KVH Industries - Q2 2023

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the KVH, the KVH Industries second quarter earnings conference. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone, and you will then be hear an automated message advising that your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Roger Kuebel. Please go ahead.

Roger Kuebel (CFO)

Thank you, operator. Good morning, everyone, and thank you for joining us today for KVH Industries' second quarter results, which are included in the earnings release we published earlier this morning. Joining me on the call are the company's Chief Executive Officer, Brent Bruun, and Chief Operating Officer, Bob Balog. Before we dive in, a couple of quick announcements. First, if you would like a copy of the earnings release, it's available on our website and from our investor relations team. If you'd like to listen to a recording of today's call, it will be available on our website. If you're listening via the web, feel free to submit questions to [email protected]. Further, this conference call will contain certain forward-looking statements that are subject to numerous assumptions and uncertainties that may cause our actual results to differ materially from those expressed in these statements.

We undertake no obligation to update or revise any of these statements. We will also discuss Adjusted EBITDA, a non-GAAP financial measure. You'll find a definition of this measure in our press release, as well as a reconciliation to comparable GAAP numbers. We encourage you to review the cautionary statements made in our SEC filings, specifically those under the heading Risk Factors in our 2022 Form 10-K, which was filed on March 16th, and Form 10-Q, which we plan to file later today. The company's other SEC filings are available directly from the Investor Information section of our website. To walk you through the highlights of our second quarter, I'll turn the call over to Brent.

Brent Bruun (CEO)

Thanks, Roger. Good morning, everyone. Thank you for joining us today. For starters, we are relatively pleased with our Q2 results, in particular with our growth in our airtime revenue. However, our television and leisure VSAT antenna shipments fell short of expectations, which resulted in a quarterly revenue of $34.2 million, down roughly 1% from the same period last year. On a positive note, operating income was $300,000, a substantial improvement from the $1 million loss recorded in the second quarter of 2022. To dig a bit deeper into the key service metrics, airtime revenue was up 4% year-over-year to $26.9 million, with an associated gross margin of 44%.

We also increased our total subscriber base to more than 7,140 subs. Our balance sheet is solid, with a quarter end cash balance of $71 million, up $2 million sequentially, and no debt. While we believe that the resource levels are appropriately aligned with the current size of our business, and that we are on the and that we possess the talent to grow, we continue to adapt to changing market dynamics and heightened competition. I'll touch on that shortly. In May, we launched our OpenNet program, which enables vessels with non-KVH antennas to join our global VSAT network and take advantage of our suite of value-added services.

With OpenNet, we also created a new service revenue stream that is not reliant on hardware sales or shipments. In the three months since we introduced OpenNet, we've built a robust pipeline for OpenNet migrations across the leisure and commercial markets. Each of these migrations will take market share from our competitors in an environment where demand for standalone VSAT installations is increasingly competitive. With the collaboration of our service partners, we continue to successfully convert existing Inmarsat FleetBroadband systems to KVH VSAT terminals and service. In addition, we see a steady demand for our subscription content offerings, driven by the need for crew welfare services. Additionally, we are in the process of refining our airtime pricing with the goal of simplifying our offering and making our rate plans more attractive.

This initiative is one way we are taking advantage of the additional capacity we have secured following our successful contract extension with Intelsat. The KVH-Intelsat partnership is mutually beneficial for both companies, as our subscribers represent the majority of the users on the Intelsat FlexMaritime HTS network. The extension secures the backbone of our multi-orbit, multi-channel global network for the coming years. As I've discussed in the past, we enjoy the flexibility to work with multiple low-earth and medium-earth orbit networks. We continue to offer Starlink terminals as a companion system to our TracNet and TracPhone products. We are also in late-stage negotiations with multiple LEO operators, with the goal of adding terminals and airtime from one or more of them to our worldwide hybrid network. We hope to wrap these discussions up in the near future.

We are, however, experiencing competitive headwinds driven by new LEO services, a transition to streaming content rather than satellite TV in the leisure market, and a corresponding reduction in satellite TV and leisure VSAT terminal sales. Given the changing market and competitive environments, we are tempering our guidance for the full year. We now anticipate revenue of $133 million-$139 million, with continued growth in our services revenue and subscribers, along with an Adjusted EBITDA between $12 million and $15 million. While these adjustments reflect, reflect our response to the changing market, we've made good progress on the strategic objectives we set at the start of the year, which are to expand our suite of value-added services, to gain scale through organic growth, and to pursue airtime subscriber growth through new hardware-agnostic approaches.

On a separate note, I want to report that our board of directors has concluded its review of strategic alternatives. We presently intend to continue to operate as a standalone company. We are not actively considering any material transactions at the moment, but we plan to continue our usual practice of reviewing opportunities as they may arise. I'll turn it over to Roger for the financial details.

Roger Kuebel (CFO)

Thanks, Brent. First, I would like to note that unless specifically stated otherwise, my comments with respect to Q2 of last year relate to our continuing operations, which exclude the results of our inertial navigation business, which was sold one year ago today. With that, as Brent mentioned earlier, our second quarter revenue came in at $34.2 million, down $0.4 million from the $34.6 million recorded in the second quarter of 2022. Our gross profit margin was 35% for the second quarter of this year, as compared with 41% in the second quarter of last year. Service revenue for the second quarter was $28.7 million, an increase of $0.8 million or 3% from $27.9 million in the second quarter of 2022.

This increase was primarily due to a $1.1 million increase in VSAT airtime revenue, primarily offset by a $0.2 million decrease in our content service sales, which was largely due to the sale of our radio business in April of last year. Airtime revenue grew to $26.9 million, or approximately 4% over the second quarter of 2022. Airtime gross margin was 44.2%, up from 42.9% last year. Product revenue for the second quarter was $5.4 million, a decrease of $1.2 million or 18% from the second quarter of last year.

This decrease in product revenue was primarily due to a $1.8 million decrease in TV receive-only products, somewhat offset by an increase in VSAT revenue and sales of Starlink antennas, which we just began offering in the second quarter. As Brent indicated, the transition to streaming video content rather than receiving through satellite TV has had a significant impact on our sales of TV receive-only antennas. From discussions we've had with other providers, it appears that this is affecting the entire industry, not just KVH. Product gross margin for the second quarter was negative by approximately $1.2 million. This was due to a number of factors that caused manufacturing costs to exceed standard costs, including lower overhead absorption due to lower unit volumes, realization of purchase price variances from higher component costs, and a reclass from Q1 between products and services.

This continues to be an area of intense focus, and we are evaluating alternatives for improvement. Operating expenses for the quarter were $11.7 million. This quarter benefited from a number of one-time reserve adjustments, and we continue to expect the normal quarterly run rate to be between $12.5 million and $13 million. At the operating income level, these changes in revenue, margins, and operating expenses resulted in a profit from operations of approximately $300,000, compared to last year's loss of about $1 million. Our bottom line net income from continuing operations was $925,000, and EPS for the second quarter was a net profit of $0.05 per share, compared with a net loss of $0.01 per share in the same period of 2022.

Our Adjusted EBITDA for the quarter was a positive $4.2 million, compared with positive $3.2 million last year. For a complete reconciliation of Adjusted EBITDA, please refer to the earnings release that was published earlier this morning. Net cash provided by operations was $3.6 million versus approximately $300,000 last year. Capital expenditures for the quarter were $2.6 million. Adjusted EBITDA less CapEx was positive by over $1.5 million. Cash provided by financing activities was $1.3 million, resulting in an increase in cash of approximately $2.3 million and an ending cash balance of approximately $71 million. This concludes our prepared remarks. I will now turn the call over to the operator to open the line for the Q&A portion of this morning's call. Operator?

Operator (participant)

Thank you. At this time, we will conduct the question and answer session. As a reminder, to ask a question, you will need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Your first question comes from Ryan Koontz of Needham & Company. Please go ahead.

Ryan Koontz (Managing Director and Senior Equity Research Analyst)

Good morning. Sounds like the Starlink capacity is really disrupting the market here. Can you speak about kind of the differentiation in the products and maybe how this, their go-to-market sales model is different from yours? Be helpful. Thank you.

Brent Bruun (CEO)

Yeah, I mean, in regards to Starlink, they do offer a high-speed, low-latency service. They do not offer a CIR, Committed Information Rate. When the service works, it works incredibly well. But with our service, we offer a Committed Information Rate as well as 24/7 phone tech support, field service to repair your units, a number of value-added services which we go through, cybersecurity. You know, what we're offering is more than just connectivity. You know, as we talked about the companion plan, it works very well, quite frankly, in combination with Starlink, and that's why we're focused on the companion plan.

You know, in regard to go-to-market, we've continued with our, our, our historic go-to-market strategy, which includes both direct sales and selling through service providers in regard to commercial market. They, they are using a number of our, of our competitors to sell their airtime, so I'm not sure that their go-to-market strategy differs all that much from what we're doing, in that they, they are selling through resellers, a significant portion of our sales are through resellers as well.

Ryan Koontz (Managing Director and Senior Equity Research Analyst)

Got it. You know, with the disruption going on, do you have the ability to go back to your partner then, with the cost of bandwidth coming down, to reduce your, you know, cost of capacity?

Brent Bruun (CEO)

Yeah, we're not at liberty to talk about our cost of capacity. We did just enter into a contract extension with Intelsat. We're bringing down quite a bit more capacity. As I alluded to in our prepared remarks, we are adjusting our airtime plans.

Ryan Koontz (Managing Director and Senior Equity Research Analyst)

As you adjust your airtime plans, obviously you're hoping to reverse kind of share loss and such there, and, is that gonna much of a, a gross margin impact going forward?

Brent Bruun (CEO)

Your first statement is accurate. Where we're talking about, you know, maintaining our subscriber base and continuing to grow it. We do anticipate, and we haven't necessarily said it on this call, but we anticipate a slight contraction in our airtime margins to the high 30s for airtime, where this quarter and last quarter were, you know, 40%+.

Ryan Koontz (Managing Director and Senior Equity Research Analyst)

I think you've talked about that a little bit before, so high, high, high 30s, contraction. All right. With regard to the different, kind of vert- segments or verticals you sell into, Are the challenges in one particular area of another, whether it's, you know, leisure or, commercial fishing, etc?

Brent Bruun (CEO)

Yeah. Leisure and light commercial have been the most impacted. You know, and we would view fishing as, as light commercial. We don't, and we do not sell into the cruise market either, which I understand has been significantly impacted. That's, that's one, that's one concern we do not have.

Ryan Koontz (Managing Director and Senior Equity Research Analyst)

Got it. In, in terms of the cruise market that's served by other, other players in the space.

Brent Bruun (CEO)

Yes.

Ryan Koontz (Managing Director and Senior Equity Research Analyst)

Inmarsat and guys like this?

Brent Bruun (CEO)

Yeah. I mean, it's, you know, it, Inmarsat doesn't have a significant focus there, but others do.

Ryan Koontz (Managing Director and Senior Equity Research Analyst)

Okay, great. That's all I had. Thanks. Thanks for taking the questions.

Brent Bruun (CEO)

Thanks, Brent Bruun.

Operator (participant)

Thank you. One moment for our next question, please. Your next question comes from Chris Quilty of Quilty Space. You may go ahead.

Chris Quilty (Co-CEO and President)

Thank you. Guys, wanted to follow up on the airtime plans and maybe a little bit of direction on how you plan to implement that. In other words, are these are automatic changes where you're gonna push those down on the customers, or do you wait for them to sort of price discover? In other words, you know, if you do the former, we would see a pretty immediate impact on margins in Q3, and that seems to be what you're guiding to.

Brent Bruun (CEO)

I wouldn't say you're gonna see any significant impact on margins in 3Q, Chris. You know, it's, but as in regards to the airtime plans, you know, people have become more bandwidth thirsty, so it's really a matter of providing more speed and more raw consumption on a go-forward basis to align with what the end user is looking for.

Chris Quilty (Co-CEO and President)

In other words, you're not really changing the pricing. What you're doing is just giving more bandwidth? Which has a higher cost to you?

Brent Bruun (CEO)

Well, it potentially could, but right now, as I said, we've just entered into a renegotiation. We're pulling down a bit more capacity from Intelsat, so it's, I think we have it so that we can maintain a reasonable gross profit level. You know, I'll repeat once again, we do anticipate a slight contraction to the high 30s, but it's not, not significant.

Chris Quilty (Co-CEO and President)

Gotcha. Switching over to the product side, obviously, it, it looks like the consumer products are taking a pretty hard hit. What's the prognosis there? I mean, is this a recoverable situation where you can either increment capabilities or lower costs, you know, relative to a Starlink antenna, which has a pretty distant price gap, between, you know, the sort of legacy services you provide?

Brent Bruun (CEO)

That, that's a very good question and something that's, you know, the forefront of our minds, and in regard, and as well as our daily activities. We're in the process of assessing that, what the overall impact is. We're not necessarily at liberty to disclose what the outcome of that assessment is going to be, since we're in the middle of it. We, we do understand that the market dynamics are changing, and our plan is to adjust to those market dynamics in order to position ourselves as effectively as we can on a go-forward basis in the market.

Chris Quilty (Co-CEO and President)

Got it. Roger, specifically on the, the product margins, I mean, expected them to be down, but that was way more down, and you seemed to indicate there were some one-time issues in there, in addition to just volume. How should we think about product margins looking into the second half of the year?

Brent Bruun (CEO)

Well, I can say that for the, the quarter, if you were sort of take out the one-time items, it would have been kind of right around the break-even. What's gonna happen for the second quarter will be highly dependent on kind of where, you know, what happens with volume. We're in a period right now of a lot of uncertainty. We're seeing sort of, you know, dramatic kind of changes in the market. It's a little hard to tell whether things are, whether there's some, you know, unusual occurrence going on, whether things are gonna change. It's really tough to say. Right now, I would say, you know, you know, we were to be expecting if I were just, sort of midpoint estimate is around break-even.

Chris Quilty (Co-CEO and President)

Okay, that is good. Just in terms of other product developments, things like KVH Watch or, you know, some of the new pricing plans, are there other developments that you have coming in the second half of the year or other areas that you want to make investments?

Brent Bruun (CEO)

You know, when it comes to developing products and R&D, we keep that stuff close to our vest, but we still have a very robust engineering department, R&D department, so they're, they stay busy on a daily basis, and, we very well could have some stuff coming out here in the not, you know, later in the year.

Chris Quilty (Co-CEO and President)

Gotcha. Final question, which is another, forgive me, Starlink question. You know, I think one of the, the challenges of partnering with them is there's a, there's no margin for the service providers. Obviously, it, it's all passed through. Where do you see that product deploying? Because you're doing it as a bundle with your own system. Is it basically adding it to a lot of your existing customers, or do you see, you know, new market opportunity created by that bundle, albeit most of your competitors now offer that bundle also?

Brent Bruun (CEO)

Yeah, I mean, it basically, for the most part our current market focus isn't gonna change, but definitely will open up if we went down that path completely, other opportunities due to the speeds that associated with the service offering.

Chris Quilty (Co-CEO and President)

Gotcha. All right. Well, thank you, gentlemen.

Brent Bruun (CEO)

Okay. Thanks, Chris.

Chris Quilty (Co-CEO and President)

Thanks.

Operator (participant)

Thank you. I would now like to turn it over to the Chief Executive Officer, Brent Bruun, for closing remarks.

Brent Bruun (CEO)

Okay. Well, thank you very much for joining us today, and enjoy today and the rest of the week.

Roger Kuebel (CFO)

Thanks, everyone.

Operator (participant)

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.