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KVH INDUSTRIES INC \DE\ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Introduction The statements included in this quarterly report on Form 10-Q, other than statements of historical fact, are forward-looking statements. Examples of forward-looking statements include statements regarding our future financial results, operating results, business strategies, projected costs, products, competitive positions and plans, customer preferences, consumer trends, anticipated product development, and objectives of management for future operations. In some cases, forward-looking statements can be identified by terminology such as "may," "will," "should," "would," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue," or the negative of these terms or other comparable terminology. Any expectations based on these forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in the section entitled "Risk Factors" in Item 1A of Part II of this quarterly report. These and many other factors could affect our future financial and operating results, and could cause actual results to differ materially from expectations based on forward-looking statements made in this document or elsewhere by us or on our behalf. For example, our expectations regarding certain items as a percentage of sales assume that we will achieve our anticipated sales goals. The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this report. Overview We design, develop, manufacture and market mobile communications products and services for the marine, land mobile and aeronautical 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 as well as live digital television on commercial airplanes while in motion. 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. We 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 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 news, sports, music, movies and training video content 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 (SDL) and Videotel Marine Asia Limited (VMA, together with SDL referred to as Videotel), a maritime training services company that KVH 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 24% of our net sales in 2011 to 34% in 2012 to 44% in 2013 to 54% in the nine months ended September 30, 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 $49.2 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 approximately $21.0 million in 2013 and $4.8 million in the three months ended September 30, 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. 20 -------------------------------------------------------------------------------- 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 the nine months ended September 30, 2014 and 2013 included $1.3 million and $15.3 million, respectively, attributable to our original $35.6 million contract 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 received 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. We generate sales primarily from the sale of our mobile satellite systems and services and our guidance and stabilization products and services. The following table provides, for the periods indicated, our sales by industry category: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands)Mobile communications $ 36,195 $ 29,013 $ 94,833 $ 79,172 Guidance and stabilization 8,055 11,203 27,324 44,168 Net sales $ 44,250 $ 40,216 $ 122,157 $ 123,340 We have historically derived a substantial portion of our sales from sales to customers located outside the United States. Notes 9 and 15 of the notes to the consolidated financial statements provide information regarding our sales to specific geographic regions. 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, sales and expenses, and related disclosure at the date of our financial statements. Our significant accounting policies are summarized in note 1 of the notes to the consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2013. As described in our annual report on Form 10-K for the year ended December 31, 2013, our most critical accounting policies and estimates upon which our consolidated financial statements were prepared were those relating to revenue recognition, allowances for accounts receivable, inventories, income taxes and deferred income tax assets and liabilities, warranty, stock-based compensation, goodwill and intangible assets and contingencies. We have reviewed our policies and estimates and determined that these remain our most critical accounting policies and estimates for the quarter ended September 30, 2014. See note 14 to the Consolidated Financial Statements for our discussion of the annual goodwill impairment test as of August 31, 2014. Readers should refer to our annual report on Form 10-K for the year ended December 31, 2013 under "Management's Discussion and Analysis of Financial Condition and Results of Operation-Critical Accounting Policies and Significant Estimates" for descriptions of these policies and estimates. 21 -------------------------------------------------------------------------------- Results of Operations The following table provides, for the periods indicated, certain financial data expressed as a percentage of net sales: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Sales: Product 38.1 % 50.6 % 45.7 % 57.9 % Service 61.9 49.4 54.3 42.1 Net sales 100.0 100.0 100.0 100.0 Cost and expenses: Costs of product sales 24.3 29.3 28.0 32.4 Costs of service sales 33.2 29.6 30.4 26.8 Research and development 7.4 8.3 8.9 7.7 Sales, marketing and support 18.3 15.8 19.0 16.9 General and administrative 15.5 11.8 14.2 10.6 Total costs and expenses 98.7 94.8 100.5 94.4 Income (loss) from operations 1.3 5.2 (0.5 ) 5.6 Interest income 0.4 0.5 0.5 0.5 Interest expense 1.1 0.5 0.7 0.4 Other (expense) income, net (0.4 ) 0.5 (0.1 ) 0.2 Income (loss) before income tax expense 0.2 5.7 (0.8 ) 5.9 Income tax (benefit) expense (0.3 ) 2.3 - 1.9 Net income (loss) 0.5 % 3.4 % (0.8 )% 4.0 % Three Months Ended September 30, 2014 and 2013 Net Sales Product sales decreased $3.5 million, or 17%, to $16.9 million for the three months ended September 30, 2014 from $20.3 million for the three months ended September 30, 2013. The decrease was primarily due to a decrease in sales of our guidance and stabilization products of approximately $2.1 million, or 24%. Specifically, sales of our FOG products decreased $1.6 million, or 27%, primarily as a result of decreased shipments of FOGs for commercial applications and a $0.2 million decrease in sales under the U.S. Army's Common Remotely Operated Weapon Stations (CROWS) III program. Also contributing to the decrease in sales of our guidance and stabilization products during the three months ended September 30, 2014 was a decrease in sales of our TACNAV defense products of $0.6 million, or 23%, as compared to the three months ended September 30, 2013. We expect that our TACNAV product sales will significantly increase year-over-year for the fourth quarter of 2014 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 could continue to be very uneven. We also expect that our FOG product sales will be consistent year-over-year for the fourth quarter of 2014. Mobile communications product sales decreased $1.4 million, or 12%, to $10.3 million for the three months ended September 30, 2014 from $11.7 million for the three months ended September 30, 2013. The decrease was primarily due to a decrease in sales of our marine satellite communications products of $1.2 million, or 11%, driven primarily by decreased sales of our TracPhone V11 products, marine satellite television products, TracPhone V3 products and Inmarsat products. Also contributing to the decrease in mobile communications product sales was a decrease in sales of our land mobile products of $0.2 million, or 22%, as compared to the three months ended September 30, 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 expect our total mini-VSAT product sales will be consistent year-over-year for the fourth quarter of 2014. Mobile communications product sales originating from the Americas for the three months ended September 30, 2014 decreased $1.0 million, or 11%, as compared to the three months ended September 30, 2013. Mobile communications product 22 -------------------------------------------------------------------------------- sales originating from our European and Asian subsidiaries for the three months ended September 30, 2014 decreased $0.4 million, or 14%, as compared to the three months ended September 30, 2013. Service sales for the three months ended September 30, 2014 increased $7.5 million, or 38%, to $27.4 million from $19.9 million for the three months ended September 30, 2013. The primary reasons for the increase were a $5.3 million increase in new service sales arising from our acquisition of Videotel on July 2, 2014 and a $3.0 million increase in airtime sales for our mini-VSAT Broadband service. Also contributing to the increase in service sales was a $0.5 million increase in media sales arising from our acquisition of KVH Media Group in May 2013. Partially offsetting the increases in service sales was a $0.8 million decrease in contracted engineering services primarily from decreased construction and program management services provided in connection with the Saudi Arabian National Guard (SANG) contract, a $0.4 million decrease in service repair sales, and a $0.2 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 we anticipate to begin generating service revenue in 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 significantly decrease in the fourth quarter year-over-year as a result of the completion of the SANG project management services in the third quarter of 2014. Costs of Sales For the three months ended September 30, 2014, costs of product sales decreased by $1.0 million, or 9%, to $10.8 million from $11.8 million for the three months ended September 30, 2013. The primary reason for the decrease was the decrease in sales of our FOG and mobile communications product sales discussed above, and a $0.3 million decrease in Inmarsat costs of service. Costs of service sales increased by $2.8 million, or 23%, to $14.7 million for the three months ended September 30, 2014 from $11.9 million for the three months ended September 30, 2013. The primary reason for the increase was a $2.2 million increase in airtime costs of sales for our mini-VSAT Broadband service. Also contributing to the increase was a $1.5 million increase in costs of service sales arising from our acquisition of Videotel, and a $0.3 million increase in costs of service sales from the KVH Media Group. Partially offsetting these increases was a $1.0 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. Gross margin from product sales for the three months ended September 30, 2014 decreased to 36% as compared to 42% for the three months ended September 30, 2013. The decrease in our gross margin from product sales was primarily due to a decrease in gross margin on our marine products. The decrease in gross margin for marine products was driven by the initial sourcing of components for our new TracVision satellite television line towards the end of the second quarter in 2014. We anticipate that the gross margins on these product sales will approach historical levels in the first half of 2015 as result of decreased manufacturing costs from transitioning the sourcing to Asia. Gross margin from service sales for the three months ended September 30, 2014 increased to 46% as compared to 40% for the three months ended September 30, 2013. The increase in our gross margin from service sales was primarily attributable to the service gross margin contributed by our new Videotel business. Also contributing to the gross margin increase was an increase in gross margin from contracted engineering services. Partially offsetting the service gross margin increase was a decrease in gross margin from service repair sales. We expect service gross margins to increase as a result of the acquisition of Videotel in July 2014. We also anticipate that the favorable impact year-over-year 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 fourth quarter of 2014 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 for the three months ended September 30, 2014 remained relatively flat at $3.3 million, consistent with the expense for the three months ended September 30, 2013. As a percentage of net sales, research and development expense for the quarter ended September 30, 2014 was 7% as compared to 8% for the quarter ended September 30, 2013. We expect that research and development expense will continue to increase year-over-year in the fourth quarter of 2014 due to the continued development efforts associated with the release of new value-added services to our mini-VSAT Broadband customers such as IP-MobileCast, including the integration of Videotel services, as well as new FOG and TACNAV products. Sales, marketing and support expense for the three months ended September 30, 2014 increased by $1.8 million, or 28%, to $8.1 million from $6.3 million for the three months ended September 30, 2013. The primary reasons for the increase in 23 -------------------------------------------------------------------------------- the third quarter of 2014 were a $1.5 million increase in sales, marketing and support expense related our new Videotel business, a one-time $0.5 million insurance recovery received in the third quarter of 2013 related to misappropriated funds identified at our Danish subsidiary, a $0.2 million increase in warranty expense mainly in relation to TracPhone V7 and V11 products, and a $0.2 million increase from the KVH Media Group business. Partially offsetting these increases were a $0.3 million decrease in bad debt expense, and a $0.1 million decrease in variable product sales expense. As a percentage of net sales, sales, marketing and support expense for the quarter ended September 30, 2014 was 18% as compared to 16% for the quarter ended September 30, 2013. We expect that our sales, marketing and support expenses will continue to increase year-over-year in the fourth quarter of 2014, driven by the additional expenses from our acquisition of Videotel in July 2014 and expenses relating to our release of new value-added services to our mini-VSAT Broadband customers such as IP-MobileCast. General and administrative expense for the three months ended September 30, 2014 increased by $2.1 million, or 44%, to $6.9 million from $4.8 million for the three months ended September 30, 2013. The primary reason for the increase in expense in the 2014 period was a $1.2 million increase in expense from our new Videotel business, a $0.8 million increase in acquisition costs from the purchase of Videotel. As a percentage of net sales, general and administrative expense for the quarter ended September 30, 2014 was 16% as compared to 12% for the quarter ended September 30, 2013. We expect general and administrative expenses to increase year-over-year in the fourth quarter of 2014, driven primarily by additional expenses from our acquisition of Videotel, including incremental amortization expenses for acquired intangible assets. Incremental amortization from the Videotel acquisition, subject to future changes in exchange rates in 2015, is currently estimated at approximately $2.2 million per year. Interest Expense and Other (Expense) Income For the three months ended September 30, 2014, interest expense and other expense increased by $0.7 million to $0.7 million, from $0.0 million for the three months ended September 30, 2013. The primary reason for the increase was a $0.3 million increase in interest expense driven by the borrowings to finance the purchase of Videotel in July 2014. Also contributing to 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 Videotel business. Income Tax (Benefit) Expense Income tax benefit for the three months ended September 30, 2014 was $0.1 million as compared to income tax expense of $0.9 million for the three months ended September 30, 2013. The decrease in income tax expense is primarily due to a $2.3 million decrease in pre-tax income. We expect our effective tax rate for the fourth quarter of 2014 to be approximately 33%, subject to the effect of unforeseen discrete tax events such as changes in forecasted expectations for pre-tax income and stock option exercise activity. Nine Months Ended September 30, 2014 and 2013 Net Sales Product sales for the nine months ended September 30, 2014 decreased $15.6 million, or 22%, to $55.9 million for the nine months ended September 30, 2014 from $71.4 million for the nine months ended September 30, 2013. The decrease was primarily due to a decrease in sales of our guidance and stabilization products of approximately $12.1 million, or 34%. Specifically, sales of our TACNAV defense products decreased $6.1 million, or 40%, primarily as a result of decreased product sales related to the original SANG contract. Product shipments under the SANG contract were completed in the second quarter of 2013. Also contributing to the decrease in sales of our guidance and stabilization products during the nine months ended September 30, 2014 was a decrease in sales of our FOG products of $6.1 million, or 31%, as compared to the nine months ended September 30, 2013, primarily as a result of decreased shipments of FOGs for commercial applications. Also contributing to the decrease in our FOG sales was a $2.7 million decrease in sales under the Crows III program. Mobile communications product sales decreased $3.5 million, or 10%, to $32.2 million for the nine months ended September 30, 2014 from $35.6 million for the nine months ended September 30, 2013. The decrease was primarily due to a decrease in sales of our marine satellite communications products of $3.1 million, or 10%, driven primarily by decreased shipments of our TracPhone mini-VSAT products, and to a lesser extent, marine satellite television sales, Inmarsat and Commbox product sales. Also contributing to the decrease in mobile communications product sales was a decrease in sales of our land mobile products of $0.4 million, or 12%, as compared to the nine months ended September 30, 2013. Mobile communications product sales originating from our European and Asian subsidiaries for the nine months ended September 30, 2014 decreased $2.1 million, or 18%, as compared to the nine months ended September 30, 2013. Mobile 24 -------------------------------------------------------------------------------- communications product sales originating from the Americas for the nine months ended September 30, 2014 decreased $1.4 million, or 6%, as compared to the nine months ended September 30, 2013. Service sales for the nine months ended September 30, 2014 increased $14.4 million, or 28%, to $66.3 million from $51.9 million for the nine months ended September 30, 2013. The primary reason for the increase was a $9.3 million increase in airtime sales for our mini-VSAT Broadband service. Also contributing to the increase in service sales was a $5.8 million increase in new media sales arising from our acquisition of Headland Media Limited in May 2013, and a $5.3 million increase in new service sales arising from our acquisition of Videotel on July 2, 2014. Partially offsetting the increases in service sales was a $4.6 million decrease in contracted engineering services primarily from decreased construction and program management services provided in connection with the SANG contract, a $1.0 million decrease in service repair sales, and a $0.5 million decrease in Inmarsat service sales. Costs of Sales For the nine months ended September 30, 2014, costs of product sales decreased by $5.8 million, or 15%, to $34.2 million from $40.0 million for the nine months ended September 30, 2013. The primary reason for the decrease was the decrease in sales of our TACNAV, FOG and marine products discussed above. Costs of service sales increased by $4.1 million, or 12%, to $37.1 million for the nine months ended September 30, 2014 from $33.0 million for the nine months ended September 30, 2013. The primary reason for the increase was a $5.9 million increase in airtime costs of sales for our mini-VSAT Broadband service. Also contributing to the increase was a $1.8 million increase in costs of service sales from the KVH Media Group and a $1.5 million increase in costs of service sales from our new Videotel business. Partially offsetting these increases was a $4.6 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 $0.3 million decrease in Inmarsat costs of service, and a $0.2 million decrease in service repair costs. Gross margin from product sales for the nine months ended September 30, 2014 decreased to 39% as compared to 44% for the nine months ended September 30, 2013. The decrease in our gross margin from product sales was primarily due to a decrease in gross margin on our TACNAV and FOG product sales. The decrease in TACNAV and FOG product gross margins were driven by the completion of TACNAV product shipments under the original SANG contract in the second quarter of 2013, and under-utilization of our FOG production capacity due to reduced unit sales for the nine months ended September 30, 2014. Gross margin from service sales for the nine months ended September 30, 2014 increased to 44% as compared to 36% for the nine months ended September 30, 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 the nine months ended September 30, 2013 included only a partial quarter of service revenue from Headland Media Limited based on the May 11, 2013 acquisition date. Also contributing to the gross margin increase was the service gross margin from our new Videotel business, and to a lesser extent, an increase in gross margin from contracted engineering services. Partially offsetting the service gross margin increase was a decrease in gross margin from service repair sales. Operating Expenses Research and development expense for the nine months ended September 30, 2014 increased by $1.3 million, or 14%, to $10.8 million from $9.5 million for the nine months ended September 30, 2013. The primary reasons for the increase in expense in the 2014 period were a $0.6 million increase in U.S.-based employee compensation for research and development personnel and a $0.2 million increase in consulting expense, in each case 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 for the nine months ended September 30, 2014 was 9% as compared to 8% for the nine months ended September 30, 2013. Sales, marketing and support expense for the nine months ended September 30, 2014 increased by $2.4 million, or 12%, to $23.3 million from $20.8 million for the nine months ended September 30, 2013. The primary reasons for the increase in the 2014 period were a $1.5 million increase in sales, marketing and support expense related our new Videotel business, a $1.1 million increase from our KVH Media business, a $0.7 million increase in warranty expense mainly in relation to TracPhone V7 and V11 products, a $0.6 million increase in U.S.-based employee compensation, a one-time $0.5 million insurance recovery received in the third quarter of 2013 related to misappropriated funds identified at our Danish subsidiary, and a $0.2 million increase in variable airtime sales expense. Partially offsetting these increases were a $1.4 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 $0.5 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 the nine months ended September 30, 2014 was 19% as compared to 17% for the nine months ended September 30, 2013. General and administrative expense for the nine months ended September 30, 2014 increased by $4.2 million, or 32%, to $17.3 million from $13.1 million for the nine months ended September 30, 2013. The primary reason for the increase in 2014 25 -------------------------------------------------------------------------------- expense was a $2.6 million increase in general and administrative expense relating to the KVH Media Group, a $1.2 million increase in expense from our new Videotel business, a $0.4 million increase in acquisition costs from the purchase of Videotel, and a $0.4 million increase in U.S.-based employee compensation. Partially offsetting this increase were a $0.6 million decrease in accrued performance-based incentive compensation. As a percentage of net sales, general and administrative expense for the nine months ended September 30, 2014 was 14% as compared to 11% for the nine months ended September 30, 2013. Interest Expense and Other (Expense) Income For the nine months ended September 30, 2014, interest expense and other expense increased by $0.8 million to $0.9 million, from $0.1 million for the nine months ended September 30, 2013. The primary reason for the increase was a $0.4 million increase in interest expense driven by the borrowings to finance the purchase of Headland Media in May of 2013 and Videotel in July 2014. Also contributing to 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 Videotel business. Income Tax Expense Income tax expense for the nine months ended September 30, 2014 was $0.1 million as compared to income tax expense of $2.4 million for the nine months ended September 30, 2013. The decrease in income tax expense is primarily due to an $8.2 million decrease in pre-tax income. Backlog Backlog is not a meaningful indicator for predicting revenue in future periods. Commercial resellers for our mobile satellite communications products and FOG products do not carry extensive inventories and rely on us to ship products quickly. Generally due to the rapid delivery of our commercial products, our backlog for those products is not significant. Our backlog for all products and services was approximately $19.7 million and $20.5 million on September 30, 2014 and December 31, 2013, respectively. As of September 30, 2014, all of our backlog was scheduled for fulfillment in 2014, except for $4.3 million scheduled for fulfillment in 2015 and $2.3 million scheduled for fulfillment in 2016. The decrease in backlog of $0.8 million from December 31, 2013 was primarily the result of the fulfillment of the order for TACNAV services received in June 2012 from SANG and the fulfillment of other TACNAV and FOG product orders. Backlog consists of orders evidenced by written agreements and specified delivery dates for customers who are acceptable credit risks. We do not include satellite connectivity service sales in our backlog even though many of our satellite connectivity customers have signed annual or multi-year service contracts providing for a fixed monthly fee. Military orders included in backlog are generally subject to cancellation for the convenience of the customer. When orders are canceled, we generally recover actual costs incurred through the date of cancellation and the costs resulting from termination. As of September 30, 2014, our backlog included approximately $4.9 million in orders that are subject to cancellation for convenience by the customer. Individual orders for guidance and stabilization products are often large and may require procurement of specialized long-lead components and allocation of manufacturing resources. The complexity of planning and executing larger orders generally requires customers to order well in advance of the required delivery date, resulting in backlog. Liquidity and Capital Resources We have generally funded our operations primarily from operating cash flows, bank financings and proceeds received from exercises of stock options. As of September 30, 2014, we had $50.4 million in cash, cash equivalents, and marketable securities, of which $10.3 million in cash equivalents was held in local currencies by our foreign subsidiaries. There were no marketable securities held by our foreign subsidiaries as of September 30, 2014. As of September 30, 2014, we had $65.7 million in working capital. Net cash provided by operations was $10.1 million for the nine months ended September 30, 2014 as compared to net cash provided by operations of $17.0 million for the nine months ended September 30, 2013. The $6.8 million decrease in cash provided by operations was primarily due to a $5.6 million decrease in net income, a $3.1 million decrease in cash inflows related to accounts receivable, a $1.2 million increase in cash outflows related to other long-term liabilities, and a $0.7 million increase in cash outflows related to prepaid expenses and other assets. Partially offsetting the increase in cash outflows were an increase in cash inflows attributable to a $3.0 million decrease in cash outflows related to accounts payable, a $0.9 million decrease in cash outflows relating to other non-current assets and a $0.5 million increase in deferred revenue. Net cash used in investing activities was $26.7 million for the nine months ended September 30, 2014 as compared to net cash used in investing activities of $45.0 million for the nine months ended September 30, 2013. The decrease of $18.3 million is primarily the result of a $24.6 million decrease in our net investment in marketable securities and a $16.4 million increase in maturities and sales of marketable securities. This decrease is partially offset by a $22.1 million increase in net cash paid for acquisitions during the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. We 26 -------------------------------------------------------------------------------- paid net cash of $45.1 million for Videotel in the nine months ended September 30, 2014 and net cash of $22.9 million for Headland Media in the nine months ended September 30, 2013. Net cash provided by financing activities was $32.9 million for the nine months ended September 30, 2014 compared to $28.4 million for the nine months ended September 30, 2013. The $4.5 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 the nine months ended September 30, 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 $1.0 million in repayments of long-term debt. In the nine months ended September 30, 2013, we generated $23.0 million in proceeds from line of credit borrowings, $4.7 million in borrowings under our long-term debt and $2.3 million in proceeds from issuances of shares under our equity compensation plans. Borrowing Arrangements 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. The loan term is 10 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 2.25 percentage points. On June 9, 2011, we entered into an amendment to the mortgage loan, providing for an adjustment of the interest rate from the BBA LIBOR Rate plus 2.25 percentage points to the BBA LIBOR Rate plus 2.00 points. Land, building and improvements with an approximate carrying value of $5.0 million as of September 30, 2014 secure the mortgage loan. The monthly mortgage payment is approximately $11,000 plus interest and increases in increments of approximately $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 the nine months ended September 30, 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 5.91% 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. On July 1, 2014, we entered into (i) 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 (the Revolver) of up to $15.0 million and a term loan (Term Loan) of $65.0 million to be used for general corporate purposes, including both (A) the refinancing of the $30.0 million indebtedness then outstanding under the credit facility described above 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 our grant of a security interest in substantially all of our assets in order to secure our obligations under the Credit Agreement and the Notes, and (v) Pledge Agreements (the Pledge Agreements) required by the lenders 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. The $65.0 million Term Note was executed 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 approximately $30.0 million toward the refinancing of the then-outstanding balance of 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 27 -------------------------------------------------------------------------------- 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. 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 is initially 2.25:1.00 and declines to 1.50:1.00 on December 31, 2014 and 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 September 30, 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 Lender's security interest therein, and any other material adverse change with respect to us. 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 10-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. 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 September 30, 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 the nine months ended September 30, 2014. As of September 30, 2014, we held $50.4 million in cash, cash equivalents and marketable securities. We believe that our cash, cash equivalents and marketable securities, together with our other 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, 28 -------------------------------------------------------------------------------- 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. 29 -------------------------------------------------------------------------------- |