Results
KVH Industries Inc.
08/09/2022 | Press release | Distributed by Public on 08/09/2022 15:29
Quarterly Report for Quarter Ending June 30, 2022 (Form 10-Q)
kvhi-20220630
Paycheck Protection Program Loan
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: June 30, 2022
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-28082
KVH Industries, Inc.
(Exact Name of Registrant as Specified in its Charter)
| Delaware | 05-0420589 |
| (State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification Number) |
50 Enterprise Center, Middletown, RI02842
(Address of Principal Executive Offices) (Zip Code)
(401) 847-3327
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Trading Symbol(s) | Name of Each Exchange on which Registered |
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The NASDAQ Stock Market LLC
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| Common Stock, par value $0.01 per share | KVHI |
(NASDAQ Global Select Market)
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☒No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☒ |
| Non-accelerated filer | ☐ | Smaller reporting company | ☒ |
| Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☒
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
| Date | Class | Outstanding shares |
| August 5, 2022 | Common Stock, par value $0.01 per share | 19,075,059 |
KVH INDUSTRIES, INC. AND SUBSIDIARIES
Form 10-Q
INDEX
| Page No. | ||
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PART I. FINANCIAL INFORMATION
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| ITEM 1. |
INTERIM FINANCIAL STATEMENTS
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Consolidated Balance Sheets as of June 30, 2022 (unaudited) and December 31, 2021
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3
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Consolidated Statements of Operations for the three and six months ended June 30, 2022 and 2021 (unaudited)
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4
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Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2022 and 2021 (unaudited)
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5
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Consolidated Statements of Stockholders' Equity for the three and six months ended June 30, 2022 and 2021 (unaudited)
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6
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Consolidated Statements of Cash Flows for the six months ended June 30, 2022 and 2021 (unaudited)
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7
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Notes to Consolidated Financial Statements (unaudited)
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8
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| ITEM 2. |
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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28
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| ITEM 4. |
CONTROLS AND PROCEDURES
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39
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PART II. OTHER INFORMATION
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| ITEM 1. |
LEGAL PROCEEDINGS
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41
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| ITEM 1A. |
RISK FACTORS
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41
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| ITEM 6. |
EXHIBITS
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53
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SIGNATURE
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54
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2
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
| June 30, 2022 | December 31, 2021 | |||
| ASSETS | (unaudited) | |||
| Current assets: | ||||
| Cash and cash equivalents | $ | 10,395 | $ | 11,376 |
| Marketable securities | 5,157 | 13,147 | ||
|
Accounts receivable, net of allowance for doubtful accounts of $1,553 and $1,636 as of June 30, 2022 and December 31, 2021, respectively
|
33,408 | 33,648 | ||
| Inventories, net | 30,981 | 24,640 | ||
| Prepaid expenses and other current assets | 3,848 | 3,789 | ||
| Current contract assets | 1,225 | 1,230 | ||
| Total current assets | 85,014 | 87,830 | ||
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Property and equipment, net
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60,714 | 60,114 | ||
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Intangible assets, net
|
564 | 1,287 | ||
| Goodwill | 5,313 | 6,570 | ||
| Right of use assets | 2,057 | 3,055 | ||
| Other non-current assets | 5,566 | 6,778 | ||
| Non-current contract assets | 3,032 | 3,104 | ||
| Deferred income tax asset | 56 | 56 | ||
| Total assets | $ | 162,316 | $ | 168,794 |
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||
| Current liabilities: | ||||
| Accounts payable | $ | 10,867 | $ | 11,265 |
| Accrued compensation and employee-related expenses | 6,152 | 7,053 | ||
| Accrued other | 8,587 | 7,892 | ||
| Accrued product warranty costs | 1,398 | 1,179 | ||
| Contract liabilities | 4,074 | 3,989 | ||
| Current operating lease liability | 1,359 | 1,912 | ||
| Liability for uncertain tax positions | 624 | 592 | ||
| Total current liabilities | 33,061 | 33,882 | ||
| Other long-term liabilities | 8 | 30 | ||
| Long-term operating lease liability | 748 | 1,224 | ||
| Long-term contract liabilities | 4,271 | 4,466 | ||
| Deferred income tax liability | 200 | 215 | ||
| Total liabilities | $ | 38,288 | $ | 39,817 |
| Commitments and contingencies (Notes 2, 10, 12, and 17) | ||||
| Stockholders' equity: | ||||
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Preferred stock, $0.01 par value. Authorized 1,000,000 shares; none issued
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- | - | ||
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Common stock, $0.01 par value. Authorized 30,000,000 shares; 20,503,438 and 20,342,695 shares issued at June 30, 2022 and December 31, 2021, respectively; and 19,070,744 and 18,910,001 shares outstanding at June 30, 2022 and December 31, 2021, respectively
|
205 | 203 | ||
| Additional paid-in capital | 157,996 | 156,199 | ||
| Accumulated deficit | (18,301) | (12,165) | ||
| Accumulated other comprehensive loss | (4,021) | (3,409) | ||
| 135,879 | 140,828 | |||
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Less: treasury stock at cost, common stock, 1,432,694 shares as of June 30, 2022 and December 31, 2021
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(11,851) | (11,851) | ||
| Total stockholders' equity | 124,028 | 128,977 | ||
| Total liabilities and stockholders' equity | $ | 162,316 | $ | 168,794 |
See accompanying Notes to Unaudited Consolidated Financial Statements.
3
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except earnings per share amounts, unaudited)
| Three Months Ended | Six Months Ended | |||||||
| June 30, | June 30, | |||||||
| 2022 | 2021 | 2022 | 2021 | |||||
| Sales: | ||||||||
| Product | $ | 13,579 | $ | 17,269 | $ | 27,949 | $ | 35,701 |
| Service | 28,258 | 26,094 | 54,982 | 49,954 | ||||
| Net sales | 41,837 | 43,363 | 82,931 | 85,655 | ||||
| Costs and expenses: | ||||||||
| Costs of product sales | 11,115 | 11,894 | 21,844 | 23,114 | ||||
| Costs of service sales | 15,422 | 16,124 | 30,414 | 31,547 | ||||
| Research and development | 3,759 | 4,505 | 8,408 | 9,072 | ||||
| Sales, marketing and support | 6,975 | 7,937 | 15,332 | 15,483 | ||||
| General and administrative | 6,898 | 8,705 | 13,973 | 15,848 | ||||
| Total costs and expenses | 44,169 | 49,165 | 89,971 | 95,064 | ||||
| Loss from operations | (2,332) | (5,802) | (7,040) | (9,409) | ||||
| Interest income | 201 | 222 | 409 | 455 | ||||
| Interest expense | 1 | 14 | 2 | 32 | ||||
| Other income (expense), net | 923 | (1) | 1,061 | (790) | ||||
| Loss before income tax expense (benefit) | (1,209) | (5,595) | (5,572) | (9,776) | ||||
| Income tax expense (benefit) | 235 | 78 | 564 | (75) | ||||
| Net loss | $ | (1,444) | $ | (5,673) | $ | (6,136) | $ | (9,701) |
| Net loss per common share | ||||||||
| Basic | $ | (0.08) | $ | (0.31) | $ | (0.33) | $ | (0.54) |
| Diluted | $ | (0.08) | $ | (0.31) | $ | (0.33) | $ | (0.54) |
| Weighted average number of common shares outstanding: | ||||||||
| Basic | 18,564 | 18,174 | 18,507 | 18,057 | ||||
| Diluted | 18,564 | 18,174 | 18,507 | 18,057 |
See accompanying Notes to Unaudited Consolidated Financial Statements.
4
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands, unaudited)
| Three Months Ended | Six Months Ended | |||||||
| June 30, | June 30, | |||||||
| 2022 | 2021 | 2022 | 2021 | |||||
| Net loss | $ | (1,444) | $ | (5,673) | $ | (6,136) | $ | (9,701) |
| Other comprehensive (loss) income, net of tax: | ||||||||
| Foreign currency translation adjustment | (419) | 41 | (612) | 264 | ||||
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Other comprehensive (loss) income, net of tax(1)
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(419) | 41 | (612) | 264 | ||||
| Total comprehensive loss | $ | (1,863) | $ | (5,632) | $ | (6,748) | $ | (9,437) |
(1) Tax impact was nominal for all periods.
See accompanying Notes to Unaudited Consolidated Financial Statements.
5
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, unaudited)
| Common Stock |
Additional Paid-in Capital |
Accumulated Deficit |
Accumulated Other Comprehensive Loss |
Treasury Stock |
Total Stockholders' Equity |
|||||||||
| Shares | Amount | Shares | Amount | |||||||||||
| Balance at March 31, 2022 | 20,328 | $ | 203 | $ | 157,142 | $ | (16,857) | $ | (3,602) | (1,433) | $ | (11,851) | $ | 125,035 |
| Net loss | - | - | - | (1,444) | - | - | - | (1,444) | ||||||
| Other comprehensive loss | - | - | - | - | (419) | - | - | (419) | ||||||
| Stock-based compensation | - | - | 705 | - | - | - | - | 705 | ||||||
| Exercise of stock options and issuance of restricted stock awards, net of forfeitures | 175 | 2 | 149 | - | - | - | - | 151 | ||||||
| Balance at June 30, 2022 | 20,503 | $ | 205 | $ | 157,996 | $ | (18,301) | $ | (4,021) | (1,433) | $ | (11,851) | $ | 124,028 |
| Common Stock |
Additional Paid-in Capital |
Accumulated Deficit |
Accumulated Other Comprehensive Loss |
Treasury Stock |
Total Stockholders' Equity |
|||||||||
| Shares | Amount | Shares | Amount | |||||||||||
| Balance at December 31, 2021 | 20,343 | $ | 203 | $ | 156,199 | $ | (12,165) | $ | (3,409) | (1,433) | $ | (11,851) | $ | 128,977 |
| Net loss | - | - | - | (6,136) | - | - | - | (6,136) | ||||||
| Other comprehensive loss | - | - | - | - | (612) | - | - | (612) | ||||||
| Stock-based compensation | - | - | 1,586 | - | - | - | - | 1,586 | ||||||
| Issuance of common stock under employee stock purchase plan | 22 | - | 193 | - | - | - | - | 193 | ||||||
| Exercise of stock options and issuance of restricted stock awards, net of forfeitures | 138 | 2 | 149 | - | - | - | - | 151 | ||||||
| Taxes accrued for net share settlement of options | - | - | (131) | - | - | - | - | (131) | ||||||
| Balance at June 30, 2022 | 20,503 | $ | 205 | $ | 157,996 | $ | (18,301) | $ | (4,021) | (1,433) | $ | (11,851) | $ | 124,028 |
| Common Stock |
Additional Paid-in Capital |
Accumulated Deficit |
Accumulated Other Comprehensive Loss |
Treasury Stock |
Total Stockholders' Equity |
|||||||||
| Shares | Amount | Shares | Amount | |||||||||||
| Balance at March 31, 2021 | 20,165 | $ | 202 | $ | 151,657 | $ | (6,430) | $ | (3,009) | (1,433) | $ | (11,851) | $ | 130,569 |
| Net loss | - | - | - | (5,673) | - | - | - | (5,673) | ||||||
| Other comprehensive income | - | - | - | - | 41 | - | - | 41 | ||||||
| Stock-based compensation | - | - | 1,055 | - | - | - | - | 1,055 | ||||||
| Exercise of stock options and issuance of restricted stock awards, net of forfeitures | 80 | - | 884 | - | - | - | - | 884 | ||||||
| Balance at June 30, 2021 | 20,245 | $ | 202 | $ | 153,596 | $ | (12,103) | $ | (2,968) | (1,433) | $ | (11,851) | $ | 126,876 |
| Common Stock |
Additional Paid-in Capital |
Accumulated Deficit |
Accumulated Other Comprehensive Loss |
Treasury Stock |
Total Stockholders' Equity |
|||||||||
| Shares | Amount | Shares | Amount | |||||||||||
| Balance at December 31, 2020 | 19,863 | $ | 199 | $ | 149,170 | $ | (2,402) | $ | (3,232) | (1,433) | $ | (11,851) | $ | 131,884 |
| Net loss | - | - | - | (9,701) | - | - | - | (9,701) | ||||||
| Other comprehensive income | - | - | - | - | 264 | - | - | 264 | ||||||
| Stock-based compensation | - | - | 1,987 | - | - | - | - | 1,987 | ||||||
| Exercise of stock options and issuance of restricted stock awards, net of forfeitures | 382 | 3 | 2,439 | - | - | - | - | 2,442 | ||||||
| Balance at June 30, 2021 | 20,245 | $ | 202 | $ | 153,596 | $ | (12,103) | $ | (2,968) | (1,433) | $ | (11,851) | $ | 126,876 |
See accompanying Notes to Unaudited Consolidated Financial Statements.
6
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
| Six Months Ended | ||||
| June 30, | ||||
| 2022 | 2021 | |||
| Cash flows from operating activities: | ||||
| Net loss | $ | (6,136) | $ | (9,701) |
| Adjustments to reconcile net loss to net cash (used in) provided by operating activities: | ||||
| Provision for doubtful accounts | 367 | 282 | ||
| Depreciation and amortization | 7,158 | 6,963 | ||
| Deferred income taxes | (15) | - | ||
| Loss on disposals of fixed assets | 216 | 597 | ||
|
Compensation expense related to stock-based awards and employee stock purchase plan
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1,586 | 1,987 | ||
| Unrealized currency translation (gain) loss | (361) | 236 | ||
| Gain on sale of KVH Media Group Entertainment Limited | (631) | - | ||
| Changes in operating assets and liabilities: | ||||
| Accounts receivable | (640) | 426 | ||
| Inventories | (6,371) | 2,375 | ||
| Prepaid expenses, other current assets, and current contract assets | (372) | (293) | ||
| Other non-current assets and non-current contract assets | 1,252 | 833 | ||
| Accounts payable | (56) | 293 | ||
| Contract liabilities and long-term contract liabilities | 114 | (592) | ||
| Accrued compensation, product warranty and other | 655 | 1,407 | ||
| Other long-term liabilities | - | 2 | ||
| Net cash (used in) provided by operating activities | $ | (3,234) | $ | 4,815 |
| Cash flows from investing activities: | ||||
| Capital expenditures | (8,012) | (10,521) | ||
| Cash paid for acquisition of intangible asset | (28) | (32) | ||
| Proceeds from sale of fixed assets | - | 100 | ||
| Proceeds from the sale of KVH Media Group Entertainment Limited, net of cash sold | 2,378 | - | ||
| Purchases of marketable securities | (10) | (4) | ||
| Maturities and sales of marketable securities | 8,000 | - | ||
| Net cash provided by (used in) investing activities | $ | 2,328 | $ | (10,457) |
| Cash flows from financing activities: | ||||
| Proceeds from stock options exercised and employee stock purchase plan | 333 | 2,473 | ||
| Payment of finance lease | (132) | (162) | ||
| Net cash provided by financing activities | $ | 201 | $ | 2,311 |
| Effect of exchange rate changes on cash and cash equivalents | (276) | (24) | ||
| Net decrease in cash and cash equivalents | (981) | (3,355) | ||
| Cash and cash equivalents at beginning of period | 11,376 | 12,578 | ||
| Cash and cash equivalents at end of period | $ | 10,395 | $ | 9,223 |
| Supplemental disclosure of non-cash investing and financing activities: | ||||
| Changes in accrued other and accounts payable related to property and equipment additions | $ | 188 | $ | 281 |
| Taxes accrued for net share settlement of options | $ | 131 | $ | - |
See accompanying Notes to Unaudited Consolidated Financial Statements.
7
KVH INDUSTRIES, INC. AND SUBSIDIARIES
Notes to Consolidated Interim Financial Statements
(Unaudited, all amounts in thousands except per share amounts)
(1) Description of Business
KVH Industries, Inc. (together with its subsidiaries, the Company or KVH) designs, develops, manufactures and markets mobile connectivity products and services for the marine and land markets, and inertial navigation products for both the commercial and defense markets. KVH's reporting segments are as follows:
•the mobile connectivity segment and
•the inertial navigation segment.
KVH's mobile connectivity products enable customers to receive voice and Internet services, and live digital television via satellite services in marine vessels, recreational vehicles, buses and automobiles. KVH sells its mobile connectivity products through an extensive international network of dealers and distributors. KVH also sells and leases products to service providers and directly to end users.
KVH's mobile connectivity service sales represent primarily sales earned from satellite voice and Internet airtime services. KVH provides, for monthly fixed and usage fees, satellite connectivity services, including broadband Internet, data and Voice over Internet Protocol (VoIP) services, to its TracPhone V-series customers. AgilePlans, a mini-VSAT Broadband service offering, is a monthly subscription model providing global connectivity to commercial maritime customers, including hardware, installation, broadband Internet, VoIP, entertainment and training content and global support for a monthly fee with no minimum commitment. KVH offers AgilePlans customers a variety of airtime data plans with varying data speeds and fixed data usage levels with overage charges per megabyte, which is similar to the plans that the Company offers to its other customers. The Company recognizes the monthly subscription fee as service revenue over the service delivery period. The Company retains ownership of the hardware that it provides to AgilePlans customers, who must return the hardware to KVH if they decide to terminate the service. Because KVH does not sell the hardware under AgilePlans, the Company does not recognize any product revenue when the hardware is deployed to an AgilePlans customer. KVH records the cost of the hardware used by AgilePlans customers as revenue-generating assets and depreciates the cost over an estimated useful life of five years. Since the Company is retaining ownership of the hardware, it does not accrue any warranty costs for AgilePlans hardware; however, any maintenance costs on the hardware are expensed in the period these costs are incurred.
Mobile connectivity service sales also include the distribution of commercially licensed entertainment, including news, sports, music, and movies to commercial and leisure customers in the maritime, hotel, and retail markets through the KVH Media Group. KVH also earns monthly usage fees from third-party satellite connectivity services, including voice, data and Internet services, provided to its Inmarsat and Iridium customers who choose to activate their subscriptions with KVH. Mobile connectivity service sales also include engineering services provided under development contracts, sales from product repairs, and extended warranty sales.
KVH's inertial navigation products offer precision fiber optic gyro (FOG)-based systems that enable platform and optical stabilization, navigation, pointing and guidance. KVH's inertial navigation products also include tactical navigation systems that provide uninterrupted access to navigation and pointing information in a variety of military vehicles, including tactical trucks and light armored vehicles. KVH's inertial navigation products are sold directly to U.S. and foreign governments and government contractors, as well as through an international network of authorized independent sales representatives. In addition, KVH's inertial navigation technology is used in numerous commercial products, such as navigation and positioning systems for various applications including autonomous platforms, precision mapping, dynamic surveying, train location control and track geometry measurement systems, industrial robotics and optical stabilization.
KVH's inertial navigation service sales include product repairs, engineering services provided under development contracts and extended warranty sales.
8
(2) Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated interim financial statements of KVH Industries, Inc. and its wholly owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company has evaluated all subsequent events through the date of this filing. All significant intercompany accounts and transactions have been eliminated in consolidation.
The consolidated interim financial statements have not been audited by the Company's independent registered public accounting firm and include all adjustments (consisting of only normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial condition, results of operations, and cash flows for the periods presented. These consolidated interim financial statements do not include all disclosures associated with annual financial statements and accordingly should be read in conjunction with the Company's consolidated financial statements and related notes included in the Company's annual report on Form 10-K for the year ended December 31, 2021 filed on March 11, 2022 with the Securities and Exchange Commission. The results for the three and six months ended June 30, 2022 are not necessarily indicative of operating results for the remainder of the year.
Significant Estimates and Assumptions and Other Significant Non-Recurring Transactions
The preparation of interim financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the interim financial statements and the reported amounts of sales and expenses during the reporting periods. As described in the Company's annual report on Form 10-K, the estimates and assumptions used by management affect the Company's revenue recognition, valuation of accounts receivable, valuation of inventory, expected future cash flows including growth rates, discount rates, terminal values and other assumptions and estimates used to evaluate the recoverability of long-lived assets and goodwill, estimated fair values of long-lived assets, including goodwill, amortization methods and periods, certain accrued expenses and other related charges, stock-based compensation, contingent liabilities, forfeitures and key valuation assumptions for its share-based awards, estimated fulfillment costs for warranty obligations, tax reserves and recoverability of the Company's net deferred tax assets and related valuation allowance, and the valuation of right-of-use assets and lease liabilities.
Although the Company regularly assesses these estimates, actual results could differ materially from these estimates. Changes in estimates are recorded in the period in which they become known. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances.
On March 7, 2022, the Company announced that its President and Chief Executive Officer, Martin Kits van Heyningen, was retiring from his executive and Board roles after more than 40 years of service and assuming a consulting position with the Company. Brent C. Bruun, its then Chief Operating Officer, was appointed as its interim President and Chief Executive Officer. Subsequently, on June 15, 2022, he was appointed as its President and Chief Executive Officer and as a Class II member of the Board of Directors. As of March 31, 2022, the Company accrued approximately $539 in consulting fees associated with a maximum of 50 hours of transition services through March 2023, which will be paid to Mr. Kits van Heyningen over the next 12 months. Approximately $405 is accrued as of June 30, 2022. In addition, the Company agreed to a separation payment of $201, which was inclusive of any amount which he may have otherwise earned under the executive bonus plan for 2021, which was paid in April 2022. The associated expenses were included in general and administrative expenses in the accompanying consolidated statements of operations. There were also modifications to Mr. Kits van Heyningen's stock option and restricted stock awards. Please see Note 5 for further discussion.
In March 2022, the Company also restructured its operations to reduce costs and better pursue a more focused strategy. The Company reduced its workforce by approximately 10% and began incurring reduced expenses from these actions beginning in the second quarter of 2022. For the three months ended June 30, 2022, the Company incurred $426 in severance payments and other employee benefit costs for employees which had a severance date of June 30, 2022 and December 31, 2022 (as amended), of which $64 was paid as of June 30, 2022. For the six months ended June 30, 2022, the Company incurred $1,818 in severance and health insurance costs and $327 in legal and advisory fees. The combined expense of $2,145 was included in the financial statement line items of the accompanying consolidated statements of operations as follows: costs of product sales of $17, costs of service sales of $55, research and development of $392, sales, marketing and support of $894, and general and administrative expenses of $787. The Company expects to incur an additional $155 in severance payments and other employee benefit costs through December 31, 2022 arising from this restructuring. The Company also modified impacted employee's stock option and restricted stock awards. Please see Note 5 for further discussion.
9
On April 29, 2022, KVH Media Group Limited, the Company's wholly owned subsidiary, sold its subsidiary KVH Media Group Entertainment Limited, which was in the KVH Media Group reporting unit of the Company's mobile connectivity segment, for net cash proceeds of $2,378. This transaction did not meet the criteria as a discontinued operation under ASC 205-20. The Company recorded a gain on the sale of approximately $630, which is recorded in other income, net in the accompanying consolidated statements of operations. See Note 14 for the reduction of goodwill and intangibles associated with the KVH Media Group reporting unit as it relates to the sale of this subsidiary.
In May 2022, the Company entered into executive employment agreements with each of Brent C. Bruun, Roger A. Kuebel, Felise Feingold and Robert Balog in order to retain their services and provide them with certain benefits in the event that the Company terminates the executive's employment without cause (as defined in the agreement) or the executive terminates his or her employment for good reason (as defined in the agreement) (either such termination, a "Qualifying Termination"), including following a change of control. The terms of the agreements are substantially identical except as to title, salary, target bonus and reporting responsibilities. The agreements provide that, if the executive continues to serve as an employee through December 31, 2022 (the "Retention Date"), the Company will pay the executive a retention bonus equal to 75% of the executive's base salary on the agreement date, and the Company will accelerate the vesting of the executive's equity awards that would otherwise have vested in the twelve months after the Retention Date. Please see Note 5 for further discussion regarding the equity compensation modifications. If a Qualifying Termination occurs before December 31, 2022, the executive will receive a pro rata portion of the retention bonus. If in connection with such a termination the executive becomes entitled to receive the change in control severance payments and benefits, the executive will also become entitled to receive the full retention bonus, and the Retention Date will be the later of the date of such change in control or such termination of employment. For the three months ended June 30, 2022, the Company accrued approximately $263 for the executive employment agreements.
(3) Accounting Standards Issued and Not Yet Adopted
ASC Update No. 2016-13, ASC Update No. 2018-19, ASC Update No. 2019-04, ASC Update No. 2019-05, ASC Update No. 2019-10, ASC Update No. 2019-11, ASC Update No. 2020-02, and ASC Update No. 2022-02
In June 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Codification (ASC) Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The purpose of Update No. 2016-13 is to replace the incurred loss impairment methodology for financial assets measured at amortized cost with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information, including forecasted information, to develop credit loss estimates.
In November 2018, the FASB issued ASC Update No. 2018-19, Codification Improvements to Topic 326, Financial Instruments-Credit Losses. This update introduced an expected credit loss methodology for the impairment of financial assets measured at amortized cost. The amendment also clarifies that receivables arising from operating leases are not within the scope of Subtopic 326-20. Instead, impairment of receivables arising from operating leases should be accounted for in accordance with Topic 842, Leases.
In May 2019, the FASB issued ASC Update No. 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. This update introduced clarifications of the Board's intent with respect to accrued interest, the transfer between classifications or categories for loans and debt securities, recoveries, reinsurance recoverables, projects of interest rate environments for variable-rate financial instruments, costs to sell when foreclosure is probable, consideration of expected prepayments when determining the effective interest rate, vintage disclosures, and extension and renewal options.
In May 2019, the FASB issued ASC Update No. 2019-05, Financial Instruments-Credit Losses (Topic 326): Targeted Transition Relief. The amendments in the update ease the transition for entities adopting ASC Update 2016-13 and increase the comparability of financial statement information. With the exception of held-to-maturity debt securities, the amendments allow entities to irrevocably elect to apply the fair value option to financial instruments that were previously recorded at amortized cost basis within the scope of Subtopic 326-20, Financial Instruments-Credit Losses-Measured at Amortized Cost.
In November 2019, the FASB issued ASC Update No. 2019-10, Financial Instruments-Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates.The amendments in this update change some effective dates for certain new accounting standards including those pertaining to Topic 326 discussed above, for certain types of entities.
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In November 2019, the FASB issued ASC Update No. 2019-11, Codification Improvements to Topic 326, Financial Instruments-Credit Losses (Topic 326).The update is effective for entities that have adopted ASU 2016-13. The purpose of Update No. 2019-11 is to clarify the scope of the recovery guidance to purchased financial assets with credit deterioration.
In February 2020, the FASB issued ASC Update No. 2020-02, Financial Instruments - Credit Losses (Topic 326) and
Leases (Topic 842).The purpose of Update No. 2020-02 is to clarify the scope and interpretation of the standard.
In March 2022, the FASB issued ASC update 2022-02, Financial Instruments - Credit Losses (Topic 326) - Troubled Debt Restructurings and Vintage Disclosures. The vintage disclosure portion of this guidance is applicable to the Company, which requires that an entity disclose current-period gross write-offs by year of origination for financing receivables and net investment in leases within the scope of Subtopic 326-20. Gross write-off information must included the amortized cost basis of financing receivables by credit-quality indicator and class of financing receivable by year of origination.
As a smaller reporting company the effective date for Topic 326 will be the fiscal year beginning after December 15, 2022. The adoption of Update Nos. 2016-13, 2018-19, 2019-04, 2019-05, 2019-10, 2019-11, 2020-20 and 2022-02 is not expected to have a material impact on the Company's financial position or results of operations.
There are no other recent accounting pronouncements issued by the FASB that the Company expects would have a material impact on the Company's financial statements.
(4) Marketable Securities
Marketable securities as of June 30, 2022 and December 31, 2021 consisted of the following:
| June 30, 2022 |
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
||||
| Money market mutual funds | $ | 5,157 | $ | - | $ | - | $ | 5,157 |
| Total marketable securities designated as available-for-sale | $ | 5,157 | $ | - | $ | - | $ | 5,157 |
| December 31, 2021 |
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
||||
| Money market mutual funds | $ | 13,147 | $ | - | $ | - | $ | 13,147 |
| Total marketable securities designated as available-for-sale | $ | 13,147 | $ | - | $ | - | $ | 13,147 |
Interest income from marketable securities was $9 and $2 during the three months ended June 30, 2022 and 2021, respectively, and $10 and $4 during the six months ended June 30, 2022 and 2021, respectively.
(5) Stockholder's Equity
(a) Stock Equity and Incentive Plan
The Company recognizes stock-based compensation in accordance with the provisions of ASC Topic 718, Compensation-Stock Compensation. Stock-based compensation expense was $701 and $1,033, excluding $4 and $22 of compensation charges related to our Amended and Restated 1996 Employee Stock Purchase Plan, or the ESPP, for the three months ended June 30, 2022 and 2021, respectively, and $1,560 and $1,957, excluding $26 and $30 of compensation charges related to ESPP, for the six months ended June 30, 2022 and 2021, respectively. As of June 30, 2022, there was $3,286 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted-average period of 2.79 years. As of June 30, 2022, there was $3,499 of total unrecognized compensation expense related to restricted stock awards, which is expected to be recognized over a weighted-average period of 2.85 years.
Stock Options
During the three months ended June 30, 2022, the Company issued 18 shares of common stock upon the exercise of stock options and received $149 as payment for the exercise price. No shares were surrendered to the Company to satisfy minimum tax withholding obligations. Additionally, during the three months ended June 30, 2022, 398 stock options were granted and 159 stock options expired, were canceled or were forfeited.
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During the six months ended June 30, 2022, upon the net exercise of 248 stock options, the Company issued 41 shares of common stock and received $149 as payment for the exercise price, 14 shares were surrendered to the Company to satisfy minimum tax withholding obligations, and 193 shares were cancelled. Additionally, during the six months ended June 30, 2022, 398 stock options were granted and 329 stock options expired, were canceled or were forfeited. During the six months ended June 30, 2021, 496 stock options were granted. The Company has estimated the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model. The weighted average assumptions utilized to determine the fair value of options granted during the six months ended June 30, 2022 are as follows:
| Six Months Ended June 30, | ||||
| 2022 | 2021 | |||
| Risk-free interest rate | 2.97 | % | 0.92 | % |
| Expected volatility | 43.16 | % | 44.98 | % |
| Expected life (in years) | 4.24 | 4.28 | ||
| Dividend yield | 0 | % | 0 | % |
During the six months ended June 30, 2022, there were accelerated vesting and extended exercise term modifications of stock options as it related to the retirement of Mr. Kits van Heyningen, which resulted in a reduction of approximately $85 in compensation cost. During the three and six months ended June 30, 2022, there were accelerated vesting term modifications of stock options for employees terminated as part of the Company's restructuring, which resulted in a reduction of approximately $81 in compensation cost. During the three months ended June 30, 2022, there were accelerated vesting term modifications of stock options for executive employment agreements, which resulted in an acceleration of compensation expense of approximately $48.
As of June 30, 2022, there were 1,948 options outstanding with a weighted average exercise price of $9.83 per share and 858 options exercisable with a weighted average exercise price of $10.39 per share.
Restricted Stock
During the three months ended June 30, 2022, 183 shares of restricted stock were granted with a weighted average grant date fair value of $8.29 per share and 26 shares of restricted stock were forfeited. Additionally, during the three months ended June 30, 2022, 79 shares of restricted stock vested, of which no shares of common stock were surrendered to the Company as payment by employees in lieu of cash to satisfy minimum tax withholding obligations in connection with the vesting of restricted stock.
During the six months ended June 30, 2022, 183 shares of restricted stock were granted with a weighted average grant date fair value of $8.29 per share and 86 shares of restricted stock were forfeited. Additionally, during the six months ended June 30, 2022, 147 shares of restricted stock vested, of which no shares of common stock were surrendered to the Company as payment by employees in lieu of cash to satisfy minimum tax withholding obligations in connection with the vesting of restricted stock.
As of June 30, 2022, there were 440 shares of restricted stock outstanding that were still subject to service-based vesting conditions. During the six months ended June 30, 2022, there were accelerated vesting term modifications of restricted stock as it related to the retirement of Mr. Kits van Heyningen, which resulted in an acceleration in compensation expense of approximately $186. During the three and six months ended June 30, 2022, there were accelerated vesting term modifications of restricted stock for employees terminated as part of the Company's restructuring, which resulted in an acceleration in compensation expense of approximately $57 for the three months ended June 30, 2022 and approximately $125 for the six months ended June 30, 2022. During the three months ended June 30, 2022, there were accelerated vesting term modifications of restricted stock for executive employment agreements, which resulted in an acceleration in compensation expense of approximately $66.
As of June 30, 2022, the Company had no unvested outstanding options and no outstanding shares of restricted stock that were subject to performance-based or market-based vesting conditions.
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(b) Employee Stock Purchase Plan
The Company's ESPP affords eligible employees the right to purchase common stock, via payroll deductions, through various offering periods at a purchase price equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower. During the three and six months ended June 30, 2022, 0 and 22 shares were issued under the ESPP plan, respectively. During the three and six months ended June 30, 2021, no shares were issued under the ESPP plan. The Company recorded compensation charges related to the ESPP of $4 and $22 for the three months ended June 30, 2022 and 2021, respectively, and $26 and $30 for the six months ended June 30, 2022 and 2021, respectively.
(c) Stock-Based Compensation Expense
The following table presents stock-based compensation expense, including under the ESPP, in the Company's consolidated statements of operations for the three and six months ended June 30, 2022 and 2021:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||
| 2022 | 2021 | 2022 | 2021 | |||||
| Cost of product sales | $ | 61 | $ | 70 | $ | 135 | $ | 116 |
| Cost of service sales | 3 | 3 | 5 | 5 | ||||
| Research and development | 190 | 185 | 331 | 341 | ||||
| Sales, marketing and support | 25 | 235 | 211 | 425 | ||||
| General and administrative | 426 | 562 | 904 | 1,100 | ||||
| $ | 705 | $ | 1,055 | $ | 1,586 | $ | 1,987 |
(d) Accumulated Other Comprehensive Loss (AOCL)
Comprehensive loss includes net loss and unrealized gains and losses from foreign currency translation. The components of the Company's comprehensive loss and the effect on earnings for the periods presented are detailed in the accompanying consolidated statements of comprehensive loss.
The balances for the three months ended June 30, 2022 and 2021 are as follows:
| Foreign Currency Translation | Total Accumulated Other Comprehensive Loss | |||
| Balance, March 31, 2022 | $ | (3,602) | $ | (3,602) |
| Other comprehensive loss | (419) | (419) | ||
| Net other comprehensive loss | (419) | (419) | ||
| Balance, June 30, 2022 | $ | (4,021) | $ | (4,021) |
| Foreign Currency Translation | Total Accumulated Other Comprehensive Loss | |||
| Balance, March 31, 2021 | $ | (3,009) | $ | (3,009) |
| Other comprehensive income | 41 | 41 | ||
| Net other comprehensive income | 41 | 41 | ||
| Balance, June 30, 2021 | $ | (2,968) | $ | (2,968) |
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The balances for the six months ended June 30, 2022 and 2021 are as follows:
| Foreign Currency Translation | Total Accumulated Other Comprehensive Loss | |||
| Balance, December 31, 2021 | $ | (3,409) | $ | (3,409) |
| Other comprehensive loss | (612) | (612) | ||
| Net other comprehensive loss | (612) | (612) | ||
| Balance, June 30, 2022 | $ | (4,021) | $ | (4,021) |
| Foreign Currency Translation | Total Accumulated Other Comprehensive Loss | |||
| Balance, December 31, 2020 | $ | (3,232) | $ | (3,232) |
| Other comprehensive income | 264 | 264 | ||
| Net other comprehensive income | 264 | 264 | ||
| Balance, June 30, 2021 | $ | (2,968) | $ | (2,968) |
(6) Net Loss per Common Share
Basic net loss per share is calculated based on the weighted average number of common shares outstanding during the period. Diluted net income per share incorporates the dilutive effect of common stock equivalent options, warrants and other convertible securities, if any, as determined with the treasury stock accounting method. For the three and six months ended June 30, 2022, since there was a net loss, the Company excluded all 2,035 and 1,802, respectively, in outstanding stock options and non-vested restricted shares from its diluted loss per share calculation, as inclusion of these securities would have reduced the net loss per share. For the three and six months ended June 30, 2021, since there was a net loss, the Company excluded all 986 and 763, respectively, in outstanding stock options and non-vested restricted shares from its diluted loss per share calculation, as inclusion of these securities would have reduced the net loss per share.
A reconciliation of the basic and diluted weighted average common shares outstanding is as follows:
| Three Months Ended | Six Months Ended | |||
| June 30, | June 30, | |||
| 2022 | 2021 | 2022 | 2021 | |
| Weighted average common shares outstanding-basic | 18,564 | 18,174 | 18,507 | 18,057 |
| Dilutive common shares issuable in connection with stock plans | - | - | - | - |
| Weighted average common shares outstanding-diluted | 18,564 | 18,174 | 18,507 | 18,057 |
(7) Inventories
Inventories, net are stated at the lower of cost and net realizable value using the first-in first-out costing method. Inventories as of June 30, 2022 and December 31, 2021 include the costs of material, labor, and factory overhead. Components of inventories consist of the following:
|
June 30, 2022 |
December 31, 2021 |
|||
| Raw materials | $ | 20,452 | $ | 15,772 |
| Work in process | 5,398 | 4,035 | ||
| Finished goods | 5,131 | 4,833 | ||
| $ | 30,981 | $ | 24,640 |
During the second quarter of 2022, the Company recorded an inventory reserve of $1,572 relating to a specialized component in its TACNAV product line. This component was originally purchased in anticipation of an order from a long-standing customer; however, that order never materialized. The Company has had a number of potential opportunities for the
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sale of this component, but at this time the remaining opportunities appear limited and given the age of the component the Company determined to book a reserve for the component's full value.
(8) Property and Equipment
Property and equipment, net, as of June 30, 2022 and December 31, 2021 consist of the following:
|
June 30, 2022 |
December 31, 2021 |
|||
| Land | $ | 3,828 | $ | 3,828 |
| Building and improvements | 24,288 | 24,271 | ||
| Leasehold improvements | 463 | 472 | ||
| Machinery and equipment | 17,256 | 16,790 | ||
| Revenue-generating assets | 68,867 | 63,587 | ||
| Office and computer equipment | 15,211 | 15,395 | ||
| Motor vehicles | 31 | 31 | ||
| 129,944 | 124,374 | |||
| Less accumulated depreciation | (69,230) | (64,260) | ||
| $ | 60,714 | $ | 60,114 |
Depreciation expense was $3,466 and $3,333 for the three months ended June 30, 2022 and 2021, respectively, and $6,839 and $6,407 for the six months ended June 30, 2022 and 2021, respectively.
Certain revenue-generating hardware assets are utilized by the Company in the delivery of the Company's airtime services, media and other content.
(9) Product Warranty
The Company's products carry standard limited warranties that range from oneto two years and vary by product. The warranty period begins on the date of retail purchase or lease by the original purchaser. The Company accrues estimated product warranty costs at the time of sale and any additional amounts are recorded when such costs are probable and can be reasonably estimated. Factors that affect the Company's warranty liability include the number of units sold or leased, historical and anticipated rates of warranty repairs and the cost per repair. Warranty and related costs are reflected within sales, marketing and support in the accompanying consolidated statements of operations. As of June 30, 2022 and December 31, 2021, the Company had accrued product warranty costs of $1,398 and $1,179, respectively.
The following table summarizes product warranty activity during 2022 and 2021:
| Six Months Ended | ||||
| June 30, | ||||
| 2022 | 2021 | |||
| Beginning balance | $ | 1,179 | $ | 1,812 |
| Charges to expense | 679 | 224 | ||
| Costs incurred | (460) | (441) | ||
| Ending balance | $ | 1,398 | $ | 1,595 |
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(10) Debt
In May 2020, the Company received a $6,927 loan (the PPP Loan) from Bank of America, N.A., (the Lender) under the Paycheck Protection Program (PPP), which was established under the Coronavirus Aid, Relief, and Economic Security Act (as modified by the Paycheck Protection Flexibility Act of 2020, the CARES Act) and is administered by the U.S. Small Business Administration (the SBA).
The term of the PPP Loan was two years from the funding date, and the interest rate was 1.00%. Interest on the loan accrued from the funding date, but was deferred. In August 2021, the Company applied for forgiveness of the full amount of the PPP Loan. On September 24, 2021, the Company received notification from the Lender that, on September 19, 2021, the SBA had determined that the PPP Loan forgiveness application was approved, and the PPP Loan, including all accrued interest thereon, was paid in full by the SBA.
Line of Credit
Effective October 30, 2018, the Company entered into an amended and restated three-year senior secured credit facility agreement (the 2018 Credit Agreement) with Bank of America, N.A., as Administrative Agent, and the lenders named from time to time as parties thereto (the 2018 Lenders), which included a reducing revolving credit facility (the 2018 Revolver) of up to $20,000 initially and reducing to $15,000 on December 31, 2019, to be used for general corporate purposes. The Company's obligations under the 2018 Credit Agreement are secured by substantially all of its assets and the pledge of equity interests in certain of its subsidiaries. As of June 30, 2022, no amounts were outstanding under the 2018 Revolver.
Borrowings under the 2018 Revolver are subject to the satisfaction of various conditions precedent at the time of each borrowing, including the continued accuracy of the Company's representations and warranties and the absence of any default under the 2018 Credit Agreement. As of June 30, 2022, the full balance of the $15,000 facility was available for borrowing.
The 2018 Credit Agreement contained two financial covenants, a maximum Consolidated Leverage Ratio and a minimum Consolidated Fixed Charge Coverage Ratio, each as defined in the 2018 Credit Agreement. The Consolidated Leverage Ratio could not exceed 2.50:1.00 through December 31, 2020 and may not exceed 2.00:1.00 after December 31, 2020. The Consolidated Fixed Charge Coverage Ratio may not be less than 1.25:1.00.
On July 30, 2020, the Company amended the 2018 Credit Agreement to reflect the incurrence of the PPP Loan. Under the amended facility, the principal and interest on the PPP Loan were not included in the maximum Consolidated Leverage Ratio or the minimum Consolidated Fixed Charge Coverage Ratio calculations except as to any portion of the PPP Loan that is not ultimately forgiven. In September 2021, the PPP Loan was forgiven in full.
On October 29, 2021, the Company amended the 2018 Credit Agreement to maintain the $15,000 2018 Revolver, extend the maturity date of the 2018 Revolver to October 28, 2022, eliminate the Consolidated Fixed Charge Coverage Ratio financial covenant, add a minimum trailing four-quarter Consolidated Adjusted EBITDA financial covenant of $3,000, modify the definition of Consolidated Adjusted EBITDA, modify the interest rate margins and certain lender fees, and transition the interest rate provisions based on LIBOR to the Bloomberg Short Term Bank Yield Index. In addition, Bank of America became the sole lender under the 2018 Credit Agreement. The Company was in compliance with these financial covenants as of June 30, 2022.
The 2018 Credit Agreement imposes certain other affirmative and negative covenants, including without limitation covenants with respect to the payment of taxes and other obligations, compliance with laws, performance of material contracts, creation of liens, incurrence of indebtedness, investments, dispositions, fundamental changes, restricted payments, changes in the nature of the Company's business, transactions with affiliates, corporate and accounting changes, and sale and leaseback arrangements.
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(11) Segment Reporting
The Company's reportable segments are mobile connectivity and inertial navigation. The financial results of each segment are based on revenues from external customers, costs of revenue and operating expenses that are directly attributable to the segment and an allocation of costs from shared functions. These shared functions include, but are not limited to, facilities, human resources, information technology, and engineering. Allocations are made based on management's judgment of the most relevant factors, such as head count, number of customer sites, or other operational data that contribute to the shared costs. Certain corporate-level costs have not been allocated as they are not directly attributable to either segment. These costs primarily consist of broad corporate functions, including executive, legal, finance, and costs associated with corporate actions. Segment-level asset information has not been provided as such information is not reviewed by the chief operating decision-maker for purposes of assessing segment performance and allocating resources. There are no significant inter-segment sales or transactions.
The Company's performance is impacted by the levels of activity in the marine and land mobile markets and defense sectors, among others. Performance in any particular period could be impacted by the timing of sales to certain large customers.
The mobile connectivity segment primarily manufactures and distributes a comprehensive family of mobile satellite antenna products and services that provide access to television, the Internet and voice services while on the move. Product sales within the mobile connectivity segment accounted for 16% and 19% of the Company's consolidated net sales for the three months ended June 30, 2022 and 2021, respectively, and 16% and 17% of the Company's consolidated net sales for the six months ended June 30, 2022 and 2021, respectively. Service sales of mini-VSAT Broadband airtime service accounted for 62% and 53% of the Company's consolidated net sales for the three months ended June 30, 2022 and 2021, respectively, and 60% and 52% of the Company's consolidated net sales for the six months ended June 30, 2022 and 2021, respectively.
The inertial navigation segment manufactures and distributes a portfolio of digital compass and fiber optic gyro (FOG)-based systems that address the rigorous requirements of military and commercial customers and provide reliable, easy-to-use and continuously available navigation and pointing data. The principal product categories in this segment include the FOG-based inertial measurement units (IMUs) for precision guidance, FOGs for tactical navigation as well as pointing and stabilization systems, and digital compasses that provide accurate heading information for demanding applications, security, automation and access control equipment and systems. Sales of FOG-based guidance and navigation systems within the inertial navigation segment accounted for 15% and 17% of the Company's consolidated net sales for the three months ended June 30, 2022 and 2021, respectively, and 16% of the Company's consolidated net sales for both the six months ended June 30, 2022 and 2021.
No other single product class accounts for 10% or more of the Company's consolidated net sales.
The Company operates in a number of major geographic areas, including internationally. Revenues from international locations primarily include Canada, European Union countries, and other European countries, as well as countries in Africa, Asia/Pacific, the Middle East, and India. Revenues are based upon customer location and internationally represented 63% and 60% of consolidated net sales for the three months ended June 30, 2022 and 2021, respectively, and 63% and 61% of consolidated net sales for the six months ended June 30, 2022 and 2021, respectively. Sales to Singapore customers represented 13% and 10% of the Company's consolidated net sales for the three months ended June 30, 2022 and 2021, respectively. No other individual foreign country represented 10% or more of the Company's consolidated net sales for the three months ended June 30, 2022 and 2021. Sales to Singapore customers represented 13% and 10% of the Company's consolidated net sales for the six months ended June 30, 2022 and 2021, respectively. No other individual foreign country represented 10% or more of the Company's consolidated net sales for the six months ended June 30, 2022 and 2021.
As of June 30, 2022 and December 31, 2021, the long-lived tangible assets related to the Company's international subsidiaries were less than 10% of the Company's long-lived tangible assets.
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Net sales and operating income (loss) for the Company's reporting segments and the Company's loss before income tax expense (benefit) for the three and six months ended June 30, 2022 and 2021 were as follows:
| Three Months Ended | Six Months Ended | |||||||
| June 30, | June 30, | |||||||
| 2022 | 2021 | 2022 | 2021 | |||||
| Net sales: | ||||||||
| Mobile connectivity | $ | 34,553 | $ | 33,755 | $ | 67,704 | $ | 64,262 |
| Inertial navigation | 7,284 | 9,608 | 15,227 | 21,393 | ||||
| Consolidated net sales | $ | 41,837 | $ | 43,363 | $ | 82,931 | $ | 85,655 |
| Operating income (loss): | ||||||||
| Mobile connectivity | $ | 4,525 | $ | 580 | $ | 5,830 | $ | 183 |
| Inertial navigation | (1,289) | 645 | (1,749) | 2,735 | ||||
| Subtotal | 3,236 | 1,225 | 4,081 | 2,918 | ||||
| Unallocated, net | (5,568) | (7,027) | (11,121) | (12,327) | ||||
| Loss from operations | (2,332) | (5,802) | (7,040) | (9,409) | ||||
| Net interest and other income (expense), net | 1,123 | 207 | 1,468 | (367) | ||||
| Loss before income tax expense (benefit) | $ | (1,209) | $ | (5,595) | $ | (5,572) | $ | (9,776) |
Depreciation expense and amortization expense for the Company's reporting segments for the three and six months ended June 30, 2022 and 2021 were as follows:
| Three Months Ended | Six Months Ended | |||||||
| June 30, | June 30, | |||||||
| 2022 | 2021 | 2022 | 2021 | |||||
| Depreciation expense: | ||||||||
| Mobile connectivity | $ | 3,003 | $ | 2,779 | $ | 5,895 | $ | 5,300 |
| Inertial navigation | 296 | 384 | 604 | 768 | ||||
| Unallocated | 167 | 170 | 340 | 339 | ||||
| Total consolidated depreciation expense | $ | 3,466 | $ | 3,333 | $ | 6,839 | $ | 6,407 |
| Amortization expense: | ||||||||
| Mobile connectivity | $ | 125 | $ | 280 | $ | 319 | $ | 556 |
| Inertial navigation | - | - | - | - | ||||
| Unallocated | - | - | - | - | ||||
| Total consolidated amortization expense | $ | 125 | $ | 280 | $ | 319 | $ | 556 |
(12) Legal Matters
In the ordinary course of business, the Company is a party to inquiries, legal proceedings and claims including, from time to time, disagreements with vendors and customers. The Company is not a party to any lawsuit or proceeding that, in management's opinion, is likely to materially harm the Company's business, results of operations, financial condition, or cash flows.
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(13) Fair Value Measurements
ASC Topic 820, Fair Value Measurements and Disclosures(ASC 820), provides a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes three levels of inputs that may be used to measure fair value:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. The Company's Level 1 assets are investments in money market mutual funds.
Level 2: Quoted prices for similar assets or liabilities in active markets; or observable prices that are based on observable market data, based on directly or indirectly market-corroborated inputs. The Company has no Level 2 assets or liabilities.
Level 3: Unobservable inputs that are supported by little or no market activity, and are developed based on the best information available given the circumstances. The Company has no Level 3 assets.
Assets and liabilities measured at fair value are based on the valuation techniques identified in the table below.
The following tables present financial assets and liabilities at June 30, 2022 and December 31, 2021 for which the Company measures fair value on a recurring basis, by level, within the fair value hierarchy:
| June 30, 2022 | Total | Level 1 | Level 2 | Level 3 |
Valuation Technique |
||||
| Assets | |||||||||
| Money market mutual funds | $ | 5,157 | $ | 5,157 | $ | - | $ | - | (a) |
| December 31, 2021 | Total | Level 1 | Level 2 | Level 3 |
Valuation Technique |
||||
| Assets | |||||||||
| Money market mutual funds | $ | 13,147 | $ | 13,147 | $ | - | $ | - | (a) |
(a)Market approach-prices and other relevant information generated by market transactions involving identical or comparable assets.
The carrying amount of certain financial instruments approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses. The carrying amount of the Company's operating and financing lease liabilities approximates fair value based on currently available quoted rates of similarly structured borrowings.
Assets Measured and Recorded at Fair Value on a Nonrecurring Basis
The Company's non-financial assets, such as goodwill, intangible assets, and other long-lived assets resulting from business combinations, are measured at fair value using income approach valuation methodologies at the date of acquisition and subsequently re-measured if indications of impairment exist. There was no impairment of the Company's non-financial assets noted as of June 30, 2022. The Company does not have any liabilities that are recorded at fair value on a non-recurring basis.
(14) Goodwill and Intangible Assets
Goodwill
The following table sets forth the changes in the carrying amount of goodwill for the six months ended June 30, 2022:
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| Amounts | ||
|
Balance at December 31, 2021
|
$ | 6,570 |
| Sale of KVH Media Group Entertainment Limited | (1,038) | |
| Foreign currency translation adjustment | (219) | |
|
Balance at June 30, 2022
|
$ | 5,313 |
Intangible Assets
The changes in the carrying amount of intangible assets during the six months ended June 30, 2022 are as follows:
| Amounts | ||
|
Balance at December 31, 2021
|
$ | 1,287 |
| Amortization expense | (319) | |
| Intangible assets acquired in asset acquisition | 28 | |
| Sale of KVH Media Group Entertainment Limited | (352) | |
| Foreign currency translation adjustment | (80) | |
|
Balance at June 30, 2022
|
$ | 564 |
Intangible assets arose from the acquisition of KVH Media Group (acquired as Headland Media Limited) in May 2013. These intangible assets are being amortized on a straight-line basis over the estimated useful life of 10 years for acquired subscriber relationships. The intangible assets were recorded in pounds sterling and fluctuations in exchange rates cause these amounts to increase or decrease from time to time. As a result of the sale of KVH Media Group Entertainment Limited in April 2022, the Company determined the goodwill and intangible assets associated with this business based on an income approach which estimated the fair value of the reporting unit before and after the sale, and included such amounts in the determination of the gain on sale of the subsidiary.
In January 2017, the Company completed the acquisition of certain subscriber relationships from a third party. This acquisition did not meet the definition of a business under ASC 2017-01, Business Combinations (Topic 805)-Clarifying the Definition of a Business, which the Company adopted on October 1, 2016. The Company ascribed $100 of the initial purchase price to the acquired subscriber relationships definite-lived intangible assets with an initial estimated useful life of 10 years. Under the asset purchase agreement, the purchase price includes a component of contingent consideration under which the Company is required to pay a percentage of recurring revenues received from the acquired subscriber relationships through 2026 up to a maximum annual payment of $114. As of June 30, 2022, the carrying value of the intangible assets acquired in the asset acquisition was $436. As the acquisition did not represent a business combination, the contingent consideration arrangement is recognized only when the contingency is resolved and the consideration is paid or becomes payable. The amounts payable under the contingent consideration arrangement, if any, will be included in the measurement of the cost of the acquired subscriber relationships. An additional $28 and $32 of consideration was earned under the contingent consideration arrangement during the six months ended June 30, 2022 and 2021, respectively.
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Acquired intangible assets are subject to amortization. The following table summarizes acquired intangible assets at June 30, 2022 and December 31, 2021, respectively:
| Gross Carrying Amount | Accumulated Amortization | Net Carrying Value | ||||
|
June 30, 2022
|
||||||
| Subscriber relationships | $ | 7,631 | $ | 7,067 | $ | 564 |
| Distribution rights | 315 | 315 | - | |||
| Internally developed software | 446 | 446 | - | |||
| Proprietary content | 153 | 153 | - | |||
| Intellectual property | 2,284 | 2,284 | - | |||
| $ | 10,829 | $ | 10,265 | $ | 564 | |
|
December 31, 2021
|
||||||
| Subscriber relationships | $ | 8,033 | $ | 6,746 | $ | 1,287 |
| Distribution rights | 315 | 315 | - | |||
| Internally developed software | 446 | 446 | - | |||
| Proprietary content | 153 | 153 | - | |||
| Intellectual property | 2,284 | 2,284 | - | |||
| $ | 11,231 | $ | 9,944 | $ | 1,287 |
Amortization expense related to intangible assets was $125 and $280 for the three months ended June 30, 2022, respectively, and $319 and $556 for the six months ended June 30, 2022 and 2021, respectively. Amortization expense was categorized as general and administrative expense.
As of June 30, 2022, the total weighted average remaining useful lives of the definite-lived intangible assets was 3.3 years.
Estimated future amortization expense remaining at June 30, 2022 for intangible assets acquired was as follows:
Years ending December 31,
| Remainder of 2022 | $ | 183 |
| 2023 | 174 | |
| 2024 | 65 | |
| 2025 | 65 | |
| 2026 | 65 | |
| Thereafter | 12 | |
| Total future amortization expense | $ | 564 |
For definite-lived intangible assets, the Company assesses the carrying value of these assets whenever events or circumstances indicate that the carrying value may not be recoverable. Recoverability of assets to be held and used is measured by comparing the carrying amount of an asset, or asset group, to the future undiscounted cash flows expected to be generated by the asset, or asset group. There were no events or changes in circumstances during the six months ended June 30, 2022 which indicated that an assessment of the impairment of goodwill and intangible assets was required.
(15) Revenue from Contracts with Customers (ASC 606)
In accordance with ASC 606, revenue is recognized when a customer obtains control of promised products and services. The amount of revenue recognized reflects the consideration which the Company expects to be entitled to receive in exchange for these products and services.
21
Disaggregation of Revenue
The following table summarizes net sales from contracts with customers for the three and six months ended June 30, 2022 and 2021:
| Three Months Ended | Six Months Ended | |||||||
| June 30, | June 30, | |||||||
| 2022 | 2021 | 2022 | 2021 | |||||
| Mobile connectivity product, transferred at point in time | $ | 5,976 | $ | 7,292 | $ | 12,083 | $ | 13,380 |
| Mobile connectivity product, transferred over time | 644 | 754 | 1,100 | 1,557 | ||||
| Mobile connectivity service | 27,933 | 25,709 | 54,521 | 49,325 | ||||
| Inertial navigation product | 6,959 | 9,223 | 14,766 | 20,764 | ||||
| Inertial navigation service | 325 | 385 | 461 | 629 | ||||
| Total net sales | $ | 41,837 | $ | 43,363 | $ | 82,931 | $ | 85,655 |
Revenue recognized during the three months ended June 30, 2022 and 2021 from amounts included in contract liabilities at the beginning of the period was $621 and $696, respectively. Revenue recognized during the six months ended June 30, 2022 and 2021 from amounts included in contract liabilities at the beginning of the period was $1,073 and $1,469, respectively.
For mobile connectivity product sales, the delivery of the Company's performance obligations are generally transferred to the customer, and associated revenue is recognized, at a point in time, with the exception of certain mini-VSAT contracts which are transferred to customers over time. For mobile connectivity service sales, the delivery of the Company's performance obligations are transferred to the customer, and associated revenue is recognized, over time. For inertial navigation product sales, the delivery of the Company's performance obligations are generally transferred to the customer, and associated revenue is recognized, at a point in time. For inertial navigation service sales, the Company's performance obligations are generally transferred to customers, and associated revenue is recognized, over time.
Business and Credit Concentrations
Concentrations of risk with respect to trade accounts receivable are generally limited due to the large number of customers and their dispersion across several geographic areas. Although the Company does not foresee that credit risk associated with these receivables will deviate from historical experience, repayment is dependent upon the financial stability of those individual customers. The Company establishes allowances for potential bad debts and evaluates, on a monthly basis, the adequacy of those reserves based upon historical experience and its expectations for future collectability concerns. The Company performs ongoing credit evaluations of the financial condition of its customers and generally does not require collateral.
No single customer accounted for 10% or more of consolidated net sales for the six months ended June 30, 2022 or 2021 or accounts receivable at June 30, 2022 or December 31, 2021.
Certain components from third parties used in the Company's products are procured from single sources of supply. The failure of a supplier, including a subcontractor, to deliver on schedule could delay or interrupt the Company's delivery of products and thereby materially adversely affect the Company's revenues and operating results.
(16) Income Taxes
The Company's effective tax rate for the three and six months ended June 30, 2022 was (19.4)% and (10.1)%, respectively, compared with (1.4)% and 0.8% for the corresponding period in the prior year. The effective income tax rate is based on estimated income for the year, the estimated composition of the income in different jurisdictions and discrete adjustments, if any, in the applicable periods, including retroactive changes in tax legislation, settlements of tax audits or assessments, and the resolution or identification of tax position uncertainties.
For the three and six months ended June 30, 2022 and 2021, the effective tax rates were lower than the statutory tax rate primarily due to the Company maintaining a valuation allowance reserve on its US deferred tax assets, the composition of income from foreign jurisdictions taxed at lower rates and foreign withholding taxes on payments to the U.S.
22
As of June 30, 2022 and December 31, 2021, the Company had reserves for uncertain tax positions of $624 and $592, respectively. There were no material changes during the six months ended June 30, 2022 to the Company's reserve for uncertain tax positions. The Company estimates that it is reasonably possible that the balance of unrecognized tax benefits as of June 30, 2022 may decrease $19 in the next twelve months as a result of a lapse of statutes of limitations and settlements with taxing authorities.
The Company's tax jurisdictions include the United States, the United Kingdom, Denmark, Cyprus, Norway, Brazil, Singapore, Japan and India. In general, the statute of limitations with respect to the Company's United States federal income taxes has expired for years prior to 2018, and the relevant state and foreign statutes vary. However, preceding years remain open to examination by United States federal and state and foreign taxing authorities to the extent of future utilization of net operating losses and research and development tax credits generated in each preceding year.
(17) Leases
Lessee
The Company has operating leases for office facilities, equipment, and satellite service capacity and related equipment. Lease expense was $537 and $927 for the three months ended June 30, 2022 and 2021, respectively, and was $1,081 and $1,904 for the six months ended June 30, 2022 and 2021, respectively. Short-term operating lease costs were $43 and $58 for the three months ended June 30, 2022 and 2021, respectively, and were $98 and $115 for the six months ended June 30, 2022 and 2021, respectively. Sublease income was $34 and $33 for the three months ended June 30, 2022 and 2021, respectively, and was $69 and $67 for the six months ended June 30, 2022 and 2021, respectively. Maturities of lease liabilities as of June 30, 2022 under operating leases having an initial or remaining non-cancelable term of one year or more are as follows:
| Remainder of 2022 | $ | 988 |
| 2023 | 824 | |
| 2024 | 381 | |
| 2025 | 13 | |
| Total minimum lease payments | $ | 2,206 |
| Less amount representing interest | $ | (99) |
| Present value of net minimum operating lease payments | $ | 2,107 |
| Less current installments of obligation under current-operating lease liabilities | $ | 1,359 |
| Obligations under long-term operating lease liabilities, excluding current installments | $ | 748 |
| Weighted-average remaining lease term - operating leases (years) | 1.59 | |
| Weighted-average discount rate - operating leases | 5.50 | % |
During the first quarter of 2018, the Company entered into a five-year financing lease for three satellite hubs for its HTS network. During the first quarter of 2021, the terms of this lease were adjusted and the Company discontinued use of two satellite hubs and was released from the related payment obligation in exchange for additional satellite service capacity. As of June 30, 2022, the gross cost and accumulated amortization associated with this lease for the remaining satellite hub is included in revenue generating assets and amounted to $1,268 and $800, respectively. The obligation under capital leases are stated at the present value of minimum lease payments.
The property and equipment held under this financing lease are amortized on a straight-line basis over the seven-year estimated useful life of the asset, since the lease meets the bargain purchase option criteria. Amortization of assets held under financing leases is included within depreciation expense. Depreciation expense for the remaining capital assets was $46 for both the three months ended June 30, 2022 and 2021 and was $91 for both the six months ended June 30, 2022 and 2021.
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The future minimum lease payments under this financing lease as of June 30, 2022 are:
| Remainder of 2022 | $ | 132 |
| 2023 | 22 | |
| Total minimum lease payments | $ | 154 |
| Less amount representing interest | $ | (1) |
| Present value of net minimum financing lease payments | $ | 153 |
| Less current installments of obligation under accrued other | $ | 153 |
| Obligations under other long-term liabilities, excluding current installments | $ | - |
| Weighted-average remaining lease term - finance leases (years) | 0.67 | |
| Weighted-average discount rate - finance leases | 1.53 | % |
Lessor
The Company enters into leases with certain customers primarily for the TracPhone mini-VSAT systems. These leases are classified as sales-type leases as title of the equipment transfers to the customer at the end of the lease term. The Company records the leases at a price typically equivalent to normal selling price and in excess of the cost or carrying amount. Upon delivery, the Company records the net present value of all payments under these leases as product revenue, and the related costs of the product are charged to cost of sales. Interest income is recognized throughout the lease term (typically threeto five years) using an implicit interest rate. The sales-type leases do not have unguaranteed residual assets.
The current portion of the net investment in these leases was $3,678 as of June 30, 2022 and the non-current portion of the net investment in these leases was $5,565 as of June 30, 2022. The current portion of the net investment in the leases is included in accounts receivable, net of allowance for doubtful accounts on the accompanying consolidated balance sheets and the non-current portion of the net investment in these leases is included in other non-current assets on the accompanying consolidated balance sheets. Interest income from sales-type leases was $193 and $221 during the three months ended June 30, 2022 and 2021, respectively, and was $400 and $452 during the six months ended June 30, 2022 and 2021, respectively.
The future undiscounted cash flows from these leases as of June 30, 2022 are:
| Remainder of 2022 | $ | 2,430 |
| 2023 | 3,576 | |
| 2024 | 2,649 | |
| 2025 | 1,265 | |
| 2026 | 445 | |
| 2027 | 26 | |
| Total undiscounted cash flows | $ | 10,391 |
| Present value of lease payments | $ | 9,243 |
| Difference between undiscounted cash flows and discounted cash flows | $ | 1,148 |
24
In 2021, the Company entered into three-year leases for its TracPhone mini-VSAT systems, in which ownership of the hardware does not transfer to the lessee by the end of the lease term. As a result, and in light of other factors indicated in ASC 842, these leases are classified as operating leases.
As of June 30, 2022, the gross costs and accumulated depreciation associated with these operating leases are included in revenue generating assets and amounted to $1,803 and $325, respectively. They are depreciated on a straight-line basis over a five-year estimated useful life. Depreciation expense for these assets was $89 and $171 for the three and six months ended June 30, 2022, respectively.
Lease revenue recognized was $133 and $259 for the three and six months ended June 30, 2022, respectively.
As of June 30, 2022, minimum future lease payments to be recognized on the operating leases are as follows:
| Remainder of 2022 | $ | 269 |
| 2023 | 538 | |
| 2024 | 331 | |
| 2025 | 18 | |
| Total | $ | 1,156 |
(18) Subsequent Events
On August 9, 2022, the Company entered into an Asset Purchase Agreement with EMCORE Corporation to sell to EMCORE the Company's inertial navigation business for gross proceeds of $55,000, less specified deductions and a holdback of $1,000 and subject to a working capital adjustment. The sale was completed simultaneously with the execution and delivery of the Asset Purchase Agreement. Simultaneously with the execution of the Asset Purchase Agreement, the Company entered into a Transition Services Agreement with EMCORE, pursuant to which the Company agreed to provide certain transition services to support the continued operation of the inertial navigation business for a specified period of time following the sale. The inertial navigation business did not meet the ASC 205-20 criteria to be classified as held for sale as of June 30, 2022.
On August 9, 2022, the Company also terminated the 2018 Credit Agreement and the related security and pledge agreements with Bank of America, N.A., as Administrative Agent. At the time of termination, no borrowings were outstanding under the 2018 Credit Agreement. With the termination of this agreement, all associated liens were released.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
The statements included in this quarterly report on Form 10-Q, other than statements of historical fact, are forward-looking statements. Examples of forward-looking statements include statements regarding our future financial results, operating results, business strategies, projected costs, products and services, competitive positions and plans, customer preferences, consumer trends, anticipated product development, and objectives of management for future operations. In some cases, forward-looking statements can be identified by terminology such as "may," "will," "should," "would," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue," or the negative of these terms or other comparable terminology. Any expectations based on these forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in the section entitled "Risk Factors" in Item 1A of Part II of this quarterly report on Form 10-Q. These and many other factors could affect our future financial and operating results, and could cause actual results to differ materially from expectations based on forward-looking statements made in this document or elsewhere by us or on our behalf. For example, our expectations regarding certain items as a percentage of sales assume that we will achieve our anticipated sales goals. The following discussion and analysis should be read in conjunction with our consolidated interim financial statements and related notes appearing elsewhere in this report.
Overview
We design, develop, manufacture and market mobile connectivity products and services for the marine and land mobile markets, and inertial navigation products for the defense and commercial markets. Our reporting segments are as follows:
•the mobile connectivity segment and
•the inertial navigation segment.
25
Through these segments, we manufacture and sell our solutions in a number of major geographic areas, including internationally. We generate a majority of our revenues from various international locations, primarily consisting of Singapore, Canada, countries in Europe, countries in Africa, other Asia/Pacific countries, the Middle East, and India.
Disposition of Assets
On August 9, 2022, we entered into an Asset Purchase Agreement with EMCORE Corporation to sell to EMCORE the Company's inertial navigation business for gross proceeds of $55,000, less specified deductions and a holdback of $1,000 and subject to a working capital adjustment. The sale was completed simultaneously with the execution and delivery of the Asset Purchase Agreement. Simultaneously with the execution of the Asset Purchase Agreement, we entered into a Transition Services Agreement with EMCORE, pursuant to which we agreed to provide certain transition services to support the continued operation of the inertial navigation business for a specified period of time following the sale. The inertial navigation business did not meet the ASC 205-20 criteria to be classified as held for sale as of June 30, 2022.
On August 9, 2022, we also terminated the 2018 Credit Agreement and the related security and pledge agreements with Bank of America, N.A., as Administrative Agent. At the time of termination, no borrowings were outstanding under the 2018 Credit Agreement. With the termination of this agreement, all associated liens were released.
Disposition of Business
On April 29, 2022, KVH Media Group Limited, our wholly owned subsidiary, sold its subsidiary KVH Media Group Entertainment Limited, which is in the KVH Media Group reporting unit of our mobile connectivity segment, for net cash proceeds of approximately $2.4 million. This transaction did not meet the criteria as a discontinued operation under ASC 205-20. We recorded a gain on the sale of approximately $0.6 million, which is recorded in other income, net in the accompanying consolidated statements of operations. See Note 14 to our consolidated interim financial statements for the reduction of goodwill and intangibles associated with the KVH Media Group reporting unit as it relates to the sale of this subsidiary.
Management Transition and Restructuring
On March 7, 2022, we announced that our President and Chief Executive Officer, Martin Kits van Heyningen, was retiring from his executive and Board roles after more than 40 years of service and assuming a consulting position with us. Brent C. Bruun, our then Chief Operating Officer, was appointed as our interim President and Chief Executive Officer. Subsequently, on June 15, 2022, he was appointed as our President and Chief Executive Officer and as a Class II member of the Board of Directors. We have incurred approximately $0.5 million of costs associated with the management transition through June 30, 2022, including a separation payment, consulting fees and health insurance coverage for Mr. Kits van Heyningen, as well as professional and advisory fees, and expect to continue to incur ongoing compensation expenses until March 2023. Approximately $0.4 million is accrued as of June 30, 2022.
In March 2022, we also restructured our operations to reduce costs and better pursue a more focused strategy. We reduced our workforce by approximately 10% and began incurring reduced expenses from these actions beginning in the second quarter of 2022. Approximately $2.2 million of severance payments, other employee benefits, and legal and advisory fees were incurred for the six months ended June 30, 2022. We expect to incur an additional $0.2 million in severance payments and other employee benefit costs through December 31, 2022 arising from this restructuring. We also modified impacted employee's stock option and restricted stock awards. Please see Note 5 to our consolidated interim financial statements for further discussion.
Executive Employment Agreements
26
In May 2022, we entered into executive employment agreements with each of Brent C. Bruun, Roger A. Kuebel, Felise Feingold and Robert Balog in order to retain their services and provide them with certain benefits in the event that we terminate the executive's employment without cause (as defined in the agreement) or the executive terminates his or her employment for good reason (as defined in the agreement) (either such termination, a "Qualifying Termination"), including following a change of control. The terms of the agreements are substantially identical except as to title, salary, target bonus and reporting responsibilities. The agreements provide that, if the executive continues to serve as an employee through December 31, 2022 (the "Retention Date"), we will pay the executive a retention bonus equal to 75% of the executive's base salary at the agreement date, and we will accelerate the vesting of the executive's equity awards that would otherwise have vested in the twelve months after the Retention Date. Please see Note 5 to our consolidated interim financial statements for further discussion regarding the equity compensation modifications. If a Qualifying Termination occurs before December 31, 2022, the executive will receive a pro rata portion of the retention bonus. If in connection with such a termination the executive becomes entitled to receive the change in control severance payments and benefits, the executive will also become entitled to receive the full retention bonus, and the Retention Date will be the later of the date of such change in control or such termination of employment. For the three months ended June 30, 2022, we accrued approximately $0.3 million for the executive employment agreements.
Mobile Connectivity Segment
Our mobile connectivity segment offers satellite communications products and services. Our mobile connectivity products enable customers to receive voice and Internet services and live digital television via satellite services in marine vessels, recreational vehicles, buses and automobiles. We sell our mobile connectivity products through an extensive international network of dealers and distributors. We also sell and lease products to service providers and directly to end users.
Our mobile connectivity service sales include sales of satellite voice and Internet airtime services, engineering services provided under development contracts, sales from product repairs, and extended warranty sales. This segment's sales also include the distribution of entertainment, including news, sports, music, and movies, to commercial and leisure customers in the maritime, hotel, and retail markets through KVH Media Group. We typically recognize revenue from media content sales ratably over the period of the service contract. We provide, for monthly fixed fees and usage-based fees, satellite connectivity services for broadband Internet, data and VoIP service to our mini-VSAT Broadband customers. We also earn monthly usage fees for third-party satellite connectivity for voice, data and Internet services to our Inmarsat and Iridium customers who choose to activate their subscriptions with us.
Within the mobile connectivity segment, our marine leisure business is highly seasonal, and seasonality can also impact our commercial marine business. Historically, we have generated the majority of our marine leisure product revenues during the first and second quarters of each year, and these revenues typically decline in the third and fourth quarters of each year, compared to the first two quarters. Temporary suspensions of our airtime services typically increase in the third and fourth quarters of each year as boats are placed out of service during the winter months.
Inertial Navigation Segment
Our inertial navigation segment offers precision fiber optic gyro (FOG)-based systems that enable platform and optical stabilization, navigation, pointing, and guidance. Our inertial navigation products also include TACNAV systems that provide uninterrupted access to navigation and pointing information in a variety of military vehicles, including tactical trucks and light armored vehicles. Our inertial navigation products are sold directly to governments, both U.S. and foreign, and government contractors, as well as through an international network of authorized independent sales representatives. In addition, our inertial navigation products are used in numerous commercial products, such as navigation and positioning systems for various applications including precision mapping, dynamic surveying, autonomous vehicles, train location control and track geometry measurement systems, industrial robotics and optical stabilization. Our inertial navigation service sales include engineering services provided under development contracts, product repairs and extended warranty sales.
27
Sales by Segment
We generate sales primarily from the sale of our mobile connectivity products and services and our inertial navigation products and services. The following table provides, for the periods indicated, our sales by segment:
| Three Months Ended | Six Months Ended | |||||||
| June 30, | June 30, | |||||||
| 2022 | 2021 | 2022 | 2021 | |||||
| (in thousands) | (in thousands) | |||||||
| Mobile connectivity | $ | 34,553 | $ | 33,755 | $ | 67,704 | $ | 64,262 |
| Inertial navigation | 7,284 | 9,608 | 15,227 | 21,393 | ||||
| Net sales | $ | 41,837 | $ | 43,363 | $ | 82,931 | $ | 85,655 |
Product sales within the mobile connectivity segment accounted for 16% and 19% of our consolidated net sales for the three months ended June 30, 2022 and 2021, respectively, and 16% and 17% of our consolidated net sales for the six months ended June 30, 2022 and 2021, respectively. Sales of mini-VSAT Broadband airtime service accounted for 62% and 53% of our consolidated net sales for the three months ended June 30, 2022 and 2021, respectively, and 60% and 52% of our consolidated net sales for the six months ended June 30, 2022 and 2021, respectively.
Within our inertial navigation segment, net sales of FOG-based guidance and navigation systems accounted for 15% and 17% of our consolidated net sales for the three months ended June 30, 2022 and 2021, respectively, and 16% of our consolidated net sales for both the six months ended June 30, 2022 and 2021.
No other single product class accounted for 10% or more of our consolidated net sales for the three months ended June 30, 2022 or 2021 or the six months ended June 30, 2022 or 2021. No individual customer accounted for 10% or more of our consolidated net sales for the three months ended June 30, 2022 or 2021 or the six months ended June 30, 2022 or 2021.
We operate in a number of major geographic areas across the globe. We generate our international net sales, based upon customer location, primarily from customers located in Singapore, Canada, countries in Europe, countries in Africa, other Asia/Pacific countries, the Middle East, and India. Revenues are based upon customer location and internationally represented 63% and 60% of our consolidated net sales for the three months ended June 30, 2022 and 2021, respectively, and 63% and 61% of our consolidated net sales for the six months ended June 30, 2022 and 2021, respectively. Sales to Singapore customers represented 13% and 10% of our consolidated net sales for the three months ended June 30, 2022 and 2021, respectively. No other individual foreign country represented 10% or more of the our consolidated net sales for the three months ended June 30, 2022 and 2021. Sales to Singapore customers represented 13% and 10% of our consolidated net sales for the six months ended June 30, 2022 and 2021, respectively. No other individual foreign country represented 10% or more of the our consolidated net sales for the six months ended June 30, 2022 and 2021. See Note 11 to our consolidated interim financial statements for more information on our segments.
Customer-Funded Research and Development
28
In addition to our internally funded research and development efforts, we also conduct research and development activities that are funded by our customers. These activities relate primarily to engineering studies, surveys, prototype development, program management, and standard product customization. In accordance with accounting principles generally accepted in the United States of America, we account for customer-funded research as service revenue, and we account for the associated research and development costs as costs of service and product sales. As a result, customer-funded research and development are not included in the research and development expense that we present in our statement of operations. The following table presents our total annual research and development effort, representing the sum of research costs of service and product sales and the operating expense of research and development as described in our statement of operations. Our management believes this information is useful because it provides a better understanding of our total expenditures on research and development activities.
| Three Months Ended | Six Months Ended | |||||||
| June 30, | June 30, | |||||||
| 2022 | 2021 | 2022 | 2021 | |||||
| (in thousands) | (in thousands) | |||||||
| Research and development expense presented on the statement of operations | $ | 3,759 | $ | 4,505 | $ | 8,408 | $ | 9,072 |
| Costs of customer-funded research and development included in costs of service sales | 53 | 78 | 70 | 489 | ||||
| Total consolidated statements of operations expenditures on research and development activities | $ | 3,812 | $ | 4,583 | $ | 8,478 | $ | 9,561 |
Supply Chain
During the six months ended June 30, 2022, we continued to experience delays in the availability and delivery of certain raw material components, which has impacted our manufacturing as well as resulted in shipping delays in getting products out to our customers. We also experienced increase in raw material costs, which we expect to continue throughout 2022. We are continuing to monitor global developments and are prepared to implement any actions that we determine to be necessary to sustain our business.
Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated interim financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these interim financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure at the date of our interim financial statements. Our significant accounting policies are summarized in Note 1 to the consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2021.
Critical accounting estimates are those estimates made that involve a significant level of estimation uncertainty and have had or are reasonably likely to have an impact on our statement of operations. As described in our annual report on Form 10-K for the year ended December 31, 2021, our accounting policies for goodwill, intangible assets, and other long-lived assets were the only estimates critical to an understanding and evaluation of our consolidated financial statements. We have reviewed our accounting policies and critical accounting estimates and determined that these remain our most critical accounting policies and estimates for the six months ended June 30, 2022.
Readers should refer to our annual report on Form 10-K for the year ended December 31, 2021 under "Management's Discussion and Analysis of Financial Condition and Results of Operation-Critical Accounting Estimates" for descriptions of these policies and estimates, as well as the notes to the consolidated interim financial statements included elsewhere within this report.
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Results of Operations
The following table provides, for the periods indicated, certain financial data expressed as a percentage of net sales:
| Three Months Ended | Six Months Ended | |||||||
| June 30, | June 30, | |||||||
| 2022 | 2021 | 2022 | 2021 | |||||
| Sales: | ||||||||
| Product | 32.5 | % | 39.8 | % | 33.7 | % | 41.7 | % |
| Service | 67.5 | 60.2 | 66.3 | 58.3 | ||||
| Net sales | 100.0 | 100.0 | 100.0 | 100.0 | ||||
| Cost and expenses: | ||||||||
| Costs of product sales | 26.6 | 27.4 | 26.3 | 27.0 | ||||
| Costs of service sales | 36.9 | 37.2 | 36.7 | 36.8 | ||||
| Research and development | 9.0 | 10.4 | 10.1 | 10.6 | ||||
| Sales, marketing and support | 16.7 | 18.3 | 18.5 | 18.1 | ||||
| General and administrative | 16.5 | 20.1 | 16.8 | 18.5 | ||||
| Total costs and expenses | 105.7 | 113.4 | 108.4 | 111.0 | ||||
| Loss from operations | (5.7) | (13.4) | (8.4) | (11.0) | ||||
| Interest income | 0.5 | 0.5 | 0.5 | 0.5 | ||||
| Interest expense | - | - | - | - | ||||
| Other income (expense), net | 2.2 | - | 1.3 | (0.9) | ||||
| Loss before income tax expense (benefit) | (3.0) | (12.9) | (6.6) | (11.4) | ||||
| Income tax expense (benefit) | 0.6 | 0.2 | 0.7 | (0.1) | ||||
| Net loss | (3.6) | % | (13.1) | % | (7.3) | % | (11.3) | % |
Three months ended June 30, 2022 and 2021
Net Sales
As discussed further under the heading "Segment Discussion" below, product sales decreased $3.7 million, or 21%, to $13.6 million for the three months ended June 30, 2022 from $17.3 million for the three months ended June 30, 2021, due to a decrease in inertial navigation product sales of $2.3 million and a decrease in mobile connectivity product sales of $1.4 million. Service sales for the three months ended June 30, 2022 increased $2.2 million, or 8%, to $28.3 million from $26.1 million for the three months ended June 30, 2021, primarily due to an increase in mobile connectivity service sales of $2.2 million, partially offset by a decrease in inertial navigation service sales of $0.1 million.
Costs of Sales
Costs of sales consists of costs of product sales and costs of service sales. Costs of sales decreased by $1.5 million, or 5%, in the three months ended June 30, 2022 to $26.5 million from $28.0 million in the three months ended June 30, 2021. The decrease in costs of sales was driven by a $0.8 million decrease in costs of product sales and a $0.7 million decrease in costs of service sales. As a percentage of net sales, costs of sales were 63% and 65% for the three months ended June 30, 2022 and 2021, respectively.
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Our costs of product sales consist primarily of materials, manufacturing overhead, and direct labor used to produce our products. For the three months ended June 30, 2022, costs of product sales decreased by $0.8 million, or 7%, to $11.1 million from $11.9 million in the three months ended June 30, 2021. As a percentage of product sales, costs of product sales were 82% and 69% for the three months ended June 30, 2022 and 2021, respectively. Mobile connectivity costs of product sales decreased by $1.0 million, or 16%, primarily due to a $0.9 million decrease in our marine mobile connectivity cost of product sales. Mobile connectivity costs of product sales as a percentage of mobile connectivity product sales were 79% and 77% for the three months ended June 30, 2022 and 2021, respectively. The decrease was primarily driven by sales volume and product mix within our marine mobile connectivity cost of product sales. Inertial navigation costs of product sales increased by $0.2 million, or 4%, primarily due to a $1.3 million increase in expensed material and other manufacturing period costs, partially offset by a $0.5 million decrease in FOG and OEM costs of product sales and a $0.5 million decrease in our TACNAV costs of product sales. As a percentage of inertial navigation product sales, costs of inertial navigation product sales were 85% and 62% for the three months ended June 30, 2022 and 2021, respectively.
Our costs of service sales consist primarily of satellite service capacity, depreciation, service network overhead expense associated with our mini-VSAT Broadband network infrastructure, direct network service labor, Inmarsat service costs, product installation costs, engineering and related direct costs associated with customer-funded research and development, media materials and distribution costs, and service repair materials. For the three months ended June 30, 2022, costs of service sales decreased by $0.7 million, or 4%, to $15.4 million from $16.1 million for the three months ended June 30, 2021. As a percentage of service sales, costs of service sales were 55% and 62% for the three months ended June 30, 2022 and 2021, respectively. Mobile connectivity costs of service sales decreased by $0.8 million, or 5%, primarily due to a $0.4 million decrease in mini-VSAT airtime costs of service sales. This decrease was primarily driven by the shutdown of our legacy Arclight network, partially offset by an increase in costs associated with our HTS network due to increased capacity required for additional customers. In addition, there was a $0.3 million decrease in content services cost of service sales, primarily driven by the sale of a subsidiary in April 2022. As a percentage of mobile connectivity service sales, costs of mobile connectivity service sales were 54% and 62% for the three months ended June 30, 2022 and 2021, respectively. Inertial navigation costs of service sales increased by $0.1 million, or 73%, primarily due to an increase in repair services cost of service sales. As a percentage of inertial navigation service sales, costs of inertial navigation service sales were 68% and 33% for the three months ended June 30, 2022 and 2021, respectively.
Operating Expenses
Research and development expense consists of direct labor, materials, external consultants, and related overhead costs that support our internally funded product development and product sustaining engineering activities. Research and development expense for the three months ended June 30, 2022 decreased by $0.7 million, or 17%, to $3.8 million from $4.5 million for the three months ended June 30, 2021. The primary reason for the decrease in research and development expense was a $0.9 million decrease in salaries, benefits and taxes, which was driven by the reduction in our workforce in March 2022. This decrease was partially offset by a $0.3 million increase in unfunded engineering expenses. There was also a corresponding reallocation of the expense of the underlying engineering work from costs of service sales, where funded engineering expenses are reflected, to research and development expense, where unfunded engineering expenses are reflected. As a percentage of net sales, research and development expense was 9% and 10% for the three months ended June 30, 2022 and 2021, respectively.
Sales, marketing, and support expense consists primarily of salaries and related expenses for sales and marketing personnel, commissions for both in-house and third-party representatives, costs related to the co-development of certain content, other sales and marketing support costs such as advertising, literature and promotional materials, product service personnel and support costs, warranty-related costs and bad debt expense. Sales, marketing and support expense also includes the operating expenses of our sales office subsidiaries in Denmark, Singapore, Brazil, and Japan. Sales, marketing and support expense for the three months ended June 30, 2022 decreased by $1.0 million, or 12%, to $7.0 million from $7.9 million for the three months ended June 30, 2021. The decrease primarily resulted from a $1.0 million decrease in salaries, benefits and taxes, which was driven by the reduction in our workforce in March 2022. This decrease was partially offset by a $0.3 million increase in warranty expense. As a percentage of net sales, sales, marketing and support expense was 17% and 18% for the three months ended June 30, 2022 and 2021, respectively.
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General and administrative expense consists of costs attributable to management, finance and accounting, information technology, human resources, certain outside professional services, and other administrative costs. General and administrative expense for the three months ended June 30, 2022 and 2021 decreased by $1.8 million, or 21%, to $6.9 million compared to $8.7 million, respectively. The decrease primarily resulted from a $2.4 million decrease in professional fees, primarily arising from a stockholder's nomination of a completing slate of directors at our annual meeting of stockholders in 2021. This decrease was partially offset by a $0.6 million increase in recruiting expenses, which was driven by professional fees associated with the search for a new Chief Executive Officer and replacements for two departed members of our board of directors. As a percentage of net sales, general and administrative expense was 16% and 20% for the three months ended June 30, 2022 and 2021, respectively.
Interest and Other Income (Expense), Net
Interest income represents interest earned on our cash and cash equivalents, as well as from investments and our sale-type lease receivables. Interest income remained flat period-over-period at $0.2 million for both of the three months ended June 30, 2022 and 2021. Interest expense remained flat period-over-period at less than $0.1 million for both of the three months ended June 30, 2022 and 2021. Other income (expense), net increased to other income, net of $0.9 million for the three months ended June 30, 2022 from other expense, net of less than $0.1 million for the three months ended June 30, 2021 primarily due to the sale of KVH Media Group Entertainment Limited during the three months ended June 30, 2022.
Income Tax Expense
Income tax expense for the three months ended June 30, 2022 was $0.2 million and related to taxes on income earned in foreign jurisdictions. Income tax expense for the three months ended June 30, 2021 was $0.1 million and related to taxes on income earned in foreign jurisdictions.
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Segment Discussion - Three months ended June 30, 2022 and 2021
Our net sales by segment for the three months ended June 30, 2022 and 2021 were as follows:
| Change | ||||||||
| For the three months ended June 30, | 2022 vs. 2021 | |||||||
| 2022 | 2021 | $ | % | |||||
| (dollars in thousands) | ||||||||
| Mobile connectivity sales: | ||||||||
| Product | $ | 6,620 | $ | 8,046 | $ | (1,426) | (18) | % |
| Service | 27,933 | 25,709 | 2,224 | 9 | % | |||
| Net sales | $ | 34,553 | $ | 33,755 | $ | 798 | 2 | % |
| Inertial navigation sales: | ||||||||
| Product | $ | 6,959 | $ | 9,223 | $ | (2,264) | (25) | % |
| Service | 325 | 385 | (60) | (16) | % | |||
| Net sales | $ | 7,284 | $ | 9,608 | $ | (2,324) | (24) | % |
Operating income (loss) by segment for the three months ended June 30, 2022 and 2021 were as follows:
| Change | ||||||||
| For the three months ended June 30, | 2022 vs. 2021 | |||||||
| 2022 | 2021 | $ | % | |||||
| (dollars in thousands) | ||||||||
| Mobile connectivity | $ | 4,525 | $ | 580 | $ | 3,945 | 680 | % |
| Inertial navigation | (1,289) | 645 | (1,934) | (300) | % | |||
| $ | 3,236 | $ | 1,225 | $ | 2,011 | 164 | % | |
| Unallocated | (5,568) | (7,027) | 1,459 | 21 | % | |||
| Loss from operations | $ | (2,332) | $ | (5,802) | $ | 3,470 | 60 | % |
Mobile Connectivity Segment
Net sales in the mobile connectivity segment increased by $0.8 million, or 2%, for the three months ended June 30, 2022 as compared to the three months ended June 30, 2021. Mobile connectivity product sales decreased by $1.4 million, or 18%, to $6.6 million for the three months ended June 30, 2022 from $8.0 million for the three months ended June 30, 2021. The decrease in mobile connectivity product sales was primarily due to a $1.3 million decrease in mini-VSAT Broadband product sales. The decrease in mini-VSAT product sales was primarily due to a decrease in unit sales volume.
Mobile connectivity service sales increased by $2.2 million, or 9%, to $27.9 million for the three months ended June 30, 2022 from $25.7 million for the three months ended June 30, 2021. The increase was primarily due to a $2.7 million increase in our mini-VSAT service sales, partially offset by a $0.6 million decrease in our content service sales, primarily driven by the sale of a subsidiary in April 2022.
The shutdown of our legacy Arclight network on December 31, 2021 impacted sales of mini-VSAT products in 2021 and mini-VSAT services in 2022. During 2021, mini-VSAT product sales benefited from the demand for units needed to migrate from the legacy network to our HTS network. During 2022, mini-VSAT service sales have been impacted by the loss of revenue from customers who did not migrate. As of December 31, 2021, the monthly recurring revenue associated with those customers was approximately $0.3 million. A number of these customer have since returned, and when combined with new customers, mini-VSAT service revenue for the three months ended June 30, 2022 was up 12% from the same quarter in 2021.
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Operating income for the mobile connectivity segment increased $3.9 million for the three months ended June 30, 2022 to operating income of $4.5 million as compared to operating income of $0.6 million for the three months ended June 30, 2021. This increase resulted primarily from an increase in sales less associated costs of $2.6 million and a $1.2 million decrease in salaries, benefits and taxes, which was driven by the reduction in our workforce in March 2022.
Inertial Navigation Segment
Net sales in the inertial navigation segment decreased $2.3 million, or 24%, for the three months ended June 30, 2022 as compared to the three months ended June 30, 2021. Inertial navigation product sales decreased $2.3 million, or 25%, to $7.0 million for the three months ended June 30, 2022 from $9.2 million for the three months ended June 30, 2021, primarily as a result of a $1.3 million decrease in our TACNAV product sales and a $1.0 million decrease in FOG and OEM product sales.
Inertial navigation service sales decreased $0.1 million, or 16%, to $0.3 million for the three months ended June 30, 2022 from $0.4 million for the three months ended June 30, 2021. The decrease was due to a $0.1 million decrease in repair services revenue.
Our operating loss for the inertial navigation segment changed by $1.9 million to an operating loss of $1.3 million for the three months ended June 30, 2022 as compared to operating income of $0.6 million for the three months ended June 30, 2021. This change resulted primarily from a decrease in sales less associated costs of $2.6 million, partially offset by a $0.9 million decrease in salaries, benefits and taxes, which was driven by the reduction in our workforce in March 2022.
Unallocated
Certain corporate-level costs have not been allocated because they are not attributable to either segment. These costs primarily consist of broad corporate functions, including executive, legal, finance, information technology, and costs associated with corporate actions.
Unallocated operating loss decreased $1.5 million, or 21%, for the three months ended June 30, 2022 as compared to the three months ended June 30, 2021, primarily due to a $2.6 million decrease in non-recurring legal and advisory fees. In 2021, these fees were incurred as a result of a stockholder's nomination of a competing slate of directors for our annual meeting of stockholders. Partially offsetting this decrease was a $0.6 million increase in recruiting expenses, which was driven by professional fees associated with the search for a new Chief Executive Officer and replacements for two departed members of our board of directors, and $0.3 million of one-time costs related to the reduction in our workforce in March 2022.
Six months ended June 30, 2022 and 2021
Net Sales
As discussed further under the heading "Segment Discussion" below, product sales decreased $7.8 million, or 22%, to $27.9 million for the six months ended June 30, 2022 from $35.7 million for the six months ended June 30, 2021, due to a decrease in inertial navigation product sales of $6.0 million and a decrease in mobile connectivity product sales of $1.8 million. Service sales for the six months ended June 30, 2022 increased $5.0 million, or 10%, to $55.0 million from $50.0 million for the six months ended June 30, 2021 due to an increase in mobile connectivity service sales of $5.2 million, partially offset by a decrease in inertial navigation service sales of $0.2 million.
Costs of Sales
Costs of sales decreased by $2.4 million, or 4%, in the six months ended June 30, 2022 to $52.3 million from $54.7 million in the six months ended June 30, 2021. The decrease in costs of sales was driven by a $1.3 million decrease in costs of product sales and a $1.1 million decrease in costs of service sales. As a percentage of net sales, costs of sales were 63% and 64% for the six months ended June 30, 2022 and 2021, respectively.
For the six months ended June 30, 2022, costs of product sales decreased by $1.3 million, or 5%, to $21.8 million from $23.1 million in the six months ended June 30, 2021. As a percentage of product sales, costs of product sales were 78% and 65% for the six months ended June 30, 2022 and 2021, respectively. Mobile connectivity costs of product sales decreased by $0.7 million, or 6%, due to a $0.5 million decrease in our marine mobile connectivity cost of product sales and a $0.2 million decrease in our land mobile connectivity costs of product sales. Mobile connectivity costs of product sales as a percentage of mobile connectivity product sales were 81% and 76% for the six months ended June 30, 2022 and 2021, respectively. The increase was primarily driven by product mix within our marine mobile connectivity cost of product sales. Inertial navigation
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costs of product sales decreased by $0.6 million, or 5%, primarily due to a $1.8 million decrease in our TACNAV costs of product sales, partially offset by a $1.0 million increase in expensed material and other manufacturing period costs. Inertial navigation costs of product sales as a percentage of inertial navigation product sales were 76% and 57% for the six months ended June 30, 2022 and 2021, respectively. The increase was primarily driven by product mix with a decrease in higher margin TACNAV product sales.
For the six months ended June 30, 2022, costs of service sales decreased by $1.1 million, or 4%, to $30.4 million from $31.5 million for the six months ended June 30, 2021. As a percentage of service sales, costs of service sales were 55% and 63% for the six months ended June 30, 2022 and 2021, respectively. Mobile connectivity costs of service sales decreased by $0.8 million, or 3%, primarily due to a $0.4 million decrease in mini-VSAT airtime costs of service sales. This decrease was primarily driven by the shutdown of our legacy Arclight network, partially offset by an increase in costs associated with our HTS network due to increased capacity required for additional customers. In addition, there was a $0.3 million decrease in content services cost of service sales, primarily driven by the sale of a subsidiary in April 2022. Mobile connectivity costs of service sales as a percentage of mobile connectivity service sales were 55% and 63% for the six months ended June 30, 2022 and 2021, respectively. Inertial navigation costs of service sales decreased by $0.3 million, or 52%, due to a decrease in contract engineering services sales. Inertial navigation costs of service sales as a percentage of inertial navigation service sales were 62% and 95% for the six months ended June 30, 2022 and 2021, respectively. This decrease in costs of inertial navigation service sales was primarily due to a decrease in costs relating to an engineering and services development contract from a major U.S. defense contractor.
Operating Expenses
Research and development expense for the six months ended June 30, 2022 decreased by $0.7 million, or 7%, to $8.4 million from $9.1 million for the six months ended June 30, 2021. The primary reason for the decrease in research and development expense was a $1.4 million decrease in salaries, benefits and taxes (excluding costs associated with the previously mentioned reduction in force) and a $0.4 million decrease in consulting fees. These decreases were partially offset by a $0.7 million increase in unfunded engineering expenses and $0.4 million in one-time costs related to the reduction in our workforce in March 2022. With respect to the decrease in funded engineering expenses, there was also a corresponding reallocation of the expense of the underlying engineering work from costs of service sales, where funded engineering expenses are reflected, to research and development expense, where unfunded engineering expenses are reflected. As a percentage of net sales, research and development expense was 10% and 11% for the six months ended June 30, 2022 and 2021, respectively.
Sales, marketing and support expense for the six months ended June 30, 2022 decreased by $0.2 million, or 1%, to $15.3 million from $15.5 million for the six months ended June 30, 2021. The decrease in sales, marketing and support expense resulted primarily from a $1.2 million decrease in salaries, benefits and taxes (excluding costs associated with the previously mentioned reduction in workforce in March 2022), a $0.2 million decrease in marketing expense and a $0.2 million decrease in external commission expense, partially offset by $0.9 million in one-time costs related to the reduction in our workforce in March 2022 and a $0.5 million increase in warranty expense. As a percentage of net sales, sales, marketing and support expense was 18% for both the six months ended June 30, 2022 and 2021.
General and administrative expense for the six months ended June 30, 2022 decreased by $1.9 million, or 12%, to $14.0 million from $15.8 million for the six months ended June 30, 2021. The decrease in general and administrative expense resulted primarily from a $3.1 million decrease in non-recurring legal and advisory fees, primarily arising from a stockholder's nomination of a competing slate of directors at our annual meeting of stockholders in 2021. This decrease in expense was partially offset by a $0.6 million increase in recruiting expenses, which was driven by professional fees associated with the search for a new Chief Executive Officer and replacements for two recently departed members of our board of directors, $0.5 million in expenses related to the separation and retirement of Mr. Kits van Heyningen in March 2022, and $0.5 million in one-time costs related to the reduction in our workforce in March 2022. As a percentage of net sales, general and administrative expense was 17% and 19% for the six months ended June 30, 2022 and 2021, respectively.
Interest and Other Income (Expense), Net
Interest income decreased by less than $0.1 million to $0.4 million for the six months ended June 30, 2022 from $0.5 million for the six months ended June 30, 2021. Interest expense remained flat period-over-period at less than $0.1 million for both the six months ended June 30, 2022 and 2021. Other income (expense), net increased to other income, net of $1.1 million for the six months ended June 30, 2022 from other expense, net of $0.8 million for the prior period primarily due to an increase in foreign exchange gains from our UK operations and the sale of KVH Media Group Entertainment Limited during the six months ended June 30, 2022.
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Income Tax Expense (Benefit)
Income tax expense for the six months ended June 30, 2022 was $0.6 million and related to taxes on income earned in foreign jurisdictions. Income tax benefit for the six months ended June 30, 2021 was $0.1 million and related to losses generated in foreign jurisdictions.
Segment Discussion - Six months ended June 30, 2022 and 2021
Our net sales by segment for the six months ended June 30, 2022 and 2021 were as follows:
| Change | ||||||||
| For the six months ended June 30, | 2022 vs. 2021 | |||||||
| 2022 | 2021 | $ | % | |||||
| (dollars in thousands) | ||||||||
| Mobile connectivity sales: | ||||||||
| Product | $ | 13,183 | $ | 14,937 | $ | (1,754) | (12) | % |
| Service | 54,521 | 49,325 | 5,196 | 11 | % | |||
| Net sales | $ | 67,704 | $ | 64,262 | $ | 3,442 | 5 | % |
| Inertial navigation sales: | ||||||||
| Product | $ | 14,766 | $ | 20,764 | $ | (5,998) | (29) | % |
| Service | 461 | 629 | (168) | (27) | % | |||
| Net sales | $ | 15,227 | $ | 21,393 | $ | (6,166) | (29) | % |
Operating income (loss) by segment for the six months ended June 30, 2022 and 2021 were as follows:
| Change | ||||||||
| For the six months ended June 30, | 2022 vs. 2021 | |||||||
| 2022 | 2021 | $ | % | |||||
| (dollars in thousands) | ||||||||
| Mobile connectivity | $ | 5,830 | $ | 183 | $ | 5,647 | 3,086 | % |
| Inertial navigation | (1,749) | 2,735 | (4,484) | (164) | % | |||
| $ | 4,081 | $ | 2,918 | $ | 1,163 | 40 | % | |
| Unallocated | (11,121) | (12,327) | 1,206 | 10 | % | |||
| Loss from operations | $ | (7,040) | $ | (9,409) | $ | 2,369 | 25 | % |
Mobile Connectivity Segment
Net sales in the mobile connectivity segment increased by $3.4 million, or 5%, for the six months ended June 30, 2022 as compared to the six months ended June 30, 2021. Mobile connectivity product sales decreased by $1.8 million, or 12%, to $13.2 million for the six months ended June 30, 2022 from $14.9 million for the six months ended June 30, 2021. The decrease in mobile connectivity product sales was primarily due to a $1.1 million decrease in mini-VSAT Broadband product sales and a $0.3 million decrease in TracVision product sales. The decrease in mini-VSAT Broadband product sales was primarily due to a decrease in unit sales volume.
Mobile connectivity service sales increased by $5.2 million, or 11%, to $54.5 million for the six months ended June 30, 2022 from $49.3 million for the six months ended June 30, 2021. The increase was primarily due to a $5.4 million increase in our mini-VSAT service sales, partially offset by a $0.4 million decrease in our content services sales, primarily driven by the sale of a subsidiary in April 2022.
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Operating income for the mobile connectivity segment increased by $5.6 million to $5.8 million for the six months ended June 30, 2022 as compared to $0.2 million for the six months ended June 30, 2021. This increase resulted primarily from an increase in sales less associated costs of $4.9 million, a $1.5 million decrease in salaries, benefits and taxes (excluding costs associated with the previously mentioned reduction in workforce in March 2022) and a $0.4 million decrease in legal and professional fees, partially offset by $1.1 million in one-time costs related to the reduction in our workforce in March 2022 and a $0.4 million increase in warranty expense.
Inertial Navigation Segment
Net sales in the inertial navigation segment decreased $6.2 million, or 29%, for the six months ended June 30, 2022 as compared to the six months ended June 30, 2021. Inertial navigation product sales decreased by $6.0 million, or 29%, to $14.8 million for the six months ended June 30, 2022 from $20.8 million for the six months ended June 30, 2021. This decrease was primarily due to a $5.8 million decrease in TACNAV product sales.
Inertial navigation service sales decreased $0.2 million, or 27%, to $0.5 million for the six months ended June 30, 2022 from $0.6 million for the six months ended June 30, 2021. The decrease was primarily due a decrease in contract engineering service revenues.
Our operating loss for the inertial navigation segment changed by $4.5 million to an operating loss of $1.7 million for the six months ended June 30, 2022 as compared to operating income of $2.7 million for the six months ended June 30, 2021. This change resulted primarily from a decrease in sales less associated costs of $5.3 million and $0.3 million in one-time costs related to the reduction in our workforce in March 2022, partially offset by a $1.4 million decrease in salaries, benefits and taxes (excluding costs associated with the previously mentioned reduction in workforce in March 2022).
Unallocated
Unallocated operating loss decreased $1.2 million, or 10%, for the six months ended June 30, 2022 as compared to the six months ended June 30, 2021 primarily due to a $3.1 million decrease in non-recurring legal and advisory fees. In 2021, these fees were incurred as a result of a stockholder's nomination of a competing slate of directors for our annual meeting of stockholders. Partially offsetting this decrease was $0.6 million of expenses related to the separation and retirement of Mr. Kits van Heyningen in March 2022, a $0.6 million increase in recruiting expenses, which was driven by professional fees associated with the search for a new Chief Executive Officer and replacements for two recently departed members of our board of directors, and $0.4 million in one-time costs related to the reduction in our workforce in March 2022.
Backlog
Backlog is not a meaningful indicator for predicting revenue in future periods. Commercial resellers for our mobile connectivity products and legacy products typically do not carry extensive inventories and rely on us to ship products quickly. Generally, due to rapid delivery of our commercial products, our backlog for those products is not significant.
Our backlog for all products and services was $3.5 million and $23.9 million as of June 30, 2022 and December 31, 2021, respectively. As of June 30, 2022, $3.5 million of our backlog was scheduled for fulfillment in 2022 and $0.1 million was scheduled for fulfillment in 2023.
Backlog consists of orders evidenced by written agreements and specified delivery dates for customers who are acceptable credit risks. We do not include satellite connectivity service sales in our backlog even though many of our satellite connectivity customers have signed annual or multi-year service contracts providing for a fixed monthly fee. Military orders included in backlog are generally subject to cancellation for the convenience of the customer. When orders are canceled, we generally recover actual costs incurred through the date of cancellation and the costs resulting from termination. As of June 30, 2022, our backlog included $0.0 million in orders that are subject to cancellation for convenience by the customer. Individual orders for inertial navigation products are often large and may require procurement of specialized long-lead components and allocation of manufacturing resources. The complexity of planning and executing larger orders generally requires customers to order well in advance of the required delivery date, resulting in backlog.
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Liquidity and Capital Resources
Our primary liquidity needs have been to fund general business requirements, including working capital requirements and capital expenditures. In recent years, we have funded our operations primarily from the sale of a business in 2019, a PPP loan, cash flows from operations, bank financings and proceeds received from exercises of stock options and the issuance of stock.
In May 2020, we received a $6.9 million loan from Bank of America, N.A. (the Lender), under the PPP, which was established under the CARES Act. Pursuant to the terms of the CARES Act, in August 2021, we applied for forgiveness of the full amount of the PPP Loan. On September 24, 2021, we received notification from the bank that, on September 19, 2021, the U.S. Small Business Administration (the SBA) had determined that the PPP Loan forgiveness application was approved, and the PPP Loan, including all accrued interest thereon, was paid in full by the SBA.
As of June 30, 2022, we had $15.6 million in cash, cash equivalents, and marketable securities, of which $2.7 million in cash and cash equivalents was held in local currencies by our foreign subsidiaries. Our foreign subsidiaries held no marketable securities as of June 30, 2022. As of June 30, 2022, we had $52.0 million in working capital. Based upon our current working capital position, current operating plans and expected business conditions, we expect to have sufficient funds, through at least twelve months from the date that this report is filed with the SEC, to fund our short-term and long-term working capital requirements, including capital expenditures and contractual obligations, primarily using our existing cash, cash equivalents and marketable securities and any operating cash flow. Our funding plans for our working capital needs and other commitments may be adversely impacted if our underlying assumptions regarding our anticipated revenues and expenses are not realized. If our operating results fail to meet our expectations, we could be required to seek additional funding through public or private financings or other arrangements. In that event, adequate funds may not be available when needed or may be available only on terms which could have a negative impact on our business and results of operations. In addition, if we raise funds by issuing equity securities, our stockholders may experience dilution.
Net cash used in operations was $3.2 million for the six months ended June 30, 2022 compared to net cash provided by operations of $4.8 million for the six months ended June 30, 2021. The $8.0 million change in cash used in operations is primarily due to an $8.7 million increase in cash outflows relating to inventories, a $1.7 million decrease in non-cash items, a $1.1 million increase in cash outflows related to accounts payable and accrued expenses, and a $1.1 million decrease in cash inflows relating to accounts receivable. Partially offsetting these items was a $3.6 million decrease in net loss, a $0.7 million decrease in cash outflows related to contract liabilities and long-term contract liabilities, and a $0.4 million decrease in cash outflows related to other non-current assets and non-current contract assets.
Net cash provided by investing activities was $2.3 million for the six months ended June 30, 2022 compared to net cash used in investing activities of $10.5 million for the six months ended June 30, 2021. The $12.8 million change in net cash provided by investing activities was primarily the result of an $8.0 million increase in net cash inflows relating to the purchase and sales of marketable securities and a $2.5 million decrease in capital expenditures, as well as $2.4 million in proceeds from the sale of KVH Media Group Entertainment Limited.
Net cash provided by financing activities was $0.2 million for the six months ended June 30, 2022 compared to net cash provided by financing activities of $2.3 million for the six months ended June 30, 2021. The $2.1 million decrease in net cash provided by financing activities is primarily attributable to the $2.1 million decrease in cash inflows relating to proceeds from stock options exercised and the employee stock purchase plan.
Borrowing Arrangements
Paycheck Protection Program Loan
In May 2020, we received a $6.9 million loan from the Lender under the PPP, which was established under the CARES Act and is administered by the SBA. The term of the PPP Loan was two years from the funding date, and the interest rate was 1.00%. Interest on the loan accrued from the funding date, but was deferred. In August 2021, we applied for forgiveness of the full amount of the PPP Loan. On September 24, 2021, we received notification from the Lender that, on September 19, 2021, the SBA had determined that the PPP Loan forgiveness application was approved, and the PPP Loan, including all accrued interest thereon, was paid in full by the SBA.
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Line of Credit
Effective October 30, 2018, we entered into an amended and restated three-year senior secured credit facility agreement (the 2018 Credit Agreement) with Bank of America, N.A., as Administrative Agent, and the lenders named from time to time as parties thereto (the 2018 Lenders), which included a reducing revolving credit facility (the 2018 Revolver) of up to $20.0 million initially and reducing to $15.0 million on December 31, 2019, to be used for general corporate purposes. Our obligations under the 2018 Credit Agreement are secured by substantially all of our assets and the pledge of equity interests in certain of our subsidiaries. As of June 30, 2022, no amounts were outstanding under the 2018 Revolver.
Borrowings under the 2018 Revolver are subject to the satisfaction of various conditions precedent at the time of each borrowing, including the continued accuracy of our representations and warranties and the absence of any default under the 2018 Credit Agreement. As of June 30, 2022, the full balance of the $15.0 million facility was available for borrowing.
The 2018 Credit Agreement contains two financial covenants, a maximum Consolidated Leverage Ratio and a minimum Consolidated Fixed Charge Coverage Ratio, each as defined in the 2018 Credit Agreement. The Consolidated Leverage Ratio could not exceed 2.50:1.00 through December 31, 2020 and may not exceed 2.00:1.00 after December 31, 2020. The Consolidated Fixed Charge Coverage Ratio may not be less than 1.25:1.00.
On July 30, 2020, we amended the 2018 Credit Agreement to reflect the incurrence of the PPP loan. Under the amended facility, the principal and interest on the PPP loan were not included in the maximum Consolidated Leverage Ratio or the minimum Consolidated Fixed Charge Coverage Ratio calculations except as to any portion of the PPP Loan that is not ultimately forgiven. In September 2021, the PPP Loan was forgiven in full.
On October 29, 2021, we amended the 2018 Credit Agreement to maintain the $15.0 million 2018 Revolver, extend the maturity date of the 2018 Revolver to October 28, 2022, eliminate the Consolidated Fixed Charge Coverage Ratio financial covenant, add a minimum trailing four-quarter Consolidated Adjusted EBITDA financial covenant of $3.0 million, modify the definition of Consolidated Adjusted EBITDA, modify the interest rate margins and certain lender fees, and transition the interest rate provisions based on LIBOR to the Bloomberg Short Term Bank Yield Index. In addition, Bank of America became the sole lender under the 2018 Credit Agreement. We were in compliance with these financial covenants as of June 30, 2022.
The 2018 Credit Agreement imposes certain other affirmative and negative covenants, including without limitation covenants with respect to the payment of taxes and other obligations, compliance with laws, performance of material contracts, creation of liens, incurrence of indebtedness, investments, dispositions, fundamental changes, restricted payments, changes in the nature of our business, transactions with affiliates, corporate and accounting changes, and sale and leaseback arrangements.
Other Matters
We intend to continue to invest in the mini-VSAT Broadband network on a global basis. As part of the future potential capacity expansion, we plan to acquire additional satellite capacity from satellite operators, expend funds to seek regulatory approvals and permits, develop product enhancements in anticipation of the expansion, and hire additional personnel. From time to time we have entered into multi-year agreements to lease satellite capacity, and we have also purchased numerous satellite hubs to support the added capacity. These transactions can involve millions of dollars.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, our management has evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2022, the end of the period covered by this interim report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2022.
Changes in Internal Control over Financial Reporting
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Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, our management has evaluated changes in our internal control over financial reporting that occurred during the second quarter of 2022. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer did not identify any change in our internal control over financial reporting during the second quarter of 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Important Considerations
The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, there can be no assurance that any system of disclosure controls and procedures or internal control over financial reporting will be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the ordinary course of business, we are a party to inquiries, legal proceedings and claims including, from time to time, disagreements with vendors and customers. We are not a party to any lawsuit or proceeding that, in our opinion, is likely to materially harm our business, results of operations, financial condition, or cash flows.
ITEM 1A. RISK FACTORS
An investment in our common stock involves a high degree of risk. You should carefully consider the following risk factors in evaluating our business. If any of these risks, or other risks not presently known to us or that we currently believe are not significant, develops into an actual event, then our business, financial condition and results of operations could be adversely affected. If that happens, the market price of our common stock could decline.
Risks related to our financial performance
We have a history of losses, and regaining profitability may take longer than we anticipate or may not be achievable.
We recorded substantial losses from continuing operations in the six months ended June 30, 2022 and each of the last three fiscal years (notwithstanding the income we recognized in 2021 from the forgiveness of the PPP Loan). We may continue to incur losses as we increase satellite capacity to handle our growing subscriber base, as we continue to shift our business from a model based primarily on product sales to a model based primarily on recurring revenue, as we confront the impact of the COVID-19 pandemic (especially regarding the global chip shortage and supply chain constraints) on our business, as we incur expenses to restructure our business (including severance expenses) and as we continue to invest in research and development to improve our existing products and develop new products. In order to regain profitability, we must grow our airtime subscriber base, reduce our costs, and continue to introduce new and improved products in order to maintain and improve our competitive position and generate revenue. Our inability to accomplish any of these goals could have a material adverse effect on our revenues, profitability and cash flow, and we cannot assure you when, or whether, we will regain profitability.
Fluctuations in our quarterly net sales and results of operations could depress the market price of our common stock.
Our future net sales and results of operations could continue to vary significantly from quarter to quarter due to a number of factors, many of which are outside our control. Accordingly, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. It is possible that our net sales or results of operations in a quarter will fall below the expectations of securities analysts or investors. If this occurs, the market price of our common stock could fall significantly. Our results of operations in any quarter can fluctuate for many reasons, including changes in demand for our products and services; delays in order fulfillment, including as a result of shortages of components and raw materials; the mix of products and services we sell, including the mix of fixed rate and metered contracts for airtime services; our ability to manufacture, test and deliver products in a timely and cost-effective manner, including the availability of components and subassemblies from our suppliers; our success in winning competitions for orders; the timing of new product introductions by us or our competitors; the scope and success of our investments in research and development; expenses incurred in pursuing acquisitions and investments; expenses incurred in expanding, maintaining, or improving our mini-VSAT Broadband network; market and competitive pricing pressures; unanticipated charges or expenses, such as increases in warranty claims; expenses incurred in responding to stockholder activism; general economic climate; seasonality of pleasure boat and recreational vehicle usage; and the impact of the COVID-19 pandemic and resulting supply chain disruptions.
A large portion of our expenses, including expenses for network infrastructure, facilities, equipment, and personnel, are relatively fixed. Accordingly, if our net sales decline or do not grow as much or as quickly as we anticipate, we might be unable to maintain or improve our operating margins. Any failure to achieve anticipated net sales could therefore significantly harm our operating results for a particular fiscal period.
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Additional impairments to goodwill or other intangible assets could result in significant charges against earnings.
As a result of our acquisitions, we have recorded, and may continue to record, a significant amount of goodwill and other intangible assets. Under current accounting guidelines, we must assess, at least annually and potentially more frequently, whether the value of goodwill and other intangible assets has been impaired. In 2020, our annual impairment test resulted in an impairment charge of $10.5 million in our KVH Media reporting unit. Even after recording this impairment, our consolidated balance sheet at June 30, 2022 includes $5.9 million of goodwill and other intangible assets, of which $1.5 million relates to KVH Media Group. Our annual impairment analysis in the fourth quarter of 2021 did not identify any further impairments. However, there can be no assurance that our remaining goodwill and other intangible assets will not be further impaired, especially if the global COVID-19 pandemic continues to impact the markets in which our Media Group operates.
Risks related to our operations
Our future performance will depend in part on the success of our management transition.
On March 7, 2022, we announced that our President and Chief Executive Officer, Martin Kits van Heyningen, was retiring from his executive and Board roles after more than 40 years of service. Brent C. Bruun, our then Chief Operating Officer, was appointed as our interim President and Chief Executive Officer. Subsequently, on June 15, 2022, he was appointed as our President and Chief Executive Officer and as a Class II member of the Board of Directors. Because Mr. Kits van Heyningen will no longer participate in the day-to-day management of our business, we will not have the full benefit of his long experience, expertise and familiarity with our customers and suppliers and the industries in which we participate. If we are not successful in implementing our management transition, it could be viewed negatively by our customers, employees or investors and have an adverse impact on our business. Further, these changes will increase our dependency on other members of our executive management team who remain with us. Our executive officers are at-will employees, competition is intense for executive management, and they could terminate their employment with us at any time. We do not maintain key-person life insurance on any of our personnel. Accordingly, the loss of one or more of our executive officers or key employees could have a material adverse effect on our business.
If we cannot effectively manage changes in our business and continue to attract and retain skilled personnel, our business may suffer.
We are highly dependent on the efforts and abilities of qualified personnel at all levels, including our senior management team and other key technical, operational, managerial and sales and marketing personnel, each of whom brings a valuable set of skills that would be difficult to replace. If we fail to retain and attract the necessary personnel, we may be unable to achieve our business objectives and may lose our competitive position, which could lead to a significant decline in net sales. In March 2022, we announced a change in our strategic priorities, whereby we plan to focus on our core businesses, implement greater discipline in our new product initiatives and reduce costs. We may not achieve the anticipated benefits and cost savings from this restructuring. As part of this change, we completed a reduction in force of approximately 10% to realign our workforce to match our strategic priorities. The workforce reduction required the reallocation and combination of certain roles and responsibilities across the organization. Moreover, the reduction in force may yield unintended consequences and costs, such as attrition beyond the intended reduction in force, the distraction of employees and reduced employee morale, and could adversely affect our reputation as an employer. In the first and second quarters of this year we incurred severance and other expenses in connection with the reduction in force, which will reduce our earnings at least in the near term. The current job market for our personnel is very competitive, resulting in increased compensation, and we face challenges in seeking to retain our continuing personnel and attract new personnel to fulfill our unmet needs. Prior to the reduction in force, we experienced increased turnover among our employees. Replacing key personnel may be difficult and may take an extended period of time because of the limited number of individuals in our industry with the breadth of skills and experience required to successfully execute our business strategy, and we cannot assure you that we will be able to identify or employ qualified personnel for any such position on acceptable terms, if at all. In order to retain and attract qualified personnel, we may need to pay higher compensation than we currently expect, which would make it more difficult to achieve our goal of returning to profitability.
Further, if we are unable to adjust our operating expenses on a timely basis in response to changes in our operations, our results of operations may be harmed. To manage changes in our business effectively, we must, among other things, match our manufacturing facilities and capacity to demand for our products and services; secure appropriate satellite capacity to match changes in demand for airtime services; effectively manage our inventory and working capital; ensure robust cybersecurity protection of company and customers data and systems; and ensure that our procedures and internal controls are revised and updated to remain appropriate for our realigned workforce and the size and scale of our business operations.
Restructuring activities could disrupt our business and affect our results of operations.
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In the first and second quarters of this year we carried out a restructuring to re-align our workforce to match strategic and financial objectives and optimize resources for long-term growth, including a reduction in force. We also implemented a management transition, and our new management may take similar steps in the future to generate operating synergies, to achieve our target operating model and financial objectives, or to reflect more closely changes in the strategic direction of our business. We may also choose to make strategic divestitures. Any of these changes could be disruptive to our business, including our research and development and product launch efforts, and could result in significant expense, including losses on any divestiture, accounting charges for inventory and technology-related write-offs and workforce reduction costs, and significant transaction costs, including for potential transactions that do not proceed. Substantial expense or charges resulting from restructuring activities or divestitures could adversely affect our results of operations and use of cash in the periods in which we take these actions. Any divestiture could also result in the retention of liabilities and expenses that are not assumed by the acquirer or the loss of operating income from the divested operations, either of which could negatively impact profitability after any divestiture.
We must generate a certain level of sales of the TracPhone V-HTS series products and our mini-VSAT Broadband service in order to maintain or improve our service gross margins.
As a result of our mini-VSAT Broadband network infrastructure, our cost of service sales includes certain costs that generally do not vary directly in proportion with the volume of service sales, and we have limited ability to reduce these fixed costs in the short term. Although we have realized savings from the shutdown of our legacy Arclight network, the cost of our HTS network has increased significantly each year as we have further expanded our network to accommodate additional subscriber demand and/or coverage areas, as well as customers who migrated from our legacy network. We expect that this trend will continue in 2022 and beyond. If sales of our TracPhone V-HTS series products and the mini-VSAT Broadband service, including through our AgilePlans subscription model, do not generate the level of revenue that we expect or if those revenues decline, our service gross margins may decline. The failure to improve our mini-VSAT Broadband service gross margins and unit or subscriber sales would have a material adverse effect on our overall profitability.
Our ability to compete in the maritime airtime services market will be impaired if we are unable to provide sufficient service capacity to meet customer demand.
We currently offer our mini-VSAT Broadband service in the Americas, Europe, the Middle East, Africa, Asia-Pacific, Indian, and Australian and New Zealand waters. We may need to expand capacity in existing coverage areas to support our subscriber base. If we are unable to reach economical agreements with third-party satellite providers to support our mini-VSAT Broadband service and its technology or if transponder capacity is unavailable to meet growing demand in a given region, our ability to provide airtime services will be at risk and could reduce the attractiveness of our products and services.
Our results of operations are adversely affected by unseasonably cold weather, prolonged winter conditions, disasters or similar events.
Our leisure marine business is highly seasonal, and seasonality can also impact our commercial marine business. Historically, we have generated the majority of our leisure marine product revenues during the first and second quarters of each year, and these revenues typically decline in the third and fourth quarters of each year, compared to the first two quarters. Temporary suspensions of our airtime services typically increase in the third and fourth quarters of each year as boats are placed out of service during winter months. Our leisure marine business is also significantly affected by the weather. Unseasonably cool weather, prolonged winter conditions, hurricanes, unusual amounts of rain, and natural and other disasters may decrease boating, which could reduce our revenues. Specifically, we may encounter a decrease in new airtime activations as well as an increase in the number of cancellations or temporary suspensions of our airtime service.
We have single dedicated manufacturing facilities for each of our mobile connectivity product categories, and any significant disruption to a facility will impair our ability to deliver our products.
We currently manufacture all of our mobile connectivity products at our manufacturing facility in Middletown, Rhode Island. Some of our production processes are complex, and we may be unable to respond rapidly to the loss of the use of our production facility. For example, our production facility uses some specialized equipment that may take time to replace if they are damaged or become unusable for any reason. In that event, shipments would be delayed, which could result in customer or dealer dissatisfaction, loss of sales and damage to our reputation. Finally, we have only a limited capability to increase our manufacturing capacity in the short term. If short-term demand for our products exceeds our manufacturing capacity, our inability to fulfill orders in a timely manner could also lead to customer or dealer dissatisfaction, loss of sales and damage to our reputation.
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Acquisitions and strategic relationships may disrupt our operations or adversely affect our results.
We evaluate opportunities to acquire other businesses and pursue other strategic relationships as they arise. The expenses we incur evaluating and pursuing acquisitions and strategic relationships could have a material adverse effect on our results of operations. If we acquire a business, we may be unable to manage it profitably or successfully integrate its operations with our own. Moreover, we may be unable to realize the strategic, financial, operational and other benefits we anticipate, and any acquisition or strategic relationship may increase our operating expenses. Further, our approach to acquisitions and strategic relationships may involve a number of special financial and business risks, such as entry into new and unfamiliar lines of business or markets, which may present challenges or risks that we did not anticipate; entry into new or unfamiliar geographic regions, including exposure to additional tax and regulatory regimes; increased expenses associated with the amortization of acquired intangible assets; increased exposure to fluctuations in foreign currency exchange rates; charges related to any abandoned acquisition; diversion of our management's time, attention, and resources; loss of key personnel; increased costs to improve or coordinate managerial, operational, financial, and administrative systems, including internal control over financial reporting; dilutive issuances of equity securities; the assumption of legal liabilities; and losses arising from impairment charges associated with goodwill or intangible assets.
Risks related to our dependence on technology and third parties
Our mobile satellite products currently depend on satellite services, gateway teleports and terrestrial networks provided by third parties, and a disruption in those services could adversely affect sales.
Our satellite antenna products include the equipment necessary to utilize satellite services. We do not own the satellites that provide two-way satellite communications or the terrestrial networks that interconnect our facilities with the satellite teleports that communicate with the satellites. We currently offer satellite television products compatible with the DIRECTV and DISH Network services in the United States, the Bell TV service in Canada, the Sky Mexico service in Mexico, the Sky UK service in the United Kingdom, Canal+ service in France and Movistar service in Spain and various other regional satellite TV services in other parts of the world.
Intelsat and Sky Perfect-JSAT currently provide the satellite capacity to support the mini-VSAT Broadband service and our TracPhone and V-HTS series products. In addition, we have agreements with various teleports and Internet service providers around the globe to support the mini-VSAT Broadband service. The terrestrial fiber links that we use to connect with the Internet and to move our voice and data services between our facilities and the various satellite earth stations that support our services are provided to us through numerous service providers, some of which have contractual relationships with our satellite service providers and not directly with us. We rely on Inmarsat for satellite communications services for our FleetBroadband and FleetOne compatible TracPhone products. We also have an arrangement with Iridium for additional satellite communications services that we make available to our customers as a backup option to provide communications redundancy with our primary service offerings.
We exercise little or no control over these third-party providers of satellite, teleport and terrestrial network services, which increases our vulnerability to problems with the services they provide. Due to our reliance on these service providers, when problems occur, it may be difficult to identify the source of the problem. Service disruption or outages, regardless of whether they are caused by our service, the equipment or services of our third-party service providers, or our customers' or their equipment and systems, may result in loss of market acceptance of our service, and any necessary repairs or other remedial actions may cause us to incur significant costs and expenses. Any failure on the part of third-party service providers to achieve or maintain expected performance levels, stability and security could harm our relationships with our customers, result in claims for credits or damages, damage our reputation, significantly reduce customer demand for our solution and seriously harm our financial condition and operating results.
If customers become dissatisfied with the programming, pricing, service, availability or other aspects of any of these satellite services, or if any one or more of these services becomes unavailable for any reason, we could suffer a substantial decline in sales of our satellite products. There may be no alternative satellite service provider available to us in a particular geographic area, and our modem or other technology may not be compatible with the technology of any alternative service provider that may be available. Even if available, delays caused by switching our technology to another service provider, if available, and qualifying this new service provider could materially harm our customer relationships, business, financial condition and operating results. In addition, the unexpected failure of a satellite could disrupt the availability of programming and services, which could reduce the demand for, or customer satisfaction with, our products.
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We depend on cloud-based data services operated by third parties, and any disruption in the operation of these services could harm our business.
Some of our content services and business records are hosted by various cloud-based data services operated by third parties. Any failure or downtime in one of these services could affect a significant percentage of our customers. Although we control and have access to our servers and the components of our network that are located in our internal facilities and certain of our external data facilities, we do not control the operation of external facilities. The providers of our data management services have no obligation to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew these agreements on commercially reasonable terms, or if one or more of our data management service providers is acquired, closes, suffers financial difficulty or is unable to meet our growing capacity needs, we may be required to transfer our data to other services, and we may incur significant costs and service interruptions in connection with doing so, which could harm our reputation with our customers and adversely affect our revenues and results of operations.
Our media and entertainment business relies on licensing arrangements with content providers, and the loss of, or changes in, those arrangements could adversely affect our business.
We distribute premium news, sports, movies, and music content for commercial and leisure customers in the maritime, hotel, and retail markets. We license this content from third parties on a non-exclusive basis without long-term license agreements. Any content provider could terminate our arrangements without notice or could adversely modify the terms of the arrangement, including price increases. Further, the licenses we obtain are limited in scope, and any violation of the terms of a license could expose us to liability for copyright infringement. We pay license fees based in part on the revenue we generate from sublicenses, and our licensors generally have the right to audit our records. Failure to pay required license fees could result in termination of our license rights, penalties and damages. The loss of content could adversely affect the attractiveness of our media and entertainment offerings, which could in turn adversely affect our revenues. Any increase in the cost of content could reduce the profitability of these offerings.
Cybersecurity breaches could disrupt our operations, expose us to liability, damage our reputation, and require us to incur significant costs or otherwise adversely affect our financial results.
We are highly dependent on information technology networks and systems, including the Internet and third-party systems, to securely process, transmit and store electronic information, including personal information of our customers. We also retain sensitive data, including intellectual property, proprietary business information, personally identifiable information, credit card information, and usage data of our employees and customers on our computer networks and those of third parties. Although we take certain protective measures and endeavor to modify them as we believe circumstances warrant, invasive technologies and techniques continue to evolve rapidly, and increasingly sophisticated hacking organizations are targeting business systems. As a result, the computer systems, software and networks that we use are vulnerable to disruption, shutdown, unauthorized access, misuse, erasure, alteration, employee error, phishing, computer viruses, ransomware or other malicious code, and other events that could have a security impact. The protective measures on which we rely may be inadequate to prevent or detect cybersecurity breaches or determine the extent of any breach, and there can be no assurance that undetected breaches have not already occurred. If any of these events were to occur, they could disrupt our operations, distract our management, cause us to lose existing customers and fail to attract new customers, as well as subject us to regulatory actions, litigation, fines, damage to our reputation or competitive position, or orders or decrees requiring us to modify our business practices, any of which could have a material adverse effect on our financial position, results of operations or cash flows.
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Risks related to economic conditions and trade relations
Our revenues, results of operations and financial condition have been, and are expected to be, adversely impacted by economic turmoil, political events, macroeconomic conditions, credit tightening and associated declines in consumer and enterprise spending, and by the continuation of the COVID-19 pandemic, including related supply chain issues.
Economic conditions in the various geographic markets we serve have experienced significant turmoil over the last several years, including a potential global recession, downturns related to the COVID-19 pandemic, slow economic activity, tight credit markets, inflation and deflation concerns, low consumer confidence, limited capital spending, adverse business conditions, war and refugee crises in the Middle East and Europe, terrorist attacks, the departure of the United Kingdom from the European Union, changes in government priorities, trade wars, a government shutdown, gridlock from a divided Congress, and liquidity concerns. These factors vary in intensity by region. Further, in response to the COVID-19 pandemic, governments have implemented, revised, withdrawn, reinstituted and expanded extensive safety precautions, including quarantines, travel restrictions, business closures, cancellations of public gatherings and other measures. Other organizations and individuals continue to take additional steps to avoid or reduce infection, including limiting travel and implementing work-at-home policies. These measures have significantly disrupted normal business operations both in and outside of affected areas, and complying with them has increased our costs. Travel restrictions and safety precautions have also limited our ability to service and install our equipment. Although we are unable to predict the ongoing impact of the pandemic, our mobile communications business in particular largely depends on travel. The operations of our KVH Media Group were particularly impacted due in part to the global reduction in travel resulting from the pandemic. We anticipate that, until the pandemic is contained, governmental, individual, business and other organizational measures to limit the spread of the virus will continue to adversely affect our revenues, results of operations and financial condition, perhaps materially. An outbreak of infection in any of our facilities could severely disrupt our operations. We continue to monitor government recommendations and have made modifications to our operations because of the pandemic. Our customers' businesses could be further disrupted, and our revenues could continue to be adversely affected. Additionally, global economic disruptions like the COVID-19 pandemic have negatively impacted, and could continue to negatively impact, our supply chain and continue to cause delays in the delivery of raw materials, components and other supplies that we need to conduct our operations and generate revenue. The extent to which the pandemic will continue to impact our business will depend on many factors beyond our control, including the speed of contagion, the appearance of new variants, the development and implementation of effective preventative measures and vaccines, the scope of governmental and other restrictions on travel and other activity, and public reactions to these factors.
There can be no assurances that government programs to maintain or improve economic conditions, including stimulus and other aid programs intended to combat the impact of the pandemic, will be effective. As a result of these and other factors, customers and government entities could continue to slow or suspend spending on our products and services. We may also incur increased credit losses and need to further increase our allowance for doubtful accounts, which would have a negative impact on our earnings and financial condition.
We cannot predict the timing, duration, or ultimate impact of the turmoil in our markets. We expect our business to continue to be adversely impacted by this turmoil, particularly in relation to the COVID-19 pandemic, to varying degrees and for varying amounts of time, in all our geographic markets.
Changes in U.S. trade policy, including changes to existing trade agreements and any resulting changes in international trade relations, may have a material adverse effect on us.
The change in U.S. presidential administrations may alter the U.S.'s approach to international trade, which may impact existing bilateral or multi-lateral trade agreements and treaties with foreign countries. The U.S. has imposed tariffs on certain foreign goods and may increase tariffs or impose new ones, and certain foreign governments have retaliated and may continue to do so. We derive a majority of our revenues from international sales (including sales by our recently sold inertial navigation business), which makes us especially vulnerable to increased tariffs. Changes in U.S. trade policy have created ongoing turmoil in international trade relations, and it is unclear what future actions the U.S. government or foreign governments will or will not take with respect to tariffs or other international trade agreements and policies. Current trade negotiations may fail, which may exacerbate these risks. Ongoing or new trade wars or other governmental action related to tariffs or international trade agreements or policies could reduce demand for our products and services, increase our costs, reduce our profitability, adversely impact our supply chain or otherwise have a material adverse effect on our business and results of operations.
Changes in foreign currency exchange rates may negatively affect our financial condition and results of operations.
Because of the scope of our foreign sales and foreign operations, we face significant exposure to movements in exchange rates for foreign currencies, particularly the pound sterling and the euro. For example, during 2022, the U.S. dollar strengthened against certain foreign currencies, which adversely affected revenues reported in U.S. dollars and decreased the reported value of our assets in foreign countries.
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We also have intragroup receivables and liabilities, such as loans, that can generate significant foreign currency effects. Changes in exchange rates, particularly the U.S. dollar against the pound sterling, could lead to the recognition of unrealized foreign exchange losses.
Moreover, certain of our products and services are sold internationally in U.S. dollars; if the U.S. dollar continues to strengthen, the relative cost of these products and services to customers located in foreign countries would increase, which could adversely affect export sales. In addition, most of our financial obligations must be satisfied in U.S. dollars. Our exposures to changes in foreign currency exchange rates may change over time as our business practices evolve and could result in increased costs or reduced revenue and could adversely affect our cash flow. Changes in the relative values of currencies occur regularly and may have a significant impact on our operating results. We cannot predict with any certainty changes in foreign currency exchange rates or the degree to which we can cost-effectively mitigate this exposure.
Risks related to the sale of our inertial navigation business
We face potential liabilities and disruptions arising from the sale of our inertial navigation business.
On August 9, 2022, we sold our inertial navigation business, one of our two operating segments, to EMCORE Corporation, for aggregate consideration of $55.0 million, less specified deductions and a holdback of $1.0 million and subject to a working capital adjustment. As a result of these provisions, we could receive proceeds that are less than we anticipate.
The sale of the inertial navigation business required us to separate and allocate specific assets to the business, including some shared assets. We could also face disputes with EMCORE regarding whether or not certain assets were included in the sale. Moreover, we agreed, for a period of time after the sale, to continue to perform certain services that we historically performed for the inertial navigation business, and we also undertook other customary obligations associated with a disposition of a business by means of asset sale.
We incurred significant legal, accounting and financial advisory fees negotiating and consummating the sale of the inertial navigation business, and we may incur additional fees to resolve any dispute that may arise over the terms of the transaction or the parties' compliance with their obligations under the transaction agreements. Although EMCORE agreed to assume most liabilities associated with the inertial navigation business, it did not assume all such liabilities, which could lead to a dispute. Any such disputes could divert the attention of our management or otherwise have a material adverse effect on our business, financial condition and results of operations.
The sale of the inertial navigation business will have the effect of reducing our operating and profit margins, and we will be solely reliant on our mobile connectivity business.
As a result of the sale of the inertial navigation business, we will no longer generate revenues associated with that business. Accordingly, the costs we incur to operate our continuing business, including the significant overhead costs associated with being a public company, will be spread over a smaller revenue base and will have the immediate effect of magnifying the impact of those costs on our operating and profit margins. In order to improve those margins, we will have to increase our revenue or reduce our costs. While the disposition of the inertial navigation business should simplify our financial reporting, we do not expect that any cost savings would be substantial.
The sale of our inertial navigation business may make it more difficult to attract and retain employees.
As a result of the sale of our inertial navigation business, our base of continuing employees will be smaller. We will have fewer personnel to perform certain functions provided by departed employees, which will have the effect of magnifying the impact of any additional departures of continuing personnel. Our smaller size may also make it more difficult to attract and retain new personnel. Our efforts to attract and retain employees may not be successful, which could have a material adverse effect on our ability to operate our business and achieve our business goals.
Our board of directors has not decided how to use the proceeds from the sale of our inertial navigation business, and stockholders may disagree with the board's decisions.
Our board will have broad discretion regarding the use of the remaining net proceeds, which may include, without limitation, general corporate purposes, stock repurchases, cash dividends, capital expenditures, working capital, and strategic acquisition opportunities that may arise. In most cases, our board of directors will be able to deploy the net proceeds without obtaining stockholder approval and, as a result, may use the net proceeds in ways with which our stockholders may disagree. Divergent
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stockholder expectations for our remaining business, including expectations regarding the use of proceeds, profitability and cash flow, may lead to significant fluctuations in our stock price.
Risks related to our industry
Competition may limit our ability to sell our mobile connectivity products and services.
The mobile connectivity market is very competitive, and we expect this competition to intensify. We may not be able to compete successfully against current and future competitors, which could impair our ability to sell our products and services. As our market share in the mobile satellite communication market has grown, competition has intensified significantly, most notably from companies that seek to compete primarily on price. These companies may continue to implement price reductions and discounts for both products and services, which have required us to reduce our prices or offer discounts in order to maintain or increase our market share. Some of our VSAT competitors have also leveraged partnerships amongst themselves in order to capture larger combined market share. Further, some of the companies that we depend on to supply us with capacity on satellite communications networks may vertically integrate by introducing their own products and services to compete with ours, which might motivate them to stop providing satellite network capacity to us, or to make it available only on less favorable terms.
In the marine market for satellite TV equipment, we compete primarily with Intellian, Cobham SATCOM and Raymarine (Intellian made). In the marine market for voice, fax, data, and Internet communications equipment, we compete primarily with Intellian and Cobham SATCOM. In the marine market for high-speed voice, fax, data, and Internet services, we compete primarily with Inmarsat, Marlink and Network Innovations. We also face competition from providers of low-speed data services, which include Inmarsat, Globalstar LP, and Iridium Satellite LLC. In the market for land mobile satellite TV equipment, we compete primarily with King Controls and Winegard Company. In the markets for media content, the KVH Media Group competes primarily with Swank Motion Pictures and NewspaperDirect Inc. Many of our competitors are well-established companies that have substantially greater financial, managerial, technical, marketing, personnel and other resources than we do, which may help them to compete more effectively against us.
The emergence of a competing small maritime VSAT antenna and complementary service or other similar service could reduce the competitive advantage we believe we currently enjoy with our smaller TracPhone V-HTS series antennas and Ku-band mini-VSAT Broadband service, or with our TracPhone V11-HTS antenna and our C/Ku-band mini-VSAT Broadband service.
Our TracPhone V-HTS and V-IP systems offer customers a range of benefits due to their integrated design, hardware costs that are lower than existing maritime Ku-band VSAT systems, and broadband technology. We currently compete against companies that offer established maritime Ku-band VSAT service using, in some cases, antennas 1-meter in diameter or larger. While we are unaware of any company offering a 37-cm VSAT solution comparable to our TracPhone V3-HTS or V30, we are encountering regional competition from companies offering 60-cm VSAT systems and services, which are comparable in size to our TracPhone V7-HTS. Likewise, our TracPhone V11-HTS, at 1.1-meters in diameter, is approximately 85% smaller and lighter than competing C-band maritime VSAT systems, which use antennas in excess of 2.4-meters in diameter to provide similar global services. We are unaware of any competitor currently offering a similar size solution for global C-band coverage, but any introduction of such a product could adversely impact our success. In addition, other companies could replicate some of the distinguishing features of our TracPhone V-HTS series products, which could potentially reduce the appeal of our solution, increase price competition, and adversely affect sales. We compete against Inmarsat's Fleet Xpress service, a global Ka-band mobile VSAT service that Inmarsat claims is faster and has a lower price per megabit than existing Ku-band services. This service may continue to adversely impact sales of our mini-VSAT Broadband service and related equipment. Our arrangement to use the IntelsatOne Flex service for our HTS network is not exclusive, and competitors' use of this service could also adversely impact sales. Moreover, consumers may choose other services such as FleetBroadband or Iridium OpenPort for their service coverage at potentially lower hardware costs despite higher service costs and slower data rates.
Any failure to maintain and expand our third-party distribution relationships may limit our ability to penetrate markets for mobile connectivity products and services.
We market and sell our mobile connectivity products and services through an international network of independent retailers, chain stores and distributors, as well as to manufacturers of marine vessels, recreational vehicles and buses. Most of these relationships are non-exclusive, allowing these third parties to market competing products. If we fail to maintain relationships with our current distributors, fail to develop relationships with new distributors in new and existing markets, or manage, train, or provide appropriate incentives to our existing distributors, or if our distributors are not successful in their sales efforts, sales of our products and services may decline and our operating results could be harmed.
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We depend on sole or limited source suppliers, and any disruption in supply could impair our ability to deliver our products on time or at expected cost.
We obtain many key components for our products from third-party suppliers, and in some cases we use a single or a limited number of suppliers. Any interruption in supply could impair our ability to deliver our products until we identify and qualify a new source of supply, which could take several weeks, months or longer and could increase our costs significantly. For example, the global chip shortage and supply chain constraints resulting from the COVID-19 pandemic have impacted our ability to deliver products in a timely manner and have increased our cost of sales due to rising prices for materials. In the second quarter of 2022, we estimate that raw material costs exceeded our expectations by approximately $0.6 million, and that orders for approximately $2.7 million could not be filled due to component shortages. We may not be able to pass along any or all of these cost increases to our customers, and customers may not wait for our products to become available. These disruptions in our supply chain could continue or worsen, which could continue to delay delivery of our products and services and adversely affect our revenue and results of operations in future periods. Suppliers might change or discontinue key components, which could require us to modify our product designs. Regulations requiring government contractors to implement processes to avoid counterfeit parts may require us to find new sources of materials or components if a supplier cannot meet those requirements. In general, we do not have written long-term supply agreements with our suppliers but instead buy components through purchase orders, which expose us to potential price increases and termination of supply without notice or recourse. We generally do not carry significant inventories of product components, which could magnify the impact of the loss of a supplier. If we must use a new source of supply, we could face unexpected manufacturing difficulties and loss of product performance or reliability. In addition, from time to time, lead times for certain components can increase significantly due to imbalances in overall market supply and demand. This, in turn, could limit our ability to satisfy demand for our products on a timely basis and could result in the cancellation of customer orders. Further, adverse economic conditions, including conditions caused by the current COVID-19 pandemic, could result in financial difficulties or bankruptcy for any of our suppliers, which could adversely affect our business and results of operations.
We may source more materials and components from international suppliers, which could disrupt our business.
Although we have historically manufactured and sourced raw materials for the majority of our products domestically, in order for us to compete with lower priced competing products while also improving our profitability, in some instances we have found it desirable to source raw materials and manufactured components and assemblies from Europe, Asia, and South and North America. Reliance on foreign manufacturing and/or raw material supply has lengthened our supply chain and increased the risk that a disruption in that supply chain could have a material adverse effect on our operations and financial performance.
Changes in the competitive environment, customer demand, supply chain issues, and the transition to new products may require inventory write-downs.
From time to time, we have recorded significant inventory charges and/or inventory write-offs as a result of substantial declines in customer demand. For example, in the second quarter of 2022, we recorded a $1.6 million inventory reserve related to a specialized component in our former TACNAV product line. This component was originally purchased in anticipation of an order from a long-standing customer; however, that order never materialized. Market or competitive changes could lead to future charges for excess or obsolete inventory, especially if we are unable to appropriately adjust the supply of material from our vendors.
Risks related to intellectual property
We are devoting significant resources to research and development efforts that may be unsuccessful. If we are unable to improve our existing mobile connectivity and inertial navigation products and services and develop new, innovative products and services, our sales and market share may decline.
The market for mobile connectivity products and services is characterized by rapid technological change, frequent new product innovations, changes in customer requirements and expectations, and evolving industry standards. For example, we now compete with Inmarsat's Fleet Xpress satellite communications products and services. If we fail to make innovations in our existing products and services and reduce the costs of our products and services in a timely way, our market share may decline. For example, the introductions of our TracVision TV-series antennas in 2014 occurred later than we had anticipated, which we believe led certain customers to purchase competing products. Products or services using new technologies, or emerging industry standards, could render our products and services obsolete. If our competitors successfully introduce new or enhanced products or services that outperform our products or services, or are perceived as doing so, we may be unable to compete successfully in the markets affected by these changes.
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Research and development in our industry is inherently complex and uncertain, and our current and anticipated research and development projects may not achieve the results we seek. The financial resources that we can devote to our research and development efforts may be insufficient to achieve our goals. Our efforts may not result in any viable products or may result in products whose performance, features, price or availability may not be attractive to customers or that we cannot manufacture and sell profitably.
Our business may suffer if we cannot protect our proprietary technology.
Our ability to compete depends significantly upon our patents, copyrights, source code, and other proprietary technology. The steps we have taken to protect our technology may be inadequate to prevent others from using what we regard as our technology to compete with us. Our patents will eventually expire and could be challenged, invalidated or circumvented. Customers or others with access to our proprietary or licensed media content could copy that content without permission or otherwise violate the terms of our customer agreements, which would adversely affect our revenues and could impair our relationships with content providers. In addition, the laws of some foreign countries do not protect our proprietary technology to the same extent as the laws of the United States, which could increase the likelihood of misappropriation. Any misappropriation of our technology or the development of competing technology could seriously harm our competitive position, which could lead to a substantial reduction in net sales. If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome, disruptive and expensive, distract the attention of management, and there can be no assurance that we would prevail.
Claims by others that we infringe their intellectual property rights could harm our business and financial condition.
Our industries are characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. We cannot be certain that our products do not and will not infringe issued patents, patents that may be issued in the future, or other intellectual property rights of others.
From time to time we have faced claims by third parties that our products or technology infringe their patents or other intellectual property rights, and we may face similar claims in the future. For example, we were sued for patent infringement in 2015, and we settled this claim in January 2016 with a payment of cash. Any claim of infringement could cause us to incur substantial costs defending against or settling the claim, even if the claim is invalid, and could distract the attention of our management. If any of our products are found to violate third-party proprietary rights, we may be required to pay substantial damages. In addition, we may be required to re-engineer our products or obtain licenses from third parties to continue to offer our products. Any efforts to re-engineer our products or obtain licenses on commercially reasonable terms may not be successful, which would prevent us from selling our products, and, in any case, could substantially increase our costs and have a material adverse effect on our business, financial condition and results of operations.
Risks related to government regulation
Our international operations complicate our business and require us to comply with multiple regulatory environments.
Historically, sales to customers outside the United States have accounted for a significant portion of our net sales. We derived 63%, 60% and 64% of our revenues in the six months ended June 30, 2022 and the years ended December 31, 2021 and 2020, respectively, from sales to these foreign customers (including sales by our recently sold inertial navigation business). We have foreign offices in Denmark, the United Kingdom, Singapore, Japan, Norway, Cyprus and the Philippines, as well as a subsidiary in Brazil that manages local sales. Nonetheless, substantially all of our personnel and operations are located in the United States. Our limited international operations may impair our ability to compete successfully in international markets and to meet the service and support needs of our customers in countries where we have little to no infrastructure. We face a number of risks associated with our international business activities, which may increase our costs and require significant management attention. These risks include restrictions on international travel, which may restrict our ability to grow and service our business; tariffs; sanctions or other trade restrictions that preclude or restrict doing business with particular foreign governments, companies or individuals; technical challenges we may face in adapting our mobile connectivity products to function with different satellite services and technology in use in various regions around the world; satisfaction of international regulatory requirements and delays and costs associated with procurement of any necessary licenses or permits; the potential unavailability of content licenses covering international waters and foreign locations; increased costs of providing customer support in multiple languages; increased costs of managing operations that are international in scope; potentially adverse tax consequences, including restrictions on the repatriation of earnings; protectionist laws and business practices that favor local competitors, which could slow our growth in international markets; potentially longer sales cycles; potentially longer accounts receivable payment cycles and difficulties in collecting accounts receivable; and economic and political instability in some international markets.
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We could incur additional legal compliance costs associated with our international operations and could become subject to legal penalties if we do not comply with certain regulations.
As a result of our international operations, we are subject to a number of legal requirements, including the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act and the customs, export, trade sanctions and anti-boycott laws of the United States, including those administered by the U.S. Customs and Border Protection, the Bureau of Industry and Security, the Department of Commerce, the Department of State, and the Office of Foreign Assets Control of the Treasury Department, as well as those of other nations in which we do business. In addition, many of the countries where our customers use our products and services have licensing and regulatory requirements for the importation and use of satellite communications and reception equipment, including the use of such equipment in territorial waters, the transmission of satellite signals on certain radio frequencies, the transmission of voice over Internet services using such equipment, and, in some cases, the reception of certain video programming services. These laws and regulations are continually changing, making compliance complex. We incur significant costs identifying and maintaining compliance with applicable licensing and regulatory requirements. In addition, our training and compliance programs and our other internal control policies may be insufficient to protect us from acts committed by our employees, agents or third-party contractors. Any violation of these requirements by us or our employees, agents or third-party contractors may subject us to significant criminal and civil liability.
We are subject to FCC rules and regulations, and any non-compliance could subject us to FCC enforcement actions, fines, loss of licenses and possibly restrictions on our ability to operate or offer certain of our services
The satellite communications industry is regulated by the Federal Communications Commission in the United States and, as a result, we are subject to existing and potential FCC regulations relating to privacy, contributions to the Universal Service Fund, or USF, and other requirements. If we do not comply with FCC rules and regulations, we could be subject to FCC enforcement actions, substantial fines, penalties, loss of licenses and possibly restrictions on our ability to operate or offer certain of our services. Any enforcement action by the FCC, which may be a public process, could hurt our reputation in the industry, possibly impair our ability to sell our services to customers and could harm our business and results of operations.
Reform of federal and state USF programs could increase the cost of our service to our customers, diminishing or eliminating our pricing advantage.
The FCC has been considering reform or other modifications to its USF program, which, if implemented, could change the way we calculate our contribution to USF. In April 2012, the FCC released a proposal to consider reforms to the manner in which companies like us contribute to the federal USF program. In general, the proposal indicates that the FCC is considering changes to the companies that should contribute, how contributions should be assessed, and methods to improve the administration of the system. We cannot predict the outcome of this proceeding or its impact on our business. The changes in the U.S. administration may renew interest in completing this proceeding. Should the FCC adopt new contribution mechanisms or otherwise modify contribution obligations that increase our contribution burden, we will either need to raise the amount we currently collect from our customers to cover this obligation or absorb the costs, which would reduce our profit margins. The attractiveness of our services may also be reduced as compared to the services of our competitors that do not appear to contribute to USF, or do not do so to the same extent that we do.
Privacy concerns and domestic or foreign laws and regulations may reduce demand for our services, increase our costs and harm our business.
Our company and our customers can use our services to collect, use and store personal, confidential and sensitive information regarding the content and manner of usage of our services by them, their employees and maritime crews. Federal, state and foreign governments have adopted and are proposing new and more stringent laws and regulations regarding the collection, use, storage and transfer of information, such as the European Union's General Data Protection Regulation ("GDPR"). The costs of compliance with, and other burdens imposed by, such laws and regulations may limit the use and adoption of our services and reduce overall demand. Non-compliance with these laws and regulations could lead to significant remediation expenses, fines, penalties or other liabilities, such as orders or consent decrees that require modifications to our privacy practices, as well as reputational damage or third-party lawsuits seeking damages or other relief. For example, the GDPR imposes a strict data protection compliance regime with penalties of up to the greater of 2%-4% of worldwide revenue or €10-20 million.
Domestic and international legislative and regulatory initiatives may harm our ability, and the ability of our customers, to process, handle, store, use and transmit information, which could reduce demand for some of our services, increase our costs and force us to change our business practices. These laws and regulations are still evolving, are likely to be in flux and may be subject to uncertain interpretation for the foreseeable future. Our business also could be harmed if legislation or regulations are
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adopted, interpreted or implemented in a manner that is inconsistent from country to country or inconsistent with our current policies and practices or those of our customers.
We may have exposure to additional tax liabilities, which could negatively impact our income tax expense, net income and cash flow.
We are subject to income and other taxes in the U.S. and the foreign jurisdictions in which we operate. The determination of our worldwide provision for income taxes and current and deferred tax assets and liabilities requires significant judgment and estimation. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, the ultimate tax outcome may differ materially from our estimates and may materially affect our income tax benefit or expense, net loss or income, and cash flows in the period in which such determination is made. As of June 30, 2022, we had gross uncertain tax positions of $1.9 million, consisting of a $1.3 million reduction to deferred tax assets and a $0.6 million liability for uncertain tax positions.
Deferred tax assets are recognized for the expected future tax consequences of temporary differences between the carrying amount for financial reporting purposes and the tax bases of assets and liabilities, and for net operating losses and tax credit carry forwards. We have historically recorded valuation allowances to reduce our deferred tax assets to estimated realizable value. We review our deferred tax assets and valuation allowance requirements quarterly. If we are unable to demonstrate that it is more likely than not that we will not be able to generate sufficient future taxable income to realize the net carrying value of deferred tax assets, we will record a valuation allowance to reduce the deferred tax assets to estimated realizable value, which could result in a material income tax charge. As part of our review, we consider positive and negative evidence, including cumulative results of recent years.
Risks related to owning our common stock
The market price of our common stock may be volatile.
Our stock price has historically been volatile. During the period from January 1, 2018 to June 30, 2022, the trading price of our common stock ranged from $6.36 to $15.29. Many factors may cause the market price of our common stock to fluctuate, including variations in our quarterly results of operations; the introduction of new products and services by us or our competitors; changes in estimates of our performance or recommendations by securities analysts; the hiring or departure of key personnel; acquisitions or strategic alliances involving us or our competitors; market conditions in our industries; and the global macroeconomic and geopolitical environment. Broad market fluctuations may adversely affect the market price of our common stock. When the market price of a company's stock drops significantly, stockholders often institute securities litigation against that company. Any such litigation could cause us to incur significant expenses defending against the claim, divert the time and attention of our management and result in significant damages.
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ITEM 6. EXHIBITS
Exhibits:
|
Exhibit No. |
Description |
Filed with this Form 10-Q |
Incorporated by Reference | |
| Form | Filing Date | Exhibit No. | ||
| Amended and Restated Certificate of Incorporation, as amended | 10-Q | August 6, 2010 | 3.1 | |
| Amended and Restated Bylaws | 10-Q | November 1, 2017 | 3.2 | |
| Specimen certificate for the common stock | 10-K | March 2, 2018 | 4.1 | |
|
10.1
|
Executive Employment Agreement dated as of May 2, 2022 between KVH Industries, Inc. and Brent C. Bruun
|
X | ||
|
10.2
|
Executive Employment Agreement dated as of May 2, 2022 between KVH Industries, Inc. and Roger A. Kuebel
|
X | ||
|
10.3
|
Executive Employment Agreement dated as of May 2, 2022 between KVH Industries, Inc. and Felise B. Feingold
|
X | ||
|
10.4
|
Executive Employment Agreement dated as of May 9, 2022 between KVH Industries, Inc. and Robert J. Balog
|
X | ||
|
31.1
|
Rule 13a-14(a)/15d-14(a) certification of principal executive officer | X | ||
|
31.2
|
Rule 13a-14(a)/15d-14(a) certification of principal financial officer | X | ||
|
32.1
|
Section 1350 certification of principal executive officer and principal financial officer | X | ||
| 101 |
The following financial information from KVH Industries, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, formatted in Inline XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets (unaudited), (ii) the Consolidated Statements of Operations (unaudited), (iii) the Consolidated Statements of Comprehensive Loss (unaudited), (iv) the Consolidated Statement of Stockholders' Equity (unaudited), (v) the Consolidated Statements of Cash Flows (unaudited), and (vi) the Notes to Consolidated Interim Financial Statements (unaudited).
|
X | ||
| 104 |
Cover Page Interactive Data File (embedded within the Inline XBRL document)
|
X |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Date: August 9, 2022 | |
| KVH Industries, Inc. | |
| By: | /s/ ROGER A. KUEBEL |
| Roger A. Kuebel | |
|
(Duly Authorized Officer and Chief Financial Officer) |
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