KVH Industries Inc (KVHI) 2011 Q2 法說會逐字稿

Good morning everyone and welcome to the KVH Industries second quarter 2011 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. Patrick Spratt, Chief Financial Officer. Please go ahead.

Good morning. I am Pat Spratt, Chief Financial Officer of KVH Industries and with me is Martin Kits van Heyningen, Chief Executive Officer. This call will address the second quarter earnings release that we issued earlier today. 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 be archived on our website for future reference.

If you are listening via the web, feel free to submit questions at ir@kvh.com. And we will answer them following this call.

This conference call will contain certain forward-looking statements that involve risk and uncertainty. 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 May 5, 2011.

The Company's SEC filings are directly available from us, from the SEC, or from the investor information section of our website. Now I will turn the call over to Martin to begin today's discussion.

Thanks Pat. Good morning. Thank you all for joining us today. Overall Q2 turned out just about as we expected. Thanks to a great quarter for our mini-VSAT business we were able to post record revenue of $30.6 million and a substantial sequential improvement on the bottom line. During Q2 we set a new record for sales and activations of our mini-VSAT broadband products and service thanks to our highest ever level of TracPhone V7 shipments and the popularity of our new TracPhone V3. We also introduced and began shipping the groundbreaking Fiber Optic Gyro that is generating significant interest with potential OEM customers.

Pat will cover the numbers in more detail shortly but let's take a look at some of our key business areas.

In our mobile satellite communications business, satellite TV business, revenue was up 25% excluding LiveTV, the aeronautical product, which generated $1.5 million in revenue in the second quarter of last year. However, a number of factors including the generally negative economic environment, high fuel prices and ongoing low levels of consumer confidence, are contributing to a lingering malaise from the leisure markets and that is affecting our marine and land mobile sales.

Our satellite TV sales to the leisure marine and RV markets were lower than expected for the second quarter in a row. Sales into the land mobile market were up only 2% while marine sales of our TracVision satellite TV and our Inmarsat products and service, that is sales excluding VSAT products and services were down 16%. On the positive side of things we believe a large part of the decline in Inmarsat sales is due to the migration of potential Inmarsat customers to our mini-VSAT.

The accelerating demand for mini-VSAT broadband was a major contributor to our success during Q2. Combined VAST and CommBox revenue was up 81% year-over-year. Hardware shipments more than doubled. And we activated a record number of accounts.

The tremendous reception to TracPhone V3 was a big part of this record-setting performance. The V3 which was introduced in February and began shipping in April is the world's smallest maritime VSAT system. From the moment we launched it, the reception for the market has been outstanding. The combination of an ultra-compact antenna, global coverage, hardware price comparable to Inmarsat, and simple affordable airtime plans appears to be a winner. In fact, the V3 exceeded our expectations for sales, adoption, and speed of activation.

To put in perspective, it took us more than three years of V7 shipments to reach the quarterly sales volume we saw in the first quarter of V3 shipments. In addition, V3 activations appear to be happening faster than with the larger V7. At this point though the sample size is too small to be certain that this will continue and likewise we are anticipating a higher degree of seasonality with V3 sales. But since this is such a new product, it is a bit too early for accurate trending.

More importantly though, there was no sign in Q2 that the V3 slowed the sales of our TracPhone V7. Our unit sales were up 44% from Q2 last year. Feedback from our sales teams and dealers actually seems to indicate that the V3 is helping V7 sales as some customers come to us intrigued by the V3's compact design and low cost but eventually choose to move up to the V7 to take advantage of our fixed pricing plans and faster upload speeds.

Together, the record shipments of TracPhone V7 and the initial sales of V3 enabled us to ship the 1,500th mini-VSAT TracPhone System. The mini-VSAT broadband network is now the world's most popular maritime VSAT service and its expansion is accelerating. It took approximately two years from the day we launched the service to reach 500 TracPhone systems shipped. And just over a year to reach 1,000. And not it took about nine months to get to the 1,500th unit mark.

Not only does this make the mini-VSAT the fastest growing maritime VSAT solution, it is also the most popular in virtually every maritime market sector.

Along with the news surrounding product shipments, we achieved a number of other milestones in our mini-VSAT business. Maersk Tankers, the world's largest tanker fleet, recently selected our CommBox Ship/Shore Network Manager for use on 120 of their vessels. The CommBox will help support least cost routing among multiple communication systems and it will help coordinate file transfers, email and internet access for both business and crew use.

Not long ago we shipped our 1,000th CommBox System, evidence of a trend of increasingly integrated onboard IT networks in shipboard communications in the shipping, fishing and other commercial maritime industries worldwide.

We also recently launched our "Writing on the Wall" campaign designed to focus awareness of alternatives to Inmarsat's older, slower technology and their recent changes in rate plans and policies. Our goal is to continue to win incremental subscribers away from Inmarsat on top of our already strong mini-VSAT growth. In addition we are very pleased to announce recently that the remaining South American coverage from mini-VSAT is under contract and going live in the next few weeks. With this new coverage along the western coast of South America, mini-VSAT is now the broadest global coverage and the widest global regulatory approval of any maritime VSAT service.

Mini-VSAT broadband network has never been more popular and with a track record of more than three years of operation of proven resource for mariners. We are now delivering more than 100 terabytes of data per year with a network reliability rate of better than 99.5%. We offer subscribers a range of airtime packages starting at $49/month, making mini-VSAT the lowest price global maritime broadband service available.

And with data rates up to 2 megabits per second, and latency less than 600 milliseconds, mini-VSAT is also the fastest global maritime broadband service.

Our goal is to continue to expand and enhance the mini-VSAT network and the hardware and services available to our customers while aggressively pursuing a wide range of business opportunities. In fact, we just received word a few days ago that one of our Japanese partners has completed a deal to install our mini-VSAT system on a number of Japanese liquefy natural gas tankers following a lengthy trial period. This marks the first significant adoption of our product and service by a Japanese commercial fleet. In fact, we are on an ongoing trial with several of the largest Japanese fleet operators right now.

Even though we just launched some exciting new products, we have more in the pipeline. We also plan to make some new product and service announcements regarding our mini-VSAT TracPhone and TracVision Satellite TV technology in the very near future, so stay tuned for that.

Within our guidance and stabilization business, military tactical navigation saw a 300% increase on a year-over-year basis as we shipped a major international order that we received earlier this year. This partially offset the year-over-year decline in fiber optic gyros sold through the CROWS program.

As expected, our fiber optic gyro sales slowed compared to the second quarter of 2010 due to the low level of procurement for the US Army's remote weapon station as the army makes the transition to the next program implementation known as CROWS III. This new procurement is now expected to enter the proposal stage later this year.

During the interim period we are continuing to receive FOG orders for the existing CROWS II program at a pace that is modestly better than our forecast. But the big news in our FOG business was the introduction of our new DSP-1750 fiber optic gyro. The 1750 is the world's smallest high performance FOG and the first to use our new 170 micron E-Core ThinFiber technology which takes up half the volume of our original optical fiber. This means we can put twice as much fiber on the same size gyro and make smaller gyros with high performance. The development of this new fiber, together with advancements in our digital signal processing and our manufacturing processes enables us to offer a super-compact FOG with truly revolutionary performance levels for a unit its size.

This includes input rates five times faster than our original DSP-1500 FOG and industry-leading noise levels five times lower than our DSP-3000 series. In addition the bias stability is 8 times better than our DSP-3000. That's a level of performance previously only available in larger, more expensive closed loop fiber optic gyros and ring laser gyros.

These performance levels are a key reason why we are seeing very strong interest from OEMs in this new gyro. The 1750 offers maximum versatility for system integrators thanks to a sensor package the diameter of a wrist watch, and a choice of single or dual access configurations and electronics that can be positioned remotely from the sensor. As a result, the DSP-1750 is an ideal, affordable solution for a broad range of mobile applications, including precision stabilization, pointing and navigation applications where low noise and high performance across a range of operating temperatures are critical.

Looking toward the future we are very excited by this product and the prospect of the DSP-1750 serving as the building block for a new line of compact fully-integrated inertial measurement in navigation systems as well.

So, overall we are pleased with our revenue growth in the second quarter as well as the sequential improvement on the bottom line. Our strategic businesses are performing as expected and we are making excellent progress including the outstanding performance of our VSAT initiative and the introduction of exciting new FOG technology.

While the leisure markets remain a challenge, we continue to have confidence in our long-term strategic plans and our ability to lead the market in maritime VSAT and in fiber optic gyros.

Now I am going to turn the call back over to Pat for some of the numbers. Pat?

Thank you Martin. Our VSAT and fiber optic gyro business results were positive and as expected. However, sales of our satellite TV and Inmarsat products and services in the leisure marine and land markets were disappointing again.

The year-over-year sales to consumers declined at an even greater rate than we saw in Q1 after several quarters of modest growth in 2010. For the quarter, gross margin was 39.2%. This was a 200 basis point improvement over Q1 but it was modestly below our expectations due to the short fall in leisure market sales. Product gross margin improved sequentially and year-over-year. We have done a good job of managing the supply chain and production process.

Service gross margin improved sequentially 530 basis points in line with our expectation. This improvement was driven by VSAT airtime services. Service revenue related to Inmarsat airtime repair services and engineering projects declined sequentially, or excuse me, declined substantially year-over-year and was only about flat compared to Q1. So the strong improvement in our VSAT service revenue and gross margin was offset somewhat by declines in other services.

Q2 was the first quarter in quite awhile in which we did not have a material increase in the fixed cost structure of the VSAST network. As a result, the sequential growth in VSAT airtime service revenue generated strong, marginal gross profit. In fact, the gross margin on the sequential incremental VSAT service revenue was well in excess of 50%.

As we continue to add VSAT accounts and service revenue, we expect the marginal gross profit will have a growing positive impact on our overall results. Over time we will add network capacity and potentially new coverage areas so the fixed costs will increase as we grow. And some infrastructure costs are fully variable. But the service gross margin trend should be positive and strong. To provide a sense of this, we believe that when we have twice the number of active VSAT accounts compared to what we have now, the VSAT service gross margin will increase by more than 2,000 basis points and gross profit will be up to 5 times the current level.

Percentage gross margin improvements over the long term will moderate as the install base gets very large. But absolute growth of profits should continue.

Operating expenses were a little below our expectation but increased 20% compared to last year. A sizable portion of the year-over-year increase in each operating area was due to the inclusion of costs for our Norway subsidiary since the acquisition of Virtek last September.

Engineering expenses increased 15% year-over-year but declined slightly compared to Q1. We continue to invest aggressively in new products for all of our businesses.

Sales and marketing spending increased 26% year-over-year. Expenses were incurred for the launch of both the TracPhone V3 and the FOG DSP-1750. Spending also included a sizable contractual sales commission for the large tactical navigation shipment.

Administration expenses increased year-over-year but declined sequentially. We still have a lot of activity underway establishing new operating units around the world and gaining license authority for our VSAT products and services in many countries. These are expensive but necessary requirements.

The effective tax expense for Q2 was much greater than expected. This was the result of a few good news/bad news factors. During the quarter we received final municipal approvals for our new production facility and construction is on pace for occupancy by year-end. So we can now plan for the benefit of additional state investment tax credits. The tax rate is also affected by changing profit projections. The good news is that our effective tax rate for the year is now expected to be below 10%. The bad news is that we had to reverse a large portion of the tax benefit that was applied to our Q1 pretax loss that was calculated using a much higher rate.

If not for this reversal of previously booked tax benefit, Q2 EPS would have been about a the midpoint of our guidance range.

On the balance sheet, cash and marketable securities were $32.5 million. Cash inflow from operations was about $0.3 million. EBITDA adjusted for equity compensation expense was $2.6 million. And EBITDA margin was 8.4%.

Accounts receivable increased sequentially to $20.4 million, day sales outstanding was 60. The number and value of customer lease financings have grown over the last few years and this inflates the DSO calculation by about six days.

Inventory increased sequentially to $17.3 million. This was about in line with our expectations. Capital expenditures were $3.2 million for the quarter, including the land purchase for our new production facility. Backlog for guidance and stabilization products and services at the end of June was $15.5 million.

Turning to our outlook for the rest of the year, as indicated earlier, the leisure markets are very weak and our outlook for the near term is now lower than what we had projected in April. We were also notified recently by a foreign defense customer that they will likely delay an anticipated order until 2012. On the other hand, the VSAT and FOG businesses are expected to continue to gain strength and generally meet our expectations for the year.

Given this, we expect that Q3 top and bottom line results will look somewhat like the Q2 results. Revenue is projected to be in the range of $29 million to $31 million and EPS is expected to be in the range of $0.02 to $0.07.

Gross margin should improve sequentially by about 100 basis points. Operating expenses will be about equal to equal to Q2 but the tax expense should be considerably lower. Even assuming continuing weakness in the leisure markets, we do expect that Q4 revenue will show strong sequential and year-over-year growth. This will be driven by anticipated strong performance in our VSAT and fiber optic gyro businesses. Operating margins should also show very strong sequential improvement in Q4. We expect that EBITDA margin will continue to expand and should be at or above 10% going forward.

In summary, we are now a bit more cautious about the near term for the reasons mentioned. The general worldwide economic weakness has put a lid on consumer spending in leisure marine and land markets. On the other hand we are very pleased with the development of our strategic businesses and we are confident in our longer term growth strategy and financial objectives.

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

Yes. Thank you very much. (Operator Instructions). And we have our first question and we will hear from Rich Valera, Needham & Company.

Thank you, good morning. Sounds like the mini-VSAT business is progressing very well. I'm just wondering if you still feel you are on track for that target of roughly doubling that business this year?

Well I think generally we are -- if you look at where we ended up this quarter it was up 81%. The unit sales more than doubled. In fact, unit sales were up by 150%. So, I think by the end of Q4 we should be on pace to be roughly double where we were in the prior year. And, again, this is -- I'm going to use the word "roughly double." I think we are up 80% now. We expect that growth rate to increase throughout the year. The business is going better than we had hoped so it is looking good.

Very good. And then with respect to the V3, last quarter you talked about using a higher cost modem for that to get it out to market quicker. Where do you stand on getting the lower cost modem into the V3?

That's in place now for starting in Q3.

So presumably that is one of the drivers of the gross margin improvement as well?

Yes.

Great. And then just I wanted to make sure I got the number. When you were talking about the potential leverage in the service gross margins if you would double the subscribers. What was the increase in gross margin you referenced there, I think it was Pat?

I said that the gross margin at that point in time should be about 2,000 basis points higher meaning about another 20 points of gross margin just for the airtime service.

Right.

And that the absolute gross profit in dollars should be about 5 times the current level.

Got you. And then talking about your comments on adding expenses as you grow, and I guess at one point the thinking was that you could add, I think, as many as sort of 5,000 kind of with the initial infrastructure that you would have in place and yet it seems like you maybe have to add capacity and other resources more incrementally than that. Just sort of wondering what are these expenses you need to add given that, I would think, in most of your regions your are probably well under the capacity of the transponder that you paid up for. So what is it that you need to keep adding as you grow the business?

Well I think what Pat was referring to is that it is not 100% additional profit when we add a subscriber going forward. And as we are successful, some regions have more usage than others. So, there may be some load balancing where you actually need to add some incremental bandwidth in one region.

But the takeaway message here is that substantially we have a fixed cost base going forward now so that as Pat mentioned, that the marginal profit that we saw even this quarter on incremental subscribers was over 50%. So, we are going to get leverage, and it is tremendous leverage, but it is not going to be 100%.

Fair enough. A couple of questions on the guidance and navigation business. First of all on the foreign order, can you talk about the rough magnitude of the one that was pushed out?

Yes. That is on the order of $2 million.

And when had you expected to get that? In the third quarter?

Yes, I will let Pat answer. But I think that is --

Yes. There was a combination of products and some non-recurring engineering that we had anticipated for TACNAV, related to TACNAV primarily. And some of that was in the third quarter but the majority of it was in the fourth quarter in terms of what we anticipated.

Great. On the FOG side, obviously two components here. I think in your prepared remarks you said that the CROWS-related FOGs were actually looking to be a little bit better than your fairly modest forecast. How do things stand on the non-CROWS FOG business, I guess a lot of which is commercial and perhaps could be driven by the new 1750 at least at some point in the future.

Yes. So the 1750 we think is going to be our best selling FOG product. But, it is an OEM product that has to get designed in other people's systems. So we don't expect that that will be a big factor in the next quarter or two. So, while we are very excited about it, it is something that has to get designed and released in other people's product. Now we have been giving people early samples and previews so we actually already have some design wins for it.

So what is baked into our guidance is not a huge upside for 1750. But we see that as happening starting in say Q1.

How about the other -- obviously you had some reasonably healthy non-CROWS FOG business particularly in the fourth quarter of last year. I think you had kind of a mid-to-high single digits million of non-CROWS FOG business. Just wondering how that business is doing and is that generally growing understanding I think that fourth quarter of last year was somewhat of an anomalous quarter.

Right. That is generally growing and we expect that to continue so as we, you know, FOG did a little bit better in Q2 than we had forecast. And we expect that by Q4 we should be maybe 50% higher from where we are today in the FOG business. But that will be a combination of remote weapon stations and the commercial business that you are talking about.

We are expecting continued ramp in all other business for the FOG.

When we began the year, Rich, our thinking was that, just to bring you back to last year and this year. Last year we did roughly $41 million in FOG revenue, pretty close to that anyway. This year entering the year we were project a bit under $30 million for the full year which was about a 30% year-over-year reduction. Now embedded in that was a very substantial reduction in CROWS revenue and about a 25% increase in the non-CROWS related FOG revenue.

And I would say that for the year and the mix we are still pretty much in line with that original thinking. And it could vary, the non-CROWS piece could vary quarter to quarter like anything can. But over the course of the year we are expecting it to be up at roughly 25% to 30%.

Great. Thanks for that. I will yield the floor.

Next question?

Next we will hear from Chris Quilty with Raymond James.

Good morning gentlemen. Pat, I was hoping -- good morning Martin -- could you update us on your full year revenue guidance. I think it was $121 million to $127 million?

Well as you know in the press release and in the scripts we didn't give any full year guidance but I would say Chris at this point what we are seeing in the leisure markets and what we just mentioned about the military, the potential shift out of the military piece of business which for now we think the prudent thing is to assume that it will shift out even though that is not -- there is always the possibility that it could change. That the last time we had given guidance of about 8% to 13% top line growth for the year and I would say at this point we are probably at or modestly below the low end of that range in our outlook.

Okay. And did you give an actual number for FOG revenues in the quarter?

We probably did not but I will be happy to give it. It was $6.1 million.

Okay.

Equal to the first quarter.

Got you. And did you give the combined, I mean you gave up 81% year-over-year but the combined TracPhone/mini-VSAT service revenue number?

No. And I don't think we have ever done that. But I can give you a general sense. We reported $6.2 million of service revenue and I can tell you that the VSAT portion of that is the lion's share, 80% or so.

And then on the product side I can tell you that in terms of system mix in the quarter we saw about a 60/40 -- there is a lot of background noise, I don't know where it is coming from.

Sorry about that.

In terms of the product mix, in terms of the sales for the quarter, it was roughly a 60/40 split in V7/V3 in dollars. Excuse me, in units shipped, not in dollars shipped, excuse me. And then on top of that we had some Virtek revenues. So we haven't disclosed the exact number but those are the key pieces.

Okay. But if I ran the numbers right, or did you just say the V7 revenues were above V3?

In terms of units sold, yes.

Units and dollars.

Yes.

Yes. So there was no cannibalization of V7. In fact it was up strongly sequentially and year-over-year for V7.

Chris Quilty. Okay. And just as a reminder, we should be modeling V3 monthly ARPU are in the $200 to $500 range relative to the $1,800 to $2,000 that you see for the V7?

Yes. I think you are in the right ballpark. I think it may be at the high end of that range but again some of these were only active for part of the partial months even as they shipped and got installed. One good thing is that it does seem like they were getting installed faster than V7. So the six month lag that we are used to seeing with V7, that may be a little bit too generous with the V3. It seems like they are coming online much quicker.

Okay.

I think ARPUs around the $500 range for V3 might be an early estimate but it is very hard to estimate right now.

Okay. And did anything change with the mix of the type of customers that are buying the V7 which I think in the past you have said are about 75% commercial. And what are you seeing in terms of the type of user for the early uptake of the V3?

It's actually a similar pattern to what we saw with the V7 which is the earliest adopters are in the leisure market meaning they just buy new products faster and make decisions faster. So we don't think that that means that there is no interest from the V3 in the commercial. In fact we expect the same pattern where 75% of the business will be from the commercial markets in the V3 as well.

Okay. And with regards to the FOG business, I think Rich asked the question but I didn't get it. Did you give a specific, what was the non-CROWS revenue growth in the quarter? I know you said 25% to 30% for the full year, but I think in Q1 it was up like 80% order of magnitude?

Yes. The second quarter it was not up nearly like that. It was probably 10% or less year-over-year. But it was up sequentially.

Okay. And do you think any of that was due to anticipation of the DSP-1750?

I don't think so. That is the good news about the flip side of having to be designed in. Once you are designed in it is difficult for people to change. So, we don't have a concern about people switching existing programs over to the new product. I don't think that is a factor.

Actually I need to correct myself, Chris. I think I just said that piece of business was up sequentially. It was up year-over-year. Sequentially, I don't have the numbers in front of me. It may have actually been a little bit down sequentially.

Operator?

And at this point it appears that Chris Quilty has inadvertently disconnected. We can let you know if he re-queues up. (Operator Instructions). And our next will come from John Bright, Avondale Partners.

John Avondale. Good morning. I'm going to follow up on the subscribers side. If you think you are going to be almost doubling by the end of the year or cumulative, you said units shipped, that really implies a pretty significant ramp for Q3 and Q4 relative to what you have been doing. What are you seeing out there that gives you that level of confidence?

Well, just to clarify, we didn't say that we doubled the number of subscribers by the end of the year. What we said is that the VSAT revenue for hardware and services would be roughly doubled where it was a year earlier by the fourth quarter. And it was up 80% already this quarter. So what we are saying is that by the end of the year we expect the growth to continue and accelerate a bit.

Do you think -- when you target where you think you might end on cumulative, you said units shipped, do you think you will break the 2,000 barrier by the end of the year?

Well, if you look, just plot the trend lines you would come to that conclusion. Yes, absolutely.

Do you think that, it seemed like sales and marketing might have ticked up a little bit and you talked about operating expenses maybe needing to go up slightly. Are you finding you are needing to spend more to attract customers?

No. I wouldn't say that we are finding that.

John, one of the things that is driving the operating expenses related to the VSAT business is really the regulatory things that have to be put in place in establishing subsidiaries around the world like in Brazil. It really is not the -- I mean if you want to count those as attracting customers because you need that structure in place to do that, then sure. But I agree with Martin that we are not throwing more money at the actual sales and marketing process, certainly not more so than on a percentage of revenue basis.

And then on guidance, a couple of questions, Pat. One, on the leisure business it has been a bugaboo the past two quarters. What are you -- how low are you expectations for the September quarter and the December quarter for that business now?

Well, without giving an exact number because I haven't got one specifically in front of me, but just to give you a general ballpark, when we came into the year, the combination of land and leisure, we were expecting growth year-over-year in the range of 7% to 10%. And now we are looking at a reduction year-over-year of approximately 10%. So we have had close to a 20-point swing in our expectations for that piece of business from when we started the year.

And I would say that the back half of the year is along those lines of a fairly substantial reduction on a year over year basis, along the lines of what we saw in the second quarter which was in the teens.

And another factor that is in there, John, is the sales of Inmarsat Systems, in other words systems that use Inmarsat service which we have provided as a reseller now for many years have just fallen like a rock. And our sales historically have been [leaning] to the leisure markets. So I think what we are seeing in leisure markets is a combination of just the woeful economy, but the other thing is that people are turning to our VSAT products very quickly and percentagewise maybe more quickly than we had estimated at the start of the year.

Thank you.

Just another point on that, if you look at the leisure markets. Brunswick reported results, and although they said their boat business was actually up which is good news on the retail side. But within those numbers, Fiberglass, [Sterndrive] which is about 60% of their revenue declined 8%. So the stuff that was up were outboard boats and aluminum boats. And that is not our target customer obviously.

Next question, Operator?

And currently there are no questions in the queue. (Operator Instructions). And we have no questions at this time.

Okay. In that case we will wrap up and as always feel free to contact Pat or myself directly. Thank you.

And that does conclude today's conference call. Thank you for your participation.