KVH Industries, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; unaudited. KVH designs and sells mobile satellite communications products and services, and navigation, guidance and stabilization systems for defense and commercial markets. Unless noted otherwise, amounts below are in millions of dollars.
Financial results and liquidity
- Revenue: $39.9, up 49% from $26.7. Product sales rose 48% to $25.2; service sales rose 53% to $14.7.
- Profitability: Gross profit was approximately $15.8, with a 39.5% gross margin versus approximately $9.9 and 37.2% a year earlier. Operating income was $2.5 versus an operating loss of $1.5. Net income was $2.0 ($0.13 diluted per share) versus a net loss of $1.4 ($0.09 per share).
- Margins: Product gross margin improved to 45% from 36%; service gross margin fell to 30% from 40%. Net margin was 4.9%, compared with negative 5.1%.
- Cash flow: Operating cash flow was $2.4, down from $5.1. Investing used $9.8, mainly reflecting net purchases of marketable securities; financing provided $4.9, including $4.7 of equipment-loan proceeds. Cash and cash equivalents declined $2.4 to $6.5.
- Liquidity: Cash, cash equivalents and marketable securities totaled $44.8; working capital was $74.8. Current assets were $96.1 versus current liabilities of $21.2.
- Debt: The company reported $7.0 outstanding on its revolving credit facility and $8.1 in current and long-term debt. A new $4.7 equipment loan bears fixed interest of 2.76% and is payable over five years. The revolving facility provides up to $15.0 and matures December 31, 2014; KVH reported compliance with its covenants.
Material changes and business drivers
- Guidance and stabilization sales rose to $17.0 from $5.9, led by TACNAV defense products (up $6.6, largely tied to the Saudi Arabian National Guard, or SANG, contract) and FOG products (up $2.9).
- Mobile communications sales were $22.9 versus $20.8. Product sales declined, including lower marine sales in Europe and lower land-mobile sales to recreational-vehicle OEMs, while mini-VSAT Broadband airtime helped lift service revenue.
- Service revenue also benefited from SANG-related engineering and project-management work. Those services carry approximately 10% gross margin, contributing to the decline in service margin.
- Backlog was $39.8 at March 31, up from $35.0 at year-end; $8.0 was scheduled for 2014 and $4.9 for 2015. Approximately $17.6 was subject to customer cancellation for convenience. Management cautioned that backlog is not a meaningful predictor of future revenue.
- Foreign customers outside the U.S. and Canada represented 45% of sales, up from 34%. One unnamed customer represented 23% of Q1 sales, versus less than 10% in the prior-year quarter.
Outlook, risks and unusual items
- Management expected TACNAV sales to rise significantly year over year in Q2 2013 due to the SANG order, but warned that sales may be uneven and could decline in Q3 absent substantial replacement orders. FOG sales were expected to increase year over year in 2013.
- The SANG contract was valued at $35.6: $21.2 for TACNAV products, with shipments estimated to be substantially complete in Q2 2013, and $14.4 for services continuing through 2014. Approximately $8.5 of service work remained as of April 1, 2013.
- Management expected service gross margin on contracted engineering work to remain under pressure for several quarters. It expected mini-VSAT Broadband margins to improve year over year, but at a more modest pace than in 2011–2012.
- Operating expenses were expected to increase in absolute terms for the rest of 2013, including SANG-related commissions and hiring, but decline as a percentage of sales. The company estimated a 2013 effective tax rate of 35% or higher, subject to discrete tax events.
- Management said available liquidity and operating cash flows should meet planned needs for at least the next 12 months, while noting additional financing might be sought and could not be assured on acceptable terms.
- Internal controls: Disclosure controls were ineffective at March 31 because a material weakness remained at the Danish subsidiary. A senior accounting employee had misappropriated funds through fraudulent transfers and other actions over at least three years; reported amounts ranged from approximately $118,000 to $250,000 in each year through 2012 and were approximately $84,000 in Q1 2013. Remediation was underway but had not operated long enough to establish effectiveness. Management was assessing potential insurance recovery.
- Other risks: Leisure-market demand remained uncertain amid global economic challenges; military backlog orders may be cancellable. Management reported no litigation expected to materially harm the company. Foreign-exchange and investment interest-rate sensitivities were described as not material.
Important facts for investors to verify
- Progress and timing of SANG product deliveries and remaining service obligations, and the effect of those activities on future sales and margins.
- Whether TACNAV orders replenish after the expected Q2 2013 surge, and whether FOG and mini-VSAT growth meets management’s expectations.
- Customer concentration and cancellability of backlog, including the unnamed customer accounting for 23% of quarterly sales.
- Completion and demonstrated effectiveness of Danish subsidiary control remediation, the final amount of losses, and any insurance recovery.
- Cash conversion, marketable-security holdings, and debt repayment and covenant capacity as investment and operating needs evolve.