KVH Industries, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Unaudited consolidated results; filed November 9, 2015. KVH designs and sells mobile communications equipment and services, and navigation, guidance and stabilization products. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $44.5 | $44.3 | $130.6 | $122.2 |
| Operating income (loss) | $0.2 | $0.5 | $(2.0) | $(0.5) |
| Net income (loss) | $(0.5) | $0.2 | $(1.8) | $(0.9) |
| Diluted EPS | $(0.03) | $0.01 | $(0.12) | $(0.06) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $10.7 | $10.7 |
Q3 revenue was nearly flat year over year. Product sales were $15.6 million, down 7%; service sales were $28.8 million, up 5%. Product gross margin fell to 34% from 36%, while service gross margin rose to 50% from 46%. Nine-month revenue rose 7%: service sales increased 23% to $81.7 million, while product sales declined 12% to $49.0 million. Nine-month product and service gross margins were 33% and 49%, respectively, compared with 39% and 44% in 2014.
Q3 general and administrative expense increased 18% to $8.2 million, mainly reflecting compensation and consulting costs. For the first nine months, G&A rose 35% to $23.4 million, including costs associated with Videotel. Foreign-currency translation losses were $3.9 million for the nine-month period; total comprehensive loss was $5.9 million.
Liquidity, cash flow and debt
At September 30, 2015, cash and cash equivalents were $23.6 million and marketable securities were $26.6 million, totaling $50.2 million; working capital was $66.7 million. Cash and cash equivalents declined $1.7 million from year-end 2014. Nine-month operating cash flow was $10.7 million; capital expenditures were $4.9 million. Investing activities used $7.0 million and financing activities used $4.7 million.
Total debt was $66.2 million, including $60.1 million under the term note; no revolving-credit borrowings were outstanding. The term note matures July 2019 and is secured by substantially all company assets and certain subsidiary shares. KVH amended its credit agreement in September 2015 to increase the maximum leverage covenant limits temporarily. The company reported compliance with financial covenants at quarter-end. Management said available funds and operating cash flows were expected to meet planned operating and capital requirements for at least 12 months.
Changes, outlook and material matters
- Drivers of results: Videotel contributed to service revenue growth, including $17.9 million of service revenue in the first nine months of 2015. Mini-VSAT airtime sales also grew. These increases were partly offset by lower TACNAV and FOG product sales; TACNAV sales were down 71% for the nine-month comparison.
- Management outlook: Q4 2015 TACNAV product sales were expected to increase year over year based on backlog, while FOG sales were expected to decrease modestly and mini-VSAT product sales to be roughly consistent. Management anticipated continued mini-VSAT service growth and higher service gross margin year over year. R&D expense for full-year 2015 was expected to be consistent with 2014; Q4 tax rate was expected to be about 25%, subject to discrete tax events.
- Backlog: $31.5 million at September 30, 2015, versus $27.3 million at December 31, 2014. Approximately $25.2 million was subject to customer cancellation for convenience; backlog is not presented as a reliable revenue predictor.
- Goodwill: The annual impairment test was still in progress after the August 31 test date. Any required impairment charge would be recorded in Q4 2015.
- Controls: Management concluded disclosure controls were ineffective at September 30 because material weaknesses in revenue recognition (bill-and-hold and lease/airtime arrangements) and tax-provision review remained under remediation.
- Contingency: Advanced Media Networks sued KVH in March 2015 alleging infringement of two patents and seeking unspecified damages. The loss range could not be determined; the company warned the matter could materially adversely affect its Mobile Broadband business and results.
- Principal risks: Uneven, potentially cancellable defense orders; competition and pricing pressure; dependence on third-party satellite capacity and technology; foreign-exchange exposure; significant debt and covenant restrictions; and reliance on key suppliers and licensed content. A new airtime pricing structure took effect October 1, 2015, and management said customer transitions and usage-related revenue variability were uncertain.
Important facts for investors to verify
- Whether Q4 TACNAV backlog converts to shipments and revenue as expected, given customer cancellation rights and historically uneven order timing.
- Progress and effectiveness of remediation for the disclosed material weaknesses in internal controls.
- Completion of the annual goodwill impairment test and whether a Q4 charge is recorded.
- Debt covenant headroom and compliance as leverage limits tighten after the temporary amendment.
- Developments in the patent litigation and any resulting exposure or operational impact.
- Actual service-margin and revenue effects of mini-VSAT growth and the new airtime rate plans.