KVH Industries, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparative period is Q1 2016. KVH designs and sells mobile satellite connectivity products and services and inertial navigation products. Financial statements are unaudited; amounts below are in millions unless noted.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Net sales | $40.2 | $40.4 |
| Product sales | $14.9 | $15.4 |
| Service sales | $25.3 | $25.0 |
| Gross profit and margin | $16.4; 40.8% | $16.7; 41.3% |
| Operating loss | $(4.5); 11.1% loss margin | $(3.4); 8.3% loss margin |
| Net loss / diluted loss per share | $(4.9) / $(0.30) | $(2.8) / $(0.18) |
| Operating cash flow | $4.3 | $8.6 |
| Cash, cash equivalents and marketable securities | $46.1 at March 31 | $52.1 at December 31, 2016 |
| Working capital | $62.2 at March 31 | Not stated for the comparable date |
| Total debt | $48.9 at March 31 | $58.1 at December 31, 2016 |
Gross margin is calculated from reported sales and costs of product and service sales. Q1 cash increased $3.0 to $29.4; marketable securities were $16.7. The company had no revolver borrowings and reported $15.0 of available revolver capacity. Long-term debt included a $46.0 term note and a $2.9 mortgage loan.
Changes versus Q1 2016
- Sales were nearly flat, but product sales fell 3%; service sales rose 1%. Service represented 63% of sales versus 62%.
- Mobile connectivity sales declined 3% to $34.3, and segment operating earnings fell 69% to $0.6. Product weakness, especially in European maritime markets, and lower content and training revenue weighed on results.
- Inertial navigation sales grew 16% to $5.9; the segment’s operating loss narrowed to $0.04 from $0.9, helped by higher product sales and lower unfunded engineering costs.
- Operating expenses increased, notably general and administrative expense (up $0.5) and research and development (up $0.2). The operating loss widened by $1.1.
- Income tax expense was $0.2 versus a $0.9 benefit in Q1 2016, contributing to the larger net loss. The company maintained a valuation allowance on U.S. deferred tax assets.
- Operating cash flow decreased $4.3, principally reflecting lower cash collections from receivables and the higher net loss. Investing cash flow was $6.9, largely reflecting marketable-security maturities and sales; financing cash outflow was $8.5, including debt repayments.
Outlook, risks and unusual items
- Management expects moderate year-over-year growth in mini-VSAT airtime service, supported by customer-base expansion and Agile Plans; hardware sales could decline as customers adopt the bundled subscription model. Management expects mobile connectivity operating earnings before corporate allocations to be generally in line with 2016.
- For inertial navigation, management expects TACNAV sales growth and modest FOG and engineering-services growth, but forecasts uneven quarterly sales and lower segment operating earnings in 2017 due to reduced contracted engineering revenue.
- Management expects R&D, sales and marketing, and G&A expenses to increase year over year. It expects service costs to grow with sales and anticipates a slight reduction in mobile connectivity service costs as a percentage of sales from cost-saving efforts.
- The March 2017 credit amendment included a $6.0 term-loan prepayment, lower quarterly amortization of $0.575 beginning April 1, revised pricing and covenant terms, and an increase in the maximum leverage covenant to 1.50:1.00. KVH reported covenant compliance and expected to remain compliant. The term note matures July 1, 2019; the mortgage has a $2.6 balloon payment due April 1, 2019.
- Management stated available liquidity and operating cash flows should cover planned needs for at least 12 months, while noting additional financing might be sought and may not be available on acceptable terms. Other risks include foreign-currency exposure (including sterling-denominated media and training sales), single-source suppliers, seasonal marine demand, customer-cancellable military backlog, variable interest rates, and potential future goodwill impairment if operating results or forecasts deteriorate.
- Backlog was $10.4 at March 31, up from $8.9 at year-end; $5.2 was subject to customer cancellation for convenience. Backlog excludes satellite connectivity service contracts and is not considered a meaningful predictor of future revenue.
- KVH adopted new stock-compensation and inventory accounting standards and early adopted the simplified goodwill impairment standard; management reported no material impact from these adoptions. The company had no material legal proceeding identified and no goodwill or other non-financial asset impairment in the quarter.
Most important facts for investors to verify
- Whether the mobile connectivity business stabilizes and service growth offsets product and content-revenue pressure.
- Progress on segment profitability, corporate overhead, and management’s 2017 outlook, particularly uneven inertial-navigation orders and engineering-services revenue.
- Debt covenant headroom and repayment capacity, including the July 2019 term-note maturity and April 2019 mortgage balloon payment.
- Cash generation and liquidity trends, including how much of reported cash is held by foreign subsidiaries and how receivables and marketable securities evolve.
- Potential effects of the Agile Plans subscription model, foreign-exchange movements, supplier interruptions, and customer cancellation of backlog.
- Final impact of adopting Topic 606, which the company planned to adopt January 1, 2018 using the modified retrospective method; assessment was still underway.