KVH Industries Inc (KVHI) 2007 Q4 法說會逐字稿

Good day, everyone and welcome to the KVH Industries' fourth-quarter year-end conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Pat Spratt, Chief Financial Officer. Please go ahead, sir.

Thank you. Good morning. I am Pat Spratt, Chief Financial Officer of KVH Industries. And with me today is Martin Kits van Heyningen, Chief Executive Officer. This call will address the fourth-quarter earnings release that we issued earlier this morning. Copies of the release are available on our website, KVH.com, and are also available from our Investor Relations department. This call is being simulcast on the Internet and will also be archived on our website for future reference.

This conference call will contain certain forward-looking statements that involve risks and uncertainties. For example, statements regarding financial and product development goals are forward-looking. The Company's future results may differ materially from the projections described in today's discussion. Factors that might cause these differences include, but are not limited to, those mentioned in today's call and risk factors described in our quarterly report on Form 10-Q filed with the SEC on November 9, 2007. The Company's SEC filings are directly available from us, from the SEC or from the Investor Information section of our website.

Now I would like to turn the call over to Martin to begin today's discussion of results.

Great, thanks, Pat and thank you all for joining us today. I am pleased to report that we closed out 2007 on a very strong note with sales and profits well above last year's fourth quarter. These improvements are the result of the hard work of our team, the hard work they put in over the course of the year. We overhauled our entire mobile satellite productline, launched two new marine communication systems and focused the Company on two major opportunities.

So Pat will cover the detailed financial results and provide some additional color on the guidance we issued this morning, but first I am going to bring you up to date on our top and bottom-line results, touch on some recent news in our key markets and outline our vision for the Company going forward.

We have two major opportunities that have the potential to dramatically change KVH starting in 2008 and I will be talking about those in a minute. During Q4, we achieved better than expected quarterly revenues of $19.7 million, a 13% increase from last year's fourth quarter. Earnings were $0.06 per share, net profit of about $1 million, which reflects a year-over-year increase of $0.05 per share. For the full year, total revenue was about $81 million. That is up 2% from 2006 with net earnings of $2.5 million or $0.17 per share.

In our mobile communications business, fourth-quarter revenue was $14.1 million and that is up 16% from Q4 of last year. We enjoyed strong growth in our marine business with revenue up 35% over last year's fourth quarter. The key drivers here were initial shipments of our TracPhone V7 and strong European sales. I will touch on the TracPhone V7 in more depth shortly.

In the land market, quarterly mobile communication sales were down 10% year-over-year, due primarily to weakness in the automotive sector. We took an important step to strengthen our land sales channel thanks to a significant product distribution deal with Coast Distribution, which gives us a new channel into the RV market both in the US and Canada and together with existing distributors, Stag-Parkway and NTP, our TracVision systems are now carried by the three largest RV distributors in North America, serving more than 2000 independent dealers.

In our guidance and stabilization business, quarterly revenue increased 7% to $5.6 million compared to Q4 of 2006. Fourth-quarter sales increased shipments of -- fourth-quarter sales included increased shipments of our TG-6000 inertial measurement unit to Raytheon, as well as solid TACNAV sales.

While slower TACNAV sales earlier in the year contributed to an 11% decline in defense revenues for the full year, these navigation systems continue to be an important core business for the Company. We added more than $20 million in long-term contracts over the course of 2007 and just a few days ago, we announced new orders for TACNAV components valued at about $1.4 million with deliveries beginning in Q1.

Fiber-optic gyro sales remained strong, both for the quarter and for the year with revenue up 9% and 13% respectively. Our existing FOG products are well-established and new products are in the pipeline. These new products include a smaller FOG for optical stabilization that we are developing for FLIR Systems and a smaller, less-expensive inertial measurement unit that we are developing with a leading precision GPS company. We expect to announce complete details about both of these products during the first half of 2008.

We also continue to aggressively pursue opportunities to supply our fiber-optic gyros for use in stabilized remote weapons stations. Despite some near-term uncertainty about production contracts, we believe that stabilized weapons will be the primary catalyst for growth in our guidance and stabilization business in 2008. There are a large number of companies building remote weapons systems and all of these will need precision gyros. Programs like the US Army CROWS system and others will need over 25,000 fiber-optic gyros over the next five years. We hope to participate in these programs in a meaningful way.

KVH is in a strong position to support these prime contractors. Our gyros are the only ones that are field-proven in remote weapons stations that have actually been used in combat. We have proven gyro production capability and we have built more than 20,000 fiber-optic gyros. We just doubled the size of our FOG production facility in 2007 and are in the process of doubling our output capacity again in anticipation of higher demand.

Many of the [primes] involved in these programs are already customers of ours, so while we currently don't have any large, long-term contracts in hand, we do have a number of recent orders and hope to receive additional orders that will drive our FOG business growth significantly in 2008 and 2009.

The other business opportunity that will be a growth driver for KVH is in our mobile communications business and that is our new TracPhone V7 and mini-VSAT Broadband service. We developed this unique combination of hardware and airtime based on the simple premise that broadband connections at sea are increasingly necessary for leisure, commercial and military vessels. But when we surveyed the market, we found that more than 80% of subscribers were not happy with the solutions they used. Frustration was the result of many factors. Legacy VSAT systems were too large, the airtime to expensive, setup and activation were a nightmare and support was too confusing due to a maze of modem, antenna, airtime and support providers.

We believe we could do better by changing the equation and making maritime broadband an affordable, convenient and reliable resource. In doing so, we have launched KVH into the financially attractive world of airtime service provider with an affordable, powerful VSAT solution that we control in corporation with our partners.

TracPhone V7 is a product with broad appeal in multiple markets. It is ideal for leisure vessels and there are 125,000 private yachts over 60 feet in length that previously were unable to use a legacy VSAT solution due to the antenna size, weight and complex installation. But KVH has always been strong in the leisure market, but the TracPhone V7 gives us our first complete solution for the commercial marine market as well.

We have the opportunity now to pursue the more than 42,000 vessels in the world merchant fleet, fewer than 5% of which have VSAT right now and TracPhone V7 is also practical for the 40,000 medium-sized commercial vessels, including work boats, fishing vessels and ferries.

Internet and voice connections are gaining even more importance in the commercial sphere as fleet owners are faced with the challenge of maintaining morale and retaining crews. In fact, a recent Wall Street Journal article noted that ships are slowing down to conserve fuel, but that means they will be at sea much longer. The captains and crews need to stay in touch and we can provide that connectivity through our V7.

These vessels need hardware, but they also need airtime too and that is why we are determined to be a player in this market. We estimate that the maritime market for airtime services generates $400 million to $500 million in annual revenues. This market is largely split between Inmarsat, which offers small antennas, but slower expensive airtime and legacy VSAT providers with their large expensive antennas and flat rate airtime.

So our goal is really to offer the best of both worlds -- small hardware size, high data rates, low cost, flat rate pricing and the global coverage necessary to support the majority of maritime customers. And we are achieving that goal.

Our mini-VSAT data rates are four times faster and half the cost of Inmarsat's newest service, FleetBroadband, which just went live a few weeks ago. Our antenna retails for about $20,000 less than the larger VSAT hardware, while offering data prices that are one-third less in price.

TracPhone V7 and our broadband service offer a disruptive end-to-end solution. We're smaller, faster, more affordable, easier to install and easier to activate. The service is broadcast via powerful Ku band satellites that offer tremendous bandwidth capacity in conjunction with military grade, spread spectrum technology. We take advantage of these services with limited risk to KVH thanks to collaborative agreements with ViaSat and satellite partners like SES AMERICOM.

As a result, we are able to offer the maritime market the first fully integrated VSAT hardware and airtime solution and just as importantly for us, it generates revenue from the hardware sale, as well as the monthly airtime revenue. In fact, our approach streamlines the airtime business model as well. Where Inmarsat has distribution partners and service providers claiming up to 65% of the airtime revenues, there is a direct line between our mini-VSAT service and the end-user. We activate the service and we collect the revenue with no airtime resellers in the middle.

Based on our projections, lifetime revenues from mini-VSAT broadband will far exceed hardware revenue. So this business model is relatively straightforward. Each subscriber purchases a TracPhone V7 with an average retail cost of about $30,000. They also select among airtime packages ranging from $1300 to $5000 per month for unlimited service. Right now, initial account activations indicate the average subscriber falls in the $1500 to $2000 per month range.

To put that in perspective, just 100 ships would generate about $2 million in annual airtime revenue every year on top of the $2 million in wholesale hardware sales to equip those ships. So over three years, airtime revenues should be three times the initial hardware sales per unit.

Shipments of the TracPhone V7 started in October and contributed to our strong fourth-quarter growth in the North American marine market and we also began shipments in late December to European customers and activations are now underway in those markets as well. The initial response from dealers and customers has been terrific. Dealers are so impressed by the easy installation and simple activation. It is remarkable how many of them are amazed by the simple fact that it works the way it is supposed to. Clearly the TracPhone V7 is an order of magnitude improvement over the legacy systems.

We are now seeing great interest from leisure, commercial and military customers and we are optimistic about growth prospects for this exciting new business for KVH. But our next step is to expand the scope of the service. Right now, we have broadband coverage in Europe, the north Atlantic and the Americas. However, to take full advantage of the opportunity, we need to offer more, which is why we are moving ahead with plans to expand our mini-VSAT coverage area significantly in 2008 and into 2009.

We aim to support vessels in the Pacific Ocean, throughout Asia, the Indian Ocean, including the shipping routes through the Gulf and the Middle East. We are on the path of becoming a true global player in the maritime market and we hope to have about 80% of the world shipping routes by volume covered over the next 12 to 18 months.

So in conclusion, we are very excited about our prospects going forward. Our diversification into several markets offers us growth opportunities even in a challenging environment. So although we are mindful of the general economy, we expect that 2008 will be the year that these new opportunities begin to contribute in a meaningful way for us. And now I would like to turn the call back over to Pat who will fill you in on some of the numbers. Pat?

Thank you, Martin. The financial results for the fourth quarter were better than we had originally expected? In the quarter, the sales level was a bit higher than expected. Gross margin was somewhat better and we continued to constrain operating expenses. Collectively, these contributed to deliver an operating margin that exceeded our target.

Now I will cover the specific results. First, I will note that all results are presented on a GAAP accounting basis. Gross margin was just under 41%. This quarterly result includes an adjustment for prior periods in 2007 that increased the Q4 gross margin by about 75 basis points. Even without that adjustment, gross margin improved on both a sequential and year-over-year basis. Compared to the third quarter of 2007, revenue was up 12%. This was better than expected and was driven by results in both mobile communications and military navigation sales.

The higher level of revenue coupled with continuing improvements in individual product costs helped us to increase gross profit by 15% on a sequential basis. For Q4, operating expenses were up 6% compared to last year, but were flat sequentially. The same 2007 prior-period adjustment that helped gross margin had an opposite impact on operating expenses. Simply stated, we corrected for transactions that totaled approximately $150,000 and should have been recorded as operating expenses rather than cost of goods.

For the fourth quarter, reported R&D spending was 17% higher than last year. As a percentage of revenue, R&D was over 11%. However, this was well below the third-quarter level and slightly above the fourth quarter last year. Like in the third quarter, we reported a relatively low level of customer-funded engineering. This drives the reported R&D number up.

In addition, the R&D percentage of revenue will tend to be higher in the second half of the year compared to the first half when revenue levels are relatively lower due to seasonal sales patterns. The absolute dollar level of reported engineering was about equal to the third quarter.

Fourth-quarter sales and marketing expenses increased 11% year-over-year and were also up sequentially. The sequential change is primarily related to a number of industry shows that we support and attend, including large boat shows in the US and Europe, RV distributor events and defense product shows.

Fourth-quarter administration expenses were somewhat favorable compared to our expectations and well below prior periods. Compared to Q3, spending was down 27% and down 16% compared to the fourth quarter of 2006. This reduction was primarily the result of having successfully completed the long-running patent litigation process in August.

Turning to the balance sheet, cash and marketable securities at quarter-end were $53.3 million. Cash flow from operations was negative at a little more than $800,000. Capital expenditures were $1.2 million. During the fourth quarter, we completed the efficiency and capacity upgrades for our Rhode Island headquarters facility. With the completion of this project, the level of capital expenditures should be lower for the next several quarters.

During the quarter, we continued the stock repurchase program that had been initiated in the third quarter. As of December 31, we have repurchased 241,000 shares. The program is continuing and it allows for the repurchase of up to one million shares.

At $12.8 million, accounts receivable was about $2.7 million higher than the prior quarter. Days sales outstanding increased to 59. This level is still in the range of acceptable performance, but it is a bit higher than we would like. The increase reflects the timing of shipments during the quarter, but we have also seen a modest slowing of payments by some customers that we believe is related to softening economic conditions. We intend to keep a very close watch on credit levels and collections efforts.

Inventory decreased sequentially by more than $700,000 to $9.3 million. This decrease reflects the fact that we began shipping our new mini-VSAT product, the TracPhone V7, during the quarter. As Martin mentioned, this began shipping in early October. Annualized inventory turns improved to approximately 5.

Now I would like to provide some context for our first-quarter and full-year 2008 expectations. In spite of the fact that we remain cautious about the leisure, marine and land consumer markets due to economic softness, we expect that the Company's top line will show strong growth in the first quarter and for the full year.

The guidance for Q1 is as follows. We expect revenue to be in the range of $23 million to $25 million or up about 13% to 23% year-over-year. Mobile communications revenue is expected to grow solidly, spurred in large measure by sales of our new mini-VSAT TracPhone V7 product and airtime services. We expect that defense sales will increase modestly compared to last year, but will decline sequentially by about 15%. Our defense backlog at the end of December was $4.3 million. This was well below the level over the last few quarters, but about equal to December 2006. However, since January 1, we have added $3.8 million in new orders to the backlog, putting us about on par with recent quarterly levels.

For Q1, we expected gross margin will be at or slightly above 40%. Absolute operating expenses should increase sequentially as they normally do in the first quarter of the year. Much of this increase is driven by the seasonality of our marine business. Measured as a percentage of revenue, we should see a meaningful sequential decline for operating expenses.

Below operating margin we expect that dramatically lower interest rates will drive much lower interest income. In Q1, we expect that this will impact per-share earnings by approximately $0.02 when compared to the actual results of Q1 2007. For the first quarter, this income statement profile would yield a profit in the range of $0.08 to $0.12 per share.

For the year, we expect that revenue will grow in the range of 14% to 20% compared to 2007. This growth is largely dependent on the growth of our mini-VSAT business and by meaningful success with our fiber-optic gyros in the remote weapons stations market. Although the TracPhone V7 is new to the market, we expect that it will be widely accepted by both leisure and commercial customers. We are also working aggressively to become a key source of supply to a number of remote weapons stations prime contractors.

We expect the gross margin will be between 40% and 41%. There will be a modest dampening effect on gross margins by the ramp of our airtime services for VSAT customers. We expect to have another good year of product cost improvement, driven by our progressive sourcing initiatives. We expect that operating expenses measured as a percentage of revenue will show a decline of up to five percentage points. Operating margin for the year should be approximately 6%.

As I mentioned earlier, interest income will be much lower than in 2007 and this will impact full-year EPS by as much as $0.09 compared to the 2007 results. We expect that the full-year tax rate will be approximately 12% to 15%. This profile would yield earnings of $0.36 to $0.44 per diluted share.

Over the last several quarters, we successfully executed on several initiatives that have improved our operating efficiencies and cost profile. And these now position us to more effectively leverage top-line growth. We have seen indications that our product and market strategies are beginning to drive that top-line growth, especially in the areas of marine applications for mobile broadband communication and in fiber-optic gyroscope applications such as remote weapons stations. As this growth develops, we should generate very positive impact on the bottom line.

Now we would like to take your questions. Operator, please open the call for questions.

(OPERATOR INSTRUCTIONS). Rich Valera, Needham & Co.

Thank you, good morning. I am wondering if you're willing to talk about how much the V7 contributed in the fourth quarter and how much you expect it to contribute in the first quarter and if not, when do you think that would become significant enough that you might start talking about that as an individual line item?

Well, as you know, we have a policy of not talking about individual product sales, so I don't expect us to start doing that. I can tell you that you can get a sense for the impact in the marine numbers. Obviously it was up strongly, but it is interesting that, in Europe, we had very strong growth and very little V7 sales yet because that product -- the service just went live the very end of December or early January, so it is kind of two factors here. One is we are seeing very strong demand for our TracVision products in Europe and the rest of the world and in the US. A lot of that growth did come from the V7, but I don't want to give you specific numbers.

Great. And in terms of the core marine sales, I guess this first quarter, you will sort of anniversary the introduction of the M3 in Europe. So do you expect -- obviously those comparisons will get a little tougher. How are you thinking about the growth of sort of the core marine business in '08 versus '07? Can you talk about that?

Well, you are right. The M3 was the -- the Q1 last year was the launch quarter, so what we saw domestically is that the year-over-year comp for just the launch quarter gets tough, but then for the rest of the year, we had good comps. So there's a little bit of channel fill in any market when you launch a new product, so that the year-over-year comp is tough in the first quarter, but we still see a very strong growth in the M3 in the US in its second year and we do expect to see that kind of growth in Europe, but perhaps not in the first quarter of this year.

Great. And with respect to the V7, is there -- I don't know if you talked about the advantage you guys have in upfront costs. It sounds like you have a big advantage on airtime, how about on the actual initial upfront cost of the unit versus alternatives?

Well, the conventional VSAT costs about $55,000 and our hardware costs about $33,000, so about a $20,000 initial capital advantage and that doesn't take into account the installation costs because there is such a big difference in size and weight and complexity. You save tens of thousands of dollars in not having to build and weld a very elaborate superstructure. But more importantly, it can be done very quickly and for these ships, having the ship tied up for installation is very expensive as well. So there's a number of economic advantage in the upfront hardware and initial installation in addition to the airtime?

Great. Just a couple more, a quick one for you, Pat. What is the interest rate you are assuming in your guidance for '08 and the interest on your cash?

Yes, I will tell you that what we plugged into the model was -- I won't say exactly what we are earning on that money, but it is about -- we assuming that interest rates will be about one half or even lower what we saw in 2007. So if you take whatever -- roughly whatever we earned in '07, we think rates are going to be at best one half that level. Now that will phase in a bit as we move into the year, so it is not as simple as just doing that.

At the start of the year.

-- the next, but we expect that rates will be approximately one half or less.

And finally, and this is my last one, just on the tax rate, Pat, you have been talking about potentially having to sort of take a charge to reverse your NOL I guess allowance on your balance sheet and then going sort of to potentially a full tax rate at least from a reporting purpose. Is that not expected to happen this year?

This year being 2007?

2008, sorry.

2008?

Is that something you are guiding for like a 12% tax rate?

Yes, 12% to 15% was the range that I --

Right.

Essentially where we are now, Rich, is that we assess the valuation allowance on a quarterly basis and we will continue to do that as we go forward and that assessment is based on many factors, including historical performance, as well as our future projections. Right now, as of the end of 2007, our decision had been not to touch the valuation allowance at that point in time because of all the factors that we considered. We will assess it again at the end of the first quarter and if we don't take action then, we will address it again at the end of the second quarter and so on.

However, I will say that, based on the guidance that I gave, if we achieve this level of guidance, we will most likely take the valuation allowance down before the conclusion of 2008 and so I have factored that into that tax rate that I gave you, but a full tax rate wouldn't kick in in this model until late in the calendar year.

And what would you assume that tax rate to be?

Well, the blended rate is probably going to be high 30%s, could be 38% to 40% when all is said and done when you blend our US, including federal, state and so on with our Danish -- our Denmark subsidiary taxes.

Great. That's very helpful. Sorry for taking so many questions.

(OPERATOR INSTRUCTIONS). Ryan Rackley, Raymond James.

Good morning, guys. First on TACNAV, you'd mentioned earlier that a couple of the larger contractors got pushed forward to 2008. Is that included in your guidance or I guess do you still expect those to hit during 2008?

Well, we have in our guidance a fairly conservative view of TACNAV business, so there is always the potential for upside because that business tends to be, when it happens, tends to be big. So I would say that there are no large TACNAV orders in the guidance.

Okay. And on a year-over-year basis, would you expect TACNAV to be up?

We are right now thinking in general that TACNAV, which has been declining over the years, we are assuming approximately flat for '08. So we don't see any further material deterioration in the TACNAV business. Then I think we see some upside beyond with orders that we expect in 2008, which would then -- as you know, some of these orders are large multiyear orders starting delivery in the end of '08 and into '09 and beyond, including some of this backlog that we already have, which is -- we have, as I mentioned in the call already, there is about $20 million in long-term contracts that we have booked.

And do you have any CROWS in your guidance for 2008?

We don't have specific programs in our guidance. We do have a fair amount of gyro business in our guidance for remote weapons stations, which program that for, we haven't identified it by program specifically.

Right, would you say that you are still in the mix for that program or still in talks with Kongsberg?

I would say that we are still being considered by all of the companies for all the various programs that are out there. So the answer to that would be yes, I would hope so.

And on the V7 front, have you added any additional distributors or resellers?

Well, we are expanding into -- in some of the commercial markets, yes. We have brought on companies like Mackay, which were not a customer of ours for the TracVision business and they are focused on the commercial market. So we will -- in addition to our normal dealers and distributors in the leisure marine, we are going to be adding more commercial dealers and distributors.

You had mentioned that you are seeing pretty broad-based strength there, but can you -- can you -- or are you seeing any specific type of vessel that is really seeing the best adoption of V7?

Not yet. It is still very early days. We just started shipping the product, as I mentioned, in October and even then, with some delivery issues from some of our suppliers, a lot of the product just shipped at the end of the quarter, so it is still early, but what we are seeing is that the mix is pretty much what we expected. We have got good interest from the leisure side, but we are also getting interest from commercial accounts, Gulf oil patch-type customers, as well as government, like US Coast Guard for example.

That does it for me. Thanks, guys.

(OPERATOR INSTRUCTIONS). At this time, we have no further questions.

Okay, if anyone would like to speak with us directly, feel free to call Pat or myself or send us an e-mail. Anything else, Pat?

No, nothing else. Thank you very much.

Okay, great. Thank you.

That concludes today's presentation. Thank you for attending and have a great day.