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RIGNET, INC. - 10-Q - Management's Discussion And Analysis Of Financial Condition And Results Of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying unaudited condensed consolidated financial statements as of September 30, 2014 and for the three and nine months ended September 30, 2014 and 2013 included elsewhere herein, and with our annual report on Form 10-K for the year ended December 31, 2013. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Risk Factors" in Item 1A of our annual report and elsewhere in this quarterly report. See "Forward-Looking Statements" below. Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are subject to a number of risks and uncertainties, many of which are beyond the Company's control. These statements may include statements about: • new regulations, delays in drilling permits or other changes in the drilling industry; • competition and competitive factors in the markets in which we operate; • demand for our products and services; • the advantages of our services compared to others; • changes in customer preferences and our ability to adapt our product and services offerings; • our ability to develop and maintain positive relationships with our customers; • our ability to retain and hire necessary employees and appropriately staff our marketing, sales and distribution efforts; • our cash needs and expectations regarding cash flow from operations; • our ability to manage and grow our business and execute our business strategy, including expanding our penetration of the U.S. and international onshore and offshore drilling rigs; • our strategy; • our financial performance, including our ability to expand Adjusted EBITDA through our operational leverage; and • the costs associated with being a public company. In some cases, forward-looking statements can be identified by terminology such as "may," "could," "should," "would," "expect," "plan," "project," "intend," "anticipate," "believe," "estimate," "predict," "potential," "pursue," "target," "continue," the negative of such terms or other comparable terminology that convey uncertainty of future events or outcomes. All of these types of statements, other than statements of historical fact included in this Quarterly Report on Form 10-Q, are forward-looking statements. The forward-looking statements contained in this Quarterly Report on Form 10-Q are largely based on Company expectations, which reflect estimates and assumptions made by Company management. These estimates and assumptions reflect management's best judgment based on currently known market conditions and other factors. Although the Company believes such estimates and assumptions to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties beyond its control. In addition, management's assumptions may prove to be inaccurate. The Company cautions that the forward-looking statements contained in this Quarterly Report on Form 10-Q are not guarantees of future performance, and it cannot assure any reader that such statements will be realized or the forward-looking statements or events will occur. Future results may differ materially from those anticipated or implied in forward-looking statements due to factors listed in the "Risk Factors" section of our annual report on Form 10-K for the year ended December 31, 2013 and elsewhere in this Quarterly Report on Form 10-Q. If one or more of these factors materialize, or if any underlying assumptions prove incorrect, our future results, performance or achievements may vary materially from any future results, performance or achievements expressed or implied by these forward-looking statements. The forward-looking statements speak only as of the date made, and other than as required by law, the Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. 18 -------------------------------------------------------------------------------- Table of Contents Our Operations We are a global provider of managed remote communications, telecoms systems integration (project management of turn-key engineered telecommunications solutions) and collaborative applications dedicated to the oil and gas industry, focusing on offshore and onshore drilling rigs, energy production facilities and energy maritime. We focus on developing customer relationships in the oil and gas industry resulting in a significant portion of our revenue being concentrated in a few customers. In addition, due to the concentration of our customers in the oil and gas industry, we face the challenge of service demands fluctuating with the exploration and development plans and capital expenditures of that industry. Network service customers are primarily served under fixed-price, day-rate contracts, which are based on the concept of pay-per-day of use and are consistent with other service terms used in the oil and gas industry. Our contracts are generally in the form of Master Service Agreements, or MSAs, with specific services being provided under individual service orders that have a term of one to three years with renewal options, while land-based locations are generally shorter term or terminable on short notice without a penalty. Service orders are executed under the MSA for individual remote sites or groups of sites, and generally may be terminated early on short notice without penalty in the event of force majeure, breach of the MSA or cold stacking of a drilling rig (when a rig is taken out of service and is expected to be idle for a protracted period of time). Segment information is prepared consistent with the components of the enterprise for which separate financial information is available and regularly evaluated by the chief operating decision-maker for the purpose of allocating resources and assessing performance. In connection with the acquisition of Inmarsat's Enterprise Energy business unit, we evaluated our current core assets and operations, and organized them into segments. We are now presenting Telecoms Systems Integration as a separate reportable segment, as this is now a greater portion of our core assets and operations due to the acquisition of Inmarsat's Enterprise Energy business unit. Certain operating segments are aggregated into one reportable segment based on similar economic characteristics. Accordingly, we operate three reportable segments, which are managed as distinct business units by our chief operating decision-maker. • Eastern Hemisphere. Our Eastern Hemisphere segment provides remote communications services for offshore and onshore drilling rigs and production facilities, as well as, energy support vessels and other remote sites. Our Eastern Hemisphere segment services are primarily performed out of our Norway, United Kingdom, Qatar, and Singapore based offices for customers and rig sites located on the eastern side of the Atlantic Ocean primarily off the coasts of the United Kingdom, Norway, West Africa, around the Indian Ocean in Qatar, Saudi Arabia and India, around the Pacific Ocean near Australia, and within the South China Sea. • Western Hemisphere. Our Western Hemisphere segment provides remote communications services for offshore and onshore drilling rigs and production facilities, as well as, energy support vessels and other remote sites. Our Western Hemisphere segment services are primarily performed out of our United States and Brazil based offices for onshore and offshore customers and rig sites located on the western side of the Atlantic Ocean primarily in the United States, Canada, Mexico and Brazil, and within the Gulf of Mexico. • Telecoms Systems Integration (TSI). Our TSI segment designs, assembles, installs and commissions turn-key solutions for customer telecommunications systems. TSI segment solutions are custom designed and engineered turn-key solutions based on the customer's specifications, as well as, international industry standards and best practices. TSI projects include consultancy services, design, engineering, project management, procurement, testing, installation, commissioning and after-sales service. Our TSI segment services are primarily performed out of our United Kingdom and United States based offices for customers globally. Cost of revenue consists primarily of satellite charges, voice and data termination costs, network operations expenses, internet connectivity fees, equipment purchases for telecoms systems integration projects and direct service labor. Direct service labor consists of field technicians, our Network Operations Center (NOC) employees, and other employees who directly provide services to customers. Satellite charges consist of the costs associated with obtaining satellite bandwidth (the measure of capacity) used in the transmission of service to and from leased satellites. Network operations expenses consist primarily of costs associated with the operation of our NOC, which is maintained 24 hours a day, seven days a week. Depreciation and amortization is recognized on all property, plant and equipment either installed at a customer's site or held at our corporate and regional offices, as well as intangibles arising from acquisitions and internal use software. Selling and marketing expenses consist primarily of salaries and commissions, travel costs and marketing communications. General and administrative expenses consist of expenses associated with our management, finance, contract, support and administrative functions. 19 -------------------------------------------------------------------------------- Table of Contents Profitability increases at a site as we add customers and increase value-added services. Assumptions used in developing the day rates for a site may not cover cost variances from inherent uncertainties or unforeseen obstacles, including both physical conditions and unexpected problems encountered with third party service providers. Recent Developments On January 31, 2014, we closed our acquisition of Inmarsat Plc's Enterprise Energy business unit for an aggregate purchase price of $26.1 million, including $12.3 million of working capital. Under the terms of the deal, Inmarsat sold to us substantially all of its energy broadband assets, which include: microwave and WiMAX networks in the U.S. Gulf of Mexico and the North Sea serving drillers, producers and energy vessel owners; VSAT interests in the United Kingdom, U.S. and Canada; an M2M SCADA VSAT network in the continental U.S. serving the pipeline industry; a telecommunications systems integration business operating worldwide; and a global L-band MSS retail energy business. We financed the transaction with borrowings under our new credit facility announced on October 3, 2013 and existing cash on hand. For the three and nine months ended September 30, 2014, we spent $0.0 million and $2.9 million, respectively, on acquisition-related costs in connection with this acquisition, which are reported as general and administrative expense in our condensed consolidated financial statements. Additionally, on January 31, 2014, we finalized an agreement with Inmarsat to become a distributor of Inmarsat's Global Xpress (GX) and L-band satellite communications network services, which will enable us to offer next-generation satellite services to existing and new customers in the global energy sector worldwide. We have agreed, under certain conditions, to purchase up to $65.0 million of capacity from the high-throughput GX network during the five years after it becomes operational. We expect to utilize GX and L-band services across our own business as well as that of the acquired Energy Broadband business. Known Trends and Uncertainties Uncertainties that could impact profitability include oil and gas market trends (exploration and development plans and capital expenditures of that industry), service responsiveness to remote locations, communication network complexities, political and economic instability in certain regions, export restrictions, licenses and other trade barriers. These uncertainties may result in the delay of service initiation, which may negatively impact our results of operations. Uncertainties that could impact operating cash flows include the availability and cost of satellite bandwidth, timing of collecting our receivables, and our ability to increase our contracted services through sales and marketing efforts while leveraging the contracted satellite and other communication service costs. We cannot predict the ultimate outcome of the OFAC and BIS investigation (described in this Item under the heading "Regulatory Matter"), the total costs to be incurred in completing the investigation, the potential impact on personnel, the effect of implementing any further measures that may be necessary to ensure full compliance with applicable laws or to what extent, if at all, we could be subject to fines, sanctions or other penalties. During our annual July 31, 2014 impairment test, the fair value of our Telecoms Systems Integration (TSI) reporting unit, which coincides with our TSI reportable segment, exceeded carrying value by approximately 8.0%. As of September 30, 2014, the goodwill balance held by our TSI reporting unit was $2.7 million. Any future downturn in our TSI business could adversely impact the key assumptions in our goodwill impairment test. While we believe that there appears to be no indication of current or future impairment, historical operating results may not be indicative of future operating results and events and circumstances may occur causing a triggering event in a period as short as three months. 20 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth selected financial and operating data for the periods indicated. Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands) Revenue $ 87,819 $ 56,856 $ 243,518 $ 161,003 Expenses: Cost of revenue (excluding depreciation and amortization) 49,217 31,140 141,394 86,189 Depreciation and amortization 7,530 5,450 21,607 15,668 Selling and marketing 1,599 937 4,892 2,753 General and administrative 17,772 13,036 48,769 36,326 Total expenses 76,118 50,563 216,662 140,936 Operating income 11,701 6,293 26,856 20,067 Other expense, net (1,020 ) (1,305 ) (1,466 ) (1,325 ) Income before income taxes 10,681 4,988 25,390 18,742 Income tax expense (4,751 ) (2,581 ) (11,404 ) (7,645 ) Net income 5,930 2,407 13,986 11,097 Less: Net income attributable to non-controlling interests 73 60 267 154 Net income attributable to RigNet, Inc. stockholders $ 5,857 $ 2,347 $ 13,719 $ 10,943 Other Non-GAAP Data: Gross Profit (excluding depreciation and amortization) $ 38,602 $ 25,716 $ 102,124 $ 74,814 Adjusted EBITDA $ 20,180 $ 14,450 $ 55,194 $ 40,973 21 -------------------------------------------------------------------------------- Table of Contents The following represents selected financial operating results for our segments: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands) Eastern Hemisphere: Revenue $ 43,759 $ 33,285 $ 121,623 $ 93,085 Cost of revenue (excluding depreciation and amortization) 19,091 15,081 56,988 41,887 Gross Profit (non-GAAP measure) 24,668 18,204 64,635 51,198 Depreciation and amortization 3,452 2,219 9,528 6,284 Selling, general and administrative 3,932 2,960 10,699 11,097 Eastern Hemisphere operating income $ 17,284 $ 13,025 $ 44,408 $ 33,817 Western Hemisphere: Revenue $ 30,366 $ 13,884 $ 81,827 $ 39,440 Cost of revenue (excluding depreciation and amortization) 16,582 6,734 45,826 18,164 Gross Profit (non-GAAP measure) 13,784 7,150 36,001 21,276 Depreciation and amortization 2,857 1,924 8,302 5,566 Selling, general and administrative 4,084 2,000 10,412 5,767 Western Hemisphere operating income $ 6,843 $ 3,226 $ 17,287 $ 9,943 Telecoms Systems Integration: Revenue $ 13,694 $ 9,687 $ 40,068 $ 28,478 Cost of revenue (excluding depreciation and amortization) 11,051 8,180 31,459 22,214 Gross Profit (non-GAAP measure) 2,643 1,507 8,609 6,264 Depreciation and amortization 930 1,088 2,939 3,248 Selling, general and administrative 920 306 2,416 720 Telecom Systems Integration operating income $ 793 $ 113 $ 3,254 $ 2,296 NOTE: Consolidated balances include the three segments above along with corporate activities and intercompany eliminations. Three Months Ended September 30, 2014 and 2013 Revenue. Revenue increased by $31.0 million, or 54.5%, to $87.8 million for the three months ended September 30, 2014 from $56.9 million for the three months ended September 30, 2013. The acquisition of Inmarsat's Enterprise Energy business unit contributed $22.7 million for the three months ended September 30, 2014, across all three reportable segments. Excluding Inmarsat's Enterprise Energy business unit, revenue increased by $8.3 million, or 14.6%. This organic increase was driven by the Eastern Hemisphere segment which increased $7.0 million, or 21.2%, and the Western Hemisphere segment which increased $4.0 million, or 28.9%. These increases are primarily due to increased revenue-per-site and increased sites served across the Eastern and Western Hemisphere segments. Cost of Revenue. Costs increased by $18.1 million, or 58.1%, to $49.2 million for the three months ended September 30, 2014 from $31.1 million for the three months ended September 30, 2013. The acquisition of Inmarsat's Enterprise Energy business unit added $16.6 million to costs for the three months ended September 30, 2014 across all three reportable segments. Excluding Inmarsat's Enterprise Energy business unit, costs increased by $1.4 million, or 4.6%, to $32.6 million for the three months ended September 30, 2014 from $31.1 million for the three months ended September 30, 2013. This increase is primarily due to incremental network services and satellite charges to support growing bandwidth needs of our customers across the Eastern and Western Hemisphere segments. 22-------------------------------------------------------------------------------- Table of Contents Gross Profit (excluding depreciation and amortization) increased by $12.9 million, or 50.1%, to $38.6 million for the three months ended September 30, 2014 from $25.7 million for the three months ended September 30, 2013. Gross Profit (excluding depreciation and amortization) as a percentage of revenue decreased to 44.0% for the three months ended September 30, 2014 compared to 45.2% for the three months ended September 30, 2013. Excluding Inmarsat's Enterprise Energy business unit, Gross Profit (excluding depreciation and amortization) increased by $6.9 million, or 26.6%, to $32.6 million for the three months ended September 30, 2014 from $25.7 million for the three months ended September 30, 2013. Excluding Inmarsat's Enterprise Energy business unit, Gross Profit (excluding depreciation and amortization) as a percentage of revenue increased to 50.0% for the three months ended September 30, 2014 compared to 45.2% for the three months ended September 30, 2013. The increased Gross Profit (excluding depreciation and amortization) is primarily attributable to growing bandwidth needs of our customers across the Eastern and Western Hemisphere segments and partially offset by increased costs, which have supported our growing revenues and Gross Profit (excluding depreciation and amortization). Depreciation and Amortization. Depreciation and amortization expense increased by $2.1 million to $7.5 million for the three months ended September 30, 2014 from $5.5 million for the three months ended September 30, 2013. This increase is primarily attributable to the continued increase in our capital expenditures and the acquisition of depreciable property, plant and equipment and amortizable intangibles as part of the Inmarsat's Enterprise Energy business unit acquisition. Selling and Marketing. Selling and marketing expense increased by $0.7 million to $1.6 million for the three months ended September 30, 2014 from $0.9 million for the three months ended September 30, 2013. General and Administrative. General and administrative expenses increased by $4.7 million to $17.8 million for the three months ended September 30, 2014 from $13.0 million for the three months ended September 30, 2013. General and administrative costs increased primarily due to costs and increased office space related to the acquisition of Inmarsat's Enterprise Energy business unit, increased compensation resulting from headcount additions and increased stock-based compensation. Income Tax Expense. Our effective income tax rate was 44.5% and 51.7% for the three months ended September 30, 2014 and 2013, respectively. Our effective tax rates are affected by factors including fluctuations in income across jurisdictions with varying tax rates, changes in valuation allowances related to operating in a loss jurisdiction for which a benefit cannot be claimed, and changes in income tax reserves, including related penalties and interest. The decrease in the effective tax rate was primarily attributable to recognizing less uncertain tax positions relative to book income during the nine months ended September 30, 2014 compared to the same period ended September 30, 2013. Nine Months Ended September 30, 2014 and 2013 Revenue. Revenue increased by $82.5 million, or 51.3%, to $243.5 million for the nine months ended September 30, 2014 from $161.0 million for the nine months ended September 30, 2013. The acquisition of Inmarsat's Enterprise Energy business unit contributed $55.6 million for the nine months ended September 30, 2014 across all reportable segments. Excluding Inmarsat's Enterprise Energy business unit, revenue increased by $26.9 million, or 16.7%. This organic increase was driven by the Eastern Hemisphere segment which increased $19.7 million, or 21.1%, and the Western Hemisphere segment which increased $10.3 million, or 26.2%. These increases are primarily due to increased revenue-per-site and increased sites served across the Eastern and Western Hemisphere segments. Cost of Revenue. Costs increased by $55.2 million, or 64.1%, to $141.4 million for the nine months ended September 30, 2014 from $86.2 million for the nine months ended September 30, 2013. The acquisition of Inmarsat's Enterprise Energy business unit added $41.5 million to costs for the nine months ended September 30, 2014 across all three reportable segments. Excluding Inmarsat's Enterprise Energy business unit, costs increased by $13.7 million, or 15.9%, to $99.9 million for the nine months ended September 30, 2014 from $86.2 million for the nine months ended September 30, 2013. This increase is primarily due to incremental network services and satellite charges to support growing bandwidth needs of our customers across the Eastern and Western Hemisphere segments. 23-------------------------------------------------------------------------------- Table of Contents Gross Profit (excluding depreciation and amortization) increased by $27.3 million, or 36.5%, to $102.1 million for the nine months ended September 30, 2014 from $74.8 million for the nine months ended September 30, 2013. Gross Profit (excluding depreciation and amortization) as a percentage of revenue decreased to 41.9% for the nine months ended September 30, 2014 compared to 46.5% for the nine months ended September 30, 2013. Excluding Inmarsat's Enterprise Energy business unit, Gross Profit (excluding depreciation and amortization) increased by $13.2 million, or 17.7%, to $88.1 million for the nine months ended September 30, 2014 from $74.8 million for the nine months ended September 30, 2013. Excluding Inmarsat's Enterprise Energy business unit, Gross Profit (excluding depreciation and amortization) as a percentage of revenue increased to 46.9% for the nine months ended September 30, 2014 compared to 46.5% for the nine months ended September 30, 2013. The increased Gross Profit (excluding depreciation and amortization) is primarily attributable to growing bandwidth needs of our customers across the Eastern and Western Hemisphere segments and partially offset by increased costs, which have supported our growing revenues and Gross Profit (excluding depreciation and amortization). Depreciation and Amortization. Depreciation and amortization expense increased by $5.9 million to $21.6 million for the nine months ended September 30, 2014 from $15.7 million for the nine months ended September 30, 2013. This increase is primarily attributable to the continued increase in our capital expenditures and the acquisition of depreciable property, plant and equipment and amortizable intangibles as part of the Inmarsat's Enterprise Energy business unit acquisition. Selling and Marketing. Selling and marketing expense increased by $2.1 million to $4.9 million for the nine months ended September 30, 2014 from $2.8 million for the nine months ended September 30, 2013. General and Administrative. General and administrative expenses increased by $12.4 million to $48.8 million for the nine months ended September 30, 2014 from $36.3 million for the nine months ended September 30, 2013. General and administrative costs increased primarily due to costs and increased office space related to the acquisition of Inmarsat's Enterprise Energy business unit, increased compensation resulting from headcount additions and increased stock-based compensation. Income Tax Expense. Our effective income tax rate was 44.9% and 40.8% for the nine months ended September 30, 2014 and 2013, respectively. Our effective tax rates are affected by factors including fluctuations in income across jurisdictions with varying tax rates, changes in valuation allowances related to operating in a loss jurisdiction for which a benefit cannot be claimed, and changes in income tax reserves, including related penalties and interest. Liquidity and Capital Resources At September 30, 2014, we had working capital of $100.1 million, including cash and cash equivalents of $61.0 million, current restricted cash of $0.7 million, accounts receivable of $83.8 million and other current assets of $16.9 million, offset by $17.1 million in accounts payable, $26.9 million in accrued expenses, $8.4 million in current maturities of long-term debt, $4.5 million in tax related liabilities and $5.4 million in deferred revenue. Over the past three years, annual capital expenditures have grown from $19.2 million to $30.2 million due to continued increase of sites served. Based on our current expectations, we believe our liquidity and capital resources will be sufficient for the conduct of our business and operations for the foreseeable future. We may also use a portion of our available cash to finance growth through the acquisition of, or investment in, businesses, products, services or technologies complementary to our current business. During the next twelve months, we expect our principal sources of liquidity to be cash flows from operating activities, cash and cash equivalents and availability under our credit facility. In forecasting our cash flows we have considered factors including contracted services related to long-term deepwater drilling programs, U.S. land rig count trends, projected oil and natural gas prices, contracted and available satellite bandwidth and the additional operations acquired from Inmarsat's Enterprise Energy business unit. While we believe we have sufficient liquidity and capital resources to meet our current operating requirements and expansion plans, we may elect to pursue additional expansion opportunities within the next year which could require additional financing, either debt or equity. Beyond the next twelve months, we expect our principal sources of liquidity to be cash flows provided by operating activities, cash and cash equivalents on hand, availability under our credit facility and additional financing activities we may pursue, which may include debt or equity offerings. 24-------------------------------------------------------------------------------- Table of Contents |