UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number: 000-22839
GLOBECOMM SYSTEMS INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 11-3225567
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
45 OSER AVENUE, 11788
HAUPPAUGE, NY (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (631) 231-9800
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of November 12, 2003, there were 12,518,882 shares of the
Registrant's common stock, $0.001 par value, outstanding.
GLOBECOMM SYSTEMS INC.
Index to the September 30, 2003 Form 10-Q
Page
----
Part I -- Financial Information
Item 1. Consolidated Financial Statements ...................................................3
Consolidated Balance Sheets -- As of September 30,
2003 (unaudited) and June 30, 2003...................................................3
Consolidated Statements of Operations (unaudited) -- For the three
months ended September 30, 2003 and 2002...........................................4
Consolidated Statement of Changes in Stockholders' Equity (unaudited)
-- For the three months ended September 30, 2003...................................5
Consolidated Statements of Cash Flows (unaudited) -- For the three
months ended September 30, 2003 and 2002...........................................6
Notes to Consolidated Financial Statements (unaudited) ..............................7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.....................................................................12
Item 3. Quantitative and Qualitative Disclosures about Market Risk .........................25
Item 4. Controls and Procedures.............................................................26
Part II -- Other Information
Item 1. Legal Proceedings...................................................................26
Item 2. Changes in Securities and Use of Proceeds...........................................26
Item 3. Defaults Upon Senior Securities.....................................................26
Item 4. Submission of Matters to a Vote of Security Holders.................................26
Item 5. Other Information...................................................................26
Item 6. Exhibits and Reports on Form 8-K....................................................26
Signatures..........................................................................28
2
PART I -- FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
GLOBECOMM SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, JUNE 30,
2003 2003
--------------------------------------------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 20,240 $ 22,016
Restricted cash 633 608
Accounts receivable, net 12,746 7,865
Inventories 6,645 10,990
Prepaid expenses and other current assets 2,437 2,040
Deferred income taxes 125 125
--------------------------------------------------
Total current assets 42,826 43,644
Fixed assets, net 16,809 17,536
Goodwill 7,204 7,204
Other assets 1,566 1,960
--------------------------------------------------
Total assets $ 68,405 $ 70,344
==================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 10,687 $ 10,615
Deferred revenues 5,746 7,666
Accrued payroll and related fringe benefits 1,361 1,114
Other accrued expenses 1,874 1,686
Deferred liabilities 426 523
--------------------------------------------------
Total current liabilities 20,094 21,604
Deferred liabilities, less current portion 1,224 1,303
Commitments and contingencies
Stockholders' equity:
Series A Junior Participating, shares authorized, issued and outstanding:
none at September 30, 2003 and June 30, 2003 - -
Common stock, $.001 par value, 22,000,000 shares authorized, shares issued:
12,980,108 at September 30, 2003 and June 30, 2003 13 13
Additional paid-in capital 123,739 123,739
Accumulated deficit (74,341) (73,857)
Accumulated other comprehensive income (loss) 124 (10)
Treasury stock, at cost, 403,845 shares at September 30, 2003 and June 30,
2003 (2,448) (2,448)
--------------------------------------------------
Total stockholders' equity 47,087 47,437
--------------------------------------------------
Total liabilities and stockholders' equity $ 68,405 $ 70,344
==================================================
See accompanying notes.
3
GLOBECOMM SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
---------------------------------------
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
---------------------------------------
Revenues from ground segment systems, networks and
enterprise solutions $ 17,031 $ 8,164
Revenues from data communications services 3,430 4,270
---------------------------------------
Total revenues 20,461 12,434
---------------------------------------
Costs and operating expenses:
Costs from ground segment systems, networks and
enterprise solutions 15,304 7,692
Costs from data communications services 3,218 6,289
Selling and marketing 1,116 1,632
Research and development 475 265
General and administrative 893 1,956
--------------------------------------
Total costs and operating expenses 21,006 17,834
--------------------------------------
Loss from operations (545) (5,400)
Other income (expense):
Interest income 62 170
Interest expense (1) (233)
--------------------------------------
Net loss $ (484) $ (5,463)
======================================
Basic and diluted net loss per common share $ (0.04) $ (0.43)
======================================
Weighted-average shares used in the calculation of basic
and diluted net loss per common share 12,576 12,583
======================================
See accompanying notes.
4
GLOBECOMM SYSTEMS INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003
(IN THOUSANDS)
(UNAUDITED)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TREASURY STOCK TOTAL
--------------- PAID-IN ACCUMULATED COMPREHENSIVE -------------------- STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT INCOME (LOSS) SHARES AMOUNT EQUITY
---------------------------------------------------------------------------------------------
Balance at June 30, 2003 12,980 $ 13 $123,739 $ (73,857) $ (10) 404 $ (2,448) $ 47,437
Comprehensive loss:
Net loss (484) (484)
Gain from foreign currency
translation 34 34
Unrealized gain on
available-for-sale equity
securities 100 100
----------
Total comprehensive loss (350)
-------------------------------------------------------------------------------------------
Balance at September 30, 2003 12,980 $ 13 $123,739 $ (74,341) $ 124 404 $ (2,448) $ 47,087
===========================================================================================
See accompanying notes.
5
GLOBECOMM SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
-----------------------------------------
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
-----------------------------------------
OPERATING ACTIVITIES:
Net loss $ (484) $ (5,463)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 799 1,092
Changes in bad debt expense (975) 42
Changes in deferred liabilities (176) 622
Changes in operating assets and liabilities:
Accounts receivable (3,880) 5,659
Inventories 4,326 (648)
Prepaid expenses and other current assets (297) 78
Other assets 394 3
Accounts payable 90 (2,873)
Deferred revenue (1,920) (770)
Accrued payroll and related fringe benefits 247 310
Other accrued expenses 189 268
-----------------------------------------
Net cash used in operating activities (1,687) (1,680)
-----------------------------------------
INVESTING ACTIVITIES:
Purchases of fixed assets (72) (96)
Restricted cash (25) -
-----------------------------------------
Net cash used in investing activities (97) (96)
-----------------------------------------
FINANCING ACTIVITIES:
Payments under capital lease - (114)
-----------------------------------------
Net cash used in financing activities - (114)
-----------------------------------------
Effect of foreign currency translation on cash 8 9
-----------------------------------------
Net decrease in cash and cash equivalents (1,776) (1,881)
Cash and cash equivalents at beginning of period 22,016 38,708
-----------------------------------------
Cash and cash equivalents at end of period $ 20,240 $ 36,827
=========================================
See accompanying notes.
6
GLOBECOMM SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and in accordance with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all material adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation of
the results for such periods have been included. The consolidated balance sheet
at June 30, 2003 has been derived from the audited consolidated financial
statements at that date but does not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. The results of operations for the
three months ended September 30, 2003, are not necessarily indicative of the
results that may be expected for the full fiscal year ending June 30, 2004, or
for any future period.
The accompanying consolidated financial statements should be read in
conjunction with the audited consolidated financial statements of the Company
for the fiscal year ended June 30, 2003 and the accompanying notes thereto
contained in the Company's Annual Report on Form 10-K, filed with the Securities
and Exchange Commission on September 29, 2003.
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, NetSat Express, Inc., or NetSat, and
Globecomm Systems Europe Limited (collectively, the "Company"). All significant
intercompany balances and transactions have been eliminated in consolidation.
Sale of Stock by Subsidiary
The Company recognizes changes in the ownership percentage of its
subsidiaries caused by issuances of the subsidiary's stock as an adjustment to
additional paid-in capital in the consolidated statement of changes in
stockholders' equity.
Accounting Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates.
Revenue Recognition
The Company recognizes revenue in accordance with Staff Accounting
Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements, for
its production-type contracts that are sold separately as standard satellite
ground segment systems when persuasive evidence of an arrangement exists, the
selling price is fixed or determinable, collectibility is reasonably assured,
delivery has occurred and the contractual performance specifications have been
met. The Company's standard satellite ground segment systems produced in
connection with these contracts are typically short-term (less than twelve
months in term) and manufactured using a standard modular production process.
Such systems require less engineering, drafting and design efforts than the
Company's long-term complex production-type projects. Revenue is recognized on
the Company's standard satellite ground segment systems upon shipment and
acceptance of factory performance testing which is when title transfers to the
customer. The amount of revenues recorded on each standard production-type
contract is reduced by the customers' contractual holdback amount, which
typically requires 10% to 30% of the contract value to be retained by the
customer until installation and final acceptance is complete. The customer
generally becomes obligated to pay 70%
7
to 90% of the contract value upon shipment and acceptance of factory performance
testing. Installation is not deemed to be essential to the functionality of the
system since installation does not require significant changes to the features
or capabilities of the system, does not require complex software integration and
interfacing and the Company has not experienced any difficulties installing such
equipment. In addition, the customer or other third party vendors can install
the system. The estimated relative fair value of the installation services is
determined by management, which is typically less than the customer's
contractual holdback percentage. If the holdback is less than the fair value of
installation, the Company will defer recognition of revenues, determined on a
contract-by-contract basis equal to the fair value of the installation services.
Payments received in advance by customers are deferred until shipment and are
presented as deferred revenues in the accompanying consolidated balance sheets.
The Company recognizes revenue using the percentage-of-completion
method of accounting upon the achievement of certain contractual milestones in
accordance with Statement of Position 81-1 ("SOP 81-1"), Accounting for
Performance of Construction-Type and Certain Production-Type Contracts, for its
non-standard, complex production-type contracts for the production of satellite
ground segment systems and equipment that are generally integrated into the
customers' satellite ground segment network. The equipment and systems produced
in connection with these contracts are typically long-term (in excess of twelve
months in term) and require significant customer-specific engineering, drafting
and design effort in order to effectively integrate all of the customizable
earth station equipment into the customers' ground segment network. These
contracts generally have larger contract values, greater economic risks and
substantive specific contractual performance requirements due to the engineering
and design complexity of such systems and related equipment. Progress payments
received in advance by customers are netted against the inventory balances in
the accompanying consolidated balance sheets.
Contract costs generally include purchased material, direct labor,
overhead and other indirect costs. Anticipated contract losses are recognized,
as they become known.
Revenues from data communications services are derived primarily from
Internet access service fees. Service revenues from Internet access are
recognized ratably over the period in which services are provided. Payments
received in advance of providing Internet access services are deferred until the
period such services are provided and are presented as deferred revenues in the
accompanying consolidated balance sheets.
Costs from Ground Segment Systems, Networks and Enterprise Solutions
Costs from ground segment systems, networks and enterprise solutions
consist primarily of the costs of purchased materials (including shipping and
handling costs), direct labor and related overhead expenses, project-related
travel and living costs and subcontractor salaries.
Costs from Data Communications Services
Costs from data communications services relating to Internet access
service fees consist primarily of satellite space segment charges, Internet
connectivity fees and network operations expenses. Satellite space segment
charges consist of the costs associated with obtaining satellite bandwidth (the
measure of capacity) used in the transmission of services to and from the
satellite leased from operators and network operations expenses. Network
operations expenses consist primarily of costs associated with the operation of
the Network Operation Center, on a twenty-four hour a day, seven-day a week
basis, including personnel and related costs and depreciation.
Research and Development
Research and development expenditures are expensed as incurred.
Stock-Based Compensation
The Company accounts for stock option grants using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25 ("APBO No. 25"),
Accounting for Stock Issued to Employees, and complies with the disclosure
provisions of Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation ("SFAS No. 123"), as amended by SFAS No. 148,
Accounting for Stock-Based Compensation-Transition and Disclosure ("SFAS No.
148").
8
Goodwill
Goodwill represents the excess of the purchase price over the fair
value of the net assets acquired. In accordance with Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS No.
142"), goodwill and other indefinite life intangible assets are no longer
amortized, but instead tested for impairment at least annually.
The net carrying value of goodwill is approximately $7,204,000, at
September 30, 2003 and June 30, 2003, which relates to the buyback of the
minority interests of NetSat.
Comprehensive Loss
Comprehensive loss for the three months ended September 30, 2003 of
approximately $350,000 includes a foreign currency translation gain of
approximately $34,000 and an unrealized gain on available-for-sale equity
securities of approximately $100,000. Comprehensive loss for the three months
ended September 30, 2002 of approximately $5,547,000 includes a foreign currency
translation gain of approximately $8,000 and an unrealized loss on
available-for-sale equity securities of approximately $92,000.
Income Taxes
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will be realized. The ultimate realization of the net
deferred tax assets is dependent upon the generation of future taxable income
prior to the expiration of any net operating loss carryforwards. For the three
months ended September 30, 2003 and the year ended June 30, 2003, due to the
uncertainty regarding the Company's ability to utilize its net operating losses
in the future, the Company provided a valuation allowance against its operating
losses and temporary differences except for approximately $125,000, representing
state investment tax credit carryforwards that will be utilized during fiscal
2004 to offset state capital taxes on the Company's combined state tax return.
2. BASIC AND DILUTED NET LOSS PER COMMON SHARE
The Company computes net loss per common share in accordance with the
provisions of SFAS No. 128, Earnings Per Share. Basic and diluted net loss per
common share is computed by dividing the net loss for the period by the
weighted-average number of common equivalent shares outstanding for the period.
Common equivalent shares consist of the incremental common shares issuable upon
the conversion of preferred stock (using an if-converted method) and incremental
shares issuable upon the exercise of stock options and warrants (using the
treasury stock method). Incremental common equivalent shares are excluded from
the calculation of diluted net loss per common share if their effect is
anti-dilutive. Diluted net loss per common share for the three months ended
September 30, 2003 and 2002 excludes the effect of approximately 40,000 and
5,000 stock options, respectively, as their effect would have been
anti-dilutive.
3. INVENTORIES
Inventories consist of the following:
SEPTEMBER 30, JUNE 30,
2003 2003
-----------------------------------
(UNAUDITED)
(IN THOUSANDS)
Raw materials and component parts $ 406 $ 495
Work-in-progress 8,239 10,495
-----------------------------------
8,645 10,990
Less progress payments under long-term contracts 2,000 -
-----------------------------------
$ 6,645 $ 10,990
===================================
9
4. FAIR VALUE DISCLOSURE OF STOCK OPTIONS
Interim pro-forma information regarding net loss and net loss per
common share is required by SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, if the Company accounts for its stock
options granted under the intrinsic value method. The fair value of options
granted under the Company's 1997 Stock Incentive Plan was estimated at the date
of grant using a Black-Scholes option pricing model.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected stock price
volatility. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options under the Black-Scholes
option valuation model.
For purposes of pro-forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro-forma information is as follows:
THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
-------------------------------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Reported net loss $ (484) $ (5,463)
Pro-forma stock compensation expense (660) (736)
------------------------------------
Pro-forma net loss $ (1,144) $ (6,199)
====================================
Reported basic and diluted net
loss per common share $ (0.04) $ (0.43)
====================================
Pro-forma basic and diluted net
loss per common share $ (0.09) $ (0.49)
====================================
5. COMMITMENTS AND CONTINGENCIES
Line of Credit
In September 2003, the Company entered into a new one year credit
agreement with its existing bank, which provides for a working capital credit
facility of up to $7.5 million consisting of a $3.75 million secured domestic
line of credit and a $3.75 million Export-Import Bank secured guaranteed line
of credit. The Company will be advanced up to 80% of eligible domestic accounts
receivable and 90% of eligible foreign accounts receivable under each
respective line of credit, as defined in the agreement. Each line of credit
bears interest at the greater of 6.0% or the prime rate plus 2.0% per annum,
and is collateralized by a first security interest on all of our personal
property. The credit agreement allows the Company to borrow and apply letters
of credit against the availability under each line of credit. In addition, the
new credit agreement contains certain financial and other covenants, deposit
requirements, monthly reporting provisions and other requirements, as defined
in the credit agreement, with which the Company was in compliance with at
September 30, 2003. As of September 30, 2003, no amounts were outstanding under
this credit facility, however, there were standby letters of credit of
approximately $6.1 million, which were applied against and reduced the amounts
available under this credit facility.
10
Product Warranties
The Company offers a one-year warranty on its contracts; the specific
terms and conditions of those warranties vary depending upon the contract and
work performed. Generally, a basic limited warranty, including parts and labor,
is provided to customers for one-year. The Company should be able to recoup
certain of these costs through product warranties it holds with its original
equipment manufacturers, which typically are one-year in term. Historically,
warranty expense has been minimal, however, management periodically assesses
the need for any additional warranty reserve.
6. SEGMENT INFORMATION
The Company operates through two business segments. Its ground segment
systems, networks and enterprise solutions segment, through Globecomm Systems
Inc. and Globecomm Systems Europe Limited, is engaged in the design, assembly
and installation of ground segment systems, networks and enterprise solutions.
Its data communications services segment, through NetSat, is engaged in
providing high-speed, satellite-delivered data communications services. NetSat
also provides Internet access to customers who have limited or no access to a
terrestrial network infrastructure capable of supporting the economical delivery
of such services.
The Company's reportable segments are business units that offer
different products and services. The reportable segments are each managed
separately because they provide distinct products and services.
The following is the Company's business segment information for the
three months ended September 30, 2003 and 2002 and as of September 30, 2003 and
June 30, 2003:
THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
---------------------------------------------
(UNAUDITED)
(IN THOUSANDS)
Revenues:
Ground segment systems, networks and enterprise solutions $ 17,031 $ 8,164
Data communications services 3,430 4,270
---------------------------------------------
Total revenues $ 20,461 $ 12,434
=============================================
Loss from operations:
Ground segment systems, networks and enterprise solutions $ (1,060) $ (2,643)
Data communications services 511 (2,760)
Interest income 62 170
Interest expense (1) (233)
Intercompany eliminations 4 3
---------------------------------------------
Net loss $ (484) $ (5,463)
=============================================
Depreciation and amortization:
Ground segment systems, networks and enterprise solutions $ 377 $ 511
Data communications services 426 584
Intercompany eliminations (4) (3)
---------------------------------------------
Total depreciation and amortization $ 799 $ 1,092
=============================================
Expenditures for long-lived assets:
Ground segment systems, networks and enterprise solutions $ 41 $ 46
Data communications services 31 50
---------------------------------------------
Total expenditures for long-lived assets $ 72 $ 96
=============================================
11
SEPTEMBER 30, JUNE 30,
2003 2003
(UNAUDITED)
------------------------------------------------
(IN THOUSANDS)
Assets:
Ground segment systems, networks and
enterprise solutions $ 118,649 $ 118,180
Data communications services 11,072 10,405
Intercompany eliminations (61,316) (58,241)
------------------------------------------------
Total assets $ 68,405 $ 70,344
================================================
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
You should read the following discussion of our financial condition and
results of operations with the consolidated financial statements and related
notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion
contains, in addition to historical information, forward-looking statements,
within the meaning of the Private Securities Litigation Reform Act of 1995,
based on our current expectations, assumptions, estimates and projections. These
forward-looking statements involve risks and uncertainties. Our actual results
could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, such as, among others, uncertain
demand for our services and products due to economic and industry-specific
conditions, the risks associated with operating in international markets and our
dependence on a limited number of contracts for a high percentage of our
revenues. These risks and others are more fully described in the "Risk Factors"
section of this Quarterly Report and in our other filings with the Securities
and Exchange Commission, including our Annual Report on Form 10-K and Quarterly
Reports on Form 10-Q. We undertake no obligation to update publicly any
forward-looking statements for any reason, even if new information becomes
available or other events occur in the future.
OVERVIEW
Since our inception, a majority of our revenues have been generated by
ground segment systems, networks and enterprise solutions business. Contracts
for these ground segment systems and networks and communications services have
been fixed-price contracts in a majority of cases. Profitability of such
contracts is subject to inherent uncertainties as to the cost of performance. In
addition to possible errors or omissions in making initial estimates, cost
overruns may be incurred as a result of unforeseen obstacles, including both
physical conditions and unexpected problems encountered in engineering design
and testing. Since our business is frequently concentrated in a limited number
of large contracts, a significant cost overrun on any contract could have a
material adverse effect on our business, financial condition and results of
operations.
Contract costs generally include purchased material, direct labor,
overhead and other direct costs. Anticipated contract losses are recognized in
the period identified. Costs from ground segment systems, networks and
enterprise solutions consist primarily of the costs of purchased materials
(including shipping and handling costs), direct labor and related overhead
expenses, project-related travel and living costs and subcontractor salaries.
Costs from data communications services consist primarily of satellite space
segment charges, Internet connectivity fees and network operations expenses.
Satellite space segment charges consist of the costs associated with obtaining
satellite bandwidth (the measure of capacity) used in the transmission of
services to and from the satellite leased from operators. Network operations
expenses consist primarily of costs associated with the operation of the network
operations center on a twenty-four hour a day, seven-day a week basis, including
personnel and related costs and depreciation. Selling and marketing expenses
consist primarily of salaries, travel and living costs for sales and marketing
personnel. Research and development expenses consist primarily of salaries and
related overhead expenses. General and administrative expenses consist of
expenses associated with our management, finance, contract and administrative
functions.
Our business has been adversely affected by the current global economic
slowdown and, in particular, the significant challenges facing the
telecommunications industry worldwide. These challenges include excess bandwidth
resulting from weak consumer and business demand, which has fallen far short of
expectations, and the
12
attendant financial distress facing both traditional telecommunication carriers
and the new generation of competitive local exchange carriers. Moreover, as a
result of the uncertainties facing the economy, corporations have restricted
their capital expenditures. The reduction in demand has been accompanied by
pricing pressures and intensifying competition, while the financial difficulties
of industry participants and customers have created risks associated with
collectibility of accounts receivable. Recently we have seen improvement in the
segments we serve, however, we may experience a decline in bookings of contract
orders if customers and prospects delay projects, which will negatively impact
our business and prospects in the future.
CRITICAL ACCOUNTING POLICIES
Certain of our accounting policies require judgment by management in
selecting the appropriate assumptions for calculating financial estimates. By
their nature, these judgments are subject to an inherent degree of uncertainty.
These judgments are based on our historical experience, terms of existing
contracts, our observance of trends in the industry, information provided by our
customers, and information available from other outside sources, as appropriate.
Actual results may differ from these judgments under different assumptions or
conditions. Our accounting policies that require management to apply significant
judgment include:
REVENUE RECOGNITION
We recognize revenue in accordance with SAB 101, Revenue Recognition in
Financial Statements, for our production-type contracts that are sold separately
as standard satellite ground segment systems when persuasive evidence of an
arrangement exists, the selling price is fixed or determinable, collectibility
is reasonably assured, delivery has occurred and the contractual performance
specifications have been met. Our standard satellite ground segment systems
produced in connection with these contracts are typically short-term (less than
twelve months in term) and manufactured using a standard modular production
process. Such systems require less engineering, drafting and design efforts than
our long-term complex production-type projects. Revenue is recognized on our
standard satellite ground segment systems upon shipment and acceptance of
factory performance testing which is when title transfers to the customer. The
amount of revenues recorded on each standard production-type contract is reduced
by the customer's contractual holdback amount, which typically requires 10% to
30% of the contract value to be retained by the customer until installation and
final acceptance is complete. The customer generally becomes obligated to pay
70% to 90% of the contract value upon shipment and acceptance of factory
performance testing. Installation is not deemed to be essential to the
functionality of the system since installation does not require significant
changes to the features or capabilities of the equipment, does not require
complex software integration and interfacing and we have not experienced any
difficulties installing such equipment. In addition, the customer or other third
party vendors can install the equipment. The estimated relative fair value of
the installation services is determined by management, which is typically less
than the customer's contractual holdback percentage. If the holdback is less
than the fair value of installation, we will defer recognition of revenues,
determined on a contract-by-contract basis equal to the fair value of the
installation services. Payments received in advance by customers are deferred
until shipment and are presented as deferred revenues.
We recognize revenue using the percentage-of-completion method of
accounting upon the achievement of certain contractual milestones in accordance
with SOP 81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts, for our non-standard, complex production-type
contracts for the production of satellite ground segment systems and equipment
that are generally integrated into the customers' satellite ground segment
network. The equipment and systems produced in connection with these contracts
are typically long-term (in excess of twelve months in term) and require
significant customer-specific engineering, drafting and design effort in order
to effectively integrate all of the customizable earth station equipment into
the customers' ground segment network. These contracts generally have larger
contract values, greater economic risks and substantive specific contractual
performance requirements due to the engineering and design complexity of such
systems and related equipment. Progress payments received in advance by
customers are netted against the inventories balance.
Revenues from data communications services are derived primarily from
Internet access service fees. Service revenues from Internet access are
recognized ratably over the period in which services are provided. Payments
received in advance of providing Internet access services are deferred until the
period such services are provided and are presented as deferred revenues.
13
COSTS FROM GROUND SEGMENT SYSTEMS, NETWORKS AND ENTERPRISE SOLUTIONS
Costs related to our production-type contracts and our non-standard,
complex production-type contracts rely on estimates based on total expected
contract costs. We use reasonable, dependable estimates of the costs applicable
to various elements. Since these contract costs depend on estimates, which are
assessed continually during the term of these contracts, costs are subject to
revisions as the contract progresses to completion. Revision in cost estimates
are reflected in the period in which they become known. In the event an estimate
indicates that a loss will be incurred at completion, we record the costs in the
period identified.
GOODWILL
Goodwill represents the excess of the purchase price over the fair
value of the net assets acquired primarily from the buyback of the minority
interests of NetSat. Beginning in the fiscal year ended June 30, 2002 with our
adoption of SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and
other indefinite life intangible assets are no longer being amortized, but
instead tested for impairment at least annually.
In assessing goodwill, we must make assumptions regarding the estimated
future cash flows and other factors to determine the fair value of our reporting
units. Future events could cause us to conclude that impairment indicators exist
and that the goodwill associated with NetSat is impaired. Any resulting
impairment could have a material adverse effect on our financial condition and
results of operations.
ALLOWANCES FOR DOUBTFUL ACCOUNTS
We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. We
assess the customer's ability to pay based on a number of factors, including our
past transaction history with the customer and the credit worthiness of the
customer. An assessment of the inherent risks in conducting our business with
foreign customers is also made since a significant portion of our revenues is
international. Management specifically analyzes accounts receivable, historical
bad debts, customer concentrations, customer credit-worthiness and current
economic trends. If the financial condition of our customers were to deteriorate
in the future, resulting in an impairment of their ability to make payments,
additional allowances may be required.
INVENTORIES
Inventories consist primarily of work-in-progress from costs incurred
in connection with specific customer contracts, which are stated at the lower of
cost or market value. In assessing the realizability of inventories, we are
required to make estimates of the total contract costs based on the various
elements of the work-in-progress. It is possible that changes to these estimates
could cause a reduction in the net realizable value of our inventories.
STOCK-BASED COMPENSATION
We currently measure compensation expense for stock option grants using
the intrinsic value method prescribed in APBO No. 25, Accounting for Stock
Issued to Employees. Under this method, we do not record compensation expense
when stock options are granted as long as the exercise price is not less than
the fair market value of the stock when the option is granted. In accordance
with SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure, we disclose
our pro-forma net loss and pro-forma net loss per common share as if the fair
value-based method had been applied in measuring compensation expense for our
stock option grants.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2003 and 2002
Revenues from Ground Segment Systems, Networks and Enterprise
Solutions. Revenues increased by $8.9 million, or 108.6%, to $17.0 million for
the three months ended September 30, 2003 compared to $8.2 million for the three
months ended September 30, 2002. The increase in revenues was primarily the
result of increased sales
14
activity due to an improving operating environment in the telecommunications
industry segments we serve and the achievement of shipment milestones associated
with projects currently in progress.
Revenues from Data Communication Services. Revenues decreased by $0.8
million, or 19.7%, to $3.4 million for the three months ended September 30, 2003
compared to $4.3 million for the three months ended September 30, 2002. The
decrease was due to agreements made with two of our vendors in February 2003 and
October 2002 in which we assigned contracts with future revenues of $35.8
million, which reduced our quarterly recurring revenues by approximately $1.2
million, offset by new contracts and upgrades in service for certain existing
customers.
Costs from Ground Segment Systems, Networks and Enterprise Solutions.
Costs from ground segment systems, networks and enterprise solutions increased
by $7.6 million, or 99.0%, to $15.3 million for the three months ended September
30, 2003 from $7.7 million for the three months ended September 30, 2002. The
increase was attributable to a higher revenue base. Costs as a percentage of
related revenues decreased to 89.9% for the three months ended September 30,
2003 from 94.2% for the three months ended September 30, 2002. The decrease was
mainly attributable to the non-recurrence of a cost overrun incurred on a major
project during the three months ended September 30, 2002.
Costs from Data Communications Services. Costs from data communications
services decreased by $3.1 million, or 48.8%, to $3.2 million for the three
months ended September 30, 2003 from $6.3 million for the three months ended
September 30, 2002. Costs as a percentage of related revenues decreased to 93.8%
for the three months ended September 30, 2003 from 147.3% for the three months
ended September 30, 2002. These decreases were due to agreements reached with
two of our vendors during February 2003 and October 2002, in which we
significantly reduced our space segment transponder costs and obligations.
Selling and Marketing. Selling and marketing expenses decreased by $0.5
million, or 31.6%, to $1.1 million for the three months ended September 30, 2003
compared to $1.6 million for the three months ended September 30, 2002. The
decrease was principally due to a reduction in salary and salary related
expenses associated with reductions in sales and marketing personnel as part of
our cost cutting initiatives.
Research and Development. Research and development expenses increased
by $0.2 million, or 79.2%, to $0.5 million for the three months ended September
30, 2003 compared to $0.3 million for the three months ended September 30, 2002.
The increase was principally due to internal development of new monitoring and
control technologies, product research and development initiatives associated
with projects currently in progress and research efforts in remote video
monitoring systems.
General and Administrative. General and administrative expenses
decreased by $1.1 million, or 54.3%, to $0.9 million for the three months ended
September 30, 2003, compared to $2.0 million for the three months ended
September 30, 2002. The decrease in general and administrative expenses was
primarily due to the recovery of $1.0 million in August 2003, from a former
customer in the Middle East, against which we previously established an
allowance for uncollectible accounts receivable during the fourth quarter of
fiscal year ended June 30, 2002.
Interest Income. Interest income decreased by $0.1 million, or 63.5%,
to $0.1 million for the three months ended September 30, 2003 compared to $0.2
million for the three months ended September 30, 2002. The decrease was
primarily the result of a decrease in cash and cash equivalents due to cash used
in our operations during the twelve months ended September 30, 2003.
Interest Expense. Interest expense decreased by $0.2 million, or 99.6%,
to less than $0.1 million for the three months ended September 30, 2003 compared
to $0.2 million for the three months ended September 30, 2002. The decrease was
due to the termination of our capital lease obligation in February 2003.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2003, we had working capital of $22.7 million,
including cash and cash equivalents of $20.2 million, restricted cash of $0.6
million, net accounts receivable of $12.8 million, inventories of $6.6 million,
prepaid expenses and other current assets of $2.4 million and deferred income
taxes of $0.1 million, offset by $10.7 million in
15
accounts payable, $5.7 million in deferred revenues and $3.7 million in accrued
expenses and other current liabilities.
Net cash used in operating activities during the three months ended
September 30, 2003 was $1.7 million, which primarily related to an increase in
accounts receivable of $3.9 million relating to the increase in business levels,
a decrease in deferred revenue of $1.9 million associated with the achievement
of milestone revenues relating to the increase in business levels and a decrease
in the provision for doubtful accounts due to the recovery of $1.0 million from
a former Middle East customer, offset by a decrease in inventory of $4.3 million
from shipments made during the first quarter associated with an increase in
business levels, as well as a $2.0 million progress payment received under a
long-term contract and depreciation and amortization expense of $0.8 million
primarily related to the network operations center and satellite earth station
equipment.
Net cash used in investing activities during the three months ended
September 30, 2003 was $0.1 million, which primarily related to the purchase of
fixed assets for our network operations center as well as test equipment.
In September 2003, we entered into a new one year credit agreement with
our existing bank, which provides for a working capital credit facility of up to
$7.5 million consisting of a $3.75 million secured domestic line of credit and a
$3.75 million Export-Import Bank secured guaranteed line of credit. We will be
advanced up to 80% of eligible domestic accounts receivable and 90% of eligible
foreign accounts receivable under each respective line of credit, as defined in
the agreement. Each line of credit bears interest at the greater of 6.0% or the
prime rate plus 2.0% per annum, and is collateralized by a first security
interest on all of our personal property. The credit agreement allows us to
borrow and apply letters of credit against the availability under each line of
credit. In addition, the new credit agreement contains certain financial and
other covenants, deposit requirements, monthly reporting provisions and other
requirements, as defined in the credit agreement, with which we were in
compliance with at September 30, 2003. As of September 30, 2003, no amounts were
outstanding under this credit facility, however, there were standby letters of
credit of approximately $6.1 million, which were applied against and reduced the
amounts available under this credit facility.
We lease satellite space segment services and other equipment under various
operating lease agreements, which expire in various years through 2008. Future
minimum lease payments due on these leases through September 30, 2004 are
approximately $5.8 million.
At September 30, 2003 we had contractual obligations and commercial
commitments as follows (in thousands):
PAYMENTS DUE BY PERIOD
LESS THAN 1 AFTER 5
TOTAL YEAR 1-3 YEARS 4-5 YEARS YEARS
--------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS
-----------------------
Operating leases $ 24,871 $ 5,813 $ 11,883 $6,852 $ 323
--------------------------------------------------------------------
Total contractual obligations $ 24,871 $ 5,813 $ 11,883 $6,852 $ 323
OTHER COMMERCIAL COMMITMENTS
----------------------------
Standby letters of credit $ 6,092 $ 1,990 $ 4,102 $ - $ -
--------------------------------------------------------------------
Total commercial commitments $ 6,092 $ 1,990 $ 4,102 $ - $ -
The above operating lease obligations include two contracts we entered
into with a vendor in fiscal 2001 for satellite space segment services on
satellites which were scheduled to be launched in late 2002 and operational by
March 2003, for a total value of approximately $6.0 million. Such satellite
space segment services are scheduled to begin when the satellite transponders
are commercially operational, as defined in the agreements. During fiscal 2003,
we learned that the vendor has experienced significant delays in the planned
launch and operational dates for the satellites. As a result of these delays, we
maintain that we have a right to terminate the contracts without cost and have
provided notification of such termination. The vendor has denied our assertion
that we have a right to terminate the contracts without cost. If our position
were sustained, total operating lease commitments would be reduced by
approximately $6.0 million.
16
On November 7, 2001, the Board of Directors authorized a stock
repurchase program whereby we can repurchase up to $2.0 million of our
outstanding stock, representing approximately 3.7% of the total shares
outstanding on that date. Since November 2001, we repurchased, in aggregate, a
total of 256,100 shares for $1.4 million. The timing, price, quantity and manner
of future purchases will be at the discretion of management, depending on market
conditions and other factors, subject to compliance with the applicable
securities laws.
We expect that our cash and working capital requirements for operating
activities will increase as we continue to implement our business strategy.
Management anticipates additional working capital requirements for work in
progress for orders as obtained and that we will experience negative cash flows
due to continued operating losses. Our expectation is that the working capital
requirements will ease as shipments are made on new orders, although we cannot
assure you as the timing and amount of new orders.
NetSat has had, and we expect it will continue to have, working capital
requirements, which have, and will, put increased pressure on our capital
resources. We have implemented strategies to reduce the drain on our resources
caused by NetSat's losses. While we will continue to seek additional means to
reduce NetSat's cost structure, we can only achieve our goal of improving
NetSat's working capital by improving operating performance. We cannot assure
you that we will successfully improve NetSat's operating performance.
Our future capital requirements will depend upon many factors,
including the success of our marketing efforts in the ground segment systems,
networks, and data communications services business, the nature and timing of
customer orders and the extent to which we must conduct research and development
efforts internally. Based on current plans, we believe that our existing capital
resources will be sufficient to meet working capital requirements through
September 30, 2004. However, we cannot assure you that there will be no
unforeseen events or circumstances that would consume available resources
significantly before that time. For example, future events occurring in response
to the war with Iraq, or in connection with a war, including, without
limitation, future terrorist attacks against the United States or its allies or
military or trade or travel disruptions impacting our ability to sell and market
our products and services in the United States and internationally may impact
our results of operations. Unexpected events negatively impacting international
commerce, including additional conflicts in the Middle East, could defer our
ability to close contracts with international customers. Additional funds may
not be available when needed and, even if available, additional funds may be
raised through financing arrangements and/or the issuance of preferred or common
stock or convertible securities on terms and prices significantly more favorable
than those of the currently outstanding common stock, which could have the
effect of diluting or adversely affecting the holdings or rights of our existing
stockholders. If adequate funds are unavailable, we may be required to delay,
scale back or eliminate some of our operating activities, including, without
limitation, the timing and extent of our marketing programs and research and
development activities and further reductions in headcount. We cannot assure you
that additional financing will be available to us on acceptable terms, or at
all.
RISK FACTORS
WE HAVE A HISTORY OF OPERATING LOSSES AND NEGATIVE CASH FLOW AND EXPECT OUR
LOSSES TO CONTINUE.
We have incurred significant net losses since we began operating in
August 1994. We incurred net losses of $0.5 million during the three months
ended September 30, 2003, $19.6 million during the fiscal year ended June 30,
2003 and $17.3 million during the fiscal year ended June 30, 2002. As of
September 30, 2003, our accumulated deficit was $74.3 million. We anticipate
that we will continue to incur net losses, although we expect them to be less
than those we incurred in the fiscal year ended June 30, 2003. Our ability to
achieve and maintain profitability will depend upon our ability to generate
significant revenues through new profitable customer contracts and the expansion
of our existing products and services, including our data communications
services. We cannot assure you that we will be able to obtain new profitable
customer contracts or generate significant additional revenues from those
contracts or any new products or services that we introduce. Even if we become
profitable, we may not sustain or increase our profits on a quarterly or annual
basis in the future.
SINCE SALES OF SATELLITE COMMUNICATIONS EQUIPMENT ARE DEPENDENT ON THE GROWTH OF
COMMUNICATIONS NETWORKS, AS MARKET DEMAND FOR THESE NETWORKS DECLINES, OUR
REVENUES AND PROFITABILITY ARE LIKELY TO DECLINE.
We derive, and expect to continue to derive, a significant amount of
revenues from the sale of satellite
17
ground segment systems and networks. If the long-term growth in demand for
communications networks does not return from its depressed level, the demand for
our satellite ground segment systems and networks may decline or grow more
slowly than we expect. As a result, we may not be able to grow our business, our
revenues may decline from current levels and our results of operations may be
harmed. The demand for communications networks and the products used in these
networks is affected by various factors, many of which are beyond our control.
For example, the uncertain general economic conditions have affected the overall
rate of capital spending by our customers. Also, many companies have found it
increasingly difficult to raise capital to finish building their communications
networks and, therefore, have placed fewer orders with our customers. The
economic slowdown resulted in a softening of demand from our customers. We
cannot predict the extent to which demand will increase. Further, increased
competition among satellite ground segment systems and networks manufacturers
has increased pricing pressures.
RISKS ASSOCIATED WITH OPERATING IN INTERNATIONAL MARKETS COULD RESTRICT OUR
ABILITY TO EXPAND GLOBALLY AND HARM OUR BUSINESS AND PROSPECTS.
We market and sell our products and services in the United States and
internationally. We anticipate that international sales will continue to account
for a significant portion of our total revenues for the foreseeable future with
a significant portion of the international revenue coming from developing
countries. We presently conduct our international sales in the following
geographic areas: Africa, the Asia-Pacific Region, Australia, Central and South
America, Eastern and Central Europe and the Middle East. There are a number of
risks inherent in conducting our business internationally, including:
o general political and economic instability in international
markets, including the war in Iraq, could impede our ability to
deliver our products and services to customers and harm our
results of operations;
o changes in regulatory requirements could restrict our ability to
deliver services to our international customers;
o export restrictions, tariffs, licenses and other trade barriers
could prevent us from adequately equipping our network
facilities;
o differing technology standards across countries may impede our
ability to integrate our products and services across
international borders;
o protectionist laws and business practices favoring local
competition may give unequal bargaining leverage to key vendors
in countries where competition is scarce, significantly
increasing our operating costs;
o increased expenses associated with marketing services in foreign
countries could effect our ability to compete;
o relying on local subcontractors for installation of our products
and services could adversely impact the quality of our products
and services;
o difficulties in staffing and managing foreign operations could
effect our ability to compete;
o potentially adverse taxes could adversely affect our results of
operations;
o complex foreign laws and treaties could affect our ability to
compete; and
o difficulties in collecting accounts receivable could adversely
affect our results of operations.
These and other risks could impede our ability to manage our
international operations effectively, limit the future growth of our business,
increase our costs and require significant management attention.
18
IF NETSAT DOES NOT EXECUTE ITS BUSINESS STRATEGY OR IF THE MARKET FOR ITS
SERVICES FAILS TO DEVELOP OR DEVELOPS MORE SLOWLY THAN IT EXPECTS, OUR RESULTS
OF OPERATIONS WILL BE HARMED AND OUR STOCK PRICE MAY BE ADVERSELY AFFECTED.
NetSat's revenues from data communications services have decreased
during the three months ended September 30, 2003. Revenues will be reduced as a
result of customer contracts assigned to vendors pursuant to settlement
agreements reached in February 2003 and October 2002. As of September 30, 2003,
the future revenues, which will be foregone, amounts to $31.0 million, of which
$5.0 million relates to fiscal year ending June 30, 2004. NetSat's future
revenues and results of operations are dependent on its execution of its
business strategy and development of the market for its current and future
services. Despite the agreements reached with two of the Company's vendors in
February 2003 and October 2002, which modified and reduced the Company's
satellite bandwidth obligations, we cannot assure you that the transponder space
will be efficiently and substantially utilized or that an increase in orders
will be realized. NetSat has had, and we expect will continue to have, cash
requirements, which have and will decrease our cash resources. If NetSat does
not efficiently and substantially utilize its transponder space capacity and
increase its level of orders, its cash requirements may increase and our results
of operations will be harmed.
YOU SHOULD NOT RELY ON OUR QUARTERLY OPERATING RESULTS AS AN INDICATION OF OUR
FUTURE RESULTS BECAUSE THEY ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS, AND IF WE
FAIL TO MEET THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS OR INVESTORS, OUR STOCK
PRICE COULD DECLINE SIGNIFICANTLY.
Our future revenues and results of operations may significantly
fluctuate due to a combination of factors, including:
o delays and/or a decrease in the booking of new contracts;
o general political and economic conditions in the United States
and abroad, including the war in Iraq;
o the length of time needed to initiate and complete customer
contracts;
o the demand for and acceptance of our existing products and
services;
o the cost of providing our products and services;
o market acceptance of new products and services;
o the mix of revenue between our standard products, custom-built
products and our communications services;
o the timing of significant marketing programs;
o our ability to hire and retain personnel;
o the competition in our markets; and
o difficult global economic conditions and uncertain international
currency markets may adversely impact our quarterly results.
Accordingly, you should not rely on quarter-to-quarter comparisons of
our results of operations as an indication of our future performance. It is
possible that in future periods our results of operations may be below
expectations, which could cause the trading price of our common stock to
decline.
19
OUR MARKETS ARE HIGHLY COMPETITIVE AND WE HAVE MANY ESTABLISHED COMPETITORS, AND
WE MAY LOSE MARKET SHARE AS A RESULT.
The markets in which we operate are highly competitive and this
competition could harm our ability to sell our products and services on prices
and terms favorable to us. Our primary competitors in the satellite ground
segment and networks market include systems integrators like IDB Systems, a
division of MCI and equipment manufacturers who also provide integrated systems
like Andrew Corporation and Tripoint Global.
In the end-to-end satellite-based communication solutions and
communications services markets, we compete with other satellite communication
companies who provide similar services, like Verestar. In addition, we may
compete with other communications service providers like MCI and satellite
owners like Panamsat, Loral Skynet, New Skies Satellites N.V. and Intelsat. We
anticipate that our competitors may develop or acquire services that provide
functionality that is similar to that provided by our services and that those
services may be offered at significantly lower prices or bundled with other
services. These competitors may have the financial resources to withstand
substantial price competition and may be in a better position to endure
difficult economic conditions in international markets, and may be able to
respond more quickly than we can to new or emerging technologies and changes in
customer requirements. Moreover, many of our competitors have more extensive
customer bases, broader customer relationships and broader industry alliances
than we do that they could use to their advantage in competitive situations.
The markets in which we operate have limited barriers to entry and we
expect that we will face additional competition from existing competitors and
new market entrants in the future. Moreover, our current and potential
competitors have established or may establish strategic relationships among
themselves or with third parties to increase the ability of their products and
services to address the needs of our current and prospective customers. Existing
and new competitors with their potential strategic relationships may rapidly
acquire significant market share, which would harm our business and financial
condition.
IF THE SATELLITE COMMUNICATIONS INDUSTRY FAILS TO CONTINUE TO DEVELOP OR NEW
TECHNOLOGY MAKES IT OBSOLETE OUR BUSINESS AND FINANCIAL CONDITION WILL BE
HARMED.
Our business is dependent on the continued success and development of
satellite communications technology, which competes with terrestrial
communications transport technologies like terrestrial microwave, coaxial cable
and fiber optic communications systems. Fiber optic communications systems have
penetrated areas in which we have traditionally provided services. If the
satellite communications industry fails to continue to develop, or any
technological development significantly improves the cost or efficiency of
competing terrestrial systems relative to satellite systems, then our business
and financial condition would be materially harmed.
WE MAY BE UNABLE TO RAISE ADDITIONAL FUNDS TO MEET OUR CAPITAL REQUIREMENTS IN
THE FUTURE.
We have incurred negative cash flows from operations in each year since
our inception. We believe that our available cash resources will be sufficient
to meet our working capital and capital expenditure requirements through
September 30, 2004. However, our future liquidity and capital requirements are
difficult to predict, as they depend on numerous factors, including the success
of our existing product and service offerings, as well as competing
technological and market developments. In particular, NetSat continues to have
cash requirements, which may continue in the future. We may need to raise
additional funds in order to meet additional working capital requirements and to
support additional capital expenditures. Should this need arise, additional
funds may not be available when needed and, even if additional funds are
available, we may not find the terms favorable or commercially reasonable. If
adequate funds are unavailable, we may be required to delay, reduce or eliminate
some of our operating activities, including marketing programs and research and
development programs. If we raise additional funds by issuing equity securities,
our existing stockholders will own a smaller percentage of our capital stock and
new investors may pay less on average for their securities than, and could have
rights superior to, existing stockholders.
A LIMITED NUMBER OF CUSTOMER CONTRACTS ACCOUNT FOR A SIGNIFICANT PORTION OF OUR
REVENUES, AND THE INABILITY TO REPLACE A KEY CUSTOMER CONTRACT WOULD ADVERSELY
AFFECT OUR RESULTS OF OPERATIONS, BUSINESS AND FINANCIAL CONDITION.
We rely on a small number of customer contracts for a large portion of
our revenue. Specifically, we have agreements with eight customers to provide
equipment and services, from which we expect to generate a significant
20
portion of our revenues. If any of these customers is unable to implement its
business plan, the market for its services declines, or if all or any of the
customers modifies or terminates its agreement with us, and we are unable to
replace these contracts, our results of operations, business and financial
condition would be materially harmed.
IF OUR PRODUCTS AND SERVICES ARE NOT ACCEPTED IN DEVELOPING COUNTRIES WITH
EMERGING MARKETS, OUR REVENUES WILL BE IMPAIRED.
We anticipate that a substantial portion of the growth in the demand
for our products and services will come from customers in developing countries
due to a lack of basic communications infrastructure in these countries.
However, we cannot guarantee an increase in the demand for our products and
services in developing countries or that customers in these countries will
accept our products and services at all. Our ability to penetrate emerging
markets in developing countries is dependent upon various factors including:
o the speed at which communications infrastructure, including
terrestrial microwave, coaxial cable and fiber optic
communications systems, which compete with satellite-based
services, is built;
o the effectiveness of our local resellers and sales
representatives in marketing and selling our products and
services; and
o the acceptance of our products and services by customers.
If our products and services are not accepted, or the market potential
we anticipate does not develop, our revenues will be impaired.
WE DEPEND UPON CERTAIN KEY PERSONNEL AND MAY NOT BE ABLE TO RETAIN THESE
EMPLOYEES.
Our future performance depends on the continued service of our key
technical, managerial and marketing personnel; in particular, David Hershberg,
Kenneth Miller, Stephen Yablonski and Donald Woodring. The employment of any of
our key personnel could cease at any time.
21
UNAUTHORIZED USE OF OUR INTELLECTUAL PROPERTY BY THIRD PARTIES MAY DAMAGE OUR
BUSINESS.
We regard our trademarks, trade secrets and other intellectual property
as beneficial to our success. Unauthorized use of our intellectual property by
third parties may damage our business. We rely on trademark, trade secret and
patent protection and contracts, including confidentiality and license
agreements with our employees, customers, strategic collaborators, consultants
and others to protect our intellectual property rights. Despite our precautions,
it may be possible for third parties to obtain and use our intellectual property
without our authorization.
We currently have been granted three patents in the United States, one
for remote access to the Internet using satellites, another for satellite
communication with automatic frequency control, and most recently, we have been
granted a patent concerning a monitor and control system for satellite
communications networks and the like. We have two other patents pending in the
United States, one for implementing facsimile and data communications using
Internet protocols and another for a distributed satellite-based cellular
network. We currently have one Patent Cooperation Treaty patent application
pending for implementing facsimile and data communications using Internet
protocols. We also intend to seek further patents on our technology, if
appropriate. We cannot assure you that patents will be issued for any of our
pending or future patents or that any claims allowed from such applications will
be of sufficient scope, or be issued in all countries where our products and
services can be sold, to provide meaningful protection or any commercial
advantage to us. Also, our competitors may be able to design around our patents.
The laws of some foreign countries in which our products and services are or may
be developed, manufactured or sold may not protect our products and services or
intellectual property rights to the same extent as do the laws of the United
States and thus make the possibility of piracy of our technology and products
and services more likely.
We have filed applications for trademark registration of Globecomm
Systems Inc., Globecomm, and GSI in the United States and various other
countries, and have been granted registrations for some of these terms in the
United States, Europe and Russia. We have received trademark registrations for
NetSat in the United States, the European Community, Russia, Singapore and
Brazil. We have various other trademarks registered or pending for registration
in the United States and in other countries and may seek registration of other
trademarks and service marks in the future. We cannot assure you that
registrations will be granted from any of our pending or future applications, or
that any registrations that are granted will prevent others from using similar
trademarks in connection with related goods and services.
DEFENDING AGAINST INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS COULD BE TIME
CONSUMING AND EXPENSIVE, AND IF WE ARE NOT SUCCESSFUL, COULD CAUSE SUBSTANTIAL
EXPENSES AND DISRUPT OUR BUSINESS.
We cannot be sure that our products, services, technologies, and
advertising we employ in our business do not or will not
22
infringe valid patents, trademarks, copyrights or other intellectual property
rights held by third parties. We may be subject to legal proceedings and claims
from time to time relating to the intellectual property of others in the
ordinary course of our business. Prosecuting infringers and defending against
intellectual property infringement claims could be time consuming and expensive,
and regardless of whether we are or are not successful, could cause substantial
expenses and disrupt our business. We may incur substantial expenses in
defending against these third party claims, regardless of their merit.
Successful infringement claims against us may result in substantial monetary
liability and/or may materially disrupt the conduct of, or necessitate the
cessation of, our business.
WE MAY NOT BE ABLE TO KEEP PACE WITH TECHNOLOGICAL CHANGES, WHICH WOULD MAKE OUR
PRODUCTS AND SERVICES BECOME NON-COMPETITIVE AND OBSOLETE.
The telecommunications industry, including satellite-based
communications services, is characterized by rapidly changing technologies,
frequent new product and service introductions and evolving industry standards.
If we are unable, for technological or other reasons, to develop and introduce
new products and services or enhancements to existing products and services in a
timely manner or in response to changing market conditions or customer
requirements, our products and services would become non-competitive and
obsolete, which would harm our business, results of operations and financial
condition.
WE DEPEND ON OUR SUPPLIERS, SOME OF WHICH ARE OUR SOLE OR A LIMITED SOURCE OF
SUPPLY, AND THE LOSS OF THESE SUPPLIERS WOULD MATERIALLY ADVERSELY AFFECT OUR
BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
We currently obtain most of our critical components and services from
single or limited sources and generally do not maintain significant inventories
or have long-term or exclusive supply contracts with our vendors. We have from
time to time experienced delays in receiving products from vendors due to lack
of availability, quality control or manufacturing problems, shortages of
materials or components or product design difficulties. We may experience delays
in the future and replacement services or products may not be available when
needed, or at all, or at commercially reasonable rates or prices. If we were to
change some of our vendors, we would have to perform additional testing
procedures on the service or product supplied by the new vendors, which would
prevent or delay the availability of our products and services. Furthermore, our
costs could increase significantly if we need to change vendors. If we do not
receive timely deliveries of quality products and services, or if there are
significant increases in the prices of these products or services, it could have
a material adverse effect on our business, results of operations and financial
condition.
OUR NETWORK MAY EXPERIENCE SECURITY BREACHES, WHICH COULD DISRUPT OUR SERVICES.
Our network infrastructure may be vulnerable to computer viruses,
break-ins, denial of service attacks and similar disruptive problems caused by
our customers or other Internet users. Computer viruses, break-ins, denial of
service attacks or other problems caused by third parties could lead to
interruptions, delays or cessation in service to our customers. There currently
is no existing technology that provides absolute security, and the cost of
minimizing these security breaches could be prohibitively expensive. We may face
liability to customers for such security breaches. Furthermore, these incidents
could deter potential customers and adversely affect existing customer
relationships.
SATELLITES UPON WHICH WE RELY MAY BE DAMAGED OR LOST, OR MALFUNCTION.
The damage, loss or malfunction of any of the satellites used by us, or
a temporary or permanent malfunction of any of the satellites upon which we
rely, would likely result in the interruption of our satellite-based
communications services. This interruption would have a material adverse effect
on our business, results of operations and financial condition.
A THIRD PARTY COULD BE PREVENTED FROM ACQUIRING SHARES OF OUR STOCK AT A PREMIUM
TO THE MARKET PRICE BECAUSE OF OUR ANTI-TAKEOVER PROVISIONS.
Various provisions with respect to votes in the election of directors,
special meetings of stockholders, and advance notice requirements for
stockholder proposals and director nominations of our amended and restated
certificate of incorporation, bylaws and Section 203 of the General Corporation
Laws of the State of Delaware could make it more difficult for a third party to
acquire us, even if doing so might be beneficial to our stockholders. In
addition, we have a poison pill in place that could make an acquisition of us by
a third party more difficult.
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RISKS RELATED TO GOVERNMENT APPROVALS
WE ARE SUBJECT TO MANY GOVERNMENT REGULATIONS, AND FAILURE TO COMPLY WITH THEM
WILL HARM OUR BUSINESS.
OPERATIONS AND USE OF SATELLITES
We are subject to various federal laws and regulations, which may have
negative effects on our business. We operate Federal Communication Commission,
or FCC, licensed earth stations in Hauppauge, New York, subject to the
Communications Act of 1934, as amended, or the FCC Act, and the rules and
regulations of FCC. Pursuant to the FCC Act and rules, we have obtained and are
required to maintain radio transmission licenses from the FCC for both domestic
and foreign operations of our earth stations. We have also obtained and are
required to maintain authorization issued under Section 214 of the FCC Act to
act as a telecommunications carrier, which authorization also extends to NetSat.
These licenses should be renewed by the FCC in the normal course as long as we
remain in compliance with FCC rules and regulations. However, we cannot
guarantee that the FCC will grant additional licenses when our existing licenses
expire, nor are we assured that the FCC will not adopt new or modified technical
requirements that will require us to incur expenditures to modify or upgrade our
equipment as a condition of retaining our licenses. We are also required to
comply with FCC regulations regarding the exposure of humans to radio frequency
radiation from our earth stations. These regulations, as well as local land use
regulations, restrict our freedom to choose where to locate our earth stations.
In addition, prior to a third party acquisition of us, we would need to seek
approval from the FCC to transfer the radio transmission licenses we have
obtained to the third party upon the consummation of the acquisition. However,
we cannot assure you that the FCC will permit the transfer of these licenses.
These approvals may make it more difficult for a third party to acquire us.
FOREIGN OWNERSHIP
We may, in the future, be required to seek FCC approval if foreign
ownership of our stock exceeds the specified criteria. Failure to comply with
these policies could result in an order to divest the offending foreign
ownership, fines, denial of license renewal, and/or license revocation
proceedings against the licensee by the FCC.
FOREIGN REGULATIONS
Regulatory schemes in countries in which we may seek to provide our
satellite-delivered data communications services may impose impediments on our
operations. Some countries in which we intend to operate have telecommunications
laws and regulations that do not currently contemplate technical advances in
telecommunications technology like Internet/intranet transmission by satellite.
We cannot assure you that the present regulatory environment in any of those
countries will not be changed in a manner, which may have a material adverse
impact on our business. Either we or our local partners typically must obtain
authorization for each country in which we provide our satellite-delivered data
communications services. The regulatory schemes in each country are different,
and thus there may be instances of noncompliance of which we are not aware. We
cannot assure you that our licenses and approvals are or will remain sufficient
in the view of foreign regulatory authorities, or that necessary licenses and
approvals will be granted on a timely basis in all jurisdictions in which we
wish to offer our products and services or that restrictions applicable thereto
will not be unduly burdensome.
REGULATION OF THE INTERNET
Due to the increasing popularity and use of the Internet, it is
possible that a number of laws and regulations may be adopted at the local,
national or international levels with respect to the Internet, covering issues
including user privacy and expression, pricing of products and services,
taxation, advertising, intellectual property rights, information security or the
convergence of traditional communication services with Internet communications.
It is anticipated that a substantial portion of our Internet operations will be
carried out in countries that may impose greater regulation of the content of
information coming into the country than that which is generally applicable in
the United States; for example, privacy regulations in 35 countries in Europe
and content restrictions in countries such as the Republic of China. To the
extent that we provide content as a part of our Internet services, it will be
subject to laws regulating content. Moreover, the adoption of laws or
regulations may decrease the growth of the Internet, which could in turn
decrease the demand for our Internet services or increase our cost of doing
business or in some other manner have a material adverse effect on our business,
operating results and financial condition. In addition, the applicability of
existing laws governing issues including property ownership, copyrights and
other
24
intellectual property issues, taxation, libel, court jurisdiction and
personal privacy to the Internet is uncertain. The vast majority of these laws
were adopted prior to the advent of the Internet and related technologies and,
as a result, do not contemplate or address the unique issues of the Internet and
related technologies. Changes to these laws intended to address these issues,
including some recently proposed changes, could create uncertainty in the
marketplace which could reduce demand for our products and services, could
increase our cost of doing business as a result of costs of litigation or
increased product development costs, or could in some other manner have a
material adverse effect on our business, financial condition and results of
operations. For example, a United States federal law banning states from
imposing sales taxes on certain Internet access charges expired on October 31,
2003 and, if Congress does not implement new legislation reinstating the sales
tax ban, states may impose sales tax on Internet access charges, which could
adversely affect our results of operations.
TELECOMMUNICATIONS TAXATION, SUPPORT REQUIREMENTS, AND ACCESS CHARGES
All telecommunications carriers providing domestic services in the
United States are required to contribute a portion of their gross revenues for
the support of universal telecommunications services; and some
telecommunications services are subject to special taxation and to contribution
requirements to support services to special groups, like persons with
disabilities. Our services may be subject to new or increased taxes and
contribution requirements that could affect our profitability, particularly if
we are not able to pass them through to customers for either competitive or
regulatory reasons.
Internet services are currently exempt from charges that long distance
telephone companies pay for access to the networks of local telephone companies
in the United States. Efforts have been made from time to time, and may be made
again in the future, to eliminate this exemption. If these access charges are
imposed on telephone lines used to reach Internet service providers and/or if
flat rate telephone services for Internet access are eliminated or curtailed,
the cost to customers who access our satellite facilities using telephone
company-provided facilities could increase to an extent that could discourage
the demand for our services. Likewise, the demand for our services in other
countries may be affected by the availability and cost of local telephone or
other telecommunications facilities to reach our facilities.
EXPORT OF TELECOMMUNICATIONS EQUIPMENT
The sale of our ground segment systems, networks, and communications
services outside the United States is subject to compliance with the regulations
of the United States Export Administration Regulations. The absence of
comparable restrictions on competitors in other countries may adversely affect
our competitive position. In addition, in order to ship our products into other
countries, the products must satisfy the technical requirements of that
particular country. If we were unable to comply with such requirements with
respect to a significant quantity of our products, our sales in those countries
could be restricted, which could have a material adverse effect on our business,
results of operations and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to a variety of risks, including foreign currency
exchange rate fluctuations relating to certain purchases from foreign vendors.
In the normal course of business, we assess these risks and have established
policies and procedures to manage our exposure to fluctuations in foreign
currency values.
Our objective to managing our exposure to foreign currency exchange
rate fluctuations is to reduce the impact of adverse fluctuations in earnings
and cash flows associated with foreign currency exchange rates for certain
purchases from foreign vendors, if applicable. Accordingly, we may utilize from
time to time foreign currency forward contracts to hedge our exposure on firm
commitments denominated in foreign currency. During the three months ended
September 30, 2003 and the fiscal year ended June 30, 2003, we had no such
foreign currency forward contracts.
Our results of operations and cash flows are subject to fluctuations
due to changes in interest rates primarily from our investment of available cash
balances in money market funds with portfolios of investment grade corporate and
government securities. Under our current positions, we do not use interest rate
derivative instruments to manage exposure to interest rate changes.
25
ITEM 4. CONTROLS AND PROCEDURES
QUARTERLY EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS AND INTERNAL CONTROLS.
(a) As of the end of the period covered by this Quarterly Report on
Form 10-Q, an evaluation was carried out under the supervision
and with the participation of senior management, including our
Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rules 13a- 14(c) and 15d-
14(c) under the Securities Exchange Act of 1934, as amended).
Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and
procedures are effective for gathering, analyzing and disclosing
the information that the Company is required to disclose in
reports filed under the Securities Exchange Act of 1934, as
amended.
(b) There have been no significant changes in the Company's internal
controls over financial reporting (as defined in Exchange Act
Rule 13a-15(f) of the Securities Exchange Act of 1934, as
amended) or in other factors during the fiscal quarter ended
September 30, 2003 that materially affected, or are reasonably
likely to materially affect, the Company's internal controls over
financial reporting.
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Index to Exhibits:
Exhibit No.
10.1 Loan and Security Agreement, dated as of September 25, 2003, by and between
Silicon Valley Bank and the Registrant (incorporated by reference to
Exhibit 10.31 of the Registrant's Annual Report on Form 10-K, for the year
ended June 30, 2003).
31.1 Chief Executive Officer Certification required by Rules 13a-14 and 15d-14
under the Securities Exchange Act of 1934, as amended (filed herewith).
31.2 Chief Financial Officer Certification required by Rules 13a- 14 and 15d- 14
under the Securities Exchange Act of 1934, as amended (filed herewith).
26
32 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
(b) Reports on Form 8-K
None
27
SIGNATURES
Pursuant to the requirements 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.
GLOBECOMM SYSTEMS INC.
----------------------
(Registrant)
Date: November 14, 2003 /s/ DAVID E. HERSHBERG
----------------------
David E. Hershberg
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: November 14, 2003 /s/ ANDREW C. MELFI
------------------------
Andrew C. Melfi
Vice President, Chief Financial
Officer and Treasurer (Principal
Financial and Accounting Officer)
28
Index to Exhibits:
Exhibit No.
10.1 Loan and Security Agreement, dated as of September 25, 2003, by and between
Silicon Valley Bank and the Registrant (incorporated by reference to
Exhibit 10.31 of the Registrant's Annual Report on Form 10-K, for the year
ended June 30, 2003).
31.1 Chief Executive Officer Certification required by Rules 13a-14 and 15d-14
under the Securities Exchange Act of 1934, as amended (filed herewith).
31.2 Chief Financial Officer Certification required by Rules 13a- 14 and 15d- 14
under the Securities Exchange Act of 1934, as amended (filed herewith).
32 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
29