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Globecomm Systems (NASDAQ:GCOM)

Q3 2013 Earnings Call

May 09, 2013 10:00 am ET

Executives

Matthew Byron - Senior Vice President of Corporate Office

David E. Hershberg - Founder, Chairman and Chief Executive Officer

Keith A. Hall - President, Chief Operating Officer and Director

Analysts

Mark C. Jordan - Noble Financial Group, Inc., Research Division

Gregory Burns - Sidoti & Company, LLC

Operator

Good day, and welcome to the Globecomm Systems Inc. Fiscal Year 2013 Third Quarter Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Matthew Byron, Senior Vice President of the corporate office. Please go ahead, Mr. Byron.

Matthew Byron

Thank you, Kelly. Good morning, everyone,, and welcome to the Globecomm Systems fiscal 2013 third quarter ended March 31, 2013 earnings conference call. Joining me today from the company are Chairman and CEO, David Hershberg; President and COO, Keith Hall; and our CFO, Andrew Melfi.

Last night after the closing bell, Globecomm issued fiscal 2013 third quarter ended March 31, 2013, earnings press release. In the event you have not seen or received a copy of the release, it is posted on the Globecomm Systems website at www.globecommsystems.com, or you can contact me directly at (631) 457-1301, and I will send a copy to you.

Comments made during this conference 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 our quarters progress. All forward-looking statements are based on 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, its quarterly reports on Form 10-Q, its current reports on 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 actual results to differ materially from those contained in its projections or forward-looking statements, which the company urges all investors to consider. Globecomm undertakes no obligation to publicly release any revisions to such forward-looking statements that may be made to reflect events or circumstances after today's date reflecting the occurrence of unanticipated events.

Throughout this call, we will be presenting both GAAP and non-GAAP financial metrics. Non-GAAP financial metrics are not intended to be considered in isolation from, a substitute for or superior to our GAAP results, and we encourage investors to consider all metrics before making an investment decision. For complete information regarding our non-GAAP financial information to most directly comparable GAAP measures and a quantitative reconciliation of those figures, please refer to last night's press release regarding our fiscal third quarter and 9-month financial results. The press release also has been furnished to the SEC as part of Form 8-K.

Please note this call is being recorded on Thursday, May 9, 2013, contains time-sensitive information and will be available as a webcast replay for at least 9 months on the Investor Relations section on 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 763-0095.

At this point in the call, I'd like to turn it over to the CEO, Dave Hershberg. Dave?

David E. Hershberg

Thank you, Matt, and Good morning, everyone. As we discussed last time in our conference call, we have some ongoing challenges, and things really haven't changed much. We met our internal plan for the third quarter and have slightly tightened our guidance for the year ending in roughly 7 weeks.

Government sequestration provides an uncertain backdrop for new government contracts. However, at this time, the company continues to see strong government service contract renewals. In the third quarter, the company achieved service reliability of 99.95% uptime on our global machine-to-machine network that is now serving over 340 ships. I believe we're the only company in the world that is currently providing this type of service on an end-to-end basis. We do this by using 22 satellite beams and 13 teleports, covering most of the shipping lanes of the world. We've also reached a maritime industry milestone. We now provide connectivity service to 3,500 ships globally.

Our Tempo platform continues to be well received by the marketplace, and we have added digital signage and Internet solutions to the product. In the third quarter, we successfully deployed the Globecomm Tempo Enterprise Media Platform at 1,100 sites for our second major customer in the retail business. We invested significant resources in the development of Tempo, so I was very pleased to have received the following correspondence from one of our customers, which is indicative to other comments received. We had something like this: "Today, we operate Tempo pretty much on our own and had a great day. Over the last several weeks, you delivered the best enterprise media platform in the world. You all made our common vision come true. This is by far one of the best experiences of my business life and I'm very proud to be associated with Globecomm, the team that was here and the ones back in New York."

I'd also like to point out that our Hughes Ka-Band Jupiter program, we commissioned 15 gateway terminals that have been off-brand, with excellent operating with results with 100% uptime this year.

One new initiative that Globecomm continues to grow is our cyber security capabilities, with a focus on conducting vulnerability assessments and providing risk mitigation services for critical infrastructure industries. Globecomm feels that our combination of network engineering expertise and customer and communication network solutions are ideally suited to deliver services to this rapidly growing market. We anticipate that the continued shift of government and private industry resources to address cyber security challenges will provide new market opportunities for our service offering.

The company continues strong cash flow from operations in over $55 million net cash on our balance sheets, provides us with the flexibility to invest in our business, including cyber security, including new products and personnel, and selectively pursue strategic opportunities that will maximize shareholder value as we continue to face some new U.S. government budget and the economic headwinds.

We also have a strong pipeline of infrastructure opportunities within our media segment, which bodes well for the coming fiscal year. Just yesterday, at close of business, we were informed we won a network project including a multi-year service element with a major U.S. broadcaster. I'm very proud of our accomplishment in this environment, and we remain focused on executing our overall business plan envisioned for a very successful fiscal year '14.

At this time, I want to turn it over to our President, Keith.

Keith A. Hall

Thank you, Dave. Good morning, everyone. As evidenced by our Q3 results, our team continues to execute well while managing through some challenging economic conditions, as well as some very complex programs. We remain focused on market opportunities that will support the long-term financial success of the corporation.

Before I jump into the specifics of the market verticals, I'd like to provide some top line color on our 2 business segments. Q3 revenue totaled approximately $78 million at a blended gross margin of approximately 26% and an adjusted EBITDA of approximately $10.4 million. The recurring services element of our business remains the primary driver of these results. The service segment revenue in Q3 totaled approximately $52 million at a blended gross margin of approximately 32%. The nonrecurring services component represented approximately 4% of this revenue total. Total service revenue was down from Q3 last year primarily due to a nonrecurring element of approximately $13 million that occurred in Q3 last year.

We continue to diversify our service-based solution offerings with initiative focus on further development of our media-based platform and our global M2M platform, increasing our overall end-to-end data management value proposition.

Our Infrastructure segment revenue in Q3 totaled approximately $26 million with a blended gross margin of approximately 13%. Pre-engineered solutions represented approximately $8.2 million of the product mix. Gross margin in this segment remain suppressed due the challenges previously identified on our NATO and HNS Jupiter programs, which contributed approximately $7.5 million in revenue with no margin.

The Infrastructure segment was challenged in Q3, from a bookings perspective, and is something we are monitoring closely. We are expecting an increase in bookings activity in Q4 with a pipeline of opportunities that remains very strong, particularly in the media segment.

As Dave pointed out, our cash position remains strong, as we manage through the ongoing delays in NATO-related shipments. Our CapEx for fiscal 2013 is trending to be approximately $12 million, of which $6 million is related to specific programs. Approximately $4.5 million of that is related to Tempo equipment installations and $1.5 million related to Showtime and other programs. Our effective tax rate is estimated at approximately 35%.

I would now like to spend the next few minutes providing an update on our 5 market verticals. The median market vertical represented approximately 5% of our consolidated revenues in Q3. As previously discussed, Globecomm has defined a strategy for this market vertical that leverages the Globecomm global network and our significant engineering capabilities to support opportunities in the traditional media distribution markets, life-cycle support services, as well as helping content providers to monetize their assets across the emerging content distribution channels such as over-the-top and direct-to-consumer markets.

To support our efforts, Globecomm recently had a very successful NAV conference, announcing and providing live demonstration of our media solutions, global connectivity, managed services, and best-in-class design integration and life-cycle support services.

The event provided Globecomm with a multitude of qualified business opportunities that are now being addressed. Q3 media bookings were highlighted by $6.5 million of contract awards with $3.6 million coming from MEASAT Broadcast Network Systems to support build-out of their ARF [ph] facilities for DTH services, as well as $2.9 million of contracts from ADTH, GlobeCast and BBC Persia to support carriage of video services on our Globecomm network.

Additionally, we are working on several large opportunities and life-cycle support contracts with content providers that are targeted to close within our fiscal year. And as Dave mentioned, we've just closed on a program with a major U.S. broadcaster.

As we look towards the rest of fiscal 2013 and into fiscal 2014, Globecomm is focusing our efforts on completing partnership agreements with several large technology providers and are targeting market shifts that are driving content providers and service providers to simplify content production, workflows and content distribution, while enabling the introduction of content from nontraditional sources to a variety of networks and ever-growing number of devices.

Maritime represented approximately 11% of consolidated revenue in Q3. Despite the shipping industry's continuing to face significantly difficulties due to a combination of the global economic situation and a general overcapacity of ships, the maritime market vertical continues to meet or exceed its targets.

Recurring revenues in the first 9 months of FY '13 are approximately 25% ahead of the same period in FY '12. Much of the growth has come from a steady increase in the size of the served fleet as well as the continuing shift towards larger, high-value airtime packages. As we have discussed on prior calls, value-added services, such as crew welfare and machine-to-machine applications, have continued to contribute to the positive financial performance in Q3.

As part of our strategy to expand value-added services, we recently launched Access Chat Plus, a secure Skype-like video chat offering for both crew and ship businesses. This is a natural extension of the crew focused Wi-Fi system that we now have commissioned on 300-plus ships, and helps promote customer retention, as well as acquisition.

The maritime pipeline remains very strong, as we continue to leverage our served fleet of 3,500-plus ships, our comprehensive VSAT network and our reputation for providing highly reliable managed services on a global basis.

As we look to FY '14, we are very excited about expanding the customer base on our global end-to-end platform and currently have several customer demos in process.

The enterprise market represents approximately 13% of our consolidated revenues in Q3, and is showing strong signs of growth for both managed and hosted services. Q3 was highlighted by the deployment of a $13-million managed services contract with a Fortune 500 retailer. This client will use our Tempo enterprise media platform to deliver employee training and digital signage to approximately 1,200 store locations across the United States.

This quarter was also marked by the general availability release 2.5 of our Tempo platform enhancements to our family of Tempo and its devices.

Demand for our Tempo platform is growing across multiple market sectors. The retail, transportation and energy sectors continue to show the greatest activity. Another significant development is the rising demand in the education market, currently driven by larger urban school districts.

Beyond Tempo, we booked approximately $1.6 million of contracts in new business from our traditional relationship enterprise customers. These customers include Eutelsat and Afghan Telecom. The pipeline for continued success in the enterprise market have gained significant momentum and promises to be a major source of organic growth for the company. Ongoing pilot deployments in the retail sector are tracking towards significant bookings in the coming quarters.

The wireless market represent approximately 14% of consolidated revenues in Q3. In Q3, our wireless vertical continues to see increases in hosting revenue with growth coming from existing customers, increasing voice and data traffic, as well as the addition of new customers in 2G, 3G and 4G technologies. One of our initial customers, Indigo Wireless, signed a 3-year renewal for 2G, 3G and 4G services.

LTE opportunities continue to be a positive among carriers with 700 megahertz spectrum and smaller carriers that favor a hosted core model. We expect to add a number of new rural carriers for LTE network hosting equipment sales in the coming quarter.

In other markets, our APAC sales team continues to make progress but we recognize the longer sales cycle in this region, as well as competition from Chinese solution providers, Huawei and ZTE.

We continue to meet with the tier 1 and tier 2 carriers in the region to refine our service offerings, particularly with LTE services. The Latin America sales team continued to grow its pipeline of opportunities through sales channels within the region.

The wireless verticals expansion into offering mobile virtual network enabler, MVNE services, to host mobile virtual network operators is bearing fruit. Our expanded infrastructure to include an MVNE platform will go into service this summer with an initial customer. We expect to close additional MVNO customers in Q4.

The government market remains strong for Globecomm, representing approximately 57% of consolidated revenue in Q3. The federal budgets remain in flux, operating under the mandate of sequestration and the continuing resolution for the U.S. government's fiscal year 2013. Procurements are being delayed, and uncertainty by the U.S. government program managers as the current and future funding levels is causing an overall stagnation of decision-making. With regard to sequestration, Globecomm has not been directly impacted with any program terminations and cuts to date. In fact, Globecomm secured several key renewals throughout the quarter.

During these uncertain times, maintaining our current customer base will be important to weather the current government budget storm. In Q3, a total of $27 million of government-related business booked in the company's third quarter comprised of the following service and infrastructure contracts. Network service bookings in Q3 were $23 million. We continue to see strong service renewals from our government customers, from our 4 key government sectors, including U.S. DoD, foreign affairs, intelligence community and civilian agencies. The quarter was highlighted by key renewals for Department of State via the Vanguard contract vehicle and services in support of several intelligence community customers.

On the infrastructure front, we received follow-on hardware orders from several long-time customers in the U.S. government, multinational peacekeeping and foreign military organizations. Regarding new business opportunities, we completed a major bid for satellite terminals in support of a NATO member country.

We continue to evaluate other similar opportunities for foreign governments where our system integration expertise and product line development aligns with their requirements to offset decreased capital spending expected from U.S. sequestration and other related budget constraints.

Looking forward, the government team is focused on 3 initiatives: furthering pursuit of relationships and business opportunities with key prime U.S. government contractors, where we can bring innovative cost-cutting solutions to them in support of their customers, provisioning of managed wireless services to government enterprise-level customers and harvesting business relationships from existing contract vehicles. For example, the U.S. Army's GTACS, DISA's FCSA or DoD's DMA for solutions, systems and services.

The Globecomm vision has come a long way in the development of our value proposition as a global infrastructure solution provider, as evidenced by our Tempo and M2M service awards of this year. With evolution of the Internet and mobile communications, we remain at the forefront of network and application innovation. Cloud and hybrid satellite network opportunities are an evolving base on these innovations. We see technology and business model disruptions providing increased market opportunities as we continue to develop seamless user experiences. We continue to build on these value propositions and are very excited about the opportunities we see in front of us.

With that, I would like to hand the call back to Dave for any questions that you may have.

David E. Hershberg

Well, thank you, Keith, and I'll be happy to answer any questions you may have. So we'll open up the line for questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Mark Jordan from Noble Financial.

Mark C. Jordan - Noble Financial Group, Inc., Research Division

A question relative to the NATO contract. What do you have in terms of -- still on your books with regards to either accounts receivable or inventory relative to that large contract? And when do you foresee it converting to cash?

David E. Hershberg

It looks like we have about $22 million, still, to collect on that contract. Is that right, guys? About $22 million. And we got about $5 million in accounts receivable right now and about $15-million-plus in inventory. We should have almost all of that NATO stuff shipped by the end of our fiscal year, June 30. However, we cannot invoice that until it gets on-site in Europe, and it gets mounted on vehicles and it gets sold off to our customers. So we do expect to get a significant amount of that cash in the first quarter of next year and it'll probably go into the second quarter before we collect all of it. But I'm happy to say that most all of that will be out of here by the end of this quarter.

Mark C. Jordan - Noble Financial Group, Inc., Research Division

Okay. Can you look forward and try to give us a little bit of a view of how you see the infrastructure component of your revenue stream evolving over the next 2 to 4 quarters? Do you see it, given the kind of the economic pressures here, kind of staying in the sort of the mid-$20 million range per quarter or do you have any -- can you give us any sense of where we might see that revenue line going over time?

David E. Hershberg

Well, I can talk to bookings better than revenue right now. As I said, we did just receive a major contract last night. We have proposals out there that look relatively good, anywhere from $10 million to $40 million to $50 million range. If we can book -- we start booking some of that, I think we can expect to have a very, very significant uptick in our media business and infrastructure business. When we talk about sequestration being a problem, basically, we're getting renewals on the contracts we have. The problem we got is we are part of a number of IDIQ contracts that are not -- there's not a lot of activity going on right now, where people are buying a lot of hardware. So that has a lot of impact on our infrastructure business. We do expect to have a very, very good year in infrastructure, mainly fueled by the media business that we expect to get in the next 3 to 4 months.

Mark C. Jordan - Noble Financial Group, Inc., Research Division

A final question for me, if I may, just to delve a little bit more into the government's behavior. Have you seen any change now, finally, with sequestration actually being implemented? Seeing that the CR or continuing resolution will continue through this year, the initial '14 budget, any sense that the customer base is starting to look a little more long-term rather than just kind of pushing things out to the right?

David E. Hershberg

I'll try to give you a little bit on that. I mean, ongoing contracts we have, we're doing pretty well. We've gotten renewals on just about every one of them. There are some -- a couple of them are on a lower level than we had before because they have to do with services in Afghanistan. As far as GTACS, which is a major buying, we have not seen the kind of RFPs come out for our task orders come out that we were expecting, and we do expect to start seeing that pick up somewhat. And talking to our customers, sequestration does have an impact on what their planning is and what their budgets are going to be, which is really, we think, affected us to some extent, mainly -- though, like I say, in the infrastructure business. Keith, maybe you can add some more to that?

Keith A. Hall

Yes, I think Dave hit on it. We haven't seen -- the service renewals have been extremely strong. The only contraction we've really seen over the last 12 months has been in Iraq, and we're projecting some contraction in Afghanistan moving forward in particular on our Vanguard contract. Outside of that, we've seen very strong service renewals and expect that to continue moving forward.

Operator

[Operator Instructions] We'll go next to Greg Burns from Sidoti & Company.

Gregory Burns - Sidoti & Company, LLC

Could you just quantify what you -- how much revenue is coming from Afghanistan or how much you think is kind of at risk going forward? And just maybe kind of a better sense of what the kind of normalized growth rate of the service segment looks like once we get past these headwinds?

David E. Hershberg

Well, in Iraq, I think we reached a steady state where we're going to be, so it really hasn't changed over the last year. In Afghanistan, our NATO contract, at least for the next fiscal year, which is a service contract, which is in place now, we shouldn't have any deterioration to that contract. In some of our U.S. government agency contracts, State Department, we do expect those to go down somewhat. We factored into our plans that those contracts will continue but at a somewhat lower level. As far as the amount of business there, maybe we can get what the latest numbers are.

Keith A. Hall

The Afghan sales in Q3 were approximately 21% of total consolidated revenue as opposed to 19% in the same quarter last year. So there's actually a slight uptick, percentage-wise, not necessarily dollar-wise. Moving forward, as I mentioned, we are going to see some contraction, in particular, at one particular contract, the Vanguard contract with the Department of State, where we're seeing a contraction of some of the supplied PRT bases throughout Iraq and Afghanistan, but more in particular Afghanistan moving forward. So we're going to see contraction there in FY '14, and we are forecasting for that.

David E. Hershberg

We did receive a contract, just last week, from the Ministry of Communications, nothing to do with the U.S. government or pullout or anything else, and it's to expand the network that we had done there in 2007 for another 1,000 terminals. So it's a nice contract. We do expect to see some kind of uptick with some opportunities that we're looking at for the Ministry of Communications in Afghanistan that were not -- which has been sort of dormant for the last year or 2. So we are seeing an uptick there, which will I think help to replace some of the downtick on what's going on with Vanguard. But we're gradually reducing our expectations there and we've factored them into our numbers for this year and next year.

Mark C. Jordan - Noble Financial Group, Inc., Research Division

Okay. So, I guess, factoring all that in, do you foresee the service segment returning to growth in fiscal '14?

David E. Hershberg

Yes. Our current internal projections is for growth in the overall service segment heading into next year. We haven't released any of those forecasts or projections at this time. But in general, we are looking for organic growth moving into FY '14 despite the contraction in Afghanistan.

Gregory Burns - Sidoti & Company, LLC

Okay. In terms of Tempo, the new retail contract, did you quantify how big that was? I think the one you announced last quarter was around $13 million.

David E. Hershberg

Yes, that is the one we're referring to. It's approximately $13 million total contract value for the latest one.

Gregory Burns - Sidoti & Company, LLC

Okay. So this is the same contract you were referring to?

Keith A. Hall

Yes. We're referring to -- we just completed the implementation of the sites, so we are now up to a full-scale revenue stream on that implementation. We got 2 more clients that we're running pilot programs for right now, and we are hopeful that there will be bookings this quarter.

Gregory Burns - Sidoti & Company, LLC

How many live implementations in Tempo are there now then?

David E. Hershberg

Three, 1 government, 2 enterprise.

Gregory Burns - Sidoti & Company, LLC

Okay, great. And just looking at where we stand now, I guess, mainly on the Infrastructure side of the business versus where we started the year, what has been, like, the major variance between then and now?

David E. Hershberg

There's a couple of areas. One is, as you know, we talked about substantial contracts at low margin. We also had challenges on the margin with both our NATO contract, our Jupiter contract. We don't see any of that going forward, and we're pretty much out of the woods as far as those contracts are concerned. We should not be having any real issues on new contracts. So I think that's the major difference. We should be showing considerably higher infrastructure margins going ahead. I think that's the major difference. But we're very hopeful that they're going to have a significant amount of bookings this quarter, and that infrastructure will be a pretty good -- there should be a pretty good increase in both revenue and bottom line next year.

Operator

[Operator Instructions] We'll take another question from Greg Burns with Sidoti & Company.

Gregory Burns - Sidoti & Company, LLC

Just one last one. Any updates on the sale process with Needham?

David E. Hershberg

No updates. We're not commenting on that.

Operator

And we do not have any further questions in queue.

David E. Hershberg

Okay. Well, thank you, everyone, and we hope to see you next quarter. Thank you very much for your interest.

Operator

And that does conclude today's conference. We thank you for your participation.

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