KVH Industries, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Unaudited results; dollar amounts below are in millions unless stated otherwise. KVH designs and sells mobile satellite communications products and services, and navigation, guidance and stabilization products, including defense-related systems.
Financial results and liquidity
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $32.0 | $30.6 | $58.7 | $55.0 |
| Operating income (loss) | $0.9 | $0.6 | $(0.6) | $(1.4) |
| Net income (loss) | $0.5 | $0.2 | $(0.9) | $(1.3) |
| Diluted EPS | $0.03 | $0.01 | $(0.06) | $(0.09) |
- Q2 sales rose about 5% year over year. Mobile communications sales increased to $24.0 million from $19.0 million, while guidance and stabilization sales declined to $8.0 million from $11.5 million.
- Product sales were $21.0 million in Q2, down 14%; service sales were $11.0 million, up 76%. Service growth was led by mini-VSAT Broadband airtime.
- Q2 product gross margin fell to 39% from 45%, largely because lower TACNAV and FOG sales reduced the share of higher-margin products. Service gross margin improved to 38% from 18%; mini-VSAT Broadband service margin rose to 33% from 11%.
- For the first half, sales increased about 7%, but the company remained loss-making. Product gross margin declined to 38% from 44%; service gross margin increased to 39% from 16%.
- Operating cash flow was $6.8 million for the first half, versus cash used of $0.8 million in 2011. Capital expenditures were $4.5 million; cash and cash equivalents ended at $8.2 million.
- Cash, cash equivalents and marketable securities totaled $31.0 million; working capital was $56.3 million. Marketable securities were $22.8 million.
- Debt included $7.0 million drawn on a $15.0 million revolving facility and approximately $3.6 million of mortgage debt. The company repaid $2.0 million on the credit line during the first half. It reported compliance with applicable credit-line covenants.
Material changes and management commentary
- Q2 service growth and improved service margins offset weaker defense-related product sales. First-half mobile communications sales rose 29% to $44.9 million, while guidance and stabilization sales fell 31% to $13.9 million.
- Backlog increased to $59.8 million at June 30 from $22.1 million at year-end, mainly due to a $35.6 million Saudi Arabian National Guard TACNAV products-and-services order. Product shipments were estimated to begin in September 2012. The order includes $22.3 million of equipment and $13.3 million of services, with services expected through 2014. Approximately $15.7 million of total backlog was subject to customer cancellation for convenience.
- Management expected TACNAV sales to increase significantly year over year in the second half, but cautioned that order timing can make sales uneven. It expected full-year FOG sales to be comparable to 2011 and sequential FOG improvement in the second half.
- Management expected operating expenses to rise sequentially in the second half, including costs related to executing the Saudi order, but to decline as a percentage of sales. It estimated a 2012 effective tax rate of 45% or higher.
- Expected 2012 capital expenditures were $7–$8 million. The company planned to acquire three hubs for C-band service and reported contractual commitments associated with a five-year capacity agreement, hubs and teleport services totaling approximately $12.2 million.
Risks, contingencies and unusual items
- Defense sales depend on large, irregular government orders that may be delayed, reduced or cancelled; management cited declining TACNAV and FOG sales and defense-budget uncertainty. The Saudi backlog is a significant opportunity but partly cancellable.
- Management remained cautious about leisure sales amid global economic weakness. The filing also highlights seasonality, competition, customer concentration, supplier and manufacturing disruptions, export licensing, and dependence on third-party satellite capacity and technology.
- Mini-VSAT service has substantial network costs; profitability depends on subscriber growth, and further coverage expansion requires investment. C-band capacity and hub commitments add execution and capital requirements.
- The company reported no litigation it believed likely to materially harm its business or financial condition. It reported effective disclosure controls and no material second-quarter change in internal control over financial reporting.
- Foreign-currency exposure was considered not material under the company’s stated sensitivity analysis. Interest-rate swaps hedge mortgage exposure; the revolving credit facility remains variable-rate.
Important facts for investors to verify
- Timing, funding, delivery progress and cancellation terms for the $35.6 million Saudi TACNAV order, and conversion of backlog into recognized revenue and cash.
- Whether service revenue and mini-VSAT margins continue to grow sufficiently to offset the lower product mix and network costs.
- Recovery in TACNAV and FOG sales, including the expected second-half shipments and full-year FOG comparison.
- Actual capital spending and commitments for C-band capacity and hubs, alongside liquidity and revolving-facility covenant headroom.
- Tax expense and effective tax rate, which management estimated at 45% or higher for 2012.