KVH Industries, Inc. — Q2 2015 Form 10-Q
Business context and reporting period. The unaudited filing covers the quarter and six months ended June 30, 2015. KVH sells mobile communications products and services and navigation, guidance and stabilization products. Videotel, acquired in July 2014, expanded maritime training and e-learning services.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $44.9m | $40.9m | $86.2m | $77.9m |
| Operating income (loss) | ($0.3m) | $0.7m | ($2.2m) | ($1.0m) |
| Net income (loss) | $0.04m | $0.06m | ($1.4m) | ($1.1m) |
| Diluted EPS | $0.00 | $0.00 | ($0.09) | ($0.07) |
| Operating cash flow | Not reported quarterly | Not reported quarterly | $4.9m | $1.3m |
- Q2 sales rose 9.6%; first-half sales rose 10.6%. Service revenue increased 35% in Q2 and 36% in the first half; product revenue declined 15% in both periods.
- Q2 product gross margin fell to 33% from 42%, mainly because lower TACNAV sales reduced the share of higher-margin products. Service gross margin increased to 49% from 43%, helped by Videotel; mini-VSAT margin faced pricing pressure.
- Q2 operating costs exceeded sales by $0.3m. General and administrative expense rose 46% to $7.6m, including higher Videotel costs. First-half G&A rose 47% to $15.3m.
- First-half investing cash outflow was $6.6m, including $3.5m in capital expenditures; financing cash outflow was $3.2m, largely debt repayments. Cash and cash equivalents declined $4.8m to $20.5m.
- At June 30, cash, cash equivalents and marketable securities totaled $48.0m; working capital was $65.4m. Total debt was $67.8m, including $61.3m outstanding under the term note. No revolver borrowings were outstanding.
Changes, outlook and material matters
- Videotel contributed $5.8m of Q2 service revenue growth and $11.8m of first-half growth. Its acquisition also increased operating expenses and debt-related interest expense.
- TACNAV sales fell sharply year over year: 85% in Q2 and 78% in the first half, reflecting uneven defense shipments and completion of programs in 2014. Management expected Q3 TACNAV product sales below the prior-year quarter, with 2015 sales expected to be flat year over year; it anticipated most 2015 TACNAV sales in Q4. FOG sales were expected to modestly decline year over year, partly due to reduced demand for the U.S. Army CROWS III program.
- Management expected mini-VSAT service revenue to increase year over year and its gross-margin percentage to rise modestly from 2014. It expected R&D expense to be modestly lower, while sales, marketing and support and G&A expenses were expected to increase, primarily due to Videotel and new services. The expected effective tax rate for the rest of 2015 was approximately 25%, subject to discrete events.
- Management said available liquidity and operating cash flows should cover planned operating and capital needs for at least 12 months. The credit agreement’s maximum leverage covenant tightens to 1.00:1.00 on September 30, 2015; KVH reported compliance with covenants at June 30. The $15m revolver was undrawn.
- Backlog was $29.2m, of which approximately $24.1m was cancelable for customer convenience; management cautioned backlog was not a meaningful predictor of future revenue. Approximately $11.9m was scheduled for 2016 and $2.9m for 2017 and later.
- Disclosure controls were deemed ineffective at June 30 because previously identified material weaknesses remained in revenue recognition for bill-and-hold and multi-element arrangements, and review of outsourced income-tax provisions. Remediation was ongoing and not yet demonstrated effective.
- Advanced Media Networks sued KVH alleging infringement of two patents and seeks unspecified damages. The case was at an early stage; the loss range could not be determined, and an adverse outcome could materially affect the Mobile Broadband business and financial results.
Most important facts for investors to verify
- Whether TACNAV orders and shipments materialize as expected, particularly the anticipated Q4 concentration and the $19m international military contract.
- Progress in remediating internal-control material weaknesses and the effect of the tighter September 2015 leverage covenant.
- Videotel’s ongoing contribution to service revenue, margins and expenses, alongside mini-VSAT pricing and margin trends.
- Developments in the patent litigation, defense-program funding and cancellation exposure, and the convertibility of backlog into revenue.
- Cash generation, debt repayment capacity and any foreign-exchange or other unusual items; Q2 other income included foreign-currency gains.