We recognize revenue using the percentage-of-completion method of accounting upon the achievement of certain contractual milestones in accordance with Statement of Position 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 customer’s 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 customer’s 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.
The timing of our revenue recognition is primarily driven by achieving shipment, final acceptance or other contractual milestones. Project risks including project complexity, political and economic instability in certain regions in which we operate, export restrictions, tariffs, licenses and other trade barriers which may result in the delay of the achievement of revenue milestones. A delay in achieving a revenue milestone may negatively impact our results of operations.
Costs related to our production-type contracts and our non-standard, complex production-type contracts rely on estimates based on total expected contract costs. Typically, these contracts are fixed price projects. We use estimates of the costs applicable to various elements which we believe are reasonable. Our estimates, are assessed continually during the term of these contracts and costs are subject to revisions as the contract progresses to completion. These estimates are subjective based on management assessment of project risk. These risks may include project complexity and political and economic instability in certain regions in which we operate. Revisions in cost estimates are reflected in the period in which they become known. A significant revision in an estimate may negatively impact our results of operations. In the event an estimate indicates that a loss will be incurred at completion, we record the loss as it becomes known.
Goodwill represents the excess of the purchase price of businesses over the fair value of the identifiable net assets acquired. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and other indefinite life intangible assets are no longer amortized, but instead tested for impairment at least annually. The impairment test for goodwill uses a two-step approach, which is performed at the reporting unit level. Step one compares the fair value of the reporting unit (calculated using a discounted cash flow method) to its carrying value. If the carrying value exceeds the fair value, there is a potential impairment and step two must be performed. Step two compares the carrying value of the reporting unit’s goodwill to its implied fair value (i.e., fair value of the reporting unit less the fair value of the unit’s assets and liabilities, including identifiable intangible assets). If the carrying value of goodwill exceeds its implied fair value, the excess is required to be recorded as an impairment charge. The impairment test is dependent upon estimated future cash flows of the data communication services segment. There have been no events during the six months ended December 31, 2006 that would result in any goodwill impairment.
In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income prior to the expiration of any net operating loss carryforwards. Due to the uncertainty regarding our ability to utilize the net operating losses in the future, we have provided a valuation allowance against the operating losses and temporary differences.
Table of ContentsAllowances 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 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
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.
Results of Operations
Three and Six Months Ended December 31, 2006 and 2005
Revenues from Ground Segment Systems, Networks and Enterprise Solutions. Revenues increased by $5.7 million, or 25.4%, to $28.4 million for the three months ended December 31, 2006 and increased by $0.2 million, or 0.4%, to $45.8 million for the six months ended December 31, 2006, compared to $22.6 million and $45.6 million for the three and six months ended December 31, 2005, respectively. The increase in revenues in the three months ended December 31, 2006 was primarily driven by the increase in the pre-engineered systems product line revenue in the government marketplace.
Revenues from Data Communication Services. Revenues increased by $1.1 million, or 14.5%, to $8.4 million for the three months ended December 31, 2006 and increased by $2.8 million, or 19.9%, to $16.6 million for the six months ended December 31, 2006, compared to $7.3 million and $13.9 million for the three and six months ended December 31, 2005, respectively. The increase in the three months ended December 31, 2006 was primarily due to an increase in life cycle support services in the government marketplace. The increase in the six months ended December 31, 2006 was primarily due to an increase in life cycle support services in the government marketplace and equipment and services to a major U.S enterprise customer, along with an increase in telephony services.
Costs from Ground Segment Systems, Networks and Enterprise Solutions. Costs from ground segment systems, networks and enterprise solutions increased by $4.5 million, or 24.1%, to $23.2 million for the three months ended December 31, 2006 and decreased by $0.9 million, or 2.5% to $37.3 million for the six months ended December 31, 2006, compared to $18.7 million and $38.2 million for the three and six months ended December 31, 2005, respectively. The gross margin increased to 18.2% and 18.6% for the three and six months ended December 31, 2006 from 17.3% and 16.2% for the three and six months ended December 31, 2005, respectively. This increase in gross margin was mainly attributable to revenue related to pre-engineered systems product line in the government marketplace, in particular one contract with a foreign government customer with a higher than normal gross margin.
Costs from Data Communications Services. Costs from data communications services increased by $0.8 million, or 13.6%, to $7.0 million for the three months ended December 31, 2006 and increased by $1.9 million, or 15.8%, to $13.6 million for the six months ended December 31, 2006, compared to $6.1 million and $11.7 million for the three and six months ended December 31, 2005, respectively. The gross margin increased to 16.7% and 18.4% for the three and six months ended December 31, 2006 from 15.9% and 15.5% for the three and six months ended December 31, 2005, respectively. The increase in the margin was primarily a result of an increase in revenue in the government marketplace within life cycle support services which has higher margin than the other service offerings, along with consistent fixed costs
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Table of Contentswithin the network operation center on a higher revenue base, partially offset by the decrease in margin in the telephony service offering primarily a result of increased minutes termination costs from international long distance carriers. The gross margin percentage experienced in the three and six months ended December 31, 2006 is higher than our historical norm and higher than the gross margin percentage expected for the remainder of fiscal year 2007.
Selling and Marketing. Selling and marketing expenses increased by $0.2 million, or 9.3%, to $1.8 million for the three months ended December 31, 2006 and increased by $0.4 million, or 13.2%, to $3.5 million for the six months ended December 31, 2006, compared to $1.6 million and $3.1 million for the three and six months ended December 31, 2005, respectively. The increase is a result of an increase in salary and salary related expenses for additional marketing personnel pursuing business in the government marketplace, travel and living expenses related to marketing efforts exploring new markets and expenses related to the sales office in Afghanistan.
Research and Development. Research and development expenses increased by $0.2 million, or 100.6%, to $0.3 million for the three months ended December 31, 2006 and increased by $0.3 million, or 93.7%, to $0.5 million for the six months ended December 31, 2006, compared to $0.2 million and $0.3 million for the three and six months ended December 31, 2005, respectively. The increase was principally due to costs associated with developing the next version of AxxSysR Network Management System on the ‘‘.Net’’ operating system.
General and Administrative. General and administrative expenses increased by $0.4 million, or 15.6%, to $3.0 million for the three months ended December 31, 2006 and increased by $0.6 million, or 11.6%, to $5.4 million for the six months ended December 31, 2006, compared to $2.6 million and $4.8 million for the three and six months ended December 31, 2005, respectively. The increase in general and administrative expenses was due to an increase in salary and related fringes primarily due to the increase in the Company’s pay for performance plan and salary increases.
Interest Income. Interest income increased by $0.1 million, or 53.3%, to $0.3 million for the three months ended December 31, 2006 and increased by $0.2 million, or 35.1%, to $0.6 million for the six months ended December 31, 2006, compared to $0.2 million and $0.5 million for the three and six months ended December 31, 2005, respectively, as a result of increased interest rates.
Liquidity and Capital Resources
At December 31, 2006, we had working capital of $46.8 million, including cash and cash equivalents of $26.0 million, net accounts receivable of $38.0 million, inventories of $14.9 million, prepaid expenses and other current assets of $1.5 million, offset by $22.5 million in accounts payable, $5.7 million in accrued expenses and other current liabilities and $5.5 million in deferred revenues.
Net cash provided by operating activities during the six months ended December 31, 2006 was $3.4 million, which primarily related to an increase in deferred revenue of $3.8 million due to timing differences between project billings and revenue recognition milestones resulting from specific customer contracts, an increase in accounts payable of $3.4 million relating to the increase in revenues and inventories and the timing of vendor payments, net income of $2.7 million, a non-cash item representing depreciation and amortization expense of $1.5 million primarily related to the network operations center and satellite earth station equipment, an increase in accrued payroll and related fringe benefits of $0.9 million due to the timing of payroll and the increase in the 401k match accrual paid once a year in January, and an increase in other liabilities of $0.6 million primarily due to the receipt of a customer deposit for a large program, offset by an increase in accounts receivable of $7.4 million due to an increase in revenues in the six months ended December 31, 2006 and the timing of billings and collections from customers, and an increase in inventory of $1.9 million due to the timing of shipments of certain jobs.
Net cash used in investing activities during the six months ended December 31, 2006 was $5.6 million, which primarily related to the purchase of network operations center and teleport assets primarily for a large program that we anticipate will be in service on July 1, 2007. This program will require significant additional capital expenditures for the network operations center, teleport and facilities upgrade during the year ending June 30, 2007. In addition, we are upgrading our facility to meet the requirements of our
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Table of Contentsincrease in business levels. We estimate an additional $10 million in capital expenditures for the remainder of the year ending June 30, 2007 primarily for the network operations center, teleport, and facility upgrade for both this large program and other requirements due to the increase in business levels. We will use our existing working capital and, if required, the $7 million bridge line under our credit facility to meet these capital expenditure requirements.
Net cash provided by financing activities during the six months ended December 31, 2006 was $3.7 million, which related to proceeds from the exercise of stock options and warrants.
At December 31, 2006, we had a credit facility in place with Citibank, N.A, which expires on November 30, 2007. The credit facility is comprised of: (1) a $25 million borrowing base line of credit (the ‘‘Line’’), which is available for standby letters of credit, commercial letters of credit and loans; (2) a bridge line of credit in the amount of $7 million, which is to support equipment purchases; and (3) a foreign exchange line in the amount of $10 million. If there are direct borrowings under the Line, the commercial letters of credit and direct borrowings may not be drawn in amounts in excess of $20 million. The Line bears interest at the prime rate or LIBOR plus 200 basis points, at our discretion, and is collateralized by a first security interest on all of our assets. We can be advanced up to 80% of eligible accounts receivable and 100% of unrestricted cash. The credit facility provides that we may borrow and apply letters of credit against the availability under the Line. In addition, the credit facility contains certain financial and other covenants, deposit requirements, monthly reporting provisions and other requirements. The credit facility is uncommitted and advances are subject to Citibank, N.A.’s approval. As of December 31, 2006, no borrowings were outstanding under the credit facility, however, there were standby letters of credit of approximately $17.6 million, which were applied against and reduced the amounts available under the facility.
We lease satellite space segment services and other equipment under various operating lease agreements, which expire in various years through 2009. Future minimum lease payments due on these leases through December 31, 2007 are approximately $5.5 million.
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Table of ContentsAt December 31, 2006, we had contractual obligations and other commercial commitments as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Payments Due by Period |
| Contractual Obligations | | | Total | | | Less than
1 year | | | 1-3
years | | | 4-5
years | | | More than
5 years |
| Operating leases | | | | $ | 8,852 | | | | | $ | 5,517 | | | | | $ | 3,101 | | | | | $ | 234 | | | | | $ | — | |
| Total contractual obligations | | | | $ | 8,852 | | | | | $ | 5,517 | | | | | $ | 3,101 | | | | | $ | 234 | | | | | $ | — | |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Amount of Commitment Expiration Per Period |
| Other Commercial Commitments | | | Total
Amounts
Committed | | | Less than
1 year | | | 1-3
years | | | 4-5
years | | | More
Than
5 years |
| Standby letters of credit | | | | $ | 17,649 | | | | | $ | 13,196 | | | | | $ | 4,453 | | | | | $ | — | | | | | $ | — | |
| Total commercial commitments | | | | $ | 17,649 | | | | | $ | 13,196 | | | | | $ | 4,453 | | | | | $ | — | | | | | $ | — | |
|
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 capital expenditures for a large program and for work in progress for orders as obtained, and that we may periodically experience negative cash flows due to variances in quarter to quarter operating performance. We will use existing working capital and, if required, use our credit facility to meet these additional working capital requirements.
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 level of capital requirements related to the expansion of our service offerings. Based on current plans, we believe that our existing capital resources will be sufficient to meet working capital requirements at least through December 31, 2007. 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 hostilities in Iraq and Afghanistan, or in connection with any armed conflict, 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 deter 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, capital expenditures, research and development activities, the timing and extent of our marketing programs, and we may be required to reduce headcount. We cannot assure you that additional financing will be available to us on acceptable terms, or at all.
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 in 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
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Table of Contentsrates. Accordingly, we may utilize from time to time foreign currency forward contracts to hedge our exposure on firm commitments denominated in foreign currency. At December 31, 2006, we had no outstanding foreign exchange 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.
| | |
| (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-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the ‘‘Exchange Act’’)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. |
| | |
| (b) | There have been no changes in the Company’s internal controls over financial reporting (as defined in Exchange Act Rule 13a-15(f)) or in other factors during the fiscal quarter ended December 31, 2006 that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. |
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Table of ContentsPart II — Other Information
Item 1. Legal Proceedings
None
Item 1A. Risk Factors
Risk Factors
A limited number of customer contracts account for a significant portion of our revenues, and the inability to replace a key customer contract or the failure of the customer to implement its plans 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 four customers to provide equipment and services, from which we expect to generate a significant portion of our revenues. We derived 20% of our revenues in the three months ended December 31, 2006 from one customer in the government marketplace. Also, we conduct a substantial proportion of our business in developing countries. If any key customer is unable to implement its business plan, the market for these customers’ services declines, political or military conditions make performance impossible or impractical or if all or any of the major 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.
We derive a substantial portion of our revenues from the government marketplace.
We derive a substantial portion of our revenues from government marketplace. This business tends to have higher gross margins than other segments of our business. A future reduction in the proportion of our business from government marketplace would negatively impact our results of operations.
Risks associated with operating in international markets could restrict our ability to expand globally and harm our business and prospects.
We market and sell a substantial portion of our products and services 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, including countries in areas of conflict like Afghanistan. There are a number of risks inherent in conducting our business internationally, including:
| | |
| • | general political and economic instability in international markets, including the hostilities in Iraq and Afghanistan, could impede our ability to deliver our products and services to customers and harm our results of operations; |
| | |
| • | difficulties in collecting accounts receivable could adversely affect our results of operations; |
| | |
| • | changes in regulatory requirements could restrict our ability to deliver services to our international customers, including the addition of a country to the list of sanctioned countries under the International Emergency Economic Powers Act or similar legislation; |
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| • | export restrictions, tariffs, licenses and other trade barriers could prevent us from adequately equipping our network facilities; |
| | |
| • | differing technology standards across countries may impede our ability to integrate our products and services across international borders; |
| | |
| • | 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; |
| | |
| • | increased expenses associated with marketing services in foreign countries could affect our ability to compete; |
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Table of Contents | | |
| • | relying on local subcontractors for installation of our products and services could adversely impact the quality of our products and services; |
| | |
| • | difficulties in staffing and managing foreign operations could affect our ability to compete; |
| | |
| • | complex foreign laws and treaties could affect our ability to compete; and |
| | |
| • | potentially adverse taxes could 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.
We derive a substantial portion of our revenues from fixed-price projects, under which we assume greater financial risk if we fail to accurately estimate the costs of the projects.
We derive a substantial portion of our revenues from fixed-price projects. We assume greater financial risks on a fixed-price project than on a time-and-expense based project. If we miscalculate the resources or time we need for these fixed-price projects, the costs of completing these projects may exceed our original estimates, which would negatively impact our results of operations.
If GNSC does not execute its business strategy or if the market for its services fails to develop or develops more slowly than we expect, our results of operations will be harmed.
GNSC’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. GNSC has had, and we expect will continue to have, cash requirements, which have decreased and will continue to decrease our cash resources. If GNSC 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. In addition, significant capital expenditures have been required as we have built our network operation center to provide our service offerings. If our service offerings are not accepted, or if the market fails to grow, we cannot assure you that we will be able to realize an appropriate return on these capital expenditures.
In the event of a catastrophic loss affecting our operations in Hauppauge, New York our results of operations would be harmed.
GNSC revenues and results of operations are dependant on the infrastructure of the Network Operations Center and the Long Island International Teleport at our headquarters in Hauppauge, New York. A catastrophic event to this facility or to the infrastructure of the surrounding area would result in significant delays in restoring a majority of the data communications services capabilities. These capabilities permit us to offer an integrated suite of products and services and the incapacity of our communications infrastructure would negatively impact our ability to sell our ground segment systems and networks. This would result in the loss of revenues and adversely affect our business, results of operations and financial condition.
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 systems and networks market generally fall into two groups: (1) system integrators, like Thales, Data Path, and SED Systems, and (2) equipment manufacturers who also provide integrated systems, like General Dynamics SATCOM Technologies, Andrew Corporation, Viasat, Alcatel and ND Satcom AG.
In the end-to-end satellite-based enterprise solutions and broadcast services markets, we compete with other satellite communication companies who provide similar services, like Ascent Media, Globecast, and Convergent Media Systems. In addition, in managed network services we may compete
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Table of Contentswith other communications service providers like Segovia and satellite owners like SES Americom 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, 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. The potential strategic relationships of existing and new competitors may rapidly acquire significant market share, which would harm our business and financial condition.
If our products and services are not accepted in developing countries with emerging markets, our revenues will be impaired.
We anticipate that a significant 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:
| | |
| • | the speed at which communications infrastructure, including terrestrial microwave, coaxial cable and fiber optic communications systems, which compete with satellite-based services, is built; |
| | |
| • | the effectiveness of our local resellers and sales representatives in marketing and selling our products and services; and |
| | |
| • | 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 have had a history of operating losses and negative cash flow. Negative cash flows may occur as we pursue our business plan and our losses may reoccur, which may strain our capital resources.
Although we have recently been profitable, we had incurred significant net losses in the past and may incur negative cash flows from operations. Our ability to 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. In the past, we have incurred significant negative cash flows, which may reoccur if our business plan is not successful. Also, if we are unable to sustain or increase our profits on a quarterly or annual basis in the future or if our business undergoes a period of rapid growth, our operating cash flows may be negatively impacted.
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Table of ContentsSince sales of satellite communications equipment are dependent on the growth of communications networks, if market demand for these networks declines, our revenue 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 does not continue, the market 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 many of our customers. Also, many companies have found it difficult to raise capital to finish building their communications networks and, therefore, have placed fewer orders. Past economic slowdowns 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 network operators has increased pricing pressures.
We depend upon certain key personnel and may not be able to retain these employees. If we lose the services of these individuals or cannot hire additional qualified personnel, our business will be harmed.
Our success also depends to a substantial degree on our ability to attract, motivate and retain highly-qualified personnel. There is considerable competition for the services of highly-qualified technical and engineering personnel. We may not be able either to retain our current personnel or hire additional qualified personnel if and when needed.
Our future performance depends on the continued service of our key technical, managerial and marketing personnel; in particular, David Hershberg and Kenneth Miller are key to our success based upon their individual knowledge of the markets in which we operate. The employment of any of our key personnel could cease at any time.
Satellites upon which we rely may malfunction or be damaged or lost.
In the delivery of our data communications services, we lease space segment from various satellite transponder vendors. The damage or loss of any of the satellites used by us, or the 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 could have a material adverse effect on 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 could materially adversely affect our business, results of operations and financial condition.
We currently obtain most of our critical components and services from 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
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Table of Contentsinterruptions, delays or cessation in service to our customers. There currently is no existing technology that provides absolute security. We may face liability to customers for such security breaches. Furthermore, these incidents could deter potential customers and adversely affect existing customer relationships.
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 if 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 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 may be unable to raise additional funds to meet our capital requirements in the future.
We believe that our available cash resources will be sufficient to meet our working capital and capital expenditure requirements through at least December 31, 2007. 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 or acquisition of assets or a business. 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, scale back or eliminate some of our operating activities, including, without limitation, the timing and extent of our marketing programs, capital expenditures and research and development activities and we may be required to reduce headcount. 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.
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 four patents in the United States, one for remote access to the Internet using satellites, one for satellite communication with automatic frequency control, one for a monitor and control system for satellite communications networks and the like, and one for implementing facsimile and data communications using Internet protocols. We have one other patent pending in the United States for a distributed satellite-based cellular network. We currently have one Patent Cooperation Treaty patent application pending for implementing facsimile and data communications using
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Table of ContentsInternet 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 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 the 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 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, segments of our business.
Risks Related to the Securities Markets and Ownership of Our Common Stock
Our stock price is volatile.
From January 1, 2006 through December 31, 2006, our stock price ranged from a low of $5.88 per share to a high of $9.70 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:
| | |
| • | quarterly variations in operating results; |
| | |
| • | announcements of new technology, products or services by us or any of our competitors; |
| | |
| • | changes in financial estimates or recommendations by securities analysts; |
| | |
| • | general market conditions; or |
| | |
| • | domestic and international economic factors unrelated to our performance. |
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.
Because our common stock is thinly traded, it may be difficult to sell shares of our common stock into the markets without experiencing significant price volatility.
Our common stock is currently traded on the Nasdaq Global Market. Because of the relatively small number of shares that are traded, it may be difficult for an investor to find a purchaser for shares of our
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Table of Contentscommon stock without experiencing significant price volatility. We cannot guarantee that an active trading market will develop, that our common stock will have a higher trading volume than it has historically had or that it will maintain its current market price. This illiquidity could have a material adverse effect on the market price of our stock.
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, by-laws 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 that have change of control provisions that could make an acquisition of us by a third party more difficult.
We have not paid dividends in the past and do not expect to pay dividends in the future, and any return on investment may be limited to the value of our stock.
We have never paid cash dividends on our common stock and do not anticipate paying cash dividends on our common stock in the foreseeable future. The payment of dividends on our common stock will depend on our future earnings, capital requirements, financial condition, future prospects and other factors as the board of directors might deem relevant. If we do not pay dividends our stock may be less valuable because a return on your investment will only occur if our stock price appreciates.
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 FCC licensed earth stations in Hauppauge, New York, subject to the Communications Act of 1934, as amended (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 GNSC. 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 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
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Table of Contentsadvances 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 that may have a material adverse impact on our business. Either we or our local partners typically must obtain authorization from 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, including but not limited to privacy regulations in numerous European countries 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 were adopted prior to the advent of the Internet and related technologies and, as a result, the laws 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.
Telecommunications Taxation, Support Requirements, and Access Charges
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, telecommunications relay services for the deaf, and/or other regulatory fees. We are subject to some of these fees, and we may be subject to other fees or 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 and, in
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Table of Contentscertain circumstances, with International Traffic in Arms 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 and implement our services in some 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.
Foreign Ownership
We may, in the future, be required to seek FCC or other government approval if foreign ownership of our stock exceeds certain 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, or denial of certain contracts from other United States Government Agencies.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
Matters voted upon at the Annual Meeting of stockholders held on November 16, 2006 and the results of the voting were as follows:
| | |
| (i) | The following individuals were elected by the Stockholders to serve as Directors: |
| | | | | | | | | | | | |
| Board Member | | | For | | | Withheld |
| Richard E. Caruso | | | | | 12,992,671 | | | | | | 1,901,247 | |
| David E. Hershberg | | | | | 14,399,412 | | | | | | 494,506 | |
| Harry L. Hutcherson, Jr. | | | | | 14,395,412 | | | | | | 498,506 | |
| Brian T. Maloney | | | | | 14,117,846 | | | | | | 776,072 | |
| Kenneth A. Miller | | | | | 14,394,179 | | | | | | 499,739 | |
| Jack A. Shaw | | | | | 14,395,212 | | | | | | 498,706 | |
| A. Robert Towbin | | | | | 14,394,429 | | | | | | 499,489 | |
| C.J. Waylan | | | | | 14,395,212 | | | | | | 498,706 | |
|
| | |
| (ii) | To approve the 2006 Stock Incentive Plan was voted upon as follows: 7,516,420 shares for; 982,447 shares against; and 42,347 shares abstaining. |
| | |
| (iii) | To ratify the appointment of Ernst & Young LLP as independent auditors of the Company for the fiscal year ending June 30, 2007 was voted upon as follows: 14,776,958 shares for; 95,294 shares against; and 21,666 shares abstaining. |
Item 5. Other Information
None
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Table of ContentsItem 6. Exhibits
Index to Exhibits:
| | | | | | |
| Exhibit No. | | | |
| 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
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: February 9, 2007 | | | /s/ DAVID E. HERSHBERG |
| | | | David E. Hershberg
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer) |
| Date: February 9, 2007 | | | /s/ ANDREW C. MELFI |
| | | | Andrew C. Melfi
Vice President, Chief Financial
Officer and Treasurer (Principal
Financial and Accounting Officer) |
|
30
Index to Exhibits:
| | | | | | |
| Exhibit No. | | | |
| 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). |
|
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