Viasat Inc Q2 FY2023 Earnings Call

Thanks, and thanks, everybody, for joining us today. We released our shareholder letter shortly after market close and is available on our website. We will be referring to that on this call. Joining me today on the call are Rick Baldridge, our Vice Chairman; Kevin Harkernweider, our Chief Operating Officer; our Chief Financial Officer, Shawn Duffy, Robert Blair, our General Counsel; and Paul Promit from Corporate Development; and Peter Opes from Investor Relations. So first have Robert provide our safe harbor discussion.

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

Okay. Thanks. So I will briefly just touch on some of the main points we just in the letter before we take questions. So first, progress on the completion of the first ViaSat-3 satellite has been really good, and it is close to plan since last quarter. It is completed and has its functional environmental and deployment tests. The deployment tests use higher technical devices. So the remaining tasks now are to inspect those, the deployable and restore the satellite to launch configuration. We expect the satellite will be ready for shipment to the launch site in December. Though schedules for some U.S. national priority launches that are contending for Falcon Heavy facilities have shifted since our previous conference call. So at this point, we can’t give a specific window other than early first quarter of calendar 2023, but we are targeting the early part of the quarter. And we are working with SpaceX to add it as soon as possible. Financial results for the quarter were consistent with the outlook we described during our last call. Also, as we previously reported, we executed an agreement to sell our Link 16 tactical data link business to L3 Harris for $1.96 billion in cash. The letter in our filings reflect separating those TDL results from our continuing operations. The total second quarter revenue was $745 million, up 6% year-over-year, that is aided by the previously reported Acacia payment and 5% growth in overall services revenues with product shipments impacted by delayed deliveries of some new planes to some of our airline customers and supply chain and certification delays for some government products. Adjusted EBITDA grew 21% year-over-year to $188 million, aided by the Acacia payment and significant growth in IFC services with headwinds from activity activating more of the ViaSat-3 ground infrastructure in advance of the launch, constraints on available U.S. bandwidth on residential, including ongoing reallocation in connectivity in anticipation of a substantial increase in airplanes coming into service in the second half of this fiscal year, and some impacts of supply chain stock shortages on component pricing and the resulting product margin impact. Total new orders were excellent this quarter at over $1.1 billion. Backlog remains strong, as does our book of delivery orders and options and potential IDIQ value, even though we have consumed about $400 million of that IDIQ order book on a year-over-year basis. Our fiscal year 2023 outlook is revised, reflecting the cumulative effect of the ViaSat-3 launch delays, combined with the infrastructure network activations, delays to portions of new aircraft activations due to those delayed deliveries to the airline customers, constraints on residential broadband, and supply chain impacts. We anticipate very good growth in the second half of the fiscal year in connectivity claims and services as we described last quarter. That is going to be driven by retrofits and line fits, and we also have growth in IFC terminal shipments and dominant growth. Our stand-alone estimate of doubling adjusted EBITDA by fiscal year 2025 relative to fiscal year 2020, including adjusting for the Link 16 sale, remains intact. As we previously described, Link 16 sales are expected to result in about $1.8 billion of net cash proceeds, which will substantially reduce debt and leverage on a stand-alone basis following the Inmarsat transaction. The U.K. Competition and Markets Authority, or CMA, reviewed the Inmarsat transaction, which has entered Phase I, and they published their findings from Phase I, which included a striking dismissal of all the other competitors in aviation connectivity. Our first steps are to meet with the new panel formed for Phase II and provide more facts on the nature of both incumbent and new entrant competition. We believe there is a strong case that substantial competition will be sustained going forward, and the process can still be completed within the original timeline. So with that, we will open it up for your questions.

Richard Prentiss with Raymond James. Your line is open.

A couple of questions. Two housekeeping ones first. On the 2023 fiscal guidance, does that include the one-time benefits? It looks like it is in there - for commercial networks, I assume that is in there for all the types of items.

Rich, this is Shawn. So yes, our guidance includes the Q2 results for Acacia.

Okay. Second kind of housekeeping one is previously, you mentioned free cash flow policy timing shortly after a couple of quarters after the ViaSat-3 launched. Has the change in supply chain and information costs affected your thoughts about when you turn free cash flow positive?

Rich, I think I would think of it as around the same timing with respect to how it is pegged to the EMEA satellite. We have said before that we need to get the satellite up and scaled. And once we do that, that kind of marks the turning point. So it is very similar.

Okay. And then more of a theoretical long-term question. We have seen a lot of discussion and announcements and events around satellite/smartphone communications. Can you share with us kind of your thoughts about how ViaSat would play in or without Inmarsat looking at L-band, San urban services versus 5G? Just what is happening in that part of the space?

Okay. So we do think it is a really, really interesting application for satellite. Obviously, to the extent that you can provide connectivity and interesting services, which are likely going to go beyond SOS to include things like messaging, email, probably web browsing, and maybe a few others. So you can provide interesting services and you can do it with modified phones. I mean, it is really attractive. The things that interest us about it are, one, just responding to your breakdown of with and without Inmarsat. Number one is it is a very challenging technical problem. We think that it really plays to our strength in terms of high-capacity connectivity from space, especially to highly disadvantaged user devices. We also think that what will be needed is to do that in some way that is sustainable in space, given all of the increased focus on those issues recently. And I think that is one area in which we are already doing work where we think we can partner with other holders of spectrum on that opportunity. And the other one is that with the Inmarsat transaction, we will be one of the largest holders of global mobile spectrum. And there are some really big advantages in terms of serving that market with life and MSS spectrum as compared to trying to reuse terrestrial spectrum. So that is the other way in which we are aiming to participate. The combination of having the spectrum and the technology, I think is going to create really good opportunities for us.

Great. And then how should we think about the timeframe of when this becomes real and meaningful?

Well, I think that what you are already seeing with Globalstar and Apple is that - let’s say we put it in two buckets. One bucket is, can it be done at all? And I think we are going to see, yes, it can be done. The issue is really going to be what kind of links you can create reliably to devices with antennas, better like smartphones or other smart devices. So the real issue that is going to be scale. And scale is going to mean speed and the number of simultaneous users because that is going to have a big impact on the types of services you can bring to market. Doing it at higher speeds and greater scale is going to require new space systems to do that. And so that is for pretty much anybody going to be, I would say, two to three years out at least.

Great. That is very helpful. Thanks, Mark.

Landon Park with Morgan Stanley. Your line is open.

Maybe just following up on Mark, on your satellite smartphone comments. Can you maybe unpack your view in terms of the benefits of the MSS spectrum versus reauthorizing terrestrial spectrum? And on this type of service, do you think it is practical that it can be done from GEO or would this require a different orbit from an investment standpoint?

Okay. So I will give you opinions here. One is the issue on the licensed MSS spectrum versus terrestrial spectrum; the reason the terrestrial spectrum is going to be very complicated in most markets is because of the way it is allocated, where you have different carriers sometimes very close together in different countries. It is going to be hard, especially if operators are making exclusive deals with a carrier, for instance, in a region, where that is going to require that other carriers wanting to have the same service will have to have a different space system to use its spectrum. As that plays out, the opportunities and the complexity of avoiding interference with terrestrial becomes a real problem. And just to jump to the second point, the real issue when connecting those types of devices is the power propensity that you can make on the ground. Once you can make power propensity, it is just a measure of how much power made from your satellite to the ground. So if you start from higher up, you need more power or a bigger antenna. But at the end, if you have the same power on the ground, it doesn’t matter what altitude it comes from. There are opportunities for both GEO and LEO systems. We are looking at both. I think they both can deliver similar functional performance to the handsets. And then it is really just a question of economics: what does it cost you to deliver a certain amount of power to those areas with the greatest demand? That is kind of the main issue that everybody deals with in satellite services in general. We think these markets will be geographically concentrated because it is almost certainly going to be over land. Also, you will have a situation where much of the demand is near metro areas. Even though those aren’t very rural, there are so many homes near metro areas that there is going to be a lot of demand there. If you want things like emergency services in times of disaster or something, you are going to need a lot of capacity to connect many phones. I think those are kind of the technical issues, and I think those outline some of the pluses and minuses of LEOs and GEOs and the two different forms of spectrum.

On the stock Services segment, the revenue was down a decent bit sequentially. Can you just maybe unpack that for me? And on the broader IFC business, how are you guys thinking about business aviation at this point? We have seen some announcements recently from Starlink. So just wondering how you think that you can scale in that market with the ViaSat-3? And then just one last one for Shawn. On the fiscal 2025 guide, I just want to make sure I’m understanding. Are you confirming it as if you had TDL still in fiscal 2025, or are you saying even without TDL, you will hit those targets? I wasn’t entirely clear.

Okay. Just on the second one, that is pretty simple. If you took our FY 2020 results and excluded the TDL contribution, and then compare that to our FY 2025, that is where you get the two to one. On the second one, from a perspective, probably the main driver on services is there are a couple of drivers for services. One is we still are expecting really strong growth in commercial aircraft in service this fiscal year. There have been delays that we see in the second half, but we expect strong activations. The second half has a much higher proportion of retrofits, so we don’t have the aircraft delivery issues, and also some of the aircraft deliveries that were delayed will come in the second half. But because of all that growth, we have to clear spectrum. I mean, we have a clear bandwidth on our satellites in advance of the growth in the F5 stuff, and that is a little behind that. We do have some headwinds in residential broadband, partly due to the economy as a whole, and inflation is putting more pressure on higher ARPU broadband services. So that is one. We also see more incursion from terrestrial wireless. Additionally, there is more competition as well. But we are going to emphasize especially with ViaSat-3, but in our plans, we are going to start to offer plans that provide a lot more bandwidth for specific streaming services. We have one really exciting partner in that regard that we will be launching - we have been doing beta tests, and I think probably early next quarter, we will start offering more of that. One more point is that the speeds we are offering are looking very competitive. We think that will especially appeal to those people who consume a lot of streaming content. Depending on when ViaSat-3 comes into service, that is when I think you will see the residential business come back. The in-flight business is thriving and holding strong through this challenging time. Regarding margins and EBITDA, we are getting hit by infrastructure costs related to the ground segment, as we are activating more of that ground network infrastructure close to launching the satellite, which is expensive because it is intended to provide hundreds of gigabits to a terabyte of capacity.

Highlights about business aviation as well. How are you thinking of that kind of opportunity longer term? Business aviation longer term?

Business Aviation. Yes, this is aviation. We really started with Ka-band in earnest over probably the last year or so, and we had a focus on distribution with OEMs, increasing our distribution, and that is working well. It is growing pretty fast, both in terms of migrating people from leased bandwidth to our own Ka-bandwidth. The number of KA terminals is increasing significantly, and I believe that the amount of bandwidth we can offer in that space is looking very competitive. Yes, we still think that is a sound market for us.

And then Amanda, this is Shawn. I have one quick thing to that. Just keep in mind that even though we moved the satellite timing a little bit, we are not taking our foot off the gas with respect to the ground. We want to be ready. So all of those ramp-ups this year are in the tune of $50 plus million. Mark, are you able to say how many BA tails you guys have between Canadian to you today, and on the commercial IFC, you guys have targeted 2,400 aircraft previously. Is it still that?

Yes. The commercial target is - what we provided last quarter was 2,400 by the end of the year for commercial business aviation; that is low hundreds. I don’t want to be evasive, but I think it is low hundreds. We don’t have a split for you right now on KA versus cap, but it is getting to be the majority, I believe.

Mike Crawford with B. Riley Securities. Your line is open.

Thank you. So Inmarsat just received a nice $410 million Blue Force Tracking extension award. Can you talk at all about any changes between your planned installation build, assuming that you are able to consummate this transaction?

Yes. So what sort of things we still need more information on is the exact status of the payment schedules for the satellites that Inmarsat has on order for L-band. The main ones are the I6 They have launched one. There is another one launching in about a year. I think those are their newest LV satellites. I think they will probably be planning more replenishments for L-band satellites. What we see is an opportunity; we have been working in the broadband market to develop more sophisticated satellites that provide much greater value in terms of available bandwidth per capita dollar. What we see with the direct to handset market is a bit extreme - there is quite a bit of elasticity for mobile satellite demand with lower airtime pricing. That is going to be our main focus. I think you will see a substantial improvement in the bandwidth delivered from MSS per airtime dollar. I think that is going to pay off in government, maritime, aviation, and these new markets as well.

Okay, thank you. Can you say like kind of percent complete of investment CapEx that you have put into, say, ViaSat-3 EMEA, ViaSat-3 APAC, and GS-4? Those three satellites?

Yes, Mike. The way we kind of look at it is across the Bostock as a whole. At the end of Q2, we are probably 74-ish percent complete right around there.

That is not biased based on ViaSat-3, but is that including the first four satellites, which I think you started to invest in?

That is excluding that. Yes, we are making some investments in some traction there. We are measuring it at this point, but yes, there are some expenses there as well.

Okay. And right now, is it just one of those satellites that you have started or more of that R&D investment that would be applicable to similar other ViaSat-4 class satellites?

Two parts. We have a satellite. We have a construction contract for the satellite, but the main driver that we have been working on is the Payload, which we will do, and the payload is a more highly integrated version of ViaSat-3 and should be quite a bit easier to manufacture, assemble, and integrate. We have one of those underway. I would say most of the expenses so far have been in the payload. As Shawn said, we are going to be managing the CapEx spend rate to achieve our overall balance sheet and growth. Right now, it is floating a little bit, but it is progressing.

Okay. I have two other quick questions. One, can you remind us of the time period covered for the case of verdict, and then how much time has accumulated where Cisco willfully continues to infringe on your intellectual property?

Mike, this is Rob Blair. So the first case went through sales made through 2019. The damages were through 2019. Any damages that occurred after that for their use of our intellectual property would be for any time on the products that were in that case, which would be from January 1, 2020, forward and would continue to this day for any sales they made on those products. We have an additional case that relates to their use of intellectual property on different products that is just getting started. Following the appeal, it is just getting restarted. So that case is at its onset.

Okay. And that period that ended through 2019, when did that period start?

I don’t recall when the agreement started; I want to say about 2014 or 2015.

We can’t draw a direct line though. You can’t take the time periods and just draw a linear line in terms of product deliveries.

Okay. Well, I certainly wouldn’t want to be in their position. And then final question, you talked about the resolution of transient supply chain and certification bioscan. Is that happening? Do you expect that to happen? What can you further add regarding that?

The supply chain issues are a little bit like whack-a-mole. They tend to surface fairly suddenly. The main way we have been dealing with them is by resorting to spot markets to fill in any gaps. I think we have done reasonably well, but overall, our situation is not much different than others that depend on - especially for us, it is more often in high-end semiconductors; that is not really the case. We are also facing shortages of commodity components that just show up as well. In cases where we can, we are paying the higher spot market prices and delivering that for our customers. The other failure point is some higher COGS for some of the products we are shipping. I think it is hard to declare an end to it.

Ryan Koontz with Needleman Company. Your line is open.

Thanks for the question. Just a quick follow-up on your IFC commentary there. How should we think about your share opportunity moving forward beyond this fiscal year? It sounds like you are really executing well there and onboarding new customers and planes. At what point do you think that the commercial business starts to saturate a bit in the U.S.? Talk briefly about the international opportunity for you; it would be great. Thank you.

Okay. The IFC market is very dynamic. The airlines are trying to respond to what they perceive is what their passengers want. The different airlines are testing various strategies, and they are really looking to enhance passenger satisfaction. They are trying to figure out if they can do that through curating onboard content, better meals, or providing connectivity. Different strategies are emerging. The U.S. market is pretty well interconnected on the ground, and airline competition is fierce. So that market is ahead of most others, but I think there will still be good growth in the total number of planes connected. There is long-term growth in the number of claims, and we believe we will compete well. We have tried to help the airlines find ways to use IFC that align with their overall go-to-market strategies and we are flexible in how we offer the in-flight connectivity. We don’t have a single mode there. Our willingness to integrate with in-flight entertainment remains strong. By far, the highest usage of bandwidth in connectivity is for entertainment. This resonates with airlines, and most analysts expect the market’s going to grow substantially in the next seven years, and I believe we will compete well based on the types of services we can offer. It seems to work so far.

Super interesting. And just a quick follow-up on the streaming technology you talked about. Is this like a CDN software stack you have licensed, you are going to productize as part of the offering? How should we think about that new development, if you can talk at all about it?

Can’t get into too much detail. The basic idea is which is catching on - there are some standards around this, which is really to push CDN further to the edge. Some of that more content can be delivered directly to end users. The real trick there is making that economically viable. That is the part that goes beyond the standard saves is using the standards to achieve that goal. To the extent that, that is done well, it is a significant multiplier to the usage available to subscribers that are streaming content. That is about 80% of all the bandwidth delivered over consumer broadband networks; hence there is a big opportunity there.

Chris Quilty with Quilty Analytics. Your line is open.

Thanks. I just wanted to follow up to Southwest, is that still scheduled for Q3 rollout? Should we expect - I think when you guys initially launched on American, you went from about a dozen aircraft to over 100 the following quarter. Is that the ramp we should be expecting?

So Southwest right now, our agreement with them is for their new aircraft deliveries, so the pace will be metered by those deliveries. So that will be steady. I believe it covers up to 700 aircraft. So it is good for us. What we would like to do is offer them a service that is so appealing that they want to outfit their whole fleet. As they mentioned, their plan is to work with a new supplier to improve the service on their existing fleet; our immediate target is to do a great job on these new planes. For other airlines, we have a mix of retrofits and new plane deliveries, and I think in the next couple of quarters, we will see a big ramp because of the number of retrofits we have.

Got you. As the ViaSat-3 coverage expands and you probably move from more narrowband to wide-body, are there any product developments that are needed to make that transition or is it pretty seamless to go after the larger aircraft?

It is pretty seamless to go after the larger aircraft. We have outfitted wide bodies already with KA and Ka/Ku, and we do now have some transatlantic wide bodies in service as well. So I think we are well prepared for that.

Great. Final question. This was just a little subjective, and you have talked about the supply chain issues, and it sounds like sort of a whack-a-mole type issue. That said, you have heard of force you throw out a number, is the supply chain issue back to 80% of where it was pre-pandemic or some number like that? The more important question is, are you seeing forward progress or stalling out in terms of some of these supply chain issues? Does that keep paring them down quarter after quarter now?

Chris, this is Kevin Harkernweider. Overall, the number of supply chain issues are declining. There are fewer this quarter than the last quarter. Unfortunately, when you have a component shortage, you need 100% of them in. It is hard to say that instead of having 10 short, two short, it is 80% better, but you still can’t deliver. In general, as the worldwide demand for integrated circuits declines, we are benefiting from it. So Q4 will be better than Q3. I can expect that trend to continue when the global macroeconomic situation improves. But looking at it quantitatively is difficult because it depends on the product, and some issues may be pervasive across the entire product line.

The other thing though, Kevin, you can talk about this. One of the things we have seen is brokers or orders are a significant contributor to these supply chain issues. It is detrimental for the manufacturers and for us. Near the end of this process, there will not be any market for brokers, and therefore, many parts shortages will get resolved quickly. I think we are getting closer to that, but a lot of it is driven by the brokers out.

Louis DiPalma with William Blair. Your line is open.

Mark, Rick, Shawn, and Peter, good afternoon. What is the timeline for the U.K. CMA Phase II investigation? What is the expected new timing for the close of the Inmarsat merger if the investigation goes in your favor?

Yes. So the Phase II has a basic period, which would be completed by March 30. It can be extended if need be, but it is intended to close by March 30. What we had said when we announced the transaction was 12 to 18-months, which would be in May. So that is kind of what our expectation was. We are working to get it done within that timeframe, that March 30 timeframe.

There is an opportunity, Louie, that they could not take the entire Phase II period. There are a couple of milestones in there. We are going to talk to them next week to give our view on this. There are some other milestones in December and a couple early next year. We should know more by January and February.

Great. Previously, when you announced the Inmarsat merger, I think you were targeting a pro forma net leverage upon the deal close. Now, with the divestiture of L3 Harris, you just provided a new potential timing for the close. What should the new pro forma or pro forma net leverage look like?

Louie, it is Shawn. If you consider both deals together, we would expect the pro forma leverage to be about 70 basis points improved to what it was on just Inmarsat alone.

Okay. So 4.3 times, is that -?

Yes, we had originally set that back. So that is where we are at.

Great. And for Mark, it seems that many of the big four U.S. airlines are moving forward with free WiFi, though it may be contingent upon the activation of your ViaSat-3 satellite. A few years ago, Mark, you conjectured that the economics of free WiFi may look something like $1 to $2 per passenger as a cost to the airlines. Do you still think that range is appropriate? How do you think about how certain third parties, such as T-Mobile or others like Amazon may want to subsidize that cost for marketing purposes or to benefit their own subscriber base?

Okay. To review, one of the things we have said in the past is that the total revenue opportunity was in the range of $1 to $2 per boarded passenger. That is a bit different from the price we would charge the airline or a third party because different passengers will use the Internet differently under different terms. That is not representative of any particular airline. Airlines might decide certain classes of passengers like business class or premium economy might get the Internet for free or they might offer it for certain classes of frequent flyers. In the past, we have had sponsorship deals with entertainment or streaming companies, and we are doing more of those. The kind of revenue potential falls within that ballpark. Some of that revenue may end up being shared with MSO, for example, or in some sense, netting against what their expenses might otherwise be. I think that the $1 to $2 of revenue per boarded passenger is a good target. It is not where we are yet, but it is a solid target. Does that help?

Yes, that makes sense. Another question: Do you view any other defense assets as nonstrategic or along those lines? Are you satisfied with your liquidity following the divestiture of L3 Harris and the close of the Inmarsat deal? Or do you believe more steps need to be taken to improve leverage and liquidity?

Well, we do not plan any other divestitures. The main thing we are doing to improve our leverage and liquidity is to drive up our earnings by performing well in the markets we are pursuing. In terms of synergies in our business, the Link 16 business was a bit complicated because it is a data link. Other participants in the data link market have synergies with other data links. L3 Harris, in particular, is very strong in specific data links. Other participants in that ecosystem had synergies that we didn’t. We are still doing quite well there. We've been winning awards, but long term, it was an investment stream that didn’t really leverage the rest of what we are doing. We are becoming more satellite-centric, with only cyber and cryptography being very relevant to our primary business. We are not planning additional divestitures. I don’t take any of this as specific guidance about what we will or won’t do; I’m just discussing how we thought about the TDL business and whether those dynamics apply to other existing businesses.

Great. Following up on the smartphone line of questions, you addressed this a little bit, but Inmarsat has 68 megahertz of global L-band spectrum rights, which is significantly more bandwidth than Iridium and Globalstar combined. Both of those satellite operators are pursuing smartphone partnerships. What greater capabilities do Inmarsat or potentially you have with that excess spectrum? You mentioned potential partnerships, could you elaborate on that?

Okay. When we did our analysis around the Inmarsat acquisition, it was based on the existing business portfolios we each have. We anticipated the opportunity in the direct-to-handset market, and we are very interested in that, I think. The combination of the spectrum that Inmarsat has and the technology we possess - looking at our ground-based beam forming for Sky Terra - we work closely with Ligado on their existing satellite. The technology that went into ViaSat-3 also holds a lot of opportunity. Some of those technologies we developed are applicable to non-geo as well. Combining some of our technology with what Inmarsat is working on for Orchestra holds great potential. We do believe the market will have price elasticity; having ample spectrum and the right technology is critical for driving costs down and attracting a larger audience. So I think this opportunity is playing out better than we hoped when we announced the transaction.

Got you. Is ViaSat-4 supposed to be a MEO? What is the intended orbit for that satellite?

So just to recap, we expect ViaSat-4 to be a seven terabit per second GEO satellite that will be Americas-focused and should provide us with significantly good economics in terms of bandwidth. We also have a filing for a small MEO constellation, which we are working on as well. That is not going to be in the multi-res range, but I believe we will gain value from that effort.

Sounds good. That is it for me. Thanks everyone.

Okay. Thanks, Louie. I think that is our last question. Just to give a quick summary: satellite disruption is nearing completion, but not on schedule with SpaceX for the first quarter. That delay and supply chain issues are impacting our outlook a bit, as described in the letter in the near term. Long term, things still seem very positive. Our awards were very strong; we are very pleased with that. The TDL transaction is progressing, which will greatly improve our balance sheet and reduce debt, increasing leverage and liquidity. We have a good approach to working the U.K. CMA approval for the Inmarsat transaction. So thank you, everyone, for joining us, and we look forward to speaking again next quarter.

This concludes today’s call. Thank you for your participation. You may now disconnect.