KVH Industries, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unaudited consolidated results; amounts below are in millions unless stated otherwise. Videotel is reported as discontinued operations, with prior-period results reclassified accordingly.
Business context
KVH operates mobile connectivity and inertial navigation businesses, serving marine and land-mobile customers and commercial and defense markets. Mobile connectivity provides satellite communications and related services; inertial navigation supplies fiber-optic-gyro and tactical navigation products. KVH sold its Videotel maritime training business in May 2019.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $39.2 | $38.6 | $75.3 | $74.0 |
| Operating loss | ($6.8) | ($2.6) | ($13.0) | ($6.4) |
| Continuing-operations net loss | ($3.5) | ($2.4) | ($9.9) | ($6.8) |
| Net income (loss), including discontinued operations | $47.2 | ($1.3) | $41.0 | ($5.2) |
| Operating cash flow | Not separately presented | Not separately presented | ($6.6) | ($1.2) |
- Q2 sales grew 1.6% year over year; first-half sales grew 1.7%. Service revenue rose 9% in both periods, while product revenue declined 9% in both.
- Q2 gross margin, calculated from reported sales and product/service costs, was approximately 29.4%, versus 37.1% a year earlier. First-half gross margin was approximately 32.4%, versus 38.4%. Operating margin was approximately (17.4)% in Q2 and (17.2)% for the first half.
- Q2 and first-half net income were driven by the Videotel sale gain: $54.5 million before tax. The sale generated $50.6 million and $50.9 million of after-tax discontinued-operations income, respectively. Continuing operations remained loss-making.
- Mobile connectivity sales increased 7% in Q2 and 4% in the first half; inertial navigation sales fell 14% and 7%, respectively. Q2 mobile connectivity operating loss was $2.5 million; inertial navigation operating loss was $0.2 million.
- Cash and cash equivalents were $15.3 million and marketable securities were $50.1 million at June 30; working capital was $75.8 million. First-half capital expenditures were $6.7 million. Cash flow includes $88.4 million of net Videotel sale proceeds, while purchases of marketable securities used $50.0 million.
- Debt was $2.0 million at June 30, down from $29.5 million at year-end. Videotel proceeds were used to repay the $21.4 million term loan and $13.0 million of revolver borrowings. The $20.0 million revolver had $18.0 million available. Operating lease liabilities totaled $8.2 million.
Material changes and unusual items
- KVH recorded a $2.1 million inventory reserve for TracPhone V-IP products after deciding to stop promoting them and focus on migrating customers to its high-throughput satellite (HTS) network and products. This materially pressured product costs and mobile connectivity results.
- Mobile connectivity service growth reflected a 13% increase in mini-VSAT subscribers and higher contract engineering revenue. Management also cited higher HTS capacity, legacy-network minimums, and AgilePlans depreciation costs.
- Inertial navigation product sales were weaker, particularly TACNAV sales. Service revenue increased partly from a defense-contractor engineering contract expected to continue through Q3 2021.
- KVH adopted lease accounting standard ASC 842 on January 1, 2019, recognizing operating lease assets and liabilities; comparative periods were not restated.
Outlook, commentary and risks
- The filing provides no specific numerical revenue or earnings guidance. Management expects mini-VSAT service sales to grow with subscriber expansion and AgilePlans, while product sales may decline as customers choose the subscription model.
- Management expects research and development, sales and marketing, and general and administrative expenses to increase year over year. It also expects ongoing costs from operating both HTS and legacy networks during the transition and continued investment in satellite capacity and product development.
- The company disclosed a history of losses and stated that losses may continue; it could not assure when, or whether, profitability will return. Risks include subscriber growth and churn, network costs and execution, competition and pricing, seasonality, international exposure and trade policy, government/defense order timing, and reliance on third-party satellite capacity and suppliers.
- AgilePlans retains KVH ownership of customer equipment, increasing capital needs and depreciation; customers can cancel without a long-term commitment. Videotel services had been included in some plans, and discontinuing them may reduce plan attractiveness.
- The Videotel sale remains subject to a working-capital adjustment being finalized in Q3 2019; KVH accrued an estimated adjustment liability of approximately $0.3 million. The company also identified potential warranty, tax, and indemnification liabilities under the sale agreements.
- Credit-facility covenants tighten over time: maximum leverage declines to 2.75:1.00 in September 2019, 2.50:1.00 in December 2019, and 2.00:1.00 in December 2020; minimum fixed-charge coverage is 1.25:1.00. Management reported $18.0 million of revolver availability at quarter-end. No litigation was identified as likely to materially harm the company.
Most important facts for investors to verify
- Separate recurring operating performance from the one-time Videotel gain; confirm the final sale working-capital adjustment and any related liabilities.
- Track continuing-operations losses, negative operating cash flow, gross-margin trends, and the company’s ability to fund planned investment without relying on asset-sale proceeds.
- Assess whether mini-VSAT subscriber growth and AgilePlans economics can offset network capacity costs, equipment investment, product-sales displacement, and customer churn.
- Monitor inertial navigation order timing and defense-contract exposure, as well as the fulfillment and cancellation risk in the $17.7 million backlog, including $5.3 million of orders cancellable for customer convenience.
- Review compliance with the tightening credit covenants and the company’s remaining borrowing capacity as operating losses and cash use continue.