services remains as the fastest growing portion of this business, about doubling compared to the same period last year. We believe we have got a strong competitive position and cost and scale advantages due to growing network effects there.

Of course, the macro environment for defense and government markets is really challenging, and our recent strong results still reflect some transient benefits due to business that was delayed from prior periods. Nevertheless, we are pretty encouraged [to have] longer-term opportunities associated with our recent surge in orders and revenues. So, we are planning on investing, mostly catalyzed by specific program successes, so we can consolidate and expand our gains in these key markets. We are simultaneously working to prepare for the impacts of sequestration, or whatever its equivalent is, even if it is difficult for us to predict exactly what the specific affects it will have on each particular program.

Let's try to summarize how things look. We have seen steady gains and growth in our Exede Internet service over the first year, and we are gaining confidence in our long-term strategy and go-to-market approach. The DirecTV launch is already contributing meaningfully to subscriber adds and reinforcing our focus on the retail opportunities. We are working to refine the Goldilocks strategy I mentioned earlier, as we make tradeoffs around pricing, service definition, market targeting, media spend, et cetera. We are more convinced there is a large market opportunity for really high-speed satellite Internet in the US.

It is pretty clear by now that ViaSat-1 enabled a big leap forward in the competitive position of satellite, compared to lower-end terrestrial alternatives. We are still not quite ready to announce the ViaSat-2 construction contract, but we do believe that ViaSat-2 is going to facilitate a comparable step ahead, compared to other alternatives. It is a challenge, we are still working on it, but we think it is going to be worthwhile. We are going to continue to invest in both the space and ground technologies that we believe are the main source of our competitive advantage.

We are doing well in the international Ka-band network market, and we believe our technology advantages will play well there, too. Government macro environment is very challenging. We think our revenue growth over the last few quarters shows that we have done a pretty good job at maneuvering into some unique opportunities. We really can't predict the short run, but we do think that we are positioned for long-term growth in government over the next few years. We do think that the last couple quarters have benefited from working through some previously pent-up demand, but we also plan on making some near-term investments in our government business that would be triggered by some of the recent successes we have had.

We have had pretty strong sequential gains in our financial results, and while certainly not bullet proof, our backlog and our subscriber growth are encouraging. So, we think we have got some pretty good opportunities for continued growth in revenue and adjusted EBITDA in our next fiscal year '14.

That pretty much covers our prepared remarks; and at this point, we would be happy to take questions.

Thank you, sir.

(Operator Instructions)

Mike Crawford, B Riley & Co.

First, could you go into some additional detail on the level of DirecTV engagement? Including what, if anything, they are telling you about their own experience of churn for DirecTV Exede bundled subscribers?

We are not -- I think we are trying to be respectful of both the DirecTV companies that we're working, and not go into it too much depth on either one of them. I would say -- the main thing I would say, just reiterate what we said is, I think we are really happy with the engagement with DirecTV. Obviously, they can be pretty effective, but I think the more important thing is we have got really good engagement on our strategic approach to what we are trying to do.

The other thing I will tell you is, every time we work with a new retail channel, we learn things about what subscribers that channel attracts and how to refine the way we attract customers so they fit our service well. So, we're working through that with DirecTV as well. I think it is -- overall we're, as I mentioned, things are fitting within our overall unit economics, and we are encouraged.

Okay. Thank you, Mark. On ViaSat-2, what is it that is keeping you from being ready to announce a ViaSat-2 construction contract? Secondarily to that, is there anything else you can share about what parameters you are considering for that satellite?

We have ambitious objectives for what we're trying to do with it. I think we've got two good candidates for how we could -- for acquiring one. There are some specific details that you have to get pretty much exactly right to do what we intend. So, we're just working [in the lab], but as we're working through those details.

Also, I think there's some pretty interesting strategic opportunities associated with the satellite procurement that have presented themselves, so we are working those as well, but it's nothing really more than that. We are about as anxious as anybody else to get it started, but we've got to make sure we get everything right.

Okay, thanks. Final question -- I noticed you've applied for a grant, California Advanced Services Fund Grant for broadband via satellite for California. Is there any expectation on timing of decision of when you might receive that funding request or not?

It's not imminent; it is a really good thing because it was triggered by the quality of service we have, relative to the quality that people would otherwise get broadband through those grants might otherwise get. I'd say that they were really interested in having satellite be in that mix. One of the issues is that the process wasn't designed to include satellite, and so that meant working through some new stuff, which has been happening. As a result of that, the scope of what we're doing has gotten bigger and more interesting, but it sort of extended the time period. That's kind of where we are right now.

Okay. Thank you very much.

Rich Valera, Needham & Company.

Mark, I think you said in your prepared remarks that wholesale gross adds were about flat in the quarter? Is that correct?

Yes. That is what I said.

With respect to your Dish partnership, I was just wondering if there is any more color you can give here? You said something in your prepared remarks to the effect of you weren't sure if you'd continue to be adding new subscribers from them. Is that a change from how you previously understood that? Is there anything new there with respect to Dish?

No. I think, one is, we don't know. They haven't reported yet, so we are not quite sure what's gone on with their system -- with Hughes. Clearly, they are going to have a preference for Hughes. We suspect that Dish did really well, and that Hughes got a lot more than we did.

I think that for us it looks like that the market is pretty big. These are pretty much things that we have talked about before -- that if Dish looks at it the way they have in the past, which is that there is a finite amount of capacity available, and they have got a lot of demand, then they may extend their commitments to us. If not, then they won't. Or, maybe they will just have a preference for Hughes. We just don't know; it is more of an internal issue. I don't think really anything has changed from over the last quarter or so. We are just getting closer to the end of the commitments that they have been so far.

Can you say with the timing is on those -- the timing of those commitments?

No, depending how it plays out, but it will be -- we will know more in months, I would say, that kind of timeframe.

Okay. Fair enough. Now, you did see a nice increase in overall gross adds. I am assuming that had something to do with DirecTV. I don't know if you could, in any way, put more color on the contribution DirecTV made quarter over quarter to your gross adds? And then, do you think that -- how do you think about the gross-add level from where you were in 3Q? Do you think we should think about that as flat, up or down, from these levels as we go forward?

Okay, so we were seeing trends upward, already, in the first two quarters, and we saw them again in the third quarter. Certainly, DirecTV is a nice plus for us. Remember, we're doing two things -- we began bundling DirecTV with our Exede service and DirecTV bundled Exede to some of their customers as well. And, they both sort of benefit from the same effect, which is that people like bundles. That is a good thing. But I would say that, going ahead, we feel like we've got positive momentum because DirecTV only participated in about 50% of the last quarter. But then, what we've got is the fact that the fourth -- the December quarter is generally a stronger quarter than the March quarter or the June quarter, so we are going to have to factor those in.

Overall, I think we are going to continue to grow. I don't think that the third quarter was the high point. We have said that in the past, but it is like every quarter we are learning something, and we are trying something different. Sometimes, it means expanding on things that we did; sometimes, it means trying to close down on some of the things that we did. And, there's puts and takes there. Overall, I think we are going to continue to grow. That is kind of what we think. I don't really have a huge sense of urgency because I think we are on track, given what we are doing, that we are going to get better and bigger, both. That is sort of how I'd describe it.

That is helpful. Thank you. Shawn, churn, obviously, you saw some very nice improvement there, and it sounded like some of that was a bit better than expected wholesale churn, and you said that might reverse a little bit next quarter. Should we still think about a 2%-ish churn as roughly the right level of churn going forward, do you think, at this point?

Yes, I would describe it as an intermediate target for us. I think that to the extent that we get customers with a good fit, we can do better than that. We see that in some of the ways at which we acquire subscribers. And those -- so, what we're trying to do is make sure we understand those things and apply them on a broader base. We are working through, what I've been calling a bubble of legacy disconnects. So, as the legacy base gets smaller, that factor gets smaller. Clearly, we should do a lot better on the retail side.

On the wholesale side, churn is kind of a number that is reported to us by our wholesalers. So, that one looked -- there was a bit of a discontinuity there, so we think that there will probably be a little bit higher churn in the wholesale part in the next quarter or two, somehow, to make up for that. That is what we would guess. On the retail side, we understand that, and that is trending down the way we'd expect.

Okay. That's helpful. Thanks very much, Mark.

Yair Reiner, Oppenheimer.

Congrats, first of all, for the strong quarter.

Thanks.

Can you give us a flavor of how the subscriber additions have been going, within the context of having competition now from Hughes, and how that has changed, if at all, the way you go to market?

First of all is, actually, believe it or not, we don't really think it's changed the way we go to market at all. With the way we've tried to frame the market, which goes into this underserved -- the underserved market is a lot bigger than -- it is a lot bigger than the unserved was, and the unserved was big enough for both of us. So, the way we look at it is, we can add roughly one million people, and we have got a lot of stuff we are trying to learn as we do that one million. And, most of it has to do with how we appeal to subscribers, and how we get the right ones.

The thing that I would -- I think is an important thing to get is that 12 megabits for $50 is actually a pretty attractive deal in the market, especially in an environment when most companies are raising their broadband prices in one way or another. What I would say is when people become aware of that and it's presented in a good context, it is pretty appealing. What we're trying to do is, when people buy it and find that it's faster than what they used to have, they are pretty happy as long as they don't -- the things we try to say is, if you are a really big streaming video customer, this probably isn't for you. If you're a -- if gaming online is really important to you, this isn't a great service. But for a lot of people, that had slower speeds, $50 for 12 megabits is a really good service.

So, we've felt like the issue isn't -- it is not like there's not enough subscribers, the real issue for us is targeting the right ones that are a good fit. And that, honestly, is that's what we've been focused on for the last year, and it still is what we're focused on.

And to that point, can you give us a sense where you are drawing your customers from? Where they were previously? You've done that in recent quarters, but I don't see that in the slide deck.

I'd say there is really not a materially change to that. I would say, if anything, when DirecTV enters the mix, it really accentuates that same dynamic, which is our ability to penetrate into the underserved. And Dish, I'm sure it is the same way, that when people look for bundles, that bundling with DirecTV makes it easier to penetrate into that underserved market, and so it just makes it important that we do that targeting correctly.

Great. Then, one quick modeling question, and I will cede the line. In terms of taxes, I guess you'll get a catch up for the R&D tax credit, here in the March quarter. Can you help us figure out how to model that, and then any help you can give us in terms modeling taxes going forward would be great? Thank you.

Sure, I think there's a couple things you need to look at as we have talked about in prior quarters. Our annual effective rate for fiscal year '13 without the benefits of the R&D tax credit was about 40%. And, with the legislation going into effect and being retroactively restated, we are basically going to get about three quarters of this year and one quarter of last year, following into the Q4, which we said was about an $8 million benefit. It's probably, looking at our effective rate, and then giving on the additional benefit for the R&D tax credit legislation, [cumulative] effect, probably ought to get you pretty close for FY '13.

And then for '14?

Looking out to '14, there is some different things that can play out. Probably looking at it, historically, where we were in fiscal year '11 and '12 when the R&D credit was in place, it's probably a good mark to look at looking forward.

Thank you.

Tim Quillin, Stephens Inc.

Nice quarter. Mark, in terms of the wholesale disconnects that, I guess, were unreported or underreported -- is that the way to look at it? And, how would you gauge that underreporting of disconnects?

Basically, they classify things in different ways, but the number of disconnects was lower, so that's what we have. And, I think that's really up to the people that we wholesale to, and I'm sure that they have good reasons for it, and they have to do with where people are in the cycle, their retention programs, or a variety of reasons for it. It would be really up to them to say what was going on there.

So, it wasn't necessarily underreported, it was a good -- kind of an usually good number.

Yes, I would say -- we trend all these things, and we look at it, and we go -- okay, for our result; okay, this is what we expect. In fact, it was less than we expected. They are telling us they've got changes in their system or they have got retention programs, and so it is not like there is no communication, but the proper interpretation of it really goes with them, not with us.

Got it. Then, the contribution margins on -- the quarter-to-quarter contribution margins in the satellite services business have been in the 50% to 55% range over the past two quarters. Is that a level that you can sustain, even with your increased advertising and marketing costs?

That's the thing that we said is going to bounce around a little bit. It's going to depend on a bunch of things -- what promotions we do, where we do them, what we're trying to do, and then also depending a little bit on this Goldilocks effect, which is -- refers to the thing I was talking about before, which is, it is not super hard to attract people who aren't a good fit, so that can enter into it as well. So, what we're trying to do is figure out how we get the right customer -- people who are a good fit.

That is what our strategy is, and it is going bounce around a little bit, but it is not going to veer off markedly in one direction or another. It is in the right range -- it is not a hard number that you are going to see every quarter.

That's fair. Then, just lastly on that -- the government business has been, probably, the strongest government business in the US today. So, how should we think about it going forward? First of all, what revenue growth expectations should we have for fiscal '13? And, how should we think about fiscal '14?

Okay, so thanks -- we think we're doing really well. You are seeing a bunch of effects in there, and it is hard to tease them all out and figure out what it means. One is, basically, what we think is we have been really focused on trying to find those market niches that are going to keep growing. It is just not hard to imagine that in-flight airborne connectivity is really valuable, whether it is for imagery, communications, whatever, and there's not very many ways to do that in a broadband basis. We have got really big market share there, and a really big head start.

So, that part is good, and we think that part has got growth potential, but you have got all the budget-cut effects, you have got the end of the conflict effects, which create new budget-acquisition processes for some people. I think people -- the underlying demand for what we're doing is good, so I think people will work through that. It is just really hard to predict quarter to quarter. Year over year and in the out years, we think it is a good growth business for us, we just can't say what is going to happen in the short term there.

And, there's a few things -- what we've got is a combination of, we have talked about this before, specific private networks for specific customers, and then a fairly extensive public network that some of our commercial and government customers roam through, and so we are making investments in some of those networks as a result of the growth that we have had. And, that's going to be a little bit of a factor going ahead. Also, we are finding that more platforms want access and they want access in different ways, and that the Ka-band [stops] becoming really attractive, so we are going to make some investments in there.

Overall, we think we are in a unique place and that we are going to keep growing. It is just hard to say -- okay, this is what is going to happen next quarter and the quarter after. The other thing we've said is, we have gone through periods where the things we thought were going to happen were delayed, and now we are going through some periods where all of those things are happening at once. I kind of describe it like the one man giveth and the one man taketh away, so we are benefiting from that lumpy stuff now.

Okay. Well done. Thanks.

Brian Ruttenbur, CRT Capital.

Going back, quickly, to the tax rate, just so that I understand. There was an $8 million tax benefit in the third quarter -- I'm just summarizing here. That was to make up for the first three quarters -- is that correct -- of your fiscal year? Or, was that just for the third quarter, sorry?

Let me clarify that a little bit. What actually happened was the legislation actually came into law actually a couple days after our quarter end, so our third quarter did not effect any benefit in from the R&D credit legislation. The fourth quarter will have that effect in it, and on, looking back, what that impact -- what it will be approximately, is about $8 million that will occur in Q4.

Okay, so you'll have a tax benefit about $8 million in the fourth quarter that makes up for the whole year, basically, the whole fiscal year?

That is the effect of the R&D tax credit, and then you need to look at our 40% effective rate on the normal base of earnings. So, it is 40% effective rate, and then, pro forma, and another approximately $8 million for the cumulative effect of the legislation change.

Perfect. That's very helpful. Then, going forward, you said look back at 2011 and 2012 for an effective tax rate. It is kind of all over the place for those two years. Can you give us a percent, maybe, for us to help with modeling?

I think if you -- I think you are right, it does -- we had some of the impact of legislation expiring in the past. I think if you look at 2011, 2012 on a weighted-average basis, you get to about what the normalized effects of that would be. So --

Wouldn't it be, Shawn -- wouldn't it be kind of a normal tax rate -- this is Rick -- for the year? And then, something approaching probably a little less than $8 million because $8 million turns out to be for five quarters, rather than four. Something a little bit less than that and add back to that, they would go ahead and calculate the effective rate?

That's probably, I think, pretty close.

Okay. Thank you. Then, going on to follow up with the last question, was the government growth -- I don't know if you addressed this, I was listening for your comments on sequestration, budget cuts. I'm trying to understand how you're getting such strong growth. Is that into a specific service, Special Ops, or is it the Green Army, is it the Navy -- where is the growth coming from that is so strong for you guys?

The single biggest thing we have been doing, that is growing the fastest and you can see this when we talked about our year-over-year results, is the in-flight mobile broadband services. It is a pretty unique capability that is not available other ways, so lots of customers are figuring out how to get it, and they acquire it through a variety of means. Some of them are through the war effort results, but then we have also had customers who have acquired it that way, and then have been able to get their programs identified as a program of record, so they show up through the normal budget process. That's become a big -- so, that's become a way of it happening. There is high demand there, so it manifests itself in different ways depending on the circumstances for the customers.

But, the other thing that is going on is we do have programs of record that either have significant backlog or were planned for growth -- that's what we aim for, so you're seeing that in things like Blue Force Tracking. In other areas, like MIDS, or MIDS JTRS, we have been saying for two or three years, we are in a development phase, low-volume terminals are phasing down, MIDS JTRS hasn't phased up, well some of those things are starting to change a little bit. The other thing that we have been anticipating -- it's been long delayed, but it is happening are the upgrades to the low-volume terminals and the MIDS JTRS to add new capabilities. The fundamental driver is that you need the situational awareness. You have just got to have this Link 16 capability on those platforms.

So, the way I'd put it is they find a way. All that said, it looks increasingly likely that there is going to be either sequestration or something equivalent to it. So, our people are burrowing through their programs trying to understand -- will that hit us? How might it hit us? It is hard -- actually, it is hard for us to see exactly how it will, but we are trying to posture ourselves, so that if it does, which seems somehow, there will be some effects of it, that we can accommodate them without over spending in some area or being over resourced. That is the tradeoff we are trying to make.

Brian -- this is Rick, again -- what we have said is that we said Q2, from a earnings standpoint, was somewhat of an anomaly because of some catch-up things, and we -- Q3 was similarly an anomaly. So, I would not launch off that point, forecasting forward. I would draw a straight line from Q1 to Q4, up a little bit to where we are, but I wouldn't launch off the Q3 ending --.

Yes, things are lumpy. Still, if you draw -- if you were to go back over two or three years and draw straight lines through our growth, I think those kinds of growth we can sustain, we just don't know exactly how it is going to manifest itself on a quarter-to-quarter basis.

Okay, that's helpful. Last question, on the ARPU, you had a nice sequential increase. Where do you see that increase going? Can you see it sustained at this rate, where you have that almost, what, $8, $9 jump in ARPU, quarter to quarter, or are we going to see stability here?

No, we are not quite there yet. We have got our basic plan -- our most basic retail plan is $50, and then we have a $10 modem lease fee that a lot of our customers end up choosing. So, you can see it getting into the low $50s. That's what we thought, is it will get there -- like we've said before, it is quite a bit higher than what we originally modeled, so that's a good number for us.

But then it probably stabilizes in that area?

It should asymptotically approach that. Now, we're talking about introducing new services, and they'll have some uptake rate, but for where we are now -- for the plan mix that we have and the distribution that we have now, kind of low $50s, approaching that asymptotically is probably a good target.

Great, thank you very much.

Amy Yong, Macquarie Capital.

This is Andrew for Amy. I wanted to ask about, I guess, the [gen-s] competition from AT&T, the new super DSL comments they made, and about the Verizon HomeFusion -- are you seeing any change as far as that is concerned?

I would say, we don't see specific market affects that we would attribute to either of those. There is a lot of people out there that don't have broadband, or if they do have broadband, have it in the low megabits, and I think that you're going to see a number of ways that people can get those, but we think there's a lot of the market that we address with a 12-megabit service. Believe me, I think -- when we look at what is out there, we don't see DSL getting a lot better. You can convert some amount of telco infrastructure to fiber-to-the-node infrastructure, so that is an example of something that creates a step up. That's a fairly bounded geographic market.

Wireless, we think wireless could get better, so we are very sensitive to that. We think we can get better too, so we are looking out for it. We don't look out and see, wow, this particular technology is eating into our growth plans. We just haven't seen that yet.

Lastly, a question on the data caps that, for example, Hughes Gen4 has, versus your free nights. Are you seeing a lot of people taking advantage of that? Or, are you seeing many people going over their data allowances?

The data caps are -- they are a factor, for sure. We think people really like the unlimited nighttime thing. It is a little bit anecdotal. We think people really like that. We think that the caps themselves -- you can imagine this from your own use. When people see the caps, a lot of people will alter their behavior instead of hitting the cap. So, whether or not people hit the cap, we know it is a factor, so we are looking to somehow make them less threatening, less scary. There's a lot of people out there who don't hit the caps at all, but they can be a little intimidating. So, these are the kinds of things that we're trying to learn on a quarter-to-quarter basis -- how to either extend them, make them less threatening, make people less wary of them, but we are not trying to drag money out of people from them. That's basically the way I'd put it.

Okay. Thank you very much.

Elizabeth Grenfell, Bank of America.

I think you originally talked about satellite services being profitable in the fourth quarter, and I realize you have spoken to some of the reasons why it may not be, but when can we expect that segment to turn the corner and to actually be profitable?

I think what we talked about was that it hitting cash flow, kind of breakeven, at the March, at the end of this quarter, first of next quarter, and we are still on that trajectory.

For next -- for fiscal '14?

Yes, it was right at the end of this quarter. And, it can move three or four months, but we're still pretty close to that. Like Shawn said earlier, we -- at the current run rate, if we stopped fueling growth, which is where we hit the expense side, we would be profitable right now. So, we'd be above that, right now, but it is really the expense occurring with the gross adds that's keeping it below that, but we still expect to crossover here within the next few months.

Right, so it depends a lot on what the growth rate is each period and --

If growth rate slows, earnings get a lot better. Growth rate keeps up, it pushes things off a little bit.

Okay. In terms of then -- for the rest of this year, how should we think about how [are account] sales that satellite services in the year?

I think what we have done is give you guys what we think the unit economics are. Then, really it is -- I think one of the things that we are not going to do is provide growth forecasts that someone turns around and hammers us for, for being a couple thousand short. Our real issue is coming up with growth forecasts, applying the unit economics to them, so one of the things we have said is we expect migrations to come down both the absolute value and as a percent.

We expect churn to continue to come down into the threshold numbers that we've said -- that we have talked about, and we expect gross adds that continue to go up, certainly, in this next quarter. I think Mark did say that the December quarter turns out to be a really good quarter, usually for these types of services, so the June quarter tends to be a low quarter for that. We don't know how that's going to affect us yet.

Okay. Thank you.

Tim Quillin, Stephens Inc.

Rick, you kind of alluded to this, but how are you thinking about migrations, not just in the March quarter, but at what point do you get past that issue?

As long as we have -- as long as there are people on the old satellites, in the new coverage area, who are paying $50 a month for 1 megabit or 1.5 megabits at some point, you would think they would be a good candidate for being migrated. So, that's -- it is going to be a while before goes to zero, but I think that there's going to be a steady decline in that number of people from where we are. You probably could do as well as we are -- as we could in extrapolating that.

What we are trying to do there, Tim, is when that happens, so when we get enough people to migrate, then we will step into those areas and upgrade to a newer technology that helps us get people speeds, better service, and actually apply it to some of those other markets we are addressing. But, it is declining, and I think this is -- it is about where we had indicated thought would happen. We said we thought this would start in December quarter and continue. We expect it to continue to come down.

Can you say how many of the legacy subscribers, now, which [guided], I think, down to something like 217,000 -- how many of those are in areas where they have beam coverage from ViaSat-1?

I think it is more than 50%, still.

Okay, thank you. Then lastly, how should we think about growth in commercial networks with the ramp up of NBN Co?

It is going to be really dependent on new wins in there. This year is really about execution on NBN Co and KACST in Saudi Arabia, and terminal deliveries and some of the other technology stuff, and we are chasing new things. You have to win quite a bit of new things, right now, to stay even. Talk about lumpy, this is an area that you could have some big wins or you could have a little bit of a drought. We have got a really good backlog going in, so our outlook for the year looks pretty good.

Yes, backlog being driven by Saudi Arabia, NBN, the deployment of the in-flight Wi-Fi stuff, so that gives us a good base to work from. We also expect add-ons on some of those programs as well.

Thanks again.

I think that is all the questions for this time. Thanks a lot, everybody, for your time and attention and all the questions. We look forward to talking to you next quarter.

Thank you, sir; and thank you, ladies and gentlemen, for your participation. That does conclude your program. You may disconnect your lines at this time. Have a great day.