ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
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We currently lease approximately 199,476 square feet of office and operations space in two locations in Longmont, Colorado. This space includes our principal executive offices. The rent varies in amounts per year through the expiration of the lease in August 2015. The annual rent for 2009, net of sublease income, was approximately $3.6 million; the expenses remaining to be paid through the end of the lease, net of sublease income, total approximately $10.3 million.
We also lease less significant properties in the following locations: Waltham, MA; Walnut Creek, CA; Arlington, VA; London, England; and Singapore.
In addition, we lease facilities in Tromso, Norway and in Fairbanks and Prudhoe Bay, Alaska to operate our ground station centers.
We believe that our existing facilities are adequate for our current needs.
From time to time, we are a party to various litigation matters incidental to the conduct of our business. We are not presently party to any legal proceedings the resolution of which, we believe, would have a material adverse effect on our business, operating results, financial condition or cash flows.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock has been listed on the NYSE and traded under the symbol “DGI” since our initial public offering (IPO) in May 2009. The following table sets forth, for the periods indicated, the high, low and last sale prices in dollars on the NYSE for the Company’s common stock and the dividend per share declared by the Company.
At February 22, 2010, there were approximately 337 record holders of our common stock. This figure does not reflect beneficial ownership of shares held in nominee/street name.
The line graph below compares the percentage change in DigitalGlobe’s cumulative total shareholder return on its common stock with the cumulative total return of the S&P Composite 500 Stock Index, GeoEye Inc., and the Russell 2000 for the period from the IPO date, May 14, 2009 through December 31, 2009. It assumes $100 was invested on May 14, 2009.
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Dividends
We have never declared or paid any cash dividends on our common stock and do not anticipate paying cash dividends on our common stock. We anticipate that we will retain all of our future earnings, if any, for use in the development and expansion of our business and for general corporate purposes. Any determination to pay dividends in the future will be at the discretion of our board of directors and will be dependent on then-existing conditions, including our financial condition and results of operations, contractual restrictions, including restrictive covenants contained in our financing facilities, capital requirements and other factors.
Use of Proceeds
On May 13, 2009, our registration statement (File No. 333-150235) was declared effective for our IPO, pursuant to which we sold 1,366,256 shares of common stock.
As a result of the offering, we received net proceeds of approximately $19.0 million, after deducting underwriting fees of $1.8 million and additional offering-related expenses of approximately $3.3 million, for total expenses to us of approximately $5.1 million. No offering expenses were paid directly or indirectly to any of our directors or officers (or their associates). A portion of the underwriting fee was paid to Morgan Stanley & Co., Incorporated, an affiliate owning 10% or more of our equity securities. There has been no material change in the planned use of proceeds from our IPO from that described in the Prospectus filed with the SEC pursuant to Rule 424(b). Proceeds of $19.0 million are currently being held in an investment account that is classified as short term and is included in cash and cash equivalents.
The selected consolidated financial information set forth below for each of the years ended December 31, 2005, 2006, 2007, 2008 and 2009 has been derived from our audited consolidated financial statements. The information below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto in Item 8 of this report.
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Consolidated Statements of Operations Data
(1)
The 2007 results include the operations for GlobeXplorer LLC, or GlobeXplorer, subsequent to the acquisition that occurred in January 2007.
(2)
Adjusted EBITDA is defined as net income or loss adjusted for depreciation and amortization, net interest income or expense, income tax expense (benefit), loss on disposal of assets, restructuring, loss on early extinguishment of debt and non-cash stock compensation expense.
Reconciliation of net income to Adjusted EBITDA is presented below:
Adjusted EBITDA is not a recognized term under generally accepted accounting principles (GAAP) in the United States and may not be defined similarly by other companies. Adjusted EBITDA should not be considered an alternative to net income, as an indication of financial performance, or as an alternative to cash flow from operations as a measure of liquidity. There are limitations to using non-GAAP financial measures, including the difficulty associated with comparing companies that use similar performance measures whose calculations may differ from ours.
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Adjusted EBITDA is a key measure used in internal operating reports by management and the board of directors to evaluate the performance of our operations and is also used by analysts, investment banks and lenders for the same purpose. Adjusted EBITDA is a measure of our current period operating performance, excluding charges for capital, depreciation related to prior period capital expenditures and items which are generally non-cash, non-core or non-recurring in nature.
We believe that the elimination of certain non-cash, non-core or non-recurring items enables a more consistent measurement of period-to-period performance of our operations, as well as a comparison of our operating performance to companies in our industry. We believe this measure is particularly important in a capital intensive industry such as ours, in which our current period depreciation is not a good indication of our current or future period capital expenditures. The cost to construct and launch a satellite and build the related ground infrastructure may vary greatly from one satellite to another, depending on the satellite’s size, type and capabilities. For example, our QuickBird satellite, which we are currently depreciating, cost significantly less than our WorldView-1 or WoldView-2 satellites. Current depreciation expense is not indicative of the revenue generating potential of the satellite.
Adjusted EBITDA excludes interest income, expense, net income taxes and loss on early extinguishment of debt because these items are associated with our capitalization and tax structures. Adjusted EBITDA also excludes depreciation and amortization expense because these non-cash expenses reflect the impact of prior capital expenditure decisions which are not indicative of future capital expenditure requirements. Adjusted EBITDA excludes non-cash stock compensation expense, because these items are non-cash expenses and loss on derivative instrument because these are not related to our primary operations.
We use Adjusted EBITDA in conjunction with traditional GAAP operating performance measures as part of our overall assessment of our performance and we do not place undue reliance on this measure as our only measure of operating performance. Adjusted EBITDA should not be considered a substitute for other measures or financial performance reported in accordance with GAAP.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are a leading global provider of commercial high-resolution earth imagery products and services. Our products and services support a wide variety of uses, including defense, intelligence and homeland security applications, mapping and analysis, environmental monitoring, oil and gas exploration, and infrastructure management. Our principal customers include U.S. and foreign defense and intelligence agencies and a wide variety of commercial customers, such as internet portals, companies in the energy, telecommunications, utility and agricultural industries, and U.S. and foreign civil government agencies. The imagery that forms the foundation of our products and services is collected daily via our three high-resolution imagery satellites and managed in our content archive, which we refer to as our ImageLibrary. We believe our ImageLibrary is the largest, most up-to-date and comprehensive archive of high resolution earth imagery commercially available; containing more than 900 million square kilometers of imagery, with new imagery added every day. With the addition of our WorldView-2 satellite, commissioned on January 4, 2010, we expect our collection capacity to expand to more than 500 million square kilometers per year.
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Products and Services
We offer earth imagery products and services that are comprised of imagery from our three-satellite constellation, and aerial imagery that we acquire from third party suppliers. We process our imagery to varying levels according to the customer’s specifications and deliver our products using the distribution method that best suits our customers needs. Customers can purchase satellite or aerial images that are archived in our ImageLibrary. Customers can also order imagery content by placing custom orders, which require tasking of our satellites, for a specific area of interest, or as a bundle of imagery and data for a region or type of location, such as cities, ports and harbors or airports. For example, CitySphere, an ImageLibrary product, that features color imagery for 300 of the world’s largest cities that is refreshed on a routine basis.
Customers specify how they want the imagery content they are purchasing from us to be produced. We deliver our satellite imagery content at three processing levels: (i) basic imagery with the least amount of processing; (ii) standard imagery with radiometric and geometric correction; and (iii) ortho-rectified imagery with radiometric, geometric, and topographic correction. All of our aerial imagery is delivered as ortho-rectified imagery.
We also use enhanced processing to produce mosaic and stereo imagery products. The mosaic process takes multiple imagery scenes, collected at different times and dates, and merges them into a single seamless imagery product. We use specialized collection and enhanced processing to produce stereo imagery products. Stereo imagery products consist of two images collected from two different viewpoints along the satellite orbit track that are produced as basic products, but can be viewed in stereo (3D) using specialized software. Stereo imagery products are used for the creation of digital elevation maps, for the more accurate creation of 3D maps and flight simulations.
We offer a range of on- and off-line distribution options designed to enable customers to easily access and integrate our imagery into their business operations and applications, including desktop software applications, web services that provide for direct on-line access to our ImageLibrary, File Transfer Protocol (FTP), and physical media such as CD, DVD, and hard drive. We offer an additional distribution option through our DAP that allows certain customers, approved by the U.S. government, to task and download data directly from our WorldView-1 and WorldView-2 satellites within their regional area of interest. DAP is designed to meet the enhanced information and operational security needs of a select and limited number of defense and intelligence customers and certain commercial customers. To date we have signed four customer contracts for our DAP.
We sell our products and services through a combination of direct and indirect channels, a global network of resellers, strategic partners, direct enterprise sales and web services.
Our QuickBird satellite was launched on October 18, 2001 and we successfully commissioned QuickBird into FOC in February 2002. In January 2003, we entered into the ClearView agreement with NGA, under which we agreed to provide a minimum of $72.0 million of QuickBird imagery products and services to the U.S. government over a three-year period, with two one-year extensions at NGA’s option. In January 2006, NGA exercised the first option to extend the ClearView agreement for one year with an additional $36.0 million minimum purchase commitment.
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In September 2003, we entered into the NextView agreement with NGA, under which we agreed to provide a minimum of $531.0 million of imagery products and services from our WorldView-1 satellite. Of this amount, $266.0 million was paid between September 2003 and November 2007, the date WorldView-1 became operational, and was used to offset the construction costs of the satellite. The remaining $265.0 million commitment was to be paid upon the delivery of imagery once WorldView-1 achieved FOC. While NGA has committed to spend these funds to purchase our products and services, actual spending of the funds is ultimately dependent on annual government appropriations of available funds. We recognize revenue under the NextView contract at the time services under the contract are provided as described in Note 2 to the consolidated financial statements included elsewhere in this annual report. The pre-FOC payments were accounted for as deferred revenue until WorldView-1 became operational in November 2007. The deferred revenue is being recognized ratably over the current estimated life of the WorldView-1 satellite as a proxy for the estimated customer relationship life, or 10.5 years.
In February 2007, the ClearView agreement was merged with the NextView agreement to include delivery of imagery from the QuickBird satellite, which, together with sales of images from WorldView-1 after its commissioning in November 2007, generated $73.2 million of revenue in 2007, $157.9 million of revenue in 2008 and $159.2 million of revenue in 2009. In January 2008, we amended the NextView agreement from image-based ordering to a service level agreement, or SLA, and increased the amount we are to receive under the NextView agreement from $265.0 million to $311.0 million. Under the SLA, we are obligated to make substantially all of the image tasking capacity of our WorldView-1 satellite available to NGA, as well as to meet certain service requirements related to the operational performance of our WorldView-1 satellite and related ground systems. In the event that we do not meet the service level requirements, NGA is granted an allowance of up to $0.8 million of the total $12.5 million monthly fee, which NGA can use to extend the SLA period or apply to any new agreement between the parties. Any revenue deferred related to this allowance will be recognized when earned in future periods. In 2009, we deferred $0.4 million of SLA revenue as a result of underperformance against the SLA performance requirements. However, our performance against these requirements has not had a significant adverse impact on our revenue from, or relationship with, NGA. Our commitment to provide a substantial portion of the WorldView-1 satellite imaging capacity to NGA under the NextView agreement limits our ability to provide tasking services from WorldView-1 to other customers, but does not materially limit our ability to sell collected imagery to other customers from our ImageLibrary. Our revenue from NGA under the NextView agreement is derived from sales of WorldView-1 imagery products under the SLA, as well as from non-SLA orders for imagery products and services. Historically, NGA has purchased more than the contracted amounts stipulated in the ClearView and NextView agreements.
We receive a significant majority of our revenue under the NextView agreement, which is scheduled to expire on March 31, 2010. If NGA does not exercise its option to extend the SLA beyond March 2010, our revenue, net income, and liquidity would be materially and negatively impacted.
Our NextView contract with the US Government is scheduled to expire on March 31, 2010. The US Government has options to extend the contract for an additional nine months through December 31, 2010. Although we expect, for the US government to extend the contract, we cannot assure you that the U.S. Government will continue to purchase earth imagery from us at similar levels. Regardless of whether or not this contract is extended or renewed,all of our contracts with the U.S. government agencies are subject to risks of termination or reduction in scope due to changes in U. S. government policies, priorities or Congressional funding level commitments to various agencies Pursuant to the contract terms, U. S. Government agencies can terminate or suspend our contracts at any time with or without cause. The U.S. Government accounted for approximately 75% of our consolidated revenue for the year ended December 31, 2009. We believe that existing cash and cash equivalents as of December 31, 2009 plus anticipated cash flow will be sufficient to fund anticipated operations and capital expenditures through 2010. If the US Government were not to renew or extend our contract at similar levels, we believe we would be able to maintain operations with existing cash and cash equivalents through 2010, however, if necessary we could reduce operating expenses and/or defer capital expenditures.
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In January 2007, we acquired GlobeXplorer for $21.3 million, net of cash acquired. This acquisition broadened our customer portfolio, expanded our product offerings to include aerial and other satellite imagery content and added web-based distribution capabilities.
We conduct our business through two segments: (i) defense and intelligence and (ii) commercial. We have organized our business into these two segments because we believe that customers in these two groups are functionally similar in terms of their areas of focus and purchasing habits. Our imagery products and services are comprised of imagery that we process to varying levels according to the customer’s specifications. We deliver our products and services using the distribution method that best suits our customers’ needs. Customers acquire our imagery either by placing a tasking order for our satellites to collect data to their specifications or purchasing images that are archived in our ImageLibrary.
Revenue
Our principal source of revenue is the licensing of our earth imagery products and services to end users and resellers.
Revenue from defense and intelligence customers accounted for 68.2%, 80.8% and 81.9% of our total revenue in 2007, 2008 and 2009, respectively. Revenue from commercial customers accounted for 31.8%, 19.2% and 18.1% of our total revenue in 2007, 2008 and 2009, respectively. Growth in defense and intelligence revenue as a percentage of total revenue was due to increases in NGA purchases under the ClearView and NextView agreements, including the start of deliveries of imagery products and services from our WorldView-1 satellite to NGA in late 2007. Funding for U.S. government purchases of our imagery products and services is subject to annual appropriation of funds by Congress. Should appropriated funds fall below current levels, we could experience a decrease in our defense and intelligence revenue trend. We generated approximately 76.4%, 83.8% and 84.4% of our revenue in the Americas and 23.6%, 16.2% and 15.6% of our revenue outside of the Americas in 2007, 2008 and 2009, respectively. We generated approximately 68.9% of our revenue from paid tasking and 31.1% from our ImageLibrary for the year ended December 31, 2009 (treating all of the revenue from the SLA under the NextView agreement as paid tasking and excluding amortized revenue).
During the fourth quarter of 2009, a DAP customer’s ground terminal was commissioned and we began generating revenue from providing satellite access time to WorldView-1 to this customer. We will not recognize revenue from a DAP customer until we commission into operation the ground terminal and can provide contractually specified access to our operational satellites. The success of DAP will depend on our ability to secure contracts with potential customers and on our ability to obtain U.S. government approval for contracts with these customers. As described in “Risk Factors - Failure to obtain or maintain regulatory approvals could result in service interruptions or could impede us from executing our business plan,” our failure to obtain approval from the U.S. government for future DAP customers could limit our sales and negatively affect our defense and intelligence revenue.
Defense and Intelligence Revenue
Our defense and intelligence segment consists of customers who are principally defense and intelligence agencies of U.S. or foreign governments. The U.S. government, through NGA, purchases our imagery products and services under the NextView agreement on behalf of various entities within the U.S. government, including the military commands, the CIA, State Department and other government agencies. We also sell to other U.S. defense and intelligence customers including defense and intelligence contractors who provide an additional outlet for our imagery by providing value-added services to our imagery to deliver a final end product to a customer.
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Our defense and intelligence customers focus on image quality, including resolution, frequency of area revisit and coverage, as well as ensuring availability of a certain amount of our capacity as they integrate our products and services into their operational planning. Our customers in this segment typically operate under contracts with purchase commitments, through which we receive monthly, or quarterly payments in exchange for delivering specific orders to the customer. Our revenue from our defense and intelligence customers has historically been largely from tasking orders, with a smaller portion from sales of imagery from our ImageLibrary. We believe this trend will continue. In 2009, we generated approximately 80.5% of our defense and intelligence revenue from paid tasking and 19.5% from our ImageLibrary (treating all of the revenue from the SLA under the NextView agreement as paid tasking and excluding amortized revenue).
In 2008 and 2009, we sold to our defense and intelligence customers both directly and through resellers, with 96.8% and 96.7% of our defense and intelligence revenue coming from direct sales and 3.2% and 3.3% from resellers.
In 2008 and 2009, $207.1 million, or 93.1%, and $214.4 million, or 92.8%, respectively, of our defense and intelligence revenue was generated within the United States and Canada, and $15.3 million, or 6.9%, and $16.6 million, or 7.2%, respectively, was generated from international defense and intelligence customers. In 2008 and 2009, our top five defense and intelligence customers accounted for 97.6% and 96.7%, respectively, of our defense and intelligence revenue. NGA was our only customer that accounted for more than 10% of our revenue in 2008 and 2009. NGA accounted for approximately 73.9% and 75.0%, respectively, of our revenue for the year ended December 31, 2008 and 2009, respectively.
Commercial Revenue
Our commercial business consists of both traditional customers, primarily civil governments, and energy, telecommunications, utility and agricultural companies that use our content for mapping, monitoring, analysis and planning activities, and customers that add our content to enhance and expand the information products and services that they develop and sell to the commercial market. We call this second type of customer an integrated information customer.
Most of our traditional commercial customers purchase our imagery products and services on an as-needed basis, either from the ImageLibrary or by placing tasking orders. By contrast, some of our integrated information customers prefer contracts to maintain access to our imagery archive, or purchase subscriptions to access our ImageLibrary. The majority of revenue from the commercial segment has historically been generated from sales of imagery from our ImageLibrary, with a smaller proportion from tasking orders. We believe this trend will continue in 2010. For the twelve months period ended December 31, 2009, we generated approximately 22.7% of our commercial revenue from paid tasking and 77.3% from our ImageLibrary.
Our commercial customers are located throughout the world. We sell to these customers both directly and through resellers, with 58.6% and 56.6%, respectively of our commercial revenue coming from resellers and 41.4% and 43.4%, respectively, coming from direct sales in 2008 and 2009.
In 2008 and 2009, $27.6 million, or 52.3% and $23.6 million, or 46.4%, respectively, of our commercial revenue was generated in the Americas and $25.2 million or 47.7% and $27.3 million, or 53.6%, respectively, was generated outside of the Americas. In 2008 and 2009, our top five commercial customers accounted for 39.7% and 48.3%, respectively, of our commercial revenue. None of these customers accounted for more than 10% of our revenue in 2008 or 2009. We believe that we will have additional opportunities in some of the countries with developing economies, such as China, India and Russia, and, as a result, we expect that sales long-term growth in our commercial segment will be higher outside of the Americas.
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Expenses
Most of our revenue has come from the sale of products and services comprised of imagery from QuickBird and, since November 2007, WorldView-1. Given that most of the operating costs of a satellite are related to the pre-operation capital expenditures required to build and launch a satellite, there is no significant direct relationship between our cost of revenue and changes in our revenue. Our cost of revenue consists primarily of the cost of personnel, as well as the cost of operations directly associated with operating our satellites, retrieving information from the satellites, and processing the data retrieved. In 2007, we acquired an aerial imagery library when we purchased GlobeXplorer. Costs of acquiring the aerial imagery are amortized on an accelerated basis as a cost of revenue.
Our selling, general and administrative expenses consist primarily of labor, benefits, travel, rent, insurance, utilities and related overhead costs, third-party consultant payments, sales commissions and marketing expenses. Our selling, general and administrative expenses have been increasing in total in recent years, and we expect the increase in costs to continue, as we expand our sales and administrative resources to accommodate our revenue growth, increase capacity for product sales and distribution, and incur costs related to being a public company. As a result, we expect that our selling, general and administrative expenses as a percent of revenue will increase in the near term. As we expand our worldwide presence, we also expect an increase in travel, selling and administrative expenses.
Depreciation and amortization consist primarily of depreciation of our satellites and other operating assets. In 2007, we began recording amortization of intangible assets as a result of the GlobeXplorer acquisition. In November 2007 when WorldView-1 reached FOC, we began depreciating this asset. WorldView-2 became operational on January 4, 2010. Our future earnings will be impacted as we begin depreciating the satellite, which will increase our depreciation expense.
Our interest charges consist primarily of interest payments on borrowings used to finance satellite construction and are capitalized as a cost of our satellite construction. During 2009, all interest incurred was capitalized to our satellite that was under construction. With the successful completion of WorldView-2, interest capitalization will be allocated to the remaining assets under construction. The completion of our satellite construction will impact our earnings by increasing our interest expense now that WorldView-2 is operational, because we may no longer capitalize all of the interest on our debt.
We had net operating losses through 2005 and accumulated a deferred tax asset related to those losses. The accumulated deferred tax assets had a full valuation allowance recorded against it. In 2007, we removed the valuation allowance previously recorded against certain of our net deferred tax assets, based on a determination that it is more likely than not that we will be able to fully use the related deferred tax assets in future years. In 2007, 2008 and 2009, taxable income was substantially offset by the utilization of our net operating loss carryforwards.
With the release of our valuation allowance in 2007, our 2008 income tax expense increased. However, we will not make federal tax payments, other than alternative minimum tax payments, until we fully utilize our net operating loss carryforwards, which is expected to occur during 2011.
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Results of Operations
For the Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
The following tables summarize our historical results of operations for the year ended December 31, 2009 compared to the year ended December 31, 2008, and our expenses as a percentage of revenue for the periods indicated:
The Company continued to experience overall growth in revenue year over year through the continued strength of the domestic defense and intelligence revenue. NGA value added projects beyond those contained within the SLA primarily related to web services and 3D imagery produced growth of $6.7 million. Projects and orders under the SLA increased by $1.3 million in 2009. The growth in NGA was offset by $0.7 million decrease in state and local government agencies, primarily due to the weakened economy and cutbacks in spending at the state and local government level. International defense and intelligence revenue increased $1.3 million in 2009 due to growth within Europe with existing customers. In the fourth quarter, one of our DAP customer facilities became operational, and we recognized revenue by providing access to our WorldView-1 satellite.
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Commercial revenue in the Americas had a decrease of $4.0 million. This decline was a result of reduced volume of orders from our reseller network in North and South America. International commercial revenue increased by $2.1 million in 2009 as a result of growth in revenue from Japan and Asia.
We continued to invest in our people and infrastructure, leading to an increase in both cost of revenue and selling, general and administrative costs in absolute terms and as a percent of our total revenue.
Increases in cost of revenue were realized related to increases in production, satellite operations and information technology costs. The $2.6 million increase in expenses is primarily attributable to (i) $1.1 million increase in the amortization of purchased aerial imagery, (ii) $0.8 million increase in expenses resulting from operating equipment and facilities costs, and (iii) $0.5 million in increased labor costs, including stock compensation and bonus accrual. Cost of revenue grew 0.6% as a percentage of revenue in 2009.
The $12.5 million increase in selling, general and administrative costs was attributable to (i) $7.4 million in labor, travel and related benefit costs, (ii) $3.0 million increase in stock compensation as a result of a grant given at the time of the IPO and stock option grants for new board members, (iii) $1.5 million sales commissions to third party consultants, (iv) $0.7 million related to software licenses and hardware costs, (v) increase in bad debt of $0.6 million. These increases were offset by a decrease in consulting and professional services of $1.8 million. Sales, general and administrative expenses increased 3.7% as a percentage of revenue.
Depreciation and amortization decreased by $1.3 million due to a decrease of $1.4 million related to extending the life of the QuickBird satellite. Depreciation will increase upon commissioning of theWorldView-2 satellite.
The loss from early extinguishment of debt for 2009 was $7.7 million due to our issuance of senior secured notes with a face value of $355.0 million in April 2009 and repayment in full of our senior credit facility and our senior subordinated notes. The early extinguishment of debt represents the expensing of the deferred financing costs of $5.9 million related to the senior credit facility and senior subordinated notes, and includes a prepayment penalty of $1.8 million related to the senior subordinated notes.
Due to an amendment made to our senior secured debt in the first quarter of 2009, our swap arrangements became ineffective for accounting purposes and a $1.8 million loss was recorded through earnings. In April 2009, in connection with the repayment of our senior secured notes, our swap was terminated.
The change from interest expense to interest income is primarily due to all interest expense being capitalized in 2009. Due to the fact that our total costs incurred on WorldView-2 exceed our outstanding debt, whereas only a portion of our interest was capitalized in 2008 based on our spending level on the satellite and other projects. Upon operational commissioning of WorldView-2, most of our interest will no longer be capitalized and interest expense will increase. We expect to expense most of our interest expense until we commence construction of another satellite, of which there is no current plan.
The decrease in income tax expense is primarily due to a decrease in pre-tax income. We performed an analysis of our projected 2009 operating results to determine an effective overall tax rate of 40% to be applied for the year. In addition, in the second quarter of 2008 we made an out-of-period adjustment, which resulted in an increase in income tax expense of $1.4 million. In connection with the preparation of the second quarter income tax provision and the 2007 federal income tax return, we became aware of certain adjustments that should have been made to release of the valuation allowance that was recorded in the fourth quarter of 2007. The net operating loss carry forward recorded as a deferred tax asset as of December 31, 2007, and related income tax benefit for the year ended December 31, 2007 should have been reduced by $1.4 million, due to tax basis and related tax depreciation differences.
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For the Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
The following tables summarize our historical results of operations for the year ended December 31, 2008 compared to the year ended December 31, 2007 and our expenses as a percentage of revenue for the periods indicated:
Revenue for the year ended December 31, 2008 increased by $123.5 million, or 81.4%, to $275.2 million from $151.7 million from the year ended December 31, 2007, primarily due to growth in domestic, which includes the U.S. and Canada, defense and intelligence revenue. The $118.1 million growth in defense and intelligence revenue for the year ended December 31, 2008 is primarily due to an increase in sales to NGA under the SLA. Domestic defense and intelligence, including NGA, increased by $115.3 million to $207.1 million from $91.8 million for the year ended December 31, 2007. The increase in NextView revenue of approximately $84.7 million is due to the first full year of operation of WorldView-1. The increase is also attributable to an increase of $8.2 million in revenue from special imagery projects in addition to revenue under the SLA. This increase includes $22.3 million of non-cash pre-FOC deferred revenue related to pre-WorldView-1 launch payments made by NGA pursuant to the NextView contract that was recognized during 2008.
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International defense and intelligence revenue increased $2.8 million, or 22.4%, to $15.3 million from $12.5 million from the year ended December 31, 2007, primarily due to increased revenue from Asia.
Commercial revenue increased by $5.4 million, or 11.4%, to $52.8 million, primarily due to increased international revenue. Domestic commercial revenue increased $0.7 million, or 2.6%, to $27.6 million from $26.9 million from the year ended December 31, 2007 was primarily due to growth in revenue from Central and South America. International commercial revenue increased $4.6 million, or 22.1%, to $25.2 million from $20.6 million from the year ended December 31, 2007, primarily due to growth in revenue from China, India and Europe.
Cost of revenue for the year ended December 31, 2008 increased by $6.4 million, or 29.0%, to $28.5 million from $22.1 million for the year ended December 31, 2007. The increase in expenses is due to the fact that we are no longer deferring certain contract costs and increased operation costs due to a full year of WorldView-1 operation. The increase in expenses is attributable to (i) a $2.6 million increase in the amortization of the aerial imagery library, (ii) $2.1 million related to subcontracted project costs, (iii) an increase in labor costs, stock compensation and bonus expense of $1.5 million, and (iv) an increase in consulting costs of $0.2 million.
Selling, general and administrative expenses for the year ended December 31, 2008 increased by $27.1 million, or 55.3%, to $76.1 million from $49.0 million from the year ended December 31, 2007. The increase is driven by (i) $11.8 million of increased expenses from compensation, travel and related costs resulting from increased headcount, (ii) an increase of $6.0 million in satellite insurance expense related to the first full year of WorldView-1 coverage, (iii) an increase in consulting expenses of $3.8 million, (iv) an increase of $3.5 million in bonus and stock compensation expense, and (v) an increase in marketing expenditures of $0.7 million. Although these expenses grew slower than our revenue in 2008, we believe that these investments are necessary to support the growth of the business.
Depreciation and amortization for the year ended December 31, 2008 increased by $28.9 million, or 61.8%, to $75.7 million from $46.8 million from the year ended December 31, 2007. Depreciation expense increased by $28.9 million for the year ended December 31, 2008 due to a full year of depreciation expense related to the operation of WorldView-1. The increase in WorldView-1 depreciation of $39.5 million was offset by a decrease of $11.1 million related to the extension of the depreciable operational life of QuickBird from March 2009 to November 2010 and $0.5 million of depreciation of other fixed assets acquired during the year. The assessment, performed in January 2008, of the estimated useful life of the QuickBird satellite led to an extension of the useful depreciable operational life of QuickBird, primarily attributable to the reduced consumption of fuel compared to previous estimates. The assessment performed in the third quarter of 2008 did not result in a change to the estimated life of QuickBird.
Interest income (expense), net, for the year ended December 31, 2008 decreased by $7.1 million to $3.0 million of net interest expense from $4.1 million of net interest income for the year ended December 31, 2007. We had interest expense in 2008 of $3.9 million and interest income of $0.9 million. The change from interest income to interest expense is primarily due to lower average cash balances and lower average interest rate returns on cash balances during 2008 as compared to 2007. Prior to the fourth quarter of 2007, when the WorldView-1 satellite became operational, all interest on our debt was being capitalized to the WorldView-1 satellite. Prior to the fourth quarter of 2008, $16.2 million of our interest expense was capitalized. During the fourth quarter of 2008, the amount of capitalized costs for the WorldView-2 satellite exceeded the total value of our outstanding debt and thereafter all interest on our debt was capitalized to the WorldView-2 satellite. We expect to capitalize all interest associated with our debt until the WorldView-2 satellite is launched and operational.
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Income tax expense for the year ended December 31, 2008 increased by $96.0 million to $38.1 million from a tax credit of $57.9 million for the year ended December 31, 2007. The increase is primarily due to the tax benefit in 2007 of $57.9 million reflecting the release of our valuation allowance as we determined that it was more likely than not, that we would utilize a certain portion of our net operating loss carry-forwards. Further, an increase in pre-tax income for the year ended December 31, 2008 compared to year ended December 31, 2007 resulted in higher income tax expense. During 2008, we utilized some of our deferred tax assets. When our deferred tax assets are fully utilized, we will pay cash taxes on our net income. We applied the estimated tax rate for the 2008 year to the quarterly results of operations. A portion of the increase is also due to an out-of-period adjustment that was made during the second quarter of 2008, which resulted in an increase in income tax expense of $1.4 million during the second quarter of 2008. In connection with the preparation of the second quarter income tax provision and the 2007 federal income tax return, we became aware of certain adjustments that should have been made to prior to the release the valuation allowance that was recorded in the fourth quarter of 2007. The net operating loss carryforward recorded as a deferred tax asset as of December 31, 2007 and related income tax benefit for the year ended December 31, 2007 should have been reduced by $1.4 million, due to tax basis and related tax depreciation differences. Prior to the fourth quarter of 2007, we held a full valuation allowance against our deferred tax related to net operating losses and only recognized alternative minimum tax expense.
Liquidity and Capital Resources
We believe that the combination of funds currently available to us and funds expected to be generated from operations will be adequate to finance our operations and development activities for the next twelve months. Our NextView contract with the US Government is scheduled to expire on March 31, 2010. The US Government has options to extend the contract for an additional nine months through December 31, 2010. Although we expect, for the US government to extend the contract, we cannot assure you that the U.S. Government will continue to purchase earth imagery from us at similar levels. Regardless of whether or not this contract is extended or renewed,all of our contracts with the U.S. government agencies are subject to risks of termination or reduction in scope due to changes in U. S. government policies, priorities or Congressional funding level commitments to various agencies Pursuant to the contract terms, U. S. Government agencies can terminate or suspend our contracts at any time with or without cause. The U.S. Government accounted for approximately 75% of our consolidated revenue for the year ended December 31, 2009. We believe that existing cash and cash equivalents as of December 31, 2009 plus anticipated cash flow will be sufficient to fund anticipated operations and capital expenditures through 2010. If the US Government were not to renew or extend our contract at similar levels, we believe we would be able to maintain operations with existing cash and cash equivalents through 2010, however, if necessary we could reduce operating expenses and/or defer capital expenditures.
In April 2009, we issued $341.8 million accreted value of our senior secured notes and used $280.3 million of the net proceeds to repay in full our senior credit facility and senior subordinated notes and will use the remaining balance for transaction costs and general corporate purposes. The note transaction resulted in net proceeds to us after giving effect to the debt repayment, increased cash interest expense and an extension of debt maturities. As of the issuance date of the senior secured notes, we estimate that our cumulative spending on the WorldView-2 satellite exceeded the accreted value of our debt. Therefore, we capitalized all of the interest expense, including the accretion of the debt discount and amortization of debt issue costs on the notes to the WorldView-2 satellite until we reached commissioning of the satellite in early 2010.
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In summary, our cash flows were:
In 2009, cash flows provided by operating activities decreased by $1.1 million from 2008. Our net income decreased $6.4 million as compared to 2008, driven by growth in operating expenses at a faster rate than our revenue growth. This lower net income resulted in a decrease in utilization of deferred tax assets, specifically net operating losses. Due to our debt refinancing in the second quarter of 2009, these decreases were offset by a $5.3 million non-cash charge related to the write off of debt financing fees and increased amortization related to our aerial image library.
Cash flows used in investing activities increased by $47.6 million in 2009 due to an increase in capital expenditures of $24.8 million as compared to 2008. This increase was primarily due to the costs related to the launch and commissioning of our WorldView-2 satellite, including costs related to insuring the WorldView-2 satellite launch. We had modestly higher non-satellite capital expenditures related to increased storage and distribution assets necessary to manage our imagery data. Investing activities increased $21.4 million from 2008 as a result of entering into letters of credit to secure future delivery of products and services under DAP contracts.
Cash flows from financing activities increased $47.0 million from 2008 as a result of $60.9 million raised in our second quarter 2009 senior notes offering and $19.0 million from our IPO also in the second quarter 2009.
In 2008, cash flow from operating activities increased by $64.3 million primarily driven by the first year of operation under the NextView SLA. The increase was largely driven by the decrease in net income, offset by the change in deferred income taxes. In 2007, we released the valuation allowance associated with the deferred tax assets and recorded a benefit of $57.9 million. In 2008, we began recording income tax expense. In addition, in 2008, we recorded an increase in non-cash recognition of deferred revenue of $22.3 million related to the full year of amortization of pre-FOC payments received from NGA and an increase in depreciation expense of $28.9 million primarily due to the first full year of depreciation of the WorldView-1 satellite.
In 2008, cash flows used in investing activities decreased by $14.3 million from 2007. Construction in progress additions decreased due to the completion and launch of the WorldView-1 satellite in September 2007.
In 2008, cash provided by (used in) financing activities increased by $39.4 million. The increase is due to issuance of $40.0 million of senior subordinated notes in February 2008 with net proceeds of $38.5 million.
Senior Credit Facility and Senior Subordinated Notes
In April 2009, we repaid in full our $230.0 million senior credit facility and our senior subordinated notes with the proceeds from the issuance of our senior secured notes.
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Senior Secured Notes
On April 28, 2009, we issued $355.0 million principal amount of our senior secured notes. Gross proceeds of $341.8 million were used to repay our senior credit facility and senior subordinated notes in full and pay fees and expenses associated with the transaction. The remaining proceeds will be used for general corporate purposes. The senior secured notes mature on May 1, 2014. The senior secured notes are guaranteed by our subsidiaries and secured by nearly all of our assets, including the shares of capital stock of our subsidiaries, and the QuickBird, WorldView-1 and WorldView-2 satellites in operation. The senior secured notes bear interest at the rate of 10.5% per annum. Interest is payable semi-annually on May 1 and November 1 of each year.
We may redeem some or all of the senior secured notes after May 1, 2012, at a redemption price equal to 105.25% of their principal amount through May 1, 2013 and 100% thereafter plus, in each case, accrued and unpaid interest. In addition, at any time on or prior to May 1, 2012, we may redeem up to 35% of the aggregate principal amount of the senior secured notes with the net cash proceeds of certain equity offerings at 110.5% of the principal amount plus accrued and unpaid interest. In the event of certain change of control events, we must give holders of the senior secured notes an opportunity to sell us their notes at a purchase price of 101% of the accreted value of such notes, plus accrued and unpaid interest.
The indenture governing the senior secured notes contains a number of significant restrictions and covenants that, among other things, limit our ability to incur additional indebtedness, make investments, pay dividends or make distributions to our stockholders, grant liens on our assets, sell assets, enter into a new or different line of business, enter into transactions with our affiliates, merge or consolidate with other entities or transfer all or substantially all of our assets, and enter into sale and leaseback transactions. The credit market turmoil could negatively impact our ability to obtain future financing or to refinance our outstanding indebtedness.
Off-Balance Sheet Arrangements, Contractual Obligations, Guaranty and Indemnification Obligations
Off-Balance Sheet Arrangements
We had no off-balance sheet arrangements as of December 31, 2009.
Contractual Obligations
We have various contractual obligations impacting our liquidity. The following represents our contractual obligations as of December 31, 2009:
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Payments due on our senior secured notes totaled $355.0 million due at maturity date of May 2014, excluding interest. Interest expense is due semi-annually in May and November. Contractual obligations are remaining amounts due on long term contracts. Our operating leases are primarily for office space in the United States. We generally believe leasing office space is more cost-effective than purchasing real estate.
Guaranty and Indemnification Obligations
We enter into agreements in the ordinary course of business with resellers and others. Most of these agreements require us to indemnify the other party against third-party claims alleging that one of our products infringes or misappropriates a patent, copyright, trademark, trade secret or other intellectual property right. Certain of these agreements require us to indemnify the other party against claims relating to property damage, personal injury or acts or omissions by us, our employees, agents or representatives. In addition, from time to time we have made guarantees regarding the performance of our systems to our customers.
Critical Accounting Policies
Our consolidated financial statements are based on the selection and application of U.S. Generally Accepted Accounting Principles (GAAP) that require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our financial statements. We believe that the policies set forth below may involve a higher degree of judgment and complexity in their application than our other accounting policies and represent the critical accounting policies used in the preparation of our financial statements. If different assumptions or conditions were to prevail, the results could be materially different from our reported results. Our significant accounting policies are presented within Note 2 to our consolidated financial statements included elsewhere in this annual report.
Revenue Recognition
Our principal source of revenue is the licensing of earth imagery products and services for end users and resellers. Revenue is recognized when an arrangement exists, the solution has been delivered to our customers, the fee is fixed or determinable and the collection of funds is reasonably assured. We have a limited number of agreements with multiple deliverables that we review to determine whether any or all of the deliverables can be separated from one another. If separable, revenue is allocated to the various deliverables based on their relative fair value and recognized for each deliverable when the revenue recognition criteria for that specific deliverable are achieved.
All direct costs are expensed as a cost of revenue. An allowance for doubtful accounts receivable is provided for at the end of each period, based upon management’s assessment of the collectability of outstanding accounts receivable.
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Our revenue is generated from: (i) licenses of imagery; (ii) subscription services; and (iii) the recognition of deferred revenue. We recognize revenue from each of our revenue sources as follows:
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Licenses. Revenue from sales of imagery licenses is recognized when the images are physically delivered to the customer or, in the case of electronic delivery, when the customer is able to directly download the image off of our system. Revenue is recognized net or authorized contractually agreed discounts.
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Subscriptions. We have several products and services that allow customers to access imagery on-line and manipulate the imagery before delivery. Customers pay for the subscription at the beginning of the subscription period. The subscription revenue is recorded as deferred revenue and recognized ratably over the subscription period. In addition, we have other arrangements in which the customer pays for their subscription to one of the Company’s web-based products by prepaying for a set number of product accesses (for instance each time users click on an image of their home). Each time a product is accessed, a portion of the customer’s prepayment is earned. These prepayments are recorded as deferred revenue when received and the revenue is recognized based on the number of times the product is accessed. Revenue is recognized net or authorized contractually agreed discounts.
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Subscription-Type Arrangements. We enter into subscription-type arrangements with customers whereby a bundle of services and/or multiple deliverables are contracted for delivery over a specified period of time. Revenue from this type of arrangement is recognized either ratably over the term of the arrangement or periodically throughout the term based on proportional performance.
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Service Level Agreements. We recognize service level agreement revenue net of any allowances resulting from failure to meet certain stated monthly performance metrics. Net revenue is recognized each month because the fee for each month is fixed and non-refundable and is for a defined and fixed level of service each month.
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Deferred Revenue. Our deferred revenue is composed of payments received in advance of recognition of revenue, the majority of which relate to the following types of arrangements: (i) prepayments from NGA; (ii) the DAP; and (iii) subscription arrangements. All fees received in connection with direct access facility construction have been recorded as deferred revenue and all costs incurred have been recorded as deferred contract costs. Upon commencement of DAP operations deferred revenue and related deferred contract costs will be amortized into the income statement over the estimated customer relationship period.
In connection with the initial contract under the DAP, in 2005 we received an upfront payment of $10.0 million from Hitachi Software. The upfront payment is included in deferred revenue and will be recognized to revenue over the estimated customer relationship period (WorldView-2 life) upon commencement of the DAP operations. We will be evaluating the estimated customer relationship period when events suggest the period may have changed or at least on an annual basis, and may make adjustments to the amortization period if a change to the estimated life of the relationship is made.
The following additional recognition policies have been applied for significant contracts.
NGA paid us $266.0 million to partially offset the cost of the construction and launch of WorldView-1. These payments were recorded as deferred revenue when received. When WorldView-1 reached FOC in November 2007, we began recognizing the deferred revenue on a straight line basis over the estimated useful life of WorldView-1, which we use as a proxy for the estimated customer relationship period of 10.5 years. We will be evaluating the estimated customer relationship period when events suggest the period may have changed or at least on an annual basis, and may make adjustments to the amortization period if a change to the estimated life of the relationship is made.
Occasionally, we enter into contracts with customers that are required to be deferred over a period of time. If the contract does not have a specified contractual life, we make an assessment as to the likely term of the remaining period of the contractual relationship with the customer. A review of the contractual relationship is performed by management quarterly, and, as such, the potential amortization of the deferred revenue may be adjusted as appropriate.
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Accounting for Stock Options
We apply the fair value recognition provisions of stock-based compensation expense and measures stock compensation at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is generally the vesting period.
In order to determine the fair value of our common stock on the date of grant for purposes of calculating the fair value of our stock option grants, we utilize the most recent publicly traded stock price on the grant date.
Since our common stock has not been publicly traded long enough to substantiate a history of volatility, we established a peer group of comparable publicly traded companies and utilized their reported cash operating earnings and revenue multiples as of each valuation date. At each valuation date, we reviewed the companies that comprise the peer group and, from time to time have changed the composition of the peer group, based on changes to our business or the business of the comparable companies and other factors outside of our control, such as mergers and consolidations.
At each stock option grant date, we utilized the peer group data to calculate our expected volatility. Expected volatility was based on comparable companies’ four-year history for options granted prior to 2009, and five-year history for options granted during 2009. Expected term and forfeiture rate were based on existing employee exercise patterns and our historical pre-vested forfeiture experience. The risk-free rate was based on an average of the yields of the treasury note with a maturity corresponding to the expected option life assumed at the grant date.
Changes to the underlying assumptions, including increased forfeiture rates, may have a significant impact on the underlying value of the stock options, which could have a material impact on our financial statements. As of December 31, 2009, there was a total of $10.8 million of unrecognized expense, which will be recognized over a weighted average period of 2.7 years.
Property and Equipment
Property and equipment are recorded at cost. The cost of our satellite includes capitalized interest cost incurred during the construction and development period. In addition, capitalized costs of our satellite and related ground systems include internal direct labor costs incurred in the construction and development, as well as depreciation costs related to assets which support the construction and development of our satellite and related ground systems. Ground systems are placed into service when they are ready for their intended use. While under construction, the costs of our satellites are capitalized during the construction phase, assuming the eventual successful launch and in-orbit operation of the satellite. If a satellite were to fail during launch or while in-orbit, the resulting loss would be charged to expense in the period in which such loss were to occur. The amount of any such loss would be reduced to the extent of insurance proceeds received as a result of the launch or in-orbit failure.
We capitalize certain internal and external software development costs incurred to develop software for internal use. We expense the costs of developing computer software until the software has reached the application development stage and capitalize all costs incurred from that time until the software is ready for its intended use, at which time amortization of the capitalized costs begins. Determination of when the software has reached the application development stage is based upon completion of conceptual designs, evaluation of alternative designs and performance requirements. Costs of major enhancements to internal use software are capitalized while routine maintenance of existing software is charged to expense as incurred. The determination of when the software is in the application development stage and the ongoing assessment of the recoverability of capitalized computer software development costs requires considerable judgment by management with respect to certain factors, including, but not limited to estimated economic life and changes in software and hardware technology.
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Internal use capitalized software costs are amortized on a product-by-product basis over their expected useful life, which is generally three to five years. Software costs that are directly related to a satellite are capitalized with the satellite and amortized over the satellites useful life. Amortization expense related to capitalized software costs, exclusive of software costs amortized as part of the cost of our satellites, was $8.1 million, $7.2 million and $7.5 million, for the years ended December 31, 2007, 2008 and 2009, respectively.
Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets, such as three to seven years for computer equipment and seven to ten and one half years for most other assets, including the satellite and ground stations. Leasehold improvements and assets used pursuant to capital-lease obligations are amortized on a straight-line basis over the shorter of their useful lives or lease terms; such amortization is included in depreciation expense. Upon sale or retirement, the cost and related accumulated depreciation are eliminated from the respective accounts and the resulting gain or loss is included in operations. Repairs and maintenance are expensed as incurred.
Asset Valuation and Estimated Useful Lives
Asset valuation includes assessing the recorded value of certain assets, including accounts receivable, goodwill, capitalized contract and related satellite costs and other intangible assets. We use a variety of factors to assess valuation, depending upon the asset. Accounts receivable are evaluated based upon the creditworthiness of our customers, historical experience, the age of the receivable and current market and economic conditions. Should current market and economic conditions deteriorate or if our other assumptions are not met, our actual bad debt experience could exceed our estimate.
We capitalize interest, an allocated portion of launch insurance premiums, contract costs and internal direct labor costs incurred in, and depreciation costs related to assets that support the construction and development of our satellites and related ground systems. Once a satellite is operational, we depreciate the asset over the expected operational life. Changes in the estimates of the operational life of the asset are reflected in subsequent periods as adjustments to future depreciation expenses.
Following each launch, and at least annually thereafter, we review the expected operational life of our satellites. We determine a satellite’s expected operational life using a complex calculation involving the probabilities of failure of the satellite’s components from design or manufacturing defects, environmental stresses or other causes. The expected operational lives of our satellites are affected by a number of factors, including the quality of construction, the supply of fuel, the expected gradual environmental degradation of solar panels and other components, levels of solar radiation, the durability of various satellite components and the orbits in which the satellites are placed.
Other intangible assets are evaluated based upon the expected period during which the asset will be utilized, forecasted cash flows, changes in technology and customer demand. Changes in judgments on any of these factors could materially impact the value of the asset. The fair value of our reporting units is based upon a discounted cash flow analysis, which is used to determine if we have a goodwill impairment. The analysis considers estimated revenue and expense growth rates. The estimates are based upon our historical experience and projections of future activity, considering customer demand, changes in technology and a cost structure necessary to achieve the related revenue. Changes in judgments on any of these factors could materially impact the value of the asset.
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In determining the purchase price allocation in connection with the GlobeXplorer acquisition, we obtained projected financial results from GlobeXplorer, adjusted those projections based on our knowledge of the market and then valued GlobeXplorer with a discounted cash flow model using those projections, an appropriate weighted cost of capital as a discount factor and an appropriate terminal multiple of earnings before interest, taxes, depreciation and amortization. After our initial valuation, we allocated the purchase price by performing a discounted cash flow valuation of GlobeXplorer’s business, the value of customer relationships, the value of the core technology and the value of certain relationships with prior management.
Income Taxes
The current provision for income taxes represents actual or estimated amounts payable or refundable on tax returns filed each year. Deferred tax assets and liabilities are recognized for the estimated future tax effects attributable to the temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in enacted tax laws is recognized as an adjustment to the tax provision or benefit in the period of enactment. The overall change in deferred tax assets and liabilities during the period is equal to the deferred tax expense or benefit for the period. The carrying value of deferred tax assets may be reduced by a valuation allowance if, based upon the judgmental assessment of available evidence, it is deemed more likely than not that some or all of the deferred tax assets will not be realizable.
As of December 31, 2009, there are no income tax positions for which the unrecognized tax benefits will significantly increase or decrease during the next twelve months. Tax years still open for examination by federal and major state agencies as of December 31, 2009 are 1996 through 2009. Federal and state agencies may disallow research tax carryforwards, net operating loss carryforwards and other carryforwards previously claimed.
As of December 31, 2009, we had federal and state net operating loss carryforwards of $214.8 million and $189.1 million, respectively, available to offset future federal and state taxable income. If not used, the net operating loss carryforwards will expire at various times during the period from 2010 to 2029. Under Section 382 of the Internal Revenue Code of 1986, or the Code, in general, an aggregate increase of more than 50% in the percentage ownership in value of our stock by 5% or greater stockholders (including public groups) over a running three-year period constitutes an “ownership change” for federal income tax purposes. Such an ownership change may limit our ability to use, for both regular and alternative minimum tax purposes, any net operating loss carryforwards attributable to the periods prior to the ownership change. We believe that such ownership changes have occurred and may occur in the future to further limit the use of our net operating loss carryforwards. We also believe that any future ownership changes should not have a material adverse effect on the use of our existing net operating loss carryforwards. In 2009, we generated a taxable loss resulting from accelerated depreciation on the WorldView-2 satellite. Current tax legislation allows this loss to be carried back to prior years which will reduce prior years AMT income to zero and will generate a refund of all previously paid AMT.
Recently Adopted Accounting Standards
In June 2009, the Financial Accounting Standards Board (FASB) established the FASB Accounting Standards Codification (Codification) as the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification did not have an impact on our Consolidated Financial Statements upon adoptions. Accordingly, our disclosures will explain accounting concepts rather than site specific topics of GAAP.
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In May 2009, the FASB issued new accounting guidance to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events, whether that evaluation date is the date of issuance or the date the financial statements were available to be issued, and alerts all users of financial statements that an entity has not evaluated subsequent events after that evaluation date in the financial statements being presented. The guidance is effective for financial statements issued for fiscal years and interim periods ending after June 15, 2009. The guidance became effective for the Company on April 1, 2009. The adoption of this guidance had no impact on its Consolidated Financial Statements.
In April 2008, the FASB issued new accounting guidance which defines the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The Company adopted this guidance on January 1, 2009 and the adoption did not have a material effect on the presentation or classification on the assets in the financial statements.
In March 2008, the FASB issued new accounting guidance that requires additional disclosures regarding: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted; and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. In addition, requires qualitative disclosures about objectives and strategies for using derivatives described in the context of an entity’s risk exposures, quantitative disclosures about the location and fair value of derivative instruments and associated gains and losses, and disclosures about credit-risk-related contingent features in derivative instruments. The requirements under this guidance must be applied as authoritative guidance for fiscal years and interim periods within these fiscal years, beginning after November 15, 2008. The Company has adopted this guidance effective January 1, 2009 and there was not a material effect on the presentation or classification of these activities in our financial statements.
In February 2008, FASB issued authoritative guidance that addresses fair value measurements for purposes of lease classification or measurement. In October 2008, the FASB issued additional authoritative guidance which clarifies the application of determining fair value when the market for a financial asset is inactive. Specifically, this guidance clarifies how (1) management’s internal assumptions should be considered in measuring fair value when observable data are not present, (2) observable market information from an inactive market should be taken into account, and (3) the use of broker quotes or pricing services should be considered in assessing the relevance of observable and unobservable data to measure fair value.
In December 2007, the FASB issued new accounting guidance which expands the definition of a business combination and requires the fair value of the purchase price of an acquisition, including the issuance of equity securities, to be determined on the acquisition date. Further, the guidance also requires that all assets, liabilities, contingent considerations, and contingencies of an acquired business be recorded at fair value at the acquisition date. In addition, all acquisition costs are generally expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, changes in accounting for deferred tax asset valuation allowances be expensed after the measurement period, and acquired income tax uncertainties be expensed after the measurement period. The requirements under this guidance must be applied for years beginning after December 15, 2008 with early adoption prohibited. The adoption of this guidance will impact any of our future acquisitions.
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In December 2007, the FASB issued further accounting guidance, which requires revenue generated and costs incurred by the parties in the collaborative arrangement be reported in the appropriate line in each company’s financial statement and not account for such arrangements on the equity method of accounting. Further, the guidance also includes enhanced disclosure requirements regarding the nature and purpose of the arrangement, rights and obligations under the arrangement, accounting policy, and the amount and income statement classification of collaboration transactions between the parties. The requirements under this guidance must be applied for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, and shall be applied retrospectively (if practicable) to all prior periods presented for all collaborative arrangements existing as of the effective date. The Company has adopted this guidance effective January 1, 2009 and the adoption did not have a material effect on the consolidated financial statement presentation.
New Accounting Pronouncements
In October 2009, the FASB issued new accounting guidance that enables vendors to account for products or services sold to customers (deliverables) separately rather than as a combined unit, as was generally required by past guidance. The revised guidance provides for two significant changes to the existing multiple element revenue arrangements guidance. The first change relates to the determination of when the individual deliverables included in a multiple element arrangement may be treated as separate units of accounting. The second change modifies the manner in which the transaction consideration is allocated across the separately identified deliverables. The first change will likely result in the requirement to separate more deliverables within an arrangement, ultimately leading to less revenue deferral. Together, these changes are likely to result in earlier recognition of revenue and related costs for multiple-element arrangements than under previous guidance. This guidance also significantly expands the disclosures required for multiple-element revenue arrangements. The guidance is required to be adopted in fiscal years beginning on or after June 15, 2010; however, early adoption is permitted. We are currently evaluating the effects on the presentation, classification, and recognition of revenue arrangements that may be affected by this guidance.
In October 2009, the FASB issued new accounting guidance that changes the accounting model for revenue arrangements that include both tangible products and software elements so that tangible products containing software components and non software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of the software revenue guidance. In addition, the guidance requires that hardware components of a tangible product containing software components always be excluded from the software revenue guidance. The guidance is required to be adopted in fiscal years beginning on or after June 15, 2010; however, early adoption is permitted. We are currently evaluating the effects on the presentation, classification, and recognition of revenue arrangements that may be affected by this guidance.
Seasonality
We do not expect seasonality to have a material impact on our business in the future.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not currently have any material interest rate risk exposure. Our debt bears interest at a fixed rate.
We are exposed to various market risks that arise from transactions entered into in the normal course of business. Certain contractual relationships with customers and vendors mitigate risks from currency exchange rate changes that arise from normal purchasing and normal sales activities.
We do not currently have any material foreign currency exposure. Our revenue contracts are primarily denominated in U.S. dollars and the majority of our purchase contracts are denominated in U.S. dollars.
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ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of DigitalGlobe, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, cash flows, and stockholders’ equity and comprehensive income present fairly, in all material respects, the financial position of DigitalGlobe, Inc. and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Denver, Colorado
February 24, 2010
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DigitalGlobe, Inc.
Consolidated Income Statements
The accompanying notes are an integral part of these Consolidated Financial Statements.
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DigitalGlobe, Inc.
Consolidated Balance Sheets
The accompanying notes are an integral part of these Consolidated Financial Statements.
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DigitalGlobe, Inc.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these Consolidated Financial Statements.
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DigitalGlobe, Inc.
Consolidated Statements of Stockholders’ Equity and Comprehensive Income
The accompanying notes are an integral part of these Consolidated Financial Statements.
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(Dollars in millions except for share and per share data, unless otherwise noted)
NOTE 1. General Information and Financial Condition
DigitalGlobe, Inc. (DigitalGlobe, the Company or we) was originally incorporated as EarthWatch, Incorporated on September 30, 1994 under the laws of the State of Colorado and, on August 21, 1995, was reincorporated under the laws of the State of Delaware. We commenced development stage operations on March 31, 1995 with the contribution of the net assets of WorldView Imaging Corporation and certain assets of Ball Corporation. On August 22, 2002, we changed our name to DigitalGlobe, Inc.
We are a provider of commercial high-resolution earth imagery products and services. We have customers in both the (i) defense and intelligence and (ii) commercial sectors.
We successfully launched and deployed the QuickBird satellite on October 18, 2001, and completed initial on-orbit calibration and commissioning in February 2002, at which time we began selling imagery collected by the satellite. Since that time, we have been operating the QuickBird satellite and associated ground processing systems to generate 61-cm resolution black and white and 2.44-meter multi-spectral products.
On January 4, 2007, the Company acquired GlobeXplorer, LLC and AirPhotoUSA, LLC. In January 2008, the Company discontinued the use of the GlobeXplorer and AirPhoto USA names. All operations are now reported under the DigitalGlobe name.
On September 18, 2007, the Company successfully launched the WorldView-1 satellite. On November 16, 2007, the National Geospatial-Intelligence Agency (NGA) of the United States government, our largest customer, certified that the WorldView-1 satellite had satisfied the performance metrics under the terms of the NextView agreement (described below) and declared the WorldView-1 satellite to have achieved full operational capability (FOC).
On May 14, 2009, the Company completed an initial public offering consisting of 14,700,000 shares of common stock at $19.00 per share. The total shares sold in the offering included 13,333,744 shares sold by selling shareholders and 1,366,256 shares sold by the Company. Cash proceeds to the Company amounted to $24.1 million (net of $1.8 million of underwriters’ discount). These proceeds were offset in equity by $5.1 million of offering costs of which $2.4 million were paid in 2009.
In September 2003, we entered into the NextView agreement with NGA, under which we agreed to provide a minimum of $531.0 million of imagery products and services from our WorldView-1 satellite. Of this amount, $266.0 million was received between September 2003 and November 2007, the date WorldView-1 became operational, and was used to offset the construction costs of the satellite. The remaining $265.0 million commitment was to be received upon the delivery of imagery once WorldView-1 achieved FOC. On June 25, 2009, the NextView agreement was amended to extend the term from July 31, 2009 through March 31, 2010 in consideration for payment of an additional $100.0 million, payable at $12.5 million per month during the extended term. The amendment also provides an option for NGA to extend the agreement on the same terms for an additional nine months, from April 1, 2010 through December 31, 2010.
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Our NextView contract with the US Government is scheduled to expire on March 31, 2010. The US Government has options to extend the contract for an additional nine months through December 31, 2010. Although we expect, for the US government to extend the contract, we cannot assure you that the U.S. Government will continue to purchase earth imagery from us at similar levels. Regardless of whether or not this contract is extended or renewed,all of our contracts with the U.S. government agencies are subject to risks of termination or reduction in scope due to changes in U. S. government policies, priorities or Congressional funding level commitments to various agencies Pursuant to the contract terms, U. S. Government agencies can terminate or suspend our contracts at any time with or without cause. The U.S. Government accounted for approximately 75% of our consolidated revenue for the year ended December 31, 2009. We believe that existing cash and cash equivalents as of December 31, 2009 plus anticipated cash flow will be sufficient to fund anticipated operations and capital expenditures through 2010. If the US Government were not to renew or extend our contract at similar levels, we believe we would be able to maintain operations with existing cash and cash equivalents through 2010, however, if necessary we could reduce operating expenses and/or defer capital expenditures.
On October 8, 2009, the Company had a successful launch and deployment of the WorldView-2 satellite. The DigitalGlobe ground station received a downlink signal confirming that the satellite successfully separated from its launch vehicle and automatically initialized its onboard processors. On October 19, 2009, the Company publicly released imagery confirming the ability of the WorldView-2 satellite to conduct imaging operations.
NOTE 2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of DigitalGlobe, Inc. and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.
Basis of Presentation
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) and the instructions to Form 10-K of the Securities and Exchange Commission (SEC). In the opinion of management, all adjustments, including normal recurring adjustments that are considered necessary for a fair presentation of the accompanying consolidated financial statements have been included.
Certain prior year accounts have been reclassified to conform to current year presentation.
Use of Estimates
Our consolidated financial statements are based on the selection and application of GAAP that require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our financial statements. If different assumptions or conditions were to occur, the results could be materially different from our reported results.
Restricted Cash
The Company’s restricted cash at December 31, 2008 was comprised of $1.3 million of collateral for an FCC performance bond associated with a milestone related to the launch of the WorldView-2 satellite. During the fourth quarter of 2009, the FCC released the restriction on $1.3 million of cash based on the successful launch of our WorldView-2 satellite. At December 31, 2008 and 2009, we had $1.2 million of restricted cash under the lease agreement for our headquarters. During 2009, we funded $22.8 million of cash into restricted cash to collateralize certain letters of credit required under certain of our Direct Access Program (DAP) contracts, of which $15.5 million is recorded as long-term restricted cash.
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Short-term Investments
As of December 31, 2008 and 2009, we had no short-term investments. However, through a portion of 2007 the Company held short term investments. All auction rate securities (ARS) and variable rate demand notes (VRDN) were classified as available-for-sale short-term investments. ARS and VRDN are variable rate investments tied to short-term interest rates, which generally reset every 30 days. Interest paid during a given period is based upon the interest rate determined during the prior auction period. Although these securities are issued and rated as long-term investments, with original maturities of approximately 30 years, they are priced and traded as short-term instruments because of the liquidity provided through the volume and frequency of the auctions. The Company only invests in securities with active secondary or resale markets to ensure portfolio liquidity and the ability to readily convert investments to cash to fund current operations, or to satisfy other cash requirements as needed. As of December 31, 2008 and 2009, we held no ARS or VRDN.
Accounts Receivable
The Company’s customer base includes customers located in foreign countries. The Company controls credit risk related to accounts receivable through credit approvals, credit limits and monitoring processes. In making the determination of the appropriate allowance for doubtful accounts, the Company considers specific accounts, analysis of accounts receivable aging reports, changes in customer payment patterns, historical write-offs, changes in customer demand and relationships, and customer credit worthiness.
Property and Equipment
Property and equipment are recorded at cost. The cost of our satellites include capitalized interest costs incurred during the construction and development period. In addition, capitalized costs of our satellites and related ground systems include internal direct labor costs incurred in the construction and development as well as depreciation costs (included in QuickBird and WorldView-1) related to assets which support the construction and development of the satellites and related ground systems. Ground systems are placed into service when they are ready for their intended use. While under construction, the costs of our satellites are capitalized assuming the eventual successful launch and in-orbit operation of the satellite. If a satellite were to fail during launch or while in-orbit, the resulting loss would be charged to expense in the period in which such loss were to occur. The amount of any such loss would be reduced to the extent of insurance proceeds received as a result of the launch or in-orbit failure.
The Company performs an annual assessment of the useful life of the satellites. The assessment evaluates the efficiencies of the operation of the satellite and the fuel level. An adjustment will be made to the estimated depreciable life of the satellite, if deemed necessary by the assessment performed. Any changes to the estimated useful life of our satellites and the related impact on depreciation expense will be accounted for on a prospective basis on the date of the change.
The Company reviews the carrying value of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Factors that would require an impairment assessment include a significant change in the extent or manner in which an asset is used, a significant adverse change in the operation of the Company’s satellites, in government spending or customer demand that could affect the value of the asset, or a significant decline in the observable market value of an asset. If these factors indicate a potential impairment, the Company would assess the recoverability of the asset by determining if the carrying value of the asset exceeds the projected undiscounted cash flows expected to result from the use and eventual disposition of the asset over the remaining economic life of the asset. If the recoverability test indicates that the carrying value of the asset is not recoverable, the Company will estimate the fair value of the asset estimating discounted cash flows. Any impairment would be measured as the difference between the asset’s carrying amount and its estimated fair value. There was no impairment charge recorded in 2007, 2008 or 2009.
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The Company capitalizes certain internal and external software development costs incurred to develop software for internal use. The Company expenses the costs of developing computer software until the software has reached the application development stage and capitalizes all costs incurred from that time until the software is ready for its intended use, at which time amortization of the capitalized costs begins. Determination of when the software has reached the application development stage is based upon completion of conceptual designs, evaluation of alternative designs and performance requirements. Costs of major enhancements to internal use software are capitalized while routine maintenance of existing software is charged to expense as incurred. The determination of when the software is in the application development stage and the ongoing assessment of the recoverability of capitalized computer software development costs requires considerable judgment by management with respect to certain factors, including, but not limited to, estimated economic life and changes in software and hardware technology.
Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets (three to seven years for computer equipment and seven to ten and one half years for most other assets, including the satellites and ground stations). Leasehold improvements and assets used pursuant to leases are depreciated on a straight-line basis over the shorter of their useful lives or lease terms; such depreciation is included in depreciation expense. Upon sale or retirement, the cost and related accumulated depreciation are eliminated from the respective accounts and the resulting gain or loss is included in operations. Repairs and maintenance are expensed as incurred.
Internal use capitalized software costs are amortized on a product-by-product basis over their expected useful life, which is generally three to five years. Software costs that are directly related to a satellite are capitalized with the satellite and amortized over the satellite’s estimated useful life on a straight line basis. Amortization expense related to capitalized software costs, exclusive of software cost amortized as part of the cost of our satellites, was $8.1 million, $7.2 million, and $7.5 million for years ending 2007, 2008, and 2009, respectively.
Goodwill and Intangible Assets
Goodwill represents the excess of purchase price over the fair value of net assets acquired. Intangible assets (identified as trademarks, core technology, customer relationships and non-compete agreements) are recorded at fair value as determined at the time of acquisition. The goodwill and intangible assets are attributable to the commercial segment.
We test the carrying value of goodwill for impairment on the reporting unit level on an annual basis and more often if a triggering event occurs that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The impairment tests consists of comparing the fair value of the reporting unit, determined using the discounted cash flows, with its carrying amount including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the Company compares the implied value of the goodwill with its carrying amount. If the carrying amount of the goodwill exceeds the implied fair value of goodwill, impairment loss would be recognized to reduce the carrying amount to its implied fair value. We have completed our 2009 impairment test on goodwill and determined that there was no impairment.
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Aerial Image Library
Our aerial image library costs are composed of the direct costs of contracting with third parties to collect aerial imagery. Our aerial image library costs are charged to cost of revenue over the estimated economic life of the imagery, which has been estimated to be two years. Such costs are charged to cost of revenue on an accelerated basis reflective of the pattern in which the economic benefits of the asset is expected to be realized. Charges to cost of revenue for aerial imagery library was $3.1 million, $4.5 million, and $5.6 million for the years ended December 31, 2007, 2008 and 2009, respectively.
Deferred Contract Costs
The Company capitalized certain costs reimbursable under the NextView agreement, incurred in the construction and development of our WorldView-1 satellite and related ground systems during the construction and development period. These costs were related to internal support costs and were required and reimbursable expenditures under the NextView agreement. These costs were not capitalized as fixed assets, but were deferred in accordance with government contract accounting guidelines. Upon the successful launch of the WorldView-1 satellite, the deferred contract costs began being amortized ratably over the customer relationship period (the same as the life of the satellite, or 10.5 years).
The Company defers certain direct costs incurred in the construction of direct access facilities built for direct access program customers, consisting of hardware, software and labor purchased from a related party. The direct access facility will allow the Company’s direct access program customers to communicate with the Company’s satellites. The costs incurred to date are related to contractual agreements for the construction of the Company’s first direct access facility and are directly related to fulfillment of direct access program related revenue contracts. Accordingly, the deferred contract costs will be recognized as expense in the period of revenue recognition of the Company’s DAP contracts, which is expected to be the life of the WorldView-2 satellite. The Company does not have deferred contract costs in excess of related contract deferred revenue.
Deferred Contract Costs from a Related Party
As a result of the Company’s initial public offering in May 2009, the Company has reevaluated related parties due to the change in ownership. Only historical information pertaining to the companies that were related parties will continue to be disclosed if balances and activity for these entities is included in the financial statements presented.
Debt Issuance Costs and Debt Discounts
Debt issuance costs are deferred and amortized to interest expense using the effective interest method.
Long-Lived Assets
With the exception of goodwill, the Company periodically evaluates the carrying value of long-lived assets for impairment when events and circumstances indicate the carrying amount of an asset may not be recoverable. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flows from such asset (or asset group) are less than the asset’s (or asset group’s) carrying value. In that event, a loss is recognized to the extent that the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. The Company believes no circumstances indicating impairment exist in any of its long-lived assets.
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Revenue Recognition
The Company evaluates its sales arrangements to determine whether they include more than one unit of accounting. Using the guidance, we have identified the following units of accounting: (a) licenses of imagery; (b) sales of direct access program and direct access facilities, consisting of access to imagery bundled with hardware, software and support; (c) service level agreements; and (d) sales of subscription and subscription-type arrangements.
The Company recognizes revenue in accordance with the applicable revenue guidance for each unit of accounting identified. Revenue from sales of our products and services is recognized in accordance with the guidance when all of the following criteria have been met:
1)
Persuasive evidence of an arrangement exists,
2)
Delivery has occurred or services have been rendered,
3)
Our price to the buyer is fixed or determinable, and
4)
Collectability is reasonably assured.
Revenue from sales arrangements that include software that is essential to the functionality of non-software deliverables is recognized under software accounting guidance. Revenue is allocated to the various units of accounting based on their relative fair value and is recognized as follows for each of our revenue sources:
Licenses. Revenue from sales of imagery licenses is recognized when the images are physically delivered to the customer or, in the case of electronic delivery, when the customer is able to directly download the image from our system. In certain customer arrangements, we have acceptance provisions. For these arrangements, revenue is recognized upon acceptance by these customers. Revenue is recognized net of authorized contractually agreed discounts.
Direct Access Program and Direct Access Facility. Sales under the direct access program include construction of the direct access facility, consisting of hardware, software and operational maintenance support, and an arrangement to allow the customer access to the satellite to task and download imagery. This arrangement has been treated as a single unit of accounting as Vendor Specific Objective Evidence of fair value for undelivered items cannot be determined nor are believed to have stand-alone value. Accordingly, all funds received have been recorded as deferred revenue and all direct costs of these arrangements are recorded as deferred contract costs as further described below.
As the direct access facilities are brought into service, the deferred revenue and deferred contracts costs will be amortized ratably over the estimated customer relationship period, which is consistent with the estimated remaining useful life of the satellite being used. If both satellites are being used, the satellite with the longer life will be used as the basis for the amortization. Based on terms and conditions specified in each arrangement, the facility revenue will be recognized gross or net of facility costs.
Access fees under each arrangement are recognized pro-rata each month based on actual usage. We began recognizing revenue for access fees on WorldView-1 during the fourth quarter of 2009.
Service Level Agreements. The Company recognizes service level agreement revenue net of any allowances resulting from failure to meet certain stated monthly performance metrics. Net revenue is recognized each month because the fee for each month is fixed and non-refundable and is for a defined and fixed level of service each month.
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Subscriptions. The Company sells time-based subscriptions to its web-based products such as Image-Connect. These arrangements allow customers access to our product via the internet for a set period of time and for a fixed fee. Revenue from these arrangements is recognized ratably over the subscription period. In addition, we have other arrangements in which the customer pays for their subscription to one of the Company’s web-based products by prepaying for a set number of product accesses (for instance each time users click on an image of their home). Each time a product is accessed, a portion of the customer’s prepayment is earned. These prepayments are recorded as deferred revenue when received and the revenue is recognized based on the number of times the product is accessed. Revenue is recognized net of authorized contractually agreed discounts.
Sales of our products and services to certain customers are subject to appropriation of available funds. We do not recognize revenue prior to funds being appropriated.
Subscription-Type Arrangements. The Company also enters into subscription-type arrangements with customers whereby a bundle of services and/or multiple deliverables are contracted for delivery over a specified period of time. Revenue from this type of arrangement is recognized either ratably over the term of the arrangement or periodically throughout the term based on proportional performance.
Royalties. Revenue from royalties is based on agreements or license with third parties that allow the third party to incorporate our product into their value added product for commercial distribution. Revenue from these royalty arrangements is recorded in the quarter earned or on a systematic basis over the term of the license agreement.
Deferred Revenue
The Company has entered into several types of transactions, as more fully discussed below, where we received payment for products or services in advance of meeting the criteria for revenue recognition set out above. These payments are recorded as deferred revenue when received and are recognized as revenue when earned.
Our deferred revenue is composed of payments received in advance of recognition of revenue, the majority of which relate to the following types of arrangements: (i) prepayments from NGA; (ii) direct access program; (iii) advanced customer payments and (iv) subscription arrangements.
Prepayments from NGA. Under the NextView agreement, we received $266.0 million from NGA, in advance of imagery deliveries, to allow us to partially fund construction of the WorldView-1 satellite. These payments were recorded as deferred revenue when received during the construction period and are being recognized as revenue over the estimated customer relationship period of 10.5 years. Recognition of this deferred revenue commenced upon WorldView-1 reaching FOC in November 2007. As of December 31, 2008 and 2009, deferred revenue for these prepayments was $239.3 million and $213.8 million, respectively.
Subscription arrangements. We sell access to imagery through web-based exploitation where fees are time or usage based. Fees paid in advance for these arrangements are deferred and recognized as discussed above. As of December 31, 2008 and 2009, deferred revenue related to subscription sales was $1.3 million and $1.1 million, respectively.
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Direct Access Program (DAP). We will begin earning revenue from our DAP, once the systems are completed and access rights to the satellites commence. Under the DAP, customers may be allowed to send instructions to the WorldView-1 and WorldView-2 satellites and download imagery directly to their ground stations. DAP arrangements consist of several elements, some of which we are paid for in advance and recorded as deferred revenue, as follows:
Direct Access Facility (DAF) Sales. DAFs are built for DAP customers and consist of hardware and software needed to communicate with our satellites. Payments received during the construction period in advance of the imagery delivery period are recorded as deferred revenue, and costs incurred are deferred as well. Deferred revenue and deferred costs will be recognized as revenue and expense, respectively, over the estimated customer relationship period upon commencement of DAP operations, which will coincide when all equipment has been delivered and installed and access to the satellite commences. As of December 31, 2008 and 2009, deferred revenue related to DAF sales was $14.7 million and $44.4 million, respectively.
Prepayments. In 2005, we entered into a distribution agreement with Hitachi Software Engineering, a related party, related to the initial contract for direct access to WorldView-2. In connection with the distribution agreement, we received an upfront fee of $10.0 million from Hitachi Software Engineering. This upfront fee is included in deferred revenue and will be recognized as revenue over the estimated customer relationship period upon commencement of the DAP operations. Once the WorldView-2 satellite reaches full operational capability, we will be able to estimate the customer relationship period. We expect that the best measure of the customer relationship period will be the expected useful life of the satellite the customer is accessing. As of December 31, 2008 and 2009, deferred revenue related to this upfront fee was $10.0 million.
We will evaluate the estimated customer relationship period on an annual basis, or more frequently if events indicate a change in the period, and will make adjustments to the amortization period if a change to the estimated life of the relationship is made.
Satellite Insurance
We currently maintain $40.0 million, $220.0 million and $230.0 million of one-year in-orbit operations insurance coverage for QuickBird, WorldView-1 and WorldView-2, respectively, $50.0 million of three-year in-orbit insurance coverage for WorldView-1 with one year remaining and $68.0 million of three-year in-orbit insurance for our WorldView-2 satellite. We intend to continue this coverage to the extent it remains available at acceptable premiums. Satellite insurance premiums, corresponding to the launch and in-orbit commissioning period prior to the satellite reaching FOC, are capitalized in the original cost of the satellite and are amortized over the estimated useful life of the asset. The remainder of the insurance premiums that are not capitalized are amortized to expense ratably over the related policy periods and are included in selling, general and administrative costs.
Research and Development Costs
We record as research and development expense all engineering costs, consisting primarily of internal labor and consulting fees, where the Company maintains the risk associated with design failure. The Company incurred $0.2 million in research and development costs for the year ended December 31, 2007. Research and development costs were not significant for the year ended December 31, 2008. We incurred $0.9 million in research and development costs for the year ended December 31, 2009. Any research and development expenses incurred are included in selling, general and administrative expenses.
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Advertising Costs
Advertising costs are expensed as incurred and have historically not been significant.
Derivative Instruments
The Company used derivative financial instruments for the purpose of hedging exposures to fluctuations in interest rates. The Company’s derivative instruments were recorded in the consolidated balance sheets at fair value within accounts receivable from related party or accounts payable to related party dependent upon the asset or liability to the Company. Upon settlement of the contracts, the cash flow were presented as an investment activity. For a derivative designated as a cash flow hedge, the effective portion of the derivative gain or loss was initially reported as a component of accumulated other comprehensive income and subsequently reclassified into earnings when the forecasted transaction affected earnings. For interest swaps that did not qualify or were not designated as cash flow hedges, all gains or losses associated with changes to the fair market value of these financial instruments were recorded in the income statement.
See Note 7 for further information about derivative instruments.
Earnings Per Share (EPS)
Basic EPS is computed by dividing net income by the weighted average number of shares of common stock outstanding. Diluted EPS is determined by dividing net income by the sum of (1) the weighted average number of common shares outstanding and (2) the dilutive effect of outstanding potentially dilutive securities and stock options determined utilizing the treasury stock method.
Stock-Based Compensation
Stock-based compensation expense is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period. See Note 8 for further information regarding our stock-based compensation expense and underlying assumptions.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax effects attributable to the temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in enacted tax laws is recognized as an adjustment to the tax provision or benefit in the period of enactment. The overall change in deferred tax assets and liabilities during the period is equal to the deferred tax expense or benefit for the period. The carrying value of deferred tax assets may be reduced by a valuation allowance if, based upon the judgmental assessment of available evidence, it is deemed more likely than not that some or all of the deferred tax assets will not be realizable.
There is a prescribed minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. We reduced our deferred tax assets associated with general business tax credits computed in and carried over from prior years by $4.5 million. The Company has elected to treat any penalties or interest incurred as a result of uncertainty in income taxes as a component of tax expense. The impact of adoption of uncertainty in income taxes in 2007 had no effect on our results of operations or retained earnings.
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Fair Values of Financial Instruments
When measuring our financial instruments we use a market-based measurement, not an entity-specific measurement, and determine the fair value based on the assumptions that market participants would use in pricing the asset or liability. Fair value losses or gains are reported when identified.
We use the valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows.
Level 1 inputs utilize observable, quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Financial assets and liabilities utilizing Level 1 inputs include actively traded equity securities.
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, that is, markets in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers (for example, some brokered markets), or in which little information is released publicly (for example, a principal-to-principal market), inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and default rates) or inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs).
Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measure in its entirety requires management’s judgment and considers factors specific to the asset or liability.
The following table provides information about the assets and liabilities measured at fair value on a recurring basis as of December 31, 2008 and 2009 and indicates the valuation technique utilized by the Company to determine the fair value.
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Valuation Techniques. Our cash equivalents consist of investments with maturity dates of less than 90 days and are quoted from market rates and are classified within Level 1 of the valuation hierarchy. At December 31, 2008 and 2009, our cash equivalents consisted of funds held in treasury money markets. For our financial instruments that are classified within Level 2 of the valuation hierarchy, we perform validations of our internally derived fair values reported for our financial instruments on a quarterly basis utilizing counterparty statements. The Company additionally evaluates the counterparty creditworthiness and has not identified any circumstances requiring that the report values of our financial instruments be adjusted as of December 31, 2008 and 2009. During the second quarter of 2009, one of our swaps matured and the other swap contract was terminated as a result of the repayment of the senior credit facility, discussed in Note 7. The Company has not identified any Level 3 financial instruments at December 31, 2008 and 2009.
For the year ended December 31, 2008 the Company recorded a loss, net of tax, in accumulated other comprehensive income, of $1.8 million for the changes in the fair value of its interest rate swaps. For the year ended December 31, 2009, the company recognized a net loss of $1.8 million on derivatives. The Company’s financial instruments consist primarily of cash and cash equivalents, accounts receivable and payable, derivatives and long-term debt. The carrying values of cash equivalents and accounts receivable and payable are representative of their fair values due to their short-term maturities. The fair value of the senior credit facility was calculated using an interest rate of 9.5%. At December 31, 2008, the fair value of the senior subordinated notes was calculated using an interest rate of 15.75%. The derivative liability fair value was derived from internally developed valuation methodologies. The senior credit facility and senior subordinated notes were paid in full in April 2009. One of the derivative liabilities expired in April 2009 and the Company paid the other derivative liability in conjunction with the debt extinguishment.
The senior secured notes are traded on an active market. The fair value of the senior secured notes is obtained from a third party pricing service that tracks the trading of the notes and evaluated by the Company.
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Concentration of Credit Risk and Significant Customers
The Company’s cash and cash equivalents and derivative instruments are maintained in or with various financial institutions. We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk in this area.
Recently Adopted Accounting Standards
In June 2009, the Financial Accounting Standards Board (FASB) established the FASB Accounting Standards Codification (Codification) as the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification did not have an impact on our Consolidated Financial Statements upon adoptions. Accordingly, our disclosures will explain accounting concepts rather than cite specific topics of GAAP.
In May 2009, the FASB issued new accounting guidance to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events, whether that evaluation date is the date of issuance or the date the financial statements were available to be issued, and alerts all users of financial statements that an entity has not evaluated subsequent events after that evaluation date in the financial statements being presented. The guidance is effective for financial statements issued for fiscal years and interim periods ending after June 15, 2009. The guidance became effective for the Company on April 1, 2009. The adoption of this guidance had no impact on its Consolidated Financial Statements.
In April 2008, the FASB issued new accounting guidance, which defines the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The Company adopted this guidance on January 1, 2009 and the adoption did not have a material effect on the presentation or classification on the assets in the financial statements.
In March 2008, the FASB issued new accounting guidance that requires additional disclosures regarding: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted; and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. In addition, requires qualitative disclosures about objectives and strategies for using derivatives described in the context of an entity’s risk exposures, quantitative disclosures about the location and fair value of derivative instruments and associated gains and losses, and disclosures about credit-risk-related contingent features in derivative instruments. The requirements under this guidance must be applied as authoritative guidance for fiscal years and interim periods within these fiscal years, beginning after November 15, 2008. The Company has adopted this guidance effective January 1, 2009 and there was not a material effect on the presentation or classification of these activities in our financial statements.
In February 2008, FASB issued authoritative guidance that addresses fair value measurements for purposes of lease classification or measurement. In October 2008, the FASB issued additional authoritative guidance which clarifies the application of determining fair value when the market for a financial asset is inactive. Specifically, this guidance clarifies how (1) management’s internal assumptions should be considered in measuring fair value when observable data are not present, (2) observable market information from an inactive market should be taken into account, and (3) the use of broker quotes or pricing services should be considered in assessing the relevance of observable and unobservable data to measure fair value.
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In December 2007, the FASB issued new accounting guidance which expands the definition of a business combination and requires the fair value of the purchase price of an acquisition, including the issuance of equity securities, to be determined on the acquisition date. Further, the guidance also requires that all assets, liabilities, contingent considerations, and contingencies of an acquired business be recorded at fair value at the acquisition date. In addition, all acquisition costs are generally expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, changes in accounting for deferred tax asset valuation allowances be expensed after the measurement period, and acquired income tax uncertainties be expensed after the measurement period. The requirements under this guidance must be applied for years beginning after December 15, 2008 with early adoption prohibited. The adoption of this guidance will impact any of our future acquisitions.
In December 2007, the FASB issued further accounting guidance, which requires revenue generated and costs incurred by the parties in the collaborative arrangement be reported in the appropriate line in each company’s financial statement and not account for such arrangements on the equity method of accounting. Further, the guidance also includes enhanced disclosure requirements regarding the nature and purpose of the arrangement, rights and obligations under the arrangement, accounting policy, and the amount and income statement classification of collaboration transactions between the parties. The requirements under this guidance must be applied for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, and shall be applied retrospectively (if practicable) to all prior periods presented for all collaborative arrangements existing as of the effective date. The Company has adopted this guidance effective January 1, 2009 and the adoption did not have a material effect on our financial statement presentation.
New Accounting Pronouncements
In October 2009, the FASB issued new accounting guidance that enables vendors to account for products or services sold to customers (deliverables) separately rather than as a combined unit, as was generally required by past guidance. The revised guidance provides for two significant changes to the existing multiple element revenue arrangements guidance. The first change relates to the determination of when the individual deliverables included in a multiple element arrangement may be treated as separate units of accounting. The second change modifies the manner in which the transaction consideration is allocated across the separately identified deliverables. The first change will likely result in the requirement to separate more deliverables within an arrangement, ultimately leading to less revenue deferral. Together, these changes are likely to result in earlier recognition of revenue and related costs for multiple-element arrangements than under previous guidance. This guidance also significantly expands the disclosures required for multiple-element revenue arrangements. The guidance is required to be adopted in fiscal years beginning on or after June 15, 2010 but early adoption is permitted. We are currently evaluating the effects on the presentation, classification, and recognition of revenue arrangements that may be affected by this guidance.
In October 2009, the FASB issued new accounting guidance that changes the accounting model for revenue arrangements that include both tangible products and software elements so that tangible products containing software components and non software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of the software revenue guidance. In addition, the guidance requires that hardware components of a tangible product containing software components always be excluded from the software revenue guidance. The guidance is required to be adopted in fiscal years beginning on or after June 15, 2010, however early adoption is permitted. We are currently evaluating the effects on the presentation, classification, and recognition of revenue arrangements that may be affected by this guidance and are planning on adopting in the first quarter of 2010.
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NOTE 3. Information on Segments and Major Customers
We conduct our business through two segments: (i) defense and intelligence and (ii) commercial. Our imagery products and services are comprised of imagery that we process to varying levels of resolution according to the customer’s specifications. Customers acquire our imagery either by placing tasking orders for our satellites to collect data to their specification or purchasing images that are archived in our ImageLibrary.
We have organized our business around (i) the defense and intelligence and (ii) commercial segments because we believe that customers in these two groups are identifiably similar in terms of their areas of focus, imaging needs and purchasing habits. We deliver our products and services using the distribution method that best suits our customers’ needs. At January 1, 2009 we determined that our civil government customers should be classified in the defense and intelligence business segment. We have reclassified 2008 presentation to be consistent with the current presentation. There are no sales between the Company’s segments.
The vast majority of the dollar value of our fixed assets are the satellites and the ground based production and support facilities that are common to all business and geographic segments. There are no significant identifiable assets specifically dedicated to either segment.
Only those costs directly associated with the two segments are shown in cost of revenue and selling, general and administrative expenses in those segments. All expenses which are common to both segments and/or represent corporate operating costs are included in the unallocated cost section. Substantially all the Company’s assets are located in the United States.
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Total U.S. and foreign sales were as follows:
Revenue percentages from all customers whose revenue exceeded 10% of the total company revenue were as follows:
Percentages of accounts receivable (net of allowance for doubtful accounts) for all customers whose receivable exceeded 10% of the net accounts receivable as of:
NOTE 4. Property and Equipment
Property and equipment consisted of the following as of:
Construction in progress includes satellite construction, ground station construction, and certain internally developed software costs and capitalized interest. Depreciation and amortization expense for property and equipment was $44.4 million, $72.7 million, and $72.6 million for the years ended December 31, 2007, 2008, and 2009, respectively.
The capitalized costs of our satellites and related ground systems include internal and external direct labor costs, internally developed software, material and depreciation costs related to assets which support the construction and development. The cost of our satellites also includes capitalized interest incurred during the construction, development and initial in-orbit testing period. The portion of the launch insurance premium allocable to the period from launch through in-orbit calibration and commissioning has been capitalized as part of the cost of the satellites and is amortized over the useful life of the satellites.
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Following each launch, and at least annually thereafter, we review the expected operational life of our satellites. We determine a satellite’s expected operational life considering calculation involving the probabilities of failure of the satellite’s components from design or manufacturing defects, environmental stresses or other causes. The expected operational lives of our satellites are affected by a number of factors, including the quality of construction, the supply of fuel, the expected gradual environmental degradation of solar panels and other components, levels of solar radiation, the durability of various satellite components and the orbits in which the satellites are placed.
We extended the estimated useful life of our QuickBird satellite again during the first quarter of 2008. For 2008, this change resulted in reduced depreciation expense and a corresponding increase in income from continuing operations of $11.1 million, an increase in net income of $6.7 million and had an impact on earnings per share of $0.15 at December 31, 2008. This assessment, performed in January 2008, of the useful life of the QuickBird satellite led to an extension of the depreciable operational life of QuickBird attributable to efficiencies in the operation of the satellite that have led to the reduced consumption of fuel compared to previous estimates. Based on mid-year analysis in 2008, the estimated useful life of our QuickBird satellite did not change.
We have aligned the assessment of the useful life of the operating satellites with the timing of our insurance renewals. We will perform an annual assessment of the useful life of the QuickBird, WorldView-1 and once operational, WorldView-2 satellites in the second half of the calendar year or when events or circumstances dictate that a reevaluation of the useful life should be done at an earlier date. The assessment evaluates the efficiencies of the operation and the fuel level of the satellite against engineering models that also estimated the satellite’s useful life. An adjustment will be made to the estimated depreciable life of the satellite if deemed necessary by the assessment performed. Any changes to the estimated useful life of our satellites and the related impact on the depreciation expense will be accounted for on a prospective basis on the date of the change.
As a result of our annual assessment during the third quarter of 2009, we extended the estimated useful life of our QuickBird satellite, which results in a change in the depreciation expense associated with the QuickBird satellite on a prospective basis beginning July 1, 2009. For the twelve month period ended December 31, 2009, this change resulted in reduced depreciation expense and a corresponding increase in income from continuing operations of $2.9 million, an increase in net income of $1.7 million and had a $0.04 impact on diluted earnings per share.
Based on our assessment, there was no change to the estimated useful life of our WorldView-1 satellite.
NOTE 5. Goodwill and Intangibles
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The identifiable intangible assets are being amortized on a straight-line basis over their useful lives, ranging from three to five years, except for customer relationships, which are being amortized using a declining balance method over their estimated life of five years. During fourth quarter of 2008, it was determined that the trademark/tradename acquired is no longer being utilized by the Company. We have fully amortized the value associated with the trademark/tradename intangible as of December 31, 2008. Goodwill is not being amortized for financial statement purposes, but is deductible for income tax purposes.
Amortization expense for intangibles was $2.4 million, $3.0 million and $1.8 million for the years ended December 31, 2007, 2008 and 2009, respectively. These intangible assets will become fully amortized in 2011. The estimated remaining aggregate amortization expense for the intangible assets is:
A summary of the goodwill activity for the year ended December 31, 2008 and 2009 is presented below:
The Company has not recorded an impairment of goodwill for any of the periods presented.
NOTE 6. Other Accrued Liabilities
The following table is a listing of items included in other accrued liabilities:
NOTE 7. Debt
Letters of Credit
As of December 31, 2009, we had $22.8 million in letters of credit and performance guarantees used in the ordinary course of business to support advanced payments from customers under certain of our DAP contracts. These letters of credits are secured by restricted cash that has been recorded in our financial statements as both short and long term restricted cash. The letters of credit, and related restricted cash amounts will be released when the respective contract obligation have been fulfilled by us.
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Senior Secured Notes
We issued $355.0 million principal amount of our senior secured notes in April 2009, net of the issuance discount of $13.2 million and fees and expenses of $10.2 million. As of December 31, 2009, we have an accreted outstanding amount of $343.5 million senior secured notes which mature on May 1, 2014. The senior secured notes are guaranteed by our subsidiaries and secured by nearly all of our assets, including the shares of capital stock of our subsidiaries, the QuickBird, WorldView-1 and WorldView-2 satellites. Assets collateralizing the senior secured notes had a net book value of $1,116.5 million as of December 31, 2009. The senior secured notes bear interest at the rate of 10.5% per annum. Interest is payable semi-annually on May 1 and November 1 each year. The Company is using the effective interest rate methodology to amortize the deferred financing costs and to accrete the discount on the notes over the term of the notes.
We may redeem some or all of the senior secured notes after May 1, 2012, at a redemption price equal to 105.25% of their principal amount through May 1, 2013 and 100.0% thereafter, plus, in each case, accrued and unpaid interest. In addition, at any time on or prior to May 1, 2012, we may redeem up to 35.0% of the aggregate principal amount of the senior secured notes with the net cash proceeds of certain equity offerings at 110.5% of the principal amount plus accrued and unpaid interest. In the event of certain change of control events, we must give holders of the senior secured notes an opportunity to sell us their notes at a purchase price of 101.0% of the accreted value of such notes, plus accrued and unpaid interest.
There was no accrued interest for the senior secured notes at December 31, 2008 and the total accrued interest on the senior secured notes at December 31, 2009 was $6.2 million. Total interest incurred, accretion of debt discount and amortization of deferred financing fees, for the year December 31, 2009 were $25.2 million, $1.7 million and $1.3 million, respectively. These amounts were capitalized in construction costs of our satellite.
The indenture governing the senior secured notes contains a number of significant restrictions and covenants that, among other things, limit our ability to incur additional indebtedness, make investments, pay dividends or make distributions to our stockholders, grant liens on our assets, sell assets, enter into a new or different line of business, enter into transactions with our affiliates, merge or consolidate with other entities or transfer all or substantially all of our assets, and enter into sale and leaseback transactions. Fluctuation in credit market conditions could negatively impact our ability to obtain future financing or to refinance our outstanding indebtedness.
Our future debt payments include the maturity of notes in May 2014, at which time we will pay the full obligation amount of $355.0 million.
Senior Credit Facility
We had outstanding a $230.0 million senior credit facility with a syndicate of financial institutions for whom an affiliate of Morgan Stanley & Co. Incorporated served as administrative agent. The senior credit facility was guaranteed by our subsidiaries and secured by nearly all of our assets, including the QuickBird and WorldView-1 satellites, and our WorldView-2 satellite. Assets collateralizing the senior credit facility had a net book value of $977.7 million as of December 31, 2008. The senior credit facility and all accrued interest was paid in full in April of 2009.
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At our election, interest under the senior credit facility was determined by reference to (i) 3-month London Interbank Offered Rate (LIBOR), plus an applicable margin of 5.5% per annum or (ii) the higher of the prime rate posted in the Wall Street Journal and the Federal Funds effective rate, plus an applicable margin of 4.5% per annum. Interest was payable quarterly based upon the amount of the outstanding loan principal balance. The interest rate on the term loans was 3-month LIBOR plus 5.5% through February 9, 2009. As a result of an amendment on February 9, 2009, the interest rate on the term loans was 3-month LIBOR plus 6.5%. We paid a fee of $0.7 million to amend the agreement.
The weighted average interest rate on the total outstanding debt at December 31, 2007 and 2008 was 10.7% and 9.2%, respectively. Total accrued interest was $3.5 million at December 31, 2008. Total interest incurred for the years ended December 31, 2007, 2008 and 2009 was $26.5 million, $27.0 million and $9.6 million, respectively, of which $25.8 million, $23.1 million and $9.6 million was capitalized in the construction costs of our satellites.
With the issuance of our senior secured notes on April 28, 2009, the senior credit facility obligations were paid in full.
Interest Rate Swaps
In April 2005, the Company entered into a series of interest rate swap agreements (the Swap) with an affiliate of Morgan Stanley & Co. Incorporated to mitigate exposure relating to variable cash flows associated with fluctuating interest rates on a portion of the senior credit facility principal. Under the Swap, the Company agreed to exchange, at specified intervals, fixed interest rate amounts specified in the agreements for variable interest amounts based on 3-month LIBOR calculated by reference to a notional amount of $100.0 million. As a result of the Swap, the Company had converted $100.0 million of the senior credit facility from a variable rate obligation to a fixed rate obligation through April 2009.
On February 21, 2006, we terminated the Swap. The termination resulted in a gain of $0.8 million which was recorded in accumulated other comprehensive income and is being amortized over the remaining original term of the Swap. Simultaneous with the termination of the Swap, we entered into a new swap agreement (the Second Swap) of the same notional amount at a fixed interest rate of 4.9999% from April 18, 2006 through April 18, 2009. The Company elected not to renew the Second Swap when it expired as we entered into the Third Swap (as described below) to comply with the covenants of the senior credit facility.
The Second Swap was designated and qualified as a cash flow hedge and has been accounted for as such through February 8, 2009. On February 9, 2009, the Company amended the senior credit facility, and as a result, the Company’s Swaps became ineffective and no longer qualified as cash flow hedges. From February 9, 2009 through April 28, 2009, the fair value changes of these derivative instruments have been recorded in the Condensed Consolidated Income Statement.
On January 8, 2009, we entered into a swap agreement (the Third Swap) with an affiliate of Morgan Stanley & Co. Incorporated. We traded the floating 3-month LIBOR rate on $130.0 million of our senior credit facility to a fixed rate of 2.00% until maturity of the loan on October 20, 2011. The covenants in our senior credit facility required a minimum interest rate hedge of $100.0 million. The Third Swap satisfied this obligation through the maturity date of the loan. A net gain of $0.3 million and a net loss of $1.5 million was recognized on derivatives in the years ended December 31, 2007 and 2008, respectively.
At December 31, 2008, a current liability related to the Second Swap in the amount of $1.0 million was included in accrued liabilities to related party. With the issuance of the Third Swap in January 2009 and the amendment to the senior credit facility in February of 2009, all fair value changes on the derivatives were recorded in the income statement through the expiration of the Second Swap on April 18, 2009, and the termination of the Third Swap on April 28, 2009. Due to the Company’s payoff of the senior credit facility the Swaps were no longer required. With the termination of the Swaps, the Company has recorded the accumulated other comprehensive income balance as an additional cost to the WorldView-2 satellite.
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Senior Subordinated Notes
In February 2008, we issued $40.0 million of senior subordinated notes due April 18, 2012. The net proceeds of $38.5 million were used to fund construction and launch expenditures associated with WorldView-2. The senior subordinated notes bore interest at 12.5% per annum due semi-annually on July 31 and January 31, commencing July 31, 2008 until January 31, 2009, after which the rate increased to 13.5% per annum. On July 31, 2008 and January 31, 2009, we elected to pay interest in kind and issued additional senior subordinated notes.
Effective February 9, 2009, we amended our senior subordinated notes for certain items, most notably to increase the allowable capital expenditures for the WorldView-2 satellite, increase the maintenance capital expenditures limits, as well as change certain satellite insurance limits. The interest rate on the loan increased to 14.75% for cash interest and 15.75% for paid in kind interest as of the date of the amendment. We paid a 0.5% one-time in-kind fee to amend the agreement, which was added to the principal value of the notes. With the issuance of our senior secured notes on April 28, 2009, the senior subordinated notes and accrued interest were paid in full.
With the issuance of our senior secured notes during the second quarter of 2009, we recorded an early extinguishment of debt representing the expensing of the deferred financing costs of $5.9 million related to the senior credit facility and senior subordinated notes, and a prepayment penalty of $1.8 million related to the senior subordinated notes.
NOTE 8. Shareholders Equity and Other Comprehensive Earnings (Loss)
On May 14, 2009, the Company completed an IPO consisting of 14,700,000 shares of common stock at $19.00 per share. At December 31, 2009, the Company’s Board of Directors had the authority to issue 250,000,000 shares of common stock. At December 31, 2009, 45,122,593 shares of common stock were issued and outstanding.
Treasury Stock
In the fourth quarter of 2008 the Company repurchased 1,184 shares of outstanding common stock from four stockholders for the deemed fair value at the repurchase date. During 2009, the Company repurchased 22,484 shares at the deemed fair value on the repurchase date.
Other Comprehensive Earnings (Loss)
Other comprehensive earnings (loss) include the cumulative effect of realized and unrealized gains and losses on derivative instruments receiving cash flow hedge accounting treatment during the year ended December 31, 2009. With the expiration and settlement of our financial derivatives the amounts recorded in accumulated other comprehensive earnings (loss) were capitalized to the cost of the WorldView-2 satellite as of December 31, 2009.
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Stock-Based Compensation Programs
The Company has a 1995 Stock Option/Stock Issuance Plan (the 95 Plan) pursuant to which qualified and nonqualified stock options to purchase shares of the Company’s common stock have been granted to employees, officers, directors, and consultants. Under the 1995 Plan, incentive stock options were granted with exercise prices not less than the fair value of the stock on the various dates of grant, as determined by the Company’s Board of Directors. Options granted pursuant to the 1995 Plan are subject to certain terms and conditions as contained in the 1995 Plan itself, have a ten-year term, generally vest ratably over a four-year period, and are immediately exercisable. Upon termination of services to the Company by optionees, any acquired but unvested shares are subject to repurchase by the Company at the original exercise price. During 1999, the board of directors amended the 1995 Plan, eliminating future grants. As a result of a recapitalization agreement adopted in 1999, the stock from any exercised options under the 1995 Plan automatically converted to the new Series C Preferred at the rates established in said recapitalization agreement.
On February 15, 2000, the board of directors approved the 1999 Equity Incentive Plan (the 1999 Plan) pursuant to which qualified and nonqualified stock options to purchase shares of the Company’s common stock may be granted to employees, officers, directors, and consultants. Options granted pursuant to the 1999 Plan are subject to certain terms and conditions as contained in the 1999 Plan itself, have a ten-year term, generally vest ratably over a four-year period. As of December 31, 2008 and 2009, there were 182,526 and 242,023, respectively, options available to be issued under the 1999 Plan. The Company does not intend to grant those options.
On February 15, 2007, the board of directors approved the 2007 Employee Stock Option Plan (the 2007 Plan), pursuant to which the following awards may be granted to employees, officers, directors, and consultants: qualified and nonqualified stock options to purchase shares of the Company’s common stock, Stock Appreciation Rights and shares of the stock itself. Options granted pursuant to the 2007 Plan are subject to certain terms and conditions as contained in the 2007 Plan itself, have a ten-year term and generally vest over a four-year period. The Company amended this plan in 2008 to extend the exercise period of terminated employees from thirty days to three months. The number of shares available for grant at December 31, 2008 and 2009 was 3,304,138 and 2,503,572, respectively.
Pursuant to the 2007 Plan, the Company may, from time to time, issue certain equity based awards, including stock options, restricted stock, and unrestricted shares (Equity Awards). Equity Awards may be awarded to employees, officers, directors and certain consultants of the Company. To date, issued Equity Awards have consisted of stock options and restricted stock. Since the completion of the initial public offering on May 14, 2009, the Company has utilized the daily closing stock price as an element in determining the value of our Equity Awards. The date of grant of the awards is used for the measurement date. The awards are valued as of the measurement date and are amortized on a straight-line basis over the requisite vesting period.
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A summary of stock option activity for the year ended December 31, 2008 is presented below:
A summary of stock option activity for the year ended December 31, 2009 is presented below:
1)
Upon exercise shares are issued from the authorized but unissued shares designated for issuance pursuant to the stock option plans.
2)
Represents the total pretax intrinsic value for stock options with an exercise price less than the Company’s calculated common stock price as of December 31, 2008 and 2009, respectively, that option holders would have realized had they exercised their options as of that date.
Weighted-average grant-date fair values for option awards granted was $7.85, $9.15 and $10.44 for the years ended December 31, 2007, 2008 and 2009, respectively. The total fair value of options vested for the years ended December 31, 2007, 2008 and 2009 was $2.3 million, $4.3 million and $7.2 million, respectively.
The Company recognized stock-based compensation during the years ended December 31, 2008 and 2009 was $4.6 million and $7.7 million, respectively, of which $0.4 million, and $0.5 million was capitalized to assets under construction.
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The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
Expected volatility is based on a variety of comparable companies within our industry, currently looking back five years (if available). The expected life and forfeiture rate are based on the Company’s historical experience. The risk-free rate is based on the five-year Treasury note rate.
The total pre-tax intrinsic value or the difference between the exercise price and the market price on the date of exercise, of stock options exercised during the year ended December 31, 2007, 2008 and 2009 was $1.6 million, $2.2 million and $4.1 million, respectively.
As of December 31, 2008 and 2009 there was a total of $8.6 million and $10.8 million, respectively, of unrecognized expense remaining to be recognized over a weighted average period of 2.7 and 2.7 years, respectively.
On November 3, 2008, the Company granted a total of 30,000 shares of restricted stock under the 2007 Plan to executives as part of the Long Term Incentive Plan (LTIP) with a fair value of $22.10 per share. All units granted vest one-third each year beginning on March 31, 2009. Upon vesting units are converted into shares of common stock. As of December 31, 2009, 10,000 units had vested. A summary of restricted stock activity as of December 31, 2008, and changes during the year is presented below:
A summary of restricted stock activity as of December 31, 2009 and changes during the year is presented below:
As of December 31, 2008 and 2009, there was $0.5 million and $0.3 million, respectively, of total unrecognized compensation cost related to the non-vested share-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 2.7 and 1.3 years, respectively.
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NOTE 9. Earnings Per Share
Basic EPS excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income by the weighted average number of common shares outstanding and dilutive potential common shares for the period. The Company includes as potential common shares the weighted average dilutive effects of outstanding stock options using the treasury stock method.
The following table sets forth the number of weighted average shares used to compute basic and diluted EPS:
The number of options that were excluded from EPS, calculated as the effects thereof were antidilutive, were 0.9 million, 1.8 million and 2.3 million for the years ended December 31, 2007, 2008 and 2009, respectively.
NOTE 10. Income Taxes
Accounting for income taxes requires deferred tax assets and liabilities to be recognized for temporary differences between the tax basis and financial reporting basis of assets and liabilities, computed at the expected tax rates for the periods in which the assets or liabilities will be realized, as well as for the expected tax benefit of net operating loss and tax credit carryforwards.
The provisions for income taxes reflected in the statements of operations for the years ended December 31, 2007, 2008 and 2009 consisted of (in millions):
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In 2007, based on the level of historical taxable income and projections for future taxable income over the periods that the Company’s deferred tax assets are deductible, the Company determined that it was more likely than not that its deferred tax assets would be utilized prior to expirations and therefore released $59.1 million of valuation allowance. Of that amount, $0.5 million was attributable to recording the tax effect on the loss on financial derivative recorded in the Consolidated Statements of Stockholders’ Equity and Statements of Comprehensive Income for the year. The balance of the reversal of the valuation allowance and other adjustments to the deferred tax assets resulted in the recognition of income tax benefits to operations of $57.9 million in 2007. As of December 31, 2008 and 2009, the Company had no valuation allowance against its deferred tax assets.
The Company’s deferred tax assets and liabilities consisted of the following as of December 31:
At December 31, 2009, the Company had net operating loss (NOL) carryforwards for federal and state income tax purposes of approximately $214.8 million and $189.1 million, respectively. In addition, the Company has research and development tax credits of approximately $9.0 million, which may be available to offset future federal income tax liabilities. If unused, the Federal carryforwards and credits will begin to expire during the years 2019 to 2029. If unused, the state carryforwards and credits will begin to expire during the years 2010 to 2029. The Internal Revenue Code places certain limitations on the annual amount of net operating loss carryforwards, which can be utilized if certain changes in the Company’s ownership occur. The Company believes that such changes have occurred and may occur in the future to further limit the utilization of the carryforwards.
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The benefit (expense) for income taxes differs from the amount computed by applying the U.S. federal income tax rate of 35% to income or loss before income taxes as follows:
In January 2007, the Company recognized a reduction in general business tax credits computed in and carried over from prior years of $4.5 million. There have been no changes in the Company’s tax contingencies during 2008 and 2009. The tax years 1996 through 2009 remain open to examination by the United States taxing jurisdictions to which we are subject. The Company recognizes accrued interest and penalties related to uncertain tax positions as a component of tax expense. The Company did not have any accrued interest or penalties recorded at December 31, 2009. The Company does not anticipate a material change to the amount of uncertain tax positions within the next 12 months.
A reconciliation of the Company’s uncertain tax positions is as follows:
While management believes the Company has adequately provided for all tax positions, amounts asserted by taxing authorities could materially differ from our accrued positions as a result of uncertain and complex application of tax regulations. Additionally, the recognition and measurement of certain tax benefits includes estimates and judgment by management and inherently includes subjectivity. Accordingly, additional provisions on tax-related matters could be recorded in the future as revised estimates are made or the underlying matters are settled or otherwise resolved.
In, prior years, the Company was subject to the alternative minimum tax (AMT) which is based on current year AMT income (AMTI) less NOL carryforwards which cannot exceed 90% of AMTI. The net result is subject to the 20% AMT rate. The Company incurred current federal AMT of $0.7 million and $1.4 million, for the fiscal years ended December 31, 2007 and 2008, respectively. In 2009 the Company generated a taxable loss resulting from accelerated depreciation on its WorldView-2 satellite. Current tax legislation allows this loss to be carried back to prior years which will reduce prior years AMT income to zero and will generate a refund of all previously paid AMT.
In connection with the preparation of the second quarter 2008 income tax provision and the 2007 income tax return, the Company became aware of certain adjustments that should be made to the release of the valuation allowance that was recorded in the fourth quarter of 2007. The net operating loss carryforward recorded as a deferred tax asset as of December 31, 2007 and related income tax benefit for the year ended December 31, 2007 should have been reduced by $1.4 million, due to tax basis and related tax depreciation differences. Management has assessed the impact of this adjustment and does not believe this amount is material, individually or in the aggregate, to any previously issued financial statements or to our operations for 2008. The Company recorded this non-cash out of period adjustment in the second quarter of 2008 increasing income tax expense and reducing net income for the three-month and six-month periods ended June 30, 2008 by $1.4 million or $0.03 basic and diluted EPS.
NOTE 11. Benefit Plan
In October 1995, we adopted a 401(k) Savings and Retirement Plan (the 401(k) Plan), a tax-qualified plan covering substantially all of the Company’s employees. Employees may elect to contribute, subject to certain limitations, up to 60% of their annual compensation to the 401(k) plan. The 401(k) Plan provides that we may contribute matching contributions to the 401(k) Plan at the discretion of the Company’s management as approved by the board of directors. We recorded approximately $1.0 million, $1.2 million and $1.5 million of matching contribution expense for the years December 31, 2007, 2008 and 2009, respectively.
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NOTE 12. Related Party Transactions
As a result of the Company’s initial public offering in May 2009, the Company has reevaluated related parties due to the change in ownership and has concluded that Morgan Stanley & Co. Incorporated (Morgan Stanley) and Beach Point Capital Management L.P. remain its only related parties. On a prospective basis, the Company will only update related party information for these two entities. As a result of the IPO, Ball Corporation, Hitachi Ltd./Hitachi Software Engineering Co., Ltd., ITT Industries, Inc./Eastman Kodak, MacDonald Dettwiler and Associates, and Telespazio S.p.A./Eurimage S.p.A. are no longer related parties going forward from the initial public offering date. Historical information pertaining to these companies will continue to be disclosed if balances and activity for these entities is included in the financial statements presented.
Morgan Stanley
There were no amounts owed to Morgan Stanley in accounts payable and/or accrued liabilities to related party at December 31, 2008 and 2009.
The accrued interest on the Second Swap transaction owed by the Company to an affiliate of Morgan Stanley was $(0.1) million at December 31, 2008. There was no accrued interest related to the Second Swap at December 31, 2009. The fair value of the Swap transactions at December 31, 2008, $(1.0) million. The Second Swap terminated on April 18, 2009 and the Company paid the fair value of the Third Swap in conjunction with the repayment of our senior credit facility and senior subordinated notes. The Company did not have any swaps at December 31, 2009.
In February 2008, we issued senior subordinated notes in the amount of $40.0 million before issuance costs to Morgan Stanley and funds and affiliates that are now managed by Beach Point Capital Management L.P.. In addition, an affiliate of Morgan Stanley earned fees totaling $0.4 million for the placement of these notes.
As a result of the debt repayment in April 2009, all deferred financing fees paid to Morgan Stanley associated with this debt were expensed to the income statement in loss from early extinguishment of debt. As a result of the early extinguishment of debt, the Company paid a penalty of $0.9 million and $7.1 million in new deferred financing fees. In April 2009, we paid our senior subordinated notes in full.
In April 2008, we made an initial filing of our S-1 registration statement (S-1) with the SEC. In that filing, we named Morgan Stanley as a book-runner manager for our proposed IPO.
In July 2008, the Company entered into an agreement with an affiliate of Morgan Stanley to provide management services for the Company’s employee stock option plans.
In April 2009, Morgan Stanley was the book-running manager for our senior secured note offering.
At December 31, 2008 and 2009 Morgan Stanley and its affiliates held 15,968,099 and 14,366,395 shares, respectively, of the Company’s common stock. Pursuant to the Investor Agreement between us and Morgan Stanley, currently, five Morgan Stanley designees have been duly elected to and are serving on our Board of Directors. The Directors are Mr. Zervigon, Mr. Albert, Mr. Jenson, Mr. Whitehurst and Mr. Cyprus. Mr. Albert, Mr. Jenson, Mr. Whitehurst and Mr. Cyprus are independent directors, as defined under the applicable rules of the New York Stock Exchange.
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Beach Point Capital Management L.P. (assignee of Post Advisory Group LLC)
In January 2009, Beach Point Capital Management L.P. (Beach Point Capital) assumed certain rights and obligations from Post Advisory Group LLC. In connection with that assignment, Beach Point Capital became investment manager of certain funds that hold common stock of the Company. In February 2008, we issued senior subordinated notes in the amount of $40.0 million before issuance costs to Morgan Stanley & Co. Incorporated and funds and affiliates that are now managed by Beach Point Capital. In addition, Beach Point Capital and its related funds and affiliates earned fees totaling $0.4 million for the placement of these notes.
As a result of the debt repayment in April of 2009, all deferred financing fees paid to Beach Point Capital associated with this debt were expensed to the income statement in loss from early extinguishment of debt. As a result of the early extinguishment of debt, the Company paid a penalty of $0.9 million. In April 2009, we paid our senior subordinated notes in full.
At December 31, 2008 and 2009, Beach Point Capital and their related funds and affiliates held 6,487,923 and 3,168,839 shares, respectively, of the Company’s common stock.
Ball Corporation
Under various contracts with Ball Aerospace, we incurred expenses of $128.1 million and $32.2 million for the years ended December 31, 2007 and 2008 respectively, which were capitalized as part of the costs of building our WorldView-1 and WorldView-2 satellites. We incurred expenses of $13.1 million for the year 2009 until the IPO date, which was capitalized as part of the costs of building our WorldView-2 satellite. There were no amounts owed to Ball Aerospace in accounts payable to related party or accrued liabilities to related party at December 31, 2008.
At December 31, 2008 and 2009, Ball Corporation and its affiliates held 2,791,090 and 697,772 shares, respectively, of the Company’s common stock. During 2007, Ball Corporation had a designated representative serving on the Board. This representative resigned from the Board in December 2007.
Hitachi, Ltd./Hitachi Software Engineering Co., Ltd.
Hitachi, Ltd. (Hitachi), currently is a master international distributor of the Company’s products and was the exclusive distributor in most of Asia. Its rights and obligations have been assigned to Hitachi Software Engineering Co., Ltd. (Hitachi Software), an affiliate of Hitachi. Its exclusivity in most of Asia was amended in January 2004 to allow DigitalGlobe access to markets outside of Japan.
On January 28, 2005, we entered into a data distribution agreement with Hitachi Software which appoints Hitachi Software as a reseller of our products and services and authorized Hitachi Software to sell access time to our WorldView-2 satellite. Under the data distribution agreement we received a payment of $10.0 million in 2005. We entered into a direct access facility purchase agreement with Hitachi Software on March 23, 2007. Under this agreement, we will construct and sell to Hitachi Software a direct access facility, which will allow a customer of Hitachi Software to directly access and task our WorldView-2 satellite. In total, under our direct access facility purchase agreement, we have received $14.7 million of payments at December 31, 2008. As of December 31, 2008, the accumulated amount received from Hitachi Software related to the data distribution agreement and the direct access facility purchase agreement of $24.7 million was included in deferred revenue from related party. Engineering work associated with the agreement has been subcontracted to MacDonald Dettwiler and Associates Ltd. (MDA), also a stockholder of the Company.
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Hitachi earned sales commissions on direct sales by the Company to customers in its region of $1.4 million for the year ended December 31, 2008. Hitachi earned sales commissions on direct sales by the Company to customers in its region of $0.5 million for the year 2009 until the initial public offering date. These amounts are accounted for as a reduction of revenue in the consolidated statements of operations. Amounts owed to Hitachi in accrued liabilities to related party totaled $0.1 million at December 31, 2008.
Hitachi Software purchased approximately $9.5 million of the Company’s products in the year ended December 31, 2008 and $2.7 million for the year 2009 until the initial public offering date. Hitachi had a balance in accounts receivable from related party of $0.9 million at December 31, 2008.
At December 31, 2008 and 2009, Hitachi and its affiliates held 3,309,144 and 3,309,144 shares, respectively, of the Company’s common stock. Until January 2008, they had a designated representative serving on the board of directors.
ITT Industries, Inc./Eastman Kodak
Under various contracts with ITT Industries, we incurred expenditures of $13.5 million and $7.0 million for the years ended December 31, 2007 and 2008, and $0.8 million for the year 2009 until the initial public offering date, which were capitalized as part of the costs of building our satellites. There were no amounts owed in accounts payable to related party at December 31, 2008. Amounts owed to ITT Industries in accrued liabilities to related party totaled $0.1 million at December 31, 2008.
At December 31, 2008 and 2009, ITT held 770,208 and 770,208 shares, respectively, of the Company’s common stock.
MacDonald Dettwiler and Associates, Ltd.
Since September 1996, we have had a series of agreements with MDA, a stockholder of the Company, for purchase of various goods, software licenses and engineering and related services.
Under various agreements we have incurred expenditures of $4.8 million and $11.8 million for the year ended December 31, 2007 and 2008, respectively, and $3.1 million for the year 2009 until the initial public offering date. Total costs incurred with MDA related to the construction of the direct access facility for Hitachi of $13.6 million was recorded as long term deferred contract costs to related parties at December 31, 2008. Remaining expenditures have been capitalized in the cost of the satellites. Amounts owed to MDA in accrued liabilities to related party totaled $1.0 million at December 31, 2008.
At December 31, 2008 and 2009, MDA and its affiliates held 27,667 and 27,667 shares, respectively, of the Company’s common stock.
Telespazio S.p.A./Eurimage S.p.A.
Telespazio S.p.A. (Telespazio), is a master reseller of our products and services in Europe. Telespazio earned sales commissions on direct sales by the Company to customers in its region of $0.5 million and $0.6 million for the year ended December 31, 2007 and 2008, respectively and $0.5 million for the year 2009 until the initial public offering date. Amounts owed to Telespazio in accounts payable to related party totaled $1.8 million at December 31, 2008.
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Telespazio and its reseller and subsidiary, Eurimage S.p.A. (Eurimage), purchased approximately $6.9 million and $5.6 million of the Company’s products in the year ended December 31, 2007 and 2008 and $1.6 million for the year 2009 until the initial public offering date. Amounts owed to us by Telespazio/Eurimage in accounts receivable from related party totaled $0.3 million at December 31, 2008.
At December 31, 2008 and 2009, Telespazio and its affiliates held 794,641 and 0 shares, respectively, of the Company’s common stock.
NOTE 13. Material Relationship
National Geospatial-Intelligence Agency (NGA)
The ClearView Agreement, executed in 2002, with NGA originally provided for minimum annual purchase commitments over four years. There is currently no minimum purchase commitment for year five of the agreement. In January 2007, the ClearView Agreement was merged into the NextView Agreement.
Under the NextView Agreement, we initiated the development of the WorldView system in August 2003 and on November 16, 2007 the WorldView-1 Satellite reached its full operational capability. The NextView agreement provided for the advance payment of $266.0 million prior to the FOC of WorldView-1. These advance payments are accounted for as deferred revenue when funds are received. In November 2007, when the WorldView-1 satellite became certified as operational, the advance payments started to be ratably recognized as revenue over the estimated remaining life of the NGA customer relationship, currently assessed to correspond with the life of the WorldView-1 satellite, or 10.5 years.
The NextView agreement originally provided for minimum data purchase commitments from the WorldView-1 satellite. In January 2008, we amended the NextView agreement to modify the purchase arrangement with NGA from area-based ordering to a Service Level Agreement (SLA).
NOTE 14. Commitments and Contingencies
The Company is obligated under certain non-cancelable operating leases for office space and equipment. We currently lease approximately 199,476 square feet of office and operations space in two locations in Longmont, Colorado. This space includes our principal executive offices. The rent varies in amounts per year through its expiration date in August 2015. Lease expense for the Longmont location has been recorded straight line over the term of the lease. The Company received approximately $8.5 million of certain rent incentives that we have deferred and are amortizing over the life of the lease. We have $3.8 million and $2.6 million of net leasehold improvements at December 31, 2008 and 2009, respectively, which we are amortizing ratably over the remaining lease term.
Rent expense net of sublease income approximated $2.6 million, $2.3 million and $3.6 million for the years ended December 31, 2007, 2008 and 2009, respectively.
We enter into agreements in the ordinary course of business with resellers and others. Most of these agreements require us to indemnify the other party against third-party claims alleging that one of our products infringes or misappropriates a patent, copyright, trademark, trade secret or other intellectual property right. Certain of these agreements require us to indemnify the other party against claims relating to property damage, personal injury or acts or omissions by us, our employees, agents or representatives. In addition, from time to time we have made guarantees regarding the performance of our systems to our customers.
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In addition, the majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. The Company evaluates and estimates losses from such indemnification based on the likelihood that the future event will confirm the loss ranging from probable to remote. To date, the Company has not incurred any material costs as a result of such obligations and has not accrued any liabilities related to such indemnification and guarantees in the Company’s financial statements.
Future minimum lease payments under all non-cancelable operating leases (net of aggregate future minimum non-cancelable sublease rentals) as of December 31, 2009 are summarized below:
In addition to operating lease commitments, other contractual commitments related to the manufacture and delivery of key components for the Company’s WorldView-2 satellite are included in the table above.
NOTE 15. Acquisition
On January 4, 2007, the Company acquired GlobeXplorer for a total purchase price of $21.3 million, consisting of $9.4 million in cash consideration, net of cash acquired of $1.4 million, approximately $0.6 million in acquisition costs and 500,000 shares of the Company’s common stock, valued in the aggregate at $11.3 million based on the December 2006 sale of common stock. GlobeXplorer is a producer, integrator and provider of geographic data and earth imagery.
In valuing GlobeXplorer for the acquisition, the Company utilized recognized valuation methodologies. We obtained projected financial results from GlobeXplorer, adjusted those projections based on our knowledge of the market and then valued GlobeXplorer with a discounted cash flow model using those projections, an appropriate weighted cost of capital as a discount factor and an appropriate terminal multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). After our initial valuation, we allocated the purchase price by performing a discounted cash flow valuation of GlobeXplorer’s business, the value of customer relationships, the value of the core technology and the value of certain relationships with prior management.
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GlobeXplorer’s accounts and results of operations have been included in the consolidated financial statements of the Company since the acquisition date. The purchase price allocation resulted in $9.0 million of identifiable intangible assets, consisting primarily of trademarks, core technology and customer relationships, and $8.7 million of goodwill, after adjusting the additional acquired net assets to fair value. The $21.3 million purchase price was allocated as follows:
Intangible assets resulting from the acquisition of GlobeXplorer during 2007 consist of the following:
The identifiable intangible assets are being amortized on a straight-line basis over their useful lives, ranging from three to five years, except for customer relationships, which are being amortized using the declining balance method over a five year period. Goodwill represents the excess of the purchase price over the value of identifiable net assets and derives primarily from synergies in the operations of the combined business as well as allowing the Company to enter the web-based imagery distribution business sooner than would otherwise have been possible.
NOTE 16. Quarterly Results from Operations (unaudited)
In connection with the preparation of our 2007 federal income tax return, we determined that certain adjustments should have been made prior to the release of the valuation allowance that was recorded in the fourth quarter of 2007 of $59.1 million. We noted that the net operating loss carryforward recorded as a deferred tax asset as of December 31, 2007 and related income tax benefit for the year ended December 31, 2007 should have been reduced by $1.4 million. We determined the adjustment is not material as of or for the years ended December 31, 2007 and 2008. Accordingly, the error was corrected in the second quarter of 2008.
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NOTE 17. Subsequent Events
On January 4, 2010, our WorldView-2 satellite achieved full operational capability. The company began taking orders from the WorldView-2 satellite during the fourth quarter of 2009 and we are currently selling imagery from the WorldView-2 satellite.
On February 9, 2010, DigitalGlobe, Inc. signed a contract to modify its Service Level Agreement, or SLA, with the National Geospatial-Intelligence Agency, or NGA. The modification restructures the option for NGA to extend the term of the SLA. The original option, if exercised, provided for a single nine-month extension of the term, from April 1, 2010 to December 31, 2010. The modified option grant NGA the option to extend the SLA for three months on the same terms, from April 1, 2010 to June 30, 2010, with the six additional options, each for a one-month period, with the last option term expiring on December 31, 2010.
Our Company has evaluated and disclosed all subsequent events that have occurred from December 31, 2009 through February 24, 2010. Besides the subsequent events listed above, there were no other subsequent events that required disclosure in our financial statements.
NOTE 18. Valuation and Qualifying Accounts
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ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer (our principal executive officer and principal financial officer, respectively), we have evaluated our disclosure controls and procedures (as defined in Securities Exchange Act Rule 13a -15(e)) as of December 31, 2009. Based upon that evaluation, the chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective.
Management’s Report on Internal Control Over Financial Reporting
This Annual Report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the company’s registered public accounting firm due to a transition period established by the rules of the SEC for newly public companies.
Changes in Internal Control Over Financial Reporting
There has been no change in the company’s internal control over financial reporting during the fourth quarter ended December 31, 2009, that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information regarding our directors, including the audit committee and audit committee financial experts, and executive officers and compliance with Section 16(a) of the Exchange Act will be included in our definitive proxy statement for the 2010 Annual Meeting of Stockholders (the Proxy Statement) and is incorporated herein by reference.
We have adopted a Code of Ethics and Business Conduct that governs our senior officers, including our chief executive officer and chief financial officer, and employees. Copies of our Code of Ethics and Business Conduct are available on our website at www.digitalglobe.com and may also be obtained upon request without charge by writing to the Secretary of the Company, DigitalGlobe, Inc., 1601 Dry Creek Drive, Suite 260, Longmont, Colorado 80503. We will post to our website any amendments to the Code of Ethics and Business Conduct, and any waivers that are required to be disclosed by the rules of either the SEC or the NYSE.
Copies of our Corporate Governance Guidelines and the charters of our Audit Committee, Compensation Committee and Nominating and Governance Committee are available on our website and may also be obtained upon request without charge as described in the preceding paragraph.
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The information required by this item will be included in the Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item, including information relating to security ownership of certain beneficial owners of our common stock and of our management, will be included in the Proxy Statement and is incorporated herein by reference.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item, including information under the caption “Certain Relationships and Related Transactions” in the Proxy Statement and information regarding director independence, will be included in the Proxy Statement and is incorporated herein by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item, including information under the caption “Independent Registered Public Accounting Firm Fees and Services” in the Proxy Statement, will be included in the Proxy Statement and is incorporated herein by reference.
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PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
List of documents filed as part of this report:
(1)
Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm
See the Index to Financial Statements and Financial Statement Schedules set forth in Part II, Item 8 of this report.
(2)
Financial Statement Schedules
See the Index to Financial Statements and Schedule set forth in Part II, Item 8 of this report.
The agreements included as exhibits to this report contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties were made solely for the benefit of the other parties to the applicable agreement and (i) were not intended to be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate; (ii) may have been qualified in such agreement by disclosures that were made to the other party in connection with the negotiation of the applicable agreement; (iii) may apply contract standards of “materiality” that are different from “materiality” under the applicable securities laws; and (iv) were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement.
We acknowledge that, notwithstanding the inclusion of the foregoing cautionary statements, the Company is responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this report not misleading.
Exhibit Index
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.