KVH Industries, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited consolidated results. KVH designs and sells mobile connectivity products and services and inertial navigation products and services.
Financial performance and condition
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $40.4 million | $46.0 million | $80.7 million | $86.3 million |
| Operating loss | $1.4 million | $0.7 million | $5.8 million | $4.1 million |
| Net loss | $2.0 million | $0.8 million | $6.9 million | $3.6 million |
| Diluted loss per share | $0.12 | $0.05 | $0.42 | $0.23 |
| Operating cash flow | Not separately presented | Not separately presented | $6.8 million | $8.9 million |
- Q2 gross margin was approximately 44.6%, compared with 42.9% a year earlier; six-month gross margin was approximately 42.7%, versus 42.2%. Q2 operating margin deteriorated to approximately negative 3.4% from negative 1.5%.
- Q2 product revenue fell 29% to $14.3 million; service revenue was nearly flat at $26.1 million. For the first half, product revenue declined 18% to $29.2 million, while service revenue increased 1% to $51.5 million. Service sales rose to 65% of Q2 revenue from 56%.
- Q2 mobile connectivity sales fell 8% to $34.0 million; segment operating earnings increased 62% to $2.6 million. Inertial navigation sales declined 29% to $6.4 million and segment operating earnings fell 77% to $0.4 million.
- At June 30, cash and cash equivalents were $30.4 million and marketable securities were $13.8 million. Working capital was $57.5 million. Total debt was $48.3 million, including $45.4 million under the term note; $15.0 million remained available under the revolver. KVH reported compliance with its financial covenants.
- Operating cash flow was $6.8 million; capital expenditures were $6.8 million. Investing activities provided $5.1 million, largely reflecting net maturities and sales of marketable securities. Financing activities used $8.9 million, including debt repayments. Cash increased $4.0 million during the half-year.
Material changes versus comparable periods
- Q2 net sales declined 12%, primarily because of lower product sales: mobile connectivity products were affected by a large prior-year order, the AgilePlans subscription model and weather-related delays in marine vessel retrofits; inertial navigation sales were affected by a large TACNAV order in Q2 2016.
- Q2 service revenue held steady as mini-VSAT airtime growth was offset by lower content and training revenue and fewer Inmarsat airtime customers. Foreign-exchange weakness reduced reported pound-sterling content and training revenue.
- Operating losses widened in Q2 and the first half. For the six months, segment operating earnings declined in both businesses, while unallocated operating costs increased 13%, primarily due to higher compensation and headcount.
- Cash from operations fell $2.1 million year over year in the first half, while capital expenditures rose to $6.8 million from $2.5 million. Debt declined from $58.1 million at year-end 2016 to $48.3 million at June 30, 2017.
Outlook, risks and unusual items
- KVH launched AgilePlans in Q2: a monthly connectivity subscription that includes hardware retained by KVH. Management expects moderate growth in mini-VSAT service sales, but product revenue may decline as customers choose subscriptions. Successful adoption could increase capital spending and depreciation; customer terminations, equipment recovery, damage, bad debt and maintenance costs are additional risks.
- Management expects 2017 research and development, sales and marketing, and general and administrative expenses to increase year over year. It expects TACNAV sales primarily in the second half, but cautions that order timing and quarterly inertial navigation sales may be uneven. It anticipates overall inertial navigation operating earnings to decline for 2017.
- Marine leisure activity is seasonal; management cited inclement Q2 weather. Other disclosed risks include defense-budget and contract timing, competition and pricing, supplier concentration, satellite capacity and third-party technology dependence, foreign-exchange exposure, and indebtedness.
- The term note matures July 1, 2019, with quarterly principal payments of $575,000 under the March 2017 amendment. A $2.6 million mortgage balloon payment is due in April 2019. The term note carries variable-rate interest; management estimated a 10% interest-rate move would affect annual interest expense by about $0.1 million.
- KVH expects its cash, securities, working capital and operating cash flows to meet planned needs for at least twelve months, while noting additional financing may be sought and is not assured. No material litigation was disclosed. No impairment was identified at June 30; management noted that further sales or operating declines could expose one reporting unit with $4.4 million of goodwill to impairment.
- Revenue standard Topic 606 was expected to be adopted January 1, 2018 using the modified retrospective method. The assessment was ongoing; management anticipated potential changes to revenue timing for certain services and to balance-sheet presentation.
Most important facts to verify
- Whether AgilePlans adoption grows recurring service revenue enough to offset lower product revenue and added equipment investment and costs.
- Whether mini-VSAT service growth and margin initiatives can offset weaker content, Inmarsat and hardware sales.
- Timing, delivery and cancellation exposure for TACNAV and other defense orders, including the $5.8 million of backlog subject to customer cancellation for convenience.
- Cash generation, capital spending, debt reduction, covenant headroom and the 2019 term-note maturity and mortgage balloon payment.
- Progress and quantified financial-statement effects of Topic 606 adoption, and any impairment indicators for the reporting unit with $4.4 million of goodwill.