KVH Industries, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Financial statements are unaudited. KVH makes mobile satellite connectivity products and services and inertial navigation systems. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $43.4 | $40.4 | $83.5 | $80.7 |
| Gross profit and margin | $17.8; 41.0% | $18.1; 44.6% | $35.2; 42.1% | $34.5; 42.7% |
| Operating loss | $(1.2) | $(1.4) | $(4.4) | $(5.8) |
| Net loss | $(1.3) | $(2.0) | $(5.2) | $(6.9) |
| Loss per share, basic and diluted | $(0.08) | $(0.12) | $(0.31) | $(0.42) |
- Q2 sales grew 7%; first-half sales grew 4%. Product sales increased while service sales also rose modestly.
- Q2 service costs rose faster than service revenue; total cost of sales increased 14% in the quarter. Gross margin contracted year over year.
- Cash used in operating activities was $1.2 million in the first half, versus $6.8 million provided in the prior-year period. Capital expenditures were $7.5 million.
- Cash, cash equivalents and marketable securities totaled $34.9 million at June 30, 2018; working capital was $44.9 million. Cash and equivalents were $34.5 million, compared with $34.6 million at year-end 2017.
- Total debt was $43.6 million, including $40.9 million under the term note and $2.7 million on the mortgage. The $15.0 million revolver was undrawn and available. KVH reported compliance with its credit covenants.
- Total assets were $203.6 million and stockholders’ equity was $102.4 million. The first-half comprehensive loss of $6.6 million included a $1.4 million foreign-currency translation loss.
Business and changes versus prior period
- Mobile connectivity: Q2 sales were $33.8 million, down 1%; first-half sales were $66.5 million, down 3%. First-half product sales fell 14%, partly reflecting the shift to AgilePlans subscriptions and ASC 606; service sales rose 2%, including growth in mini-VSAT subscribers. Segment operating income fell 32% in the first half to $2.2 million.
- Inertial navigation: Q2 sales rose 50% to $9.6 million; first-half sales rose 38% to $17.0 million, driven by FOG and TACNAV products and contracted engineering work. First-half segment operating income increased to $1.9 million from $0.3 million.
- Consolidated operating loss improved year over year, but segment improvement was uneven: stronger inertial navigation results and lower unallocated costs were partly offset by lower mobile connectivity earnings and higher network costs.
- Service sales were 62.8% of Q2 revenue, versus 64.6% a year earlier. International sales represented 60% of Q2 revenue and 59% of first-half revenue.
Outlook, accounting matters and risks
- Management expects mini-VSAT service sales to grow with subscriber expansion and AgilePlans adoption, but expects mobile connectivity operating earnings to decline slightly in 2018. It expects inertial navigation operating earnings to increase modestly, supported by FOG backlog and engineering services. Management did not provide a numerical consolidated earnings or revenue forecast.
- Management expects mobile connectivity service costs as a percentage of sales to increase as the HTS network is integrated, and anticipates higher R&D and sales, marketing and support expenses year over year. It expects cash and working capital, together with operating cash flows, to cover planned needs for at least 12 months.
- KVH adopted ASC 606 on January 1, 2018 using the modified retrospective method. The adoption increased accumulated deficit by $2.7 million and changes the timing of revenue and related costs for certain mini-VSAT contracts. For first-half 2018, reported sales were $83.5 million and net loss was $5.2 million; under prior accounting guidance, pro forma sales would have been $84.1 million and net loss $5.1 million. Prior-year results were not restated.
- AgilePlans revenue was less than 2% of total revenue in Q2 and the first half. KVH retains ownership of deployed equipment, increasing capital needs and depreciation; management cautions that adoption may reduce product revenue and may not offset that decline.
- Debt repayment is an important near-term consideration: the term note matures July 2019, and the mortgage includes a balloon payment of approximately $2.6 million due April 2019. The term note bears variable interest; KVH estimated a 10% rate movement would affect annual interest expense by about $0.2 million.
- Other disclosed risks include HTS integration and operating costs, competition and pricing pressure, dependence on third-party satellite capacity and suppliers, unpredictable government and defense orders, seasonality, foreign exchange exposure, and regulatory and tax uncertainty. Management reported no litigation likely to materially harm the company and no material impairment of goodwill or other nonfinancial assets at June 30.
Most important facts for investors to verify
- Whether mini-VSAT subscriber and AgilePlans growth can offset declining mobile product sales and higher HTS network costs.
- Whether the substantial first-half operating cash use reflects timing and working-capital movements or a continuing cash-generation issue.
- How the July 2019 term-note maturity and April 2019 mortgage balloon will be funded or refinanced, and whether covenant compliance is maintained.
- How ASC 606 deferrals affect reported revenue, contract assets and liabilities, and comparisons with periods prepared under prior guidance.
- Whether inertial navigation growth and backlog convert to sustainable revenue and earnings, given the timing and cancellation risks of large defense orders.