KVH Industries, Inc. (KVHI) Q2 2023 Earnings Report, Transcript and Summary

Good day and thank you for standing by. Welcome to the KVH Industries Second Quarter Earnings Conference. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] 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.

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 is available on our website and from our Investor Relations team. If you would like to listen to a recording of today’s call, it will be available on our website. If you are listening via the web, feel free to submit questions to ir@kvh.com. 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. Now, to walk you through the highlights of our second quarter, I’ll turn the call over to Brent.

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 1,000 – excuse me, 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 we are on – and that we possessed the talent to grow, we continue to adapt to changing market dynamics and heighten 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 stand-alone VSAT installations in 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 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, multichannel global network for the coming years. As I’ve discussed in the past, we enjoy the flexibility to work with multiple lower 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 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 and leisure market, and a corresponding reduction in satellite TV and leisure and 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 to $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 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 stand-alone 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. Now, I’ll turn it over to Roger for the financial details.

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 $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 re-class 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 and 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, and 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?

Thank you. At this time, we will conduct the question-and-answer session. [Operator Instructions] Your first question comes from Ryan Koontz of Needham & Co. Please go ahead.

Hi, good morning. It 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 – their go-to-market sales model is different from yours? It would be helpful. Thank you.

Yeah. I mean, in regard to Starlink, they do offer a high-speed, low-latency service. They do not offer a CIR, committed information rate. So 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 and a number of value-added services, which we go through cybersecurity. So you know what we’re offering is more than just connectivity. And 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 historic go-to-market strategy, which includes both direct sales and selling through service providers in regard to commercial market. They are – using a number 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, that they are selling through resellers in majority. A significant portion of our sales are through resellers as well.

Got it. And 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?

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

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

Your first statement is accurate, where we’re talking about you know maintaining our subscriber base and continue to grow it. And 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% plus.

I think you’ve talked about that a little bit before. So high 30s contraction. All right. And with regard to the different kind of vertical segments or verticals you sell into, is the – are the challenges in one particular area of another, whether it’s you know leisure or commercial fishing, et cetera?

Leisure and light commercial have been the most impacted. So you know and we would view fishing as light commercial. As far as blue water commercial, your tankers, your car carriers, all carriers, we haven’t seen as much. And we don’t – we do not sell into the cruise market either, which I understand has been significantly impacted. That’s one concern we do not have.

Got it. And in terms of the cruise market that’s served by other players in the space –

Yes –

Inmarsat and guys like this?

Yeah. I mean it’s you – Inmarsat didn’t have a significant focus there, but others do.

Okay. That’s all I had. Thanks for taking the questions.

Thanks, Ryan.

Thank you. [Operator Instructions] Your next question comes from Chris Quilty of Quilty Space. You may go ahead.

Thank you. Guys, just want to follow-up on the airtime plans and maybe a little bit of direction on how you plan to implement that? In other words, these are automatic changes where you’re going to 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?

I wouldn’t say, you’re going to see any significant impact on margins in 3Q, Chris. So, you know it’s – but 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 our end user is looking for.

So in other words, you’re not really changing the pricing, what you’re doing is just giving more bandwidth, which has a higher quality to you.

It potentially could. But right now, as I said, we 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 slight contraction to the high 30s, but it’s not significant.

Got you. Switching over to the product side. Obviously, 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 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?

Yeah. That’s a very good question and something that’s you know the forefront of our minds and in regard – and as well their 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 set is going to be since we’re in the middle of it. But we do understand that the market dynamics are changing and where our plan is to adjust to these market dynamics in order to position ourselves as effectively as we can on a go-forward basis in the market.

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

Well, I can say that for the quarter, if you sort of take out the one-time items, it would have been kind of right around the breakeven and what’s going to 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 so 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 going to change. So it’s really tough to say. Right now, I would say, you know we would be expecting if I were just sort of midpoint estimate is around breakeven.

Okay. That was good. And 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 wanted to make investments?

You know, when it comes to developing products in R&D, we keep that stuff close to our vest, but we’re still having very robust engineering department, R&D department. So they stay busy on a daily basis. And very well could have some stuff coming out here in the – you know later in the year.

Got you. And final question, which is another, forgive me, Starlink question. You know I think one of the challenges at partnering with them is, there’s no margin for the service providers. So obviously, it’s all pass 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?

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

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

Okay. Thanks, Chris.

Yeah. Thanks, Chris.

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

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

Thanks, everyone.

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