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KVH Industries, Inc. (NASDAQ:KVHI)

Q1 2010 Earnings Call Transcript

April 22, 2010 10:30 am ET

Executives

Pat Spratt – CFO

Martin Kits Van Heyningen – Chairman, President and CEO

Analysts

Hamed Khorsand – BWS Financial

Chris Quilty – Raymond James

Rich Valera – Needham & Company

Aaron Edelheit – Sabre Value

Jim Roumell – Roumell Asset Management

Operator

Good day everyone, and welcome to the KVH Industries first quarter 2010 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.

Pat Spratt

Good morning, everyone. 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 first quarter earnings release that we issued earlier today. Copies of the release are available on our website and are 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 to IR@KVH.com and we’ll be answered them following this 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 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 yearly report on Form 10K filed with the SEC on March 9th, 2010. The company’s SEC filings are directly available from us, from the SEC, or from the investor information section of our website.

Now, I’d like to turn the call over to Martin to begin today’s discussion of results. Martin?

Martin Kits van Heyningen

Thanks Pat, and thank you all for joining us today. This is an outstanding quarter for KVH not only it did exceed our expectations but we also set new records for quarterly revenue and for net income.

On the top-line we recorded $28.0 million in sale surpassing our previous record that just last quarter year-over-year up 53% increase in revenue. In addition we recorded net profit of $2.1 million also a record result that equates our earnings of $0.14 per share but also a $0.32 or $4.6 million improvement over our first quarter results of last year. These results are due to strong contributions from our strategic initiatives in fiber optic gyros and global satellite communications.

We continue to gain momentum in our mini-VSAT business as we build credibility with the speed and reliability of our now global mini-VSAT network. This is helping us renew account and as more people take advantage of our exciting new technology which is starting to reach critical mass in improvement commercial markets.

In our guidance and stabilization business revenue was up 65% from the first quarter of 2009. Sales of fiber optic gyros were roughly equal the record level achieved in Q4 of last year and up 95% from Q1 of last year. At the same time our established defense business continues their steady contribution. As you may recall KVH is pursuing a large TACNAV opportunity for land vehicle navigation and looks like that contract could happen soon. It has a potential that worth more than $13 million.

We’ve already started work on the engineering development portion of this program looking under a letter of contract authorization. We hope to receive a formal production contract within the next three or six months.

In our FOG business we continue to run factory very efficiently even as we shipped product to our existing Kongsberg remote weapon station FOG contracts, to support this contract we continue to lend new fiber optic gyro business like the $3.1 million what are we announcing in February. We have a solid backlog going in Q2 and we’re optimistic that recently announced remote weapon station awards to Kongsberg could lead to additional orders for KVH. Part of our strategy with our fiber optic business is to continue to diversify both in terms of new military customers and in terms of new commercial products.

Towards that end we just strengthened our product portfolio for the commercial market with the introduction of our new CG5100 inertial measurement unit. Through seamless integration of three precision FOGs and three MEMS accelerometers the 5100 offers a ground breaking low cost solution for inertial measurement within a single compact enclosure. The six-axis 5100 is targeted at a number of applications like precision terrestrial surveying, navigation and GPS augmentation for broader way of commercial application.

For example the 5100 is perfect, a perfect solutions for autonomous vehicle that need high quality sensors as well as the reliable backup with GPS is interrupted or unavailable. New products like the CG5100 IMU and our miniature single-axis DSP5100 FOG are opening new markets and opportunities for us performing the cornerstone of our ongoing effort steadily expand the breadth of our FOG business to include a wider spectrum of applications in market.

Moving onto our mobile satellite business revenue was up 45% year-over-year in large part due to on the continued strength of our maritime satellite communications product where mini-VSAT was up very strongly year-over-year. We also enjoy the benefit of $3.0 million in shipments of our new aviation satellite TV system for commercial airliners.

Although the economy continues to access a drag in a leisure market our new TracVision HD7 satellite TV system is off to a great start following our Q4 launch is a growing demand for high-definition TV in the marine market especially on boats 40 feet and larger. However, providing HDTV service is a challenge after DIRECTV moved virtually all of its HD programming to a pair of new Ka-band satellites. Our new HD7 overcomes this challenge by tracking three DIRECTV satellite simultaneously even as the boat is pitching, rolling and turning. As a result boaters get to enjoyed DIRECTV HD just like they do at home but no satellite switching and full DVR support. It's also the best tracking product we’ve ever build making a perfect for high performance vessels like sport fishing boats. The HD7 quickly established itself as a best HD TV solutions sailable for boats. In fact we are regularly seeing competitors satellite TV systems being removed and replace with the HD7 because competing systems just enable to deliver the quality, the liability and performance that our marine customers expect.

Now let’s state you on the mini-VSAT business we worked extremely had to ensure that our satellite communication customers join outstanding level of quality, liability, and performance from the mini-VSAT broadband service. Earlier this week we announced that we added a transponder capacity and doubled our bandwidth in our existing North Pacific Ocean coverage to meet growing demand and who ensure quality service for existing and new customers.

In the coming weeks we will implement several significant technological advancement that enable us to double our bandwidth capacity in the US as well as in Europe without leading the purchase any additional transponder bandwidth, major steps and the evolution of our network thanks to our superior technology that serves as a backbone. Along with the enhancements to our existing network we continue to rollout of our global service, just days ago mini-VSAT went live for the Indian Ocean along with Guam and the region North of Australia.

It is also worth noting that our Indian Ocean coverage is unique extending well sound for the equator well other VSAT services in the region simply hug the Indian coast. This is just one example of how we are setting ourselves a part from the competition in maritime satcom industry. Other legacy marine time VSAT networks claimed off a global coverage even though they don’t have significant satellite capacity leased in all regions, or they don’t know how to choose seamless coverage in its debt require multiple subscriptions to get service in different regions. Unlike those competitors, I am proud to say that the KVH now offers the only seamless multi-negative broadband service for ships and plane that encircle the globe.

Additional efforts underway south of the equator as KVH recently incorporated a subsidiary in Brazil, this is a critical step and our effort to secure satellite licenses and operate the waters off the Brazilian cost so that we can address the offshore oil and gas industry there. We expect the service in this region will be live as Summer. Further east our efforts in Asia will under way talking advantage of both are new service regions as well as strategic geographic expansion. KVH Singapore is now opened and our team there is aggressively pursuing many commercial maritime opportunities.

Our Singapore office is playing a critical role and bringing a mini-VSAT service to the commercial maritime market. That Singapore serve is one of world’s preeminent hubs for commercial shipping businesses and in the end International maritime operators. The Asian region is something more than two-thirds of the world’s 20 busiest seaport and to support this region we recently signed distribution agreement with Japan Radio, Co. Under the terms of this agreement JRC is selling a TracPhone V7 within the Japanese market as well as through their established global distributor and dealing cannels. Overall the commercial market continues to be extremely receptive to TracPhone V7 and the mini-VSAT service.

One example of this is our recent announcement of DSP shipping, so less of the V7 firstly the critical elements of sale that is getting – is to getting on board of vessel for testing. And once is there the prospect experiences the benefit on a day-to-day basis. We almost always go on to buy the V7 and get to the mini-VSAT servers for the other vessels.

Now is the case with DSP shipping, which concluded and makes sense seven successful field test the more solution of one vessel then elected to add the V7 to any of the fleet. So in conclusion this one is very successful for us with back of getting financial results strong contributions from satellite communications on phone product and makes the milestone achieved in overall strategic plans.

Looking ahead, we expect to complete our investment in the mini-VSAT broadband network rollout in the coming months, after which we will begin to see the benefits of the airtime margins improving later on this year. And very confident with our strategic efforts investments are paying off and preparing us the success at we will continue.

Now I would like to turn the call back over to Pat, to have a closely look at the numbers, Pat.

Pat Spratt

Thank you, Martin. The first quarter results were better than our original expectations and they show that we continue to make good progress strategically in operation. This was achieved without the benefit of any noticeable improvement in macro economic conditions. For the quarter gross margin was 42.2% this was up nearly 400 basis point sequentially and it was way above the first quarter of last year. This was much better than we had anticipated after start of the quarter.

We saw benefit from several factors, one the supply chain improvement for efficiencies. Two, somewhat slower phase to the ramp-up mini-VSAT network cost. And three, in earns termination fee related to the completion of the TACNAV refurbishment program, which contributed about 100 basis points the gross margin for the company and will not recurring future quarters.

Due to the nature of this factors, we expect to receive some ongoing benefit, but we will not bit to the full extend that we experienced in the first quarter. As was also the case in the fourth quarter of 2009, the VSAT infrastructure build out together with changes in the mix of overall service revenue, significantly affected the year-over-year dynamics of our services gross margin.

In the first quarter mini-VSAT airtime services grew very strongly in absolute terms and also as a percentage of our total airtime services revenue. Inmarsat airtime services revenue declined year-over-year, as did revenue from services for nonrecurring engineering in repairs. So as was the case last quarter, our primary growth driver for services mini-VSAT airtime is also where we have been investing aggressively. Well, other relatively higher margin services have phone off. This is why service gross margin showed year-over-year decline for the first quarter.

Our product gross margins have shown fairly steady sequential improvement over the last several quarters. And part due to the substantial ramp-up of fiber optic gyro production. For Q1 operating expenses were up 15% compared to last year. One key year-over-year driver was reported R&D. In Q1, we had ripped a very low level of customer funded engineering activity; we still work on reported number.

Our total investment and engineering for the quarter was actually about equals to Q1 of last year. As a percentage of revenue reported R&D spending was 9.2% for the quarter. First quarter sales in marketing expense increased on both the year-over-year in sequential basis. Increases in spending reflect both seasonality factors and staffing to support the expansion of our sales presence for the mini-VSAT business.

Administration expenses increase compared to prior period 23% year-over-year and 12% sequentially. Cost for professional and consulting services related to the build out to the mini-VSAT network were a key factor as was the modest increase in support staff. Our tax rate for the quarter was in line with expectation is 16%.

However the tax rate has the potential to increase as we go forward. We have now used most of our available tax benefits that were driven by prior period net operating losses. We continue to have substantial R&D tax credit available, but tax regulations including the impact of alternative minimum tax, we strict the amount of benefit taken to use in any given period.

Consequently, our 2010 go forward tax rate could be about 30%. Turning to the balance sheet, cash and marketable securities were $41.9 million this was better than anticipated due to higher than expected profit margins. The time needed capital expenditures and the timing of accounts payable for Q1 cash flow from operations was positive at about $1.5 million.

We expect our cash balance to decline approximately $4 million during the second quarter primarily due to continuing outlays for additional hubs for the mini-VSAT network and normalizing accounts balances. Capital expenditures were approximately $1.6 million for the quarter this was less than expected and reflect the slight change in the timing of VSAT hub deployments.

We have well in excess of $1 million of prepayments for hub in the other non-current assets account on the balance sheet, which will convert to CapEx when the hubs will deploy. We expect capital expenditures for the second quarter to be approximately $3 million and approximately $7 million for all of 2010.

Accounts receivable increased sequentially to the $18.4 million day sales outstanding was 59. Inventory increased sequentially to $15.2 million this was a little higher than our expectations and reflects the staging of product for future shipments. We expected over the next few quarter inventory will decline from the current level. Our backlog for guidance in stabilization product and services at the end of March was $16.1 million. In addition, we have approximately $1.5 million of backlog for aeronautical antenna system which is expected to shift during Q2.

Now I will review our expectations going forward. We are still cautious with respect to our future expectations and those who has aeronautic signs of economic conditions is slowly improving the patterns seems to be uneven. For the second quarter, we expect another strong year-over-year revenue increased.

Revenue is expected to be nearly equal to the first quarter this year or up approximately 25% compared to Q2, 2009. We expect to sustain if now modestly increased the current of fiber optic gyro sales and to see continuing growth in TracFone V7 sales in new activations.

However as we indicated previously, we expect the revenue from shipments of our aeronautical antenna to Live TV will be about $1.5 million lower than the quarter just ended. This is in line with the plan to complete the 2010 shipments at the end of the second quarter.

We do not expect a material near-term change in maritime at land SATCOM leaser market demands. We expect to report a profit for the quarter in the range of 6 to $0.10 per share. Gross margin were likely be approximately 200 basis points lower in the first quarter to largely the cost increases related to the final phases of the VSAT network rollout.

We expect the modest sequential increase in operating expenses due to seasonality factors in the deployment of resources for strategic growth areas. This EPS guidance includes the assumption and tax expense will be about 30% of pretax profit for the quarter. Using our original tax rate assumption of regarding 15% [ph], our Q2 projection would have been 7 to $0.12.

For the full year, we continue to expect the 2010 will show strong top line growth, well also establishing a trend line of improving profit performance, but doing so within the context of normal lesser market seasonality. Either now we expect to increase revenue levels for fiber optic gyros, the rate of year-over-year growth will moderate as we go forward.

We continue to expect to see significant benefit in our mini-VSAT business with the completion of global network around midyear and expansion of our international sales channel. We look for some recovery in consumer markets, but our new term expectations for growth is quite modest. As I mentioned earlier, we do not expect to shift any aeronautical TV antenna systems Live TV during the second half of the year.

In summary, we expect our strategic growth businesses to continue to build momentum on the top and bottom line and see and accept the stage for positive long term results.

Now, we would like to take your questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) and our first question will come from Hamed Khorsand with BWS Financial.

Hamed Khorsand – BWS Financial

Good morning, guys. Could you put out some color here as to why you guys stand as with how many platforms are deployed?

Pat Spratt

Well, as you know we don’t report specific subscribers, but we have reported unit sales last year of get the 500. So certainly, we have more than 500 subscribers now on the network.

Hamed Khorsand – BWS Financial

Can you guys hit 1000 in Q2?

Pat Spratt

I think that in the next time we announce a milestone whether it’s about couple thousand will certainly – but you know, I don’t want give specific guidance by products, so I can’t answer to that question for you.

Hamed Khorsand – BWS Financial

Okay. As far as the so many goes there was an increase in Q1. Are you seeing usage increase would the incremental TracFone’s in service or customers primarily saying within the parameters to the plan?

Pat Spratt

Almost the customers are on a fixed rate plans, so the price is fixed even though the consumption might vary from month-to-month, we do have about 15 % of our customers who on a variable plan, where the pay by the megabyte with majority on fixed rate plans. So our average revenue for a subscribers is more than pretty steady.

Hamed Khorsand – BWS Financial

Okay. That’s it, thank you.

Pat Spratt

Yeah.

Operator

And moving onto Chris Quilty with Raymond James.

Chris Quilty – Raymond James

Martin, could you elaborate for us. You made a quick mentioned of doubling, you see the capacity of the data rate in the US and some other markets without incremental trend responder cost. First of all was it data rate or capacity. And can you give us, I mean is there any user software patch or is there incremental spin associated with that.

Martin Kits Van Heyningen

New way form on the – as far as the spread back end technology so to do a way form that VSAT is pushing out to the hub and we are uploading into all modem that will have our data rate capability with the existing bandwidth. So it would be approximately doubling the speed in each of the regions.

Chris Quilty – Raymond James

And it's still CDMA based?

Martin Kits Van Heyningen

Yeah. CDMA based. They are calling it an also way formed but it's an improvement in the efficiency of the transmission technology. So it’s a factor do with improvement.

Chris Quilty – Raymond James

I mean, that’s pretty – I mean you are already one of the highest data rates available out there I mean?

Martin Kits Van Heyningen

Right. So what we are going to do is, when I necessarily get a doubled the data rate for a subscriber, we are going to use the increased capacity term to just had more capacity and…

Chris Quilty – Raymond James

Service levels.

Martin Kits Van Heyningen

Service levels will improve and people should be happier, all that kind of stuff. So everybody likes faster performance so.

Chris Quilty – Raymond James

Absolutely. Pat, can you help us perhaps a little bit with the service revenue. You mentioned, I guess this is the second or third quarter in a row where other service revenues have been down and many VSAT up are we at the point now where as like a 90/10 split or is it more like a 70/30?

Pat Spratt

Well, I would like to avoid give any exact percentage, but I think you can assume that airtime services the VSAT and Inmarsat combined is clearly the line show the total service activity of that further service that we reported at 3.9 million. And within the airtime VSAT is the lion share of that. So I don’t think, I am getting more specifically in that for servers into say that VSAT is clearly the as far as the biggest portion of our service based. And the other pieces have shown quite a bit over that couple of quarters. Now as you know that can be fairly variable for example, we had a significant in our re-contract than – that could show some growth in those types of things or services overall. But recently those things have been declining well the VSAT business has been growing quite nicely.

Chris Quilty – Raymond James

Okay. I just want to confirm Martin, you did say monthly are to staying relatively study around that. I think you had mentioned previously $2000 a month?

Martin Kits Van Heyningen

Yeah. That is still in that range, so we haven’t seen any material changes there.

Chris Quilty – Raymond James

And termed issues?

Martin Kits Van Heyningen

No, none to speak. We have of course some of the activations people sale above that type of thing. We will also have seasonal suspensions to allow customers, for example New England to shut the service off for a few months. But that then gets tagged on to the back end of the contract. So within our subscriber based we do have some temporarily suspended. I believe the maximum is three months, that’s allowed three year so.

Chris Quilty – Raymond James

Right. Not a problem for you since you are ice breaker doesn’t have problem, all right.

Martin Kits Van Heyningen

Right.

Chris Quilty – Raymond James

So another question. Can you give us a sense you have talked in the past about the fact that you have done a number of pilots with commercial operators and then they have subsequently grown from handful of ships up to dozen or dozens. Can you give us an idea of how many potential pilots are in or at least the sense of; we doubled over the last six months the numbers of big commercial pilots were involved in?

Pat Spratt

Well, double is certainly true. I think that I would say almost all of our customers now that were selling to have many more ships that were our mind, so one level down with all pilots today. The other interesting thing as you know we started with 100% recreational into leaser product and that’s we continue to expand last quarter about 70% of our VSAT sales were to the commercial market.

Chris Quilty – Raymond James

Okay. So how you gave me a different metric, if you look at your existing customer based are you 30% or 50% penetrated with the entire fleets or the entire addressible fleets?

Pat Spratt

Well, that is the metrics fleet; I don’t know how to talk from my head because it’s the large number of customers. But my sense is that lots of these customers have 5 times as many ships is currently on, so it’s a very small percentage. Then only penetrations of potential customers or within the customers that we have lot of them have many more vessels.

Chris Quilty – Raymond James

Got it. Can we Pat, out of the mix here receivables were up decent amount sequentially anything particular in there?

Pat Spratt

There are no issues. We had some shipments for certain products that occurred later in the quarter. For example good portion of the shipments for live TV at their request in the month of December and so consequently those were on the books as a receivable at the end of the year is a good amount. So consequently that tends to (inaudible) outstanding for the quarter.

Chris Quilty – Raymond James

Okay. And Pat, I think you gave us a different number?

Pat Spratt

Excuse me, when I said December there is a live TV at mid March.

Chris Quilty – Raymond James

Okay. Or you got some long receivables.

Pat Spratt

Yeah. Now I would like to have a time in that first.

Chris Quilty – Raymond James

The defense backlog, I think you gave us the whole defense and stabilization and then in the past I think usually goes a different number or am I?

Pat Spratt

No, the number I gave today is 16.1 million is what we would common we call defense.

Chris Quilty – Raymond James

Okay.

Pat Spratt

It’s the fiber optic gyros practical navigations that type of product and that number is that, I have historically given we tend – we called it guidance for stabilization as a product and service area. And in addition to that is the aviation TV antenna for live TV and the reason for giving that is just because its reasonably substantial number and it's not a book in ship kind of business.

Chris Quilty – Raymond James

Right. And then course is also the commercial FOG business that’s not included?

Pat Spratt

No I would include any commercial FOG business in that backlog number that I gave you so the majority is defense related but there is some commercial FOG business that is not be particularly a big number normally Chris because again that’s more based on our… recurring revenue streams and booking as oppose to larger orders at a time.

Chris Quilty – Raymond James

Got you, and how significant is that commercial side of the business becoming or how fast is it growing, can you have navigation?

Pat Spratt

We are getting into a specific number it’s growing very nicely ad our goal is to continue to have it grow not only in absolute terms but as a percentage of the total fiber optic gyro revenue so, we are working very hard to grow that commercial business and it has been paying off to this point.

Martin Kits Van Heyningen

And we won’t turn down any military orders to get the mix better.

Chris Quilty – Raymond James

Got you, and Pat in terms of the service cost, I mean your margin, service margins were better than we had projected and I guess convert inversely the cost lower is it fair to assume that we will see a reasonable step up in service cost in the second quarter?

Chris Quilty – Raymond James

Actually I will think it’s more likely to see a step down in service gross margins in the second quarter>

Chris Quilty – Raymond James

Or we think service cost?

Chris Quilty – Raymond James

Mostly the same thing.

Pat Spratt

Yes step up a service cost is absolutely and the reason is twofold one is in the most of that is the – defect business and they continue the infrastructure additions that we are putting in place there as you know we just went live with the Indian Ocean region this several days ago and that is actually too deep so it’s really two regions east and west and Indian Ocean so that’s – that increased in our cost in the second quarter that we did not have in the first quarter. And then other just ongoing activities with the mini-VSAT business and then on the gross margin side I mentioned this onetime fee that we earned for cancellation of a repair program… refurb program for TACNAV products with a large prime contractor in the first quarter that was the one time item and it had roughly a 100 basis point impact on the total company gross margin and since that it was service related it actually had a more substantial impact on the service gross margins in the first quarter positive impact. I would say going forward in the second quarter cost will be up and the gross margins for service would likely be down.

Chris Quilty – Raymond James

Got you, and so when do we get to sort of a steady state service cost is it after you exit the second quarter any new mini-VAST infrastructure that builds out is I guess South America is ViaSat's region I mean do we essentially exit Q2 with a relatively fixed cost to service?

Pat Spratt

I would say as we exit Q2 it should be pretty close… it really is a function of timing for example just take something and this is not a particularly big impact but things like this the Indian Ocean coming online mid April obviously we don’t have a full 100% quarter of cost for that in the second quarter but we will in the third quarter.

Chris Quilty – Raymond James

Got you.

Pat Spratt

The Brazilian cover South America will come online in the mid year and that there are some cost associated with that for us naturally and those may or may not have a full impact in the third, I mean assuming it comes midyear late Q2 very early Q3 it may not be a full quarter even at Q3 but I would say the majority of the cost will be in place for large majority by the time we exit Q2 and I would say by the time we exit Q3 and enter Q4 we absolutely be there.

Chris Quilty – Raymond James

Got you, and so final question here I don’t know if you saw last night but Oshkosh got a award like a $11 million award for over 1000 remote weapon station mounts on the M80V vehicles so obviously you are getting some attachment there with a pretty high volume contract do you know or have you seen any specific… specifications that would tell you, you are going to be on all 165 center but I think they increase the number to like 80 something.

Pat Spratt

Right, yes, you know I don’t have visibility into where all these CROWS weapon stations are going. Kongsberg did just get another award two days ago for over a billion… about $200 million that they announced so that was probably related to that…

Chris Quilty – Raymond James

And presumably this is all baked into you know the forecast you are giving is staying around $8 million to $9 million a quarter?

Pat Spratt

Well the order I just mentioned was new and that’s not in our guidance because we don’t have an order I mean this is a new order for them that is outside of our current backlog so if we would to get another order it would most likely the very end of this quarter for delivery or mostly for the balance of the year.

Chris Quilty – Raymond James

Okay, so just fills the four pipeline?

Pat Spratt

Yes, but I would say again it depending on what – obviously we don’t have an order and if we got the order we don’t how big it would be but if we would get a substantial portion or even the tradition portion that we normally get it would be in excess of what we normally have in our projections, so this order – say this order is new and it’s bigger than the people thought.

Chris Quilty – Raymond James

Okay. Awesome, well great, guys keep up the good work and I can’t wait to hear that 1000 number on the next conference call.

Pat Spratt

Okay.

Martin Kits Van Heyningen

Thank you.

Operator

And Rich Valera with Needham & Company has our next question.

Rich Valera – Needham & Company

Thanks good morning guys, actually – right out the question about the 1000 subs with that so could you repeat your answer to that one Martin?

Martin Kits Van Heyningen

My answer was evasive I said that we… we haven’t said that we would announced when we got to a 1000 I did say that we have more than 500 subscribers now on the network. And that sales are going well.

Rich Valera – Needham & Company

Okay, so the last comment about hearing that on Q3 was not from your lips?

Pat Spratt

That’s correct.

Rich Valera – Needham & Company

Okay, I just want to clarify.

Pat Spratt

Though the question, you know it is possible that we would have that during in Q2.

Rich Valera – Needham & Company

During Q2, okay. Got you. Okay, just with respect to your recent increase in capacity and the North Specific I would kind of surprise to see that because I was under the impression that you know when you kind of suggested that you are building the network getting all these regions deployed in that you thought you could scale your subscribers by almost like an order of magnitude from where you were today without anymore fixed expense so I just curious what’s going on the north Pacific that you have seen greater uptick then you thought or are things not as efficient as you thought you know you need to buy down at this early stage, I mean in the North Pacific?

Pat Spratt

Right, well actually we deploy more bandwidth, this bandwidth we had under contract so this doesn’t have any impact on our cost we had full transponder available to us we have been running with half of transponder and we were originally planning on experiment it was some video broadcast services in the Pacific so and sales in the Alaska the fishing boat market have gone well, we are doing some trials with some I think your company is in west coast and it was just a good time to bring on the rest of that capacity.

Rich Valera – Needham & Company

Okay, I guess with the respect to the rest of the network it sounds like obviously your upgrade to double the capacity should certainly help with respect to the number of subscribers you can support but what would you view your should in the future needs in terms of adding additional transponder capacity as you scale are you set now to sort of increase your subs buying order of magnitude before you have to meaningfully add additional transponder cost?

Pat Spratt

I think you are thinking about it right away I am not sure it’s truly an order of magnitude but it is closer to that then doubling, so in other words could you get to the 5000 subs without any additional capacity maybe not but you get pretty close so it’s a pretty robust infrastructure we put in place.

Rich Valera – Needham & Company

Okay. That’s helpful.

Martin. Kits Van Heyningen

So the costs right now is that as its going to be and it will get better with each subscriber we add for the foreseeable future.

Rich Valera – Needham & Company

Right. Okay. That’s helpful. I don’t think you said whether you mentioned how strong that these seven airtime revenue was year-over-year, can you confirm that it was actually up quarter-over-quarter?

Martin. Kits Van Heyningen

Yes.

Rich Valera – Needham & Company

Okay. Great. And then Martin just a little more color if I could on this that comps forgot. You mentioned if you get your traditional allocation you should be above your projection? Are you referring to – you are not referring to the second quarter presumably you are referring to more of the second half of the year, is that fair?

Martin. Kits Van Heyningen

Yes. I think that’s fair. I think that we don’t have long term contracts in place so we tend to get the MRP system and material planning system, so they place orders according to our lead time. So we traditionally don’t have a year’s visibility or six month visibility. We just get purchase orders that come out on a regular basis, just the same way we give purchase orders to our vendors when we build something. But we have to make assumptions in order to give some general guidance for the year and the general assumptions and guidance we had for the year does not include an order as large as this. So this would be generally better than what we thought for this one customer and so if they are a big customer it would be upside for the whole company if this were to happen

Rich Valera – Needham & Company

That would suggest at least maintaining if not possibly increasing the current fog run rate in the back half of the year?

Martin. Kits Van Heyningen

Yes. It would be an increase if this were to happen.

Rich Valera – Needham & Company

Okay. Got you and when do you expect to know what I guess the order for your portion of that – is that a matter of days, weeks if it's…

Martin. Kits Van Heyningen

Yes. Usually it’s a matter of weeks. So we – as you know we are not the sole source on that program so they have an Alexander and there was not a guarantee that we would get that order.

Rich Valera – Needham & Company

Got you. And do you have any – I know you don’t know exactly where your thoughts go in terms of where those systems are shipped. Compsberg [ph] has talked a lot about the fact that they are shipping now their protector system to 17 countries besides the US, do you have any sense of how much of that is driving the demand that you are seeing their diversification and any sense of the sort of the growth from non-US applications for them?

Martin. Kits Van Heyningen

Well I think all the other countries put together are still smaller than the US.

Rich Valera – Needham & Company

Sure.

Martin. Kits Van Heyningen

That’s my sense and – but that diversification certainly helps and I think that over time may be all the other counties put together would equal to US which would be a great thing.

Rich Valera – Needham & Company

Sure. Okay. That’s helpful perspective. And with respect to the completion of the footprint, it sounds like may be this Brazil deployment has lift a little bit from your prior plans, anything going on there or is it that we should be worried out? Are you pretty confident how that’s going to get done around that June timeframe?

Martin. Kits Van Heyningen

Yes. We are pretty close to our original schedule. I mean the only hold up is its very difficult regulator environment for license. So its I would think – I would have to say it probably one of the most difficult in the world that we have seen.

Rich Valera – Needham & Company

Okay.

Martin. Kits Van Heyningen

As it takes a little longer. So that’s where we stand on Brazil but even without that now you can literally say around the world and not exit our footprint if that levers wholly.

Rich Valera – Needham & Company

Sure. And just one more for you Pat, the tax rate you mentioned something like 30% probably for the balance of this year, is that then the rate we should assume longer term sort of into 2011 as well?

Pat Spratt

You know actually longer term Rich, we still have – we have very sizable valuation allowances remaining on the balance sheet. The challenge we have in the very term as long as those exist is the primarily now related to R&D tax credits. And the tax laws are such that AMT actually caps the amount that you can use in any in any given period. And so that’s what causing the tax rate to move up to the 30% for the next several quarters. Once when we either have consumed all of the valuation allowances or we take them to the P&L then our go forward long-term run rate tax percentage will probably be around 38 to 40%.

Rich Valera – Needham & Company

Okay.

Pat Spratt

And that in turn will be a function of whether the U.S. Government continues to renew the R&D tax credits that can be used on a yearly basis, which they tend to wait until the very end of the year, every year before they decide whether to renew that or not.

Rich Valera – Needham & Company

Okay. So, where would your tax rate be if in fact you did get the R&D tax greater than on annual basis?

Pat Spratt

Be at the lower end of that range I just gave you.

Rich Valera – Needham & Company

So, 38%?

Pat Spratt

That, you know 37.5, 38 up to 40

Rich Valera – Needham & Company

Okay.

Pat Spratt

Possibly even a shade above. But that would be about the bandwidth of the with and without the R&D tax credit.

Rich Valera – Needham & Company

Great. And I am sorry one more for you Pat just, OpEx relative to the Q2 run rate and I’m sorry, did you say that you expected Q2 OpEx to be flat to slightly up flat and where do you expect to go beyond that?

Pat Spratt

I expected to go modestly up and then I think through the rest of the year we’ll probably have a little bit of an increase but I wouldn’t expect too much. So, over the course of the year I would expect to see modest increases in OpEx on a quarter-over-quarter basis.

Rich Valera – Needham & Company

Okay. That’s helpful. All right thanks very much.

Pat Spratt

Okay, thank you.

Operator

Our next question comes from Aaron Edelheit with Sabre Value.

Aaron Edelheit – Sabre Value

Hi, all of my questions have been answered, good quarter guys.

Pat Spratt

Yes, thanks.

Operator

Moving on to Jason Nelson, Roumell Asset Management.

Jim Roumell – Roumell Asset Management

Hi, guys this is actually Jim. Martin could you talk, as the VSAT market has developed and kind of attracted in more participants as global footprints have been created that can really compete with Inmarsat. Can you give some color, say compared to a year or two ago when we rolled out VSAT. How the comparative landscape has developed and change? How is it different today than it was 18 months ago? And what kind of – what are the push back you’re getting from potential on commercial customers and specifically I’m wondering if you getting any push back regarding the proprietary nature of the KVH VSAT solution and a customer is concerned that if they sign for VSAT rather than say one of the iDirect VSAT solutions and in a year or two you after the contract expires you can jack up the service revenue and they don’t have an alternative service provider to go to, where if they go with (inaudible) and the other guys and they try to screw him so to speak on the service on the service side they can go to another iDirect platform?

Martin. Kits Van Heyningen

Yes, I think that the – let start beginning the comparative landscape hasn’t change. You still have a number of small players on iDirect hub all sharing the satellite footprints, same bandwidth, just scramming as many customers as they can on to tiny slices of bandwidth competing with each other with identical antennas trying to compete on price and delivering poor quality service the customers hate. So, there was the situation when we develop our alternative and that’s how the situation today. So we offer the customers an end-to-end solution, that’s engineered, its managed. We don’t have contention [ph]. We have a very desirable quality of service which is what people want. And we are the alternative to those other solutions. We actively position ourselves against that alternative and as far as air time price stability goes, it’s really the same situation as with Inmarsat. So you have – we sell air time but we also wholesaler air time to companies like Croton-on. We have probably about half a dozen other wholesalers around the world now selling our airtime including SP-JSAT in Japan is airtime sales agent. So, we have number of alternatives. Even though they are run to our networks so there is at least a perception of price competition which is exactly the same situation that Inmarsat has. They have one service and they have a few ISPs and DP selling that the airtime that in fact is often one source.

Jim Roumell – Roumell Asset Management

Are saying that the proprietary nature of the KVH solution is not coming up in the field as an optical for making commercial sales?

Martin. Kits Van Heyningen

On the contrary is a big benefit. People like the fact that we know work that end to end solution, so it’s a sell point.

Jim Roumell – Roumell Asset Management

So, some of the people I spoken to the commercial customers do you have some concerned about singing up where they basically don’t have an out down the line if they wanted to exercise that as they do with others, you are not seeing that?

Martin. Kits Van Heyningen

Did you hear that from a commercial customer? Did you hear that from an expert in the industry?

Jim Roumell – Roumell Asset Management

A commercial customer.

Martin. Kits Van Heyningen

Yes, no, I never heard that before.

Jim Roumell – Roumell Asset Management

No, is absolutely commercial customer. The second question which is related to this is what related but a different potential push back is the commercial customers believe that the 60 centimeter can give them the robustness of what they need, any push back there that they even with the attractiveness of easy to install and what not that they believe that the 1.2 is just kind of what they need given their bandwidth demands in that. Is that coming up as a push back, I am really obviously trying to get out is, just how the VSAT industry is emerging among the competition and is intensifying today versus 18 months ago or so when you came out with this?

Martin. Kits Van Heyningen

Yes. The intensifies [ph] puzzle people because they don’t understand how we can deliver such a high quality service and such high data rates with antenna that’s so much smaller than the competitors. So we do have white papers and part of our sales presentation we do have to explain the customers about spread spectrum technology why its better, why its bit more resistant to noise and interference why the military uses it, why CDMA and next generation cell phones are made on spread spectrum technologies. So once you compare with the things they know like the new 4G or UMPS cell phones wide band CDMA which is spread spectrum technology. You get better noise and unity. So once you explain in that context you are able to understand it.

Jim Roumell – Roumell Asset Management

Okay. Thank you.

Operator

Moving onto a follow up question from Chris Quilty from Raymond James.

Chris Quilty – Raymond James

Yes. First of all this is a personally [ph] but I just want to clarify since I was on the hills of Rich’s question about the 1000 units that I was into at point your – Martin, I think I am only modeling less than 780 units in the second quarter. So, you can do that, my price target is too well. But, actually just a follow on the question just there from, Jim. I think is the question he is getting at really driven around the issue that lot of your competitors are trying to do the same thing as you, which is get to a small antenna but their modem technology is depending on having a big aperture or big dynamo. And so that they don’t work, they are trying do a me too in terms of the size, but they don’t have the modem?

Martin. Kits Van Heyningen

That’s exactly right Chris and that’s a good point. And is not just a modem but it’s the entire hub. And that’s why if you look at our network people say well KVH can't do that because they have to put some giant network in place in order to use this spread spectrum technology. They can't just take little slices of bandwidth like everybody else is doing, and that’s true, and we done that now and we have the subscriber base now to support what we’ve done. And the advantages that we get this wonderful system which has smaller antennas and higher data speed, is more resistant to noise and has the ability to improve, technology improve through software like we just said we can double bandwidth. And if you try to do the same thing with small antenna using a traditional hub and a traditional modem that’s not spread you get poor performance and you get signal fade, you get rain fade, you get small footprint and that’s the way it is. So it does require some education, but the good news is the people try our system. They say, okay, if it's horrible, give it back and nobody gives it back because they love it and they buy more.

Chris Quilty – Raymond James

Good. So the only other area I forget to ask about was Japan inking deals with and JSAT and JRC and I think as we all know you have to have Japanese partners to get into that market. What you see there is the opportunity for your near-term the longer term in terms of number new build vessels or fleet operators and how aggressive you think your partners can be at penetrating in that market?

Martin. Kits Van Heyningen

Well the Japanese market is a very large market. I think they are number one or number two in terms of largest vessels, registered vessels and as you point out is a very closed market, in other words they like doing business with Japanese companies, you need to be Japanese company to have a license period. So we partnered with one of largest satellite providers in Japan, which is where we getting our satellite coverage from. So but – even so it’s a long process. So we don’t expect quick success in that market but it’s a market is too big to ignore and we are going to be focused on it for next couple of years.

Chris Quilty – Raymond James

Okay. And like final question, because we never mentioned your RV market, you seen any signs of life?

Martin A. Kits Van Heyningen

Coming back from strong. We sold more RV products OEM in the first quarter than we did all of last year which is same much. But it is coming back. It’s still not a material part of our business but we are seeing recovery in that market finally.

Chris Quilty – Raymond James

And you didn’t give similar metrics for your traditional leisure maritime satellite TV but (inaudible)?

Martin A. Kits Van Heyningen

(inaudible) TV is up which is good. We normally report, we flow in our Inmarsat hardware into that mix and if you do that I think it might down maybe 1% or something but the satellite TV business is actually up. And I see both of those markets is upside now. In other words, if that market recovers we will do very well because we have great product and excellent market share. So that’s really the way we are focused on it is, we are in good shape there if market recovers we will do well.

Chris Quilty – Raymond James

Very good. All right, thanks gentlemen.

Martin A. Kits Van Heyningen

Okay. Thank you.

Operator

(Operator Instructions)

Martin Kits Van Heyningen

I think we will wrap up then, operator.

Operator

Absolutely, sir, there is no questions in the queue. I’d turn it back to you.

Martin Kits Van Heyningen:

Okay. If anybody does have any follow up questions please feel free to give Pat or me or directly, thank you.

Operator

That does conclude our conference call today. Thank you for your participation.

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Source: KVH Industries, Inc. Q1 2010 Earnings Call Transcript
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