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KVH Industries, Inc. (NASDAQ:KVHI)

Acquisition of Headland Media Call

May 13, 2013 10:30 AM ET

Executives

Peter Rendall – CFO

Martin Kits Van Heyningen – President, CEO and Chairman

Analysts

Rich Valera – Needham & Company

Jim Mcllree – Dominick & Dominick

Chris Quilty – Raymond James

Greg Weaver – Invicta

Operator

Good day everyone, and welcome to the KVH Industries Message to Investors’ Conference Call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Peter Rendall. Please go ahead, sir.

Peter Rendall

Thank you. Good morning, everyone. I am Peter Rendall. I’m the Chief Financial Officer of KVH Industries, and with me on the phone today is Martin Kits Van Heyningen, Chief Executive Officer of KVH Industries. This call will address the announcement made this morning of KVH Industries acquisition Headland Media Limited. Copies of the press release are available on our website and also from our Investor Relations department.

This call is being simulcast on the internet, and will be archived on our website for future reference. If you are listening via the web, feel free to submit questions to ir@kvh.com and we will answer them following this call.

Certain matters discussed on this call may include forward-looking statements regarding among other things, future operating results, performance or achievements. Such statements are subject to a number of risks and uncertainties. Actual results in the future could differ from those described in the forward-looking statements as a result of various important factors.

Such factors have been set forth in the press release issued this morning, as well as the company’s most recent reports on forms 10-Q and 10-K as filed the SEC. Included on the call will be a discussion of non-GAAP financial measures, specifically EBITDA. These metrics are not meant to replace GAAP measurements, but are provided as supplemental detail to assist the public in their analysis.

Now, at this point I’d like to turn the call over to, Martin, to discussion the acquisition. Martin?

Martin Kits Van Heyningen

Great, thank you all for joining us today. This morning KVH announced another significant milestone in our efforts to bring innovative new services to the maritime market. We acquired Headland Media, the maritime industries leading supplier or licensed news, sports, music and entertainment content.

For those of you who may not be familiar with Headland Media, they are a UK-based company with a 115 employees, in offices in Europe, India, the Philippines and the United States. It’s a licenses and premium content products which include digital newspapers, news, and sports clips, movies from all the major studios, music and safety training films to customers in the maritime industry primarily, and to a lesser extent, in the lodging and retail markets. Their 2012 sales were about US$12.2 million, and 85% of that is recurring revenue that came from customers with subscriptions to their various services.

Headland Media owns many well-known brands in the maritime markets, including news link, digital newspapers, Walport entertainment and training videos, and Headland Media’s own SatNews and Crew Media Player and a Crewtoo, social media website. The licensed commercial music brands include Mezzo [ph] for the retail industry and HipHotels music for the lodging industry. They also market digital newspapers Good Morning News and SatNews for hotels as well.

Headland Media distributes content under limited commercial used licenses. The licenses required by international copyright law for exhibition of content and commercial settings including on-board ship.

Their products are tailored to the unique requirements for their customers, to present all their digital newspaper services are used to create 70 different daily newspapers in 17 different languages. Each variant of the newspaper carries articles of interest to the home countries with their unique group of readers. Headland Media’s customer base currently includes more than 9,600 vessels, 1,700 hotels and about 1,700 retail establishments around the world.

New regulations in maritime labor convention require shipping companies to improve living conditions on-board ships, and access to news and entertainment is one of this suggested improvements. The alternative of crew members bringing their personal DVDs on-board for entertainment violates international copyright law, so it can’t be allowed by reputable shipping companies.

Headland Media offers legally licensed content delivered on a regular basis to ships around the world. The movie content that Headland Media provides typically involves sending very large files that has been far too expensive to transmit using maritime satellite services. As a result, they’ve had to physically ship DVDs to ports around the world coordinating their arrival with vessel schedules which can be difficult, labor intensive exercise for both Headland and their customers.

Using KVH’s planned new multicasting service, on our mini-VSAT Broadband network we’ll be send these large files to any numbers of ships with a single transmission, rather than sending a file individually to each vessel. So the combined KVH-Headland Media service offers shipping companies an easy cost-effective way to deliver legal news, sports and music and movie content to the vessels.

Outside of the marine market, Headland Media also distributes rights approved music for retailers, restaurants, and hotels, and event makings to a radio shows for large retail store chains, one of their big customers in the UK is the in-store radio service, ASDA, which is part of Wal-Mart.

They also use their newspaper creating capabilities to create digital delivered newspapers for hotels with international guest. The hotel and retail businesses demonstrate the breadth of the appeal of their license content, as well as have their ability to format content for particular customer groups, create significant revenue opportunities with relatively modest additional costs.

We believe KBH is going to offer Headland Media support for stronger marketing and sales efforts that will help them grow in these markets. Their ability to format content targeting individual segments of customers will create interesting future opportunities for KBH’s next-generation value-added services for the maritime market.

From a revenue point of view, we believe the acquisition has a lot of synergies. Headland Media provides a very desirable collection of news, sports and entertainment content that is popular amongst seafarers. Shipping companies need to offer this type of amenity to their crews due to new labor laws. Bandwidth restrictions prevent this from occurring today.

We intend to create a new satellite delivery service that will make it easy and affordable to the shipping companies to provide these services on-board their vessels. KBH can work to convert some of the 9,600 vessels receiving one or more of Headland Media’s news, entertainment or training products to the mini-VSAT Broadband service, and offer their content to all the vessels already using our mini-VSAT Broadband service. This will help to increase our ARPUs through value-added service sales and also include Headland Media’s revenues through organic sales growth.

We believe the KBH offering Headland Media’s unique content is part of our broadband offering, will help differentiate our service, providing an advantage in winning new customers, creating a good reason for existing customers not to leave us when their contracts expire, and also helping us avoid possible margin eroding commoditization of the maritime broadband market if new services come online.

Several of Headland Media’s businesses appear to be highly scalable. For example, their newspaper business can double and triple in size with no increase in costs beyond digital distributing the files. For their music business, they have an e-commerce website that allow customers in the hotel and retail industries to schedule their own music programming and play lists and pay their bills online.

Their marketing strategy is to offer free trails for their service which they have a fairly high conversion rate on, so we think we can help them grow the sales with more aggressive marketing efforts. For synergies from a cost point of view, we believe Headland Media runs a fairly lean organization. The cost savings are going to result from offering the benefits with more efficient distribution of their digital products over our mini-VSAT Broadband network.

Also by providing marketing support, they had helped Headland Media grow their sales with enable them to spread their fixed overhead associated with many of their new services across and even larger base of customers. Another point of area of cost is as is it relates to the mini-VSAT Broadband service. Specifically, we don’t believe that there is any significant cost increases will be required to deliver value-added services.

Many of our recent network enhancements have been implemented at forward-link capacity to the network, meaning from shore-to-ship. After our latest upgrade to variable coding, spreading, and modulation technology, which more than doubled the forward-link capacity of our network, we currently have both unused capacity and the ability to schedule our multicasting in other content deliveries to be sent when idle time is available on the network.

So delivering these new services will neither interfere with the quality of our customers’ transmissions, nor immediately require us to add additional capacity to our network. Looking ahead, the future combinations of Headland Media content and KVH Technologies, we’re working to break seafarers to safe side those modern internet content and connectivity that they enjoy at home.

Crew members will be able to enjoy digital newspapers, movies, news clips, or updates on their favorite sporting events, accessed by modern devices including not only computers but also tablets, smartphones, and smart TVs. We plan to multicast premium services to our on-board content platform which will be distributed throughout the ship.

We have several announcements of enhancements for our TracPhone product line and about our future multicasting plans for mini-VSAT Broadband network at the upcoming Nor-Shipping Show which will be held in Oslo at the beginning of June.

So in conclusion, we’re very excited about the new chapter in the mini-VSAT Broadband service. We expand our market leading connectivity platform to also become the most efficient way to move large amounts of digital contents from shore-to-ship. Headland Media provides us a great head start in this effort and will help KVH capture an early mover leadership position in the market.

We also foresee using our multicasting capabilities removing other large files by electronic [ph] chart databases, high resolution weather forecast, and e-learning courses to ships, there is the exciting growth opportunity. Due to the asymmetrical nature of our network, we can deliver these files using unused satellite capacity during the background transmissions in multicasting, which should make value-added services a profitable addition to our mini-VSAT Broadband services.

And at this point, I’d like to turn the call back over to, Peter, to talk about some of the deal highlights. Peter?

Peter Rendall

Thank you, Martin. Now I’d like to provide some of the financial highlights of this acquisition that we announced this morning. We acquired Headland Media for $24 million in cash. That’s $24 million. The majority of this transaction was financed through our existing credit facility, which we increased from $15 million to $30 million, immediately prior to the acquisition.

As a result of the transaction, we maximized our borrowings under this line by drawing down $23 million. Interest payable under this credit facility equals the BBA LIBOR Daily Floating Rate plus 1.25% which today is approximately 1.5%.

As Martin described earlier, Headland Media’s revenues in 2012 were a little over $12 million. Approximately 85% of these revenues were subscription based typically billed in advanced and recognized over the life of the subscription period. The gross profit margin for 2012 was almost 78% and the EBITDA margin for the year was 27%.

Cash generated from operating activities in 2012 amounted to $2.8 million. Other than debt used to finance this transaction, no bank or structured third-party debt was assumed in conjunction with this acquisition. The balance sheet that we acquired remains subject to conventional purchase accounting adjustments whereby assets and liabilities acquired will be recorded at their fair value as of the date of acquisition.

Headland Media’s financial statements have historically been recorded under UK GAAP. Going forward of course they would be included in our consolidated financial statements under US GAAP. It is also anticipated that our operating expenses will increase modestly as we integrate the Headland Media business into the KVH business as a whole.

Although, we expect the Headland Media acquisition to be accretive for the remainder of 2013 for all of the reasons I’ve just outlined, we are not yet prepared to amend our previous revenue and EPS guidance for 2013. We will update our full-year guidance upon the release of our second quarter earnings, which will be scheduled towards the end of July.

At this point, we’re prepared to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll take our first question from Rich Valera with Needham & Company.

Rich Valera – Needham & Company

Thank you. Good morning, gentlemen.

Martin Kits Van Heyningen

Good morning.

Rich Valera – Needham & Company

First, Peter, can you just say if the accretion excludes any kind of one-time integration charges or amortization of acquisition based intangibles?

Peter Rendall

So the accretion will exclude those.

Rich Valera – Needham & Company

Okay, so will you report sort of a non-GAAP number going forward that excludes, for instance, the amortization of the acquisition based intangibles?

Peter Rendall

We actually haven’t made a decision on that. What we would do is present what makes sense to that business once we have those numbers to hand for the next quarter.

Rich Valera – Needham & Company

Okay. And do you have any sense of what kind of one-time integration charges there might be?

Martin Kits Van Heyningen

I think – just let me jump in here, so for the full-year we expect it to be accretive even with the integration charges.

Rich Valera – Needham & Company

Got you.

Martin Kits Van Heyningen

So in the second quarter, there may be an integration charge specific to the actual deal cost, but even including that for the full-year it will be accretive.

Rich Valera – Needham & Company

Okay, thank you. So with respect to the rollout of the combined service, it certainly sounds like a very good pairing of your network and their content. But can you give us some sense of the timeline, first, of the rollout of the your multicast service, and then what needs to be done to integrate the distribution of their content into your multicast service, and when we can start looking to see that sort of in the market?

Martin Kits Van Heyningen

So the general timeline is that we’ve done some pilot testing on the multicast already. There will be a new release of software coming out in the July, August, timeframe, and we’ll be rolling out fly-tested for a month or two and then deploy it across the entire network. So I’d say by Q4 we should start multicasting content on a global scale. And the revenue from that is not yet included in – when we say it will be accretive, we’re just talking about their current stand-alone business as it exists today.

Rich Valera – Needham & Company

Got it. And then with the lodging and retail portions of the business, is there anything you plan to do differently with those business or just kind of run them as they have been?

Martin Kits Van Heyningen

Yes, 72% of Headland’s business is maritime, and so there is this hotel component which obviously isn’t market that we’re in today. But some of the content is identical, so it means it’s literally the same newspapers that are also distributed via email to these hotels. So it’s a nice extremely positive, the margins on that are in the 90s, it’s a profitable business, so I think we certainly intend to continue it. They have some room for growth, they don’t have anything in Asia for example, they’re basically confine to Europe in terms of geography, so if we wanted to grow that business I think we can think of some interesting ways to do that.

Rich Valera – Needham & Company

Great, sounds good. Good luck with the transaction, gentlemen.

Martin Kits Van Heyningen

All right, thanks Rich.

Operator

And we’ll take our next question from Jim Mcllree with Dominick & Dominick.

Jim Mcllree – Dominick & Dominick

Yes, thanks. Good morning. So are you going to deliver this content to maritime subscribers, who aren’t KVH mini-VSAT users?

Martin Kits Van Heyningen

Well the answer is yes. There are current customers today receive their content electronically, so for example the newspapers are delivered electronically to almost 10,000 ships and they are either printed locally or they are viewed on laptops or iPad. So we absolutely are going to continue to deliver that content to people who aren’t customers, but at the same time we’re going to encourage those customers to switch to our service or even if they aren’t interested in our service for broadband, we envision having like a Movie Catcher which is just maybe V3 [ph] that is just used for receiving content, so you can imagine there would be a low cost packages where you just use this to get your media content. And then once it’s onboard our product has WiFi out of the box, it has cool internet café right out of the box, so it might be sort of a approaching [ph] to get on-board of these vessels and to get people to try our service and find out how good it is.

Jim Mcllree – Dominick & Dominick

And then overtime, is the idea that the current delivery method would either just kind of stay where it is or atrophy and then most of the content would be delivered over the satellite?

Martin Kits Van Heyningen

Yes, I think as we move forward in time, the days of mailing DVDs around or numbered, so just like they are on land. It’s logistically very difficult if you are a vessel owner and you’ve got a 100 ships, you’ve got to get the DVDs in and then figure out where all the stuffs are going to be and what they deliver them. And if they don’t get there for whatever reason then the crew is unhappy because they spend another month at sea with the same 10 movies they got last month. So it really is the way of the future.

Jim Mcllree – Dominick & Dominick

Right, okay. And does this portent possibly a new KVH division, KVH content and this would be the beginning of that, use this as a base to acquire more content companies?

Martin Kits Van Heyningen

Yes. I’m not sure we have to acquire more companies, but what we’ve acquired is a company that knows how to acquire content. So the thing that we really liked about Headland is that they know how to negotiate digital rights from movie studios, they actually have digital master files stored on premise which are secured and audited by the Hollywood studios and they actually try to hack in to make sure that it’s a secured facility. And they have these long standing relationships with the studios which enable them to do these things.

So we really see them as our leverage to go out and get more content because we have a lot of ideas for the type of content that our customers want, not all of which Headland has yet, but they know how to go out and get content.

Jim Mcllree – Dominick & Dominick

All right, okay. And I just want to make sure I understand the timing. This has been completed, this transaction is done?

Martin Kits Van Heyningen

Done.

Jim Mcllree – Dominick & Dominick

Okay.

Martin Kits Van Heyningen

Yes.

Jim Mcllree – Dominick & Dominick

Great. Well, sounds very exciting. Congratulations and good luck.

Martin Kits Van Heyningen

All right. Thanks, Jim.

Operator

And we’ll take our next question from Chris Quilty with Raymond James.

Chris Quilty – Raymond James

Thanks, Mark.

Martin Kits Van Heyningen

Hi Chris.

Chris Quilty – Raymond James

Just want to follow on the last question. I know Headland has talked about or they say that they can deliver content electronically, presumably over the networks that exist today, they are not delivering movies. Is that a fair assumption?

Martin Kits Van Heyningen

Yes. In fact, yes. So they are shorter clips and mostly newspapers.

Chris Quilty – Raymond James

Got you.

Martin Kits Van Heyningen

Video clips.

Chris Quilty – Raymond James

So the question is do they have content rights to distribute movies electronically or is that something you’re going to have to go out and get permissions for?

Martin Kits Van Heyningen

They have the rights to deliver content electronically from the movie studios, and they receive the files in digital format. Some of their customers are already taking digital content delivered on hard drives. So the media is not the problem, but delivering mechanism is the problem.

Chris Quilty – Raymond James

Got you.

Martin Kits Van Heyningen

But certainly think that – we also have some ideas for some news things that we’d like to do that would require additional rights or different rights.

So for example, if we want to do an Impulse Pay-Per-View where we charge people that would require some additional license deals and would fall out of the current license. So right now the way it works is if they have the rights to deliver the movies, and the right to sell the movies and they clearly can watch them unlimited number of times, so even the digital versions. So if it’s not a pay-per-view where the crew is paying for a review and that’s a different type of license.

Chris Quilty – Raymond James

Okay. And presumably as this becomes available electronically, the amount of usage by the crew would go up significantly because they could get content more easily? Is that part of the idea?

Martin Kits Van Heyningen

You’re saying the crew usage of the media would go up?

Chris Quilty – Raymond James

Correct.

Martin Kits Van Heyningen

Yes, right. So they can watch as much as they want. There will be a lot of content available, so we’re talking about hundreds of gigabytes of content per month or terabytes per year, so it’s a tremendous amount of content. And the crew can watch it on their iPad or on their laptop or on a set-top box. So that’s going to be a real game changer for how it’s done now which is watching a DVD in the cafeteria on the TV screen.

Chris Quilty – Raymond James

And what would be the forward-link data rate for the multicasting service?

Martin Kits Van Heyningen

It’s going to be variable. So it will be as a background task – and we really don’t get too much into the technology because there is really something interesting things that we’ve developed here that are going to be proprietary. So but the key point is that it’s going to be a lot of capacity and it will have zero impact on the internet data rates, I mean literally zero.

Chris Quilty – Raymond James

Okay. And I guess for, Peter, how should we think about modeling headwind I mean in fact will just show up as a higher ARPU in the mini – in the TracPhone services, or it is going to be called out as a discrete line item?

Peter Rendall

So going forward, clearly it is designed to increase our ARPUs. And as – actually it’s a slightly different business model, you should see that appearing separately in our financials.

Chris Quilty – Raymond James

Okay, good. Foreign exchange issues?

Peter Rendall

So today their financials are measured under UK GAAP and will be converted to US GAAP.

Chris Quilty – Raymond James

But are there major – do they bill mostly in pound sterling or US dollar or…

Peter Rendall

It’s a combination of pounds sterling, US dollars, and euros, about 40% US dollars today.

Chris Quilty – Raymond James

Got you. And what would be rationale – I mean good interest rate, but what was the rationale for using the facility rather than cash on hand?

Peter Rendall

As you said, it was very low interest rate to use to structure this deal.

Chris Quilty – Raymond James

Okay. And just there is a lot of – from my point of view, a lot of excess cash available already, at this point it seems that would be a better use of cash to put it to work on the acquisition?

Peter Rendall

Fair analysis [ph] to be flexible in the future.

Chris Quilty – Raymond James

Fair enough. All right, looks good guys. Congratulations.

Peter Rendall

Thank you.

Martin Kits Van Heyningen

Thanks, Chris.

Operator

(Operator Instructions) And we’ll take our next question from Greg Weaver with Invicta.

Greg Weaver – Invicta

Good morning, gentlemen. Interesting working deal here. Just a couple of questions here. Can you give us a little color in terms of the transaction background? Are there bankers involved here, company shop and any kind of retention for Mark Woodhead and his other team members?

Martin Kits Van Heyningen

Yes. We’ve got long-term agreements with the key people here including, Mark. We did work with a banker and now the deal wasn’t being shop.

Greg Weaver – Invicta

Okay. How about in terms of the current connectivity for the 9,600 vessels that are out there today, any sense of how many of them have broadband capability of some sorts?

Martin Kits Van Heyningen

I don’t know the answer to that, but it’s such a large number that I would assume we would be – it would be statistically significant enough that it would mirror the population of vessels meaning that, we would have the full gamut of connectivity options and everything from old F77 and fleet broadband to VSATs, and there is of course some overlap with our customers as well.

Greg Weaver – Invicta

Is there any particular type within those 9,600 that tended to favor the service or is it pretty much again a pretty representative swap of commercial and maritime?

Martin Kits Van Heyningen

I think it’s pretty representative.

Greg Weaver – Invicta

Okay. Any sense of the 9,600, how many of them have signed up for the Crew Media Player service that Headland is currently offering?

Martin Kits Van Heyningen

The Crew Media Player is pretty new. One of the first people who signed up for it was Maersk Tankers. So they are deploying that now and they also bought the Entertainment On-Board packages which is the DVD. So there are currently no customers who are receiving movies via satellite.

Greg Weaver – Invicta

Got you. Okay. Thanks. Appreciate it.

Martin Kits Van Heyningen

Yes.

Operator

It appears there are no further questions at this time.

Martin Kits Van Heyningen

Great. Well, thanks everyone for dialing in. And if you think of any follow-up questions, as always please feel free to call me or Peter. Thank you.

Operator

This does conclude today’s conference. Thank you for your participation.

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