KVH Industries, Inc. — Q3 2017 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three and nine months ended September 30, 2017, compared with the same 2016 periods. KVH designs and sells mobile connectivity products and services and inertial navigation products. Amounts below are in millions of dollars unless otherwise stated.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $40.5 | $45.8 | $121.1 | $132.2 |
| Gross profit / gross margin | $17.5 / 43.3% | $21.3 / 46.3% | $52.0 / 42.9% | $57.7 / 43.7% |
| Operating income (loss) / margin | $(1.8) / (4.5)% | $3.0 / 6.6% | $(7.6) / (6.3)% | $(1.1) / (0.8)% |
| Net income (loss) | $(2.4) | $2.9 | $(9.3) | $(0.7) |
| Diluted EPS | $(0.15) | $0.18 | $(0.57) | $(0.05) |
| Operating cash flow | Not presented separately | Not presented separately | $9.4 | $19.0 |
- Revenue mix and segments: Q3 product sales fell 26% to $14.2 million, while service sales declined 2% to $26.3 million. Mobile connectivity sales fell 10% to $32.8 million; inertial navigation sales fell 18% to $7.7 million. For nine months, mobile connectivity sales declined 7% and inertial navigation sales declined 15%.
- Profitability: Q3 product gross margin fell to about 32% from 42%, reflecting product mix; service gross margin was about 49% in both periods. Segment operating earnings declined 55% for mobile connectivity and 84% for inertial navigation in Q3. Nine-month segment operating earnings also declined substantially in both segments, while unallocated corporate costs increased.
- Balance sheet and liquidity: At September 30, cash and cash equivalents were $35.4 million and marketable securities were $8.3 million, totaling $43.7 million. Working capital was $56.1 million. Total debt was $47.7 million, including $44.9 million under the term note; the $15.0 million revolver was undrawn and available. KVH reported compliance with its debt covenants.
- Cash flow and investment: Nine-month operating cash flow was $9.4 million, down from $19.0 million. Capital expenditures were $10.2 million, compared with $4.8 million. Cash increased by $9.0 million to $35.4 million, with marketable-securities sales and maturities contributing to investing cash flow.
Material changes versus prior periods
- Q3 sales declined 12%; nine-month sales declined 8%. The decline was concentrated in product revenue, down 26% in Q3 and 20% year to date, while nine-month service sales were approximately flat.
- Management attributed weaker mobile product sales partly to AgilePlans, which replaces upfront hardware sales with subscription revenue, as well as large prior-year lease orders and weather impacts. Hurricanes in the Caribbean and Gulf of Mexico and earlier inclement weather affected marine demand.
- In inertial navigation, lower TACNAV revenue reflected large orders shipped in 2016; FOG product sales increased. Contracted engineering service revenue also rose.
- Operating cash flow decreased by $9.6 million year over year. Debt was reduced through scheduled payments and early repayment of equipment loans; the March 2017 credit amendment included an additional $6.0 million term-loan repayment.
Outlook, commentary, and risks
- Management expects moderate growth in mini-VSAT airtime sales, supported by subscriber expansion and AgilePlans, but expects mini-VSAT hardware product sales to decline as customers choose subscriptions. AgilePlans retains hardware ownership with KVH, requiring upfront investment and potentially increasing capital expenditures, depreciation, recovery costs, bad debt, and liquidity pressure.
- Management expected 2017 research and development, sales and marketing, and general and administrative expenses to increase year over year. It also expected TACNAV sales to decline versus 2016 because anticipated large international orders had not been received, while forecasting growth in FOG products and engineering services. Order timing remains uncertain.
- KVH said cash, securities, working capital, and expected operating cash flows should meet planned needs for at least 12 months, while noting that future additional financing may be sought and is not assured.
- On November 1, 2017, after quarter-end, KVH announced a high-throughput satellite service using Intelsat and SKY Perfect JSAT capacity. Management expects potential longer-term cost and capability benefits but identified near-term costs of operating both new and legacy networks, technical challenges, and execution and management-attention risks.
- Revenue standard Topic 606 was scheduled for adoption January 1, 2018. KVH expected a material financial-statement effect, particularly for mini-VSAT contracts, including changes in revenue timing and balance-sheet presentation. Its preliminary estimate was an increase in accumulated deficit of less than $5 million, associated with gross margin on approximately $10–15 million of previously recognized revenue; the estimate remained subject to change.
- Other principal risks include seasonality and weather, dependence on satellite and other third-party capacity, competition and price pressure, foreign-currency exposure, government funding and order timing, supplier concentration, debt and covenant restrictions, and the execution of AgilePlans and the HTS transition. Goodwill testing found reporting-unit fair values more than 10% above carrying values; no impairment was recorded. KVH reported no legal proceeding likely to materially harm the business and said disclosure controls were effective.
Most important facts for investors to verify
- Whether AgilePlans subscriber growth and recurring service revenue offset lower product sales and the associated upfront capital needs.
- Whether service margins and mini-VSAT subscriber economics improve as management expects, and how capital spending and depreciation trend.
- Timing and amount of TACNAV orders, and whether FOG growth can offset continued defense-product variability.
- Actual Topic 606 transition adjustment and its effects on revenue recognition, contract balances, and controls.
- Costs, technical performance, and transition schedule for the HTS network, including continuity of the legacy service.
- Debt repayment capacity, covenant headroom, and liquidity after capital expenditures and any further investment.