ITEM 1B.
Unresolved Staff Comments
None.
The following table provides information about our facilities as of December 31, 2014.
ITEM 3.
ITEM 3.
Legal Proceedings
From time to time, we are involved in litigation incidental to the conduct of our business. In the ordinary course of business, we are a party to inquiries, legal proceedings and claims including, from time to time, disagreements with vendors and customers.
ITEM 4.
ITEM 4.
Mine Safety Disclosures
Not applicable.
PART II
ITEM 5.
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information. Our common stock trades on the NASDAQ Global Market under the symbol “KVHI.” The following table provides, for the periods indicated, the high and low sale prices for our common stock as reported on the NASDAQ Global Market.
Stockholders. As of March 13, 2015, we had 92 holders of record of our common stock. This number does not include stockholders for whom shares were held in a nominee or “street” name.
Dividends. We have never declared or paid cash dividends on our capital stock, and we have no plan to pay any cash dividends in the foreseeable future. We currently intend to retain any future earnings to finance our operations and future growth. In addition, the terms of our senior credit agreement, which we entered into in July 2014, place restrictions on our ability to pay cash dividends on our common stock.
Issuer Purchases of Equity Securities. On November 26, 2008, our Board of Directors authorized a program to repurchase up to one million shares of our common stock. The repurchase program is funded using our existing cash, cash equivalents, marketable securities, and future cash flows. Under the repurchase program, at management’s discretion, we may repurchase shares on the open market from time to time, in privately negotiated transactions or block transactions, or through an accelerated repurchase agreement. The timing of such repurchases depends on availability of shares, price, market conditions, alternative uses of capital, and applicable regulatory requirements. The program may be modified, suspended, or terminated at any time without prior notice. The repurchase program has no expiration date. There were no other repurchase programs outstanding during the year ended December 31, 2014, and no repurchase programs expired during the period.
We did not repurchase any shares of our common stock in open market transactions during the years ended December 31, 2014, 2013, and 2012.
During the year ended December 31, 2014, 35,450 vested restricted shares were surrendered in satisfaction of tax withholding obligations at an average price of $13.59 per share.
STOCK PERFORMANCE GRAPH
The following graph compares the performance of our cumulative stockholder return with that of the NASDAQ Composite Index, a broad equity market index, and the NASDAQ Telecommunications Index, a published industry index. The cumulative stockholder returns for shares of our common stock and for the market indices are calculated assuming $100 was invested on December 31, 2009. We paid no cash dividends during the periods shown. The performance of the market indices is shown on a total return (dividends reinvested) basis. Measurement points are the last trading days of the years ended December 2010, 2011, 2012, 2013, and 2014.
ITEM 6.
ITEM 6.
Selected Financial Data
We have derived the following selected financial data from our audited consolidated financial statements. You should read this data in conjunction with “Item 7.
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the other financial information and consolidated financial statements and related notes appearing elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of a variety of factors, including those discussed under the heading “Item 1A. Risk Factors” and elsewhere in this annual report.
Overview
We design, develop, manufacture and market mobile communications products and services for the marine and land mobile markets, and navigation, guidance and stabilization products for both the defense and commercial markets.
Our mobile communications products enable customers to receive voice and Internet services and live digital television via satellite services in marine vessels, recreational vehicles, buses and automobiles. Our CommBox offers a range of tools designed to increase communication efficiency, reduce costs, and manage network operations. We sell and lease our mobile communications products through an extensive international network of dealers and distributors. We also sell and lease products directly to end users.
Our mobile communications service sales include sales earned from satellite voice and Internet airtime services, engineering services provided under development contracts, sales from product repairs, and extended warranty sales. Our mobile communications services sales also include our distribution of entertainment, including news, sports, music, and movies, to commercial and leisure customers in the maritime, hotel, and retail markets through KVH Media Group (acquired as Headland Media Limited), the media and entertainment service company that we acquired on May 11, 2013, and the distribution of training films and eLearning computer-based training courses to commercial customers in the maritime market through Super Dragon Limited and Videotel Marine Asia Limited (together referred to as Videotel), a maritime training services company that we acquired on July 2, 2014. We typically recognize revenue from media content sales ratably over the period of the service contract. We provide, for monthly fixed and usage fees, satellite connectivity services for broadband Internet, data and Voice over Internet Protocol (VoIP) service to our TracPhone V-series customers. We also earn monthly usage fees for third-party satellite connectivity for voice, data and Internet services to our Inmarsat and Iridium customers who choose to activate their subscriptions with us. Our service sales have grown as a percentage of total revenue from 34% of our net sales in 2012 to 44% in 2013 to 53% in 2014, a portion of which is attributable to our acquisition of the KVH Media Group business in May 2013 and Videotel in July 2014.
We acquired Videotel for an aggregate purchase price of $47.4 million in cash. The purchase price was subject to a potential post-closing adjustment based on the value of the net assets delivered at the closing. We financed $35.0 million of the purchase price through a new senior credit facility and paid the remaining portion of the purchase price from cash and cash equivalents. Revenue for the Videotel group companies was $10.4 million in the six months ended December 31, 2014. Videotel’s revenue is included in service revenue in our consolidated financial statements. The majority of Videotel’s services are invoiced in pounds sterling, which increases our exposure to fluctuations in exchange rates.
We also offer precision fiber optic gyro (FOG)-based systems that enable platform and optical stabilization, navigation, pointing, and guidance. Our guidance and stabilization products also include tactical navigation systems that provide uninterrupted access to navigation and pointing information in a variety of military vehicles, including tactical trucks and light armored vehicles. Our guidance and stabilization products are sold directly to U.S. and foreign governments and government contractors, as well as through an international network of authorized independent sales representatives. In addition, our guidance and stabilization products are used in numerous commercial products, such as navigation and positioning systems for various applications including precision mapping, dynamic surveying, autonomous vehicles, train location control and track geometry measurement systems, industrial robotics and optical stabilization.
Our guidance and stabilization service sales include engineering services provided under development contracts, product repairs and extended warranty sales. Our guidance and stabilization sales in 2014 and 2013 included $1.3 million and $15.3 million, respectively, attributable to our original $35.6 million contract from 2012 with the Saudi Arabian National Guard (SANG), the largest contract in the history of our company. We completed the delivery of TACNAV product shipments under the original SANG contract in the second quarter of 2013, and we completed the services portion of the original SANG contract in the third quarter of 2014. In May 2014, we entered into a contract modification to the original order for an additional $5.2 million for TACNAV products and services. All additional TACNAV products related to the contract modification were shipped in the second quarter of 2014, and we completed the services portion of the contract modification in the third quarter of 2014. In October 2014, we entered into a $19.0 million TACNAV product and services contract with an international military customer. This contract includes program management and engineering services expected to be delivered through 2017 and hardware shipments expected to be fulfilled in 2015 and 2016 as well as out-year support services to be provided as part of this
order. Our guidance and stabilization sales in 2014 included $1.1 million related to this order.
We generate sales primarily from the sale of our mobile communications systems and services and our guidance and stabilization products and services. The following table provides, for the periods indicated, our sales by industry category:
Net sales to SANG accounted for less than 10% of our net sales in 2014 and 12% of our net sales in 2013. The decrease in net sales to SANG from 2013 to 2014 was primarily driven by the timing of deliverables in fulfillment of the 2012 SANG contract described above. The terms and conditions of these sales to SANG were consistent with our standard terms and conditions of product sales as discussed in Note 1 of our consolidated financial statements. There were no receivables outstanding related to the SANG contract as of December 31, 2014. No other customer accounted for more than 10% of our net sales for each of the years ended December 31, 2014, 2013, and 2012.
We have historically derived a substantial portion of our revenue from sales to customers located outside the United States and Canada. The following table provides, for the periods indicated, sales to specified geographic regions:
See Note 13 to our consolidated financial statements for more information on our geographic segments.
In addition to our internally funded research and development efforts, we also conduct research and development activities that are funded by our customers. These activities relate primarily to engineering studies, surveys, prototype development, program management, and standard product customization. In accordance with accounting principles generally accepted in the United States of America, we account for customer-funded research as service revenue, and we account for the associated research and development costs as costs of service and product sales. As a result, customer-funded research and development are not included in the research and development expense that we present in our statement of operations. The following table presents our total annual research and development effort, representing the sum of research costs of service and product sales and the operating expense of research and development as described in our statement of operations. Our management believes this information is useful because it provides a better understanding of our total expenditures on research and development activities.
Results of Operations
The following table provides, for the periods indicated, certain financial data expressed as a percentage of net sales:
Years ended December 31, 2014 and 2013
Net Sales
Product sales decreased $9.2 million, or 10%, to $81.1 million in 2014 from $90.3 million in 2013. The decrease was primarily due to a decrease in sales of our guidance and stabilization products of $5.1 million, or 12%, from $43.3 million in 2013 to $38.2 million in 2014. Specifically, sales of our FOG products decreased $5.5 million, or 23%, primarily as a result of decreased product sales under the Crows III program. This decrease was partially offset by a year-over-year increase of $0.5 million of TACNAV hardware sales. Two large TACNAV contracts in 2014 more than replaced the $9.8 million of TACNAV product sales related to the SANG contract that were shipped in the first half of 2013.
We expect that our TACNAV product sales will decrease year-over-year for at least the first quarter of 2015 based on existing backlog. Although we expect that TACNAV sales will continue to grow over the long term, sales on a quarter-to-quarter or year-to-year basis will continue to be very uneven.
Mobile communications product sales decreased $4.0 million, or 8%, to $43.0 million in 2014 from $47.0 million in 2013. The decrease was primarily due to a decrease in sales of our marine satellite communications products of $3.6 million, or 10%, driven primarily by an 11% decrease in shipments of our TracPhone mini-VSAT products and an 8% decrease in marine satellite television sales. Sales of our land mobile products of $4.7 million were flat with 2013.
Mobile communications product sales in 2014 originating from our U.S. and European subsidiaries decreased $3.8 million, or 10%, compared to 2013. Mobile communications product sales originating from our Asian subsidiaries increased by $0.3 million, or 8%, compared to 2013.
We remain cautious about the prospects for our marine leisure sales, specifically in Europe, as a result of ongoing challenges in the global economy. We are also cautious in our outlook for vessels that serve the oil exploration and distribution industry.
Service sales for 2014 increased $19.4 million, or 27%, to $91.4 million from $72.0 million for 2013. The primary reason for the increase was an $11.4 million increase in airtime sales for our mini-VSAT Broadband service. Also contributing to the increase in service sales was a $10.4 million increase in new service e-Learning and maritime safety training sales arising from our acquisition of Videotel in July 2014 and a $5.6 million increase in new media sales arising from our acquisition of
Headland Media Limited in May 2013. Partially offsetting these increases was a $6.5 million decrease in contracted engineering services primarily from decreased installation and program management services provided in connection with the SANG contract as well as a $0.6 million decrease in Inmarsat service sales.
We expect that our mini-VSAT services sales will continue to grow year-over-year primarily from an overall increase in our mini-VSAT Broadband customer base, and from new value-added services to our mini-VSAT Broadband customers such as IP-MobileCast, which was launched during the fourth quarter of 2014. We also expect service sales to increase as a result of the acquisition of Videotel in July 2014. However, we expect that our contracted engineering services will decrease year-over-year in at least the first quarter of 2015 as a result of the completion of the SANG installation and project management services in 2014.
Costs of Sales
Our costs of product sales consist primarily of materials, manufacturing overhead, and direct labor used to produce our products. For 2014, costs of product sales decreased by $2.7 million, or 5%, to $48.8 million from $51.5 million in 2013. The primary reason for the decrease was the decrease in sales of our FOG and marine products discussed above offset by a $0.5 million increase in warranty expense predominantly associated with our mini-VSAT products.
Our costs of service sales consist primarily of satellite service capacity, depreciation, and service network overhead expense associated with our mini-VSAT Broadband network infrastructure, direct network service labor, engineering, and related direct costs associated with customer-funded research and development, media materials and distribution costs, service repair material, Inmarsat service costs, as well as product installation costs. Costs of service sales increased by $5.2 million, or 12%, to $50.3 million in 2014 from $45.1 million in 2013. The primary reason for the increase was a $9.2 million increase in airtime costs of sales for our mini-VSAT Broadband service. Also contributing to the increase was a $3.1 million increase in costs of service sales from our new Videotel business and a $1.8 million increase in costs of service sales from the KVH Media Group. Partially offsetting these increases was a $6.6 million decrease in engineering services costs of sales due primarily to a decrease in the services provided in connection with the SANG contract as discussed above, a $0.5 million decrease in Inmarsat costs of service, and a $0.2 million decrease in service repair costs.
Gross margin from product sales for 2014 decreased to 40% as compared to 43% for 2013. The decrease in our gross margin from product sales was primarily due to a decrease in gross margin on our marine TV product sales resulting from the launch of a new TV product series in June 2014. The gross margins on these products improved in the second half of 2014 as we were able to take advantage of improved material prices on volume purchases. Also contributing to the reduction in gross profit margin was under-utilization of our FOG production capacity due to reduced unit sales in 2014.
Gross margin from service sales in 2014 increased to 45% as compared to 37% in 2013. The increase in our gross margin from service sales was primarily attributable to the service gross margin contributed from our KVH Media Group business, as the service revenue for 2013 included only a partial year of service revenue from that business based on the May 11, 2013 acquisition date. Also contributing to the increase in gross margin was the service gross margin from our new Videotel business and an increase in gross margin from contracted engineering services that resulted from completing the low margin installation and project management services under the SANG contract.
We expect service gross margins to increase in the first half of 2015 as a result of the acquisition of Videotel in July 2014. We also anticipate that the favorable year-over-year impact to our mini-VSAT Broadband service margin that we expect to achieve from an overall increase in our mini-VSAT Broadband customer base in the first quarter of 2015 will be offset by the additional costs of new satellite capacity and the release of new value-added services to our mini-VSAT Broadband customers, such as IP-MobileCast.
Operating Expenses
Research and development expense consists of direct labor, materials, external consultants, and related overhead costs that support our internally funded product development and product sustaining engineering activities. Research and development expense for 2014 increased by $1.1 million, or 8%, to $14.1 million from $13.0 million in 2013. The primary reasons for the increase in expense in the 2014 period were a $0.5 million increase in U.S.-based employee compensation for research and development personnel and a $0.2 million increase in consulting expense, both of which were driven by the development of our new satellite television products and IP-MobileCast content delivery service. Also contributing to the increase was a $0.5 million increase in expensed materials. As a percentage of net sales, research and development expense was 8% for 2014 and 2013.
We expect that research and development expense will be modestly lower year-over-year as a result of the completion of
a major product development effort for a significant portion of our marine TV product line in the first half of 2014.
Sales, marketing and support expense consists primarily of salaries and related expenses for sales and marketing personnel, commissions for both in-house and third-party representatives, other sales and marketing support costs such as advertising, literature and promotional materials, product service personnel and support costs, warranty-related costs and bad debt expense. Sales, marketing and support expense also includes the entire operating expenses of our subsidiaries in Denmark, Singapore, Brazil, and Japan. Sales, marketing and support expense for 2014 increased by $4.2 million, or 15%, to $33.0 million from $28.8 million for 2013. The primary reasons for the increase in the 2014 period were a $2.8 million increase in sales, marketing, and support expense related to our new Videotel business, a $1.3 million increase from our KVH Media business, a $0.6 million increase in warranty expense mainly in relation to TracPhone V7 and V11 products, a $0.5 million increase in U.S.-based employee compensation, and a one-time $0.5 million insurance recovery received in the third quarter of 2013 related to misappropriated funds identified at our Danish subsidiary. Partially offsetting these increases were a $0.8 million decrease in variable product sales expense primarily as a result of the completion of product shipments relating to the SANG contract in the second quarter of 2013, a $0.3 million decrease in bad debt expense, and a $0.3 million decrease in sales promotions and demonstration units. As a percentage of net sales, sales, marketing and support expense for 2014 was 19% as compared to 18% for 2013.
We expect that our sales, marketing, and support expense will increase by at least 9% year-over-year in 2015 due to the acquisition of Videotel on July 2, 2014.
General and administrative expense consists of costs attributable to management, finance and accounting, information technology, human resources, certain outside professional services, and other administrative costs. General and administrative expense for 2014 increased by $6.6 million, or 37%, to $24.4 million from $17.8 million for 2013. The primary reason for the increase in 2014 expense was a $3.0 million increase in expense from our new Videotel business, a $2.9 million increase in general and administrative expense relating to the KVH Media Group, and a $0.5 million increase in U.S.-based employee compensation, as well as a $0.4 million increase in compensation expense related to purchase accounting and a $0.4 million increase in acquisition costs, both of which related to the purchase of Videotel. Partially offsetting this increase was a $0.4 million decrease in accrued performance-based incentive compensation. As a percentage of net sales, general and administrative expense for 2014 was 14% as compared to 11% for 2013.
We expect general and administrative expenses to increase year-over-year in 2015, driven primarily by additional expenses from our acquisition of Videotel, including incremental amortization expenses for acquired intangible assets. Incremental amortization from the Videotel acquisition that is allocated to general and administrative expense, based on currency exchange rates in effect at December 31, 2014, is currently estimated at approximately $2.2 million per year. The actual amount of amortization in 2015 will depend on currency exchange rates in effect during 2015.
Interest and Other Expense (Income), Net
Interest income remained consistent from 2013 to 2014 at $0.7 million. Interest expense for 2014 increased by $0.7 million, or 117%, to $1.3 million from $0.6 million for 2013. The primary reason for the increase was borrowings under our new senior credit facility executed in July 2014 to finance the purchase of Videotel in July 2014. Other expense (income), net for 2014 decreased by $0.5 million, or 108%, to other expense of $0.1 million from other income of $0.5 million for 2013. The primary reason for the increase in expense was a reduction in the market value of cash flow hedges, as well as foreign currency exchange losses primarily associated with our UK operations.
Income Tax Expense
Income tax expense for 2014 was $1.3 million as compared to income tax expense of $2.2 million for 2013. The decrease in income tax expense is primarily due to a $5.4 million decrease in pretax income offset by increased valuation allowances, which created discrete tax charges of $0.9 million in 2014.
Years ended December 31, 2013 and 2012
Net Sales
Product sales decreased in 2013 by $0.4 million, or less than 1%, to $90.3 million from $90.7 million in 2012. The primary reason for the decrease in 2013 was a decrease in sales of our mobile communications products to $47.0 million, or 2%. The decrease was primarily due to a $1.2 million, or 25%, decrease in sales of our land mobile products. The decrease in our land mobile products was primarily a result of decreased sales to original equipment manufacturers in the recreational vehicle market. Sales of marine products in 2013 were consistent with 2012. Sales of our TracPhone V11 product, which was released in the fourth quarter of 2012, increased as did our TracPhone V7 sales in the Americas. Partially offsetting these increases in marine product sales was decreased sales of our TracPhone V7 product in Asia and Europe.
Mobile communications product sales originating from our European and Asian subsidiaries decreased $3.3 million, or 18%, in 2013 as compared to 2012. Mobile communications product sales originating from the Americas increased $2.1 million, or 7%, in 2013 as compared to 2012.
Offsetting the decrease in mobile communications product sales was an increase of $0.8 million, or 2%, in sales of guidance and stabilization products. Specifically, sales of our FOG products increased $1.1 million, or 5%, primarily due to increased demand for commercial applications. Partially offsetting the increase in FOG products was decreased sales from the U.S. Army’s Common Remotely Operated Weapon Stations (CROWS) III Program. Sales of our TACNAV defense products decreased $0.6 million, or 3%, primarily as a result of decreased product sales related to our SANG contract, the largest contract in our history. The SANG contract contributed $9.8 million and $11.4 million to our product sales in 2013 and 2012, respectively, and we completed delivery of products under the SANG contract in the second quarter of 2013.
Service sales increased in 2013 by $25.6 million, or 55%, to $72.0 million from $46.4 million in 2012. The primary reason for the increase was a $12.2 million increase in airtime sales for our mini-VSAT Broadband service. Also contributing to the increase were $8.8 million in new media service sales arising from our acquisition of Headland Media Limited (now known as the KVH Media Group) in May 2013, and a $4.8 million increase in contracted engineering services driven by construction and program management services provided in connection with the SANG contract.
Costs of Sales
Our costs of product sales consist primarily of materials, manufacturing overhead and direct labor used to produce our products. Costs of product sales in 2013 decreased by $0.3 million, or less than 1%, to $51.5 million from $51.8 million in 2012, consistent with the decrease in product sales discussed above.
Our costs of service sales consist primarily of satellite service capacity, depreciation and service network overhead expense associated with our mini-VSAT Broadband network infrastructure, direct network service labor, engineering and related direct costs associated with customer-funded research and development, media materials and distribution costs, service repair material, Inmarsat service costs, as well as product installation costs. Costs of service sales increased by $14.7 million, or 48%, to $45.1 million in 2013 from $30.4 million in 2012. The primary reason for the increase was a $6.2 million increase in airtime costs of service sales for our mini-VSAT Broadband service. Also contributing to the increase was a $5.8 million increase in engineering services costs of sales due primarily to the services provided in connection with the SANG contract discussed above, and a $2.5 million increase in costs of service sales from media services arising from our new KVH Media Group business.
Gross margin from product sales remained consistent at 43% in 2013 and 2012.
Gross margin from service sales increased to 37% in 2013 from 35% in 2012. The increase in our gross margin from service sales was primarily attributable to the service gross margin contributed from our new KVH Media Group business. Also contributing to the gross margin increase was an increase in gross margin for mini-VSAT Broadband service sales to 35% from 31% in the year-ago period. Partially offsetting the increase in gross margin for mini-VSAT broadband service was a significant decrease in gross margin for contracted engineering services as a result of the facility construction, installation and project management services in Saudi Arabia, as these services had a gross margin of approximately 10%.
Operating Expenses
Sales, marketing, and support expense consists primarily of salaries and related expenses for sales and marketing personnel, commissions for both in-house and third-party representatives, other sales and marketing support costs such as advertising, literature and promotional materials, product service personnel and support costs, warranty-related costs, and bad debt expense. Sales, marketing, and support expense also includes the entire operating expenses of our subsidiaries in Denmark, Singapore, Brazil and Japan. Sales, marketing and support expense in 2013 increased by $4.7 million, or 20%, to $28.8 million from $24.1 million in 2012. The primary reasons for the increase in 2013 were a $2.7 million increase in sales, marketing and support expense related to our new KVH Media Group business, and our Danish and Japanese subsidiaries, and a $1.0 million increase in warranty expense predominantly associated with our mini-VSAT products.
Also contributing to the increase was a $0.8 million increase in U.S.-based compensation for sales, marketing and support, a $0.5 million increase in bad debt expense mainly related to airtime sales for our mini-VSAT Broadband service, a $0.3 million increase in variable sales expense primarily as a result of the sales relating to the SANG contract and related facility construction, and a $0.2 million increase in demonstration equipment expense. Partially offsetting these increases was a $0.5 million insurance recovery related to misappropriated funds identified at our Danish subsidiary, and a $0.2 million decrease in sales, marketing and support expense related to our Norwegian subsidiary. As a percentage of net sales, sales, marketing and support expense was 18% in 2013, which was consistent with 2012.
Research and development expense consists of direct labor, materials, external consultants and related overhead costs that support our internally funded product development and product sustaining engineering activities. Research and development costs are generally expensed as incurred. Research and development expense in 2013 increased by $0.9 million, or 7%, to $13.0 million from $12.1 million in 2012. The primary reason for the increase in 2013 expense was a $0.6 million increase in U.S.-based compensation for research and development personnel driven by the development of our new IP-MobileCast content delivery service. As a percentage of net sales, research and development expense decreased to 8% in 2013 from 9% in 2012.
General and administrative expense consists of costs attributable to management, finance and accounting, information technology, human resources, certain outside professional services and other administrative costs. General and administrative expense in 2013 increased by $5.6 million, or 46%, to $17.8 million from $12.2 million in 2012. The primary reason for the increase in 2013 was a $3.9 million increase in general and administrative expense relating to our new KVH Media Group business, and $0.9 million in transaction expenses related to that acquisition. Also contributing to the increase was a $0.5 million increase in U.S.-based employee compensation, and a $0.2 million increase in legal expense. As a percentage of net sales, general and administrative expense increased to 11% in 2013 from 9% in 2012.
Income Tax Expense
Income tax expense decreased by $1.1 million to $2.2 million in 2013 from $3.3 million in 2012. The decrease in income tax expense is primarily due an income tax benefit from the American Taxpayer Relief Act of 2012, which extended the research and development tax credit for two years to December 31, 2013. As a result of the retroactive extension, a discrete income tax benefit of $0.4 million was recognized in 2013 for qualifying research and development amounts incurred in 2012, and an income tax benefit of $0.4 million was recognized for qualifying research and development amounts incurred in 2013. In 2012, we also recognized a discrete income tax expense of $0.2 million associated with tax shortfalls for non-qualified stock options expirations and shortfalls associated with restricted stock awards vesting.
Critical Accounting Policies and Significant Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure at the date of our financial statements. Our significant accounting policies are summarized in Note 1 to our consolidated financial statements. The significant accounting policies that we believe are the most critical in understanding and evaluating our reported financial results include the following:
Revenue Recognition
Product sales. Product sales are recognized when persuasive evidence of an arrangement exists, goods are shipped, title has passed, and collectability is reasonably assured. Our standard sales terms require that:
•
All sales are final;
•
Terms are generally Net 30;
•
Shipments are tendered and shipped FOB (or as may be applicable, FCA or EXW) our plant or warehouse; and
•
Title and risk of loss or damage passes to the dealer or distributor at the point of shipment when delivery is made to the possession of the carrier.
For certain guidance and stabilization product sales, customer acceptance or inspection may be required before title and risk of loss transfers to the customer. For those sales, revenue is recognized after transfer of title and risk of loss and after notification of customer acceptance. In certain circumstances customers may request a bill and hold arrangement. Under these bill and hold arrangements, revenue is recognized when we have fulfilled all of our performance obligations, the units are segregated and available for shipment in accordance with the defined contract delivery schedule, and we have received notification of customer acceptance which transfers title and risk of loss to the customer.
Under certain limited conditions, we, at our sole discretion, provide for the return of goods. No product is accepted for return and no credit is allowed on any returned product unless we have granted and confirmed prior written permission by
means of appropriate authorization. We establish reserves for potential sales returns, credits and allowances, and evaluate, on a monthly basis, the adequacy of those reserves based upon historical experience and our expectations for the future.
Multiple-element revenue arrangements. Some of our sales involve multiple-element arrangements that include both hardware-related products and contracted service, or satellite connectivity. We analyze revenue arrangements with multiple deliverables to determine if the deliverables should be divided into more than one unit of accounting. For contracts with more than one unit of accounting, we allocate the consideration we receive among the separate units of accounting based on a selling price hierarchy for determining the selling price of each deliverable, which includes: (1) vendor-specific objective evidence (VSOE) if available; (2) third-party evidence (TPE) if VSOE is not available; and (3) best estimated selling price (BESP), if neither VSOE nor TPE is available. Best estimate selling price is determined based on prices of the deliverables if sold on a stand-alone basis, or if not sold on a stand-alone basis, the prices we would charge if sold on a stand-alone basis. We recognize revenue for each deliverable based on the revenue recognition policies described in this section.
We have accounted for our $35.6 million contract received in June 2012 from SANG to purchase TACNAV defense products and services as a multiple-element arrangement. The total contract value associated with TACNAV defense products is $21.2 million, for which the final shipments were completed in the second quarter of 2013. The total contract value associated with all services is $14.4 million, and such services were completed in the third quarter of 2014. In October 2014, we entered into a $19.0 million TACNAV product and services contract with an international military customer. This contract includes program management and engineering services expected to be delivered through 2017 and hardware shipments expected to be fulfilled in 2015 and 2016, as well as out-year support services. The revenue for these services is recognized using the proportional performance accounting method. Total revenue recognized in 2014 related to this order was $1.1 million.
Contracted service sales. We also engage in contracts for development, production and services activities related to standard product modification or enhancement, which we account for using the proportional performance method of revenue recognition. The use of contract accounting requires significant judgment relative to estimating total contract revenues and costs, including assumptions relative to the length of time to complete the contract, the nature and complexity of the work to be performed, and prices for subcontractor services and materials. Our estimates are based upon the professional knowledge and experience of our engineers, program managers and other personnel, who review each long-term contract monthly to assess the contract's schedule, performance, technical matters, and estimated cost at completion. A cancellation, schedule delay, or modification of a fixed-price contract which is accounted for using the proportional performance method may adversely affect our gross margins for the period in which the contract is modified. Changes in estimates are applied when adjustments in estimated contract costs are identified, such revisions may result in current period adjustments to earnings applicable to performance in prior periods.
Satellite connectivity and media content sales. Directly sold and re-sold satellite connectivity service for voice, data and Internet is recognized monthly based upon minutes or megabytes of traffic processed or contracted fixed fee schedules. Typically, all subscribers enter into a contracted one-year minimum service agreement. We record all satellite connectivity service sales to subscribers as gross sales, as we are the primary obligor in the contracted service arrangement. All associated regulatory service fees and costs are recorded net in our consolidated financial statements. Media content sales include our distribution of commercially licensed news, sports, movies and music content for commercial and leisure customers in the maritime, hotel, and retail markets as well as training videos to the merchant marine market that are typically based on a contracted fixed fee schedule. We typically recognize revenue from media content sales ratably over the period of the service contract. The accounting estimates related to the recognition of satellite connectivity and media content service sales in our results of operations require us to make assumptions about future billing adjustments for disputes with subscribers as well as unauthorized usage.
Accounts Receivable Allowance
Our estimate of allowance for doubtful accounts related to trade receivables is primarily based on specific and historical criteria. We evaluate specific accounts where we have information that the customer may have an inability to meet its financial obligations. We make judgments, based on facts and circumstances, regarding the need to record a specific reserve for that customer against amounts owed to reduce the receivable to the amount that we expect to collect. We also provide for a reserve based on an aging analysis of our accounts receivable. We evaluate these reserves on a monthly basis and adjust them as we receive additional information that impacts the amount reserved. If circumstances change, we could change our estimates of the recoverability of amounts owed to us by a material amount. For example, our bad debt expense increased $0.5 million in 2014 from 2013, driven by bad debt expense associated with airtime sales for our mini-VSAT Broadband service.
We wrote off $0.6 million, $0.5 million, and $0.2 million of our accounts receivable in 2014, 2013, and 2012, respectively. These write-offs were driven largely by the financial deterioration of several airtime and lease customers as well as several mobile communications product distributors. The current economic downturn could continue to adversely impact the
financial condition of our customers, which could result in additional write-offs and increases in our allowance for doubtful accounts and have a negative impact on our results of operations.
Inventories
Inventory is valued at the lower of cost or market. We generally must order components for our products and build inventory in advance of product shipments. We regularly review current quantities on hand, actual and projected sales volumes and anticipated selling prices on products and write down, as appropriate, slow-moving and/or obsolete inventory to its net realizable value. In 2014, 2013, and 2012, we wrote off $0.2 million, $0.1 million, and $0.2 million, respectively, of fully reserved inventory. However, if we overestimate projected sales or anticipated selling prices, our inventory might be overstocked or overvalued, and we would have to reduce our inventory valuation accordingly.
Accounting for Income Taxes
As part of the process of preparing our financial statements, we are required to estimate our provision for income taxes in each of the jurisdictions in which we operate. This involves estimating our actual current tax exposure, including assessing the risks associated with tax audits, together with assessing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We assess the likelihood that our deferred tax assets will be recovered from future taxable income and record a valuation allowance to reduce the deferred tax assets to an amount that, in our judgment, is more likely than not to be recovered.
Management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our deferred tax assets. The valuation allowance is based on our estimates of future taxable income and the period over which we expect the deferred tax assets to be recovered. Our assessment of future taxable income is based on historical experience and current and anticipated market and economic conditions and trends. In the event that actual results differ from these estimates or we adjust our estimates in the future, we may need to adjust our valuation allowance, which could materially impact our consolidated financial position and results of operations. At December 31, 2014, we had valuation allowances of $4.2 million to offset gross deferred tax assets of $13.6 million.
Warranty Provision
We typically offer a one to two year warranty for all of our base products. We provide for the estimated cost of product warranties at the time product revenue is recognized. Factors that affect our warranty reserves include the number of units sold, historical and anticipated rates of warranty repairs and the cost per repair. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, our estimated warranty obligation is affected by ongoing product failure rates, specific product class failures outside our baseline experience, material usage and service delivery costs incurred in correcting a product failure. If actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required. For example, our warranty expense increased $0.5 million in 2014 from 2013, driven primarily by warranty expense associated with our mini-VSAT products.
Assumptions and historical warranty experience are evaluated to determine the appropriateness of such assumptions. We assess the adequacy of the warranty provision on a quarterly basis and we adjust this provision when necessary.
Stock-Based Compensation
Our stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is generally the vesting period.
We use the Black-Scholes valuation model for estimating the fair value on the date of grant of compensatory stock options. Determining the fair value of stock option awards at the grant date requires judgment regarding certain valuation assumptions, including the volatility of our stock price, expected term of the option, risk-free interest rate and expected dividends. Changes in these assumptions and estimates could result in different fair values and could therefore impact our earnings. These changes would not impact our cash flows. The fair value of restricted stock awards is based upon our stock price on the grant date.
The amount of stock-based compensation expense recorded in any period for unvested awards requires estimates of the amount of stock-based awards that are expected to be forfeited prior to vesting.
Compensation costs for awards subject only to service conditions that vest ratably are recognized on a straight-line basis over the requisite service period for the entire award.
Goodwill and Intangible Assets
Goodwill is tested at least annually for impairment. If an event occurs or circumstances change that indicate that the carrying value may not be recoverable, we will perform an interim test at that time. The impairment test begins by allocating goodwill to its reporting unit. Goodwill is then tested using a two-step process that begins with an estimation of the fair value of the reporting unit using an income approach, which looks to the present value of expected future cash flows. The impairment test is performed through the application of a two-step process. The first step is a screen for potential impairment by comparing the carrying value of our reporting units to their estimated fair values as of the test date. The estimated cash flows are calculated using an income approach. If fair value is less than carrying value, a second step is performed to quantify the amount of the impairment, if any.
Intangible assets with estimated lives and other long-lived assets are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of intangible assets with estimated lives and other long-lived assets is measured by comparing the carrying amount of the asset to future net undiscounted cash flows expected to be generated by the asset. If these comparisons indicate that an asset is not recoverable, we will recognize an impairment loss for the amount by which the carrying value of the asset exceeds the related estimated fair value. Estimated fair value is based on either discounted future operating cash flows or appraised values, depending on the nature of the asset.
Considerable judgment is required to estimate discounted future operating cash flows. Judgment is also required in determining whether an event has occurred that may impair the value of goodwill or identifiable intangible or other long-lived assets. Factors that could indicate an impairment may exist include significant underperformance relative to plan or long-term projections, changes in business strategy, significant negative industry or economic trends, a significant change in circumstances relative to a large customer, a significant decline in our stock price for a sustained period and a decline in our market capitalization to below net book value. We must make assumptions about future cash flows, future operating plans, discount rates and other factors in our models and valuation reports. To the extent these future projections and estimates change, the estimated amounts of impairment could differ from current estimates. Our annual testing for impairment of goodwill is completed as of August 31 of each year. As of August 31, 2014, we performed our annual impairment test for goodwill at the reporting unit level and, after conducting the first step, determined that it was not necessary to conduct the second step as we concluded that the fair value of our reporting units exceeded their carrying value. Accordingly, we determined no adjustment to goodwill was necessary. There were no indicators of potential goodwill, intangible asset, or other long-lived asset impairment noted as of December 31, 2014. As of December 31, 2014, we have goodwill of $40.5 million and intangible assets of $33.6 million, which are associated with the purchase of Virtek Communication in September 2010, Headland Media Limited (KVH Media Group) in May 2013, and Videotel in July 2014.
Contingencies
We are subject to ongoing business risks arising in the ordinary course of business. See Item 3. Legal Proceedings, for more information regarding litigation matters. An estimated loss contingency is accrued when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. We regularly evaluate current information available to determine whether such amounts should be adjusted and record changes in estimates in the period they become known. We reserve for legal contingencies and legal fees when the amounts are probable and reasonably estimable. At December 31, 2014, we have not recorded any material loss contingencies.
Liquidity and Capital Resources
We have historically funded our operations primarily from cash flows from operations, net proceeds from public and private equity offerings, bank financings, and proceeds received from exercises of stock options. As of December 31, 2014, we had $49.8 million in cash, cash equivalents, and marketable securities, of which $9.8 million in cash equivalents were held in a local currency by our foreign subsidiaries. There were no marketable securities held by our foreign subsidiaries as of December 31, 2014. As of December 31, 2014, we had $65.2 million in working capital.
Operating Activities
Net cash provided by operations for 2014 was $10.4 million as compared to net cash provided by operations of $16.3 million for 2013. The $5.9 million decrease is primarily due to a decrease in cash inflows attributable to accounts receivable of $9.5 million, a $4.5 million decrease in net income (which reflects a $4.0 million increase in depreciation and amortization expense and a $1.1 million increase in deferred income taxes), and a $1.4 million increase in cash outflows related to accrued expenses and accounts payable. Partially offsetting the decrease in cash inflows were a $2.8 million decrease in cash outflows related to inventory, a $1.5 million increase in cash inflows related to deferred revenue, a $1.2 million decrease in cash
outflows related to other non-current assets, and a $0.5 million decrease in cash outflows related to prepaid expenses and other assets.
Net cash provided by operations for 2013 was $16.3 million as compared to net cash provided by operations of $15.1 million for 2012. The $1.2 million increase is primarily due to an increase in cash inflows attributable to accounts receivable of $3.5 million, a $1.3 million decrease in prepaid and other assets, a $1.0 million increase in net income, and a $0.7 million increase in cash inflows related to deferred revenue. Partially offsetting the increase in cash inflows are a $4.4 million increase in cash outflows as a result of increased inventory levels, and a $0.3 million increase in cash outflows related to accrued expenses and accounts payable.
Investing Activities
Net cash used in investing activities for 2014 was $26.7 million as compared to net cash used in investing activities of $44.7 million for 2013. The $18.1 million decrease in cash outflows is primarily due to the net cash paid for the acquisition of Videotel of $43.5 million in 2014 and an increase in capital expenditures of $0.4 million. Partially offsetting the increase in cash outflows is a $39.0 million decrease in our net investment in marketable securities
Net cash used in investing activities for 2013 was $44.7 million as compared to net cash used in investing activities of $12.3 million for 2012. The $32.4 million increase in cash outflows is primarily due to the net cash paid for the acquisition of Headland Media Limited (now known as KVH Media Group) of $22.9 million and an $11.3 million increase in our net investment in marketable securities. Partially offsetting the increase in cash outflows is a decrease in capital expenditures of $1.8 million.
Financing Activities
Net cash provided by financing activities for 2014 was $32.7 million as compared to net cash provided by financing activities of $29.3 million for 2013. The $3.4 million increase in cash provided by financing activities is primarily due to the net proceeds from borrowings on a term note, net of payments, in the amount of $63.8 million in 2014. These proceeds were offset by a $30.0 million repayment of borrowings under a line of credit in connection with the debt restructuring we undertook in connection with the acquisition of Videotel, as well as a $1.7 million decrease in proceeds from exercises of stock options and purchases under our employee stock purchase plan and $1.3 million in repayments of long-term debt.
Net cash provided by financing activities for 2013 was $29.3 million as compared to net cash used in financing activities of $0.9 million for 2012. The $30.2 million increase in cash provided by financing activities is primarily due to $23.0 million in borrowings from our line of credit used to finance the majority of the acquisition cost of Headland Media Limited (now known as the KVH Media Group) in May 2013, and $5.8 million in borrowings on long-term debt associated with the equipment security notes that we entered into in January and December 2013. Also contributing to the increase was a $2.0 million reduction in payments on our line of credit and a $0.8 million increase in proceeds from exercises of stock options and purchases under our employee stock purchase plan. Partially offsetting this increase was a $1.0 million increase in repayments of long-term debt, as well as a $0.5 million increase in payments related to employee restricted stock withholdings.
Borrowing Arrangements
Principal Credit Facility
As of December 31, 2014, there was $63.8 million in aggregate principal amount outstanding under our principal credit facility. On July 1, 2014, we entered into a five-year senior credit agreement with Bank of America, N.A., as administrative agent, and the lenders named from time to time as parties thereto, for an aggregate amount of up to $80.0 million, including a revolving credit facility of up to $15.0 million and a term loan of $65.0 million to be used for general corporate purposes, including both the refinancing of the $30.0 million of indebtedness then outstanding under our former credit facility and permitted acquisitions. We also entered into a security agreement with respect to our grant of a security interest in substantially all of our assets in order to secure our obligations under the credit agreement and the related notes and pledge agreements with respect to our grant of a security interest in 65% of the capital stock of each of KVH Industries A/S and KVH Industries U.K. Limited held by us in order to secure our obligations under the credit agreement and the notes.
We executed $65.0 million in term notes on July 1, 2014 in connection with our acquisition of Videotel. We applied proceeds in the amount of $35.0 million toward the payment of a portion of the purchase price for Videotel, and we applied proceeds in the amount of $30.0 million toward the refinancing of the then-outstanding balance under our former credit facility. We must make principal repayments on the term loan in the amount of approximately $1.2 million at the end of each of the first eight three-month periods following the closing; thereafter, we must make principal repayments in the amount of approximately $1.6 million for each succeeding three-month period until the maturity of the loan on July 1, 2019. On the maturity date, the entire remaining principal balance of the loan, including any future loans under the revolver, is due and payable, together with
all accrued and unpaid interest, penalties and other amounts due and payable under the credit agreement. The credit agreement contains provisions requiring the mandatory prepayment of amounts outstanding under the term loan and the revolver under specified circumstances, including (i) 100% of the net cash proceeds from certain dispositions to the extent not reinvested in our business within a stated period, (ii) 50% of the net cash proceeds from stated equity issuances and (iii) 100% of the net cash proceeds from certain receipts of more than $250,000 outside the ordinary course of business. The prepayments are first applied to the term loan, in inverse order of maturity, and then to the revolver. In the discretion of the administrative agent, certain mandatory prepayments made on the revolver can permanently reduce the amount of credit available under the revolver.
Loans under the credit agreement bear interest at varying rates determined in accordance with the credit agreement. Each LIBOR Rate Loan, as defined in the credit agreement, bears interest on the outstanding principal amount thereof for each interest period from the applicable borrowing date at a rate per annum equal to the LIBOR Daily Floating Rate or LIBOR Monthly Floating Rate, each as defined in the credit agreement, as applicable, plus the Applicable Rate, as defined in the credit agreement, and each Base Rate Loan, as defined in the credit agreement, bears interest on the outstanding principal amount thereof from the applicable borrowing date at a rate per annum equal to the Base Rate, as defined in the credit agreement, plus the Applicable Rate. The Applicable Rate ranges from 1.50% to 2.25%, depending on our Consolidated Leverage Ratio, as defined in the credit agreement. The highest Applicable Rate applies when the Consolidated Leverage Ratio exceeds 2.00:1.00. Upon certain defaults, including failure to make payments when due, interest becomes payable at a higher default rate.
Borrowings under the revolver are subject to the satisfaction of numerous conditions precedent at the time of each borrowing, including the continued accuracy of our representations and warranties and the absence of any default under the credit agreement. As of December 31, 2014, there were no borrowings outstanding under the revolver.
The credit agreement contains two financial covenants, a Maximum Consolidated Leverage Ratio and a Minimum Consolidated Fixed Charge Coverage Ratio, each as defined in the credit agreement. The Maximum Consolidated Leverage Ratio was initially 2.25:1.00, declined to 1.50:1.00 on December 31, 2014, and declines to 1.00:1.00 on September 30, 2015. The Minimum Consolidated Fixed Charge Coverage Ratio may not be less than 1.25:1.00 at any time after December 31, 2014. We were in compliance with these financial ratio debt covenants as of December 31, 2014. The credit agreement imposes certain other affirmative and negative covenants, including without limitation covenants with respect to the payment of taxes and other obligations, compliance with laws, entry into material contracts, creation of liens, incurrence of indebtedness, investments, dispositions, fundamental changes, restricted payments, changes in the nature of our business, transactions with affiliates, corporate and accounting changes, and sale and leaseback arrangements.
Our obligation to repay loans under the credit agreement could be accelerated upon a default or event of default under the terms of the credit agreement, including certain failures to pay principal or interest when due, certain breaches of representations and warranties, the failure to comply with our affirmative and negative covenants under the credit agreement, a change of control, certain defaults in payment relating to other indebtedness, the acceleration of payment of certain other indebtedness, certain events relating to our liquidation, dissolution, bankruptcy, insolvency or receivership, the entry of certain judgments against us, certain events relating to the impairment of collateral or the lenders’ security interest therein, and any other material adverse change with respect to us.
Mortgage Loan
On April 6, 2009, we entered into a mortgage loan in the amount of $4.0 million related to our headquarters facility in Middletown, Rhode Island. On June 9, 2011, we entered into an amendment to the mortgage loan. The loan term is ten years, with a principal amortization of 20 years, and the interest rate will be a rate per year adjusted periodically based on a defined interest period equal to the BBA LIBOR Rate plus 2.00 percentage points. Land, building and improvements with an approximate carrying value of approximately $5.0 million as of December 31, 2014 secure the mortgage loan. The monthly mortgage payment is approximately $12,000, plus interest and increases in increments of $1,000 each year throughout the life of the mortgage. Due to the difference in the term of the loan and amortization of the principal, a balloon payment of $2.6 million is due on April 1, 2019. The loan contains one financial covenant, a Fixed Charge Coverage Ratio, which applies in the event that our consolidated cash, cash equivalents, and marketable securities balance falls below $25.0 million at any time. As our consolidated cash, cash equivalents, and marketable securities balance was above $25.0 million throughout 2014, the Fixed Charge Coverage Ratio did not apply. Under the mortgage loan we may prepay our outstanding loan balance subject to certain early termination charges as defined in the mortgage loan agreement. If we were to default on our mortgage loan, the land, building and improvements would be used as collateral. As discussed in Note 16 to the consolidated financial statements, effective April 1, 2010, in order to reduce the volatility of cash outflows that arise from changes in interest rates, we entered into two interest rate swap agreements that are intended to hedge our mortgage interest obligations by fixing the interest rates specified in the mortgage loan to 5.9% for half of the principal amount outstanding and 6.1% for the remaining half of the principal amount outstanding as of April 1, 2010 until the mortgage loan expires on April 16, 2019.
Other Matters
It is our intent to continue to invest in the mini-VSAT Broadband network on a global basis in cooperation with ViaSat under the terms of a ten-year agreement announced in July 2008. As part of the future potential capacity expansion, we would plan to seek to acquire additional satellite capacity from satellite operators, expend funds to seek regulatory approvals and permits, develop product enhancements in anticipation of the expansion, and hire additional personnel. In addition, in December 2011, we entered into a five-year agreement to lease satellite capacity from a satellite operator, effective February 1, 2012, and in 2012 we also purchased three satellite hubs to support this added capacity. The total cost of the five-year satellite capacity agreement, the satellite hubs, and teleport services is approximately $12.2 million, of which approximately $2.7 million related to the total cost of the three hubs. On January 30, 2013, we borrowed $4.7 million from a bank and pledged as collateral six satellite hubs and related equipment, including the three hubs purchased in 2012. The term of the equipment loan is five years, and the loan bears interest at a fixed rate of 2.76% per annum. The monthly payment is approximately $83,000, including interest expense. On December 30, 2013, we borrowed $1.2 million from a bank and pledged as collateral one satellite hub and related equipment. The term of the equipment loan is five years, and the loan bears interest at a fixed rate of 3.08% per annum. The monthly payment is approximately $21,000, including interest expense.
On November 26, 2008, our Board of Directors authorized a program to repurchase up to one million shares of our common stock. The share repurchase program is funded using our existing cash, cash equivalents, marketable securities and future cash flows. As of December 31, 2014, 341,009 shares of our common stock remain available for repurchase under the program. We did not purchase any shares of our common stock in 2014.
As of December 31, 2014, we held $49.8 million in cash, cash equivalents, and marketable securities. We believe that our cash, cash equivalents, and marketable securities, together with our other existing working capital and cash flows from operations, will be adequate to meet planned operating and capital requirements through at least the next twelve months. However, as the need or opportunity arises, we may seek to raise additional capital through public or private sales of securities or through additional debt financing. There are no assurances that we will be able to obtain any additional funding or that such funding will be available on terms acceptable to us.
Contractual Obligations and Other Commercial Commitments
As of December 31, 2014, our contractual commitments consisted of satellite service capacity, near-term purchase commitments, term notes payable, a mortgage note payable, equipment notes payable, and equipment and facility leases. Our purchase commitments include unconditional purchase orders for inventory, manufacturing materials and fixed assets extending out over various periods throughout 2015. We are also obligated under satellite service capacity leases and multi-year facility leases that terminate at various times between 2015 and 2018.
The following table summarizes our obligations under these commitments, excluding interest, at December 31, 2014:
We did not have any off-balance sheet commitments, guarantees, or standby repurchase obligations as of December 31, 2014.
Recently Issued Accounting Pronouncements
See Note 1 of our accompanying audited consolidated financial statements for a description of recently issued accounting pronouncements including the dates of adoption and effects on our results of operations, financial position and disclosures.
ITEM 7A.
ITEM 7A.
Quantitative and Qualitative Disclosure About Market Risk
Our primary market risk exposures are interest rate risk and foreign currency exchange rate risk.
We are exposed to changes in interest rates because we finance certain operations through fixed and variable rate debt instruments.
We had $63.8 million in borrowings outstanding at December 31, 2014, at an interest rate equal to the LIBOR Daily Floating Rate plus 1.50% under our new variable-rate credit facility. For more information regarding our new credit facility, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Borrowing Arrangements. A hypothetical 10% increase or decrease in interest rates would have an approximately $0.2 million impact on our annual interest expense, based on the $63.8 million outstanding at December 31, 2014 with an interest rate of 2.41%.
As discussed in Note 16 to the consolidated financial statements, effective April 1, 2010, in order to reduce the volatility of cash outflows that arise from changes in interest rates, we entered into two interest rate swap agreements. These interest rate swap agreements are intended to hedge our mortgage loan related to our headquarters facility in Middletown, Rhode Island by fixing the interest rates specified in the mortgage loan to 5.9% for half of the principal amount outstanding and 6.1% for the remaining half of the principal amount outstanding as of April 1, 2010 until the mortgage loan expires on April 16, 2019.
We are exposed to currency exchange rate fluctuations related to our subsidiary operations in the United Kingdom, Denmark, Norway, Brazil, Singapore, Hong Kong, Cyprus, Japan, Belgium, and the Netherlands. Our recent acquisition of Videotel expanded our international operations and therefore our exposure to these fluctuations. Certain transactions in these locations are made in the local currency, yet are reported in the U.S. dollar, the functional currency. For foreign currency exposures existing at December 31, 2014, a 10% unfavorable movement in the foreign exchange rates for our subsidiary locations would not expose us to material losses in earnings or cash flows.
From time to time, we have purchased foreign currency forward contracts. These forward contracts are intended to offset the impact of exchange rate fluctuations on cash flows of our foreign subsidiaries. Foreign exchange contracts are accounted for as cash flow hedges and are recorded on the balance sheet at fair value until executed. Changes in the fair value are recognized in earnings. We did not enter into any such contracts during 2014. However, we did inherit cash flow hedges from our acquisition of Headland Media Limited (now known as the KVH Media Group) in May 2013, all of which settled prior to December 31, 2014. We do not currently anticipate that we will enter into new agreements to replace the settled contracts.
The primary objective of our investment activities is to preserve principal and maintain liquidity, while at the same time maximizing income. We have not entered into any instruments for trading purposes. Some of the securities that we invest in may have market risk. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities that can include United States treasuries, certificates of deposit, investment grade asset-backed corporate securities, money market mutual funds, municipal bonds, and government agency and non-government debt securities. As of December 31, 2014, a hypothetical 100 basis-point increase in interest rates would have resulted in an immaterial decrease in the fair value of our investments that had maturities of greater than one year. Due to the conservative nature of our investments and the relatively short duration of their maturities, we believe this interest rate risk is substantially mitigated. As of December 31, 2014, 59% of the $24.5 million classified as available-for-sale marketable securities will mature or reset within one year. Accordingly, long-term interest rate risk is not considered material for our investment activities. We did not invest in any financial instruments denominated in foreign currencies as of December 31, 2014.
ITEM 8.
ITEM 8.
Financial Statements and Supplementary Data
Our consolidated financial statements and supplementary data, together with the reports of Grant Thornton LLP and KPMG LLP, our independent registered public accounting firms, are included in Part IV of this annual report.
ITEM 9.
ITEM 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
ITEM 9A.
ITEM 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our President, Chief Executive Officer and Chairman of the Board, or CEO, and Chief Financial and Accounting Officer, or CFO, as appropriate to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of our CEO and CFO, our management has evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2014, the end of the period covered by this annual report. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were not effective as of December 31, 2014 due to the material weaknesses in our internal control over financial reporting described below.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is the process designed by and under the supervision of our CEO and CFO to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external reporting in accordance with accounting principles generally accepted in the United States of America. Management has evaluated the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013).
Under the supervision and with the participation of our CEO and CFO, our management has assessed the effectiveness of our internal control over financial reporting as of December 31, 2014 and concluded that it was not effective because of the material weaknesses described below. Management’s assessment of internal control over financial reporting did not include Videotel Marine Asia Limited, Super Dragon Limited or any of their respective subsidiaries (collectively, Videotel), which were acquired in July 2014. Videotel’s financial statements reflect total assets and revenues constituting 26% and 6%, respectively, of the corresponding amounts in our consolidated financial statements as of and for the year ended December 31, 2014.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Management's assessment identified the following control deficiencies in our internal control over financial reporting as material weaknesses:
•
We enter into guidance and stabilization contracts that may contain bill and hold provisions. We have a control to identify and evaluate these types of transactions that have been recognized each quarter. However, the control did not operate effectively during 2014 because it did not identify a bill and hold transaction at December 31, 2014 for evaluation by the finance team in the quarter in which it was reported.
•
We engage a third party to assist in the preparation of our quarterly and annual income tax provisions. However, our preliminary provision at December 31, 2014 did not properly identify changes in the Rhode Island tax rate and related impact on the realizability of the state tax asset carryforwards. We have since adjusted those amounts. We do not have sufficient controls over the review of the work performed by the third party to ensure accurate financial reporting.
•
We lease our antenna products directly to certain end users and also enter into airtime service agreements with these customers. The pricing of the lease and airtime service agreement is negotiated with each individual customer. We do not have a control designed and implemented to evaluate these multi-element arrangements to ensure proper allocation of the transaction price among the elements.
The material weaknesses did not result in material misstatement in the financial statements included in Item 8 or previously issued financial statements, however, we concluded that, as of December 31, 2014, there was a reasonable possibility that material misstatements could occur in the consolidated financial statements.
Our independent registered public accounting firm, Grant Thornton LLP, has issued an adverse report regarding the effectiveness of our internal control over financial reporting as of December 31, 2014, and that report is included in Item 9a in this annual report.
Evaluation of Changes in Internal Control over Financial Reporting
Under the supervision and with the participation of our CEO and CFO, our management has evaluated changes in our internal control over financial reporting that occurred during the fourth quarter of 2014. Based on that evaluation, our CEO and CFO did not identify any change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
However, during the first quarter of 2015, management commenced implementation of a remediation plan, which is ongoing. Management believes that the implementation of this plan will remediate the material weaknesses described above. The remediation plan includes the following steps:
•
With respect to bill and hold arrangements, we plan to revise sales orders and general ledger entries to facilitate identification of these arrangements at the time they are created. We plan to implement written procedures to document all material bill and hold arrangements, as well as other terms and conditions that may impact revenue recognition, such as multiple-element arrangements. We plan to perform quarterly assessments of quantities of inventory on hand that are subject to bill and hold arrangements with customers. We also plan to enhance existing review controls through the implementation of more detailed checklists and the involvement of additional personnel with knowledge of these arrangements.
•
With respect to reliance on third parties to assist in the calculation of our provision for income taxes, we plan to implement a more formalized process to review the work completed by third parties, including detailed checklists to perform a proper evaluation of each element of the apportionment of state taxes and any related impact on our deferred tax assets.
•
With respect to the allocation of revenue for multiple-element arrangements involving leased antennas and airtime service agreements, we instituted a new control earlier in the first quarter of 2015 to review each lease at the time of execution in order to assess and document any lease discount arising from reasonably anticipated airtime service agreements.
Management may determine to enhance existing controls and/or implement additional controls as implementation progresses.
Important Considerations
The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, there can be no assurance that any system of disclosure controls and procedures or internal control over financial reporting will be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
KVH Industries, Inc.
We have audited the internal control over financial reporting of KVH Industries, Inc., a Delaware corporation, and subsidiaries (the “Company”) as of December 31, 2014, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Report on Internal Control over Financial Reporting.” (“Management’s Report”). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. Our audit of, and opinion on, the Company’s internal control over financial reporting does not include the internal control over financial reporting of Videotel Marine Asia Limited and Super
Dragon Limited (together referred to as Videotel), wholly owned subsidiaries, whose financial statements reflect total assets and revenues constituting 26 and 6 percent, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2014. As indicated in Management’s Report, Videotel was acquired during 2014. Management’s assertion on the effectiveness of the Company’s internal control over financial reporting excluded internal control over financial reporting of Videotel.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in management’s assessment.
As of December 31, 2014, management disclosed material weaknesses over the effectiveness of controls related to (1) guidance and stabilization contracts where revenue is recognized on a bill and hold basis, (2) the accounting for income taxes and (3) the accounting for multiple element lease transactions.
In our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2014. The material weaknesses identified above were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2014 consolidated financial statements, and this report does not affect our report dated March 16, 2015, which expressed an unqualified opinion on those financial statements.
ITEM 9B.
ITEM 9B.
Other Information
None.
PART III
We have omitted the information required in Part III of this annual report because we intend to include that information in our definitive proxy statement for our 2015 annual meeting of stockholders, which we expect to file before 120 days after the end of fiscal 2014. We incorporate the information required in Part III of this annual report by reference to our 2015 proxy statement.
ITEM 10.
ITEM 10.
Directors, Executive Officers and Corporate Governance
Except as set forth below, the information required by this item is incorporated by reference to our 2015 proxy statement.
Our Board of Directors has adopted a Code of Business Conduct and Ethics that applies to our directors, executive officers and employees. Our Code of Business Conduct and Ethics can be found on our website, which is located at www.kvh.com. We intend to make all required disclosures concerning any amendments to or waivers from, our Code of Business Conduct and Ethics on our website. Any person may request a copy of the Code of Business Conduct and Ethics, at no cost, by writing to us at the following address: KVH Industries, Inc., 50 Enterprise Center, Middletown, Rhode Island, 02842, Attention: Investor Relations.
The information required by this item is incorporated by reference to our 2015 proxy statement.
ITEM 12.
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated by reference to our 2015 proxy statement.
ITEM 13.
ITEM 13.
Certain Relationships and Related Transactions and Director Independence
The information required by this item is incorporated by reference to our 2015 proxy statement.
ITEM 14.
ITEM 14.
Principal Accountant Fees and Services
The information required by this item is incorporated by reference to our 2015 proxy statement.
PART IV
ITEM 15.
ITEM 15.
Exhibits and Financial Statement Schedules
*
Management contract or compensatory plan.
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
KVH Industries, Inc.
Date: March 16, 2015
By:
/S/ MARTIN A. KITS VAN HEYNINGEN
Martin A. Kits van Heyningen
President, Chief Executive Officer and Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
KVH Industries, Inc.
We have audited the accompanying consolidated balance sheet of KVH Industries, Inc. and subsidiaries (the “Company”) as of December 31, 2014, and the related consolidated statement of operations, comprehensive (loss) income, stockholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of KVH Industries, Inc. and subsidiaries as of December 31, 2014, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2015 expressed an adverse opinion thereon.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
KVH Industries, Inc.:
We have audited the accompanying consolidated balance sheet of KVH Industries, Inc. and subsidiaries as of December 31, 2013, and the related consolidated statements of operations, comprehensive income, stockholders’ equity and accumulated other comprehensive income, and cash flows for each of the years in the two-year period ended December 31, 2013. These consolidated financial statements are the responsibility of the KVH Industries, Inc.’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the KVH Industries, Inc. and subsidiaries as of December 31, 2013, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
See accompanying Notes to Consolidated Financial Statements.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
See accompanying Notes to Consolidated Financial Statements.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands)
See accompanying Notes to Consolidated Financial Statements.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
See accompanying Notes to Consolidated Financial Statements.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying Notes to Consolidated Financial Statements.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014, 2013 and 2012
(in thousands, except per share amounts)
(1)
Summary of Significant Accounting Policies
(a)
Description of Business
KVH Industries, Inc. (together with its subsidiaries, the Company or KVH) designs, develops, manufactures and markets mobile communications products and services for the marine, and land mobile markets, and navigation, guidance, and stabilization products for both the defense and commercial markets.
KVH’s mobile communications products enable customers to receive voice and Internet services, and live digital television via satellite services in marine vessels, recreational vehicles, buses and automobiles. KVH’s CommBox offers a range of tools designed to increase communication efficiency, reduce costs, and manage network operations. KVH sells and leases its mobile communications products through an extensive international network of dealers and distributors. KVH also sells and leases products directly to end users.
KVH’s mobile communications service sales represent primarily sales earned from satellite voice and Internet airtime services. KVH provides, for monthly fixed and usage fees, satellite connectivity services, including broadband Internet, data and Voice over Internet Protocol (VoIP) services, to its TracPhone V-series customers. Mobile communications services sales also include the distribution of commercially licensed entertainment, including news, sports, music, and movies to commercial and leisure customers in the maritime, hotel, and retail markets through KVH Media Group (acquired as Headland Media Limited), the media and entertainment service company that KVH acquired on May 11, 2013, and the distribution of training films and eLearning computer-based training courses to commercial customers in the maritime market through Super Dragon Limited and Videotel Marine Asia Limited (together referred to as Videotel), a maritime training services company that KVH acquired on July 2, 2014. KVH also earns monthly usage fees from third-party satellite connectivity services, including voice, data and Internet services, provided to its Inmarsat and Iridium customers who choose to activate their subscriptions with KVH. Mobile communications service sales also include engineering services provided under development contracts, sales from product repairs, and extended warranty sales.
KVH acquired Videotel for an aggregate purchase price of $47.4 million in cash. The purchase price was subject to a potential post-closing adjustment based on the value of the net assets delivered at the closing. We financed approximately $35.0 million of the purchase price through a new senior credit facility and paid the remaining portion of the purchase price from cash and cash equivalents. Revenue for the Videotel group companies was $10.4 million in the year ended December 31, 2014. The majority of Videotel’s services are invoiced in pounds sterling, which increases our exposure to fluctuations in exchange rates.
KVH also offers precision fiber optic gyro (FOG)-based systems that enable platform and optical stabilization, navigation, pointing and guidance. KVH’s guidance and stabilization products also include tactical navigation systems that provide uninterrupted access to navigation and pointing information in a variety of military vehicles, including tactical trucks and light armored vehicles. KVH’s guidance and stabilization products are sold directly to U.S. and foreign governments and government contractors, as well as through an international network of authorized independent sales representatives. In addition, KVH's guidance and stabilization products are used in numerous commercial products, such as navigation and positioning systems for various applications including precision mapping, dynamic surveying, autonomous vehicles, train location control and track geometry measurement systems, industrial robotics and optical stabilization.
KVH’s guidance and stabilization service sales include product repairs, engineering services provided under development contracts and extended warranty sales.
(b)
Principles of Consolidation
The accompanying consolidated financial statements of KVH Industries, Inc. and its wholly owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company has evaluated all subsequent events through the date of this filing. All of the operating expenses of the subsidiaries that serve as the Company’s European, Singaporean, Japanese, and Brazilian international distributors are reflected within sales, marketing, and support within the accompanying consolidated statements of operations. All significant intercompany accounts and transactions have been eliminated in consolidation.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
(c)
Significant Estimates and Assumptions
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of sales and expenses during the reporting periods. Significant estimates and assumptions by management affect the Company’s revenue recognition, valuation of accounts receivable, valuation of inventory, assumptions used to determine fair value of goodwill and intangible assets, deferred tax assets and related valuation allowance, stock-based compensation, warranty and accounting for contingencies.
Although the Company regularly assesses these estimates, actual results could differ materially from these estimates. Changes in estimates are recorded in the period in which they become known. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances.
The Company has accounted for its $35,600 contract received in June 2012 from SANG to purchase TACNAV products and services under ASC 605-25, Multiple-Element Arrangements. See section (e) of this note for estimates and assumptions related to multiple-element-arrangements and completed contract sales accounting.
The SANG total contract value associated with TACNAV products is $21,200, for which final shipments were completed in the second quarter of 2013. Revenue was recognized for these product sales after transfer of title and risk of loss and after inspection occurred. The total contract value associated with all services is $14,400, and services were completed in the third quarter of 2014. The revenue for these services is recognized using the proportional performance accounting method. The Company limits the amount of revenue recognized for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations, or subject to customer-specific return or refund privileges. Total revenue recognized on the SANG contract in 2014 and 2013 was approximately $1,300 and $19,600, respectively.
(d)
Concentration of Credit Risk and Single Source Suppliers
Cash, cash equivalents and marketable securities. The Company is potentially subject to financial instrument concentration of credit risk through its cash, cash equivalent and marketable securities investments. To mitigate these risks the Company maintains cash, cash equivalents and marketable securities with reputable and nationally recognized financial institutions. As of December 31, 2014, $24,513 classified as marketable securities was held by Wells Fargo and substantially all of the cash and cash equivalents were held by Bank of America, N.A. See Note 2 for a description of marketable securities.
Trade accounts receivable. Concentrations of risk (see Note 12) with respect to trade accounts receivable are generally limited due to the large number of customers and their dispersion across several geographic areas. Although the Company does not foresee credit risk associated with these receivables to deviate from historical experience, repayment is dependent upon the financial stability of those individual customers. The Company establishes allowances for potential bad debts and evaluates, on a monthly basis, the adequacy of those reserves based upon historical experience and its expectations for future collectability concerns. Activity within the Company’s allowance for doubtful accounts for the periods presented is as follows:
Certain components from third parties used in the Company’s products are procured from single sources of supply. The failure of a supplier, including a subcontractor, to deliver on schedule could delay or interrupt the Company’s delivery of products and thereby materially adversely affect the Company’s revenues and operating results.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
(e)
Revenue Recognition
Product sales. Product sales are recognized when persuasive evidence of an arrangement exists, goods are shipped, title has passed and collectability is reasonably assured. The Company’s standard sales terms require that:
•
All sales are final;
•
Terms are generally Net 30;
•
Shipments are tendered and shipped FOB (or as may be applicable, FCA, or EXW) the Company’s plant or warehouse; and
•
Title and risk of loss or damage passes to the dealer or distributor at the point of shipment when delivery is made to the possession of the carrier.
For certain guidance and stabilization product sales, customer acceptance or inspection may be required before title and risk of loss transfers. For those sales, revenue is recognized after transfer of title and risk of loss and after notification of customer acceptance. In certain circumstances customers may request a bill and hold arrangement. Under these bill and hold arrangements, revenue is recognized when the Company has fulfilled all of its performance obligations, the units are segregated and available for shipment in accordance with the defined contract delivery schedule, and the Company has received notification of customer acceptance which transfers title and risk of loss to the customer.
Under certain limited conditions, the Company, at its sole discretion, provides for the return of goods. No product is accepted for return and no credit is allowed on any returned product unless the Company has granted and confirmed prior written permission by means of appropriate authorization. The Company establishes reserves for potential sales returns, credits, and allowances, and evaluates, on a monthly basis, the adequacy of those reserves based upon historical experience and expectations for the future.
Multiple-element revenue arrangements. Some of our sales involve multiple-element arrangements that include both hardware-related products and contracted service, or satellite connectivity that are accounted under ASC 605-25, Multiple-Element Arrangements.
Multiple elements, arrangement consideration is allocated to each element based on the relative selling prices of all of the elements in the arrangement using the fair value hierarchy as required by “Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements,” (Accounting Standards Update “ASU” 2009-13). The Company adopted the provisions of ASU 2009-13 as of January 1, 2010. ASU 2009-13 requires the Company establish VSOE of fair value based upon the price charged when the same element is sold separately or established by management having the relevant pricing authority. When VSOE exists it is used to determine the selling price of a deliverable. When VSOE is not established, the Company attempts to establish the selling price of each element based on TPE. When the Company is unable to establish selling price using VSOE or TPE, the Company uses BESP in the allocation of arrangement consideration for the relevant deliverables. The objective of BESP is to determine the price at which the Company would transact a sale if a product or service was sold on a stand-alone basis. The Company determines BESP for our products and certain services by considering multiple factors including, but not limited to, overall market conditions, including geographic or regional-specific market factors and profit objectives for such deliverables.
Each deliverable within the Company's multiple-deliverable revenue arrangements is accounted for as a separate unit of accounting under the guidance of ASU 2009-13 if both of the following criteria are met: the delivered item or items have value to the customer on a standalone basis; and for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. The Company considers a deliverable to have standalone value if the item is sold separately by the Company or another vendor or if the item could be resold by the customer. Further, the Company's revenue arrangements generally do not include a general right of return relative to delivered products.
Deliverables not meeting the criteria for being a separate unit of accounting are combined with a deliverable that does meet that criterion. The appropriate allocation of arrangement consideration and recognition of revenue is then determined for the combined unit of accounting.
Satellite connectivity and media content sales. Directly sold and re-sold satellite connectivity service for voice, data and Internet is recognized monthly based upon minutes or megabytes of traffic processed or contracted fixed fee schedules. Typically, all subscribers enter into a contracted one-year minimum service agreement. The Company records all satellite
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
connectivity service sales to subscribers as gross sales, as the Company is the primary obligor in the contracted service arrangement. All associated regulatory service fees and costs are recorded net in the consolidated financial statements. Media content sales include the Company's distribution of commercially licensed news, sports, movies and music content for commercial and leisure customers in the maritime, hotel, and retail markets as well as training videos to the merchant marine market that are typically based on a contracted fixed fee schedule. The Company typically recognizes revenue from media content sales ratably over the period of the service contract. The accounting estimates related to the recognition of satellite connectivity and media content service sales in results of operations requires the Company to make assumptions about future billing adjustments for disputes with subscribers as well as unauthorized usage.
Lease financing. Lease financing consists of sales-type leases primarily of the TracPhone V-IP Series. The Company records the leases at a price typically equivalent to normal selling price and in excess of the cost or carrying amount. Upon delivery, the Company records the present value of all payments under these leases as revenues, and the related costs of the product are charged to cost of sales. Interest income is recognized throughout the lease term (typically three years) using an implicit interest rate. Through December 31, 2014, lease sales have not been a significant portion of the Company’s total sales.
Contracted service sales. The Company engages in contracts for development, production, and services activities related to standard product modification or enhancement, which it accounts for using the proportional performance method of revenue recognition. The Company considers the nature of these contracts and the types of products and services provided when determining the proper accounting for a particular contract. Customer and government-agency contracted engineering service and grant sales under development contracts are recognized primarily under the proportional performance method during the period in which the Company performs the service or development efforts in accordance with the agreement. Services performed under these types of contracts include engineering studies, surveys, building construction, prototype development, and program management. Performance is determined principally by comparing the accumulated costs incurred to date with management’s estimate of the total cost to complete the contracted work. The Company establishes billing terms at the time project deliverables and milestones are agreed. Unbilled revenue recognized in excess of the amounts invoiced to clients are classified within the accompanying consolidated balance sheets in the caption “prepaid expenses and other assets.”
The use of contract accounting requires significant judgment relative to estimating total contract revenues and costs, including assumptions relative to the length of time to complete the contract, the nature and complexity of the work to be performed, and prices for subcontractor services and materials. The risk to the Company on a fixed-price contract is that if estimates to complete the contract change from one period to the next, profit levels will vary from period to period. The Company's estimates are based upon the professional knowledge and experience of its engineers, program managers and other personnel, who review each long-term contract monthly to assess the contract's schedule, performance, technical matters and estimated cost at completion. Changes in estimates are applied when adjustments in estimated contract costs are identified, such revisions may result in current period adjustments to earnings applicable to performance in prior periods. Any advance payments arising from such extended-term development contracts are recorded as deposits. If, in any period, estimated total costs under a contract indicate an expected loss, then such loss is provided for in that period. Through December 31, 2014, contracted service revenue has not been a significant portion of the Company’s total sales.
Product service sales. Product service sales other than under development contracts are recognized when completed services are provided to the customer and collectability is reasonably assured. The Company establishes reserves for potential sales returns, credit and allowances, and evaluates, on a monthly basis, the adequacy of those reserves based upon historical experience and its expectations for the future. Through December 31, 2014, product service sales have not been a significant portion of the Company’s total sales.
Extended warranty sales. The Company sells extended warranty contracts on mobile communications and guidance and stabilization products. Sales under these contracts are recognized ratably over the contract term. Through December 31, 2014, warranty sales have not been a significant portion of the Company’s total sales.
(f)
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments, which include cash equivalents, investments, accounts receivable, accounts payable and accrued expenses approximate their fair values due to the short maturity of these instruments. The carrying amount of the Company’s mortgage loan approximates fair value based on currently available quoted rates of similarly structured mortgage facilities. See Note 2 for more information on the fair value of the Company’s marketable securities.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
(g)
Cash, Cash Equivalents, and Marketable Securities
In accordance with the Company’s investment policy, cash in excess of operational needs is invested in money market mutual funds, government agency bonds, United States treasuries, municipal bonds, corporate notes, and certificates of deposit, which are reflected within marketable securities in the accompanying consolidated balance sheets. The Company determines the appropriate classification of marketable securities at each balance sheet date. As of December 31, 2014 and 2013, all of the Company’s marketable securities have been designated as available-for-sale and are carried at their fair value with unrealized gains and losses included in accumulated other comprehensive (loss) income in the accompanying consolidated balance sheets.
The Company reviews investments in debt securities for other than temporary impairment whenever the fair value of an investment is less than amortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. To determine whether an impairment is other-than-temporary, the Company considers whether it intends to sell the security, whether it expects to recover the credit loss, and if it is more likely than not that the Company will be required to sell the security prior to recovery. Evidence considered in this assessment includes the reasons for the impairment, compliance with the Company’s investment policy, the severity and duration of the impairment, changes in value subsequent to year-end and forecasted performance of the investee. The Company has reviewed its securities with unrealized losses as of December 31, 2014 and 2013, and has concluded that no other-than-temporary impairments exist.
(h)
Inventories
Inventories are stated at the lower of cost or market using the first-in first-out costing method. The Company provides inventory reserves based on excess and obsolete inventory determined primarily by future demand forecasts. The Company records inventory charges to costs of product sales.
(i)
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are computed on the straight-line method over the estimated useful lives of the respective assets. The principal lives used in determining the depreciation rates of various assets are: buildings and improvements, 5-40 years; machinery, satellite hubs and equipment, and video-on-demand (VOD) units, 5-10 years; office and computer equipment, 3-7 years; and motor vehicles, 5 years.
(j)
Goodwill and Intangible Assets
The Company’s goodwill and intangible assets are associated with the purchase of Virtek Communication (now known as KVH Industries Norway AS) in September 2010. Headland Media Limited (now known as the KVH Media Group) in May 2013, and Videotel in July 2014.
Goodwill is recorded when the consideration for an acquisition exceeds the fair value of net tangible and identifiable intangible assets acquired. Goodwill is not amortized, but instead is tested for impairment at least annually, or if events or changes in circumstances indicate that the carrying value may not be recoverable. The Company estimates the fair value of the reporting unit using a discounted cash flow model or other valuation models, such as comparative transactions and market multiples. The impairment test is performed through the application of a two-step process. The first step compares the carrying value of the Company’s reporting units to their estimated fair values as of the test date. If fair value is less than carrying value, a second step is performed to quantify the amount of the impairment, if any. As of August 31, 2014, the Company performed its annual impairment test for goodwill at the reporting unit level and, after conducting the first step, determined that it was not necessary to conduct the second step as it concluded that the fair value of its reporting units exceeded their carrying value. Accordingly, the Company determined no adjustment to goodwill was necessary. There were no indicators of potential goodwill impairment noted as of December 31, 2014.
Intangible assets are comprised of the following, which are being amortized on a straight-line basis over the following estimated useful lives:
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
Intangible assets with estimated lives and other long-lived assets are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of intangible assets with estimated lives and other long-lived assets is measured by a comparison of the carrying amount of an asset or asset group to future net undiscounted cash flows expected to be generated by the asset or asset group. If these comparisons indicate that an asset is not recoverable, the Company will recognize an impairment loss for the amount by which the carrying value of the asset or asset group exceeds the related estimated fair value. Estimated fair value is based on either discounted future operating cash flows or appraised values, depending on the nature of the asset. There are no events or changes in circumstances that indicated any of the carrying amounts of the Company’s intangible assets may not be recoverable during 2014. See Note 10 for further discussion of goodwill and intangible assets.
(k)
Other Non-Current Assets
Other non-current assets are primarily comprised of long-term lease receivables, prepaid expenses, and deposits.
(l)
Product Warranty
The Company’s products carry limited warranties that range from one to four years and vary by product. The warranty period begins on the date of retail purchase or lease by the original purchaser. The Company accrues estimated product warranty costs at the time of sale and any additional amounts are recorded when such costs are probable and can be reasonably estimated. Factors that affect the Company’s warranty liability include the number of units sold or leased, historical and anticipated rates of warranty repairs and the cost per repair. Warranty and related costs are reflected within sales, marketing and support in the accompanying statements of operations. As of December 31, 2014 and 2013, the Company had accrued product warranty costs of $1,853 and $1,269, respectively. The following table summarizes product warranty activity during 2014 and 2013:
(m)
Shipping and Handling Costs
Shipping and handling costs are expensed as incurred and included in cost of sales. Billings for shipping and handling are reflected within net sales in the accompanying statements of operations.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
(n)
Research and Development
Expenditures for research and development, including customer-funded research and development, are expensed as incurred. Revenue and related development costs from customer-funded research and development are as follows:
(o)
Advertising Costs
Costs related to advertising are expensed as incurred. Advertising expense was $2,825, $3,189, and $2,523 for the years ended December 31, 2014, 2013, and 2012, respectively, and is included in sales, marketing, and support expense in the accompanying consolidated statements of operations.
(p)
Foreign Currency Translation
The financial statements of the Company’s foreign subsidiaries located in Denmark and Singapore are maintained using the United States dollar as the functional currency. Exchange rates in effect on the date of the transaction are used to record monetary assets and liabilities. Revenue and other expense elements are recorded at rates that approximate the rates in effect on the transaction dates. Realized foreign currency remeasurement gains and losses are recognized within “other (expense) income” in the accompanying consolidated statements of operations. For the years ended December 31, 2014, 2013, and 2012, the Company experienced foreign currency losses of $126, $123, and $37, respectively.
The financial statements of the Company’s foreign subsidiaries located in the United Kingdom, Brazil, Norway, Cyprus, Belgium, the Netherlands and Japan subsidiaries use the foreign subsidiaries’ respective local currencies as the functional currency. The Company translates the assets and liabilities of these foreign subsidiaries at the exchange rates in effect at year-end. Net sales, costs and expenses are translated using average exchange rates in effect during the year. Gains and losses from foreign currency translation are credited or charged to accumulated other comprehensive loss included in stockholders' equity in the accompanying consolidated balance sheets.
(q)
Income Taxes
Income taxes are accounted for under the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company records valuation allowances to reduce deferred income tax assets to the amount that is more likely than not to be realized. The Company determines whether it is more likely than not that a tax position will be sustained upon examination. If it is not more likely than not that a position will be sustained, no amount of the benefit attributable to the position is recognized. The tax benefit to be recognized of any tax position that meets the more likely than not recognition threshold is calculated as the largest amount that is more than 50% likely of being realized upon resolution of the contingency. See Note 8 for further discussion of income taxes.
(r)
Net Income per Common Share
Basic net income per share is calculated based on the weighted average number of common shares outstanding during the period. Diluted net income per share incorporates the dilutive effect of common stock equivalent options, warrants and other convertible securities, if any, as determined in accordance with the treasury stock accounting method. Common stock equivalents related to options and restricted stock awards for 784,000, 545,000, and 862,000 shares of common stock for the years ended December 31, 2014, 2013, and 2012, respectively, have been excluded from the fully diluted calculation of net income per share, as inclusion would be anti-dilutive.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
A reconciliation of the basic and diluted weighted average common shares outstanding is as follows:
(s)
Contingent Liabilities
The Company estimates the amount of potential exposure it may have with respect to claims, assessments and litigation in accordance with ASC 450, Contingencies. As of December 31, 2014, the Company was not party to any lawsuit or proceeding that, in management’s opinion, was likely to materially harm the Company’s business, results of operations, financial condition or cash flows, as described in Note 17. It is not always possible to predict the outcome of litigation, as it is subject to many uncertainties. Additionally, it is not always possible for management to make a meaningful estimate of the potential loss or range of loss associated with such litigation. As of December 31, 2014, no losses have been accrued with respect to pending litigation.
(t)
Operating Segments
The Company operates in a single segment. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker in making decisions regarding resource allocation and assessing performance. To date, the chief operating decision maker has made such decisions and assessed performance at the company level, as one segment. The Company’s chief operating decision maker is its President, Chief Executive Officer and Chairman of the Board.
(u) Film Production Costs
The Company capitalizes direct costs incurred in the production of its training videos, such as writing, directing, narrating, casting, location rental, and editing. These film costs are classified as a non-current asset on its consolidated balance sheet and are placed into service upon the film title being released and available for customers' use. The Company’s sales model associated with training is subscription-based, in which fees from third parties are not directly attributable to the exhibition of a particular film but relate instead to access to the entire film library. Accordingly, management estimates that the straight line method is the most representative method for the amortization of film costs. Consistent with the period over which revenues are assessed (i.e. the subscription period), the film costs are amortized over four years. In the event that the film title is replaced or removed from the film library before the amortization period has expired, all unamortized costs are expensed immediately.
(v) Recently Issued Accounting Standards
Revenue
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), regarding ASC Topic 606 of the same nomenclature. ASU 2014-09 represents the culmination of efforts by the FASB and the International Accounting Standards Board (“IASB”) to issue a common revenue standard. When effective, ASU 2014-09 will generally supersede the current revenue guidance included in ASC Topic 605 “Revenue” and its associated Subtopics. The ASU requires that an entity recognize revenue to depict the transfer of a promised good or service to its customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for such transfer. ASU 2014-09 also specifies accounting for certain costs incurred by an entity to obtain or fulfill a contract with a customer and provides for enhancements to revenue specific disclosures intended to allow users of the financial statements to clearly understand the nature, amount, timing and uncertainty of revenue and cash flows arising from an Entity’s contracts with its customers. ASU 2014-09 becomes effective for public entities for annual periods, and interim periods within annual periods, beginning after December 15, 2016. The ASU becomes effective for all other entities for annual periods beginning after December 15, 2017 and interim periods within annual periods beginning after December 15, 2018. The Company is currently evaluating the impact, if any, the adoption of ASU 2014-09 will have on its financial position, results of operations and cash flows.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
Presentation of Financial Statements - Going Concern
In August 2014, the FASB issued ASU 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”), regarding ASC Topic 205-40 “Presentation of Financial Statements-Going Concern.” ASU 2014-15 requires management to assess an entity’s ability to continue as a going concern, including requiring an evaluation every reporting period including interim periods, and requires certain disclosures when there is substantial doubt of the entity’s ability to continue as a going concern, whether or not it is alleviated as a result of consideration of management’s plans. ASU 2014-15 becomes effective for the Company for annual periods ending after December 15, 2016, with early application permitted. The Company does not believe implementation of ASU 2014-15 will have an impact on its financial statement disclosures.
Extraordinary and Unusual Items
In January 2015, the FASB issued ASU 2015-01, “Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items” (“ASU 2015-01”), which amends ASC 225-20 “Income Statement - Extraordinary and Unusual Items” (ASC 225-20). ASU 2015-01 eliminates the concept of extraordinary items from generally accepted accounting principles and also expands the disclosure requirements of items that are unusual in nature or occur infrequently. Upon adopting this amended guidance, a material event or transaction that an entity considers to be unusual or infrequent, or both, may still be presented separately but would now be presented on a pretax basis within income from continuing operations or disclosed in the notes to the financial statements. ASU 2015-01 becomes effective for the Company for annual periods beginning after December 15, 2015 and may be applied retrospectively or prospectively, with early adoption permitted. The Company does not believe implementation of ASU 2015-01 will have an impact on its financial statement disclosures.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
(2)
Marketable Securities
Included in marketable securities as of December 31, 2014 and 2013 are the following:
The amortized costs and fair value of debt securities as of December 31, 2014 and 2013 are shown below by effective maturity. Effective maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
The Company realized gains of $110 and $0 from marketable securities during the years ended December 31, 2014 and 2013.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
(3)
Inventories
Inventories are stated at the lower of cost or market using the first-in first-out costing method. Inventories as of December 31, 2014 and 2013 include the costs of material, labor, and factory overhead. Inventories consist of the following:
(4)
Property and Equipment
Property and equipment, net, as of December 31, 2014 and 2013 consist of the following:
Depreciation for the years ended December 31, 2014, 2013, and 2012 amounted to $6,127, $4,815, and $4,216, respectively.
(5)
Debt and Line of Credit
Long-term debt consists of the following:
Term Note and Line of Credit
On July 1, 2014, the Company entered into (i) a five-year senior credit facility agreement (the Credit Agreement) with Bank of America, N.A., as Administrative Agent, and the lenders named from time to time as parties thereto (the Lenders), for an aggregate amount of up to $80,000, including a revolving credit facility (the Revolver) of up to $15,000 and a term loan
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
(Term Loan) of $65,000 to be used for general corporate purposes, including both (A) the refinancing of the Company’s $30,000 then-outstanding indebtedness under its previous credit facility and (B) permitted acquisitions, (ii) revolving credit notes (together, the Revolving Credit Note) to evidence the Revolver, (iii) term notes (together, the Term Note, and together with the Revolving Credit Note, the Notes) to evidence the Term Loan, (iv) a Security Agreement (the Security Agreement) required by the Lenders with respect to the grant by the Company of a security interest in substantially all of the assets of the Company in order to secure the obligations of the Company under the Credit Agreement and the Notes, and (v) Pledge Agreements (the Pledge Agreements) required by the Lenders with respect to the grant by the Company of a security interest in 65% of the capital stock of each of KVH Industries A/S and KVH Industries U.K. Limited held by the Company in order to secure the obligations of the Company under the Credit Agreement and the Notes.
The $65,000 Term Note was executed on July 1, 2014 in connection with the acquisition of Videotel. See Note 13 below for more information regarding the acquisition. Proceeds in the amount of $35,000 were applied toward the payment of a portion of the purchase price for the acquired shares of Videotel, and proceeds in the amount of approximately $30,000 were applied toward the refinancing of the then-outstanding balance of the Company’s previous credit facility. The Company must make principal repayments on the Term Loan in the amount of approximately $1,200 at the end of each of the first 8 three-month periods following the closing; thereafter, the Company must make principal repayments in the amount of approximately $1,600 for each succeeding three-month period until the maturity of the loan on July 1, 2019. The Company made the first payment on this debt in September 2014. On the maturity date, the entire remaining principal balance of the loan, including any future loans under the Revolver, is due and payable, together with all accrued and unpaid interest, penalties, and other amounts due and payable under the Credit Agreement. The Credit Agreement contains provisions requiring the mandatory prepayment of amounts outstanding under the Term Loan and the Revolver under specified circumstances, including (i) 100% of the net cash proceeds from certain dispositions to the extent not reinvested in the Company’s business within a stated period, (ii) 50% of the net cash proceeds from stated equity issuances and (iii) 100% of the net cash proceeds from certain receipts of more than $250 outside the ordinary course of business. The prepayments are first applied to the Term Loan, in inverse order of maturity, and then to the Revolver. In the discretion of the Administrative Agent, certain mandatory prepayments made on the Revolver can permanently reduce the amount of credit available under the Revolver.
Loans under the Credit Agreement bear interest at varying rates determined in accordance with the Credit Agreement. Each LIBOR Rate Loan, as defined in the Credit Agreement, bears interest on the outstanding principal amount thereof for each interest period from the applicable borrowing date at a rate per annum equal to the LIBOR Daily Floating Rate or LIBOR Monthly Floating Rate, each as defined in the Credit Agreement, as applicable, plus the Applicable Rate, as defined in the Credit Agreement, and each Base Rate Loan, as defined in the Credit Agreement, bears interest on the outstanding principal amount thereof from the applicable borrowing date at a rate per annum equal to the Base Rate, as defined in the Credit Agreement, plus the Applicable Rate. The Applicable Rate ranges from 1.50% to 2.25%, depending on the Company’s Consolidated Leverage Ratio, as defined in the Credit Agreement. The highest Applicable Rate applies when the Consolidated Leverage Ratio exceeds 2.00:1.00. Upon certain defaults, including failure to make payments when due, interest becomes payable at a higher default rate.
Borrowings under the Revolver are subject to the satisfaction of numerous conditions precedent at the time of each borrowing, including the continued accuracy of the Company’s representations and warranties and the absence of any default under the Credit Agreement. As of December 31, 2014, there were no borrowings outstanding under the revolver.
The Credit Agreement contains two financial covenants, a Maximum Consolidated Leverage Ratio and a Minimum Consolidated Fixed Charge Coverage Ratio, each as defined in the Credit Agreement. The Maximum Consolidated Leverage Ratio was initially 2.25:1.00, declined to 1.50:1.00 on December 31, 2014, and declines to 1.00:1.00 on September 30, 2015. The Minimum Consolidated Fixed Charge Coverage Ratio may not be less than 1.25:1.00 at any time after December 31, 2014. The Company was in compliance with these financial ratio debt covenants as of December 31, 2014. The Credit Agreement imposes certain other affirmative and negative covenants, including without limitation covenants with respect to the payment of taxes and other obligations, compliance with laws, entry into material contracts, creation of liens, incurrence of indebtedness, investments, dispositions, fundamental changes, restricted payments, changes in the nature of the Company’s business, transactions with affiliates, corporate and accounting changes, and sale and leaseback arrangements.
The Company’s obligation to repay loans under the Credit Agreement could be accelerated upon a default or event of default under the terms of the Credit Agreement, including certain failures to pay principal or interest when due, certain breaches of representations and warranties, the failure to comply with the Company’s affirmative and negative covenants under the Credit Agreement, a change of control of the Company, certain defaults in payment relating to other indebtedness, the
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
acceleration of payment of certain other indebtedness, certain events relating to the liquidation, dissolution, bankruptcy, insolvency or receivership of the Company, the entry of certain judgments against the Company, certain events relating to the impairment of collateral or the Lenders' security interest therein, and any other material adverse change with respect to the Company.
Mortgage Loan
On April 6, 2009, the Company entered into a mortgage loan in the amount of $4,000 related to its headquarters facility in Middletown, Rhode Island. On June 9, 2011, the Company entered into an amendment to the mortgage loan. The loan term is ten years, with a principal amortization of 20 years, and the interest rate will be a rate per year adjusted periodically based on a defined interest period equal to the BBA LIBOR Rate plus 2.00 percentage points. Land, building and improvements with an approximate carrying value of $5,000 as of December 31, 2014 secure the mortgage loan. The monthly mortgage payment is approximately $12 plus interest and increases in increments of approximately $1 each year throughout the life of the mortgage. Due to the difference in the term of the loan and amortization of the principal, a balloon payment of $2,551 is due on April 1, 2019. The loan contains one financial covenant, a Fixed Charge Coverage Ratio, which applies in the event that the Company’s consolidated cash, cash equivalents, and marketable securities balance falls below $25,000 at any time. As the Company’s consolidated cash, cash equivalents, and marketable securities balance was above the minimum threshold throughout the twelve months ended December 31, 2014, the Fixed Charge Coverage Ratio did not apply. Under the mortgage loan, the Company may prepay its outstanding loan balance subject to certain early termination charges as defined in the mortgage loan agreement. If the Company were to default on its mortgage loan, the land, building and improvements would be used as collateral. As discussed in Note 16 to the consolidated financial statements, effective April 1, 2010, in order to reduce the volatility of cash outflows that arise from changes in interest rates, the Company entered into two interest rate swap agreements that are intended to hedge its mortgage interest obligations by fixing the interest rates specified in the mortgage loan to 5.91% for half of the principal amount outstanding and 6.07% for the remaining half of the principal amount outstanding as of April 1, 2010 until the mortgage loan expires on April 16, 2019.
Equipment Loan
On January 30, 2013, the Company borrowed $4,700 from a bank and pledged as collateral six satellite hubs and related equipment, including three hubs purchased in 2012. The term of the equipment loan is five years, and the loan bears interest at a fixed rate of 2.76% per annum. The monthly payment is approximately $83, including interest expense. On December 30, 2013, the Company borrowed $1,200 from a bank and pledged as collateral one satellite hub and related equipment. The term of the equipment loan is five years, and the loan bears interest at a fixed rate of 3.08% per annum. The monthly payment is approximately $21, including interest expense.
The following is a summary of future principal payments under these long-term debt agreements:
(6)
Commitments and Contingencies
The Company has certain operating leases for satellite capacity, various equipment, and facilities. The following reflects future minimum payments under operating leases that have initial or remaining non-cancelable lease terms at December 31, 2014:
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
Total rent expense incurred under facility operating leases for the years ended December 31, 2014, 2013, and 2012 amounted to $820, $639, and $302, respectively. Total expense incurred under satellite capacity and equipment operating leases for the years ended December 31, 2014, 2013, and 2012 amounted to $30,280, $23,215, and $18,135, respectively, which also includes payments for usage charges in excess of the minimum contractual requirements.
In the normal course of business, the Company enters into unconditional purchase order obligations with its suppliers for inventory and other operational purchases. Outstanding and unconditional purchase order obligations were $9,282 as of December 31, 2014.
The Company did not have any off-balance sheet commitments, guarantees, or standby repurchase obligations as of December 31, 2014.
(7)
Stockholders’ Equity
(a)
Employee Stock Options
Options are granted with an exercise price equal to the fair market value of the common stock on the date of grant and generally vest in equal annual amounts over four years beginning on the first anniversary of the date of the grant. No options are exercisable for periods of more than five years after date of grant. Under the Company’s Amended and Restated 2006 Stock Incentive Plan, each share issued under awards other than options will reduce the number of shares reserved for issuance by two shares. Shares issued under options will reduce the shares reserved for issuance on a share-for-share basis. All plans were approved by the Company’s shareholders, pursuant to which 9,415,000 shares of the Company’s common stock were reserved for issuance. As of December 31, 2014, 7,392,732 options and awards to purchase shares of common stock had been issued, net of expired, canceled or forfeited options, and 2,022,268 were available for future grants. The Compensation Committee of the Board of Directors administers the plan, approves the individuals to whom options will be granted and determines the number of shares and exercise price of each option. Outstanding options under the plan at December 31, 2014 expire from November 2015 through October 2019. None of the Company’s outstanding options includes performance-based or market-based vesting conditions as of December 31, 2014.
The Company has estimated the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model. The expected volatility assumption is based on the historical daily price data of the Company’s common stock over a period equivalent to the weighted average expected life of the Company’s options. The expected term of options granted is derived using assumed exercise rates based on historical exercise patterns and represents the period of time the options granted are expected to be outstanding. The risk-free interest rate is based on the actual U.S. Treasury zero-coupon rates for bonds matching the expected term of the option as of the option grant date. The dividend yield of zero is based upon the fact that the Company has not historically declared or paid cash dividends, and does not expect to declare or pay dividends in the foreseeable future.
The per share weighted-average fair values of stock options granted during 2014, 2013, and 2012 were $4.71, $5.45, and $4.97, respectively. The weighted-average assumptions used to value options as of their grant date were as follows:
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
The changes in outstanding stock options for the year ended December 31, 2014 are as follows:
The total aggregate intrinsic value of options exercised was $232, $933, and $173 in 2014, 2013, and 2012, respectively. The total aggregate intrinsic value of options outstanding at December 31, 2013 and 2012 was $1,958 and $112, respectively. The total aggregate intrinsic value of options exercisable at December 31, 2013 and 2012 was $619 and $85, respectively.
As of December 31, 2013 and 2012, the number of options exercisable was 349,449 and 290,911, respectively, and the weighted average exercise price of those options was $11.90 and $10.52 per share, respectively. The weighted average remaining contractual term for options exercisable at December 31, 2013 and 2012 was 2.21 and 1.78 years, respectively. The weighted average remaining contractual term for options outstanding at December 31, 2013 and 2012 was 2.83 and 3.28 years, respectively.
As of December 31, 2014, there was $2,492 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted-average period of 2.33 years. In 2014, 2013, and 2012, the Company recorded compensation charges of $1,368, $1,438, and $1,130, respectively, related to stock options. Compensation costs for options subject only to service conditions that vest ratably are recognized on a straight-line basis over the requisite service period for the entire award. During 2014, 2013, and 2012, cash received under stock option plans for exercises was $471, $1,344 and $689, respectively.
(b)
Restricted Stock
The Company granted 265,380, 265,625, and 43,340 restricted stock awards to employees under the terms of the Amended and Restated 2006 Stock Incentive Plan for the years ended December 31, 2014, 2013, and 2012, respectively. The restricted stock awards vest annually over four years from the date of grant subject to the recipient remaining an employee through the applicable vesting dates. Compensation expense for restricted stock awards is measured at fair value on the date of grant based on the number of shares granted and the quoted market closing price of the Company’s common stock. Such value is recognized as expense over the vesting period of the award, net of estimated forfeitures. The weighted-average grant-date fair value of restricted stock granted during 2014, 2013, and 2012 was $13.57, $13.61, and $12.53 per share, respectively.
As of December 31, 2014, there was $4,034 of total unrecognized compensation expense related to restricted stock awards, which is expected to be recognized over a weighted-average period of 2.46 years. Compensation costs for awards subject only to service conditions that vest ratably are recognized on a straight-line basis over the requisite service period for the entire award. Compensation cost for awards initially subject to certain performance conditions are recognized on a ratable
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
basis over the requisite service period for the entire award. In 2014, 2013, and 2012, the Company recorded compensation charges of $2,317, $2,613, and $2,495, respectively, related to restricted stock awards.
Restricted stock activity under the Amended and Restated 2006 Stock Incentive Plan for 2014 is as follows:
(c)
Employee Stock Purchase Plan
Under the Company’s Amended and Restated Employee Stock Purchase Plan (ESPP), the Company is authorized to issue up to 650,000 shares of common stock, of which 46,575 shares remain available as of December 31, 2014.
The ESPP covers all of the Company’s employees. Under the terms of the ESPP, eligible employees can elect to have up to six percent of their pre-tax compensation withheld to purchase shares of the Company’s common stock on a semi-annual basis. The ESPP allows eligible employees the right to purchase the Company’s common stock on a semi-annual basis at 85% of the market price at the end of each purchase period. During 2014, 2013, and 2012, 12,398, 27,027, and 27,308 shares, respectively, were issued under this plan. The Company utilizes the Black-Scholes option-pricing model to calculate the fair value of these discounted purchases. The fair value of the 15% discount is recognized as compensation expense over the purchase period. The Company applies a graded vesting approach because the ESPP provides for multiple purchase periods and is, in substance, a series of linked awards. In 2014, 2013, and 2012, the Company recorded compensation charges of $55, $73, and $54, respectively, related to the ESPP. During 2014, 2013, and 2012, cash received under the ESPP was $138, $308, and $270, respectively.
(8)
Income Taxes
Income tax expense (benefit) for the years ended December 31, 2014, 2013, and 2012 attributable to income (loss) from operations is presented below.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
The actual income tax expense differs from the “expected” income tax expense computed by applying the United States Federal corporate income tax rate of 35% to income before tax expense as follows:
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
The components of income before income tax expense (benefit) determined by tax jurisdiction, are as follows:
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of the dates presented are as follows:
As of December 31, 2014, the Company had foreign net operating loss carry-forwards available to offset future foreign income of $6,000. The foreign net operating loss carry-forwards have no expiration.
As of December 31, 2014, the Company had federal research and development tax credit carry-forwards in the amount of $3,379 that expire in years 2026 through 2034, and foreign tax credit carry-forwards in the amount of $762 that expire in years 2018 through 2024. The Company also had alternative minimum tax credits of $132 that have no expiration date. As of December 31, 2014, the Company had state research and development tax credit carry-forwards in the amount of $3,367 that expire in years 2015 through 2021. The Company also had other state tax credit carry-forwards of $256 available to reduce future state tax expense that expire in years 2015 through 2021. The tax benefit related to $1,702 of federal and state tax credits would result in a credit to additional paid-in capital when these deferred tax assets reduce taxes payable.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
The Company’s ability to utilize these net operating loss carry-forwards and tax credit carry-forwards may be limited in the future if the Company experiences an ownership change pursuant to Internal Revenue Code Section 382. An ownership change occurs when the ownership percentages of 5% or greater stockholders change by more than 50% over a three-year period.
In assessing the reliability of its net deferred tax assets, the Company considered whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2014, the Company concluded that a net increase of $1,457 of the valuation allowance was appropriate. As part of the Company’s analysis, the Company evaluated, among other factors, its recent history of generating taxable income and its near-term forecasts of future taxable income. The net increase in valuation allowance of $1,457 is composed of expense of $1,665, a decrease of $223 related to the expiration of previously reserved state tax credit carry-forwards, and an increase of $15 related to the use of net operating loss and credit carryforwards attributed to tax deductions in excess of recognized compensation expense from employee stock compensation awards that existed as of the adoption of ASC 718, Compensation - Stock Compensation. $1,243 of the valuation allowance is attributable to tax deductions in excess of recognized compensation cost from employee stock compensation awards that existed as of the adoption of ASC 718. The Company will recognize the net deferred tax asset and corresponding benefit to additional paid-in capital for these windfall tax benefits once such amounts reduce income taxes payable, in accordance with the requirements of ASC 718.
As of December 31, 2014, the Company has not provided for U.S. deferred income taxes on undistributed earnings of its foreign subsidiaries of approximately $3,464 since these earnings are expected to be indefinitely reinvested. Upon distribution of those earnings in the form of dividends or otherwise, the Company will be subject to additional U.S. and state income taxes (less foreign tax credits), as well as withholding taxes in its foreign locations. The amount of taxes attributable to the undistributed earnings is not practicably determinable.
The Company establishes reserves for uncertain tax positions based on management’s assessment of exposure associated with tax deductions, permanent tax differences, and tax credits. The tax reserves are analyzed periodically and adjustments are made as events occur to warrant adjustment to the reserve. The Company's policy is to recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense.
During the years ended December 31, 2014, 2013, and 2012, the aggregate changes in the total gross amount of unrecognized tax benefits are summarized as follows:
The Company had gross unrecognized tax benefits of $2,487, $0, and $0 as of December 31, 2014, 2013, and 2012. At December 31, 2014, $1,172 represents the amount of unrecognized tax benefits that, if recognized, would result in a reduction of the Company's effective tax rate.
As of December 31, 2014, the combined amount of accrued interest and penalties related to tax positions taken on our tax returns and included in non-current income taxes payable was approximately $1,067.
The timing of any resolution of income tax examinations is highly uncertain, as are the amounts and timing of any settlement payment. These events could cause fluctuations in the balance sheet classification of current and non-current assets and liabilities. The Company expects a reduction of approximately $2,684 of unrecognized tax benefits within the next twelve months. $2,473 of the expected decrease is attributable to tax positions related to the Videotel acquisition that the Company anticipates will be resolved with taxing authorities during 2015. $211 of the expected decrease is related to temporary differences that the Company anticipates will reverse during 2015.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
The Company’s tax jurisdictions include the United States, the UK, Denmark, Cyprus, Norway, Brazil, Singapore, Belgium, Bermuda, the Netherlands, Hong Kong, and Japan. In general, the statute of limitations with respect to the Company's United States federal income taxes has expired for years prior to 2011, and the relevant state and foreign statutes vary. However, preceding years remain open to examination by United States federal and state and foreign taxing authorities to the extent of future utilization of net operating losses and research and development tax credits generated in each preceding year.
(9) Acquisitions
Videotel
On July 2, 2014, KVH Media Group Limited (KMG UK), an indirectly wholly owned subsidiary of KVH, entered into a Share Purchase Agreement with Nigel Cleave to acquire all of the issued share capital of Super Dragon Limited and Videotel Marine Asia Limited, for an aggregate purchase price of approximately $47,446, which excluded $1,719 of cash consideration that was considered deferred compensation in purchase accounting. The Company expensed approximately $400 related to the deferred compensation during the year ended December 31, 2014. Videotel is a maritime training services company headquartered in London that produces and distributes training films and eLearning computer-based training courses to commercial customers in the maritime market. Videotel also has sales offices in Hong Kong and Singapore. The acquisition was consummated on the same day. The purchase price was determined through arm’s-length negotiation and is subject to a potential post-closing adjustment based on the value of the net assets delivered at the closing.
The Share Purchase Agreement contains certain representations, warranties, covenants and indemnification provisions. The Share Purchase Agreement provides that 10% of the purchase price shall be held in escrow for a period of approximately 21 months after the closing in order to satisfy valid indemnification claims that KMG UK may assert for specified breaches of representations, warranties and covenants. The escrow and holdback amounts of approximately $6,000 were not funded as of December 31, 2014, which have been accrued for in accrued other on the Company's consolidated balance sheets.
In the Share Purchase Agreement, Mr. Cleave agreed to comply with certain confidentiality, non-competition and non-solicitation covenants with respect to the business of Videotel for a period of 18 months after the closing.
The total purchase price and the excess of the total purchase price over the estimated fair value of the net assets acquired are as follows:
The Company's fair value estimate of assets acquired and liabilities assumed is pending completion of several elements, including the finalization of valuations of the fair value of the assets acquired and liabilities assumed and final review by the Company's management. Included in the liabilities is an uncertain tax position liability of approximately $3,800 which was held on Videotel’s balance sheet as of the acquisition date and which the Company is continuing to evaluate. The final determination of the assets acquired and liabilities assumed will be based on the established fair value of the assets acquired and the liabilities
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
assumed as of the acquisition date. The excess of the purchase price over the fair value of net assets acquired is allocated to goodwill. The final determination of the purchase price, fair values and resulting goodwill may differ significantly from what is reflected in the foregoing table.
The acquired finite-lived intangible assets from the Videotel acquisition were recorded at their estimated fair value of $25,524 on the acquisition date. Refer to Note 1 and Note 14 for the classification of Videotel intangible assets including their useful lives.
Total service revenue of approximately $10,400 from Videotel is included in the Company's results for the year ended December 31, 2014. Transaction costs related to the acquisition of Videotel were $1,200 for the year ended December 31, 2014.
The following table summarizes the supplemental statements of operations information on an unaudited pro forma basis as if the Videotel acquisition had occurred on January 1, 2013:
The pro forma results presented above are for illustrative purposes only for the periods presented and do not purport to be indicative of the actual results which would have occurred had the transaction been completed as of the beginning of the period, nor are they indicative of results of operations which may occur in the future.
Headland Media Limited
On May 11, 2013, KVH Industries U.K. Limited, a newly formed, wholly owned subsidiary of KVH, entered into a Share Purchase Agreement with Oakley Capital Private Equity L.P., Mark Woodhead, Andrew Michael Galvin and the Trustees of the Headland Media Limited Employee Benefit Trust to acquire all of the issued share capital of Headland Media Limited (now known as the KVH Media Group), a media and entertainment service company based in the United Kingdom that distributes news, sports, movies, music and training video content for commercial and leisure customers in the maritime, hotel, and retail markets, for an aggregate purchase price of £15,576 ($24,169 at the exchange rate of £1.00: $1.5517 on May 11, 2013). The aggregate purchase price includes $169 in payments made in July 2013 related to a post-closing adjustment. The acquisition of Headland Media Limited (now known as the KVH Media Group) was accounted for under the acquisition method of accounting for the business combination. The purchase price was determined as a result of arms-length negotiation and was subject to a potential post-closing adjustment based on the value of the net assets delivered at the closing.
The Share Purchase Agreement contains certain representations, warranties, covenants and indemnification provisions. The Share Purchase Agreement provides that 10% of the purchase price shall be held in escrow for a period of at least 18 months after the closing in order to satisfy valid indemnification claims that KVH may assert for specified breaches of representations, warranties and covenants. The Company released the escrow in November 2014.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
The total purchase price and the excess of the total purchase price over the fair value of the net assets acquired are as follows:
Since the date of the acquisition, May 11, 2013, the Company has recorded approximately $23,200 of service revenue attributable to KVH Media Group within its consolidated financial statements, of which approximately $14,400 was recorded during the year ended December 31, 2014.
The following table summarizes the supplemental statements of operations information on an unaudited pro forma basis as if the KVH Media Group acquisition had occurred on January 1, 2012:
The pro forma results presented above are for illustrative purposes only for the periods presented and do not purport to be indicative of the actual results which would have occurred had the transaction been completed as of the beginning of the period, nor are they indicative of results of operations which may occur in the future.
(10) Goodwill and Intangible Assets
The Company’s goodwill and intangible assets are associated with the purchase of Virtek Communication (now KVH Industries Norway AS) in September 2010, Headland Media Limited (now known as the KVH Media Group) in May 2013, and Videotel in July 2014.
Intangible assets are subject to amortization. The following table summarizes other intangible assets as of December 31, 2014 and 2013, respectively:
The Company amortizes its intangible assets over the estimated useful lives of the respective assets as discussed above in our Summary of Significant Accounting Policies. Amortization expense related to intangible assets was $3,859, $1,179, and $394 for years ended December 31, 2014, 2013, and 2012, respectively.
Estimated future amortization expense for intangible assets recorded by the Company at December 31, 2014 is as follows:
Goodwill is recorded when the consideration for an acquisition exceeds the fair value of net tangible and identifiable intangible assets acquired. The changes in the carrying amount of goodwill during the year ended December 31, 2014 is as follows:
The changes in the carrying amount of intangible assets during the year ended December 31, 2014 is as follows:
(11) 401(k) Plan
The Company has a 401(k) Plan (the Plan) for all eligible employees. Participants may defer a portion of their pre-tax earnings subject to limits determined by the Internal Revenue Service. Participants age 50 or older may be eligible to make additional contributions. As of December 31, 2014, the Company matches one half of the first 6% contributed by the Plan participants. The Company’s contributions vest over a five-year period from the date of hire. Total Company matching contributions were $462, $376, and $352 for the years ended December 31, 2014, 2013, and 2012, respectively. In addition, the Company may make contributions to the Plan at the discretion of the Compensation Committee of the Board of Directors. There were no discretionary contributions in 2014, 2013, or 2012.
(12) Business and Credit Concentrations
Significant portions of the Company’s net sales are as follows:
*
Represents less than 10% of net sales.
The terms and conditions of sales to SANG are consistent with the Company’s standard terms and conditions of product sales as discussed in Note 1 above. All receivable balances outstanding for this customer as of December 31, 2014 were paid as of the date of this report. No other individual customer accounted for more than 10% of the Company’s net sales for the years ended December 31, 2014, 2013, and 2012, respectively.
(13) Segment Reporting
Under common operational management, the Company designs, develops, manufactures and markets its navigation, guidance and stabilization and mobile communications products for use in a wide variety of applications. Products are generally sold directly to third-party consumer electronic dealers and retailers, original equipment manufacturers, government contractors or to U.S. and other foreign government agencies. Primarily, sales originating in the Americas consist of sales within the United States and Canada and, to a lesser extent, Mexico and some Latin and South American countries. The Americas’ sales also include all guidance and stabilization product sales throughout the world. Sales originating from the Company’s European and Asian subsidiaries principally consist of sales into all European countries, both inside and outside the European Union, as well as Africa, Asia/Pacific, the Middle East, and India.
The Company operates in two geographic segments, exclusively in the mobile communications, navigation and guidance and stabilization equipment industry, which it considers to be a single business activity. The Company has two primary product categories: mobile communication and guidance and stabilization. Mobile communication sales and services include marine, land mobile, and automotive communication equipment and satellite-based voice, television and Broadband Internet connectivity services; distribution of commercially licensed news, sports, movies, and music content for commercial and leisure customers in the maritime, hotel, and retail markets; and distribution of training films and eLearning
computer-based training courses to commercial customers in the maritime market.
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
Guidance and stabilization sales and services include sales of defense-related navigation and guidance and stabilization equipment based upon digital compass and FOG sensor technology. Mobile communication and guidance and stabilization sales also include development contract revenue, product repairs and extended warranty sales.
The following table summarizes information regarding the Company’s operations by geographic segment:
KVH INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2014, 2013, and 2012
(in thousands except share and per share amounts)
(14) Share Buyback Program
On November 26, 2008, the Company’s Board of Directors authorized a program to repurchase up to 1,000,000 shares of the Company’s common stock. As of December 31, 2014, 341,009 shares of the Company’s common stock remain available for repurchase under the authorized program. The repurchase program is funded using the Company’s existing cash, cash equivalents, marketable securities and future cash flows. Under the repurchase program, the Company, at management’s discretion, may repurchase shares on the open market from time to time, in privately negotiated transactions or block transactions, or through an accelerated repurchase agreement. The timing of such repurchases depends on availability of shares, price, market conditions, alternative uses of capital, and applicable regulatory requirements. The program may be modified, suspended or terminated at any time without prior notice. The repurchase program has no expiration date. There were no other repurchase programs outstanding during the year ended December 31, 2014 and no repurchase programs expired during the period.
During the years ended December 31, 2014, 2013, and 2012 the Company did not repurchase any shares of its common stock in open market transactions.
(15) Fair Value Measurements
ASC 820, Fair Value Measurements and Disclosures, provides a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes three levels of inputs that may be used to measure fair value:
Level 1:
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. The Company’s Level 1 assets are investments in money market mutual funds, government agency bonds, United States treasuries, corporate notes, and certificates of deposit.
Level 2:
Quoted prices for similar assets or liabilities in active markets; or observable prices that are based on observable market data, based on directly or indirectly market-corroborated inputs. The Company’s Level 2 assets are investments in municipal bonds and its Level 2 liabilities are interest rate swaps.
Level 3:
Unobservable inputs that are supported by little or no market activity, and are developed based on the best information available given the circumstances. The Company has no Level 3 assets.
Assets and liabilities measured at fair value are based the valuation techniques identified in the table below. The valuation techniques are:
(a)
Market approach-prices and other relevant information generated by market transactions involving identical or comparable assets.
(b)
The valuations of the interest rate swaps intended to mitigate the Company’s interest rate risk are determined with the assistance of a third-party financial institution using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each instrument. This analysis utilizes observable market-based inputs, including interest rate curves and interest rate volatility, and reflects the contractual terms of these instruments, including the period to maturity.
(c)
The valuations of foreign currency forward contracts are determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each instrument. This analysis utilizes observable market-based inputs, including commodity forward curves, and reflects the contractual terms of these instruments, including the period to maturity.
(d)
The valuations of municipal bonds are determined utilizing standard pricing procedures of the Company’s investment brokerage firm, which include various third-party pricing services. These procedures also require specific price monitoring practices as well as pricing review reports, valuation oversight, and pricing challenge procedures to maintain an accurate representation of investment fair market value.
The following tables present financial assets and liabilities at December 31, 2014 and December 31, 2013 for which the Company measures fair value on a recurring basis, by level, within the fair value hierarchy:
Certain financial instruments are carried at cost on the consolidated balance sheets, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses.
Assets Measured and Recorded at Fair Value on a Nonrecurring Basis
The Company's non-financial assets and liabilities, such as goodwill, intangible assets, and other long-lived assets resulting from business combinations, are measured at fair value using income approach valuation methodologies at the date of acquisition and subsequently re-measured if there are indicators of impairment. There were no indicators of impairment identified during the year ended December 31, 2014. As of December 31, 2014, the Company did not have any other non-financial assets and liabilities that were carried at fair value on a recurring basis in the consolidated financial statements or for which a fair value measurement was required.
(16) Derivative Instruments and Hedging Activities
Effective April 1, 2010, in order to reduce the volatility of cash outflows that arise from changes in interest rates, the Company entered into two interest rate swap agreements. These interest rate swap agreements are intended to hedge the Company’s mortgage loan related to its headquarters facility in Middletown, Rhode Island by fixing the interest rates specified in the mortgage loan to 5.9% for half of the principal amount outstanding and 6.1% for the remaining half of the principal amount outstanding as of April 1, 2010 until the mortgage loan expires on April 16, 2019.
As required by ASC Topic 815, Derivatives and Hedging, the Company records all derivatives on the balance sheet at fair value. As of December 31, 2014, the fair value of the derivatives is included in other accrued liabilities and the unrealized loss is included in other comprehensive loss.
As of December 31, 2014, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:
(17) Legal Matters
From time to time, the Company is involved in litigation incidental to the conduct of its business. In the ordinary course of business, KVH is a party to inquiries, legal proceedings and claims including, from time to time, disagreements with vendors and customers. The Company is not a party to any lawsuit or proceeding that, in management’s opinion, is likely to materially harm the Company’s business, results of operations, financial condition or cash flows.
(18) Quarterly Financial Results (Unaudited)
The following financial information for interim periods includes transactions which affect comparability of the quarterly results for the year ended December 31, 2014. During the second quarter of 2013 and the third quarter of 2014, the Company acquired Headland Media Limited (now known as KVH Media Group) and Videotel, respectively, as described in Note 9 “Acquisitions,” resulting in increased service sales and service gross margins.
Financial information for interim periods was as follows:
(a)
Net (loss) income per share is computed independently for each of the quarters. Therefore, the net (loss) income per share for the four quarters may not equal the annual net (loss) income per share data.