KVH Industries, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited results cover the quarter and six months ended June 30, 2014. KVH develops mobile satellite communications products and services, and navigation, guidance and stabilization equipment. Unless noted otherwise, financial amounts below are in millions of U.S. dollars.
Financial performance and liquidity
| Metric | Three months ended June 30, 2014 | Three months ended June 30, 2013 | Six months ended June 30, 2014 | Six months ended June 30, 2013 |
|---|---|---|---|---|
| Net sales | $40.9 | $43.2 | $77.9 | $83.1 |
| Product sales | $21.0 | $25.9 | $39.0 | $51.1 |
| Service sales | $19.9 | $17.3 | $38.9 | $32.0 |
| Operating income (loss) | $0.7 | $2.3 | ($1.0) | $4.8 |
| Net income (loss) | $0.1 | $1.5 | ($1.1) | $3.5 |
| Diluted earnings (loss) per share | $0.00 | $0.10 | ($0.07) | $0.23 |
Reported gross margins were 42% on products and 43% on services in Q2 2014, compared with 45% and 37%, respectively, a year earlier. For the first half, product margin was 40% versus 45%; service margin was 42% versus 34%. The company attributed stronger service margins largely to the KVH Media Group acquisition and, to a lesser extent, improved mini-VSAT Broadband margins.
Operating cash flow was $1.3 million in the first half, down from $11.8 million. Investing activities provided $3.6 million, largely reflecting net sales and maturities of marketable securities; capital expenditures were $1.9 million. Cash and cash equivalents were $13.4 million at June 30. Cash, equivalents and marketable securities totaled $54.3 million, and working capital was $80.7 million.
At June 30, KVH had $30.0 million outstanding on its line of credit, plus $7.7 million of long-term debt including the current portion. On July 1, it entered a new five-year facility of up to $80.0 million, including a $65.0 million term loan and a $15.0 million revolver. The term loan refinanced approximately $30.0 million of prior borrowings and helped fund the Videotel acquisition. The new facility is secured by substantially all company assets and includes leverage and fixed-charge coverage covenants.
Material changes versus the prior comparable period
- Q2 sales fell 5% year over year; first-half sales declined 6%. First-half product sales fell 24%, mainly due to lower TACNAV and FOG shipments following completion of major SANG contract product deliveries and lower CROWS III and commercial FOG demand.
- Service sales increased 15% in Q2 and 21% in the first half, supported by mini-VSAT Broadband airtime growth and the inclusion of KVH Media Group, acquired in May 2013. Service revenue represented about 50% of first-half sales, versus 38.5% a year earlier.
- First-half operating costs and expenses rose to $78.9 million from $78.3 million despite lower revenue. Research and development and general and administrative expenses increased; total operating results moved from profit to loss.
- First-half operating cash flow declined by $10.5 million, reflecting lower earnings and less favorable working-capital movements, particularly accounts receivable.
Outlook, commentary, risks and unusual items
- Management expected TACNAV product sales to increase year over year in the second half based on backlog, while cautioning that defense sales can be uneven. It expected FOG sales to improve modestly sequentially and mini-VSAT service sales to continue growing. It also expected IP-MobileCast service revenue to begin in Q3 2014.
- KVH expected SANG project-management services to conclude in Q3 2014. Remaining service contract value at June 30 was approximately $0.2 million on the original order and $0.8 million on a May 2014 modification.
- On July 2, KVH completed the acquisition of Videotel, a maritime training services company, for approximately $49 million. The company said it expected Videotel revenue to be classified as service revenue. Integration, acquired intangible amortization and public-company reporting requirements were expected to increase expenses.
- Management stated that available liquidity after applying part of its resources to Videotel, together with working capital and operating cash flows, should cover planned requirements for at least twelve months; it noted that additional financing might be sought and was not assured.
- Backlog was $15.9 million at June 30, down from $20.5 million at year-end; $9.7 million was subject to customer cancellation for convenience. Management cautioned that backlog is not a reliable predictor of future revenue.
- Key risks include weak marine leisure demand and economic conditions, volatile and potentially cancelable government orders, dependence on a small number of defense customers, competition, supplier and satellite-capacity disruptions, and execution and integration risks from acquisitions. Increasing service mix can also pressure overall margins, and service profitability depends on subscriber growth and network utilization.
- KVH reported no legal proceeding that management believed likely to materially harm the business. No goodwill or intangible-asset impairment indicators were identified in the period. The company reported effective disclosure controls as of June 30 and no material change in internal control during Q2; it noted Videotel’s controls would need to be brought up to its reporting standards.
Most important facts for investors to verify
- Whether service growth, mini-VSAT subscriber additions and IP-MobileCast launch deliver the expected revenue and margin contribution.
- Whether product demand—especially TACNAV, FOG and marine products—recovers, and how much of reported performance remains affected by the SANG contract runoff and government-program variability.
- Videotel’s purchase accounting, contribution to revenue and cash flow, integration costs, and the effect of the acquisition financing on leverage and covenant headroom.
- Cash conversion and working-capital trends, including receivables, inventory and deferred revenue, alongside the company’s post-acquisition liquidity.
- Backlog conversion and cancellation exposure, and the pace of remaining SANG services completion.