Description
Filed with the SEC from July 19 to July 25:
Globecomm Systems (GCOM)
Discovery Equity Partners said in a filing that it believes the prices at which GCOMI shares have been trading do not adequately reflect the potential value of the company's business and assets. Discovery also said it may hold discussions on this and other issues with management.
BUSINESS OVERVIEW
Overview
Globecomm Systems Inc. (“we”, “our”, “us”, the “Company” or “Globecomm”) is a leading global provider of satellite-based network solutions. Employing our expertise in emerging communication technologies we are able to offer a comprehensive suite of system integration, system products, and network services enabling a complete end-to-end solution for our customers. We believe our integrated approach of in-house design and engineering expertise combined with a world-class global network and our 24 by 7 (“24/7”) network operating centers provide us a unique competitive advantage. We are now taking this value proposition to selective vertical markets, including government, wireless, media, enterprise and maritime.
As a network solution provider we leverage our global network to provide customers managed access services to the United States Internet backbone, video content, the public switched telephone network or their corporate headquarters or government offices. We currently have customers for which we are providing these services in the United States, Europe, South America, Africa, the Middle East and Asia.
Globally, communications networks are moving rapidly toward Internet protocol-based (“IP”) networks and services based on the lower cost of implementation and the flexibility these networks offer. Satellite-based communications complement this trend as many of the regions in the world lack the “next generation” terrestrial networks required to accommodate the rapid and reliable transmission of the vast amounts of information underlying the growth in traffic. Even in a well connected area of the globe, satellite communications offer a diverse network path in support of disaster recovery and network augmentation.
We were incorporated in Delaware in August 1994. Our Globecomm Systems division provides our infrastructure solutions. Our services are principally provided by our wholly-owned subsidiaries, Globecomm Network Services Corp. (“GNSC”), a Delaware corporation, and Globecomm Services Maryland LLC (“GSM”), a Delaware limited liability company. In July 2008, we formed Cachendo LLC, (“Cachendo”) a wholly-owned Delaware limited liability company, to operate our professional engineering services business. In fiscal 2009, we added two companies to our services business through the acquisition of B.V. Mach 6 (“Mach 6”), a Netherlands company headquartered near Amsterdam, and Telaurus Communications LLC (“Telaurus”), a Delaware limited liability company, based in New Jersey. In fiscal 2010, we added two companies to our services business through the acquisition of Carrier to Carrier Telecom B.V. (“C2C”) a Netherlands company headquartered near Amsterdam and Evocomm Communications Limited (“Evocomm”), a British Virgin Islands company. In fiscal 2011, we further added to our services business through the acquisition of ComSource Inc. (“ComSource”), a Maryland corporation, based in Maryland.
Growth Strategy
Our growth strategy continues to focus on the development of recurring revenue streams by leveraging our engineering expertise and our global network to provide IP networking solutions for mission critical applications. Our strong service platform allows us to continue to develop additional value-added, application-based solutions for our core customers. We will continue to focus on maturing this global platform as we integrate our acquisitions and expand the reach of our managed network solution offerings.
We have supplemented our organic growth through acquisitions. With the recent completion of the ComSource acquisition we have continued our expansion outside satellite-centric based applications, enhanced our position within the wireless market and positioned ourselves to penetrate new markets. We plan to continue to employ a selective and disciplined approach when evaluating acquisition opportunities.
We focus our efforts toward increasing market share through vertical markets with the creation of value-added service solutions in emerging market niches. This has been supplemented by an ongoing effort to identify and develop select research and development projects and network components into marketable shared-service “hosted” platforms. With the natural cycle of technology advancement and the continued convergence of communications applications to Internet protocol, we remain excited about the new addressable market opportunities.
Solution Offerings
We provide our communication solutions through two business segments; services and infrastructure. Our services segment is supported primarily by GNSC, GSM, Cachendo, Melat, Mach 6, Telaurus, C2C, Evocomm and ComSource. These companies focus primarily on providing communication services including Managed Network Services, Professional Services and Lifecycle Support Services. Our infrastructure segment, through Globecomm Systems Inc., is engaged in the design, assembly and installation of ground segment systems and networks, which includes both our pre-engineered products and our custom systems design and integration product lines.
Services Solution Overview
We work to continually evolve our service platforms to meet the communication needs of our customers. Our customer base has grown as our service and customer support have proven the value of outsourced services. Our strategy includes offering flexible service-based solutions with fixed monthly pricing in order to make it easy for our customers to support an outsourcing decision.
Our global network is comprised of three teleport or data center facilities; our Kenneth A. Miller International Teleport, located in Hauppauge, New York, our GSM facility located in Laurel, Maryland and our C2C facility located in the Netherlands. These facilities are interconnected via terrestrial transmission and are used to transport signals to serve customers in Latin America, the United States, Canada, Europe, the Middle East, Africa and Asia. Our facilities are designed to meet stringent requirements for high-speed data communications and leverage redundant critical systems and uninterruptible power supplies with back-up power generation to ensure high reliability and availability.
To supplement our global network, we also lease facility services in Los Angeles, Hong Kong, the United Kingdom, the Netherlands and Poland, as well as other locations, to enable seamless access and global connectivity for our customers. This is further enabled by leased satellite capacity and by high-capacity fiber connections between facilities and public Point of Presence (POP) locations.
We have built and staff a centralized global network operation center, or NOC, at our Hauppauge, New York facility. We also have regional NOCs in Maryland and the Netherlands. The NOCs operate 24/7 to monitor customer networks, provide help desk services, respond to customer inquiries and initiate new services. The NOCs provide technology specific engineers to assist our customers with troubleshooting and problem resolution. We utilize our internally developed AxxSys Orion network management systems to monitor and control satellite communication equipment and satellite terminal networks at our NOCs. At our GSM facility in Laurel, Maryland and our Mach 6 and C2C facilities in the Netherlands, we have regional data centers that provide 24/7 localized technical support to our customers. We also leverage these facilities to dispatch technical personnel to support our Lifecycle Support Services offering.
Our service-based offerings are continuously being fine-tuned, partly through customer-funded programs and partly through internally funded programs. Our goal is to create high-value, customized application-based solutions for our customers, which are based on standardized building blocks, or service lines. The following service lines are the focal point of our evolving strategy.
Managed Network Services Line
Our core service line, Managed Network Services, incorporates our ability to provide product offerings leveraging our engineering capability and our global network allowing customers the opportunity and flexibility to outsource some or all of their communication needs. Two key components of this service line is our ability to provide global data, voice and video transport services which we call our Access product line and an ability to provide back office applications services, which we call our Hosted application product line.
Access Services is defined by our ability to support the transport of video, voice and data services globally. We further break down the Access service line into specific product offerings. The Access business is the backbone our services offering and a key driver of our overall revenue.
Access Plus utilizes a combination of terrestrial connectivity, satellite bandwidth and our teleports, along with a variety of remote very small aperture terminal, or VSATs, or a network of VSATs, to provide end-to-end connectivity. Our VSAT hubs, at our teleports, coupled with the extension and expansion of our terrestrial backbone network to these locations provide us with global VSAT coverage. This coverage and flexibility provide a wide range of services encompassing fundamental satellite technologies, including:
• Single Channel per Carrier (SCPC)
• Multiple Channel per Carrier (MCPC)
• Time Division Multiple Access (iDirect)
• Deterministic SCPC (Vipersat)
• Broadband Global Area Network (BGAN)
Access Video Backhaul based upon Access Plus, is specifically developed for video-centric delivery. The primary technology enabling this service is the Digital Video Broadcast standard (DVB/DVB-S2). Our Access Video Backhaul product leverages the core service elements with a greater concentration on maximizing video throughput while ensuring the highest service availability into potentially residential-grade reception systems or to cable head ends. The current evolution of IP-centric video delivery will continue to shape new technologies in this arena. The current adoption of H.264 and MPEG-4 technologies has been slow, though they continue to gain ground. As the industry evolves, we will continue to position the Access Video Backhaul product within the market to offer the greatest amount of value to the end user. Specifically, we look to retain the current platform in place and continue to offer services with only gradual adaptation of new technology to ensure a broad market access until end-users have widely adopted the new technology.
Access Voice Termination is also based upon the Access Plus product and is specifically designed for voice trunking services. We are licensed by the FCC and we provide high quality, toll-based termination of voice calls while leveraging high compression and highly reliable connectivity between the Globecomm network and the voice origination network. This differentiates us from many low cost providers. In addition, we often take advantage of utilizing pre-existing links, which allows us to position the Access Voice Termination product as extremely competitive alongside high value voice over IP providers while delivering a superior service in terms of features (caller ID, signaling pass through, etc.) and overall quality.
Access Bandwidth is one of the largest elements of our cost of doing business, but it is also an asset which we utilize as a source of revenue. We lease over one GHz of total satellite bandwidth across the globe for different frequencies, coverage areas and polarizations. Given our increased demand, we are able to leverage our increased buying power in the satellite provider market, and are often capable of procuring bandwidth at very competitive rates. Accordingly, we leverage our current inventory of capacity or resell our provider’s capacity. We continually attempt to optimize and consolidate bandwidth to ensure attractive margins while being cost-competitive compared to our competitors and competing mediums. This service is a derivative of our base Access line and affords us the ability to provide long-term satellite bandwidth resale opportunities with minimal overall risk.
Access Maritime is technically similar to our Access Plus line but is customized by Telaurus and Evosat SA Proprietary Ltd (“Evosat”) for the maritime industry, and supports traditional narrowband services as well as broadband IP based services. This product provides vessel owners and operators with a diverse range of services, including; e-mail, Internet access, remote network management, on board Wi-Fi, virtual private network and voice over IP applications. Access Maritime utilizes all available technologies from Inmarsat, Iridium, Thuraya, and traditional VSAT providers to provide a full feature set of solutions to the maritime market. We will look to capitalize on the convergence of these various technologies in order to provide a single ubiquitous service to the maritime market that will help drive higher IP throughput at a lower cost to the vessel operator.
Access Hardware products range from VSAT terminals to IP-centric routing hardware and co-location hardware. The ability to offer a complete solution through the Access Hardware product line enables the delivery of our services on a global level. Frequently, our Access Hardware products are shipped, installed and maintained globally. Our Access Hardware product line provides us with the opportunity to offer lifecycle support services for this equipment.
AccessX ® , our new X-Band based service is also technically similar to our Access Plus line, though customized for the military market, and operates on commercial X-Band frequencies. Only recently have commercial X-Band frequencies been made available for use. We can offer X-Band services through our partnership with our Poland teleport operator. We have successfully tested and operated on XTAR and Paradigm X-Band fleets into our TomCat ® product. We are one of the only providers that manufactures microsat terminals and can provide the service into these terminals via our Access X ® service offering.
Hosted services is based on creating scalable application-based solution offerings which provide cost-effective outsource capabilities to niche market segments. Our hosted products are currently positioned to address the needs of the enterprise, media, maritime and wireless vertical markets.
Hosted Cellular allows our customers the ability to outsource their switching services through a full-featured hosted mobile switching center for GSM/UMTS and CDMA/EVDO technologies. The target customer base includes hundreds of small to mid-sized cellular operators in North America, emerging cellular operators globally and large international operators extending their coverage and/or meeting Universal Services Obligations. This particular product is driven by leveraging our core service elements, including:
• Our GSM-UMTS/HSPA Switching/Core Platform
• Our CDMA-EVDO Switching/Core Platform
• Domestic and international connectivity for voice, data and internet
• Our network of Tier 1 IP terrestrial providers at our teleport locations and the interconnectivity between our teleport facilities
• Our large pool of diverse satellite bandwidth coverage, frequencies and providers
• Our centralized global NOC
The hosted value proposition is focused on creating alternative, cost-effective solutions to establish or grow cellular networks while delivering a compelling return on investment with lower capital requirements and operating expenses. In some cases, the hosted model represents the only viable financial model. The solution provides a cost-effective solution to introduce new services and technologies to an existing network (2G to 3G migration, SMS, MMS, etc.) and an affordable solution to deliver cellular services to unserved areas while meeting government-imposed Universal Services Obligations. Lastly, the solution provides an accepted and “trusted” source where large, established cellular operators are comfortable that its roaming customers will interoperate with our hosted customers and are paid under their respective roaming agreements.
We house our mobile switching center in our Kenneth A. Miller International Teleport. The switching systems are part of a complete central office facility that provides all the systems and services required to support a cellular operator. Our satellite solution incorporates mobile signaling but keeps voice traffic off the satellite, which minimizes operational cost, optimizes quality of service for local calling and allows remote geographic areas to join the GSM network with a small investment in base stations and VSATs.
Our Ericsson GSM/UMTS Switching Core (“Core”) positions us to expand this business. The Core will provide a full featured hosted GSM/UMTS (2G/3G) platform to scale the hosted business in North America and internationally with the ability to migrate to LTE (4G) in the future.
Hosted Video minimizes customer capital and operating expenditures and is positioned to address the needs of the enterprise and media market verticals. A key differentiator for us in providing high quality networked service is the ability to leverage our facility in Hauppauge, New York, allowing for outstanding satellite and terrestrial connectivity. This product includes both the hardware for hosting the services and the software platforms for customers to securely publish, process and distribute their content. This solution also allows viewers to interact with the content and provides stakeholders with valuable viewership reporting. The capabilities for our Hosted Video product include:
• Publishing platform for hosting of Video On Demand content
• Media processing infrastructure for the transcoding of live and on-demand content for viewing across hybrid networks and for viewing on televisions, computers and mobile devices
• Security platforms to ensure secure content delivery and digital rights management across diverse networks
• Streaming media platform for delivery across hybrid network topologies
• Interactive platform allowing viewers to interact with live presenters and on-demand content
• Administrative platform providing customers with back office control and reporting
Tempo sm is a hosted terrestrial enterprise media platform that provides enterprises with a single platform to deliver interactive employee communications to a global audience. This product provides a secure platform to publish content, conduct interactive live events, and manage each viewer’s access to programming through the PC, TV, and the mobile handheld world. Tempo’s sm advanced technology operates in a complete browser environment without the need for any additional plugins, applications, or programs to be installed on any device, a true browser-based service. In addition, Tempo sm offers interactive, high quality video broadcasts with integrated polling and chat features, and captures meaningful analytics on viewing behavior and testing results to improve effectiveness of enterprise communications.
Professional Services Line
Our professional services line is primarily provided by Cachendo and ComSource. These companies act as trusted advisors to our government and commercial clients by providing end-to-end technology solutions. We provide these services on either a stand-alone basis, or bundled with other service lines or infrastructure solutions.
Advisory solutions provide engineering expertise for executive level consulting, IT strategic alignment and policy development and enterprise architecture. This service centers on providing the necessary advice to clients on the acquisition and utilization of IT and on business strategy, security, modeling, engineering, operations and change management.
Consulting solutions provide engineering services for customers who need our engineering specialists and program managers to complement their internal staff in systems design and testing, security engineering and integration services.
CEO BACKGROUND
David E. Hershberg founded the Company in 1994 and has been its Chief Executive Officer and Chairman of the Board of Directors since its inception. In addition, Mr. Hershberg was President of the Company from September 2008 to June 2009. From 1976 to 1994, Mr. Hershberg was the President of Satellite Transmission Systems, Inc. (“STS”), a provider of satellite ground segment systems and networks, which he founded and which became a subsidiary of California Microwave, Inc. (“CMI”), and is currently part of Narda Satellite Networks, a subsidiary of L3 Communications Corporation. From 1990 to 1994, Mr. Hershberg also served as Group President of the Satellite Communications Group of CMI, where he also had responsibility for EFData, Inc., a manufacturer of satellite communications modems, and for Viasat Technology Corp., a manufacturer of communications systems that specialized in portable and mobile satellite communications equipment. Mr. Hershberg was a director of Primus Telecommunications Group, Inc. (“Primus”) from 1995 to 2009. Mr. Hershberg holds a B.S. in Electrical Engineering from Rensselaer Polytechnic Institute, an M.S. in Electrical Engineering from Columbia University and an M.S. in Management Science from Stevens Institute of Technology.
Mr. Hershberg brings to the Board of Directors over 50 years of experience in the satellite communications industry. As the founder of the Company, he adds in-depth knowledge, strong leadership capabilities, strategic planning and mergers and acquisitions experience, an understanding of a broad range of technologies and operating expertise. He has founded or was responsible for several satellite communication companies becoming successful. During his 18 years as President and Chief Executive Officer of STS, the company became the global leader and premier company in the field of satellite communications ground station systems. Mr. Hershberg’s prior experience on the Primus board of directors provides the Company with in-depth knowledge on proper board oversight, including valuable perspectives and insights from his prior service on the Primus compensation committee. As an industry pioneer, he serves on numerous industry panels and speaks at many satellite communication conferences.
Keith A. Hall has been President and Chief Operating Officer of the Company since July 2009, and was appointed as a director in July 2009. From June 2008 to June 2009, Mr. Hall served as Senior Vice President and General Manager of Globecomm Network Services, which included Globecomm Network Services Corporation and Globecomm Services Maryland LLC. From 2003 to June 2008, he served as Vice President and General Manager of Globecomm Network Services Corporation. Mr. Hall served as Senior Director of Project Management of Globecomm Network Services Corporation from 2000 to 2003. From 1996 to 1999, Mr. Hall was employed by Globecomm Systems as a Senior Project Engineer. From 1992 to 1996, Mr. Hall was employed by STS as a Systems Engineer. Mr. Hall holds a B.S.E.E. from Auburn University and an M.B.A. from Dowling College.
As President and Chief Operating Officer of the Company, Mr. Hall brings to the Board of Directors business leadership, strategic planning and acquisition and operating experience. With over 19 years of knowledge of the satellite communications industry and his prior role serving as the Company’s Senior Vice President and General Manager of the Company’s Network Services, he has extensive experience in the growing satellite services portion of the Company’s business.
Richard E. Caruso has been a senior executive in the telecommunications and consulting industries. He is currently Vice President of Business Development of GlobalLogic, a research and development services company. Mr. Caruso served as Managing Director, Communications Industry of Tata Consulting Services, an information technology consulting and outsourcing company, during 2008. From 2004 to 2007, Mr. Caruso was Managing Director, Technology, Communications & Media Industries of BearingPoint, Inc., a provider of business consulting, systems integration and managed services. From 2001 to 2003, Mr. Caruso was a Senior Partner at TechLeaders Consulting, LLC, and an information technology consulting company. From 1999 to 2001, Mr. Caruso served as President of Hosting Solutions and Storage Networking at Nortel Networks Corporation, a global supplier of networking solutions and services. From 1994 to 1999, Mr. Caruso served as Vice President and General Manager of Global Solutions for IBM’s Communications Sector. From 1983 to 1994, Mr. Caruso held various senior executive positions with Bellcore/Telcordia, including Corporate Vice President of Technology and Industry Markets. From 1969 to 1983, Mr. Caruso held various positions at AT&T Bell Labs, most recently Executive Director of the Network Provisioning Systems Lab. Mr. Caruso holds a B.S. in Industrial Engineering from Rutgers University and an M.S. in Industrial Engineering from the New Jersey Institute of Technology.
Mr. Caruso’s current role at GlobalLogic brings to the Board of Directors business leadership, strategic planning and a market perspective. His past experience at IBM, along with other senior management positions previously held at Bellcore/Telcordia and Nortel Networks, have given him extensive experience in the communications and information technology industries. This technology experience contributes to the Board of Directors’ understanding of the impact of changing technology on the Company’s business. Mr. Caruso also provides a global business perspective, based on his leadership at IBM. He currently serves as a member of the Company’s Audit, Compensation, Nominating and Corporate Governance Committees.
Harry L. Hutcherson, Jr. has been affiliated with Navigant Consulting, Inc. (formerly, Peterson Consulting) as an independent contract consultant providing financial analytical and business consulting on various large projects since 1992. From 1977 through 1992, Mr. Hutcherson was an audit partner of Arthur Andersen LLP. Mr. Hutcherson is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants, the Greater Washington Society of Certified Public Accountants and the Virginia State Society of Certified Public Accountants. Mr. Hutcherson holds a B.S. in Accounting from the University of Richmond.
Mr. Hutcherson brings financial expertise to the Board of Directors as a former senior partner at a major international accounting firm. With his financial analytical and business consulting experience, he also brings significant management expertise to the Board of Directors. Mr. Hutcherson was nominated to serve as a director on the Company’s Board of Directors due to his extensive experience in business, finance, accounting and auditing, SEC reporting, public company management and mergers and acquisitions. Additionally, he provides the Board of Directors with consulting on risk management and fraud controls. He currently serves as the Chairman and financial expert of the Company’s Audit Committee, and is a member of the Company’s Strategy Committee.
Brian T. Maloney is currently an independent consultant in the technology and telecommunications industries. Mr. Maloney served as Chief Executive Officer of Ygomi LLC, a private equity firm, from October 2008 through October 2009. From May 2006 to January 2008, Mr. Maloney was President of Global Industries at Unisys Corporation, a worldwide information technology consulting services and solutions company. Prior to joining Unisys Corporation, Mr. Maloney was an independent consultant in the telecommunications industry from January 2005 to April 2006. From 2002 to September 2004, Mr. Maloney served as Chief Operating Officer for Perot Systems Corporation. From 1978 to 2002, Mr. Maloney held various positions with AT&T, most recently as Senior Vice President of AT&T, and as President and Chief Executive Officer of AT&T Solutions. Mr. Maloney received a B.S. in English from Hunter College and an M.A. in English from Columbia University.
As a former president and chief executive officer of AT&T Solutions, Mr. Maloney brings to the Board of Directors business leadership, strategic planning, human resources and operating experience from a large diversified company. Based on his past experiences at AT&T Solutions and as an independent consultant in the technology and telecommunications sector, he has extensive experience in the communications industry. Mr. Maloney also provides a global business perspective, based on his leadership role in global business operations at Unisys Corporation. Mr. Maloney’s recent role at a private equity firm provides the Board of Directors with capital markets, mergers and acquisitions and corporate finance expertise. He currently serves as a member of the Company’s Audit, Compensation and Strategy Committees and is Chairman of the Company’s Nominating and Corporate Governance Committee.
Jack A. Shaw is currently retired. He held various positions at Hughes Electronics Corporation (“Hughes”) from 1998 to December 2003, most recently as its President and Chief Executive Officer and as a member of its board of directors. From 1998 to 2001, Mr. Shaw served as Senior Executive Vice President of Hughes. Mr. Shaw is currently a director of Sirius XM Radio Inc. (“Sirius XM”) and is a senior member of the Institute of Electrical and Electronics Engineers. He is also on the Board of Trustees of Trine University. Mr. Shaw holds a B.S. in Electrical Engineering from Purdue University.
As a former president and chief executive officer of Hughes, Mr. Shaw brings to the Board of Directors business leadership and strategic planning, mergers and acquisitions and international operating experience. With his past experience at Hughes, and as a current director of Sirius XM, a large satellite radio company and a publicly-traded company, he has extensive experience in the satellite communications industry. His current role on the Sirius XM board of directors provides the Company with in-depth knowledge on proper board oversight, as well as valuable perspectives and insights from his service on their nominating and corporate governance and compensation committees. He currently serves as a member of the Company’s Compensation, Nominating and Corporate Governance and Strategy Committees.
A. Robert Towbin has been the Executive Vice President of Stephens Inc. since 2006, prior to which he served as a Managing Director from December 2001 to 2005. From 2000 to 2001, he was Co-Chairman of C.E. Unterberg, Towbin Co. and from 1995 to 1999 was Senior Managing Director of C.E. Unterberg, Towbin. From 1994 to 1996, Mr. Towbin was President and Chief Executive Officer of the Russian-American Enterprise Fund, a U.S. government-owned investment fund, and later, Vice Chairman of its successor fund, the U.S. Russia Investment Fund. Mr. Towbin was a Managing Director of Lehman Brothers and Co-Head of High Technology Investment Banking from 1987 to 1994. From 1959 to 1987, Mr. Towbin was Vice Chairman and a Director of L.F. Rothschild, Unterberg, Towbin Holdings Inc. and its predecessor companies. Mr. Towbin served on the board of directors of Gerber Scientific, Inc. from 1992 to 2007 and North Fork Bancorporation, Inc. from 2004 to 2006. Mr. Towbin holds a B.A. from Dartmouth College.
With over 50 years of experience in investment banking, Mr. Towbin brings to the Board of Directors relevant experience in the areas of capital markets, finance, executive leadership and mergers and acquisitions and broad international business exposure. Mr. Towbin’s prior experience on the board of directors of a number of other public companies provides the Company with in-depth knowledge on proper board oversight. With over 14 years of service, he also provides continuity to the Board of Directors.
C. J. Waylan acts as an advisor to telecommunication and satellite companies. Dr. Waylan served as Executive Vice President for GTE Mobilnet and President of GTE Spacenet Corporation (collectively, “GTE”) until his retirement in 1996. From 1996 to 1997, he was Executive Vice President of NextWave Telecom, Inc., a start-up provider of wireless communications and from 1997 to 2006, he was President and Chief Executive Officer of CCI International, NV, a mobile satellite communications company. Dr. Waylan was a member of the board of directors of Radyne Corporation (“Radyne”) from 2000 to 2008 and Chairman from 2006 to 2008 and a director of CCI International, NV from 1997 to 2006. He holds a B.S. from the University of Kansas as well as an M.S. in Electrical Engineering and a Ph.D. from the Naval Postgraduate School.
Based on Dr. Waylan’s prior executive officer roles at GTE, he brings to the Board of Directors industry experience, business leadership, strategic planning, human resources and mergers and acquisitions and operating experience. As a former Chairman of the board of directors of Radyne, a publicly-traded company, Dr. Waylan brings to the Board of Directors relevant experience in the areas of operations, management, finance, executive leadership, strategic planning and corporate governance. He also brings to the Board of Directors valuable perspectives and insights from his prior service on Radyne’s corporate governance and nominating committee and compensation committee. With over 14 years of service, he also provides continuity to the Board of Directors. He currently serves as a member of the Company’s Audit, Compensation and Nominating and Corporate Governance Committees, and is the Chairman of the Company’s Strategy Committee.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
Our business is global and subject to technological and business trends in the telecommunications marketplace. We derive much of our revenue from the government marketplace and developing countries. Our business is therefore affected by geopolitical developments involving areas of the world in which our customers are located, particularly in developing countries and areas of the world involved in armed conflicts, which directly impacts our military-related sector business. Our business may also be affected by the government’s budgetary issues and its recent efforts to reduce the national deficit and defense spending, which may have a significant effect on our results of operations.
The products and services we offer include: pre-engineered products, systems design and integration services, access, hosted, and lifecycle support services. To provide these products and services, we engineer all the necessary satellite and terrestrial facilities as well as provide the integration services required to implement those facilities. We also operate and maintain managed networks and provide life cycle support services on an ongoing basis. Our customers generally have network service requirements that include point-to-point or point-to-multipoint connections via a hybrid network of satellite and terrestrial facilities. In addition to the government marketplace, these customers are communications service providers, commercial enterprises and media and content broadcasters.
Since our products and services are often sold into areas of the world which do not have fiber optic land-based networks, a substantial portion of our revenues are derived from, and are expected to continue to be derived from, developing countries. These countries carry with them more enhanced risks of doing business than in developed areas of the world, including the possibility of armed conflicts or the risk that more advanced land-based telecommunications will be implemented over time, and less developed legal protection for intellectual property.
In the year ended June 30, 2011, 19% of our consolidated revenues and 28% of our services revenues were derived from Northrop. The U.S. Government’s prime contract with Northrop, under which we served as a subcontractor, will expire in February 2012 and will be replaced with a prime contract under which we are providing similar services as a subcontractor to another subcontractor. Although the identity of customers and contracts may vary from period to period, we have been, and expect to continue to be, dependent on revenues from a small number of customers or contracts in each period in order to meet our financial goals. From time to time these customers are located in developing countries or otherwise subject to unusual risks.
As a consequence of the worldwide financial and economic crisis and continuing business downturn that has occurred during the past several years, our customers have reduced and may continue to reduce their budgets for spending on equipment and systems, which has impacted our infrastructure segment revenues, resulting in an operating loss in this segment in the years ended June 30, 2011, 2010 and 2009. We are also experiencing a shift in our infrastructure business from numerous smaller orders to ones that are larger and include various milestones which affect revenue recognition. This may result in more significant quarter-to-quarter shifts in revenues from this segment in the future. We expect an increase in revenues from this segment in the fiscal 2012 as a result of this shift.
Our cash provided by operating activities was negatively impacted in fiscal years ended June 30, 2011 and 2010 due to the increase in inventories and the payment of accounts payable during the current period. This increase was the result of inventory purchases related to a significant contract in the infrastructure business which is now expected to be shipped in fiscal 2012. We have not recognized certain revenues from this contract as a result of not yet achieving certain contract milestones. Moreover, this contract carries an unusually low margin which will negatively impact our gross margin in fiscal 2012 as milestones are reached.
Revenues related to contracts for infrastructure solutions and services have been fixed-price contracts in a majority of cases. Profitability of such contracts is subject to inherent uncertainties as to the cost of performance. Cost overruns may be incurred as a result of unforeseen obstacles, including both physical conditions and unexpected problems encountered in engineering design and testing. Since our business is frequently concentrated in a limited number of large contracts, a significant cost overrun on any contract could have a material adverse effect on our business, financial condition and results of operations. Revenue and gross margin may also be affected by our recent $74.1 million contract with a U.S. Government Agency, which carries a lower margin due to the competitive landscape.
Contract costs generally include purchased material, direct labor, overhead and other direct costs. Anticipated contract losses are recognized, as they become known. Costs from infrastructure solutions consist primarily of the costs of purchased materials (including shipping and handling costs), direct labor and related overhead expenses, project-related travel and living costs and subcontractor costs. Costs from services consist primarily of satellite space segment charges, voice termination costs, network operations expenses and Internet connectivity fees. Satellite space segment charges consist of the costs associated with obtaining satellite bandwidth (the measure of capacity) used in the transmission of services to and from the satellites leased from operators. Network operations expenses consist primarily of costs associated with the operation of the network operations center on a 24 hour a day, seven-day a week basis, including personnel and related costs and depreciation. Selling and marketing expenses consist primarily of salaries, travel and living costs for sales and marketing personnel. Research and development expenses consist primarily of salaries and related overhead expenses. General and administrative expenses consist of expenses associated with our management, finance, contract, and administrative functions, as well as amortization of intangible assets.
Critical Accounting Policies
Certain of our accounting policies require judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, terms of existing contracts, our observance of trends in the industry, information provided by our customers, and information available from other outside sources, as appropriate. Actual results may differ from these judgments under different assumptions or conditions. Our accounting policies that require management to apply significant judgment include:
Revenue Recognition — Infrastructure Solutions
We recognize revenue for our production-type contracts that are sold separately as standard satellite ground segment systems when persuasive evidence of an arrangement exists, the selling price is fixed or determinable, collectability is reasonably assured, delivery has occurred and the contractual performance specifications have been met. Our standard satellite ground segment systems produced in connection with these contracts are typically short-term (less than twelve months in term) and manufactured using a standard modular production process. Such systems require less engineering, drafting and design efforts than our long-term complex production-type projects. Revenue is recognized on our standard satellite ground segment systems upon shipment and acceptance of factory performance testing which is when title transfers to the customer. The amount of revenues recorded on each standard production-type contract is reduced by the customer’s contractual holdback amount, which typically requires 10% to 30% of the contract value to be retained by the customer until installation and final acceptance is complete. The customer generally becomes obligated to pay 70% to 90% of the contract value upon shipment and acceptance of factory performance testing. Installation is not deemed to be essential to the functionality of the system since installation does not require significant changes to the features or capabilities of the equipment, does not require complex software integration and interfacing and we have not experienced any difficulties installing such equipment. In addition, the customer or other third party vendors can install the equipment. The estimated value of the installation services is determined by management, which is typically less than the customer’s contractual holdback percentage. If the holdback is less than the estimated value of installation, we will defer recognition of revenues, determined on a contract-by-contract basis equal to the estimated value of the installation services. Payments received in advance by customers are deferred until shipment and are presented as deferred revenues.
We recognize revenue using the percentage-of-completion method of accounting upon the achievement of certain contractual milestones, 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 from Infrastructure Solutions
Costs related to our production-type contracts and our non-standard, complex production-type contracts rely on estimates based on total expected contract costs. 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’s 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 and Other Intangibles Assets
Goodwill represents the excess of the purchase price of businesses over the fair value of the identifiable net assets acquired. The amount of goodwill recorded in our balance sheet has significantly increased over the recent past as we have made several acquisitions. Goodwill and other indefinite life intangible assets are 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 services segment. There have been no events during the year ended June 30, 2011 that resulted in the impairment of any goodwill or other intangible assets.
Deferred tax assets
We regularly estimate our ability to recover deferred income taxes, report such deferred tax assets at the amount that is determined to be more-likely-than-not recoverable, and we have to estimate our income taxes in each of the taxing jurisdictions in which we operate. This process involves estimating our current tax expense together with assessing any temporary differences resulting from the different treatment of certain items, such as the timing for recognizing revenue and expenses for tax and accounting purposes. These differences may result in deferred tax assets and liabilities, which are included in our consolidated balance sheets.
We are required to assess the likelihood that our deferred tax assets, which include net operating loss carry forwards and temporary differences that are expected to be deductible in future years, will be recoverable from future taxable income or other tax planning strategies. If recovery is not likely, we have to provide a valuation allowance based on our estimates of future taxable income in the various taxing jurisdictions, and the amount of deferred taxes that are ultimately realizable. The provision for current and deferred taxes involves evaluations and judgments of uncertainties in the interpretation of complex tax regulations. This evaluation considers several factors, including an estimate of the likelihood of generating sufficient taxable income in future periods, the effect of temporary differences, the expected reversal of deferred tax liabilities and available tax planning strategies.
At June 30, 2011 and June 30, 2010, we had a liability for unrecognized tax benefits of approximately $1.4 million and $1.1 million, respectively which if recognized in the future, would favorably impact our effective tax rate.
We record both accrued interest and penalties related to income tax matters, if any, in the provision for income taxes in the accompanying consolidated statements of operations. At June 30, 2011 and June 30, 2010 we had not accrued any amounts for the potential payment of penalties and interest.
Stock-Based Compensation
Stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the appropriate vesting period. Determining the fair value of stock-based awards at the grant date requires judgment, including estimating the expected term of stock options and the expected volatility of our stock. In addition, judgment is required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates or different key assumptions were used, it could have a material effect on our consolidated financial statements.
As of June 30, 2011 there was approximately $3.7 million of unrecognized compensation cost related to non-vested stock-based compensation related to the restricted shares and restricted share units. The cost is expected to be recognized over a weighted-average period of 1.8 years. As of June 30, 2011 there was approximately $240,000 of unrecognized compensation cost related to non-vested outstanding stock options. The cost is expected to be recognized over a weighted-average period of 3.1 years.
Allowances for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We assess the customer’s ability to pay based on a number of factors, including our past transaction history with the customer and the 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.
Valuation of contingent consideration
We maintain a liability for contingent consideration related to potential earn-out payments to the former shareholders of C2C, Evocomm and ComSource if certain milestones are met. These amounts are estimated based on a number of factors including likelihood of meeting those milestones based on forecasted results. We review these estimates and updated forecasts on a quarterly basis and record adjustments as required. In the year ended June 30, 2011, we recorded expense of approximately $4.8 million in operating results relating to increases in these estimates.
Recent Accounting Pronouncements
On July 1, 2009 the Company adopted the accounting pronouncement relating to business combinations, including assets acquired and liabilities assumed arising from contingencies. Changes for business combination transactions pursuant to this pronouncement include, among others, expensing acquisition-related transaction costs as incurred, the recognition of contingent consideration arrangements at their acquisition date fair value and capitalization of in-process research and development assets acquired at their acquisition date fair value. The adoption of this pronouncement resulted in the inclusion of acquisition related costs of $468,000 and $940,000 in general and administrative expenses in the year ended June 30, 2011 and 2010, respectively.
In October 2009, the FASB issued Accounting Standards Update No. 2009-13, Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”) which updates ASC Topic 605-25, Multiple Elements Arrangements, of the FASB codification. ASU 2009-13 provides new guidance on how to determine if an arrangement involving multiple deliverables contains more than one unit of accounting, and if so allows companies to allocate arrangement considerations in a manner more consistent with the economics of the transaction. ASU 2009-13 was effective for the Company, for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The adoption of this pronouncement did not have a material impact on the financial condition or results of operations for the year ended June 30, 2011.
In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 requires new disclosures regarding transfers in and out of the Level 1 and 2 and activity within Level 3 fair value measurements and clarifies existing disclosures of inputs and valuation techniques for Level 2 and 3 fair value measurements. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosure of activity within Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010, and for interim periods within those years. This update did not have a material impact on the Company’s fair value disclosures.
In April 2010, the FASB issued ASU 2010-13, Compensation — Stock Compensation (Topic 718) - Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades (A Consensus of the FASB Emerging Issues Task Force) (“ASU 2010-13”). ASU 2010-13 clarifies that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, such an award should not be classified as a liability if it otherwise qualifies as equity. This clarification of existing practice is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010, with early application permitted. The adoption of this pronouncement will not have a material impact on the consolidated financial condition or results of operations.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
Our business is global and subject to technological and business trends in the telecommunications marketplace. We derive much of our revenue from the government marketplace and developing countries. Our business is therefore affected by geopolitical developments involving areas of the world in which our customers are located, particularly in developing countries and areas of the world involved in armed conflicts, which directly impacts our military-related sector business. Our business may also be affected by the government’s budgetary issues and its recent efforts to reduce the national deficit and defense spending, which may have a significant effect on our results of operations.
The services and products we offer include: access, hosted, and lifecycle support services, pre-engineered products, systems design and integration products. To provide these services and products, we engineer all the necessary satellite and terrestrial facilities as well as provide the integration services required to implement those facilities. We also operate and maintain managed networks and provide life cycle support services on an ongoing basis. Our customers generally have network service requirements that include point-to-point or point-to-multipoint connections via a hybrid network of satellite and terrestrial facilities. In addition to the government marketplace, these customers are communications service providers, commercial enterprises and media and content broadcasters.
Since our services and products are often sold into areas of the world which do not have fiber optic land-based networks, a substantial portion of our revenues are derived from, and are expected to continue to be derived from, developing countries. These countries carry with them more enhanced risks of doing business than in developed areas of the world, including the possibility of armed conflicts or the risk that more advanced land-based telecommunications will be implemented over time, and less developed legal protection for intellectual property.
As a consequence of the worldwide financial and economic crisis and continuing business downturn that has occurred during the past several years, our customers have reduced and may continue to reduce their budgets for spending on equipment and systems, which has impacted our infrastructure segment revenues, resulting in an operating loss in this segment in the nine months ended March 31, 2012 and in the years ended June 30, 2011, 2010 and 2009. We are also experiencing a shift in our infrastructure business from numerous smaller orders to ones that are larger and include various milestones which affect revenue recognition. This may result in more significant quarter-to-quarter shifts in revenues from this segment in the future. We experienced a significant increase in revenues from this segment in the fiscal 2012 as a result of this shift, although these larger contracts often carry lower gross margins.
In the three months ended March 31, 2012, 21% of our revenues were derived from products sold to the US Army CECOM. In the nine months ended March 31, 2012, 19% and 12% of our revenues were derived from US Army CECOM and Northrop Grumman Information Technologies Inc. (“Northrop”), respectively. The multi-year, $74 million agreement with US Army CECOM (“Contract A”) is a pass-through subcontract entailing little risk of unexpected costs and under which we earn comparatively low profit margins. The U.S. Government’s prime contract with Northrop, under which we served as a subcontractor and with respect to which our profit margin has been significantly above our norm, expired in February 2012. We have entered into a service contract, with an initial term ending December 31, 2013, with the subcontractor under the U.S. Government’s contract with Northrop’s successor for the next phase of this program, and under which we expect to continue to provide similar services, albeit at a somewhat lower profit margin. Although the identity of customers and contracts may vary from period to period, we have been, and expect to continue to be, dependent on revenues from a small number of customers or contracts in each period in order to meet our financial goals. From time to time these customers are located in developing countries or otherwise subject to unusual risks.
In a majority of cases, revenues related to contracts for infrastructure solutions and services have been fixed-price contracts. The profitability of such contracts is subject to inherent uncertainties as to the cost of performance. Cost overruns may be incurred as a result of unforeseen obstacles, including both physical conditions and unexpected problems encountered in engineering design and testing. Since our business is frequently concentrated in a limited number of large contracts, a significant cost overrun on any single contract could have a material adverse effect on our business, financial condition and results of operations. In the three and nine months ended March 31, 2012, we recorded $0.4 million and $1.5 million, respectively, for additional costs incurred on a fixed-price contract in the infrastructure segment (“Contract B”). The additional costs were due in large part to unexpected difficulties associated with engineering and production issues. The revenues associated with Contract B are expected to be recognized toward the end of fiscal 2012 and in fiscal 2013 and will have no profit margin associated with them, which has negatively impacted our gross margin percentage in the three and nine months ended March 31, 2012 and which will negatively impact our gross margin percentage in the remainder of fiscal 2012 and fiscal 2013 as milestones are reached.
While our cash provided by operating activities has improved and reflects more normalized results in the nine months ended March 31, 2012, our cash provided by operating activities was negatively impacted in fiscal years ended June 30, 2011 and 2010 due to the increase in inventories and the payment of accounts payable. This increase was the result of inventory purchases related to Contract B, which is now expected to be shipped in later in fiscal 2012 and 2013. We have not recognized certain revenues from this contract as a result of not yet achieving certain contract milestones. As we recognize revenues from Contract B in the future, our cash provided by operating activities is expected to continue to normalize and significantly improve. However, due in large part to engineering and production issues in connection therewith, no margin is being generated under Contract B, which has negatively impacted our gross margin percentage in the three and nine months ended March 31, 2012 and which will negatively impact our gross margin percentage in the remainder of fiscal 2012 and fiscal 2013 as milestones are reached.
Contract costs generally include purchased material, direct labor, overhead and other direct costs. Anticipated contract losses are recognized, as they become known. Costs from infrastructure solutions consist primarily of the costs of purchased materials (including shipping and handling costs), direct labor and related overhead expenses, project-related travel and living costs and subcontractor costs. Costs from services consist primarily of satellite space segment charges, voice termination costs, network operations expenses and Internet connectivity fees. Satellite space segment charges consist of the costs associated with obtaining satellite bandwidth (the measure of capacity) used in the transmission of services to and from the satellites leased from operators. Network operations expenses consist primarily of costs associated with the operation of the network operations center on a twenty-four hour a day, seven-day a week basis, including personnel and related costs and depreciation. Selling and marketing expenses consist primarily of salaries, travel and living costs for sales and marketing personnel. Research and development expenses consist primarily of salaries and related overhead expenses. General and administrative expenses consist of expenses associated with our management, finance, contract, and administrative functions, as well as amortization of intangible assets.
Critical Accounting Policies
Certain of our accounting policies require judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, the terms of existing contracts, our observance of trends in the industry, information provided by our customers, and information available from other outside sources, as appropriate. Actual results may differ from these judgments under different assumptions or conditions. Our accounting policies that require management to apply significant judgment include:
Revenue Recognition—Infrastructur e Solutions
We recognize revenue for our production-type contracts that are sold separately as standard satellite ground segment systems when persuasive evidence of an arrangement exists, the selling price is fixed or determinable, collectability is reasonably assured, delivery has occurred and the contractual performance specifications have been met. Our standard satellite ground segment systems produced in connection with these contracts are typically short-term (less than twelve months in term) and manufactured using a standard modular production process. Such systems require less engineering, drafting and design efforts than our long-term complex production-type projects. Revenue is recognized on our standard satellite ground segment systems upon shipment and acceptance of factory performance testing which is when title transfers to the customer. The amount of revenues recorded on each standard production-type contract is reduced by the customer’s contractual holdback amount, which typically requires 10% to 30% of the contract value to be retained by the customer until installation and final acceptance is complete. The customer generally becomes obligated to pay 70% to 90% of the contract value upon shipment and acceptance of factory performance testing. Installation is not deemed to be essential to the functionality of the system since installation does not require significant changes to the features or capabilities of the equipment, does not require complex software integration and interfacing and we have not experienced any difficulties installing such equipment. In addition, the customer or other third party vendors can install the equipment. The estimated value of the installation services is determined by management, which is typically less than the customer’s contractual holdback percentage. If the holdback is less than the estimated value of installation, we will defer recognition of revenues, determined on a contract-by-contract basis equal to the estimated value of the installation services. Payments received in advance by customers are deferred until shipment and are presented as deferred revenues.
We recognize revenue using the percentage-of-completion method of accounting upon the achievement of certain contractual milestones, 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.
The Company enters into multiple-element arrangements with its customers including hardware, engineering solutions, professional services and maintenance services. For arrangements involving multiple deliverables, the Company evaluates and separates each deliverable to determine whether it represents a separate unit of accounting based on whether the delivered item has value to the customer on a stand-alone basis. Consideration is allocated to each deliverable based on the item’s relative selling price. The Company uses a hierarchy to determine the selling price to be used to allocate revenue to each deliverable as follows: (i) vendor-specific objective evidence of the selling price; (ii) third party evidence of selling price; and (iii) best estimate of selling price.
Costs from Infrastructure Solutions
Costs related to our production-type contracts and our non-standard, complex production-type contracts rely on estimates based on total expected contract costs. 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’s 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 and Other Intangible Assets Impairment
Goodwill represents the excess of the purchase price of businesses over the fair value of the identifiable net assets acquired. The amount of goodwill recorded in our balance sheet has significantly increased over the recent past as we have made several acquisitions. Goodwill and other indefinite life intangible assets are 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 services segment. There have been no events during the nine months ended March 31, 2012 that would indicate that the goodwill and indefinite life intangible assets were impaired.
Deferred Income Taxes
We regularly estimate our ability to recover deferred income taxes, report such deferred tax assets at the amount that is determined to be more-likely-than-not recoverable, and we have to estimate our income taxes in each of the taxing jurisdictions in which we operate. This process involves estimating our current tax expense together with assessing any temporary differences resulting from the different treatment of certain items, such as the timing for recognizing revenue and expenses for tax and accounting purposes. These differences may result in deferred tax assets and liabilities, which are included in our consolidated balance sheets.
We are required to assess the likelihood that our deferred tax assets, which include net operating loss carry forwards and temporary differences that are expected to be deductible in future years, will be recoverable from future taxable income or other tax planning strategies. If recovery is not likely, we have to provide a valuation allowance based on our estimates of future taxable income in the various taxing jurisdictions, and the amount of deferred taxes that are ultimately realizable. The provision for current and deferred taxes involves evaluations and judgments of uncertainties in the interpretation of complex tax regulations. This evaluation considers several factors, including an estimate of the likelihood of generating sufficient taxable income in future periods, the effect of temporary differences, the expected reversal of deferred tax liabilities and available tax planning strategies.
At March 31, 2012 and June 30, 2011 we had a liability for unrecognized tax benefits of approximately $1,449,000 and $1,423,000, respectively, which if recognized in the future, would favorably impact our effective tax rate.
Stock-Based Compensation
Stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the appropriate vesting period. Determining the fair value of stock-based awards at the grant date requires judgment, including estimating the expected term of stock options and the expected volatility of our stock. In addition, judgment is required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates or different key assumptions were used, it could have a material effect on our consolidated financial statements.
As of March 31, 2012, there was approximately $173,000 of unrecognized compensation cost related to unvested outstanding stock options. The cost is expected to be recognized over a weighted-average period of 2.5 years. As of March 31, 2012, there was approximately $5,416,000 of unrecognized compensation cost related to unvested stock-based compensation related to restricted shares. The cost is expected to be recognized over a weighted-average period of 1.9 years.
Allowances for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We assess the customer’s ability to pay based on a number of factors, including our past transaction history with the customer and the 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.
Valuation of Contingent Consideration
We maintain a liability for contingent consideration related to potential earn-out payments to the former shareholders of ComSource if certain milestones are met. These amounts are estimated based on a number of factors including, likelihood of meeting those milestones based on forecasted results. We review these estimates and updated forecasts on a quarterly basis and record adjustments as required. In the three and nine months ended March 31, 2012, we recorded expense of approximately $2,829,000 and a gain of approximately $7,745,000, respectively, in operating results due to fair value adjustments on the earn-out liability related to ComSource acquisition. The expense in the three months ended March 31, 2012 was due to the achievement of certain revenue milestones. The unforeseen loss of funding on a program in September 2011 and reduction in the forecasted results due to delays in funding of new programs in the six months ended December 31, 2011, was partially offset by the achievement of certain revenue milestones in the three months ended March 31, 2012, and resulted in the fair value gain of $7,745,000 in the nine months ended March 31, 2012.
Recent Accounting Pronouncements
In April 2010, the FASB issued ASU 2010-13, Compensation—Stock Compensation (Topic 718)—Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades (A Consensus of the FASB Emerging Issues Task Force) (“ASU 2010-13”). ASU 2010-13 clarifies that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, such an award should not be classified as a liability if it otherwise qualifies as equity. This clarification of existing practice is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010, with early application permitted. The adoption of this pronouncement did not have a material impact on our consolidated financial condition or results of operations.
In September 2011, the FASB issued amended guidance related to Intangibles—Goodwill and Other: Testing Goodwill for Impairment. The amendment is intended to simplify how entities test goodwill for impairment. The amendment permits an entity to first assess qualitative factors to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The more-likely-than-not threshold is defined as having a likelihood of more than 50%. This amendment is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. We do not believe that this guidance will have a material impact on our consolidated financial condition or results of operations.
CONF CALL
Matthew Byron
Thank you, Katy. Good morning, everyone. Welcome to the Globecomm Systems Fiscal 2011 First Quarter Earnings Conference Call. Joining me today from the company is our Chairman and CEO, David Hershberg; President and COO, Keith Hall; and our CFO, Andrew Melfi.
Last night, after the closing bell, Globecomm issued its fiscal 2011 first quarter earnings press release. In the event you have not received or seen a copy of the release, it is posted on the Globecomm System’s website at www.globecommsystems.com or you can contact me at (631) 457-1301, and I will send a copy to you.
Comments made during this call may contain projections or other forward-looking statements regarding future events or the future financial performance of Globecomm Systems. These statements are only projections and reflect the current beliefs and expectations of the company. Actual events or results may differ materially. With that said, it is routine for internal projections and expectations to change as quarters progress.
All forward-looking statements are based on the information available to the company on the date hereof, and the company assumes no obligation to update such statements. Please refer to the documents the company files from time to time with the SEC, specifically the company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q and its current reports on Form 8-K and the Safe Harbor language contained in the company’s press releases.
These documents contain and identify important factors that could cause the company’s actual results to differ materially from those contained in these projections or forward-looking statements, which the company urges all investors to consider. Globecomm undertakes no obligation to publicly release the revisions for such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Please note that this call is being recorded on Friday, November 5, 2010, contains time-sensitive information and will be available as a webcast replay for at least nine months on the Investor Relations section of the Globecomm Systems website and as a phone replay at 1 (888) 203-1112 for domestic callers or (719) 457-0820 for international callers, with an access code of 8435331.
At this point, I’d like to turn the call over to our Chairman and CEO, Dave Hershberg. Dave?
David Hershberg
Well, thank you, Matt, and good morning, everyone, and welcome to our Fiscal 2011 First Earnings Conference Call. Despite a continuing challenging environment, Globecomm announced its 26th consecutive quarter of profitability and also record guidance demonstrating the diversity of the company’s business model.
Globecomm’s ability to provide complete end to end solutions for both infrastructure and service continues to provide good value to our customers. The company continues to invest heavily in new product and service offering across all our vertical markets and looks forward to making various announces to this front at various points throughout this current year, and I’ll also – you can see by recent announcements a lot of these are paying off.
As outlined in our Q4 conference call, we anticipated a live infrastructure segment revenue in Q1 with continued strength throughout the fiscal year. Infrastructure bookings have been robust as demonstrated by continued recent announcements further enhancing the company’s ability to maintain our record guidance. Our backlog for both the infrastructure and service level are at record levels.
A particular note is our continued bookings in Ka-Band infrastructure, including this very important $80 million Jupiter contract we used and an $8.7 million project for Ka-Band military infrastructure. We’re working on providing a complete line of Ka-Band products in anticipation of new Ka-Band satellites for both military and commercial.
In addition, we have a number of proposals in the media infrastructure market including a recent contracts announcement per systems in the Asia-Pacific region. We’re also very excited by our first contract for our AxxSys Orion Monitoring Control software product, which we have invested heavily over the past three years, and this comes as part of recent important U.S. government bookings.
On the service side, we’re continue to book cellular and government service contracts with very little churn with our existing customers. With significant increases in voice and data traffic on our CSM and CDMA hosted service switch platforms and our increase in maritime contracts, we’re performing well on all of our verticals. We are pleased with the 67% increase in earnings per share as compared to Q1 last year and a 59% increase in adjusted EBITDA over the same time period.
At further discussion the Q4 conference call, the balance sheet remains very strong even though the timing of our cash collections relating to a major product in NATO has been very slow.
With that said, we have ample cash and a line of credit to execute against our existing acquisition strategy. Keith will now take you through the company’s five existing protocols including some very exciting recent announcements and then Andy will drove down into the numbers.
At this point, I want to turn the call over to Keith.
Keith Hall
Thanks, Dave. Good morning, everyone. It’s been a great start to the new fiscal year. Recurring services remain our focal point for growth and related revenues increased over 50% from the same period last year. With our recent acquisitions C2C and Evosat performing well and contributing as expected.
Of the $42.9 million in services revenue, $39 million is recurring in nature with organic growth continuing to be fueled by existing customer expansion. Our acquisitions as a whole are performing very well and we are continuing a long-term strategy of functional integration to create synergies as we expand as a global solutions company.
We are pleased with our balance of organic and external growth and we continue to pursue acquisition opportunities leveraging our strong balance sheet and available line of credit through Citibank, which currently avoids us with a favorable interest rate environment.
We are executing well in all areas of the business and are pleased by the strength of recent infrastructure bookings highlighted by those within the media and government verticals.
Over the last few calls, I’ve been providing updates on our market vertical base activity and I would like to continue that trend by highlighting some of our recent contract awards and market-based initiatives. We are very much focus on growing our share of the media market vertical and we’re off to a good start this year with approximately $15 million in related infrastructure base awards to date.
We are addressing a growing set of qualified media center opportunities in Asia-Pacific, Middle East and South America including DTH, studios, IPTV and possible hosting opportunities and we believe these trends will continue.
Within services, we continue to press on with hosted-based offerings for linear and on-demand content. We are looking forward to competing for new business in the Enterprise market with our recently launched Tempo software as the service offering. We expect several RFPs for the service to be competed over the next few quarters.
Within the wireless market sector, we signed several new contracts to support U.S. based hosted services and our mobile operators are now successfully generating over 3.5 million minutes per month and processing over 100 gigabytes of data.
New wireless contracts were highlighted by networks in Central and Eastern Texas and the addition of several gold-foiled platforms. We also expanded our network support in Afghanistan with the implementation of new secure switches for the U.S. government.
With the success of our U.S. based marketing push including our annual tech forum and the recent 4G show in Chicago coupled with a strong value proposition, we are seeing a steady flow of new opportunities in this market.
There have been a number of significant developments for the Globecomm in the Maritime market during the first quarter. The supported fleet size has grown at further 10% from last quarter and we now support in excess of 2,400 ships globally. The transition from narrow brand to broadband continuous to gather momentum with broadband now accounting for 30% of all activations and approximately 25% of the total fleet is now on this service.
This was highlighted by awards from a major German shipment operator to upgrade its entire fleet of 52 vessels to broadband service and a program with the South African Navy.
Product development continues to focus on enhancing the services that can be provided over the broadband network. In the first quarter saw the launch of se@REMOTE, which enable ship owners and operators to diagnose ship board IT problems remotely from their shore-based facilities saving considerable time and money that would otherwise be spent on a ranging ship visits.
Further, software developments will be forthcoming by the middle of Q2. Our order switching solution is complete and operational and we will be demonstrating our capabilities at the Digital Ships Trade Show in Athens on December 1st and 2nd.
The government market remains strong highlighted by our efforts to support our deployed government and military personnel with global access and infrastructure solutions. We expect our government commercial business mix to remain in line with last year’s results, which were approximately 60% government-related.
Within the government market, we project less than 10% of our revenues to be DOD-related in FY ‘11. I highlight this metric as many are concerned about potential government budget cuts. Globecomm, obviously, relies on an extremely small percentage of the overall defense budget and we do not see our market positions threatened by talks of cutbacks.
The majority of what we define as government business is diplomatic and foreign-aid agencies, civilian agencies and foreign government work. This area of the business continues to grow. We expect the overall available government spending budget to remain fairly constant with some change in mix between DOD and non-DOD entities as the draw down in Iraq and transitions the stability operations in Afghanistan transpires.
As Dave mentioned earlier, new contracts were highlighted by a recently announced Ka-Band infrastructure award from Hughes Corporation. We look forward to becoming the industry leader and supporting Ka-Band network rollouts over the next few years.
We were also awarded several government contracts that significantly increase the deployed footprint of our AxxSys Orion Network Management software product. AxxSys Orion’s distributed architecture provides a true global enterprise solution with asset management down to the desktop. These awards showcase our evolving vision of combining our products and services for our customers under a unified Globecomm as a managed network services company.
As Dave mentioned earlier, we remain on plan our holding guidance at this time. We believe results will continue to prove, improve as the year progresses and are excited about the opportunities in front of us.
Lastly, I’d like to congratulate Dave on being the recipient of the Leroy Grumman Award. The Cradle of Aviation Museum will be honoring Dave with this prestigious award for technical achievement. We are all very proud of Dave on this award and a lifetime of excellence in the communications industry. Congratulations, Dave.
David Hershberg
Thank you.
Keith Hall
And then Melfi, our CFO, will now take you through our financial results.
Andrew Melfi
Thank you, Keith. Good morning, everyone. Revenues for the company’s fiscal 2011 first quarter increased 11.6% to $53.2 million compared to $47.7 million in the same period last year. Revenues from Services increased 50.1% to a record $42.9 million as compared to $28.6 million in the same period last year. The increase in Service revenues was primarily driven by an increase of AxxSys service offerings coupled with the company’s acquisitions of C2C/Evocomm, which combined, contributed $4.3 million.
Revenues from Infrastructure solutions decreased 46% to $10.3 million as compared to $19.1 million in the same period last year. The decrease in Infrastructure solution revenues was primarily caused by the timing of revenue milestones and by the global economic slowdown resulting in government and commercial customers and prospects delaying projects.
Net income for the company’s fiscal 2011 first quarter increased to $2.1 million or $0.10 diluted net income per share as compared to net income of $1.2 million or $0.06 per diluted share in the same period last year.
Adjusted EBITDA for the first quarter of 2011 increased to $6.4 million, as compared to $4.0 million in the first quarter of 2010.
The company’s balance sheet remains strong. I would like to point out that the reduction of cash of approximately $10 million was primarily driven due to the pay down of accounts payable for the payments of inventory for our long term project, we weren’t [ph] compresses inventory of approximately $19 million. This inventory will start to turn slowly into revenues in Q3 and forward.
The company continues to utilize our non-operating losses with no cash payments of federal taxes. Globecomm continues to maintain its guidance for fiscal 2011.
Consolidated revenues between $290 million and $305 service segment revenues to be approximately $175 million. Cap diluted net income per common share to be between $0.50 and $0.55. Adjusted EBITDA to be between $28 and 29 million.
At this point, I’d like to turn the call back to Dave for questions.
David Hershberg
Okay. Thank you, Andy. And be happy to answer any of your questions you might have.
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Fund Letters
