Viasat Inc (VSAT) 2017 Q4 法說會逐字稿

Welcome to ViaSat's Full Year 2017 Fourth Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. Your host for today's call is Mark Dankberg, Chairman and CEO. You may proceed, Mr. Dankberg.

Okay, thanks. Good afternoon, everybody, and welcome to our ViaSat's earnings conference call for our fourth quarter and full year fiscal year 2017. I'm Mark Dankberg, Chairman and CEO; and I've got with me, Rick Baldridge, our Chief Operating Officer and President; Shawn Duffy, our CFO; Robert Blair, who is now our General Counsel; and Bruce Dirks, our Treasurer; Keven Lippert, who was General Counsel is now our President for Satellite Services.

Before we start, Robert will provide our safe harbor disclosure.

Thanks, Mark. As you know, this discussion will contain forward-looking statements. This is simply 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.

With that said, I'll turn it back to Mark.

Okay, thanks. So we'll be referring to slides that are available over the web. And I'll start with some highlights and a top-level business overview and then after that, Shawn will discuss the consolidated and segment level financial results and then I'll give some additional details and color and finally, I'll summarize our outlook and we'll take some questions.

So we'll organize our discussion around 3 main themes for this quarter. First is growth. Company-wide revenues for our fourth quarter grew 12% year-over-year and 10% for the fiscal year as a whole to a record of $1.56 billion. Government Systems led the way in our fourth quarter with 20% year-over-year growth and 13% for the fiscal year as a whole. Satellite Services grew 11% in the fourth quarter and also 13% for the fiscal year as a whole. We feel we're well positioned for sustained growth. New orders for the year were a record at $1.66 billion. Government orders grew over half that amount at a record of $851 million. That's about 24% higher than this year's government revenues.

We've got a current backlog of over 830 commercial in-flight connectivity orders scheduled to begin installations in our second quarter of this fiscal year '18. We now have 559 commercial aircraft in service, that's a 17% increase over last year. Although it's still a relatively small part of our Satellite Services business, in-flight connectivity revenues are up 40% on a year-over-year basis.

Our backlog creates a good opportunity to sustain rapid growth and our momentum in that industry continues to be strong. While the launch delay on ViaSat-2, coupled with the high utilization of our existing satellites, is a headwind, we can still anticipate good year-over-year revenue growth in our fiscal year '18 and beyond.

Second point, execution. Our operating businesses are delivering strong financial performance and cash flow, and it's a telling indicator of how we can leverage the performance advantages of ViaSat-1 across residential, mobile and Government Service opportunities, while also capitalizing on our competitive advantages as a government prime contractor. Adjusted EBITDA was $83 million in the fourth quarter and $341 million for fiscal year '17 as a whole. Those are increases of about 3.5% and 3%, respectively, over the prior periods. But excluding the R&D, due just to ViaSat-3, EBITDA for the fourth quarter was $100 million, and it would've been $394 million for fiscal year '17. Operating cash flow for fiscal year '17 was $411 million, that's up 39% from fiscal year '17 (sic) ['16] and reaching 26% of revenue.

So the third point then is investment in our future opportunities. We believe our strong top line revenue growth and operating cash flow are compelling evidence of the market power of our unique business models in satellite broadband services and government secure data networks. So we're making substantial investments that we believe will sustain and accelerate that growth and cash flow generation in the years to come.

Our strategy is simple, we want to lead the way with the highest speeds and the most bandwidth at the lowest total cost with a flexibility to apply those resources to the most valuable geographic and vertical markets on a global basis. At root, it's a very complex technology problem, and we believe we're in the best position to compete on that playing field. Later in the call, we'll show some examples of the progress we're making on those investments.

So for now then, with that, I'll turn it over to Shawn.

Thanks, Mark. I'll spend just a few minutes on Slide 4, which shows revenue and adjusted EBITDA performance for the fourth quarter. But before I turn to the details, I wanted to hit a couple of high points. Our Q4 reflected another very good quarter with strong financial results and many new records. Our existing businesses are generating excellent growth, double-digit level performance, which supports the significant investments we're making to expand our global Ka capacity by nearly 15x through our ViaSat-3 program, alongside the substantial investments in next-gen aviation solutions and STCs, our fast-growing commercial air Wi-Fi business.

To put it in perspective, our Q4 adjusted EBITDA performance, excluding our ViaSat-3 R&D investment, is trending over $100 million per quarter. Looking into the segments for the quarter, as Mark mentioned earlier, we achieved another quarter of record revenues of $416 million in Q4, primarily driven by our Satellite Services and Government Systems segments.

In Satellite Services, revenues were up 11% year-over-year, due to higher consumer ARPU, which was up 13% on a slightly lower sub base, plus we had nearly 100 more commercial aircraft in service on average during the period, with greater usage per aircraft lifting in-flight connectivity revenues 40% year-over-year. With continued service operating expansion such as VoIP, 25 megabit-per-second speed plan, in-home Wi-Fi and extended care packages in residential, plus broader in-flight solutions and networking enhancements, we've been able to continue to grow -- improve on our bandwidth economics, which led to over 70% of our year-over-year segment revenue growth going straight to earnings, generating net segment adjusted EBITDA increase of 18% to $75 million, along with margin expansion to 47%, up about 280 basis points from last year.

Our government segment also had a very strong quarter, with top line growth of 20% spread across our fiber, security and information assurance products, tactical data links and tactical satcom radio. Segment adjusted EBITDA of $45 million was also very strong, growing both year-over-year and sequentially despite an $11.8 million loss contingency reserve we recorded by our 52% owned subsidiary, TrellisWare. This was recorded in G&A and it impacted both our government segment EBITDA and company-wide EBITDA by $8 million net of minority interest impact.

Note that our portion of TrellisWare's Q4 bottom line loss resulting from the reserve was partially offset by TrellisWare's earnings for the quarter for a total loss of $2.6 million as reflected in the consolidated statement of operations in our press release. So without this TrellisWare reserve, adjusted EBITDA for the government segment in Q4 would have been up 22% from the prior year period.

Commercial Networks showed a slight decrease in revenues from the year ago period due to primarily lower consumer terminal sales, partially offset by higher sales of antenna system products. Adjusted EBITDA was negatively impacted by increased R&D spending on ViaSat-3 and the success-based mobility investment I mentioned earlier, which was the main contributor to the $10 million erosion in EBITDA from the prior year period.

Just as I touched upon earlier, if we exclude the Q4 ViaSat-3 R&D expenditures, adjusted EBITDA growth for the quarter on a consolidated basis would have been 15%, outpacing our top line performance, and even with these investments, we are generating growth and good margins, as I also highlighted.

Turning to Slide 5. We see fiscal 2017 was also a very strong year for us financially with record consolidated revenues of nearly $1.6 billion, a 10% increase year-over-year. Our new order flows were also a record high at nearly $1.7 billion, generating 8 consecutive years of positive book to bill and a FY '17 year-end backlog position of over $1 billion, which was also up year-over-year by about 9%. Our FY '17 drivers line up very similar to our Q4 results with strong operating contributions, again, derived from Satellite Services and Government System segments.

In Satellite Services, revenues increased $70 million or 13% from the previous year to a record of $630 million. This top line growth was spread across our business, driven by higher consumer service revenues, coupled with growth in general aviation and commercial air Wi-Fi services. Consumer ARPU for the year was up 10% as a result of a higher percentage of premium plans, more value-added services and a slight increase in our retail mix. For the period, we had about a 0.5% fewer total subscribers, which partially offset the positive impact of the ARPU increase.

On the aviation front, we continue to see strong indicators in commercial air with ending tail count increasing by 17% from fiscal 2016 and meaningful increases in average revenue per aircraft during the year. Service revenues from resellers of our Yonder mobility service were also higher. Today, we have over 90% of the world's most frequently traveled flight paths covered, and we're seeing that evidenced as our in-flight business continues to expand globally.

In late 2016, we launched our first European commercial in-flight service on EL AL Airlines, utilizing the KA-SAT satellite [called by] euro infrastructure company, one of the joint venture entities with Eutelsat, of which we own 49%. We expect our presence in that region to expand, both through our new joint venture and our existing customer relationships, such as Icelandair.

Our segment EBITDA performance for the quarter was solid and profitable, though down slightly on a sequential quarter basis, primarily to a combination of the impact of seasonal passenger trends, which are the lowest in the January through March period. At the same time, we're seeing a slight tick-up in costs for current and future in-flight service launch activities, plus we did have 2 less service days in Q4 versus Q3. Despite these modest impacts, we ended the year with segment adjusted EBITDA margins around 47%, up over 350 basis points compared to last year, reflecting the continuing top line growth and overall scaling efficiencies in our business.

The lines of business driving our 13% revenue growth in Government Systems were the same as what we discussed for Q4. Adjusted EBITDA of $162 million was also a new record and was up 13% from fiscal 2016. So despite the continuing resolution environment we operating in for most of fiscal 2017, our government segment had another tremendous year, setting new records across financial metrics, including orders, revenue and EBITDA, providing a good base as we head into fiscal 2018.

In Commercial Networks, revenues was off slightly compared to last year, due to lower sales of mobility and residential broadband terminals, offset partially by higher sales of antenna system products, optical ASIC development revenues and higher fixed satellite network support sales. As planned, our commercial R&D spending this year totaled $113 million, up $51 million year-over-year with ViaSat-3 investments being the largest contributor to the growth. The balance of the increase was driven by our recent commercial air wins and together with advanced ramping ViaSat-3 activities, was the main contributor to FY '17's reduction in segment EBITDA. So just like I mentioned on the last slide, if we exclude the ViaSat-3 R&D expenditures from the calculation, adjusted EBITDA growth for the year on a consolidated basis would have been 13%, and even with our significant R&D investments this year, we still achieved record fiscal adjusted EBITDA generation outside of fiscal year '15 when we recorded the $40 million nonrecurring benefit from the Loral settlement.

So in summary, our fiscal 2017 was a great year financially with multiple records for the company as well as in our Government System and Satellite Services segment. We're entering fiscal 2018 with over $1 billion in backlog and our existing lines of business are poised for continued top line growth next year with some of the things Mark mentioned earlier weighing on our FY '18 EBITDA margin.

This next slide summarizes both our income and cash flow statements as well as our overall leverage position. Net income and non-GAAP net income were higher year-over-year in both the fourth quarter and full year period and the earnings per share figures follow the same relationship.

A few other items I'd like to point out. First, our SG&A line includes the $11.8 million contingency reserve included in our Q4 results for our 52% owned subsidiary, TrellisWare, I discussed earlier. While the full charge is shown in this line, the net impact to our bottom line was approximately $4 million, net of tax and the minority interest adjustment, or about $0.07 on a per diluted share basis for fiscal 2017. And when you exclude this charge, our recurring SG&A expenses were up year-over-year, but down as a percentage of revenue.

Second, our fiscal 2017 income taxes included 4 quarters of federal R&D credit versus 5 quarters included in the last year. With the federal R&D credit and a permanently reenacted status currently, this year-over-year income tax impacts should be minimized, offset with potential variations related to income allocation globally and variability in our deductions per stock comp, which can move based on our stock price and in fiscal 2018 based on changes in the accounting rules will now flow to tax expense versus (inaudible) in prior years.

And finally, our FY '17 diluted shares take into account the weighted effect of the 7.5 million share issuance completed in November 2016, and this equated to about $0.06 per share diluted impact to our FY '17 non-GAAP earnings. As we look to the cash flow statement, to reiterate what Mark said in the opening remarks, we achieved record levels of operating cash flows this year, up $411 million. Our satellite investments also grew with 3 satellites under construction. ViaSat-2 is about ready to launch and our 2 ViaSat-3s, together, are driving up satellite CapEx to $275 million, up 77% year-over-year. Plus in Q4, we closed and funded the acquisition of 49% of euro infrastructure company for $140 million for our strategic partnership with Eutelsat.

So in context, our operating cash flows this year funded essentially all of our FY '17 Satellite-related CapEx, plus our initial strategic investment in the European broadband market. The $392 million of cash from financing activities reflected the $503 million equity offering in November 2016, offset partially by our net debt paydown of a $103 million. We ended the quarter with nothing outstanding on our $800 million revolver and $275 million outstanding on our Ex-Im loan. Our net leverage is sitting at a very comfortable position at 2.2x trailing 12-month adjusted EBITDA and our liquidity position remains very strong with unused loan commitments and cash balances providing flexibility in excess of $1 billion.

With that, I'll turn it back to you, Mark.

Okay. Thanks, Shawn. So this next slide gives an overview of our exceptional Government System segment performance in a challenging defense environment. In fiscal '17, we delivered mid-teens growth in revenue, adjusted EBITDA and new contract orders, all setting records for the company. It was a very good year across the board including tactical data links, cybersecurity and satellite products and services. We won programs of record and also created new products and services that end users need but aren't delivered through the DoD's acquisition processes.

That second skill of filling in the gaps in the acquisition system has been a key to strong growth despite the macro environment. We've invested wisely in R&D and have leveraged foundational satellite technologies that are driving growth in our commercial markets too. One way to think about it is that we have a much more defense experience and capability than other commercial companies offering comparable services to the Defense Department and a much more commercial business approach than the pure-play defense companies. That market position has been very effective in navigating a time of great change in our national defense missions and competitive posture. The top and bottom line results speak for themselves. But we're also pleased with the business mix driving that growth. This year, we've earned several contracts that effectively scaled up products and services to organizations and/or platforms that we had initially captured in prior periods, such as following 16 terminals on Apache helicopters or tactical encryption devices. But we're also introducing new products and services to new organizations and platforms that have good opportunities to scale even further in the future such as handheld Link 16 radios and cybersecurity for mobile satellite broadband as well as new satellite products and services for a variety of mobile platforms.

So going forward, we anticipate continued challenging market conditions and we'll have multiple competitors in our market segments. DoD budget wrangling is likely going to create lumpiness in award timing, but we're excited by the growth opportunities in front of us and our progress to date. So while still relative -- while still small relative to our overall business, our in-flight commercial connectivity business is growing fast.

As we mentioned earlier, in-flight connectivity revenue is up 40% year-over-year as we serve more planes, more passengers using more devices and as Internet bandwidth usage grows. We're building a reputation for quality, performance and affordability, and we now have a backlog of orders for 830 aircraft over the next few years, following our most recent win with Icelandair.

Overall, we're pleased with our progress to date and our prospects going forward. Having JetBlue as our launch partner enabled us to set a benchmark for creating an exceptional passenger experience that's put a spotlight on the limitations of other systems. And we're building on that benchmark by working with JetBlue to continue improving both the passenger experience and the economics of delivering it.

This year will be an exciting and important one for us in the in-flight connectivity market. We'll be increasing the pace of installations on new aircraft substantially as we welcome new customers including American Airlines, Finnair, SAS, Qantas and Icelandair that will collectively expand the presence of our best-in-class service both domestically and in a number of international markets. Each of these airlines has expressed a strong interest in creating a service that's very passenger-friendly and engaging. American will be our largest customer by plane count. We continue to meet critical milestones towards the line fit process in support of the Boeing 737 MAX delivery to American Airlines in the coming months. It's a big step for us because the 737 MAX is expected to be Boeing's largest selling plane with 3,700 already on order. Icelandair is our most recent new partner and the first planning to use ViaSat-2 for transatlantic service. Qantas is very exciting with their commitment to a free Internet service that features the benefits of streaming media for sports and entertainment. We're working with the National Broadband Network in Australia to deliver their service. Finnair and SAS, our European carriers that along with our existing partner, EL AL, will help grow in-flight connectivity on our recently executed joint venture with Eutelsat on KA-SAT.

Overall, we still have a lot of work to do and believe we will continue to expand our share of market in the still-early days of this business opportunity. The wins we've announced over the past year help illustrate that airlines around the world are becoming more aware of the extent to which exceptional Wi-Fi service impacts the overall passenger experience.

Our Satellite Services segment includes residential broadband, in-flight connectivity and nascent enterprise and Wi-Fi service offerings. Results this quarter continue trends from prior periods. Residential ARPU was again at record levels, up 13% year-over-year. ARPU growth results from a combination of factors including an increasing mix of higher value, higher speed, higher bandwidth service plans, growing proportion of retail versus wholesale subscribers and growing contributions from nonbandwidth-centric value-added services such as Voice over IP and in-home Wi-Fi networking. Satellite Services revenue is up slightly sequentially in the fourth quarter with a slight decrease in sequential EBITDA, due to expenses in the in-flight connectivity portion associated with our rapid growth. The growth of our in-flight connectivity service and a growing amount of government services under our U.S. Ka-band satellites contributes to a bandwidth-constrained environment for us pending ViaSat-2. Also, we continue to market test higher speed and higher bandwidth residential plans as we prepare for the launch of ViaSat-2. The net effect of those factors is that we anticipate the absolute number of residential subscribers will continue to decrease until ViaSat-2 is in service. But as we've seen so far, ARPU growth may compensate for that.

We've significantly scaled our R&D investments over the last 6 quarters. By now, it should be obvious, that we are super excited about the competitive advantages we believe we'll gain as a result of those investments and the growth opportunities they create for the company and its investors. This quarter, we thought it would be worthwhile to show off a little of the tangible results of those investments and share some of the enthusiasm and excitement we, at the company, feel about our accomplishments. So remember, when we talk about the growth in R&D investments, we refer to the incremental R&D we're expensing that's associated with the ViaSat-3 satellites. So the implication of framing it that way is that we're continuing our core R&D that's been driving the exceptional growth in our government business and commercial initiatives such as in-flight connectivity. We think our track record in government and our success in disrupting the IFC market speaks for itself about the value and effectiveness of our R&D program. But this photo on this page represents another way to frame the benefits of our core R&D and our approach to holistic broadband system design. So the right-hand portion of the photo shows the elements of a ViaSat-1 class teleport gateway. That's still the state of the art for high-capacity broadband satellites. It shows a 7-meter antenna system in a building that houses the satellite network equipment needed to connect that gateway to the fiber Internet backbone.

ViaSat-1 had 20 such gateways, with a ground infrastructure capital investment of about $100 million. Now remember the maximum amount of user bandwidth or broadband satellite can deliver to its users can't be any more than the amount it draws from the fiber Internet backbone. So to get more capacity, you need more gateways. The size and much of the expense of that gateway is driven by ViaSat-1 class satellite architecture and there aren't any geosynchronous high-capacity satellites in the world that, even today, use an architecture better than that ViaSat-1. So you can't double the capacity of ViaSat-1 class satellite with the same user terminal assumptions without doubling the number of those gateways and the roughly $100 million capital investment required.

But look at the ViaSat-2 gateway on the left-hand side. The Gateway antenna is much smaller and all the ground equipment needed to support it is housed in just 2 small utility cabinets. There will eventually be more than twice as many gateways for ViaSat-2 than for ViaSat-1, but we can light up the whole satellite with only about half the fully built-out quantity. These smaller, much less expensive gateways can be located in more favorable locations with lower cost fiber access. It'll also deliver higher network reliability and greater security than is possible with a ViaSat-1 architecture. So this all derives from the core portions of our R&D investments. The capital investment savings derived from this R&D expense over the next couple of quarters is in excess of $100 million compared to just using the prior state-of-the-art ViaSat-1 technology. ViaSat-2 architecture and gateways offers a unique competitive advantage as an integral part of our bandwidth economic strategy.

So as I mentioned before, when we talk about the growth in R&D over prior years, that really means the expenses associated with the ViaSat-3 program. Both of those R&D expenses are to create the engineering prototypes and qualification hardware that proceeds construction and the actual flight hardware. The flight hardware will be capitalized as would a satellite we purchased from a third-party supplier, as we did with ViaSat-1 and 2. We're in the process of transitioning from design and testing to flight qualification testing. Overall, we're really pleased. While there's still much to do, we've retired substantial risks and are still on track to achieve the technical and functional objectives we set out 2 years ago. So we hope the photos on this page will help people understand the economic value of the new technologies we're inventing and the progress we've made.

The pictures on the left-hand side shows much of the communications payload hardware for ViaSat-1. The physical scale should be evident by the people standing in the background and foreground next to those big circuit panels. The picture on the lower left is a 3-dimensional computer-aided design drawing of the waveguide assembly that was needed to connect all that communications hardware on those panels to the satellite antennas. The size of that waveguide assembly is similar to the circuit panels. So remember, our target on ViaSat-3 is over 1 terabit per second. That's roughly 10x the bandwidth capacity of ViaSat-1. That ViaSat-1 hardware is still close to the state of the art for broadband satellites. It would be impossible to build a ViaSat-3 scale satellite out of those components and with that architecture, and launch it on any existing or planned rocket.

Now the right-hand picture shows an engineer holding one of the ViaSat-3 payload modules that we've been inventing with our R&D expenses. That little module processes significantly more bandwidth much more effectively than the entire ViaSat-1 payload does. Testing to date indicates the payload module shown meets the requirement it needs to, to play its role in the ViaSat-3 system. We aren't going to discuss the architecture or design of the module, but it doesn't take a lot of imagination to get some sense of the scale of integration we're achieving and how it can yield the functional results we're aiming for. It would take roughly $5 billion in capital investment in ViaSat-1 class satellites or maybe $2.5 billion in ViaSat-2 class satellites to get the amount of downstream capacity from a single ViaSat-3. Plus ViaSat-3 has substantial advantages in geographic coverage, flexibility in allocating its bandwidth to the places with the greatest demand and advances in reliability and security of service. You can also imagine that we could take a module like that one, or even just a portion of it, and integrate it into a very small, extremely low cost, LEO, or low-earth orbit satellite. But even though we could do this, it still wouldn't be anywhere near as cost effective as what we are doing. Our geosynchronous satellite should get about triple the useful life of the payload system, share all the spacecraft bus functions among multiple copies and have 100% of the use of those electronics focused on the geographic markets that have the highest economic value. A LEO satellite would spend about 75% of its time over places where it would be impossible or just highly unlikely to generate revenue. So first -- or finally, let's consider the financial value of reinventing communication satellite payloads.

As we've discussed with today's financial results, ViaSat-1 revenues are approaching about $600 million a year at almost 50% EBITDA margins. If we were to maintain the same unit price of bandwidth in our markets, each ViaSat-3 satellite would then generate something like $6 billion a year of revenue. We still haven't seen meaningful improvements in bandwidth productivity relative to ViaSat-1 from other satellite operators, but even with bandwidth unit pricing that's just a fraction of today's value, each ViaSat-3 satellite could generate multiples of our current ViaSat-1 run rate. It will take a few more years until we realize all the benefits of these R&D investments but we're always taking a long-term view of our business. We're really excited about the prospects and we're confident these R&D investments will drive significant value creation for our stakeholders as we bring our revolutionary new satellites into service over the next few years.

Okay, so now I'll go over some of the major factors that will affect our revenue and earnings outlook for our fiscal year '18, for each of our business segments, and I'll start with Satellite Services. First main point is that the payments we've been receiving from Space Systems/Loral as part of the $109 million settlement for their right to use ViaSat-1 technology ended with the end of fiscal year '17. So that's about $26 million per fiscal year that will not recur in fiscal year '18. And thinking about our residential broadband services for the first 3 quarters of fiscal '18, we'll still be bandwidth constrained. We anticipate growth in in-flight connectivity and in government mobile broadband. The government mobile broadband services fall into our government segment, so that will transfer some revenue and earnings from the Satellite Services segment.

In-fight connectivity growth can increase the revenue in Satellite Services. For residential services, we'd likely see current trends continue with fewer subscribers, higher ARPU. With ViaSat-2 launching imminently, we'll also begin incurring fixed fiber and ground networking cost for its ground infrastructure, just as we did prior to entering service after the launch of ViaSat-1. Even though the bandwidth of ViaSat-2 is more than double ViaSat-1, there are only a few more initial gateways than ViaSat-1 had, though each of those handles more fiber capacity. When ViaSat-2 does enter service later in the fiscal year, we expect more rapid subscriber growth and we'll incur the variable SAC expenses commensurate with that growth.

For our Commercial Networks segment, one of the bigger factors in fiscal '18 will be revenue growth from sales of airborne terminals for our rapidly growing in-flight connectivity network. We've got a significant backlog of over 830 aircraft stretching over about 3 years, and we still have good opportunities to grow that backlog including revenue opportunities for fiscal '18 amid strong market momentum. Growth with new airlines and new aircraft types will involve more terminal flight worthiness qualifications and additional STCs and line-fit R&D expenses as part of our core R&D program. We also expect growth in ViaSat-3 R&D expenses as we ramp up the flight qualification portion of that program. Government Systems has excellent opportunities for continued strong growth and momentum. Book to bill this past year was positive by over 20%. We've got a strong backlog entering fiscal '18 and good opportunities in mobile broadband, tactical data links and cybersecurity. We also have good opportunities to increase mobile broadband services revenue from user terminals that were installed during this past fiscal '17. So with that, we'll be happy to open it up for questions.

(Operator Instructions) And our first question comes from the line of Rich Valera from Needham.

Just wanted to get a little color on your thoughts on the timing and magnitude of the ramp of your in-flight installs. I think you said in your second fiscal quarter, you expected that to start. Could you give us a sense of kind of what kind of quarterly rate you might expect that to get to as you start executing on your backlog, particularly American planes?

Yes, Rich, this is Rick Baldridge. It's a -- since right now, we're in a little bit of a pause in the new equipment's going onto the new airplanes. So it'll start ramping late this quarter and kind of ramp through the year. On a quarterly basis, we get -- we don't get to full rate within this calendar year. I think that happens in early next calendar year. But that should be -- that should get to over -- definitely over 100 a quarter in early next calendar year.

Got it, that's helpful. And then just wanted to get your thoughts on ARPU, which were pretty exceptional this quarter. I mean, the quarter-over-quarter growth is quite impressive. It sounds like you expect to be able to continue to grow ARPU, but just wondering if -- when we think about what kind of rate you can grow ARPU over the next year or so, how we should think about that relative to prior trends?

Well, it's like Mark said, we're making some trades. One of the things that doesn't get included in that ARPU numbers is what's going on in the other services. Like some of the stuff we've got in emerging markets, and so we exclude that. So we think, in the residential ARPU, we're going to still see migrations towards retail from wholesale, so that will cause ARPU to continue to grow. And we're selling -- like Mark mentioned, we're selling services that have generally higher speeds and higher volumes in preparation for ViaSat-2 service launch. So we think ARPU is going to continue to grow fairly strong. We're certainly not giving a specific indication, but offsetting that is certainly the reductions in absolute subscriber count. And so overall, the revenue in that business we're expecting to be closer to flat for this next year.

Got it. And just one more if I could, Mark. Just sort of bigger picture, you've alluded to the fact that JetBlue, among others have kind of heightened the awareness of carriers to the quality broadband. Can you just talk about sort of broadly in the market how that's affected your pipeline and the prospects for getting more business, particularly on the international front? Just give a little more color on kind of what you're seeing out there with -- in terms of awareness of broadband.

Okay, so one of the big things that JetBlue's done with their free services is that the number of passengers that use it is by far much higher than any other in-flight service. And I think that some of that is because it's free, but JetBlue is benefiting from that passenger satisfaction engagement that comes with that high penetration. So I think that -- that's, I think, one of the most powerful factors that stands behind our growth. That if you need -- like one way you can define a good in-flight connectivity service is it costs $35 or $40 and it works okay. And another one is that it's free and everybody uses it and it works really well. And I think that that's kind of a contrast in terms of customer experience. One of the things we've been clear on is that the ability to deliver that is really a function of the satellite. There's nothing you can do with a modem or an antenna on an airplane that changes the satellite being the bottleneck for delivering good service to high numbers of passengers. So for us, on international, really, the way we've grown is we've grown as our coverage footprint grows. So it's been U.S., Europe when we were able to light up the service on KA-SAT, Australia with NBN. With ViaSat-2, were going to be able to do transatlantic, Latin America, Caribbean, so that's how we're expanding. ViaSat-3 is really the kind of a transformational factor that's going to enable us to get to worldwide coverage. And as we're getting closer and closer to the launch of ViaSat-3, and looking at the time lines at which the stuff is deployed, it's becoming more and more real and immediate to the airlines. And so that's -- I think those are the factors that are influencing our success in the market, and we think those are only going to get better.

And our next question comes from the line of Mike Crawford from the B. Riley.

Thanks for showing those ViaSat-3 modules. And I'm wondering how do those compare with the hardware you provided for Iridium NEXT.

Okay, so Iridium NEXT is -- basically what we did on that was the Ka-band, space-to-ground and space-to-space inter-satellite links. So the -- I would say the level of integration is a little bit comparable. I think ViaSat-3 is more integrated but the amount of bandwidth that we're delivering on the Iridium NEXT is a tiny, tiny fraction of what we do on ViaSat

(technical difficulty)

And Iridium NEXT satellite is -- I'm not going to speculate but it's got to be 1,000 -- over 1,000x less than the bandwidth that's on a ViaSat-3. So the big issue there is scale. But the underlying Ka-band technology, we kind of proved out in the Iridium program.

Okay. And then just regarding your majority-owned subsidiary, TrellisWare, that makes this advanced waveforms. How do those waveforms compare to the ones that you are developing and working with in the Government Systems arena such as your Link 16 and other solutions? Do you use TrellisWare? Or is that separate?

TrellisWare and our Link 16, right now, deliver -- really address 2 different markets. Link 16 is primarily an airborne situational awareness link and the work that TrellisWare is doing primarily ground handheld radios. There's definitely an opportunity for those 2 markets to converge in the future when you think about air-to-ground communications and the ability to closely integrate ground with airborne support. But right now, they're sort of on 2 separate tracks.

Right, including the HHL 16 radio?

Right. So the handheld Link 16 radio is really a way for ground users to tap into the airborne situational awareness that Link 16 provides. And there's a video that the Air Force put out 6 months, 9 months ago that talked about on how they could apply that. It's really a way for ground tactical operators to coordinate more closely or quickly with close air support.

Okay. Just one more, if you don't mind. So in emerging markets, you've talked about entering those in a different capacity, probably, a Wi-Fi hotspot model with prepaid airtime. And you've talked about tests you're doing in Mexico. But you've also mentioned in other forums, places like Venezuela and Colombia that seem to be outside of the footprint for ViaSat-2 that you show, for example, in the presentation today. So is it true -- does the footprint actually -- how far into a place like Colombia does the ViaSat-2 footprint reach?

Okay. The ViaSat-2 footprint goes to the northern tip of South America, which is where Colombia and Venezuela are. And even though we don't cover all of those countries, we do cover the coastal areas, which is where most of the population is. So those are -- they're candidates for us. As we've mentioned multiple times, one of the good things about ViaSat-2 is we have the ability to move bandwidth around. So if there are market opportunities for us there, we can go that far south. If not, we can use the bandwidth in other places.

And our next question comes from the line of Louie DiPalma from William Blair.

Mark, EchoStar, on its earnings call indicated that it expects to make a final decision within the next few months regarding Jupiter-3. I was wondering if there's any potential for ViaSat and EchoStar to form a ViaSat-3 partnership similar to your proposed partnerships with Eutelsat. Or do you view the existing duopoly market structure with each provider launching satellites in tandem as the most efficient over the long term?

Well, there's a bunch of speculation associated with that one. We're not going to speculate. But I wouldn't say that 2 sets of satellites is the most efficient.

Okay. And on another topic, I guess, the backlog for in-flight connectivity increased last quarter from 750 to 830 and it appears that Icelandair was for 16 aircraft. Was the remainder for Qantas converting from a trial to a commercial order? Or was there an unannounced win in your backlog?

There aren't -- there are not unannounced wins at this point. So all of the growth in backlog is from our existing airline customers.

It was mostly Qantas.

Okay. And lastly, could you provide more color on how the defense market is challenging? It seems that a lot of the defense contractors such as Raytheon and Lockheed Martin are seeing strong demand with all the geopolitical uncertainty.

Well, so challenging. I think there's 2 parts to it. One is if you can -- if you look on that graph, you can see sort of what the trend are -- has been over the last 8-or-so years in terms of government R&D spending and procurement. And it looks like that may tick up. But the other challenge has been just on the whole budgeting process, and we've been operating under continuing resolutions for so long. And if that -- that's a little bit tricky because continuing resolutions are really meant to preserve current spending rates on each individual program line item and we've been growing at a pretty good rate. So you've got to somehow harmonize, figuring how to -- I think both we and our customers have to figure out how to harmonize growth in our programs with the continuing resolution environment.

Great. And one last one for Shawn. Shawn, you and Rick previously indicated that total R&D in fiscal year '18 should be roughly the same as fiscal year '17. And I was wondering if that view has changed at all and if that takes into account any potential spending on ViaSat-3 Asia.

Yes, sure. So I think what we've talked about is that the ViaSat-3 activities are going to continue to ramp at an accelerated rate into the first half of next year and continue throughout the year. So I think of it as R&D being at somewhere between 15% and 20% on a year-over-year basis and you got to include in that, we're going to have some...

Related to ViaSat-3.

Related to ViaSat-3, yes. And then you got to include into that we're going to -- we have some additional STC expenses that can cause some variability. But it's going to be up definitely in the first half of the year and then up a little bit year-over-year.

Okay. And are you guys pursuing line-fit offerability for the other airframes besides the 737 MAX?

Yes.

And our next question comes from the line of Chris Quilty from Quilty Analytics.

A quick question just back on the IFC market. I know amongst the many service providers out there there's lots of different revenue models that both the airlines are using as well as the service providers. Can you give us your sense of where you think things will go in terms of free across all the airlines versus some of the airlines that are using per-megabyte packages. And tagged onto that, what are the metrics that you're using? Is it sort of a monthly charge per aircraft or per number of passengers that you think is optimal for you on the service provider side?

Well, the models are certainly going to evolve. I mean, I think that the airlines are learning, different airlines are learning in different ways, but they're just learning sort of what the overall role of in-flight connectivity is on the whole passenger experience. Essentially, just think of it as they're trying to buy customer satisfaction or invest wisely in customer satisfaction. And they can do that with meals, they can do that with in-flight entertainment, they can do it with the seats, they can do it with Wi-Fi and connectivity. I mean, there's multiple ways they can do it. But what we believe is that, and surveys from multiple sources kind of show this, is that in-flight connectivity is one of the most desired amenities. And what we're showing is that when you deliver it on a very large scale, you can do it at a very low cost. And that was kind of the JetBlue approach pretty much from the beginning, and it seems to be working for them. Also you see on in-flight entertainment that whereas people used to charge for that, that's become free. Other things are going the opposite direction, right. I mean, meals used to be free and in a lot places now you pay for them. And carry-ons used to be free and some airlines are charging for those. I think it's just going to be a shakeout of what the passengers like. Our sense is that the passengers really like and value in-flight connectivity. And then you can add to that, that whole landscape there, the fact that, well, getting the attention of airline passengers is pretty valuable to a lot of different media companies, Internet companies and sponsors. And we are seeing with JetBlue and with others that under the right circumstances, if the passengers associate their brand with a good experience, that's valuable to those companies and that can further offset the cost of the in-flight connectivity. So I think it's going to take a little while for all this stuff to shake out. I think that as more and bigger airlines sign up and sign up with the objective of really improving that connectivity experience and of reaching more passengers. I think you'll see more and more influence sort of ripples through the route systems. Each airline is affected by what the competition is on the routes that are most important to it. So I think those are the factors. We'll have to see how it plays out.

Let me ask the question in a different way, are all of your customer contracts substantially the same in the way that they're structured? And have you seen any pushback from customers that want to buy capacity in a different way?

So one is we're there to help the airlines make more money, right. So that's the purpose of the in-flight connectivity, so we're not trying to impose on the airlines any particular rigid way of doing it. So we will work with airlines to come up with a program that best fits their needs. So that's what we're doing. I think that the airlines all are sort of aware of these trends. And even if they don't go with the free models example or the model that we would suggest -- we'll do it the way they like but they all sort of can see that free is a likely outcome, right. So that whether it takes a year, 2 years, 3 years, but that's probably where it's going to end up and so no matter how we start, we give the airlines optionality to figure out a good way to get there on their own.

Got you. On the other side of the mobility, your government mobility has grown real nicely in recent years. Are you tapped out on the number of platforms that you can address with that legacy Ku network? And where do you see that eventually converting to Ka, if you do?

No, we are not tapped out. We're seeing very good growth. I think a lot of our government customers like the optionality and flexibility that Ka, Ku gives them. So we can do Ka. We can do Ku. We can do Ka and Ku integrated. And all of those things are happening. I think that most of our defense customers recognize the value of the Ka-band satellites and that as the ViaSat-3 series gets closer and closer, we're going to see most of the usage go on those.

Got you. And a question for Shawn. Can you remind us, from an accounting perspective, how and where you're reflecting the Eutelsat arrangement? And how it impacts ARPUs and whether you'll ever report separate subs on that business?

Sure. So to kind of put it in the simplest form, it's very consistent to what we've talked about in prior periods. The retailco entity is the entity we own 51% of, and they will be consolidated into our financials. So we'll have all of those revenues and expenses flowing in with an offset of the 49% owned by Eutelsat going to minority interest. On the infrastructure side that we own the 49% of, that's going to come in as an equity method investment as a one-line item into our income statement and we're going to get our percent of their earnings offset from some of the slight acquisition accounting adjustment that we do. So that's how it will come into the financials. And as it relates to the subscribers, I think we're going to have very similar reporting to what we do in our U.S. market, and we'll continue to address that as we define a little bit more what offers will be there.

And one final question on the subscribers. I think EchoStar talked about the fact that they had converted their relationship with DISH from wholesale to retail. Is it fair to assume you're doing the same?

Yes, I mean that was a decision on DISH's part. So we expect that that's how we'll do most of our business or most or all of our business with DISH after some transition.

On a go-forward basis, so they'll continue to own the existing wholesale subs?

Yes. Right. The existing subs that they own, they will own, yes.

And final question just on Qantas. I've read some stories that they're doing better than expected in Australia with those Sky Muster satellites on the retail side that the capacity is getting sucked up. Where does that leave you in terms of the Qantas model for Ka-band? And can you also discuss the sort of Ka, Ku strategy there?

Okay. So for domestic Australia, we've gone through this with NBN. NBN is very aware of what their primary mission is, is to provide service for residential. And we've worked with them to go through allocations of what the impact of the in-flight service would be for Qantas and it's negligible. I think that NBN is comfortable with supporting Qantas in the -- for the service that Qantas wants and expects. So I think that's worked out. I think the Qantas international long haul is a different topic, and we're not really prepared to discuss that at this time.

Obviously, ViaSat-3 Pacific would solve those issues?

Yes, absolutely. Yes, and certainly it could also augment any issues that Australia has in terms of satellite bandwidth available for its residential subscribers.

Mark, why don't we take one more question?

And our next question comes from the line of Andrew Spinola from Wells Fargo.

Can you clarify the comment about Satellite Services revenue being flat next year? Does that include contributions from Eutelsat or not?

No, it doesn't include anything from Eutelsat.

Got it. In terms of sort of the Aero ramp that's in front of you guys. How do we get comfortable not so much with the satellite side but more the structural engineering side regarding the STCs and your ability to install. You're talking about getting to a rate over 100 per quarter next year. You sort of been the wholesale provider in the past. So what sort of milestones, where are you in terms of certifications? And how do we get comfortable that you can sort of scale to that type of install rate?

We really can't talk about in-line installation certifications as an agreement with our -- with Boeing. But we've made great progress on getting through the certifications with our new product. This is a next-generation set of equipment. And so we plan to be installable ahead of the ViaSat-2 satellite availability on all those, so we're starting soon. And we could -- I mean, 100, 120, 200 that part is -- just takes a little bit of time, but it's not a limiting factor for us. It's a more of a limiting factor is for the airlines is how many -- how to get the airline off-line around their maintenance schedules and get the installations done. That is not an equipment availability issue. It's really an airline installation issue. We coordinate that with each airline.

Yes, but I mean, from an engineering perspective, I mean, we've been through it. I think one of the strengths of us as a company is we do a lot of airborne satellite work both with DoD and with business jets and commercial airlines. So we've been through it. We think they're well engineered but ultimately, the rate at which they're installed on the retrofits is going to be driven by the rate at which the airplanes are made available by the airlines.

Got it. And on the consumer broadband side, I think you sort of made a comment that net adds will sort of continue at this levels. Given that in the future quarters [I think, before ViaSat-2] you now have Hughes in the market. Is there any way for you guys to defend against Hughes by upgrading customers that are off contract? Or are there any things that you're doing to defend that -- your existing position? And then why shouldn't we expect churn maybe to kick up a little bit higher so that net adds turn more negative during the rest of the year as you have this competitor in the market that has capacity?

They're good questions. I mean, they've been in service on the new satellite for over 2 months. So we have a little bit of a feel for what the competitive landscape is. I think the service plans they're offering are pretty comparable to what we have, if you think of 25 megabits, and we also have 25 megabits services. I think they're doing more price promotions, which are valuable and, certainly, because they have way more capacity than we do. And I think this is the biggest factor. It makes sense for them to spend a lot more money on advertising and promotion than we do. So their share of voice is high. But on the other hand, we have in front of us, a satellite that we think will allow us to offer better plans. And so one of the ways that we can deal with it, one of the tools is to start improving our plans in anticipation of what the ViaSat-2 plans will be in the selected spot-beam environment. But there's still plenty of demand. I think -- we don't dismiss the questions that you're raising but, so far, experience has been that we think we can do what we've described. And that's what it looks like. The outlook for the -- through the end of this calendar year when ViaSat-2 goes into service. The other thing is we think that the target market that we're aiming for is much bigger than a market of just between us and Hughes. I mean that we're not fighting over every subscriber with Hughes at speeds of 25 megabits per second. We're really better than -- I think that's probably -- I haven't check for sure, but I'm going to bet it's probably better than the average of broadband in the U.S. So it's a pretty broad market. So we'll see, I mean we'll report next quarter, but so far, that's the way it looks.

The only thing I'd add there, Mark, is that we do have -- we have demand for our bandwidth on -- with other applications right now. So part of it is as we do churn people off and we said earlier that we do expect subscribers will go down over the year, we've got uses for that bandwidth.

Got it, that's helpful. One last question from me, Mark, you made a comment earlier on that in your work with JetBlue, you're looking to help improve the economics to them with the next-generation solution. And given their at unlimited now at a certain ARPA, I'm sort of asking the high-level question about ARPA. As airlines get to this unlimited plan, is it -- I mean, are we in a deflationary environment going forward such that you'll be passing along some of this benefits to the airlines? And how do we think of the average revenue per plane going forward as planes sort of -- airlines reach this unlimited level like JetBlue?

Yes, so good question. So yes, one of the things we've been pretty vocal about and we did it again here is we're trying to drive down the cost of bandwidth. And we are offering to share those savings with our customers, right, whether they're residential, government or commercial air. So what that means is you've got these offsetting factors, which is just doing the same things on an airplane take more bandwidth each year, right? Websites have more integrated video. Social media has more integrated video. So if you do nothing else, bandwidth consumption would go up. The other thing that we're trying to do with JetBlue is to increase -- help them increase engagement. They find that passengers who use the in-flight connectivity are happier, right, and that they're more likely to fly JetBlue again. They have a preference for the airlines. So another way to increase bandwidth usage is to get more engagement. And finally, I think we're just scratching the surface of how people are going to use streaming media on airplanes. I think that you'll see more and more choices for over-the-top live TV services, more choices for sports and I think that will drive more bandwidth consumption and then also as device screens get to be higher resolution, that will also drive more bandwidth consumption. So you've got all these factors that we think can improve the overall passenger experience, and we can improve their economics by passing on some of the savings on bandwidth costs. And the other thing that we can do is working with JetBlue -- and we're also doing the same with these other new airlines, is that as engagement grows, and more and more people are aware of it, there are more opportunities to get revenue from sources other than the passengers. So we're pretty actively engaged with that. That's another way to help JetBlue and our other airlines improve their economics.

All right. If I can just follow up on that. I guess, is it -- so that -- will the demand from the airlines exceed your cost improvement from the capacity at -- such that you think for a customer, like JetBlue, that the average revenue per plane will go higher going forward? Or you think that them taking advantage of the better capacity will be just a function of taking advantage of your new technology and not necessarily translating it to a higher revenue per plane?

So what's happened so far, and we've been working in all these things, is that the average revenue per plane has gone up because all those other factors. And then that's actually true for us not just on JetBlue but I think it's just that more engagement, more bandwidth per website, no matter what the mechanism is by which people access the Internet, the trends are for bandwidth usage to grow. And so the net result of that so far has been growth in average revenue per plane. And I think that there's a way to do that. And what we want to do is we want to do it in a way that's good for everybody, right. That's good for the airlines, that's good for the passengers, that's good for the third-party media companies and for us. But I think that's the -- I think that's the trend and that you'll see even with airtime pricing come down, that the consumption and passenger satisfaction is going to go up.

And our next question comes from the line of Rick Prentiss from Raymond James.

I've been offsite at a conference, so I apologize if some of the questions were asked. First one, you guys talked a little bit about the install time or the install pace with American. How many days do they need to take it onto a maintenance schedule at American for you guys to do the installs?

I think you got to ask American that. I mean we're working -- obviously, we're working with them, but I think they've got control of disclosure on the amount of time they have an aircraft off-line.

Okay. And I assume there's some seasonality to when they want to take somebody off as well, can you help us understand any kind of seasonality impact as far as what that pacing might look like?

Sure. We've got 2 things going with American: you have retrofit aircraft and that's definitely affected by seasonality, and then you have new deliveries for in-line things. We have both of those going with them, right. So I think they're pretty anxious to get this stuff on, though. In fact, I know they are. They stress that with me all the time. So I think they're going to go about as fast as they can, when they're ready. But you're right, there's seasonality -- of course, certainly for certain aircraft types on certain routes.

The only other thing I'd want to add there is some element of this is just an artifact of doing an install for a satellite antenna at all. I think for our particular satellite -- install, I think our install is probably the most efficient in the industry, partly because we have fewer pieces of equipment, more of it is integrated. There's fewer cables. So I think that while install rate is a little bit of an issue, it's a fair question for satellite as a whole, I think we're pretty favorably positioned in that respect with the airlines.

Okay. And then did you talk at all about the next phase of the JV with Eutelsat? I know the initial phase, and you talked a little bit about the retailco and infraco, but there was a possibility of expanding that relationship. Is there an update on that?

No, the next phase will be the ViaSat-3 portion. And I think we're both sort of aiming more for the end of the calendar year to have an update on that.

Okay, that makes sense. And as far as timing for potential on a ViaSat-3 C, is there any kind of time frame as when we should be expecting a kind of a go, no-go decision or how you might proceed with it?

I think it's likely we'll proceed. But the timing, again, will be kind of the end of the calendar year for us to have a further disclosure on that.

All right. Mark, that's it.

Okay, so lots of questions, lots of stuff to discuss. Thanks a lot, everybody, for joining us, and I look forward to speaking to you again next quarter.

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