KVH Industries, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; unaudited. KVH designs and sells mobile satellite communications products and services, and navigation, guidance and stabilization systems. Unless otherwise noted, amounts below are in U.S. dollars; financial statement figures are in millions.
Financial performance
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Net sales | $41.3 | $37.0 |
| Product sales | $15.4 | $18.0 |
| Service sales | $25.9 | $19.0 |
| Operating loss | $(1.9) | $(1.7) |
| Net loss | $(1.4) | $(1.1) |
| Diluted loss per share | $(0.09) | $(0.07) |
| Operating cash flow | $3.2 | $(0.6) |
- Revenue increased 12% year over year. Service sales rose 37%, while product sales declined 15%. Services represented 62.8% of revenue, compared with 51.3% a year earlier.
- Product gross margin fell to 32% from 37%, primarily reflecting lower sales of higher-margin guidance and stabilization products. Service gross margin improved to 49% from 42%, supported by Videotel and lower-margin SANG engineering work ending in 2014.
- Operating expenses totaled $43.2 million, exceeding sales. General and administrative expense rose 48% to $7.6 million, mainly due to Videotel-related costs and higher consulting and audit fees. Interest expense increased to $0.4 million, primarily because of acquisition financing.
- Operating cash flow improved to $3.2 million, substantially helped by a $5.4 million increase in deferred revenue. Investing activities used $7.8 million, including $1.3 million of capital expenditures and net purchases of marketable securities. Financing activities used $1.7 million, including debt repayments.
Balance sheet and liquidity
- At March 31, cash and cash equivalents were $18.4 million and marketable securities were $31.0 million, totaling $49.4 million; working capital was $64.5 million. Cash and cash equivalents alone decreased $6.9 million from year-end.
- Total debt was $69.3 million, including $62.6 million under the term loan; $6.2 million was current. No revolving-credit borrowings were outstanding. The company reported compliance with its financial covenants at quarter-end.
- The $65 million term loan, entered into in July 2014 to help finance the Videotel acquisition and refinance prior debt, matures in July 2019. Its maximum leverage covenant tightens to 1.00:1.00 on September 30, 2015. The company said available liquidity and operating cash flows should cover planned needs for at least 12 months.
- Total comprehensive loss was $6.3 million, including a $4.8 million foreign-currency translation loss.
Material changes and management outlook
- Videotel, acquired in July 2014, contributed $5.9 million of Q1 service revenue. Its acquisition materially affects year-over-year comparability; Videotel-related costs also increased operating expenses. The company funded approximately $6.0 million of acquisition escrow and holdback amounts during the quarter.
- Service revenue growth also reflected a $1.5 million increase in mini-VSAT airtime sales; contracted engineering services declined $0.8 million, primarily due to reduced SANG work.
- Management expected mini-VSAT Broadband service revenue to continue growing year over year, with a modest increase in gross margin percentage from 2014. It expected FOG sales to decrease modestly year over year, partly due to reduced U.S. Army CROWS III demand; TACNAV sales were expected to be lower in Q2 year over year, with results described as uneven across periods. R&D expense was expected to be modestly lower, while sales, marketing and support and G&A expenses were expected to rise, principally due to Videotel and new services. No quantified full-year revenue or earnings guidance was provided.
- Backlog was $28.3 million, versus $27.3 million at December 31, 2014; $23.3 million was subject to customer cancellation for convenience. Backlog is not considered a meaningful predictor of future revenue by management.
Risks, contingencies and unusual items
- Disclosure controls and procedures were deemed ineffective at March 31, 2015 because of continuing material weaknesses in controls over bill-and-hold revenue recognition, income-tax provision review, and allocation of revenue in antenna lease and airtime arrangements. Remediation was in progress but had not operated long enough to establish effectiveness.
- Advanced Media Networks sued KVH in March 2015, alleging infringement of two patents and seeking unspecified damages and other relief. The complaint had not been formally served, both patents were under reexamination, and the company said the potential loss could not be estimated; an adverse outcome could materially affect its Mobile Broadband business and results.
- Military orders in backlog may be canceled for customer convenience. The company also identified foreign-exchange exposure associated with international operations, including the expanded exposure following the Videotel acquisition.
- The $19 million TACNAV contract with an international military customer includes hardware, engineering, program-management and support obligations extending into future periods; approximately $0.3 million of revenue was recognized on it in Q1 2015.
Important facts for investors to verify
- Whether service growth and Videotel integration can offset declining product sales and increased operating costs.
- Progress and effectiveness of remediation for the disclosed material weaknesses, particularly revenue recognition controls.
- Debt-covenant headroom ahead of the September 2015 leverage-covenant step-down and the company’s capacity to service debt.
- Potential financial and business impact of the patent litigation, and the conversion and cancellation risk of reported backlog.