KVH Industries, Inc. — Q3 2019 Form 10-Q
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2019. KVH sells mobile satellite connectivity products and services and inertial navigation products and services. Videotel, its maritime training business, was sold in May 2019 and is reported as discontinued operations.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $39.3m | $39.3m | $115.4m | $113.3m |
| Operating loss, continuing operations | $4.9m | $1.9m | $17.8m | $8.3m |
| Net loss from continuing operations | $3.3m | $1.9m | $13.1m | $8.8m |
| Net income (loss), including discontinued operations | $(4.3)m | $(1.2)m | $36.7m | $(6.4)m |
| Basic and diluted EPS, total | $(0.25) | $(0.07) | $2.11 | $(0.38) |
Amounts are rounded; financial statements are in thousands. Q3 gross margin was approximately 34%, versus 39% a year earlier; nine-month gross margin was approximately 33%, versus 39%. These figures are calculated as net sales less product and service costs of sales.
- Q3 product sales declined 10% to $14.8m; service sales increased 7% to $24.5m. Nine-month product sales fell 7% to $43.2m, while service sales rose 8% to $72.2m.
- Mobile connectivity revenue increased 8% in Q3 and 7% for the nine-month period. Inertial navigation revenue declined 24% and 14%, respectively.
- Cash and cash equivalents were $9.2m and marketable securities $46.3m at September 30, totaling $55.6m. Working capital was $73.7m.
- Operating cash flow was negative $11.5m for the nine months; capital expenditures were $9.3m. Cash from the sale of Videotel supported investing cash flow, while debt repayments drove financing outflows.
- No debt was outstanding at quarter-end; $20.0m was available under the revolver. KVH repaid its term loan and mortgage and used sale proceeds to reduce revolver borrowings.
Material changes versus prior comparable periods
- Despite nearly flat Q3 sales, operating losses widened, reflecting increased costs of sales and operating expenses. For nine months, operating loss more than doubled.
- Mobile connectivity service growth, including mini-VSAT airtime, was offset by weaker inertial navigation product sales and higher network, depreciation, and other costs. Management cited 15% subscriber growth for mini-VSAT services.
- Nine-month reported net income primarily reflects the $53.7m pretax gain on the Videotel sale. Continuing operations remained loss-making.
- KVH recorded a $2.1m inventory reserve for TracPhone V-IP products as it shifted focus toward HTS products and customer migration.
Outlook, commentary, risks and unusual items
- No quantified revenue or earnings guidance is provided. Management expects mini-VSAT service sales to grow, while product sales may decline as customers adopt AgilePlans. It expects research and development, sales and marketing, and general and administrative expenses to increase year over year.
- Management expects continuing losses in the near term, citing the cost of running legacy and HTS networks in parallel, network expansion, investment in products and R&D, and the Videotel sale. It states that a return to profitability depends on successful customer migration and new product introductions.
- Videotel sale proceeds were approximately $89.4m, subject to working-capital adjustment. KVH accrued $1.1m for a potential adjustment and anticipated finalizing it in Q4 2019. The sale generated $49.8m of after-tax discontinued-operations income for the nine months.
- An immaterial ASC 606 error involving sales-type leases was corrected in Q3 and earlier 2019 periods. The correction increased Q3 net loss by $0.336m and nine-month net loss by $0.250m; management said the affected periods were not materially misstated.
- Key disclosed risks include sustained operating losses, AgilePlans’ effect on product revenue and capital needs, costs and execution challenges during the HTS transition, volatile defense orders, competition, international and currency exposure, and dependence on third-party satellite capacity and suppliers. Some defense backlog is cancellable; $5.6m of reported backlog was subject to customer cancellation for convenience.
- The credit facility has leverage and fixed-charge coverage covenants; the maximum leverage ratio tightens to 2.50:1.00 at December 31, 2019. Management reported disclosure controls were effective at September 30, 2019 and no material quarterly change in internal control over financial reporting. KVH reported no legal proceeding it believed likely to cause material harm.
Most important facts for investors to verify
- Whether recurring mini-VSAT and AgilePlans growth can improve margins after network costs, hardware depreciation, and legacy-network expenses.
- Whether weak inertial navigation sales and segment profitability recover, given reliance on large and sometimes unpredictable defense orders.
- The final Videotel working-capital adjustment and any other sale-related indemnity or tax exposure.
- Cash burn, capital expenditure needs, revolver availability, and compliance with tightening credit covenants.
- The scale and financial-statement effects of the sales-type lease accounting correction, and whether further revenue-recognition issues emerge.