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KVHI > SEC Filings for KVHI > Form 10-K on 2-Apr-2013All Recent SEC Filings

Show all filings for KVH INDUSTRIES INC \DE\ | Request a Trial to NEW EDGAR Online Pro

Form 10-K for KVH INDUSTRIES INC \DE\


2-Apr-2013

Annual Report


ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the other financial information and consolidated financial statements and related notes appearing elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of a variety of factors, including those discussed under the heading "Item 1A. Risk Factors" and elsewhere in this annual report. Overview
We design, develop, manufacture and market mobile communications products for the marine, land mobile and aeronautical markets, and navigation, guidance and stabilization products for both the defense and commercial markets. Our mobile communications products enable customers to receive voice and Internet services and live digital television via satellite services in marine vessels, recreational vehicles and automobiles as well as live digital television on commercial airplanes while in motion. Our CommBox offers a range of tools designed to increase communication efficiency, reduce costs, and manage network operations. We sell our mobile communications products through an extensive international network of retailers, distributors and dealers. We also lease products directly to end users.
We offer precision fiber optic gyro-based (FOG) systems that enable platform and optical stabilization, navigation, pointing and guidance. Our guidance and stabilization products also include tactical navigation systems that provide uninterrupted access to navigation and pointing information in a variety of military vehicles, including tactical trucks and light armored vehicles. Our guidance and stabilization products are sold directly to U.S. and allied governments and government contractors, as well as through an international network of authorized independent sales representatives. In addition, our guidance and stabilization products have numerous commercial applications such as precision mapping, dynamic surveying, autonomous vehicles, train location control and track geometry measurement systems, industrial robotics and optical stabilization.
Our mobile communications service sales include sales earned from satellite voice and Internet airtime services, engineering services provided under development contracts, sales from product repairs, and certain DIRECTV account subsidies and referral fees earned in conjunction with the sale of our products and extended warranty sales. We provide, for monthly fixed and usage fees, satellite connectivity services for broadband Internet, data and Voice over Internet Protocol (VoIP) service to our TracPhone V-series customers. We also earn monthly usage fees for third-party satellite connectivity for voice, data and Internet services to our Inmarsat TracPhone customers who choose to activate their subscriptions with us. Under current DIRECTV programs, we are eligible to receive a one-time commission for each DIRECTV receiver activated for service and a new mobile account activation fee from DIRECTV for each customer who activates their DIRECTV service directly through us. Our service sales have grown from 18% of our net sales in 2010 to 24% in 2011 to 34% in 2012. Our guidance and stabilization service sales include engineering services provided under development contracts, product repairs and extended warranty sales.
We generate sales primarily from the sale of our mobile satellite systems and services and our guidance and stabilization products and services. The following table provides, for the periods indicated, our sales by industry category:


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Year Ended December 31,
2012 2011 2010
(in thousands)

Mobile communications $ 87,685 $ 70,202 $ 62,473 Guidance and stabilization 49,427 42,334 49,770 Net sales $ 137,112 $ 112,536 $ 112,243

Net sales to SANG accounted for approximately 11% of our net sales for the year ended December 31, 2012, driven by a TACNAV related order received in 2012 for which the majority of the deliverables will be completed in 2013. Net sales to General Dynamics Land Systems-Canada (General Dynamics) accounted for approximately 11% of our net sales for the year ended December 31, 2011, and less than 10% of our net sales for each of the years ended December 31, 2012 and 2010, respectively. The decrease in net sales to General Dynamics from 2011 to 2012 was primarily driven by the timing of deliverables in fulfillment of large TACNAV related order. Net sales to Kongsberg accounted for approximately 14% of our net sales for the year ended December 31, 2010. In addition, net sales to a subcontractor to Kongsberg accounted for approximately 5% of our net sales for the year ended December 31, 2010. Net sales to Kongsberg, including the subcontractor for Kongsberg, were less than 10% of our net sales for the years ended December 31, 2012 and 2011, respectively. The decrease in net sales to Kongsberg and this subcontractor was primarily driven by a slowdown of the U.S. Army's procurement of Common Remotely Operated Weapon Stations (CROWS) under existing contracts. The terms and conditions of sales to SANG, General Dynamics, Kongsberg and the subcontractor to Kongsberg are consistent with our standard terms and conditions of product sales as discussed in note 1 of our consolidated financial statements. The SANG receivable balance was current as of December 31, 2012 and the outstanding receivable balance has been paid as of the date of this report. No other customer accounted for more than 10% of our net sales for each of the years ended December 31, 2012, 2011 and 2010, respectively.
We have historically derived a substantial portion of our revenue from sales to customers located outside the United States and Canada. The following table provides, for the periods indicated, sales to specified geographic regions:

                                                    Year Ended December 31,
                                                 2012         2011         2010
                                                         (in thousands)
Originating from the Americas locations
United States                                 $  71,489    $  62,748    $  70,620
Canada                                           11,513       17,518        5,923
Europe                                           12,210        8,315       17,892
Other                                            22,202        7,143        3,950
Total Americas                                  117,414       95,724       98,385
Originating from European and Asian locations
Europe                                           15,255       13,244       10,398
Other                                             4,443        3,568        3,460
Total Europe and Asia                            19,698       16,812       13,858
Net sales                                     $ 137,112    $ 112,536    $ 112,243

See note 12 to our consolidated financial statements for more information on our geographic segments.
In addition to our internally funded research and development efforts, we also conduct research and development activities that are funded by our customers. These activities relate primarily to engineering studies, surveys, prototype development, program management and standard product customization. In accordance with accounting principles generally accepted in the United States of America, we account for customer-funded research as service revenue, and we account for the associated research and development costs as costs of service and product sales. As a result, customer-funded research and development are not included in the research and development expense that we present in our statement of operations. The following table presents our total annual research and development effort, representing the sum of research costs of service and product sales and the operating expense of research and development as described in our statement of operations. Our management believes this information is useful because it provides a better understanding of our total expenditures on research and development activities.


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Year ended December 31,
2012 2011 2010
(in thousands)

Research and development expense presented on the statement of operations $ 12,148 $ 11,548 $ 10,715 Costs of customer-funded research and
development included in costs of service sales 3,424 412 953 Costs of customer-funded research and
development included in costs of product sales - - 1,001 Total consolidated statements of
operations expenditures on research and
development activities $ 15,572 $ 11,960 $ 12,669

As of December 31, 2012, we had approximately $38.3 million in cash, cash equivalents and marketable securities and accumulated earnings of approximately $7.3 million.
Results of Operations
The following table provides, for the periods indicated, certain financial data expressed as a percentage of net sales:

                                 Year Ended December 31,
                                2012        2011      2010
Sales:
Product                         66.1  %    75.6  %    82.0 %
Service                         33.9       24.4       18.0
Net sales                      100.0      100.0      100.0
Costs and expenses:
Costs of product sales          37.8       41.4       45.8
Costs of service sales          22.1       18.6       14.3
Research and development         8.9       10.2        9.5
Sales, marketing and support    17.6       20.9       16.5
General and administrative       8.9        9.4        9.0
Total costs and expenses        95.3      100.5       95.1
Income (loss) from operations    4.7       (0.5 )      4.9
Interest income                  0.4        0.3        0.3
Interest expense                 0.2        0.2        0.2
Other income                     0.1        0.8          -
Income before income taxes       5.0        0.4        5.0
Income tax (expense) benefit    (2.4 )      0.4        2.4
Net income                       2.6  %     0.8  %     7.4 %

Years ended December 31, 2012 and 2011
Net Sales
Product sales increased in 2012 by $5.5 million, or 7%, to $90.7 million from $85.1 million in 2011. The primary reason for the increase in 2012 was an increase in sales of our mobile communications products of $4.3 million, or 10%. The increase was primarily due to an increase in sales of our marine products of $5.7 million, or 15%, driven primarily by increased demand for our TracPhone V7 and TracPhone V3 products, as well as our new HD11 and TracPhone V11 products that were released in first quarter of 2012 and the fourth quarter of 2012, respectively. Also contributing to the marine products increase was increased sales of our HD7 product. Partially offsetting this increase was a decrease in land mobile products of $1.3 million, or 20%. The decrease in our land mobile products was primarily a result of decreased sales to original equipment manufacturers in the recreational vehicle market. We remain cautious about the prospects for our leisure mobile communications product


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sales as a result of ongoing challenges in the global economy. However, we expect our mini-VSAT product revenue will continue to grow year-over-year. Mobile communications product sales originating from the Americas increased $2.2 million, or 8%, in 2012 as compared to 2011. Mobile communications product sales originating from our European and Asian subsidiaries increased $2.1 million, or 13%, in 2012 as compared to 2011.
Also contributing to the increase in product sales was an increase of $1.3 million, or 3%, in sales of guidance and stabilization products. Specifically, sales of our TACNAV defense products increased $1.0 million, or 5%, primarily as a result of product sales related to the previously announced SANG contract. Also contributing to the increase in sales of our guidance and stabilization products was an increase in sales of our FOG products of $0.7 million, or 3%. Although we expect that TACNAV sales will continue to grow over the long term, sales on a quarter-to-quarter or a year-to-year basis could continue to be very uneven. Largely as a result of uncertainty regarding future military expenditures, we expect our TACNAV product sales will decline in 2013 from 2012. Subject to the disruptions that may arise from federal budgetary pressures, we expect our FOG sales to increase on a year-over-year basis as we begin to receive orders under the U.S. Army's procurement of Common Remotely Operated Weapon Stations (CROWS) III program.
Service sales increased in 2012 by $19.0 million, or 69%, to $46.4 million from $27.4 million in 2011. The primary reason for the increase was a $12.6 million increase in airtime sales for our mini-VSAT Broadband service. Also contributing to the increase was a $4.4 million increase in contracted engineering services driven primarily by the SANG order and a separate TACNAV-related development effort, as well as contracted aviation antenna services, and a $1.9 million increase in service repair sales. We expect our mini-VSAT Broadband service revenue will continue to grow year-over-year, although at a slower rate of growth than we experienced from 2011 to 2012. We also expect that a portion of our services revenue in 2013 will be derived from very low margin contracted engineering services related to the SANG order. Costs of Sales
Our costs of product sales consist primarily of materials, manufacturing overhead and direct labor used to produce our products. Costs of product sales in 2012 increased by $5.2 million, or 11%, to $51.8 million from $46.6 million in 2011. The primary reason for the increase in costs of product sales was the increase in sales of our mobile communications products discussed above. Our costs of service sales consist primarily of satellite service capacity, depreciation and service network overhead expense associated with our mini-VSAT Broadband network infrastructure, direct network service labor, engineering and related direct costs associated with customer-funded research and development, service material and direct labor associated with non-warranty product repairs, as well as Inmarsat service costs. Costs of service sales increased by $9.4 million, or 45%, to $30.4 million in 2012 from $21.0 million in 2011. The primary reason for the increase was a $5.3 million increase in airtime costs of sales for our mini-VSAT Broadband service. Also contributing to the increase was a $3.0 million increase in engineering services costs of sales due primarily to the services provided in connection with the SANG contract as well as a $0.9 million increase in cost of service repair sales.
Gross margin from product sales decreased in 2012 to 43% from 45% in 2011. The decrease in our gross margin from product sales was primarily due to the increase in mobile communications product sales discussed above, which generally have lower margins than our TACNAV defense products.
Gross margin from service sales increased in 2012 to 35% from 23% in 2011. The increase in our gross margin from service sales was primarily due to the increase in gross margin for mini-VSAT Broadband service sales, which increased in 2012 to 31% from 15% in 2011. Although we expect that mini-VSAT Broadband service revenue will continue to grow year-over-year, we do not anticipate the same year-over-year increase in gross margin percentage. This expectation is driven by the larger mini-VSAT Broadband customer installation base as of January 1, 2013 compared to January 1, 2012. This larger installed base requires a much larger increase in growth in customer installations in order to generate a year-over-year improvement in gross margin percentage comparable to that realized in 2012 from 2011. Partially offsetting the increase in gross margin for the mini-VSAT Broadband service sales was a decrease in gross margin for contracted engineering services as a result of facility construction services and project management services in Saudi Arabia, as these services under the SANG contract had a gross margin of approximately 10%. We anticipate the gross margin percentage for contracted engineering services will continue to decrease for the next several quarters as a result of the facility construction and project management services portion of the SANG TACNAV contract. The contract value for the services portion of the SANG TACNAV order remaining to be performed as of January 1, 2013 is approximately $11.0 million. These project management services are estimated to continue to be performed well into 2014.


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Operating Expenses
Sales, marketing and support expense consists primarily of salaries and related expenses for sales and marketing personnel, commissions for both in-house and third-party representatives, other sales and marketing support costs such as advertising, literature and promotional materials, product service personnel and support costs, warranty-related costs and bad debt expense. Sales, marketing and support expense also includes the operating expenses of our subsidiaries in Denmark, Singapore, Brazil and Japan. Sales, marketing and support expense in 2012 increased by $0.6 million, or 3%, to $24.1 million from $23.5 million in 2011. The primary reasons for the increase in 2012 were a $0.8 million increase in sales, marketing and support expense related to our Danish and Singaporean subsidiaries driven by the international expansion of our sales channel presence for the mini-VSAT Broadband satellite communication service, and a $0.4 million increase in variable sales expense primarily as a result of the sales related to the SANG TACNAV order and related facility construction that commenced in the third quarter of 2012. Also contributing to the increase was a $0.2 million increase in bad debt expense, a $0.2 million increase in trade show expenses, and a $0.2 million increase in demonstration equipment. Partially offsetting these increases was a $0.4 million decrease in U.S.-based compensation for sales, marketing and support, a $0.4 million decrease in warranty expense, a $0.2 million total decrease in marketing literature and cooperative advertising, and a $0.2 million decrease in Norwegian-based compensation for sales, marketing and support. As a percentage of net sales, sales, marketing and support expense decreased in 2012 to 18% from 21% in 2011. We expect that our sales, marketing and support expenses will continue to grow in 2013 as we hire additional sales, marketing and support personnel but will grow more slowly than our anticipated growth in net sales.
Research and development expense consists of direct labor, materials, external consultants and related overhead costs that support our internally funded product development and product sustaining engineering activities. Research and development costs are generally expensed as incurred. Research and development expense in 2012 increased by $0.6 million, or 5%, to $12.1 million from $11.5 million in 2011. The primary reason for the increase in 2012 was a $0.5 million increase in U.S.-based employee compensation. Also contributing to the increase was a $0.2 million increase in research and development expense related to our Norwegian subsidiary. As a percentage of net sales, research and development expense decreased in 2012 to 9% from 10% in 2011.
General and administrative expense consists of costs attributable to management, finance and accounting, information technology, human resources, certain outside professional services and other administrative costs. General and administrative expense in 2012 increased by $1.6 million, or 15%, to $12.2 million from $10.6 million in 2011. The primary reason for the increase in 2012 was a $0.9 million increase in U.S.-based employee compensation. Also contributing to the increase was a $0.8 million increase in facility expenditures, a $0.2 million increase in equipment lease expense and software maintenance expense, and a $0.1 million increase in recruiting expense. Partially offsetting these increases was a $0.5 million decrease in legal expense. As a percentage of net sales, general and administrative expense was 9% in 2012, which was consistent with 2011. Interest and Other Income, Net
Interest and other income, net decreased by $0.7 million to $0.3 million in 2012 from $1.0 million in 2011. The primary reason for the decrease was a $0.8 million net benefit in other income in September 2011 resulting from reaching agreement with LiveTV regarding the termination of our original antenna development and production agreement.
Income Tax (Expense) Benefit
Income tax expense increased by $3.7 million to $3.3 million as compared to an income tax benefit of $0.5 million in 2011. The increase in income tax expense is primarily due to a $6.5 million increase in pre-tax income. Also, in 2011 we completed the construction of our new Rhode Island production facility, and as a result we had fewer Rhode Island state investment tax credits in 2012. Further, Congress did not pass the 2012 federal research and development tax credit until January 2013, which reduced our federal research and development tax credits for 2012. Instead, these credits will be treated as a discrete tax event that will be accounted for in the first quarter of 2013. Partially offsetting this tax expense was a reduction in income tax expense associated with windfalls for non-qualified stock option exercises and restricted stock award vesting. We estimate that our effective tax rate for 2013 will be in the range of 35% to 40%, subject to the tax effect of discrete events, such as stock option exercises and restricted stock vesting.
Years ended December 31, 2011 and 2010
Net Sales
Product sales decreased in 2011 by $6.9 million, or 8%, to $85.1 million from $92.1 million in 2010. The primary reason for the decrease in 2011 was a decrease in sales of our guidance and stabilization products of $6.9 million, or 14%. Specifically,


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sales of our FOG products decreased $17.9 million, or 44%, driven largely by a slowdown of the U.S. Army's procurement of Common Remotely Operated Weapon Stations (CROWS) under existing contracts, as the industry awaits updates on the outcome of the U.S. Army procurement for the next CROWS program contract, which is in the solicitation phase. This decrease in FOG product sales was partially offset by an increase in sales of our TACNAV defense products of $11.4 million, or 190%.
Mobile communications product sales in 2011 were $43.9 million, which was consistent with 2010. Sales of our marine products increased $4.7 million, or 14%, driven primarily by demand for our TracPhone V3 and V7 products and sales of our network management products from our Norwegian subsidiary, which was acquired in September 2010. Partially offsetting this increase was a $4.3 million, or 97%, decrease in sales of our satellite television antenna used on narrowbody commercial aircraft. We began shipping this antenna to LiveTV in the second quarter of 2009. However, this contract was terminated in March 2011, and we did not have any shipments of this antenna to LiveTV after such termination. Sales of our land mobile products decreased $0.4 million, or 5%, driven primarily by decreased sales to original equipment manufacturers in the recreational vehicle market.
Mobile communications product sales originating from the Americas decreased $2.0 million, or 7%, in 2011 as compared to 2010. Mobile communications product sales originating from our European and Asian subsidiaries increased $2.0 million, or 14%, in 2011 as compared to 2010.
Service sales increased in 2011 by $7.2 million, or 36%, to $27.4 million from $20.2 million in 2010. The primary reason for the increase was a $7.2 million increase in airtime sales for our mini-VSAT Broadband service. Also contributing to the increase was a $0.3 million increase in Inmarsat service revenue. Partially offsetting this increase was a $0.2 million decrease in DIRECTV account activation fees and service repair sales, primarily related to a decline in guidance and stabilization TACNAV product refurbishment and repair programs. Costs of Sales
Costs of product sales in 2011 decreased by $4.8 million, or 9%, to $46.6 million from $51.3 million in 2010. The primary reason for the decrease was the decrease in sales of FOG and aeronautical products discussed above. Costs of service sales increased by $4.9 million, or 30%, to $21.0 million in 2011 from $16.1 million in 2010. The primary reason for the increase was a $5.7 million increase in airtime costs of sales for our mini-VSAT Broadband service. This increase was partially offset by a decrease of $0.7 million in contracted engineering services and service repair costs of sales.
Gross margin from product sales increased in 2011 to 45% from 44% in 2010. The primary reason for the increase was the increase in TACNAV product sales discussed above.
Gross margin from service sales increased in 2011 to 23% from 20% in 2010. The increase in our gross margin from service sales was primarily attributable to increased airtime sales for our mini-VSAT Broadband service and improved profitability on customer-funded engineering projects. Operating Expenses
Sales, marketing and support expense in 2011 increased by $5.0 million, or 27%, to $23.5 million from $18.5 million in 2010. The primary reason for the increase in 2011 was a $2.5 million increase in variable sales expense in part as a result of two large TACNAV orders that occurred in the second and fourth quarters. Also contributing to the increase in 2011 were costs related to the global and domestic expansion of our sales channel and support services presence for the mini-VSAT Broadband satellite communication service. Specifically, we experienced a $1.3 million increase in sales, marketing and support expense related to our Singaporean, Norwegian, Danish and Brazilian subsidiaries, which (other than our Danish subsidiary), were incorporated or acquired during 2010, as well as a $0.5 million increase in U.S.-based compensation for sales, marketing and support, and a $0.3 million increase in warranty expense. As a percentage of sales, sales, marketing and support expense increased in 2011 to 21% from 16% in 2010.
During 2011, research and development costs were expensed as incurred, excluding the aviation antenna development costs that were related to the original development project for LiveTV, which were capitalized from 2009 through the second quarter of 2011 until the original antenna development and production agreement with LiveTV was terminated in March 2011. We reached an agreement with LiveTV regarding the termination of the production agreement in September 2011 and as a result, all such expenditures were expensed to other expense in the third quarter. Prior to the third quarter of 2011 we had a contractual right to recover such costs. Research and development expense in 2011 increased by $0.8 million, or 8%, to $11.5 million from $10.7 million in 2010. The primary reason for the increase in 2011 expense was a $0.5 million decrease in customer-funded engineering costs for contracted engineering services. Also contributing to the increase was a $0.3 million


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