KVH Industries, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited consolidated results; comparisons are with the corresponding 2017 periods. KVH provides mobile satellite connectivity, media and training services, and inertial navigation products through its mobile connectivity and inertial navigation segments. Unless noted otherwise, dollar amounts below are in millions.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $43.5 | $40.5 | $127.0 | $121.1 |
| Product sales | $16.4 | $14.2 | $46.5 | $43.4 |
| Service sales | $27.2 | $26.3 | $80.5 | $77.8 |
| Gross profit / margin | $18.4 / 42.2% | $17.5 / 43.3% | $53.5 / 42.2% | $52.0 / 42.9% |
| Operating loss / margin | $(0.9) / (2.1)% | $(1.8) / (4.5)% | $(5.3) / (4.3)% | $(7.6) / (6.3)% |
| Net loss | $(1.2) | $(2.4) | $(6.4) | $(9.3) |
| Diluted loss per share | $(0.07) | $(0.15) | $(0.38) | $(0.57) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $1.8 | $9.4 |
Q3 revenue rose 7.6%; nine-month revenue increased 4.9%. Product gross margin improved, while service costs rose faster than service revenue and weighed on overall gross margin. Nine-month capital expenditures were $11.5 million, compared with $10.2 million a year earlier.
Segments and changes versus prior periods
- Mobile connectivity: Q3 sales increased 2% to $33.4 million, but segment operating income fell 30% to $1.4 million. For the nine months, sales declined 1% to $99.9 million and operating income fell 31% to $3.7 million. Mini-VSAT service growth was partly offset by lower product sales and content/training sales. Higher airtime costs, including operating the new HTS network alongside the legacy network, contributed to lower segment earnings.
- Inertial navigation: Q3 sales increased 31% to $10.1 million and operating income rose to $1.9 million from $0.3 million. Nine-month sales increased 35% to $27.1 million and operating income rose to $3.8 million from $0.7 million. Growth was led by FOG products and contracted engineering services.
- Consolidated operating losses narrowed in both periods, principally reflecting improved inertial navigation results and lower unallocated costs year to date. However, the mobile connectivity segment’s operating earnings declined.
Cash, debt and liquidity
- At September 30, cash, cash equivalents and marketable securities totaled $33.2 million; working capital was $25.0 million. Cash and cash equivalents alone were $32.9 million.
- Total debt was $42.9 million at September 30, including $40.3 million under the 2014 term note and a $2.6 million mortgage loan. The company reported no borrowings on the old $15 million revolver at quarter end. Debt classification reflects the company’s stated ability to refinance $20.3 million of the term loan on a long-term basis.
- Nine-month operating cash flow declined to $1.8 million from $9.4 million. Cash and cash equivalents decreased $1.7 million during the period. The company attributed weaker operating cash flow mainly to working-capital movements, including accounts payable/accruals, receivables, contract liabilities and inventory.
- Subsequent event: On October 30, 2018, KVH replaced the 2014 facility with a three-year facility of up to $42.5 million: a $22.5 million term loan and a revolving facility initially up to $20 million, stepping down to $15 million at the end of 2019. KVH repaid $17.2 million of the old term loan, refinanced the remaining balance and drew $5 million on the new revolver. The facility is secured by substantially all company assets and specified foreign-subsidiary equity, and includes leverage and fixed-charge coverage covenants. The mortgage loan has a $2.6 million balloon payment due in April 2019; its covenant applies if cash and equivalents plus marketable securities fall below $25 million.
Outlook, risks and unusual items
- Management expected mini-VSAT service sales to continue growing with subscriber expansion and AgilePlans, while mobile connectivity product sales could decline as customers choose subscriptions. Management expected mobile connectivity operating earnings to decline slightly in 2018 and inertial navigation operating earnings to increase modestly.
- Management said cash, working capital and operating cash flows should be adequate for planned needs for at least the next 12 months, while noting that additional financing might be sought and could not be assured on acceptable terms.
- AgilePlans shifts hardware ownership to KVH and can reduce upfront product revenue while increasing capital needs and depreciation. HTS integration adds costs in the near term; management expects mobile connectivity service costs as a share of sales to rise as the network is integrated.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method. It deferred revenue and related costs for certain bundled mini-VSAT contracts, creating contract assets and liabilities and increasing the opening accumulated deficit by $2.7 million. For the first nine months, the new standard reduced revenue by about $1.0 million and increased net loss by $0.1 million versus prior guidance; operating cash flow was unchanged.
- Backlog was $10.2 million at September 30, down from $16.3 million at December 31, 2017; $3.5 million was subject to customer cancellation for convenience. Management cautioned that backlog is not a meaningful predictor of future revenue.
- Principal risks include HTS transition and network costs, adoption and economics of AgilePlans, variable timing and cancellation risk of defense orders, competition and pricing pressure, foreign exchange exposure, reliance on satellite and single-source suppliers, seasonality, and debt covenants. The company reported no litigation it believed likely to materially harm its business, financial condition, results or cash flows. Disclosure controls were judged effective as of September 30, 2018.
Important facts for investors to verify
- Review the October 2018 refinancing, actual borrowing levels, covenant headroom and the April 2019 mortgage balloon repayment plan.
- Track HTS network operating costs, service gross margins and whether subscriber growth offsets transition expenses.
- Assess AgilePlans adoption, capital requirements, equipment recovery/credit exposure and ASC 606’s continuing effect on revenue and reported balances.
- Monitor operating cash generation against capital expenditures and debt service, given the decline in nine-month operating cash flow.
- Evaluate the quality and timing of backlog, especially cancelable defense orders and reliance on large, unpredictable customer awards.