KVH Industries, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Unaudited consolidated results. KVH develops mobile satellite communications products and navigation, guidance, and stabilization systems.
Financial performance
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $25.6 | $27.8 | $80.6 | $85.2 |
| Operating income (loss) | $(0.3) | $1.3 | $(1.7) | $5.6 |
| Net income (loss) | $0.6 | $0.6 | $(0.7) | $8.0 |
| Diluted EPS | $0.04 | $0.04 | $(0.05) | $0.54 |
| Operating margin | (1.2)% | 4.6% | (2.2)% | 6.5% |
- Q3 product sales were $18.0 million, down 17%; service sales were $7.6 million, up 24%. Nine-month product sales fell 13% to $61.2 million, while service sales rose 27% to $19.4 million.
- Q3 product gross margin was 46%, unchanged year over year; service gross margin improved to 28% from 26%. For nine months, product gross margin was 45%, unchanged, while service gross margin eased to 21% from 22%.
- Operating cash flow was $(0.7) million for the first nine months, versus $9.5 million in 2010. Investing cash flow was $(5.7) million, including $8.1 million of capital expenditures; financing cash flow was $4.5 million.
- At September 30, cash and cash equivalents were $5.3 million and marketable securities $27.6 million. Management reported $32.9 million in combined cash, equivalents, and marketable securities, and $60.1 million in working capital.
- Debt included $6.5 million drawn on a $15 million revolving facility and approximately $3.7 million of mortgage debt, including its current portion. Total liabilities were $25.2 million.
Material changes and unusual items
- Nine-month guidance and stabilization sales declined 25% to $28.0 million. FOG sales fell 42%, primarily amid a slowdown in U.S. Army CROWS procurement; TACNAV sales increased 118%, including a large international order.
- Mobile communications sales grew in Q3, supported by marine products and mini-VSAT Broadband airtime. Nine-month mobile product sales were slightly lower, partly because LiveTV antenna shipments ceased after termination of the prior agreement.
- The LiveTV agreement was terminated in March 2011. KVH recorded a $2.9 million Q3 expense to write off capitalized antenna development costs, offset by a termination fee; the filing reports a net $0.8 million benefit in other income. A new three-year maintenance and potential-purchase agreement was signed in September.
- Q3 net income included $0.9 million of reported other income, despite the operating loss. The nine-month tax benefit was $0.1 million, compared with $2.3 million in 2010, when a valuation-allowance reversal contributed substantially to the tax benefit.
- Inventory increased to $19.6 million from $14.8 million at year-end, contributing to operating cash use. Backlog fell to $15.3 million from $20.8 million; approximately $11.1 million was cancellable for customer convenience.
Outlook, liquidity, and risks
- Management expected full-year 2011 to produce a modest tax benefit, citing weaker anticipated leisure marine and RV satellite-TV sales and Rhode Island tax credits related to the new facility.
- Management expected FOG sales to decline in 2011 versus 2010 and did not anticipate more than nominal CROWS-related FOG sales in Q4. TACNAV sales were expected to increase year over year in Q4, but management cautioned against treating that as evidence of longer-term growth. No Q4 aviation antenna sales were expected.
- Management expected mini-VSAT service gross margins to improve as the initial global network build-out was complete and service sales grew, but warned that additional capacity or coverage expansion could raise costs. The $12–$14 million new manufacturing facility was under construction; up to $12 million of project financing was anticipated, including the $6.5 million already borrowed.
- Management said available liquidity, working capital, and operating cash flows should fund planned operating and capital needs for at least 12 months. The revolving facility requires at least $20 million of defined unencumbered liquid assets; KVH reported compliance with its covenants at September 30.
- Key risks include uneven military procurement and cancellable orders, weak consumer demand and seasonality, service-network economics and dependence on third-party satellite capacity, competitive pressures, supplier and manufacturing concentration, foreign exchange and regulatory exposure, and execution of planned investment. Management reported no legal proceeding expected to materially harm the company and concluded disclosure controls were effective.
Important facts for investors to verify
- Whether CROWS procurement timing and defense orders support a recovery in FOG sales, and how cancellable backlog converts to revenue.
- Whether mini-VSAT subscriber growth improves service margins enough to cover network costs and any further capacity investment.
- Cash conversion and inventory levels, planned manufacturing-facility spending and financing, and continued availability of the revolving credit facility.
- The components and recurrence of Q3 other income, including the LiveTV write-off and termination-fee accounting, and the assumptions behind the 2011 tax outlook.
- Whether consumer-market weakness, seasonality, supplier constraints, or reliance on third-party satellite providers materially affect sales and operations.