KVH Industries, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited consolidated results. KVH sells mobile satellite communications products and services and navigation, guidance and stabilization systems. Videotel, acquired July 2, 2014, added maritime training content and services.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $44.3m | $40.2m | $122.2m | $123.3m |
| Operating income (loss) | $0.5m | $2.1m | ($0.5m) | $6.9m |
| Net income (loss) | $0.2m | $1.4m | ($0.9m) | $4.9m |
| Diluted EPS | $0.01 | $0.09 | ($0.06) | $0.32 |
- Q3 sales rose 10% year over year, as service sales increased 38% to $27.4m, offsetting a 17% decline in product sales to $16.9m. Service sales were 61.9% of quarterly revenue versus 49.4% a year earlier.
- Q3 product gross margin was 36%, down from 42%; service gross margin was 46%, up from 40%. Operating margin was approximately 1.2% in Q3 versus 5.2% in Q3 2013.
- Nine-month sales were nearly flat, but operating results weakened materially: product revenue fell 22% to $55.9m while service revenue rose 28% to $66.3m. Product gross margin declined to 39% from 44%; service gross margin improved to 44% from 36%.
- Cash provided by operating activities was $10.7m for the nine months, versus $17.0m in 2013. Capital expenditures were $3.5m. Net cash paid for acquisitions was $45.2m, primarily for Videotel.
- At September 30, cash and cash equivalents were $25.9m and marketable securities were $24.5m; management reported combined cash, equivalents and securities of $50.4m and working capital of $65.7m. Total debt was $71.2m, including $63.8m under the new term loan. The company reported compliance with its credit-facility financial covenants at quarter-end.
Material changes and significant items
- On July 2, KVH acquired Videotel for approximately $49.2m in cash. Videotel contributed approximately $4.8m of service revenue in the quarter. Preliminary acquisition accounting recorded $25.5m of identifiable intangible assets and $24.0m of goodwill; valuations were not final.
- KVH entered a five-year credit facility on July 1, including a $65m term loan and a $15m revolving facility. The loan is secured by substantially all company assets and certain foreign subsidiary shares. Scheduled amortization and covenant thresholds tighten over time.
- Service growth also reflected higher mini-VSAT airtime revenue and the full-period contribution of KVH Media Group, acquired in 2013. Lower TACNAV revenue as the large Saudi Arabian National Guard (SANG) contract wound down, weaker FOG sales, and lower CROWS III program sales pressured product revenue.
- Foreign-currency translation reduced accumulated other comprehensive income; Q3 translation loss was $3.8m. Videotel and KVH Media Group increase exposure to pound sterling and other foreign currencies.
- The annual goodwill test found reporting-unit fair values above carrying values, but the Norway unit’s fair value cushion was under 10%; management said it would refine the analysis, and any resulting impairment would be recorded in Q4 2014.
Outlook, risks and contingencies
- Management expected Q4 TACNAV product sales to increase year over year based on backlog, FOG and total mini-VSAT product sales to be roughly consistent year over year, and mini-VSAT service revenue to grow. It expected contracted engineering services to decline substantially after completion of SANG services. Management also anticipated higher R&D, sales and marketing, and G&A expenses, including Videotel costs. Expected Q4 effective tax rate was approximately 33%.
- Management said cash, working capital and operating cash flows should fund planned operating and capital needs for at least 12 months, while noting that additional financing might be sought and was not assured.
- Backlog was $19.7m at September 30, down from $20.5m at year-end; $4.9m was subject to customer cancellation for convenience. Management cautioned that backlog is not a reliable predictor of future revenue.
- After quarter-end, the filing disclosed a $19.0m international TACNAV contract in October and a $4.3m TACNAV order in November. The filing also cites an October order as $18.6m in another passage; verify the amount and terms. The orders contribute to uneven defense revenue and may be subject to funding, delivery and cancellation risks.
- Key risks include weaker discretionary marine demand and government defense spending, unpredictable large military orders, competition, satellite capacity and supplier dependence, foreign-exchange movements, acquisition integration and control costs, and substantial debt with restrictive covenants. Videotel represented approximately 27% of total assets, and its operations were excluded from management’s quarter-end internal-control evaluation. Management reported disclosure controls effective and no material control change identified for the quarter.
- The company reported no litigation that management believed was likely to materially harm its business or financial condition. The statements identify no other material contingency with a clear quantified exposure.
Investor verification priorities
- Confirm Videotel’s final purchase-price allocation, post-closing adjustment, tax-position liability and integration/control costs; the purchase accounting was preliminary.
- Track profitability and cash conversion: nine-month operating cash flow declined, and the company reported a nine-month net loss despite higher service revenue.
- Review debt amortization, interest-rate exposure, security interests and tightening leverage and coverage covenants; confirm ongoing covenant compliance.
- Assess the Norway goodwill impairment review and the recoverability of acquired goodwill and intangible assets.
- Verify the post-quarter TACNAV order amounts and fulfillment schedules, and monitor the cancellable portion of backlog and dependence on large defense contracts.