KVH Industries, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Financial statements are unaudited. Unless noted, amounts are in millions of dollars.
Business context
KVH designs and sells mobile satellite communications equipment and services, plus navigation, guidance and stabilization products, including defense-related TACNAV and fiber-optic gyroscope products. The business serves marine, land-mobile, aeronautical, defense and commercial markets.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $38.8 | $25.6 | $97.6 | $80.6 |
| Operating income (loss) | $3.1 | ($0.3) | $2.6 | ($1.7) |
| Net income (loss) | $1.7 | $0.6 | $0.8 | ($0.7) |
| Diluted earnings (loss) per share | $0.12 | $0.04 | $0.05 | ($0.05) |
- Q3 sales rose 52% year over year; nine-month sales increased 21%. Q3 product sales were $24.5 million and service sales $14.3 million; nine-month totals were $62.7 million and $34.9 million, respectively.
- Q3 operating margin was 8.1%, versus a 1.2% operating loss margin a year earlier. Nine-month operating margin was 2.7%, versus a 2.2% loss margin.
- Product gross margin was 46% in Q3 and 41% year to date; service gross margin was 30% and 35%, respectively. Year-to-date product margin declined from 45% as FOG sales fell; service margin improved from 21%, principally on mini-VSAT Broadband growth.
- Q3 customer concentration was notable: one customer represented 18.9% of sales. Sales to foreign customers outside the U.S. and Canada were 45.3% of Q3 sales and 37.9% year to date.
Cash, debt and liquidity
- At September 30, cash and cash equivalents were $8.6 million and marketable securities were $24.3 million, totaling $32.9 million. Working capital was approximately $60.0 million.
- Nine-month operating cash flow was $9.4 million, compared with cash used of $0.7 million in 2011. Investing activities used $6.0 million, including $5.2 million of capital expenditures; financing activities used $1.6 million.
- Debt included $7.0 million outstanding on a $15.0 million revolving credit facility and approximately $3.6 million of mortgage debt. The revolving facility matures December 31, 2014; the mortgage has a $2.6 million balloon payment due in 2019. KVH reported compliance with the credit facility covenants.
- Management believed available cash, securities, working capital and operating cash flows would meet planned operating and capital needs for at least the next 12 months.
Changes, outlook and material items
- Q3 sales growth reflected higher guidance and stabilization sales, including TACNAV shipments, and higher mini-VSAT Broadband airtime revenue. Q3 service sales also included $2.7 million of engineering services related to the Saudi Arabian National Guard contract.
- The $35.6 million Saudi Arabian National Guard contract comprises $21.2 million of TACNAV products and $14.4 million of services. KVH recognized approximately $7.3 million of revenue through September 30, all in Q3. Product shipments were expected through Q4 2012 and the first half of 2013; services were expected to continue into 2014.
- Backlog was $48.3 million at September 30, up from $22.1 million at year-end, largely due to the Saudi contract. Approximately $12.7 million of backlog was subject to customer cancellation for convenience; military orders are generally cancellable.
- Management expected TACNAV sales to increase significantly year over year in Q4 2012, while noting that orders and sales can be uneven; FOG sales were expected to be relatively flat sequentially. Management anticipated operating expenses would rise year over year in absolute terms for the remainder of 2012, largely due to the Saudi contract, but decline as a percentage of sales.
- Management estimated the 2012 effective tax rate at 50% or higher because of discrete tax effects, including stock-option exercises and restricted-stock vesting. Q3 tax expense was $1.5 million.
- Q3 2011 other income included an $0.8 million net benefit related to termination of an antenna agreement with LiveTV; this made the year-over-year comparison less favorable.
- The CFO retired effective October 1, 2012 and was to remain part-time during a transition expected to end around March 31, 2013. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Risks and contingencies
- Management cited uncertain global economic conditions, discretionary and seasonal marine demand, and unpredictable government procurement, funding, acceptance and export-license timing. FOG sales declined 10% year over year for the first nine months; management noted no comparable TACNAV order in backlog for 2013 or later.
- KVH depends on third-party satellite capacity and technology, and its broadband network carries fixed costs that require subscriber growth to support margins. Competition, supplier concentration, manufacturing interruptions and inventory obsolescence are additional risks.
- Service engineering work on the Saudi contract carries relatively low margins: facility construction and program-management services were approximately 10% gross margin. Management expected engineering-services margin to continue declining over the next several quarters.
- KVH reported no litigation believed likely to materially harm the business. The filing describes ordinary-course claims and disputes but provides no material quantified contingency.
Important facts for investors to verify
- Whether Saudi contract shipments and services progress on schedule, and how much of backlog converts to revenue; separately assess the $12.7 million cancellation-exposed portion.
- Whether mini-VSAT subscriber growth and TracPhone V11 activations improve service margins enough to absorb network capacity and infrastructure costs.
- Whether FOG and other defense sales recover, given lumpy procurement, customer concentration and the absence of a comparable TACNAV order in disclosed 2013-and-later backlog.
- Actual tax rate versus management’s estimate of 50% or higher, and the effect on earnings and cash flow.
- Liquidity and borrowing exposure, including the $7.0 million variable-rate revolver, covenant thresholds and the mortgage balloon payment due in 2019.