KVH Industries, Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Financial statements are unaudited. KVH develops mobile satellite communications and media services, and navigation, guidance and stabilization products.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $40.2 million | $38.8 million | $123.3 million | $97.6 million |
| Operating income | $2.1 million | $3.1 million | $6.9 million | $2.6 million |
| Net income | $1.4 million | $1.7 million | $4.9 million | $0.8 million |
| Diluted EPS | $0.09 | $0.12 | $0.32 | $0.05 |
- Q3 sales rose 4% year over year, while operating income declined 34% and net income declined 21%. Nine-month sales increased 26% and net income improved substantially from the prior year.
- Q3 product sales were $20.3 million, down 17%; service sales were $19.9 million, up 39%. Services represented 49% of sales versus 37% a year earlier. For the nine-month period, product sales rose 14% and service sales rose 49%.
- Q3 product gross margin declined to 42% from 46%, reflecting lower TACNAV and fiber-optic-gyro sales. Service gross margin increased to 40% from 30%, aided by Headland Media and improved mini-VSAT margins. Nine-month product and service gross margins were 44% and 36%, respectively, versus 41% and 35%.
- Operating cash flow was $17.0 million for the first nine months, compared with $9.4 million in 2012. Investing cash outflow was $45.0 million, including $22.9 million for the Headland Media acquisition and increased purchases of marketable securities. Financing provided $28.4 million, including $23.0 million in line-of-credit borrowings.
- At September 30, cash and cash equivalents were $9.2 million and marketable securities were $48.4 million. Working capital was $78.1 million. Total debt was approximately $37.5 million, including $30.0 million drawn on the revolving credit facility, compared with approximately $10.6 million at December 31, 2012.
Material changes and outlook
- The May 2013 acquisition of Headland Media Limited expanded media and entertainment services. Purchase consideration was approximately $24.2 million; the company recorded $5.2 million of acquired-business service revenue in the nine months after acquisition. The acquisition added $13.1 million of goodwill and $13.9 million of identifiable intangible assets.
- Q3 mobile communications sales benefited from mini-VSAT airtime growth and Headland Media. Guidance and stabilization product sales fell, principally because SANG contract product shipments had been completed in Q2 and CROWS III-related FOG demand declined.
- Management expected TACNAV sales to fall significantly quarter over quarter for the rest of 2013, citing completion of the SANG product order and potential effects of U.S. defense sequestration. Management anticipated year-over-year FOG growth from commercial demand, partly offset by lower CROWS III demand.
- Management expected Q4 product gross margin to be consistent with Q3, with a significant year-over-year decline because the prior-year quarter included SANG shipments. Mini-VSAT service margins were expected to continue improving year over year, though more modestly. Management estimated a Q4 effective tax rate of approximately 40%.
- Backlog was $23.8 million at September 30, down from $35.0 million at year-end; $14.4 million was subject to customer cancellation for convenience. Management cautioned that backlog is not a meaningful predictor of future revenue.
- Management believed available cash, securities, working capital and operating cash flows would cover planned operating and capital requirements for at least the next 12 months. The $30.0 million revolving facility matures December 31, 2014; the company reported compliance with its covenants at quarter-end.
Risks, controls and contingencies
- Disclosure controls and procedures were deemed ineffective at September 30, 2013 because a material weakness in internal control over financial reporting remained. The weakness followed a fraud and asset-misappropriation scheme at the Danish subsidiary. Remediation steps had been implemented, but management said there was insufficient time to establish their effective operation. The company recovered $522,000 under insurance.
- Key business risks include uneven and potentially cancellable government orders, U.S. defense budget pressure, economic weakness affecting discretionary marine sales, competition, satellite capacity and third-party service dependence, and the ability to improve mini-VSAT service margins.
- The company reported no legal proceeding that management believed was likely to materially harm its business or financial condition. The filing disclosed no material impairment indicators for goodwill or other long-lived assets in the period.
Investor verification points
- Track post-acquisition Headland Media revenue, profitability, integration and the assumptions supporting acquired goodwill and intangible assets.
- Assess the timing and profitability of remaining SANG service work, expected to continue into Q1 2014, and the replacement of completed TACNAV product shipments.
- Monitor mini-VSAT subscriber growth, airtime margins, capacity needs and service costs against management’s outlook.
- Review progress and independent evidence of effective remediation of the Danish subsidiary control weakness.
- Monitor the $30.0 million revolving borrowing, its December 2014 maturity, covenant headroom and the company’s liquidity after acquisition spending.
- Evaluate the quality and timing of backlog, particularly the portion cancellable by customers and orders dependent on government funding.