Good day and welcome to the KVH Industries, Inc. Q2 2020 Earnings Conference Call. Today’s call is being recorded. At this time, I would like to turn the conference over to Donald Reilly, Chief Financial Officer. Please go ahead.

Thank you, operator. Good morning, everyone. Thanks for joining us today to discuss KVH Industries’ second quarter results, which are included in the earnings release we published this morning. With me on this call is Martin Kits van Heyningen, the company’s Chief Executive Officer; and Brent Bruun, our Chief Operating Officer. The earnings release is available on our website and through our Investor Relations department. If you would like to listen to a recording of today’s call, you can access a webcast replay on our website. If you are listening via the web, feel free to submit questions to ir@kvh.com. This conference call will contain certain forward-looking statements that are subject to many 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 forward-looking statements. We will also discuss certain non-GAAP financial measures. You will find definitions of these measures in our press release as well as reconciliations of these non-GAAP measures to comparable GAAP measures. We encourage you to review the cautionary statements made in our SEC filings, specifically those under the heading Risk Factors in our first quarter Form 10-Q filed on May 1, and our 2019 Form 10-K, which was filed on February 28 and our Form 10-Q for the second quarter, which we expect to be filed later today. The company’s other SEC filings are available directly from the Investor Information section of our website. And at this time, I would like to turn the call over to Martin. Martin?

Thanks, Don. Good morning, everyone and thank you for joining us today. So as was the case for most companies, we entered the second quarter with incredible uncertainty relating from the COVID-19 global pandemic. I’m happy to say, however, that while we anticipated and prepared for a range of scenarios, both of our business segments held up well in the face of these global health and economic challenges. Our quarterly revenue was $37 million, down only 7% compared to Q2 of last year. Our VSAT shipments remained strong. Our airtime revenue continued to grow. Our FOG and TACNAV sales were healthy, and our gross margins expanded. We are very pleased with the results for the quarter in the face of the challenges we all experienced. We also worked very hard to manage our operating expenses while sustaining our business. Both of our factories ran at full capacity throughout the second quarter. We implemented and continue to maintain an array of health and safety initiatives, resulting in no missed shipments, no health issues and no outbreaks amongst our employees around the globe. We managed our supply chain aggressively. And as a result, we have products on the shelf that we continue to be able to deliver. We acted early and decisively. We reduced operational spending in almost every area. In addition, we temporarily reduced pay across the board with the exception of those making under $50,000. The largest reductions were for our executive team. These steps enabled us to avoid layoffs during Q2 and no layoffs are planned for the future. As a result of these efforts, we improved our EBITDA for continuing operations by $900,000 versus a year ago, getting us to breakeven for the quarter. We cut our loss in half sequentially from Q1 of this year. Together, these…

Thank you, Martin. First, in order to put our second quarter results of context, I think we need to recall the global economic environment we were facing as the second quarter began, and we are still facing today. Given the impact that COVID-19 has had on nearly every aspect of our business, we believe we’ve made excellent progress on almost all fronts for the quarter. That said, I’d like to walk through some of our second quarter results in more detail. As Martin mentioned earlier, our second quarter revenue came in at $36.9 million. This compares to $39.7 million recorded in the second quarter of 2019. The revenue from our Mobile Connectivity segment decreased to $2.3 million, and our Inertial Navigation revenue decreased $0.5 million from the prior year second quarter. Product revenue for the second quarter was $13.9 million, a decrease of $1.2 million or 8% from $15.2 million for the second quarter of the prior year. By segment, product revenues in our Inertial Navigation segment increased to just over $600,000 or about 9% as our FOG and OEM revenues decreased slightly about $200,000 compared to the prior year, while TACNAV sales increased about $800,000. In our Mobile Connectivity segment, product sales decreased by about $1.9 million or 22%, driven primarily by a $1.5 million decrease in TracVision sales. Of course, this product is largely targeted to the leisure marine industry, which was and continues to be impacted by the pandemic. Service revenue for the second quarter was $23 million, a decrease of $1.6 million or 6% from $24.5 million in the second quarter of the prior year. By segment, service revenues and our Inertial Navigation segment decreased just over $1.1 million or about 70%, primarily due to lower contract engineering service revenue. In our Mobile Connectivity segment, service…

Thank you. [Operator Instructions] We will take our first question from Ric Prentiss with Raymond James.

Hi. Good morning, guys.

Hi, Ric.

Hey, Ric.

You certainly navigated the storm of COVID-19 very well in the quarter. I hope you, your employees and families continue to stay well.

Thank you.

I want to first touch on the recovery that you saw or the resurgence you saw in June. What has continued into July? Was June kind of pent-up demand or is it good levels in July seeing similar levels? What’s the kind of the trend from June to July?

Yes. It varied a little bit by market. So on the leisure side, I think there was definitely pent-up demand in June. And normally, by July, in a normal year, things start to slow down significantly as people start using their boats as opposed to buying new things for their boats. But this year, it seems to have been delayed. So July continued to be strong compared to a normal July for the leisure markets. For the commercial markets, I think what we saw is that there were obviously deals in the pipeline and things that had been in progress, and those all continued to pay. So there wasn’t really the same level of resurgence as much as just sort of a continuation of things that were in process. So I don’t know if that answers your question, but it does vary by segment.

Sure. Sure. Okay. And as you think about – I think Don you mentioned the backlog. The $25 million backlog in 2020 is made up of the $15.6 million and then plus the $10 million TACNAV orders is the way you think about it?

That’s exactly right, yes.

Okay. And any thoughts on how their shipping timing will play out given COVID-19 for that backlog? Is it more rear end loaded in the year or evenly loaded?

Yes. The TACNAV order is scheduled for Q4 and then the FOG business is more uniform throughout the second half of the year.

Okay. And any bad debt issues? I mean, clearly, you guys have weathered it pretty well, but there are some issues out there, oil and gas and leisure. How is bad debt looking in the reserves?

Bad debt. So we are pleased to say we really haven’t seen a significant disruption in the cash collection process with any of our customers. I mean, a little – a few customers, smaller customers have asked for, as I said in the first quarter call, accommodations, which we have made, and they have basically abided by those revised terms. So no, we haven’t seen any real change in collection activity that would tell us our bad debt reserve need to change.

Okay. And it certainly seems like in this environment, Martin, you touched on a little bit, that the KVH Watch product could become even more compelling. Is it really just tough to make sales and visits and pitches during this environment? But it seemed to me that the value of that product should start jumping off the page?

Right. Yes. So I think that the interest in the product and the pipeline of prospective customers and partners is larger than we had anticipated. So the strong demand. But pace of getting actually people to do installations and demos and live visits is – was definitely impacted during Q2. So hopefully, that starts to change now. The new builds in China, people are visiting China again, whereas before, a lot of the customers simply refused to travel. So I think that’s starting to open up again. So our goal for Q3 is to get live installs and real customer – potential customer feedback. So there’s a lot of demand for this right now because of the pandemic and the whole value proposition of being able to access data remotely and see what’s going on in vessels and then to be able to do intervention, do face-to-face remote experts who walk people through repairs on board, even in the middle of the ocean.

Yes, okay. And it seems, obviously, the service business hung in there very good, which it should be resilient in a needed service. What are your thoughts on that guidance? Obviously, from the year end call you gave guidance, you pulled it on 1Q as nobody made a depth and duration. You have had a really good 2Q navigating in 3Q, July, sounds like it’s shaping up well but there’s still a lot of uncertainty out there. What are the thoughts on a rough order of magnitude, even on third quarter, if not for the full year?

Yes. I think that after we get through this quarter, I think we will be in a position to have more visibility and give guidance for Q4 and going forward. So I think it’s hard to believe that it’s only been a few months, but it does feel like there’s still a lot of things that we don’t know yet. So – but I do feel much more confident than we were 3 months ago and the way things are going, is significantly better than we feared. So – which is great news.

Okay. And last one from a kind of a 30,000 foot view or a 2,000 kilometer view. A lot of news in the market about the new LEOs, SpaceX, Starlink, OneWeb coming out of bankruptcy looking like with the British government, Hyper getting some FCC approval yesterday, what are your thoughts as far as what the new LEOs mean into your business model?

Well, I think that there’s definitely going to be a – someone’s going to be successful in that LEO market. We are not quite sure yet who will be. So we are looking at all of them. Some of them are targeting, like if you look at SpaceX, they don’t have inter-satellite links. So they are very much tied to land-based operations now. Eventually, the plan is to replace the 600 satellites they have already launched with satellites that do have that capability. But until that happens, it won’t work over the oceans. Because you need ground stations that are nearby. So they are all very different. The architectures, we have been studying them, looking at the different options. Some of them look really attractive for our business models. And other ones are more attractive for terrestrial use.

Okay. And so jury is still out, a lot of work to do, but should bring more supply into the marketplace.

Yes. No one told us that they have too much bandwidth and much lower service. So...

Definitely. Well, again wish you you and your family <> stay well during this difficult time. So, I have just sea navigating well.

Thanks, Ric. We will appreciate that though. Thank you.

We go to our next question from Rich Valera with Needham & Company.

Thank you. Let me add my congratulations for navigating through the tough environment very well. So a question on the FOG – I am sorry, the $25 million backlog that’s supposed to ship in Inertial in the back half. Can you say how much of that is FOG versus TACNAV?

Sure. I think Don’s got those numbers handy. So it’s probably $11 million for TACNAV off the top of my head, the rest being FOG but Don?

Yes. Just give me a second. Yes. So FOG is in the neighborhood of $11 million and TACNAV, let’s see. Yes, this is – I am sorry, FOG is in the neighborhood of $11 million. And TACNAV, when you include the GDLS – excuse me – the big military [indiscernible] that we announced would be in our neighborhood of $12 million.

Got it. So that’s – I guess, it’s $23 million. Is there service in there or something?

[Indiscernible]

That’s the total backlog for the whole company.

Got it. Okay, fair enough. That’s helpful. Thank you for that.

Normally, the VSAT business doesn’t have backlog, but it does have some. Because it’s normally a book and ship kind of business, but there is. It’s not zero, yes.

Got it, okay. So, I just wanted to follow-up with some of Rick’s questions. It’s sort of the outlook. I mean, if you’re looking Q3 versus Q2, it sounds like at the margin most businesses should have a better environment. I think we understand sort of the dynamics around Inertial, which is really going to be around timing of shipments. But looking at sort of the commercial side, it seems like you have got at least as good, if not better, conditions for the whole of the September quarter than likely you had for the whole of the June quarter. So I am just trying to figure out, is there any reason we wouldn’t expect there to be maybe some quarter-over-quarter improvement in the commercial side of the business? Anything we should think about there that might keep that business from improving quarter-over-quarter?

Right. Yes. I think that barring additional crazy things happening in 2020, we do expect things to continue to improve here in Q3, and then we have got good backlog for Q4. So we have better visibility for Q4 right now. So – but you are right. I think as we sit here today, we do expect improvement. How much improvement? We will see. It’s difficult to predict. But right now, it looks like Q3 should be better than Q2 and – but Q2 traditionally is not a very strong quarter. So that’s actually an improvement.

Right, right. And then, Don, you mentioned the OpEx, you have been taking some fairly extraordinary measures, I think, to keep them under control. Should we expect those measures to abate somewhat in 3Q? Or should we expect flattish OpEx? How should we think about OpEx trending over the near term here?

I think OpEx in the third quarter will be a little higher than second quarter. Fourth quarter, maybe a little higher than that. I mean, I think we will start to see maybe a little more travel and – but the overall cost controls that we put in place in the second quarter will stay in place. I think the growth will be kind of a natural growth. But we will still continue to be really cautious about what we spend money on.

Right. Understood. Then Martin just wanted to ask you about the P-1775, congrats on getting your first commercial shipment there with the PIC technology embedded. For a customer looking to buy IMU from you, what’s the difference they’re going to see in that product versus the product using your traditional technology from a price or a performance perspective?

Well, initially, there is not a lot of difference on – in terms of the face value specs. So what we have done is we have announced products that have similar performance even though the performance internally is, in fact, better. So what we wanted to do is to get a quarter’s worth of production in before we tighten the specs. I didn’t want this to become a yield issue for manufacturing. But so far, we have seen the opposite. So the yields are very, very good. Performance is super consistent. So as we – the plan is that we are going to put this into some additional products. We are going to add some improved accelerometers. And then we will be announcing further spec improvements as the year progresses. So it’s going remarkably well. So we are very, very pleased.

Got it. So then – as you get – as you are able to advertise the product with the better specs, I guess, one, it gives you some competitive differentiation. Does it give you pricing power? Or is that sort of not what you are looking for at this point more about market share versus maybe trying to get any pricing?

Yes. I think that as it progresses, we will selectively introduce lower cost models as well. But what we did not want to do is to just take all the cost savings and lower the price and not get improved margins. So for the short term, we are going to see some margin improvement. And then as we launch additional new products, we will try and differentiate it further, so that the high end becomes even more high-end and with better excels, and then there is going to be room for new products at the mid and low end range, which we think will expand the market at lower price points. And then just one starting – go ahead.

No, that’s – I want to let you finish.

Yes. No, I was just going to say and that we are starting this quarter. And hopefully by the end of the year, we’ll have the migration finished. So also, as we’re doing this, we’re also mindful that we want to work down our inventory because we didn’t necessarily know exactly when we’d be in full rate production with the photonic chips since it was brand new. So we want to be able to work down inventory, not have to write-off any old product. So all that’s happening now as we transition. So we think that will be orderly process throughout the next two quarters.

Got it. Makes sense. And just one final one for me, I think, for Don. Can you give the split between FOG and TACNAV for the quarter in Inertial?

Sure. So FOG sales for the quarter were above – little over $6 million and TACNAV was a little over $1 million.

Got it. Thank you.

Alright.

We will go to our next question from Chris Quilty with Quilty Analytics.

Thanks. Don, wanted to just confirm, did you say that the mini-VSAT airtime margins were 37% in the quarter?

Just under.

Just under. That’s a nice 5-point bump from Q1.

Yes.

Is that – does that feel sustainable on a go-forward basis? And was there anything onetime nature in there?

There are always – there are always some onetime impacts, positive and negative. But I think that trend is – we may not get quite that high in the third quarter, but the trend is certainly heading in that direction.

Well, I think that – yes. So we did have the bump from the – what we internally call our COVID promotion, where we got people to buy bigger plans because the crews were not able to change. So there is some risk that, that doesn’t sustain. So, some of that growth was due to these new promotions. And as we continue to add subscribers, we will be incrementally adding bandwidth throughout the network. So it won’t be continuous progression, but it’s a really nice trend. It’s not going to be that much every quarter and they may still bounce around a little bit. But the general overall trend is very encouraging.

And so you did mention airtime. Can you give us an update on where you see the market today? I mean, there has been some bankruptcies with Intelsat, which is a large partner of yours and incremental KU and KA capacity coming on the market. How do you feel about both the availability of capacity, the airline-centric models are not using as much in pricing trends and how that may impact margins on a go forward?

Yes. I think we are fairly locked into our – at least for 2020 in terms of what we need and what we will be buying and what we are paying for. So we have a pretty good idea of where our margins are. But you are right, the long-term trend could be favorable. So that over time we could see lower costs. But typically, what happens is that it almost never results in improved margin because if the bandwidth costs go down, people buy more bandwidth, but at lower prices. And so the margins, I think our long-term strategic goal of around a 40% gross margin is probably the high end of where we will be. I don’t see, with the market dynamics, getting to much higher margins than that just because of competitors and the way things work so. But for us, 40% gross margins are ideal. I mean that’s just right in our sweet spot. So we think that’s going to be great.

I understand. And on the content business, a pretty steep fall off there, are you seeing with vessel activity picking up, the content starting to also pick up because that’s nice, high-margin business for you?

Right. Yes. So the content business in our VSAT market has increased, increased in Q2 and continues to increase, the content business that declined by 50%, was our NEWSlink print newspapers for cruise ships and hotels. So that is a non airtime related content business, and that was down, as I said, $1.5 million. So, half of the total company’s revenue decline in Q2 was from that cruise ship newspaper business.

So that’s not coming back, at least near term.

Yes. True enough.

Understood. So last quarter, you had talked about the fact that some of your competitors are shedding customers and you were dealing with an issue of third-party antennas. And it sounds like you solved that problem and brought on some customers. Can you talk about whether – was that done at some sort of a degradation in performance or has it technically worked out well and does that provide an easier go forward path for targeting competitive wins?

Yes. I think it was – in this case, it was a little bit opportunistic on our part. They’re – transitioning the airtime was easier than visiting every single vessel and flipping them over to AgilePlans. This particular customer already had some AgilePlans, too. So I don’t think – it’s not a change in our business strategy. But from technical point of view, we are able to get it working. And from the airtime and data rate speeds, everything worked fine. What you lose is the sort of enhanced tools and visibility, monitoring and a lot of the value-added services that we think are really key differentiator. So it’s not going to be our business model going forward, but it’s a great tool to have when you need to flip a fleet quickly.

Understand. And final question, back to the PIC product. Are you still investing in miniaturizing the electronics? And how is that coming along? And any marginal updates, although it’s long-term on autonomous vehicle?

Yes. So the plan is still to miniaturize the electronics, right now, where we’ve developed a new generation of electronics that we’re just completing. So – but this is – this new version is not yet miniaturized, but it’s a brand-new clean sheet design with the latest and greatest technology for FPGAs and DSPs and A-D. So it’s that’s the precursor to then going to a custom electronic chip. So we wanted to do the redesign first, get that into production. This is going into a new product starting in Q4. And then that will be the basis for the miniaturization and the custom chip. So as far as the automotive, not much has happened in Q2 on that front. There has not been a lot of development. So I think there was a lot of – so nothing new to report during Q2 as far as self-driving cars and autonomy. So we expect that – those companies to reemerge here during the current quarter.

I understand. And actually, I do have one more question. Back to the A-PNT. Is that program progressing on the schedule that you anticipated? Or it kind of feels like it’s go figure, it’s dragging out once again, and this...

Yes, yes. No, you’re right. The – so there were some tests that they’ve tried to just be like a 3-week test in the desert and they scaled that back because of COVID, that is now scheduled for Q4, it’s only going to be 3 days and with – so that definitely has had an impact on schedule. On the other hand, some of the other domestic programs are seemingly unaffected so hopefully, we’ll have some good news there.

Understand. And that’s even in light of – I think we’ve had an executive order, and we’ve got the Senate getting involved with the Ligado situation and yet nobody’s lit a fire under the A-PNT program office?

Yes. Feel free to allow the call in there for us, Chris. So it is happening. And you arer ight, they’ve had all these high level indications that this is a top priority, and we absolutely have to get it done. So it’s just a question of when.

Yes. It’s an army program.

Yes. So in the meantime, we have got these other TACNAV programs. We’ve got other things in the fire. So – and the A-PNT program was not in our original guidance when we gave guidance for the year. So we haven’t seen anything fall out, let’s put it that way.

Okay very good and congrats on the quarter, guys. This was a nice surprise.

Alright thanks Chris

Thanks Chris

And no further questions operator?

There no further questions at this time.

Okay, thank you. As always, feel free to contact either Don or myself directly, and thanks for listening.

This concludes today’s call. Thank you for your participation. You may now disconnect.