|Here is part one of the full Q2 2002 Conference Call transcript. I proofed it for accuracy and it seems to be correct, although some words were unclear and some callers names and firms are best guesses. This is my own effort and is posted on a best effort basis, but it is no substitute for listening to the actual CC.|
Q2 2002 Earnings Conference Call
Dick Forsyth, VP of Finance
Standard forward-looking statements disclaimer.
Martin Kits van Heyningen, CEO
We have a lot to talk about today, including some new product announcements as well as some positive financial news. As you can see from our earnings announcement this morning we have enjoyed tremendous growth so far this year and we have a number of exciting new initiatives running in parallel.
In order to keep our operations running smoothly, and to prepare ourselves for even more growth in the future, we have made several management changes in addition to those over the last year, including two in the second quarter, bringing on a VP of Engineering, Dr. Kalyan Ganesan in May, and as you have seen in today's release, Pat Spratt has joined KVH as our new Chief Financial Officer Pat has an outstanding track record in the technology industry, and his leadership in Finance, Investor Relations and Business Planning will enhance the expertise of our entire team.
I'm very happy that Dick Forsyth will continue to be a member of KVH's executive management in the position of VP of Finance, where he can continue to focus on the successful management of the company's resources, and we've now got a very strong team together.
We're delighted to have Pat with us today. Pat, welcome aboard
Thank you very much Martin. Today I will keep my comments especially brief. Being new to KVH, I am now at the initial stage of a steep learning curve. And given that, my ability to add value to your understanding of the financial results is somewhat limited. So, for this conference call, I have asked Dick Forsyth to handle the review of our financials, as he has capably done for so many years. In the short time that I have known Dick, I have already grown to appreciate his valuable contributions to KVH, and I am very pleased that we will be working together.
I do have a couple of additional comments that I would like to make. First, I was attracted to KVH because it has a wealth of outstanding potential, and a wealth of strength as well. But the most impressive factor for me is the passion - for customer satisfaction, for using leadership in technology to develop the best product, and the passion for always striving to improve, in every dimension of the business. KVH provides an environment in which everyone is challenged to contribute and to grow. Having this kind of passion is fundamental to long-term success - in product and service offerings, as well as in financial performance.
And that leads to my second comment. My immediate priorities are squarely focused on our financial performance. We WILL adjust our cost structure to yield profits in the near term, and sustain profitable growth in the longer term. We will also improve asset utilization to strengthen cash flow, and provide for additional tactical and strategic investment flexibility. And I intend to provide the finance management, leadership and support, that will drive the company to achieve best in class performance over the longer term. I am very excited to have this opportunity to contribute to the growth of KVH, and I am equally committed to rewarding your confidence in us, as represented by your investment in the company. Thank you. At this point I will turn it back to Martin, and to Dick. Martin?
Martin Kits van Heyningen, CEO
Thanks Pat. Now, let's get started.
KVH had another excellent quarter with record revenues of $12.6 million, which is a 61% increase over the second quarter of 2001, and a 31% increase from the first quarter of this year. We reduced our operating loss by 66% from last year's second quarter, and we are on track to return to profitability during the second half of this year. Our revenue growth was driven by a 51% increase in our satellite communications sales, a 7% increase in our Fiber Optic sales, and an almost 5-fold increase in our military sales over the same period last year. During the quarter we increased gross margins by 600 basis points over the second quarter of 2001, and we also continued to invest in research and development for our new products. R&D expenditures in the quarter rose slightly in actual dollars, but decreased as a percentage of sales to 19% from 24% in the first quarter of this year.
Now looking ahead to the third quarter and the year as a whole, KVH is well positioned to achieve its goals of solid revenue growth and a return to profitability.
I'd like to go through an overview of each of our markets, beginning with our Satellite Communications Group.
Sales of our satellite systems in N. America were up 74% from the same period last year and our overall satellite communication sales totaled $7.9 million, which is a 51% increase over the last year's quarter. The ongoing recovery of the domestic land mobile market place has been the primary driver in the continued growth of our satellite communications revenue, more than offsetting a small decline in our European Marine sales for the satellite segment.
Now our land mobile sales achieved a significant milestone this quarter, when three major OEM RV and coach manufacturers, Fleetwood, Featherlite and Rexhall, all selected our TracVision satellite TV systems, as either standard or optional equipment on their 2003 model year vehicles. Now to earn this business, we specifically designed and launched two new TracVision antennas, specifically designed for OEM integration and easy factory installations. The rapid development and production of these two new designs allowed up to ship the first units in June. Together, these OEM customers represent the potential sales of several thousand additional units over the next 12 months. The growing demand for KVH's satellite communication systems as standard or optional equipment solidifies our position as the number one manufacturer of satellite solutions for the land mobile industry. Now we anticipate sales of RVs in general to continue to be strong, and we expect to continue to gain momentum with our products targeting this market and expect additional major customer wins in the near future.
Now, unlike the land mobile market, we believe that the overall Marine market will remain relatively flat for new boat sales for the time being, which is depending on the pace of the general economic recovery. However, the sales from our new products and services are helping to compensate for the moderate sales of existing products in the Marine marketplace.
Our new Marine TracNet Internet system rollout was extremely successful, and the product is selling very well. In addition, we also saw positive results in the distribution of our Inmarsat satellite communication equipment, our new TracPhone F77 from Thane & Thrane, so TracNet and our expanded family of Inmarsat products represent more than just hardware sales. To support each of these product lines, KVH is now actively selling and supporting airtime services for mobile DirecPC and Inmarsat, creating a new, recurring revenue stream for the company. As an Inmarsat service provider, we now offer airtime service subscriptions to all of our new and existing TracPhone customers, as well as non-KVH Inmarsat users.
We invested significant resources in Q2, to get this up and running, which is now complete, and now our satellite services group is already beginning to realize new subscription driven revenues.
We also continue to make good progress in the development of our new low profile satellite TV and Internet antenna for the automotive market. During the second quarter we increased our R&D spending to increase the probability that we meet our development schedule as well as our performance and manufacturing cost target, we are pushing hard in this breakthrough technology and we remain on track to introduce the product this year.
While our Fiber optic group made significant technical progress during the second quarter, we are working hard to establish this business in the market place as a consistent revenue generator. With approximately $900,000 in sales for the quarter, they were up 7% over the same period last year, but this is less growth than we were expecting. Now despite the slower than expected shipments in the fiber optic area during Q2, we booked several major gyro orders for military antenna stabilization and missile training simulators which should be delivered starting in Q3.
Now during last quarter's conference call, I mentioned that we were focusing on guided munitions as a key new opportunity for our fiber optic gyros. I am pleased to report that we are now working with L-3 Communications on a funded project to develop a low cost IMU unit using our new DSP based fiber optic gyros. This is for use in smart bomb guidance systems. These smart munitions guidance and drone navigation are two applications that are receiving lots of attention and funding from the military, and we are optimistic that our new FOG based guidance package will allow KVH to participate in this large, critical and growing defense area.
In the photonics arena, our program to develop Active Fiber technology and a new class of high-speed in-fiber optical components remains on track. However, due to a slowdown within the Telecommunications industry, we reduced our R&D expenditures on Active Fiber by about 10% from the first to second quarter this year, and directed additional resources to our Mobile Broadband effort. Now despite this short-term uncertainty within the industry, we have a high degree of confidence in our Active Fiber approach, and in the eventual need for this technology in the market place. We are proceeding with the development efforts, while pacing the rate of investment in the technology to match the rate of recovery in the Optical Telecom networking industry, and the arrival of the 40-gigabit networks.
Now going into this year, we set a goal to double our defense related revenues for the year. During the second quarter, our Defense related sales rose almost 500% to $2.7 million, up from only $461,000 during the same period in 2001. Year to date our defense related sales total $4.9 million, which is more than a 200% increase from last year. We continue to book new and follow-on military business, and we are pursuing a number of significant opportunities.
As I have indicated in previous calls, we are expecting to win a number of large orders from the US military for our TacNav vehicle navigation products, and our confidence remains VERY high that we will book these orders in the second half of this year, so that our growth in defense will continue.
I'm very proud to report that our TacNav systems are playing a major role in our military's counter terrorism efforts abroad, aboard vehicles currently operating in Afghanistan and elsewhere. We have recently learned that our TavNav systems aboard Canadian light armored vehicles participating \in Operation Anaconda performed flawlessly during direct combat with enemy forces. Now, position guided munitions, uh, smart bombs, generally require the type of precise far target location capabilities, which is a key capability of TacNav, so not only are we developing a guidance package for the munitions itself, we are providing the Nav system for the vehicles that provide the target locations.
Our TacNav FOG system, which incorporates our Fiber Optic gyros, was also used in the Afghanistan theater. As you may recall, KVH was awarded a $4 million contract with the US military last November for TacNav FOG navigation systems. Now these systems were installed aboard the recently unveiled ground Prophet vehicle, which is an advanced signal intelligence and autonic warfare system.
Our product provides the precision bearing and position data, which allows the system to intercept and track enemy communication signals. And based on the system's performance to date and it's value to the military, we expect this program to be accelerated, which could result in substantial follow-on orders for our TacNav FOG nav systems in the near future.
So as you can see, KVH is well positioned to improve upon first half sales growth of our TacNav military systems and our fiber optic gyro products into the military. In the first half of 2002, the sales increases for the business developed, and in most cases booked, were prior to the tragic events of 9-11. So, our continuing field successes, the growing recognition of the value of TacNav, and the release of additional funding for defense, should all benefit KVH, starting in the second half of this year.
Looking ahead, KVH is in a very strong position as we enter the third quarter. We are on pace for record yearly revenues, and we are seeing growth across the board. New products and services are expanding our customer and revenue base, and we continue to pursue significant opportunities in all of our target markets. Even so, we are working hard to improved our financial performance, and our near term objectives are to return to profitability in the second half, and to post 30%-40% revenue growth over last year.
Now I would like to turn the call over to Dick to take you through the numbers. Dick?
Dick Forsyth, VP Finance.
Thanks, Martin. Let's begin with the top line.
Second quarter sales increased 61% from last year, to $12.6 million as a result of strong communication and defense sales.
Q2 Communication sales increased to $7.9 million, a 51% increase from last year's sales of $5.2 million. Year to date communications shipments rose to $13.8 million, a 41% increase over the prior year. Communication sales growth resulted from wider distribution through national distributors, and increasing orders from RV manufacturers.
Q2 defense revenues grew to $2.7 million, a 5-fold increase from the prior year. While year to date defense shipments were $4.9 million, more than double last year's volume. Foreign defense sales accounted for the strong first half performance, while domestic defense orders have been slow to close, reflecting delays in the defense administrative funding process, which makes it difficult to forecast the timing of orders. Continued slowness in the defense funding process could delay an order that is currently shipped to forecast in the 3rd quarter, potentially having an adverse affect on expected third quarter performance. However we do anticipate that we will ship the order no later than the fourth quarter.
Defense backlog rose to roughly $4.3 million at the end of the second quarter, with $1.7 million scheduled to ship in the current quarter.
Fiber Optic sales increased to $900,000, up 7% for the quarter, but down on a year to date basis. FOG sales will increase this quarter, as we begin to ship from existing backlogs.
Looking ahead, we anticipate continued strong revenue growth throughout the remainder of the year, as we benefit from positive trends in all sales categories.
Q2 Gross profit as a percentage of net sales increased to 42%, up from last year's 36% of sales, while year to date gross profit was 43% of sales, up from 37% in 2001. The year to date gross profit improvement resulted from a favorable mix of higher margin defense shipments, reductions in direct product costs, and a 4-point reduction in our manufacturing overhead rate. Improved methods, increased manufacturing volumes, and stronger cost management all contributed to reduce year to date manufacturing overhead to 13% of sales. Looking ahead, we anticipate Gross Profit will continue to improve sequentially over the new two quarters, as we make more efficient use of our manufacturing facilities, and continue to reduce product costs.
Q2 R&D expense increased to $2.4 million, an 8% increase from last year's spending of $2.3 million. R&D spending included significant PhotonicFiber and low profile [antenna] research costs, which are forecast to slow in the second half as we complete the product development stage, and begin the transition to sustaining engineering. R&D expense is forecast to decrease for the remainder of the year, as project spending begins to decline, and increased customer funded engineering begins to offset internal spending.
Q2 S&M expense increased by $800,00 to $2.8 million, up 40% from last year, while year to date spending rose to $5.1 million, a 21% increase from the prior year. The majority of the spending increase resulted from variable sales commissions, which increased $600,000 in response to 61% quarterly sales growth. Outside sales commissions were unusually high in the quarter, due to a non-recurring $350,000 commission related to a large defense shipment. We expect marketing and sales expense will decrease as a percentage of sales over the next two quarters, as commission expense normalizes.
Q2 G&A expense increased $170,000 to $800,000, a 27% increase from last year's spending, while year to date spending rose by $250,000 to $1.5 million, a 20% increase over the prior year. Spending growth was due to non-recurring recruiting fees and professional services. Administrative expenses should remain relatively flat for the remainder of the year
Consistent with our accounting treatment for the prior year, we fully reserved the tax benefit associated with the quarterly and year to date operating losses. Reserving the income tax benefit increased the quarterly net loss by roughly $300,000 and the net loss per share by 3 cents, while year to date net loss increased by roughly $800,000, or 7 cents per share. Although this accounting treatment increased our net loss, I would like to point out that we have not lost the positive tax savings associated with the current tax benefit. As soon as we are profitable, we will net the reserved income tax benefit directly against income tax expense, increasing earnings in that period.
Positive quarterly asset management resulted in DSO of 42 days, down from 49 days at year end, while Inventory turns increased to 5.7, up from 5 turns at year end, despite a buildup of defense related inventory, which was staged in anticipation of orders forecast to ship this quarter.
Cash closed at $6.5 million, down $2.6 [million] from the first quarter's cash balance of $9.1 million. The operating components of the decrease were a cash operating loss of $400,000, increased receivables of $700,000, Accounts Payable and customer deposit decreases totaling $1.2 million, combined with capital expenditures of roughly $300,000.
Cash flow from operations is forecast to improve significantly for the remainder of the year, in response to improved operating results, turning positive this quarter, and continuing positive for the remainder of the year. However, positive cash flow from operations will be offset by second half capital expenditures, resulting in an estimated decrease in our current cash balance of roughly $500,000 by year-end. Based upon our current operating forecast, our cash balances and bank line of credit are sufficient to fully fund planned operating and capital requirements going forward.
In closing, we're very encouraged by our current sales outlook, we look forward to continued growth and our return to profitability.
Now we'd like to take our Questions. Operator, please open the call.