to various elements which we believe are reasonable. 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 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.
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 creditworthiness 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 creditworthiness 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 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.
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.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities", which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements", relating to consolidation of certain entities. First, FIN 46 requires identification of our participation in variable interests entities ("VIE"), which are defined as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a standalone basis, or whose equity holders lack certain characteristics of a controlling financial interest. Once entities
are identified as VIE, FIN 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE, if any, bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN 46 also sets forth certain disclosures regarding interests in VIE that are deemed significant, even if consolidation is not required. This standard became effective in the third quarter of fiscal 2004. The adoption of this standard did not have a material impact on our consolidated financial statements.
Results of Operations
Three and Nine Months Ended March 31, 2004 and 2003
Revenues from Ground Segment Systems, Networks and Enterprise Solutions. Revenues increased by $9.7 million, or 105.4%, to $19.0 million for the three months ended March 31, 2004 and increased by $26.6 million, or 91.0%, to $55.9 million for the nine months ended March 31, 2004, compared to $9.2 million and $29.2 million for the three and nine months ended March 31, 2003, respectively. The increase in revenues was primarily the result of increased infrastructure sales in the U.S. Government and governmental agencies marketplace, coupled with increased sales activity due to a general overall improvement in the telecommunications industry segments we serve and the achievement of shipment milestones associated with projects currently in progress.
Revenues from Data Communications Services. Revenues were consistent at $3.3 million, for the three months ended March 31, 2004 and 2003 and remained relatively consistent at $10.5 million and $10.7 million, respectively, for the nine months ended March 31, 2004 and 2003.
Costs from Ground Segment Systems, Networks and Enterprise Solutions. Costs from ground segment systems, networks and enterprise solutions increased by $7.2 million, or 80.4%, to $16.2 million for the three months ended March 31, 2004 and increased by $21.8 million, or 79.6%, to $49.3 million for the nine months ended March 31, 2004, compared to $9.0 million and $27.4 million for the three and nine months ended March 31, 2003, respectively. The increase was attributable to the higher revenue base. Costs as a percentage of related revenues decreased to 85.4% and 88.2% for the three and nine months ended March 31, 2004, respectively, compared to 97.1% and 93.8% for the three and nine months ended March 31, 2003, respectively. The decrease was mainly attributable to cost overruns incurred on a major project during the three and nine months ended March 31, 2003 and increased margin on revenues related to government and government related entities projects during the three and nine months ended March 31, 2004.
Costs from Data Communications Services. Costs from data communications services decreased by $0.6 million, or 15.1%, to $3.1 million for the three months ended March 31, 2004 and decreased by $4.9 million, or 33.6%, to $9.6 million for the nine months ended March 31, 2004, compared to $3.7 million and $14.5 million for the three and nine months ended March 31, 2003, respectively. Costs as a percentage of related revenues decreased to 94.9% and 91.2% for the three and nine months ended March 31, 2004, respectively, compared to 113.4% and 134.8% for the three and nine months ended March 31, 2003, respectively. 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.
Selling and Marketing. Selling and marketing expenses decreased by $0.3 million, or 19.4%, to $1.2 million for the three months ended March 31, 2004 and decreased by $1.3 million, or 27.3%, to $3.5 million for the nine months ended March 31, 2004, compared to $1.5 million and $4.8 million for the three and nine months ended March 31, 2003, respectively. The decrease was principally due to a reduction in salary, salary related expenses and travel and living costs associated with reductions in sales and marketing personnel as part of our cost-cutting initiatives.
Research and Development. Research and development expenses increased by $0.1 million, or 84.7%, to $0.2 million for the three months ended March 31, 2004 and increased by $0.4 million, or 72.3%, to $1.0 million for the nine months ended March 31, 2004, compared to $0.1 million and $0.6 million for the three and nine months ended March 31, 2003, respectively. The increase was due to product research and development initiatives associated with projects currently in progress, research efforts in remote video monitoring systems and internal development of new monitoring and control technologies.
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General and Administrative. General and administrative expenses decreased by $0.2 million, or 7.0%, to $2.1 million for the three months ended March 31, 2004 and decreased by $1.5 million, or 23.1%, to $5.1 million for the nine months ended March 31, 2004, compared to $2.3 million and $6.6 million for the three and nine months ended March 31, 2003, respectively. The decrease in general and administrative expenses for the three months ended March 31, 2004 was primarily due to executive incentive compensation paid in the third quarter of 2003. The decrease in general and administrative expenses for the nine months ended March 31, 2004 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 and a reduction of salary expenses as part of our cost cutting initiatives.
Interest Income. Interest income for the three months ended March 31, 2004 and 2003 remained consistent at $0.1 million and decreased by $0.2 million, or 46.8%, to $0.2 million for the nine months ended March 31, 2004, compared to $0.4 million for the nine months ended March 31, 2003. The decrease was due to the reduction of the average balance of cash and cash equivalents, due to cash used in our operations during the twelve months ended March 31, 2004, plus a reduction in the interest rates.
Interest Expense. Interest expense decreased to zero for the three and nine months ended March 31, 2004, compared to $0.1 million and $0.5 million for the three months and nine months ended March 31, 2003, respectively. The decrease was due to the termination of our capital lease obligation in February 2003.
Gain on Sale of Available-For-Sale Securities. The gain on sale of available-for-sale securities of $0.1 million for the nine months ended March 31, 2004 related to the sale of an investment that resulted in proceeds of $0.4 million during the three months ended December 31, 2003.
Liquidity and Capital Resources
At March 31, 2004, we had working capital of $28.7 million, including cash and cash equivalents of $26.3 million, restricted cash of $1.0 million, net accounts receivable of $13.7 million, inventories of $8.0 million, prepaid expenses and other current assets of $1.9 million and deferred income taxes of $0.1 million offset by $16.6 million in accounts payable, $1.9 million in deferred revenues and $3.9 million in accrued expenses and other current liabilities.
Net cash used in operating activities during the nine months ended March 31, 2004 was $1.3 million, which primarily related to the following uses of cash: a decrease in deferred revenue of $5.8 million associated with the achievement of milestone revenues relating to the increase in business levels, an increase in accounts receivable of $5.8 million based on significant billings in March 2004 and a decrease in the provision for doubtful accounts due to the recovery of $1.0 million from a former Middle East customer. These uses were partially offset by the following factors: a decrease in inventory of $3.2 million from shipments made associated with the increase in business levels, an increase in accounts payable of $5.8 million based on the timing of payments to certain vendors and non-cash depreciation and amortization expense of $2.3 million primarily related to the network operations center and satellite earth station equipment.
Net cash used in investing activities during the nine months ended March 31, 2004 was $0.8 million, which primarily related to the purchase of $1.0 million of fixed assets mainly for our network operations center and an increase in restricted cash of $0.4 million based on a certificate of deposit issued as collateral for a specific project, offset by proceeds received of $0.4 million from the sale of available-for-sale securities and a repayment of a $0.3 million promissory note from a related party.
Net cash provided by financing activities during the nine months ended March 31, 2004 was $6.3 million. In December 2003, we completed a private placement transaction of equity securities where we issued 1,500,000 shares of common stock at a price of $4.50 per share for an aggregate price of $6,750,000 and issued warrants to purchase up to 750,000 shares of common stock at an exercise price of $5.50 per share. We incurred total expenses of approximately $580,000, of which approximately $456,000 represented underwriting commissions and approximately $124,000 represented other offering expenses. The net proceeds to the Company after deducting total expenses were approximately $6,170,000.
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We also received $0.5 million of proceeds from the exercise of stock options and sale of common stock in connection with the employee stock purchase plan purchase, offset by the purchase of $0.3 million of treasury stock.
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 (the "Domestic Line") and a $3.75 million Export-Import Bank secured guaranteed line of credit (the "EXIM Line"). 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. In March 2004, we amended the agreement to allow us to borrow up to $7.5 million against the Domestic Line, reduced by borrowings against the EXIM Line. The amendment also provides eligibility of up to 50% of the amount of our cash and cash equivalents at the bank, up to the $7.5 million. 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 March 31, 2004. As of March 31, 2004, no borrowings were outstanding under this credit facility, however, there were standby letters of credit of approximately $7.3 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 March 31, 2005 are approximately $6.0 million.
At March 31, 2004 we had contractual obligations and commercial commitments as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | |
| | | Payments Due by Period |
| | | Total | | Less than
1 year | | 1-3 years | | 4-5 years | | After 5 years |
| Contractual Obligations | |
| Operating leases | | $ | 19,257 | | | $ | 5,961 | | | $ | 9,524 | | | $ | 3,772 | | | $ | — | |
| Total contractual obligations | | $ | 19,257 | | | $ | 5,961 | | | $ | 9,524 | | | $ | 3,772 | | | $ | — | |
| Other Commercial Commitments | | | | | | | | | | | | | | | | | | | | |
| Standby letters of credit | | $ | 7,334 | | | $ | 3,246 | | | $ | 4,088 | | | $ | — | | | $ | — | |
| Total commercial commitments | | $ | 7,334 | | | $ | 3,246 | | | $ | 4,088 | | | $ | — | | | $ | — | |
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In fiscal 2001, we entered into two contracts with a vendor 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 were scheduled to begin when the satellite transponders were commercially operational, as defined in the agreements. During fiscal 2003, we learned that the vendor had experienced significant delays in the planned launch and operations dates for the satellites. As a result of these delays, we maintained that we had a right to terminate the contracts without cost and provided notification of such termination. The vendor denied our assertion that we had a right to terminate the contracts without cost. In March 2004, we reached a settlement with the vendor wherein we agreed to terminate the contracts and use our best efforts to purchase new space segment requirements from the vendor, for up to a total contracted value of $1.0 million. In the event we do not enter into $1.0 million of new contracts by March 2006, we have agreed to pay the vendor a fixed settlement amount of $0.2 million, which has been included in the "Contractual Obligations" amounts shown above.
On November 7, 2001, our 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. On November 12, 2003, we repurchased 61,506 shares at a fair market price of $5.41 per share from an officer of our Company. Since November 2001, we have repurchased, an aggregate of 317,606 shares for approximately $1.7 million. The timing, price, quantity and manner of
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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 obtained and that we may 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 to the timing and amount of new orders.
NetSat has had, and may continue to have, working capital requirements, which have, and may continue to put pressure on our capital resources. We have implemented strategies to reduce the drain on our resources caused by NetSat's losses. 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 for at least the next twelve months. 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 any other 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 $1.7 million during the nine months ended March 31, 2004, $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 March 31, 2004, our accumulated deficit was $75.6 million. We anticipate that we may continue to incur net losses, although we expect them to be less in the fiscal year ending June 30, 2004 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, if 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 ground segment systems and networks. If the long-term growth in demand for communications networks
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does not continue to return from recent depressed levels 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 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:
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| • | 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; |
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| • | changes in regulatory requirements could restrict our ability to deliver services to our international customers; |
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| • | export restrictions, tariffs, licenses and other trade barriers could prevent us from adequately equipping our network facilities; |
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| • | differing technology standards across countries may impede our ability to integrate our products and services across international borders; |
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| • | 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; |
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| • | increased expenses associated with marketing services in foreign countries could affect our ability to compete; |
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| • | relying on local subcontractors for installation of our products and services could adversely impact the quality of our products and services; |
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| • | difficulties in staffing and managing foreign operations could affect our ability to compete; |
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| • | potentially adverse taxes could adversely affect our results of operations; |
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| • | complex foreign laws and treaties could affect our ability to compete; and |
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| • | 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.
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.
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 settlement agreements, which modified and reduced our satellite bandwidth obligations, we cannot assure you that
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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:
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| • | delays and/or a decrease in the booking of new contracts; |
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| • | general political and economic conditions in the United States and abroad, including the war in Iraq; |
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| • | the length of time needed to initiate and complete customer contracts; |
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| • | the demand for and acceptance of our existing products and services; |
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| • | the cost of providing our products and services; |
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| • | market acceptance of new products and services; |
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| • | the mix of revenue between our standard products, custom-built products and our communications services; |
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| • | the timing of significant marketing programs; |
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| • | our ability to hire and retain personnel; |
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| • | the competition in our markets; and |
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| • | difficult global economic conditions and uncertain international currency markets. |
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.
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.
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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 at least the next twelve months. 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. 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 currently have agreements with six customers to provide equipment and services, from which we expect to generate a significant 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:
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| • | the speed at which communications infrastructure, including terrestrial microwave, coaxial cable and fiber optic communications systems, which compete with satellite-based services, is built; |
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| • | the effectiveness of our local resellers and sales representatives in marketing and selling our products and services; and |
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| • | 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 we 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.
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 patent applications 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 and service marks 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 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
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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.
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
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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 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 People's 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 intellectual property issues, taxation, libel, court jurisdiction and personal privacy to the Internet is uncertain. The vast majority of these laws was adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the unique
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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 tax 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 taxes 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.
Risks Related to the Securities Markets and Ownership of Our Common Stock
Our stock price is highly volatile.
From April 1, 2003 through March 31, 2004, our closing stock price ranged from a low of $2.45 per share to a high of $7.29 per share. The market price of our common stock, like that of the securities of many telecommunications and high technology industry companies, could be subject to significant fluctuations and is likely to remain volatile based on many factors, including the following:
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| • | quarterly variations in operating results; |
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| • | announcements of new technology, products or services by us or any of our competitors; |
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| • | acceptance of satellite-based communication services and Internet access services in developing countries and emerging markets; |
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| • | changes in financial estimates or recommendations by securities analysts; |
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| • | general market conditions; or |
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| • | domestic and international economic factors unrelated to our performance. |
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Additionally, numerous factors relating to our business may cause fluctuations or declines in our stock price.
The stock markets in general and the markets for telecommunications stocks in particular, have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock. Accordingly, we cannot assure you that you will be able to resell the shares of common stock at any particular price, or at all.
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 Law 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 and employment provisions with our senior executives have change of control provisions that could make an acquisition of us by a third party more difficult.
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 and our wholly-owned subsidiary, Globecomm Systems Europe Limited, which primarily deals in British Pounds Sterling. 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 the 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. 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 nine months ended March 31, 2004 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.
Item 4. Controls and Procedures
Quarterly Evaluation of the Company's Disclosure Controls and Internal Controls.
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| (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. |
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| (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 March 31, 2004 that materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting. |
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Part II — Other Information
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| Item 1. | Legal Proceedings |
None
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| Item 2. | Changes in Securities and Use of Proceeds |
None
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| Item 3. | Defaults Upon Senior Securities |
None
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| Item 4. | Submission of Matters to a Vote of Security Holders |
None
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| Item 5. | Other Information |
None
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| Item 6. | Exhibits and Reports on Form 8-K |
(a) Exhibits
Index to Exhibits:
Exhibit No.
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| 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). |
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| 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). |
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| 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
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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: May 17, 2004 | | /s/ DAVID E. HERSHBERG |
| | | David E. Hershberg
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer) |
| Date: May 17, 2004 | | /s/ ANDREW C. MELFI |
| | | Andrew C. Melfi
Vice President, Chief Financial
Officer and Treasurer (Principal
Financial and Accounting Officer) |
|
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Index to Exhibits:
Exhibit No.
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| 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). |
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| 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). |
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| 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). |
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