KVH Industries, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; unaudited. KVH designs and sells mobile satellite communications products and services, and navigation, guidance and stabilization products. It acquired UK media-content distributor Headland Media on May 11, 2013.
Key financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $43.2M | $32.0M | $83.1M | $58.7M |
| Operating income (loss) | $2.3M | $0.9M | $4.8M | ($0.6M) |
| Net income (loss) | $1.5M | $0.5M | $3.5M | ($0.9M) |
| Diluted EPS | $0.10 | $0.03 | $0.23 | ($0.06) |
| Operating margin | 5.4% | 2.9% | 5.7% | (1.0%) |
- Q2 sales grew 35% year over year; six-month sales grew 42%. Product sales were $25.9M and service sales $17.3M in Q2; service represented 40% of sales, up from 34%.
- Q2 guidance and stabilization sales rose to $15.9M from $8.0M, primarily on TACNAV shipments under the Saudi Arabian National Guard (SANG) contract and higher FOG sales. Mobile communications sales fell to $27.3M from $24.0M? The filing reports $27.3M versus $24.0M for the category, although mobile communications product sales declined; service growth drove the category increase.
- Product gross margin was 45% in Q2 versus 39%; service gross margin was 37% versus 38%. For the six months, product gross margin was 45% versus 38%, while service margin was 34% versus 39%.
- Six-month operating cash flow was $11.8M, versus $6.8M. Investing cash use was $39.2M, including $22.8M net cash for Headland and increased marketable-security purchases. Financing provided $28.4M, including $23.0M of revolver borrowing and $4.7M of equipment-loan proceeds.
Financial position and liquidity
- At June 30, cash and cash equivalents were $9.9M and marketable securities $44.4M, totaling $54.3M in cash, equivalents and securities; working capital was $75.3M.
- Debt included $30.0M outstanding on the revolving credit line, $7.8M of long-term debt including its current portion, and $66.9M total liabilities. The revolver matures December 31, 2014, bears interest at daily LIBOR plus 1.25%, and was fully drawn. KVH reported compliance with its covenants.
- Management said existing liquidity and operating cash flows should fund planned operating and capital needs for at least 12 months. The company also cautioned it may seek additional capital and cannot assure availability on acceptable terms.
Changes, outlook and risks
- Headland was acquired for approximately £15.5M ($24.0M); the filing records $22.8M net cash paid, excluding approximately $8.2M of acquired intercompany debt due KVH. Preliminary acquisition accounting included $13.9M of identifiable intangibles and $12.8M of goodwill. Headland contributed about $1.9M of Q2 service revenue; purchase-price allocation remained provisional.
- The SANG hardware deliveries were completed in Q2. Management expects TACNAV sales to decrease significantly quarter over quarter in the remainder of 2013, citing completion of the order and expected softness in U.S. defense spending due to sequestration. TACNAV sales can be uneven; management expects FOG sales to increase year over year.
- About $6.2M of SANG services remained at July 1, 2013, with work expected to continue into 2014. Those services carried approximately 10% gross margin; management expected contracted-engineering margins to remain low for several quarters. It expected mini-VSAT service margins to improve in 2013, but at a more modest pace than recent growth.
- Backlog was $30.8M at June 30, down from $35.0M at year-end, mainly due to completed SANG hardware deliveries. Approximately $17.1M was subject to customer cancellation for convenience; backlog excludes satellite connectivity service sales.
- Disclosure controls were deemed ineffective at June 30 because a material weakness in internal control over financial reporting remained. A senior Danish subsidiary accounting employee had misappropriated funds over at least three years; identified amounts were approximately $522,000, which KVH recovered under insurance in July 2013. Remediation steps were underway, but not yet tested long enough to establish effectiveness.
- Management estimated a 2013 effective tax rate of 35% or higher. Other risks include discretionary marine demand and European weakness, U.S. defense funding and order variability, competition, reliance on third-party satellite capacity and content licenses, foreign-currency exposure, and acquisition integration. Management reported no litigation expected to materially harm the company.
Investor verification priorities
- Track post-SANG revenue and margins, particularly TACNAV, FOG and low-margin SANG service work.
- Verify Headland’s contribution, final purchase-price allocation, integration costs and performance against acquisition expectations.
- Monitor the $30.0M revolver balance, December 2014 maturity, covenant headroom and liquidity after acquisition spending.
- Assess whether Danish-control remediation is independently demonstrated to operate effectively and whether any further losses or accounting effects emerge.
- Check backlog conversion and cancellations, and the timing and funding of defense orders.