KVH Industries
Q4 2002 Earnings Conference Call, 02/20/2003
Pat Spratt, CFO
Thank you. Good morning and thank you for joining us. I’m Pat Spratt, CFO for KVH Industries, and with me today is Martin Kits van Heyningen, our President and CEO. This call will address the 4th quarter and fiscal year 2002 earnings release which we issued earlier this morning. Copies of the release are available on our website www.kvh.com and are also available from our investor relations department. This conference call is being simulcast on the Internet and will also be archived on our website for future reference.
Before we proceed, I need to inform you that this conference call will contain certain forward-looking statements that involve risks and uncertainties. For example, statements regarding the company’s 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 the risk factors described in our SEC Form 10-K, dated March 20, 2002. The company’s SEC filings are available directly from us, from the SEC, or through the Investor Information section of our website.
Now I’d like to turn the call over to Martin to begin discussion of today’s results. Martin?
[Martin:] Thanks, Pat
In early January we provided a preliminary indication of the results for the quarter and the year, so we don’t have any big surprises for you today. We will be going into details on our positive financial results and our exciting product announcements from early January.
I’m going to begin with a recap of our quarterly and yearly operations in all our business areas, and then Pat’s going to elaborate on the financial results for the quarter and the year. After that we’ll take your questions. So let’s get started.
Now those of you who are familiar with KVH, know that we design and manufacture products for two principle markets, mobile satellite communications and defense guidance and navigation. We do so using our proprietary satellite antenna technology and our fiber optic technology. Our balanced approach with these diverse markets allowed us to maintain growth, expand market share, and pursue new opportunities despite the uncertain economic conditions during 2002.
In fact, 2002 was a breakthrough year for KVH. We entered the year with goals of returning to profitability in the second half, doubling our Defense revenues, and achieving annual growth of 30%-40%. And I’m pleased to report that we met or exceeded each of these goals.
After return to profitability in the third quarter, we improved on that performance in the 4th quarter, increasing earnings to 3 cents per share, on record setting revenues of $13 million. This is a 47% increase in revenue over the same period last year. Total revenues for the year were $47.7 million, up 46% from 2001.
These results were driven by the continued growth of our satellite communications business, and a solid jump in our Defense sales. We are entering 2003 with some exciting new products, and our goal is to grow revenues substantially, while building profitability.
I’d now like to go through an overview of each of our key markets, beginning with our satellite communications and mobile broadband group.
Throughout 2002, we continued to execute well in our satellite business. We expanded our distribution network, introduced new products and gained market share. This success is reflected in our results.
Sales of our satellite communications products increased 52% over the 4th quarter of 2001, and 46% for the year as a whole. I don’t have to mention, but will anyway, that this is a major success story during the current economic conditions. Our sales team has done an outstanding job.
In the land mobile market, we signed major OEM agreements with 8 of the top RV and coach manufacturers during 2002. That trend has continued, as in January we announced that we have signed a 9th OEM, Newell Coach has selected TracVision as it’s exclusive mobile satellite TV solution. Together these companies account for the majority on new Class A and luxury coaches built in the U.S. These OEMs are now including our TracVision satellite TV systems as standard or optional equipment on their new vehicles. At the same time, our aftermarket sales continued to climb, supported by our nationwide distribution agreements.
We also took steps to expand our already dominant presence in the maritime market, through the launch of new products and services. In October we introduced the upgraded TracNet 2.0 mobile high-speed Internet system, which offers expanded range and higher speeds. A few weeks later we announced that a European version of TracNet would be available starting in 2003. KVH is now the only company to offer mobile broadband Internet access for vessels on both sides of the Atlantic.
We also filled in our satellite TV product portfolio. While our existing 18” and 24” TracVision antennas are the #1 products in their categories, we recognized the need to offer a satellite TV solution for larger vessels, and to provide broader coverage areas.
The solution is our new TracVision G8, which was introduced at the London and Miami boat shows during the past several weeks. The 32” TracVision G8 is the most advanced Marine satellite TV antenna available. It not only includes a high efficiency carbon fiber antenna, but it’s also the first TracVision to use KVH’s Fiber Optic Gyros to provide superior tracking and stabilization. TracVision G8 offers extended coverage, outstanding performance, and enables us to market and sell to a class of vessels that need higher gain satellite TV antennas.
While our land mobile and marine sales have continued to flourish, we made the largest splash in the automotive market, with the introduction of our TracVision A5 low profile satellite TV antenna. Unveiled at the 2003 Consumer Electronics Show in January, TracVision A5 received a tremendous amount of positive attention from consumers, retailers and the media. TracVision A5 is the product of more than two years of research and development. This groundbreaking antenna is approximately 4” high, mounts on the roof of an SUV or minivan, and connects directly to an automobile’s passenger entertainment system.
As you know, passenger entertainment systems have become one of the hottest accessories to reach the automotive market in years. Every model of minivan and SUV now offers video as an option, and roughly a million units were sold in 2002. That number is expected to grow in 2003.
However, until now, the only thing you could watch on those screens was pre-recorded DVDs or videotapes. TracVision A5 changes all that. Simply turn it on and it provides in-motion access to more than 300 channels of satellite TV entertainment and 50 channels of commercial free music, from DirecTV, virtually anywhere in the continental United States.
To achieve this, we had to develop an entirely new type of antenna, using flat panel, phased-array technology. The revolutionary technology used in TracVision A5 has enabled us to build an affordable phased-array antenna that is practical for use in automobiles. With several patents pending, we are now in the final design and production-planning phase.
We anticipate that the TracVision A5 systems will ship to retailers at the end of Q2. To support the launch of TracVision A5, we have a comprehensive marketing and distribution program underway. We intend to base the TracVision A5 rollout on our successful land mobile and marine models. A new, nationwide network of automotive sales reps is already in place. And these reps are meeting with, qualifying, and signing up new dealers around the country.
Initially TracVision A5 will be available through automotive and electronics retail outlets, and we’ve already started accepting orders from our new authorized dealers. We are also having discussions with OEMs and industry representatives to build support for the TracVision as an OEM product, once the initial demand for it among consumers has been established.
Now initially, the TracVision A5 will be compatible with the DirecTV satellite service, and we are working closely with DirecTV to establish mobile subscriber policies that will make it easier for TracVision A5 owners to buy monthly service. TracVision A5 is also compatible with our mobile Internet service, providing a future upgrade path to additional capabilities.
And based on the initial response from consumers, dealers and vehicle manufacturers, we’re very excited about the prospects for TracVision A5. I’m confident that this product will be our most successful product ever. However, the automotive satellite TV market is entirely new, and we have no baselines upon which to provide projections for our sales expectations, or the rate at which this product will be adopted. But obviously, a successful launch of the TracVision A5 should greatly expand our addressable market, and provide added strength to our revenues in the 2nd half of the year.
Now moving on to the Defense area, entering 2002 we set a goal to double our military revenue and as I said, we did just that. Fourth quarter military revenues were $5.3 million, up 106% from the same quarter last year. Year to date Defense sales were $15.3 million, and that’s a 114% increase over last year. And a lot of this was driven by orders from the U.S. Special Forces. Now throughout the year, the U.S. and allied military forces are expanding their capabilities in preparation for counter terrorism and possible military action in Iraq. In doing so, they place greater focus on rapid operations and precision navigation, for both vehicles and munitions.
Now within the military, there remains a publicly stated concern regarding the possible vulnerability of the Global Positioning System. GPS jamming technology is readily available on the open market, and military planners recognize that the armed forces need tools to ensure they have uninterrupted navigation data.
Now KVH’s TACNAV tactical navigation systems include both inertial and magnetic field sensors, making our systems impossible to jam, and ideal for vehicle navigation in combat situations. In October, we announced that KVH had received a contract, potentially worth $10 million to provide TACNAV systems for all U.S. army Special Forces vehicles. Several hundred TACNAV systems shipped at the end of the third quarter, and we shipped the remainder of the initial order to the U.S. Special Operations command during the fourth quarter.
Our engineers are now working closely with members of the Special Forces to field those systems as quickly as possible. We also expect follow-on orders from the Special Forces this year to equip additional vehicles in their fleet.
So we continue to see a trend of strong Defense related sales. However, the uneven military procurement process continues to make it difficult to accurately predict our revenue patterns from quarter to quarter. Even so, we are aggressively pursuing TACNAV sales opportunities with both our domestic and international customers, including recent sales to the U.S. Marine Corps and the Saudi and Omani ministries of Defense, and most of these small contracts have significant follow-on potential.
Our Defense related business also remains the number one market for our Fiber Optic Gyros. KVH “FOGs” are also at the heart of our TACNAV-FOG and TACNAV-2 navigation systems. Our fiber gyros are also the KEY to a recently announced award from the British army, which is already using our standard TACNAV systems.
During the fourth quarter, the British army ordered our new TACNAV-FOG upgrade, which is the first of our military systems to employ our new DSP based Fiber Optic Gyro. These systems will significantly enhance the vehicle’s existing precision navigation and pointing capabilities, and this order will be shipping during the first quarter of 2003.
Now, excluding the gyros integrated in our military navigation products, Fiber Optic revenues did slow somewhat in 2002. For the year, non-military fiber optic revenue was down 17%, but total FOG sales were roughly comparable to 2001.
Now we don’t see this as a trend, rather a temporary situation due to the timing of larger contracts. Strengthening our fiber optic technology sales is a major goal of our business development efforts in 2003. To achieve this, we continue to improve our technology and pursue new market opportunities, but at the same time we are concentrating on the integration of our FOGs within complete systems, rather than offering them as just stand-alone sensors.
The FOG enhanced line of the TACNAV products and the new TracVision G8 TV antenna are good examples of this integration. Another one is the development of a FOG-based IMU, which is Inertial Measurement Unit, in cooperation with
L-3, as an example of the potential of our integrated systems. The proposed IMU will be capable of providing precision guidance and navigation data for a variety of applications, including smart munitions, like the JDAM guided bomb.
We are making very good progress in this effort and expect to deliver the final prototype unit during the first quarter. In addition to it’s potential use in smart munitions, we’ll be marketing this low cost, precision IMU for a variety of other military and commercial applications, and we expect to continue the development and refinement process of this system throughout 2003. And while we are not counting on any significant revenues for the product this year, we believe that there is tremendous upside potential for a KVH IMU.
So, looking ahead, 2003 promises to be another strong year for KVH. We began the year with a good backlog of military orders for the first half of the year, and we expect our satellite communications products to continue to perform well, especially with the ramp in production for the automotive product the second half of the year.
Despite ongoing [un] predictability in the global economy and the possibility of military action in Iraq, I believe that our diverse revenue stream, new products, and expanded services, will enable us to achieve our goals of improving profitability for the year, and an annual growth rate in the 20%-30% range.
Now I’d like to turn the call over to Pat, who will provide some more financial details. Pat?
[Pat Spratt] Thank you Martin,
The fourth quarter results were very gratifying, and they reflect a solid conclusion for a year in which KVH made great strides. During the quarter we experienced strong growth in primary markets. We continued to show improvements in operations, and we maintained strength on the balance sheet.
Sales increased 47% to $13 million, a record for the company. This, along with continuing improvements in operating management, resulted in a net profit of $332,000, or 3 cents per share. For the year, revenues were $47.7 million, a 46% increase over 2001. Also for the year, we reported a net loss of $1.5 million, or 13 cents per share, but this was down, from a loss of $6.3 million, or 61 cents per share in 2001. Quarterly and annual revenue growth was spurred by increases in both the satellite and Defense business areas.
Fourth quarter satellite communications sales grew to $5.8 million, a 52% increase, and for the year, $25.9 million, a 46% increase.
Fourth quarter Defense revenue grew 106% to $5.5 million, as we shipped substantial orders for the U.S. Special Forces and the U.S. Marine Corps. Annual Defense shipments were $15.3 million, a 114% increase over 2001.
Defense backlog at year-end was $4 million. Although this is lower than the Q3 level, it was in line with our expectations for the period. Our military customers have shortened the cycle from order placement to delivery, and our backlog now consists primarily of orders scheduled for near term shipments.
As Martin indicated, fiber optic sales were $1 million, down 41% for the fourth quarter. For the year, fiber optic revenue was $3.6 million, down 17% from 2001. These sales figures exclude fiber optic gyros that are integrated into Defense shipments however. When factoring these in, total fiber optic for Q4 and 2002 was about equal to the 2001 levels.
For the fourth quarter, legacy products, which include OEM sensors and Marine compasses, rose 16% to approximately $640,000. Full year revenue for these products was $2.8 million, and were down 18%. We expect that this product set will continue to show a long-term decline, as we focus attention on more strategic core products and services.
Now to the cost side of our results.
Excellent progress continued with our product cost initiatives. Fourth quarter Gross Profit dollars rose 62%, year over year, to $6 million. Gross Margin increased to 46%, up 4 percentage points from last year, while full year Gross Margin was 44%, up from 38% in 2001. The quarter and YTD Gross Profit improvements were the result of volume driven capacity utilization, greater efficiencies in manufacturing operations, improvements in purchase component prices, and a beneficial mix of higher margin military systems.
We also continued to focus on controlling Operating Expenses. For the quarter, these expenses were up 16% year over year, to $5.6 million, but this reflects a 12-point reduction as a percentage of sales to 43%. Operating Expenses were 47% for the full year, an 11-point improvement from 2001. During the year we improved Operating Margin 16 percentage points, by effectively leveraging the capabilities of the in-place operating support structure.
Fourth quarter R&D expenses declined to $1.9 million, or 14% below last year. This also represents a 17% decline on a sequential basis compared to the third quarter of 2002. This marks the second consecutive quarter in which R&D expenses have declined in absolute dollars, primarily reflecting the continuing adjustments to the level of Photonics research. For the year, total R&D investment was $8.9 million, a 12% increase in absolute dollars, but a 5-point year over year decline as a percentage of revenue, to 19%.
Fourth quarter Sales and Marketing expense increased to $2.5 million, or 17% over last year. Sequentially these expenses were up modestly, driven by the seasonally heavy trade show calendar, while annual S&M expenses rose to $9.9 million, up 18% from 2001. These expenses declined 5 points as a percentage of revenue, to 21%.
Fourth quarter administration expense increased to $1.2 million, more than double last year, while full year spending, at $3.6 million was up 43%, and roughly equal to 2001 as a percentage of sales. The quarterly increase in administrative expenses was due in part to the addition of senior staff to support growth. It also reflects the consolidation of the company’s disparate Professional Service contracts, within Administration, providing us with a tighter control over this spending company wide.
Tax expense for the year was nominal.
As I mentioned earlier, our balance sheet profile is also very positive. The year-end cash balance was $7.2 million. Although net cash flow for the quarter was negative by $300,000, it is important to note that for the second half of the year, net cash flow was actually positive by $700,000. Cash flow from operations for the second half was positive by $1.1 million. This marked improvement over the first half of the year, was the direct result of Operating Profits and very strong performance in our inventory management.
Second half inventory reductions contributed $1.2 million to the year-end cash balance. At $3.9 million, inventory was $200,000 lower than the 2001 year end inventory level, and yet, this reduced inventory supported an almost 50% increase in annual revenue.
Turning inventory much more quickly, now 6.8 times on an annualized basis, drove this reduction. Inventory efficiency for the fourth quarter was 1.5 turns better than last year, and one full turn better than the second quarter of 2002.
Offsetting this positive cash flow some what, was the $1.1 million sequential increase in Accounts Receivable, to $9.7 million.
Days Sales Outstanding, or DSO, increased 5 days to 67. This was driven by military order delivery requirements scheduled for late in the quarter. The quality of our Accounts Receivable remains very good, and we expect DSO to be somewhat lower in the first quarter.
Looking ahead to 2003, we anticipate that revenue growth will continue to be strong, although at a lower rate than experienced in 2002. It would be unrealistic to assume that the 2002 growth rates will be repeated. For one, the comparables are much tougher. In 2002 we benefited from the strong growth of the ramp of satellite product shipments to new RV manufacturing customers. Secondly, the military business more than doubled, as the U.S. and our allies adjusted to the military demands of the war on terrorism, and other unsettled international conditions. Although for 2003 we have planned for a lower level of growth than that experienced in 2002, we will be prepared to satisfy higher demand, should it materialize. We are also planning for continued improvements across the entire operating model. I must … [recording interrupted] |
