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Globecomm Systems Inc. (NASDAQ:GCOM)

F3Q10 Earnings Call

May 11, 2010 10:00 am ET

Executives

Matthew Byron – Senior Vice President of Corporate Office

Andrew Melfi –Chief Financial Officer

David Hershberg – Chairman and Chief Executive Officer

Keith Hall - President and Chief Operating Officer

Analysts

Stephen Ferranti – Stephens Inc.

Mark Jordan – Noble Financial

Jim McIlree – Merriman Curhan Ford & Co.

Rich Valera – Needham & Company

Dick Ryan – Dougherty Brokerage

Operator

Welcome to today’s Globecomm Systems fiscal year 2010 third quarter earnings conference call. Today’s call is being recorded. For opening remarks and introductions, I will like to turn the call over to Matthew Byron, Senior Vice President of Corporate Office.

Matthew Byron

Thank you, Michael. Good morning everyone and welcome to the Globecomm Systems fiscal 2010 third quarter earnings conference call. Joining me today from the company are Chairman and CEO, David Hershberg; President and Chief Operating Officer, Keith Hall and our Chief Financial Officer, Andrew Melfi.

Last night Globecomm issued its fiscal 2010 third quarter earnings press release. In the event you have not seen a copy of the release, it is posted on Globecomm Systems’ 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 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 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 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 its projections or forward-looking statements, which the company urges all investors to consider. Globecomm undertakes no obligation to publicly release the revisions to 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 Tuesday, May 11, 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 3480623.

At this point, I’d like to turn the call over to our Chairman and CEO, Dave Hershberg. Dave.

David Hershberg

Thank you, Matt, and good morning everyone. Welcome to our fiscal 2010 third quarter earnings conference call. Last night Globecomm issued its fiscal 2010 third quarter financial earnings press release. With the economy still experiencing some difficult times, the company completed the largest acquisition in our history and capped off a record revenue quarter with an increase in operating income of 239% excluding acquisition costs.

We adjusted previously issued consolidated revenue guidance to the high end of our range of $225 million, adjusting service revenue from approximately $130 million to approximately $140 million and maintained our $0.30 to $0.35 of fully diluted earnings per share including the $0.03 acquisition cost charge. Andy Melfi will provide more details on our financials a little later.

Our service segment is more robust than ever and should provide stability and visibility for the foreseeable future. There are multiple drivers supporting the continued service segment momentum. In the Government market we continue to witness strong renewals which have included significant increases in scope.

The Maritime market remains strong as a transition from narrowband to broader band is increasing every day. In the Broadcast area, the transition from standard definition to high definition is driving demand and we are also working on design of a 3D broadcast system to be in a position to support upgrades to existing and for new broadcast centers.

In the Wireless Cellular market, we continue to add hosting customers to our modern 3G cellular switch and believe this will be a major growth area for the company. We recently launched TEMPO which is an enterprise hosted interactive software solution platform for both satellite and terrestrial applications. This is the first of a new initiative to host and license applications in our business areas.

Regarding our infrastructure business, we are experiencing increased demand for our newly developed Ka and X-Band products suites. We are investing heavily in products supporting these frequency bands and believe that commercial initiatives such as the upcoming launches of mobile, ka band and satellite and the government’s commitment to the new wideband global initiatives supporting X and Ka band will drive this demand for new ground segment infrastructure.

The third quarter represents the company’s 24th consecutive quarter of profitability. We’ll enter fiscal ’11 with greater visibility than ever as the recurring revenue portion of the company’s consolidated revenues is at a record level and continues to grow. We are very excited about our future and look forward to a record fourth quarter and what is shaping up to be a record revenue year for fiscal year ’11.

I also want to welcome our latest acquisition to the Globecomm team of C2C and Evosat. This acquisition brings us new capabilities of world class European teleport and is accretive to the company’s bottom line. With the three recent acquisitions, we’re going to step back proactively seeking acquisitions for the next few quarters and work on integrating the companies and obtaining [inaudible] savings synergies that are available to us.

However, if the right opportunity presents itself, we’ll certainly take a look at it. Our strategy is to accrete service revenue, increase our government business, and increase our project business, and promote products and service that are not threatened by terrestrial fiber expansion in our core company competence.

These include SATCOM [on the move], airborne SATCOM, maritime, tactical [termo], cellular hosting and back haul, logistics support and maintenance, network management, and to develop allocations of products to serve both the terrestrial and satellite systems.

At this point I’d like to hand it over to Keith to give you a little more detail on the operations.

Keith Hall

Thanks Dave. Good morning everyone. I’d like to start by [inaudible] by Dave’s comments, saying I’m very pleased with our team in achieving record Q3 fiscal results while executing the largest acquisition in our company’s history.

Low customer churn coupled with contract expansion within our existing customer base has set the foundation for top and bottom line stability during the current economic downturn. This was highlighted in Q3 with the announced increase of $34.2 million on an existing government services contract and the $9.1 million increase in NATO Force Tracking services.

Our execution in the service segment remains strong. Customer churn has been running at less than 5% of year-over-year revenue. Organic growth within the services segment has been especially strong this year at 28% year-to-date. This organic growth was again highlighted by strong expansion within our existing customer base.

With these strong metrics and our most recent acquisitions, we are increasing our service guidance for the year to $140 million, of which approximately 8% is related to non-recurring equipment sales.

Within our infrastructure segment, the percentage of our higher margin pre-engineered systems is showing signs of improvement. Pre-engineered systems represents approximately 27% of the infrastructure revenue in Q3 and approximately 14% year-to-date. We continue to work to improve this product mix to levels seen previously in FY ’07 and FY ’08 where levels were approximately 33%.

We are also seeing a general and steady increase in the opportunity funnel as Cap Ex spending increases. We feel this will result in increased broadcast and wireless infrastructure projects in the coming quarters.

We are excited about our new acquisition. I’d like to welcome Pierre [dePlussy] and Harry Taylor to our management team and we look forward to working with them as we continue to expand our operation globally. C2C has a strong European presence and we will be integrating the teleport facility located in the Netherlands and through our network, further enhancing our global managed services value proposition.

The addition of Evosat, an [marsat direct] provider allows us the added benefit to provide fleet broadband services at cost levels which make us much more competitive. One year later, the acquisitions of Mach 6 and Telaurus continue to pay dividends and we are now focused on further integration of these subsidiaries into Globecomm.

As we continue to explore new market verticals and expand our presence within existing ones, I am pleased to reaffirm we are holding EPS guidance for the year despite taking on $940,000 in acquisition related costs.

I would like to now provide some insight into our Q3 market vertical base activity. Within the Maritime market, we continue to work to enhance both our narrowband and broadband service offerings and we are seeing an increase in the rate of adoption of broadband solutions which now account for approximately 25% of all Maritime service activations. Our focus remains on increasing the valuated services we provide to these shifts.

Even in the face of the global economic downturn, we were able to increase the support of fleet size in Q3 and now support a cumulative total of over 2200 vessels globally. The Maritime market currently represents approximately 9% of our consolidated revenue year-to-date and we believe that in the near term, the increased adoption of broadband type services will continue to provide greater opportunities for growth.

Our media and broadcast market vertical represents approximately 13% of our consolidated revenue year-to-date. Globally we are watching the adoption rate of HD services and the need for new facilities to address this trend. We believe we are well positioned to capitalize on this market from an infrastructure and services perspective.

We are also looking forward to growth in the broadcast market vertical through service expansion. We are set to announce the launch of our hosted base content origination and distribution services. We are very excited to add this offering to our portfolio of quality services.

Building upon our media and broadcast experience, we recently announced the launch of our TEMPO offering which is a bold new step for the enterprise market. TEMPO addresses the need for organizations to maintain a level of engagement and interactivity with [users] that traditional networks have not been able to previously bridge. Through our knowledge of media, broadcast, and networking, TEMPO delivers streaming media and interactivity to the three screen world of TV, PC, and mobile devices as a service.

Market feedback at the NAB conference in Las Vegas and at the recent CMMA conference in Dallas has been very positive and we look to have more announcements in the near future.

In the wireless market as previously announced, Globecomm launched our Ericsson based IP hosted cellular platform. We currently have three mobile operators successfully operating on this new platform and generating over 2 million minutes per month, adding to our existing customer base operating on other wireless technology platforms.

We expect to add at least one new mobile operator before the end of the fiscal year. We continue to believe that we have tremendous growth potential in this market. Currently it represents approximately 11% of our consolidated revenue. In the government market, efforts to support our military with global access and infrastructure solutions have continued to increase. Government-based business represents approximately 62% of year-to-date revenue.

53% of our services based revenue is government related and 69% of our infrastructure revenue to date is government related. Globecomm remains actively involved in several new X and Ka Band initiatives, most recently combining our TomCat manpack solution with our X Band service capabilities to our global network.

We also completed our triband auto explorer system, an idea fit for the WGS Satellite user community. Our presence and capabilities continue to expand within Afghanistan. We are well positioned to support the expansion of troops in the region and are gaining traction with our recently established Afghan SP which supports a wide range of commercial and government data services. Our corporate Afghanistan related revenue represents approximately 15% of consolidated revenue year-to-date.

To conclude, we are pleased with strong contract renewals in all markets and the prospects for both our infrastructure and services segments. As we head into Q4 and set the stage for next year, we are looking forward to record backlog to enter FY ’11.

Andy Melfi, our CFO, will now take you through our financial results in detail.

Andrew Melfi

Thank you Keith. Good morning everyone. Revenues for the company’s fiscal 2010 third quarter increased 36% to $52.8 million as compared to $38.6 million in the same period last year. Revenues from services increased 77% to a record $34 million as compared to $19.2 million in the same period last year.

Revenues from infrastructure solutions decreased 3% to $18.8 million as compared to $19.4 million in the same period last year. The increase in service revenues was primarily driven by the company’s acquisitions of Mach 6, Telaurus, and C2C and Evocomm which combined contributed $8.9 million. This coupled with an increase in the access service offerings in the government marketplace. Infrastructure solutions revenues remained relatively flat as bookings and revenues and the infrastructure solutions segment continue to be adversely affected by the global economic slowdown.

Net income for the company’s fiscal 2010 third quarter increased 129% to $1.2 million or $0.6 per diluted share as compared to net income of $500,000 or $0.03 per diluted share in the third quarter of fiscal 2010 on a GAAP basis.

Under the new accounting pronouncement on business combinations effective fiscal 2010 for the company, acquisition related transaction expenses are applied to the expense rather than capitalized. In the third quarter of fiscal 2010, the company incurred approximately $900,000 or $0.03 per diluted share of acquisition costs related to the acquisition of C2C and Evocomm.

Excluding these acquisition costs, earnings per share would have been 200% to $0.09 compared to $0.03 in the same period last year. Adjusted EBITDA for the third quarter 2010 increased 86% to $5.5 million compared to $3 million in the third quarter of 2009. Looking at our fiscal ‘09 March results revenues for the company’s nine months ending March 31 increased 30% to a record $157.6 million as compared to $120.9 million in the same period last year.

Revenues from services increased 69% to a record 96% as compared to $56.7 million in the same period last year. The increase in services as mentioned previously was driven by the company’s acquisition of Mach 6, Telaurus, one month of C2C and Evocomm revenues which combined contributed $25.4 million.

Infrastructure solutions decreased 4.5% to $61.4 million compared to $64.3 million in bookings and revenues in the infrastructure segment. Net income for the company’s first nine months of fiscal 2010 increased 67% to $3.9 million or 19.9 per diluted share compared to net income of $2.3 million or $0.11 per diluted share.

In the same period last year on a GAAP basis, during the third quarter the company completed the acquisition of C2C and Evocomm and incurred $900,000 of acquisition course or $0.03 per diluted share. Excluding these costs earnings per diluted share increased 100% to $0.22 as compared to $0.11 in the same period. Adjusted EBITDA for the first nine months of fiscal 2010 increased 53% to $13.9 million compared to $9.1 million in the same period last year.

Globecomm currently expects the following results of fiscal 2010: a record fourth quarter and a record fiscal year. Consolidated revenues to be approximately $225 million. Service segment revenue to be approximately $140 million and GAAP earnings per diluted share between $0.30 and $0.35. Adjusted EBITDA to e approximately $20 million.

At this point I’d like to hand the call back to Dave.

David Hershberg

Thank you Andy and Keith and if you have any questions we’d be quite happy to answer them.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Stephen Ferranti – Stephens Inc.

Stephen Ferranti – Stephens Inc.

So just looking at the remainder of year for fiscal ’10 your service revenue guidance of $140 million implies about a $10 million uptick in the June quarter relative to March quarter levels. Can you give us a sense for, it looked like the C2C acquisition was running about $5 million a quarter which would imply the core business should be up pretty nicely sequentially? Can you just give us maybe some additional insight into the underlying dynamics of how services should trend here?

David Hershberg

Keith, do you want to answer that?

Keith Hall

Sure. The service revenue should continue to trend up. You should be looking at record quarterly revenue in Q4 this year. I think you hit it on pretty close with the contribution of the new acquisitions. The organic growth as I mentioned earlier has been on a record pace. I think that will trend a little less in Q4 but still be a record organic growth year for us. So I think you hit on it. Record numbers in Q4 for services. I’m not sure it’s quite $10 million over the Q3 but again record.

Stephen Ferranti – Stephens Inc.

Okay, okay and then I guess Keith maybe you could provide a little more granularity in terms of either the verticals or maybe some of the specific contracts that are really, you know, driving the strength in that business from an organic standpoint?

Keith Hall

Sure. The organic growth continues to be highlighted by the government sector. The renewals have been extremely strong. The expansion within the renewals remains extremely strong. So I would again say that the government sector is driving a lot of the organic growth. But we are starting to see contributions from the wireless market, you know, maritime market with Telaurus and some of the revenue coming from Mach 6 has also been a benefit to us over the last three to six months.

I would say government first followed by the wireless market with the switch. You know we said earlier we looked to add another customer in Q4 and I think as we start adding into next year I think wireless and the broadcast media markets and I’ll include TEMPO and our new software platform will begin to start contributing considerably to the organic growth.

Stephen Ferranti – Stephens Inc.

Okay that’s helpful. And can you remind us on the switch services what’s the business model there? Is it a per minute revenue model or some sort of wholesale bulk model. How do we think about the revenue model there in terms of…?

Keith Hall

Yes, I think right now a lot of the revenue is being driven off of roaming minutes. So we gave a number earlier of over 2 million minutes per month. We’ll continue to update you on that metric as we expand our customer base. We’ll probably add a subscriber number also to that so you can track that metric as well. But I think the driving metric at this point is minutes per month that we drive through that switch. So we’ll continue to update you on both minutes and subscribers. Right now the subscriber number is not relevant to the sort of revenue total but we’ll add that in the future.

So I’ll try to update you both. Probably third metric would be a number of operators. So number of operators, minutes per month and then subscriber total. And right now we have three operators integrated in 2 million minutes per month.

Stephen Ferranti – Stephens Inc.

Great. That’s very helpful and then just last one from me. It was good to see the increased contribution from the pre-engineered systems for the quarter and I guess that helps to explain the uptick in the gross margins in that particular segment. But just looking at the K, it looked like the operating margin is still somewhat weak in that segment and I’m just wondering where there any sort of one time charges that we should be backing out of what you report in the Q and the operating profits for that segment or if not then what does it take to get the operating profits margins to start responding favorably in that segment?

Keith Hall

I could start with that and then maybe Andy or Dave can add some color to it. But in Q3 the percentage of the pre-engineered was greater and that is a positive. The overall revenue totals in that segment were down, so there is a little bit of a hurdle to overcome on the operating side due to the pretty steady operating expenses. You should see an uptick in Q4 on the revenue on both which will lead to better operating income.

David Hershberg

I think one think about the revenue for infrastructure. We’ve actually done quite a bit of rewards than what the revenue shows because we have two contracts that we really can’t bill until we finish significantly. One is the chip-and-modem contract which will be going into next year which we expected some this year but it’s going into next year. Also on the NATO project which is a $28 million project, we got some small initial funding but we will not receive any more funding or we can’t bill anymore until we start shipments which will also be going into next fiscal year.

So it is low because of the contract conditions that tell us we can’t bill until we ship and that’s a little unusual because usually we can get some progress payments along the way with these longer-term contracts. But in both these cases we are not getting any progress payments and we can’t bill any progress payments.

Andrew Melfi

And just to add what, this is Andy, to what Keith and Dave added. The infrastructure margins were very strong in Q3. We had a few pre-engineered programs that wound down and have some uptick in the margins. We don’t expect that level of gross margin to continue in Q4 for the immediate future. And as far as operating expenses we can’t forget that we did have close to $940,000 in expenses related to the acquisition.

Operator

We will take our next question from Mark Jordan – Noble Financial.

Mark Jordan – Noble Financial

Question relative to services if you’re looking at, I guess the question will be in the fourth quarter are there any non-recurring items in the services piece or is that a decent base that they are looking into and next year we could annualize that fourth quarter and then add some factor on for our growth assumption?

David Hershberg

I guess there’s two pieces when you look at the service trend that you need to take into account. One is the non-recurring equipment sales that are included within the service revenue and that’s running approximately 8%. And that’s been a pretty steady number year-over-year, somewhere between 5% and 10% non-recurring equipment sales but that is something that is not a recurring element obviously.

And then the second piece is churn. Now churn has been running very low so replacement of customers has been less than 5%, 5% or less on a revenue basis year-over-year.

So when you look at the trend you’ve got to take those two factors into account. Organic growth has been you know if you look at 5 years, you know, 15% is a, 15% to 18% year-over-year organic growth. So you take those three factors and you’ll come pretty close to the expected revenue run rate.

Mark Jordan – Noble Financial

With the addition could you give us what you think might be the depreciation. I know that 10-Q you gave what the amortization will be about $508,000 in the fourth quarter. What would be the depreciation run right now with the addition of [inaudible] business?

David Hershberg

Andy, do you have that number handy?

Andrew Melfi

Yes. I’ll give that to you in a second. $1.3 million to date.

David Hershberg

About $1.5 million.

Mark Jordan - Noble Financial

Okay so the D&A in aggregate will be just a little over $2 million in the fourth quarter?

David Hershberg

Yes.

Mark Jordan – Noble Financial

Final question. Relative to your investments in KA and X-Band systems, are there any specific contracts that you need to ramp the sales of this that you’re looking for the DOD or could you flush out a little bit what your marketing strategy is for marketing these systems that you’ve been developing?

David Hershberg

Well we continue to work against some of these IDIQ contracts that we have which is WWSS. We do expect some requirements coming out from that. There are some requirements coming up for our small manpack unit. That’s why we’re modifying that unit from X to KU to Ka Band so we’ll be ready for that. There’s a very large program coming up for 2,000 terminals for GBS. We think we have won a couple of contracts for large Ka Band terminals and flyaways and mobile terminals in another contract.

We had some bids out on some Ka Band gateway terminals, some pretty extensive large bids there. But we haven’t seen the exact [inaudible] piece that we expect to see but we do have the products ready to go and those are [a piece to come out].

One of the issues about those requirements is that we normally have to do a demo. We can’t just write a paper proposal. We have to have a product ready to show. We also bid a very large maritime program in the $100 million range which includes a considerable amount of hardware also for the government. So there is a lot of stuff out there right now. It’s a question of what we’re going to be successful on booking but we have some pretty good holds because we think we have some excellent equipment to demonstrate.

Andrew Melfi

I think to add to that Dave, I think one area from a marketing perspective that we’ve seen some excitement from is coupling our products with our managed service offering, in particular the X Band product, the TomCat manpack product. When we couple that with our ability to provide an end to end global managed service using our X Band service licenses. I think packaging those two together is really the value proposition that Globecomm brings to the table and we’ve seen some excitement on that front. We’re going to continue to try to patch those moving forward.

David Hershberg

I think that’s one of our real value added… Our company is one of the few ones that can actually do that, that can offer within the same company, a lot of companies can offer that but normally they're going to sub-contract equipment out, they're going to sub-contract services out. We’re sort of a unique company in that we can provide the worldwide services along with the hardware.

Operator

We will take the next question from Jim McIlree – Merriman Curhan Ford & Co.

Jim McIlree – Merriman Curhan Ford & Co.

The $940,000 acquisition cost, where does that show up in the income statement?

David Hershberg

It would be in G&A

Jim McIlree – Merriman Curhan Ford & Co.

Okay, right, and Andy I think in an earlier question you were saying that the reason for the infrastructure margins being low was because of this acquisition cost? That can't be right.

Andrew Melfi

No, no, no the infrastructure margins were actually high in Q3.

David Hershberg

The infrastructure margins were high in Q3 sort of relative to the operating expenses including additional expense of the acquisition costs.

Jim McIlree – Merriman Curhan Ford & Co.

The Q that you released said that the infrastructure margins were negative 13% in Q3 so that’s the disconnect that I’m having on your infrastructure margins.

David Hershberg

Yes you're referring to operating margin…

Jim McIlree – Merriman Curhan Ford & Co.

Correct.

David Hershberg

… gross margin. I think what we’re talking about, high Q3 margins we’re referring to are gross margins.

Andrew Melfi

Yes, gross margin you’re following out down to the bottom line.

Jim McIlree – Merriman Curhan Ford & Co.

So you had good gross margins but high OpEx obviously offset that.

David Hershberg

Correct.

Jim McIlree – Merriman Curhan Ford & Co.

I think it was mentioned at least two times, I might have heard it three times about either better ordering activity or better bidding activity in the infrastructure side. Is that across the board or all government related?

David Hershberg

There’s government and commercial, as you know there's requirements coming up for both ViaSat and [use] network systems with their new networks and we think there's some opportunities there that we’re pursuing besides the government and also there's four government requirements too because there are some commercial cable and satellites, a big launch that are available, so there's both commercial, US government and there's foreign government requirements for Ka Band.

Jim McIlree – Merriman Curhan Ford & Co.

And Andy, can you give us what you think a reasonable operating expense level will be in Q4 after you fold in the C2C acquisition and then of course you're going to be excluding the, you see a drop down in sales and market, or excuse me G&A from the lack of the acquisition cost but I’m assuming that there's going to be some fold in for the full quarter for the acquisitions. Can you just kind of ball-park what the operating expenses will be in the June quarter.

David Hershberg

I’d say if you pull that out, we’ll be up about 3% to 5%.

Jim McIlree – Merriman Curhan Ford & Co.

3% to 5% over the prior year?

David Hershberg

No over the prior third quarter.

Jim McIlree – Merriman Curhan Ford & Co.

Okay so the 11.2 plus the 3% to 5% delta. Is that correct?

David Hershberg

[inaudible] it looks like the total operating expenses, is that what we’re talking about?

Andrew Melfi

Yes, yes, all operating expenses.

David Hershberg

[inaudible], pretty flat.

Andrew Melfi

Flat [inaudible], of course we’re going to integrate other operating expenses from subsidiaries so it's going to go up a little bit but not much.

Jim McIlree – Merriman Curhan Ford & Co.

Okay, great and just lastly, Dave, I think you said that the game plan right now was to integrate the acquisitions so you're kind of pausing on new acquisitions. Is that correct? I mean if something came along that was compelling, you're not going to reject it but at least for now you just want to get these new guys on board and integrate it, right?

David Hershberg

There's two issues there, one is when you're doing an acquisition that requires an awful lot of due diligence and we don’t have a team just sitting around doing due diligence, they really have to do their day job also, so that puts a big strain on the operation especially one like the one we just finished which is we’re talking about the Netherlands and South Africa and all the legal and accounting issues that will go along with that. The second thing is we do want to integrate these companies so the difference is going to be we’re not proactively going after something right now but if something that comes up that is in our wheel house that we think maybe looks like a good deal, we’ll certainly take a look at it.

Operator

And we will take our next question from Rich Valera – Needham & Company.

Rich Valera – Needham & Company

Keith, I just wanted to circle back on how we should think about the services business run rate into next year. When can you say how much you expect to get from C2C, Evo in this fiscal year? That would be just a starting point and I have a couple follow ups to sort of try to triangulate.

Keith Hall

I think we’ve been talking to about a $20 million annualized revenue rate from the combined EvoSat and C2C.

Rich Valera – Needham & Company

Okay but something on your…

Keith Hall

…and we would expect that to grow next year.

Rich Valera – Needham & Company

Right, so something like $6 million or $6 million plus for this fiscal year?

Keith Hall

For the four months.

Rich Valera – Needham & Company

Right. So then as we look out to next year trying to figure out sort of you know you’ve got well you know sort of back out the $6 million and use that as an organic baseline, how much should we think of that organic baseline rolling into next year?

Keith Hall

Well if you take, what we’re saying now is the new projections are greater than $140 million.

Rich Valera – Needham & Company

Right.

Keith Hall

You back out approximately 8% of equipment costs, non-recurring and you back out the $6 million just for the four months and then you can add back the 20 plus for EvoSat and C2C next year and then you put an organic growth rate of approximately say, what we’ve seen historically, this year is a high number but let's use the 15% organic growth rate, the non-recurring equipment sales we’re saying is 8% but that’s been running pretty constant historically somewhere in about the 5% you 10% range and that’s like small reset sales and…

Rich Valera – Needham & Company

Right.

Keith Hall

And spares and some equipment like that. Does that get you close?

Rich Valera – Needham & Company

Yes. I should be able to work with that and just to also circling back on that fourth quarter it does seem like a sequential bump up is pretty sharp even excluding the C2C Evo. Is there anything sort of one time maybe on the equipment side on the service business that’s driving that sharp sequential move in the fourth quarter?

Keith Hall

You know it's really strong organic growth, we’ve seen despite the economic down turn, the government sector has been extremely strong. We’re capitalizing in Afghanistan, we’re capitalizing in Iraq and you know I think if anything we’re gaining momentum so we’re building upon existing relationships, expansion of current contracts. I think that is the largest contributor outside the acquisitions.

Rich Valera – Needham & Company

Great and also on the service business, the gross margin as you report them were the highest we’ve seen in a while, I think around 27%, anything unusual in the mix? I know sometimes I think the equipment side of things can move around those gross margins.

Keith Hall

Yes, sometimes the product mix within the services can be a little misleading. We have sometimes that 8% of non-recurring equipment sales can kind of throw off the margins depending on what the compliment is so that tends to fluctuate a little bit but in the baseline, the way that we look at gross margins internally which is taking he [inaudible] of the network operation costs and moving that kind of below the line. The gross margins are actually very consistent historically in the 35% to 40% range, somewhere you know in the 37% to 38% gross margins and that’s a little bit different than you see the gross margins outside because the way we do the accounting, the network operation costs are shown above the line. Not to confuse anything but…

Rich Valera – Needham & Company

Okay. That’s helpful. With respect with the C2C Evo acquisition, just wanted to follow up on the comment that I think you made Keith about them enabling you to offer a much lower cost in MarSat offering, can you sort of clarify that, I suppose you did have the ability prior to sort of offering [inaudible].

Keith Hall

Absolutely. With the acquisition of Telaurus that really was our entry into the narrowband market of iridium and in MarSat. What EvoSat provides is what they call DP Status which is Direct Provider Status and that enables them to pricing for items such as fleet broadband services that are at a different level than say Telaurus had previously. It's, I don’t know if you're familiar with like Cisco re-sellers but it's like having a different status and with that status you get different discount levels and EvoSat at a different discount level status than even Telaurus is due to their DP Status so for things as we move into some of the broadband side, like free broadband services we’re in a better position to be cost competitive with some of our competitors.

Rich Valera – Needham & Company

Okay, now that’s helpful clarification.

David Hershberg

And what Evo Sat, they’ve been you know if you look at their narrow band services they been more involved in the [B Gan] side of the business more so than the Maritime side of the business so the two together are very complimentary, Telaurus and EvoSat, both using narrowband services but for different applications.

Operator

We will take the next question from Dick Ryan – Dougherty Brokerage.

Dick Ryan – Dougherty Brokerage

Dave could you talk a little bit on the hosted switch side? You’ve got three customers, can you give a general profile of the three customers and you know kind of how you're getting this message to market and kind of the low hanging fruit opportunity that might exist there?

David Hershberg

Actually we have much more than three, what we were referring to three it was for our new switch which is the Ericsson, we have eight other customers on our Legacy switches that we have and then some of them will probably be moving over to that switch eventually. You know the Ericsson switch is a full modern, full service 3G type of switch and we’re providing services to three carriers in the US. On our other switch we were doing both US, Caribbean, we’re actually providing service as far away as Afghanistan on the older switches so I think the total we have now is about 11 hosted customers right now but Keith can give you a little more detail who they are and how we are making money on them.

Keith Hall

I think when you look at a profile the current profile is a merging provider or what they call Tier 3 providers as well as private networks. So Dave mentioned we are looking globally. I think on the merging provider front US is the priority right now. Private networks, whether it's a military network or otherwise we’re looking globally. From a marketing perspective, we’re leaning heavily on our partnership with Ericsson and Ericsson’s sales force.

They are partnered with Globecomm to get the message out whether it's through print or conference and trade shows so the funnel is building, we’re getting the message out. It's really a new brand for Globecomm so it's going to take a little bit of time but we’re very happy with the progress.

I just want to add, this is a very, again, low turn business, get the customer, very sticky, maybe a little bit slow building but it's like the rest of our service business, it takes a little time but then it builds upon itself.

Dick Ryan – Dougherty Brokerage

Is there anybody working with Ericsson along the same lines that you are?

David Hershberg

There are other providers. I’m not sure that there are other providers that have the partnership from a manufacturer and from a global managed provider. So I think from a value proposition I would say we’re at the top. There are other service providers that don’t have the partnership and there are other manufacturers that don’t have the other so.

Keith Hall

I think the key there is that it gives these two or three operators an opportunity to provide a switch with the same service capabilities as the larger carriers Tier 1 carriers which is very important so we can go to a company that has two, three, four thousand subscribers and say okay, we can give you same kind of services but this is a $4 million switch that you have to maintain and care for so a smaller operator really can’t afford that and would be at a disadvantage using a switch without all the capabilities that we have.

So we get that message out and get it to enough people we said we’ve got a really good value proposition for our customers and we do have a lot of potential people out there that we’ve been bidding to.

Operator

And we’ll take a follow-up question from Stephen Ferranti - Stephens Inc.

Stephen Ferranti - Stephens Inc.

You guys mentioned earlier about some of the Ka-band opportunity you saw out there and you tied it into some of the activity that ViaSat and Hughes are undertaking with regard to their own Ka-band efforts. Could you give us some idea of how Globcomm’s offering sort of [interleaves] or where the opportunity is within something like what ViaSat or Hughes is doing for Globecomm? Is it predominantly in the infrastructure build out? Just trying to get a better picture of that.

David Hershberg

I think it’s in a couple of areas. One is on the Hughes project there are opportunities to build gateway terminals. With the ViaSat and that’s directly for use. With ViaSat and with Hughes there would be users out there that are using the satellite and we would be one of them. When you’re talking about a satellite dish that can offer T1s in $400 to $500 range as compared to $4,000 to $5,000 range. We think that’s going to open up a lot of potential customers and we would be working directly with them to supply infrastructure.

So it would be two ways. There is no potential for the gateways with ViaSat because they are certainly in a position to build their own gateways. They have antennas they have capabilities to do that. But there would be an opportunity for customers including ourselves if we’re users on that satellite and other users.

With Hughes we have built a lot of gateways for Hughes over the years and we’re certainly working with them to try to be able to provide gateways for their Jupiter project. So it’s really both ways. One to provide the gateways for the operators. The second is to provide for customers provide customer premise terminals for other users. And we’ve open the possibility for government users also.

Stephen Ferranti - Stephens Inc.

I see that’s helpful, thanks. And Keith, you talked earlier about the Evosat acquisition that provided you with DP status for [in MarSat] services. Is there an expiration date or associated with that or is that a sort of an indefinite status and can all of your [in Mar Sat] services now qualify for DP status given the acquisition?

Keith Hall

We will, one of the things that we went through when we did the acquisitions was ensuring that that license transferred over to Globecomm so that is secure. And yes, we have the ability now so Telaurus will be buying their bandwidth through Evosat so within the company purchase to ensure that we can… We still need to purchase it through Evosat because they’re the license holder but we have the ability to buy through our companies to obtain that cost delta.

Stephen Ferranti - Stephens Inc.

Okay. Last one for me. Just given the trends that you’re seeing on the product side of the business with the pre-engineered revenues starting to pick up how do we think about the gross margins going forward in that segment? I mean typically it’s been a fairly lumpy pattern in terms of gross margins there but it would seem like a baseline. We’re starting with from the third quarter coupled with the fact that revenues in that segment are starting to perk up again. It would imply that maybe a higher level gross margin might be a little bit more sustainable there going forward?

Keith Hall

Well I can start. I think the gross margin in infrastructure segment as you probably heard over and over on these calls is a product of the two main offerings the pre-engineered systems and the project base infrastructure systems. So I think it remains a little bit lumpy because I think both segments are somewhat unpredictable. But as long as we can keep the product mix a little bit slanted with more pre-engineered systems or at least a higher contribution from that that will drive the margin.

Just because we have more revenue in the infrastructure segment doesn’t necessarily mean more gross margin. We need the product mix to have enough pre-engineered systems. More revenue helps the bottom line because we overcome the operating expense hurdle, but the actual gross margin is really a product mix issue.

David Hershberg

We think from if we just show our base products that we develop here that those margins would still be in the 25% to 30% region. However, there are two projects that have relatively low margins. One was a subcontract that we had with ViaSat which a lot of it is just a pass through so that does not have a high gross margin. The second is NATO who are building these [trucks]. We are depending on a number of change orders that are supposed to be coming in. On that NATO has a big budget problem right now. So when they come in I think the margin will improve there, will have a reasonable margin.

However, we’re still waiting for those change orders and they do have some significant budget issues. So those two areas are not going to be high margin. I think NATO has an opportunity of the higher margin. But on the chipping project which is a ViaSat pass through that’s not a high margin project.

I think from the standpoint of building more product I think we have some very good products. We’ve had some run-offs with other suppliers and we came out on top. And so we’re hoping to get some reasonably good orders there. I think a really good product that can be set up fast that’s robust and reliable would command a little higher margin than one that isn’t So I think our products are some of the few cost products that going through [full mill] environmental testing which is to differentiate it for us and should keep our margins up in that area.

Operator

And we have another caller question from Mark Jordan – Noble Financial.

Mark Jordan – Noble Financial

One question relative to inventories. Inventories were up $8.6 million sequentially and looked like they’d almost doubled since start of the fiscal year. You would alluded to working on some projects that hadn’t been available yet. I would assume that’s the cause of work in process virtually doubling so far this year. My question would be is that correct?

And then secondly when do you expect those sales to become available to flow through the P&L and is the normal inventory level [inaudible] at the $17 million level where you were a year ago or is it a higher number?

David Hershberg

That’s exactly right, there’s looking at the work in process when you inventory and what we’ve been trying to do with this $20 million NATO project which is a stretch out delivery where you deliver a couple of products at a time and get paid for them is to try to do a just-in-time type of thing which we’ve been somewhat successful or else that number would be somewhat larger. But when you have a $28 million project you’re working on and you don’t get paid. I think we got a 5% upfront on that project.

Keith Hall

Yes, 5% down payment.

David Hershberg

We got a 5% down payment. We don’t get another nickel on that project until we start delivering product which will be in the first quarter of next year.

So that’s exactly right. That’s that work in process that have jacked those inventories up.

Keith Hall

That one project NATO is driving inventory up over $12 million [maximum].

Mark Jordan – Noble Financial

And then when would you expect that inventory you know kind of bubble to work down and have inventory at a normalized level?

As the schedule looks now we’re hopeful and we’re optimistic that we’ll start to see that bubble down towards the end of Q1 which is September and certain by December of next year fiscal year.

Operator

And that does conclude the day’s question and answer session. I would now like to turn the conference back to Mr. David Hershberg for any further and closing remarks.

David Hershberg

Well thank you very much for participating. Keep watching the press releases and we’re very optimistic going forward here and I really want to thank you all for your support.

Thank you.

Operator

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

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