KVH Industries Inc (KVHI) 2009 Q3 法說會逐字稿

Good day, everyone, and welcome to the KVH Industries third-quarter conference call. Today's call is being recorded.

At this time for opening remarks and introductions I would like to turn the conference over to Mr. Patrick Spratt, Chief Financial Officer. Please go ahead, sir.

Good morning. I am a 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 third-quarter earnings release that we issued earlier this morning. Copies of the release are available on our website and also from our Investor Relations Department. This call is being simulcast on the Internet and will also be archived on our website for future reference. For those of you listening via the Web, feel free to submit questions to ir@kvh.com, and we will be happy to answer them following the call.

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 discussions. 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 August 6, 2009. 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. Martin?

Thanks, Pat, and thank you all for joining us today. We are in a unique position compared to many other companies in our industry. While many companies are experiencing significant declines or operating only in markets under tremendous economic pressure, we made a strategic long-term decision years ago to diversify the Company and pursue a range of interrelated opportunities. Our results last quarter and now again in Q3 illustrate the value of that decision.

In Q3 we enjoyed growth on the top and bottom lines that exceeded our expectations. We established a strong position in markets that are growing even in the face of economic challenges.

We've continued to invest heavily in new product development, and major new projects products will be unveiled shortly. And most importantly, we are able to take advantage of a solid financial foundation and a strong balance sheet that allows us to dedicate resources to the strategic initiatives that are helping us exceed now and setting us up for very exciting times in the future.

The third-quarter revenue totaled $22.6 million, and that is a 44% increase year-over-year and a sequential increase over a solid second quarter. Net profit for Q3 was $385,000; this is an earnings of about $0.03 per share.

The key drivers for this growth have been strategic initiatives we put into place over the last several years, each of which is rapidly becoming a major contributor to the future of the Company. It's important to understand how these are impacting our growth today, and I will just highlight them.

Leading the way is our fiber optic gyro business, which achieved its third consecutive record quarter with almost $8 million in sales. That is an increase of more than 750% over last year. This comes following a 10-year investment in the development and commercialization of our fiber optic gyro technology.

Starting about 18 months ago we elected to invest in a major expansion of our production capacity. That preemptive move enabled us to win many major new businesses over the last year because we were the only FOG manufacturer equipped to meet the rapidly expanding demand for affordable precision fiber optic gyros.

On the satellite side of our Company, we realized that we needed to move beyond simply selling mobile satellite antennas and instead use our unique skill set to become a major player in the world of satellite airtime as well. Doing so would enable us to benefit from a recurring airtime revenue stream.

With that goal in mind we launched a development effort almost four years ago to create an entirely new approach to bringing broadband service to mobile users. The results of that were the TracPhone V7 and the satellite communications mini-VSAT broadband network.

So we activated our first mini-VSAT customer two years ago this month. Since then, this integrated satellite communication system and service helped offset the economic weakness in the leisure markets and emerged as a major growing source of revenue. We are now building out our global network in an effective manner that is meeting the needs of existing and prospective customers.

And most recently we aggressively sought to enter the aviation market with our mobile satellite TV technology. In doing so we leveraged our earlier investments in our hybrid phased-array antenna designed for the automotive market and displaced LiveTV's existing vendor. We are now wrapping up some final updates for our antennas, and we expect that our aeronautical business will add to our revenue growth during Q4.

So with that foundation, we'll take a look at the performance in the key markets. In the mobile satellite business the economic challenges remain, especially in our leisure satellite TV markets. However, the declines appear to be moderating and perhaps point to the start of a recovery in the coming months.

Overall our satellite revenue in total was down just 2% year-over-year to about $12 million. Within the land mobile market, sales were down 7% from Q3 of last year. But several key manufacturers are beginning to resume production under new ownership; and our sales into the US RV market were actually up slightly from last year. Clearly the RV market has seen the bottom.

Within the marine business, sales were down 1% year-over-year following a slight decline internationally and flat domestic sales due to continued softness in the leisure markets. But nevertheless we think there are some exciting new opportunities to be seized in the recreational boating industry.

We are not simply waiting for the market to recover. Next week we will be unveiling a major new advance in our TracVision technology at the Fort Lauderdale Boat Show. I believe it represents a dramatic breakthrough in maritime satellite TV technology; that is one that we have worked on for several years.

Two weeks ago we were honored to receive our 12th consecutive award for the Best Marine Entertainment Product from the National Marine Electronics Association. This year's award was given to our TracVision M1, the world's smallest and lightest marine satellite TV antenna, which we brought to market one year ago and has since become one of our top-selling products in terms of unit sales.

Our success in the VSAT market continued in the third quarter, with TracPhone V7 product and mini-VSAT airtime revenue growing strongly year-over-year. Total airtime service revenue for the mini-VSAT and Inmarsat combined exceeded $3 million in the quarter, with the mini-VSAT showing continued strong growth, offsetting a seasonal decline in Inmarsat airtime.

As I mentioned earlier, we just passed the two-year mark for the mini-VSAT broadband product as a live, commercially available service. In that time we have shipped more than 500 antennas, which we believe represent a significant percentage of the worldwide total for maritime VSAT systems shipped during this period. Overall we feel we're off to a very good start.

We've made major progress in the rollout of our global satellite communication network. During the third quarter we activated the mini-VSAT service in the Asia-Pacific, Australia, and New Zealand regions. We also doubled our existing Atlantic Ocean coverage, extending it from Greenland all the way below the equator to Northern Brazil. Our coverage for Africa is now under contract, so we will soon be able to support the communication needs of the West African offshore oil fields and global shipping companies transiting around Africa.

Two weeks ago we announced a new agreement with On-Waves, a mobile maritime cell phone service provider. The combination of our TracPhone V7 and their picocell technology means that our customers will soon be able to use their cell phones -- including their iPhone -- anywhere within the mini-VSAT coverage area, even in the middle of the ocean.

We continue to build momentum in the commercial market with the addition of significant new customers. Tanker operator Simonsen chose the TracPhone V7 as their primary communication system for a number of their vessels. And more recently we announced that Clipper Marine Services selected the TracPhone V7 for 22 of its vessels for their fleet. Clipper now relies on our system for day-to-day use while still using their original Inmarsat system as an automatic backup if they go outside our coverage area.

Looking ahead, the satellite we're under contract to use for the Indian Ocean service is expected to launch in November. Following a successful lunch we hope to bring this service for the Indian Ocean online shortly thereafter.

We are now pursuing service contracts for South America, which is the only remaining region in our rollout of the worldwide mini-VSAT broadband service.

Finally, in the satellite market we began shipping our aeronautical satellite TV system to LiveTV at the very end of Q2. Based on the results from initial in-flight tests, we have worked with them on some requested changes. As a consequence we did not recognize revenue for this product during the quarter. The requested design changes have been completed, and we expect to resume shipments shortly. So we do expect to be booking that revenue during Q4.

Moving on to our guidance and stabilization business, we enjoyed another great quarter. Sales were up 206% to $10.6 million compared to the third quarter of 2008. Quarterly military navigation sales were up 28%, and our fiber optic gyro sales soared 767% to $7.9 million. This marks our third consecutive record quarter for FOG sales.

We continue to bring in a new business for the fourth quarter and beyond. New orders included $3.8 million for FOG for remote weapon stations and $2 million in our TACNAV displays and other components.

We're also tracking some significant new opportunities that are on the horizon. Among them is an RFI that came out from the U.S. Army, which is seeking information from remote weapon station manufacturers about their ability to supply an additional 19,500 new CROWS III remote weapons systems. These systems are required to be shipped at a rate of 75 per week. And since there is typically three gyros per system, that would represent up to an additional 225 gyros per week. That would be a $175 million sales opportunity for us over the next five years. So it is a big opportunity.

In addition to stabilize weapons, our FOGs are an outstanding solution for a range of applications, many of which represent significant growth opportunities. For example, we exhibited at the conference of the Association of the U.S. Army, AUSA, show earlier this month. As I walked the show floor I was struck by how many companies now have started building drones. There were literally dozens of different types of drones on the show floor. But each one included flight control systems and of course of the obligatory camera which is -- and each of those require guidance and stabilization technology.

The other big trend of the show was stabilized cameras with improved infrared thermal capability and fused vision system. For example, our customer Kongsberg was showing off and new 360-degree field of view camera in conjunction with [Cole-Morgan] that is for their new CROWS system. Others were showing digital image merging of various day and night sensors in a single image.

So all these sophisticated technologies need outstanding stabilization to support the precision video capability. So collectively these are major technology trends that favor more remote sensors and stabilization technology. That is exactly what our fiber optic gyro products are designed to provide.

So in conclusion, we are very pleased with our performance during the third quarter. Our long-term strategic initiatives are gathering momentum and sustaining us even as the leisure markets continue to face challenges.

I'm feeling very good about the remainder of this year, as these initiatives continue to expand and new products come to market. We will also begin to see improvements in the margins of our mini-VSAT broadband network thanks to an increasing subscriber base that moves us above the breakeven point in established regions, even as we continue to fund the network expansion in new regions.

With those factors in mind, Q4 should see another increase in both the top and bottom lines both sequentially and year-over-year.

Now I would like to turn the call back over to Pat to give you a closer look at the numbers. Pat?

Thank you, Martin. The third-quarter results showed good progress for the Company and they give us confidence going forward. Our financial results were better than expected while we also continued to advance our strategic growth initiatives. This was achieved in the face of continuing weak economic conditions in every geographic area in which we operate.

Gross margin improved from Q2 to 39.5%, up about 400 basis points. We had projected that it would be about flat sequentially.

During the quarter we saw incremental improvement in the utilization of production capacity, especially in our fiber optic gyro business; and we achieved a higher level of output overall, led by our relatively higher margin guidance and stabilization products. Continuing investments in the mini-VSAT global infrastructure contributed to keeping overall gross margins below the prior year third-quarter level.

For Q3, operating expenses were up more than $1 million compared to last year and up sequentially by about $800,000. The spending level was modestly above our expectations.

For the quarter, reported R&D spending was 10.1% of revenue. This reported level of engineering spending was in line with expectations and now reflects the fact that the offsetting impact of capitalizing the expenses of our aeronautical antenna development is essentially behind us.

Third-quarter sales and marketing expense increased almost 20% year-over-year. This was a bit higher than we had expected. Drivers included volume-driven variable expenses and preparations for upcoming industry shows.

Administration expenses were up sequentially, but down modestly compared to last year. Cost for professional and consulting services related to the buildout of the mini-VSAT infrastructure continued to impact spending.

Turning to the balance sheet, cash and marketable securities were $41.5 million. This was only $700,000 lower than the Q2 level. This cash balance was better than anticipated due to a very solid improvement in collections and the timing of processing for accounts payable.

For the quarter, cash flow from operations was about $1.4 million. We expect our cash balance to decline by approximately $4 million during the fourth quarter to fund sales growth and capital expenditures.

Capital expenditures for the third quarter were approximately $2.1 million, pushing the year-to-date total to just over $4 million. We expect capital expenditures for the full year to exceed $6 million to support the ongoing deployment of hubs and other network management tools for the mini-VSAT network deployment.

Accounts receivable decreased sequentially to $12.3 million. Days sales outstanding declined to 49, four days better than Q2. Although the weak economy continues to put pressure on some collections activity, we are experiencing the benefits of excellent partnerships with some large commercial and defense customers.

Inventory increased to $14.8 million. During the quarter we experienced an increase in material supplies due to the timing of new product programs and stocking for anticipated future demand. Also contributing was the fact that we did not recognize any revenue shipments for the aeronautical LiveTV antenna system.

Now I will turn to our expectations for the fourth quarter. As has been the case all year, the visibility for the coming months is still somewhat cloudy, especially for our consumer markets. Yet we will provide some insight based on what we see now.

We expect revenue for the fourth quarter to increase sequentially. Compared to the third quarter, we expect sales increases for our mini-VSAT products and airtime services business, for fiber optic gyroscopes, for our tactical navigation products, and for the aeronautical antenna system. We expect to see continuing market softness in consumer markets for sales of our SATCOM products, coupled with seasonal weakness. We also expect only a nominal level of engineering services revenue.

This should translate into year-over-year revenue growth in the range of 18% to 24%. This would imply full-year revenue growth of 7% or more, a really strong performance in the face of severe economic challenges.

We expect to report a modest level of profit for the quarter. High levels of ongoing investment in the mini-VSAT business infrastructure will pressure our margins as we continue to invest aggressively for our future. We also expect to initiate another step increase in production capacity for our fiber optic gyro business.

Based on the range of projected revenue growth we expect EPS to be in the range of $0.02 to $0.07.

Our backlog for guidance and stabilization products and services at the end of September was $12.6 million. In addition, we have approximately $3.5 million of current backlog for our aeronautical antenna system. Combined, the backlog for our defense, commercial stabilization, and aeronautical products and services is now approximately $16 million.

We are still awaiting the next production order for our FOG-based TG-6000 inertial measurement unit for the Mark 54 torpedo program and have not included this in our fourth-quarter projections.

In closing, we are capitalizing on our diversified portfolio of products and services, and we will continue to invest in our strategic growth businesses. Our new strategic growth drivers are now in the forefront of the Company's business profile, and we feel this positions us very well for the future, especially when the economy eventually improves.

Now we would like to take your questions. Shannon, could you please open the call for questions?

(Operator Instructions) Hamad Khorsand, BWS Financial.

Good morning, guys. My question was how much of a clarity are you seeing on the mini-VSAT service from potential maritime customers?

By clarity, if you mean visibility I think it is a business-to-business type sale primarily, so you tend to have a number of opportunities in a sales pipeline. So you don't have visibility in the sense that you've got orders pending; but you do have great visibility in terms of potential customers and where they are in the sales process.

Okay. Let me ask you another way. Potential customers signing up with field testing, has that increased this quarter, going into the fourth quarter?

Yes. We are seeking definite momentum in our -- in the whole VSAT business, both in terms of sales growth and in potential sales, order pipeline growth.

Okay. Then would you start recognizing service revenue from the Clipper placement?

We did in Q3.

For all 22 ships?

I don't know that all 22 ships are outfitted just yet. But we had some installed late in the third quarter. And we expect that the majority of the remainder, the remaining initial purchase will be done through the fourth quarter.

Okay. Outside of Clipper is there anyone else with a significant amount of deployed mini-VSAT 7?

Yes, there are several. One of the ones we mentioned recently was a tanker company called Simonsen.

Okay. All right, thank you.

Chris Quilty, Raymond James & Associates.

Morning, gentlemen. Just a quick follow-up on that earlier question. What time are you generally seeing in terms of the turnaround from your shipment until these units are getting turned on?

Well, we have been using about a six-month lag in general; and that is probably conservative now. I think we are expecting that that will shorten a bit.

That is -- so I think six months is at the outside and probably three months would be an ideal level. But it always takes longer than you think, particularly when these are newbuilds.

Okay. Two series of questions here on gross margin. Maybe I will start with the product margin first.

The third-quarter margin was the best margin you have seen in quite some time. Was that really just an impact from the FOG product sales? Or were there other benefits in other hardware areas that we should note?

Well, I think that it was a combination of a few different areas, Chris. Certainly we saw greater efficiencies in the FOG operation. As the volumes continue to climb we are getting a lot more leverage out of the capacity that we do have in place.

In the quarter we had a pretty good quarter for TACNAV product sales; those are relatively stronger margins. Certainly it was a better quarter than we had a year ago and better than we had sequentially as well. It was our best quarter so far this year, as a matter of fact.

In addition, we are seeing some other improvements in terms of overall efficiencies and management of what we call manufacturing overhead, if you will -- the non-material and non-direct-labor types of expenses.

And I would say the last factor was during the first portion of the year we had some -- because of some of the sudden changes that we saw in terms of demand and revenue, we had some additional reserves associated with materials. But that wasn't -- I don't want to overdo that. That was a factor in the first half of the year, not as much so in the third quarter.

Okay. And not a significant portion of your product revenues at this time, but the V7 -- are you seeing any improvements as you start to ramp volumes there?

That product cost has been relatively constant. So we don't see any big change in margin there.

And on the marine satellite TV obviously you've got volume-related issues there. If you start to see a pickup in the Q4 or into next year, I'm assuming that there are several points of margin expansion you should get.

Yes, I think the general point is that because those -- we've got a number of businesses that are down significantly year-over-year, and then you've got other businesses that are really up. It's kind of masking that.

So I think you are right. If the economy turns around we will see a big benefit in terms of growth, and then that growth will improve margins because you'll have better absorption for factory overheads and things like that.

Okay. So I don't know if you said this, Pat, but Q4 gross margins -- product gross margin, sort of similar to Q3?

Q4 products?

Yes.

Probably a little bit lower, Chris.

Okay.

Not quite as strong as Q3. Some of that is mix. Some of it is, as I mentioned, we are anticipating that we will be taking the initial steps of adding capacity in the -- additional capacity in our fiber optic gyro operation.

Okay. So moving on to service revenues, and maybe this is a bigger-picture question towards the structure of your cost of service. I just want to understand for the longer-term modeling. If I am thinking about this correctly, you are going to have around eight to 10 transponders you are going to be leasing on a global basis, paying $1.2 million to $1.5 million, and that represents a largely fixed cost.

Obviously you will have to add transponders over a period of time in the next year or two if the demand picks up sufficient. But is that the right way of thinking about what your fixed cost of the service component looks like?

Yes, I think that is a fair approximation. And so -- and the only thing I would say is that we are going about this a little bit differently from some of the other people, in that the bandwidth we are buying tends to be in larger chunks, which gives a big performance benefit. And also because we use a spread spectrum technology, we actually spread it over an entire transponder typically.

So the advantage for the user is that you get a lot less latency and you get a lot more capacity, and everybody is in a giant pool of bandwidth. So you don't have these tiny little slivers that can be -- that have a high contention ratio.

But what that also means is that once we have these regions established we don't need to add capacity for a long time. So we have -- once you get to a full transponder in most regions that should last years. So we are not talking about another big incremental cost in regions where we are already active.

Okay. So that's call it, based on the numbers I used, a $10 million or a $12 million a year sort of fixed cost of service to do the global network. Then probably there is depreciation from all the hubs and transponder or teleport leases that add a couple of million dollars, $2 million, $4 million of fixed cost.

Then the variable component is only your relationship with ViaSat to the degree you guys have some regional sharing where they operate the primary service in the North Atlantic and Europe? And that is what we should think about as being the variable cost?

Yes, I think as time goes on more of the costs are fixed. But you are correct, there is a variable component that is in there which makes it a little bit hard to give a crisp answer as to what is the margin or what is the -- how that business scales. But what you have described is accurate.

Okay. A clarification for you, Pat. You mentioned that you are now no longer capitalizing the R&D for the aero product. And have you guys come up with a name for that yet?

But was Q3 a good assumed run rate for what R&D should look like on a go-forward basis, or should we think about it as a percent of sales?

Thinking about it as a percent of sales is probably a pretty good indicator, Chris.

Okay. And if I remember from your roadshow presentation, is it 8% to 10%?

Yes, and that would be a target over time. As the airtime business grows we would expect that if you looked at our total sales all of the operating expenses as a percent of sales should show some reduction over time.

But for the immediate short term, I would say that the engineering percentage of revenue is a fair indicator for the near term.

Okay, great. I will cut it off there and circle back in with other questions. Thank you.

Rich Valera, Needham & Company.

Thank you, good morning. I was wondering if you could help us out. Trying to get a sense of the trajectory or momentum on the V7 units. Last quarter you gave a data point of 500 units having been shipped. I was wondering if you could give us any sense of how recently, say, the last 250 of them were shipped, or any color on when you might hit the benchmark of 1,000 units.

Since it has been I guess two years since inception, but I assume most of those units probably were in the last year or so, just any color on that front would be helpful.

Yes, that is always a problem when you report milestones; then you sort of raise the question of what is the next big milestone.

So we were thinking that 5,000 would be the next big milestone. But I can't answer that question directly, but I can tell you that we are seeing big year-over-year growth in that product. So that we are seeing sequential growth quarter-to-quarter. This quarter was up significantly over the last quarter.

So going in the right direction, we are happy with the growth. It is still a tough economy. Shipping companies are having a tough time.

So we haven't sold this product except in this economy, so we don't really know how much of that is being affected by the general economic conditions. But we are happy with the growth, and it seems to be catching on and gaining momentum, and it is on a good path.

Where you sit today given the run rate you expect to exit the year at, say, in that business in terms of, say, quarterly shipments, is there any reason you wouldn't expect next year to be higher, given full year of momentum, more regions activated, etc.?

No. We absolutely expect it to be higher.

Any quantification of that at all?

Well, the other benefit you get of course is the compounding effect. So that we will exit the year with a significant backlog in airtime business, which then becomes the floor, then whatever you sell. So that we have that advantage.

That also helps then with visibility. So that is the other nice thing that is starting to happen, is that we are starting to get more visibility which should even out the quarter-to-quarter lumpiness in some of our other business. This is the steady-state contracted airtime revenue business.

So we are now giving guidance for Q4, and I think traditionally we will wait till end of next quarter to give guidance for the full year, next year. But we expect the VSAT business to be a big part of our growth.

Specifically, obviously it would grow because of the compounding of the service revenue. But in terms of units you would expect a significant increase in new units sold as well year-over-year?

Yes, absolutely. We are seeing that now and we expect that trend to continue. So that as we add regions and gain momentum we expect increased unit sales.

Sure, okay, that is helpful. Then moving on to the FOG production, you mentioned you are going to increase production. Could you say it where your -- you are doing $8 million per quarter now. With your increased production what would be your maximum quarterly run rate? And do you expect to achieve that in the near term?

Well, what we did last time is we put the capacity in place in preparation for future business that we don't have it yet. We were I think smart to do that, and we are basically doing the same thing now.

We do have visibility into other orders that are pending and that we expect to get. And if some of those happen it could have fairly short-term horizons. Some of these things are for deployments going to Afghanistan. So we need to be ready in case those orders hit.

So specifically we try to increase our capacity a minimum of 25%, something like that, so that we'd be able to do $10 million a quarter should we get orders that would support that.

Okay. And you mentioned some pending orders potentially going to Afghanistan. Do you know if those are related to the MATV? And do you have any visibility into potential demand specifically from the MATV program at this point?

The MATV is a potential. I don't know if they have a CROWS requirement yet. But that is -- I know those vehicles are going specifically to Afghanistan, and I know that they would like to put CROWS on there. I don't know if there is a formal requirement to do that yet. But that is one of the potential opportunities that we are tracking.

Okay, that is helpful. Just to clarify in terms of the expectations for V7 coverage. You mentioned I guess two additional regions that you expect to roll out. I'm not sure if that was in the fourth quarter. And then do you have your complete global footprint? Is that correct?

We have -- everything is under contract today except for South America. So right now we have coverage that goes down to the North coast of Brazil; but we don't have full coverage of South America yet. That is the last region that we are working on. After that we are done with our network buildout for a while.

So you probably expect to hit -- move into 2010 with everything rolled out? Or is it not clear that you get South America in the fourth quarter?

Yes, that one will probably be in Q1; and the satellite that is launching in November, assuming that that launch goes on schedule and everything works well, that satellite will be live. And then that will probably actually be ready for revenue service hopefully at Q1.

And, Rich, one clarification on that related to the cost structure. It probably won't be until about the second quarter of next year that you will see the full impact of the complete infrastructure on a complete quarterly basis. Because as these come online -- naturally everything is not coming online the first day of the quarter.

Okay, right, right. Okay, that is it for me. Thank you.

(Operator Instructions) Gentlemen, it does appear there are no further questions at this time.

Okay, well, we are done. And as always feel free to call us directly if you have any follow-up. Thank you.

That does conclude today's teleconference. Thank you all for your participation.