KVH Industries, Inc.

hello and welcome to the kvh industries q3 2022 earnings call my name is laura and i will be your coordinator for today's event please note this call is being recorded and for the duration of the call your lines will be on listen only however you will have the opportunity to ask questions at the end of the call this can be done by pressing star 1 on your telephone keypad to register your question if you require assistance at any point Please press star zero and you will be connected to an operator. I will now hand you over to your host, Roger Cable, to begin today's conference. Thank you.

Thank you, Laura. Good morning, everyone, and thank you for joining us today for KVH Industries' third quarter results, which are included in the earnings release we published this morning. Joining me on the call are the company's Chief Executive Officer, Brent Bruin, and Chief Technology Officer, Bob Bailoff. 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 at 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 certain non-GAAP financial measures, and you'll 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 2021 Form 10-K, which was filed on March 11th, and Form 10-Q, which is expected to be filed sometime this afternoon. The company's other SEC filings are available directly from the information section of investors on our website. Before turning the call over to Brent, I would like to briefly comment on the delay in filing our 10-Q for the third quarter. On August 9th, we signed, announced, and closed the sale of our inertial navigation business to MCOR Corporation. In the form 12B25 that we filed on November 10th, we noted that as a result of the added demands on our financial and accounting personnel due to the sale, we were unable to file our 10-Q in a timely manner. Without going into all the details, I can tell you that having the inertial navigation business in the same legal entity and same set of accounting books as the mobile connectivity business, having shared vendors, closing the sale mid-month, and complying with our reporting obligations to MCAR under both the sale agreement and the transition services agreement all made the disaggregation of results a complicated and lengthy process. However, we have completed that process and believe we are in a good position to move forward. Now, to walk you through the highlights of our third quarter, I'll turn the call over to Brent.

Thank you, Roger. Good morning, everyone. We wrapped up a very positive and exciting third quarter that was highlighted by solid financial results, the sale of our inertial navigation business, the launch of our new TrackNet H series, and we also completed a lengthy competitive process, which resulted in a five-year renewal of our U.S. Coast Guard contract. Financially, it was a good quarter. Excluding any contributions from inertial navigation, we recorded $35.2 million in revenue, up 2% from the third quarter of last year. An aggregate gross margin of 37.1%, which includes airtime gross margin of 44.2%, a new record. Adjusted EBITDA of $4.1 million, non-GAAP EPS of $0.07 per share, and we ended the quarter with more than 6,800 airtime subscribers. However, our growth was slower than anticipated. Continued supply chain challenges slowed shipments, while economic and inflationary pressures seemed to be impacting some new orders. We're also seeing increased competitive pressure, particularly in the leisure marine market. KVH is in a good position to respond to these challenges. The restructuring we embarked on in March is working. After the initial navigation divestiture, we implemented additional restructuring initiatives that resulted in further annualized savings of approximately $2 million. Overall, we have made significant positive progress in reducing operating expenses. Third quarter OpEx on a reported basis was $14 million. an 11% decrease versus Q3 of last year. As discussed during our call in August, we sold inertial navigation assets to MCOR, which resulted in net proceeds of approximately $52 million. Over the last four months, we've unwound inertial navigation from our operations. These efforts touched on almost every department in the company, including sales and service, marketing, human resources, IT and data systems, facilities, engineering, and finance, which has proven to be the most difficult. We are still in a transitionary period, but the bulk of this effort is now behind us. We continue to evaluate the best use of the proceeds from the transaction and the best path forward, including assessment of strategic alternatives for the company. We can now focus on the success and growth of our core business. On that front, we completed some outstanding initiatives and achieved strong results during Q3. First, the US Coast Guard selected us to deliver global communications for their small cutter fleet. We won this five-year contract renewal through a competitive bid process. The contract is worth as much as $69 million and supports more than 140 vessels and platforms. U.S. Coast Guard Cutters will continue to use our TracFone V7 HTS terminals and our global HTS network. We're proud to have delivered superior communications to the Coast Guard for more than 12 years and are thrilled to be keeping crew and ships connected for the next five. Additionally, we look forward to pursuing other connectivity and service opportunities with the Coast Guard. In July, we introduced our new KVH-1 hybrid network and TrackNet H-series terminals. Every TrackNet terminal includes fully integrated VSAT, 5G cellular, and shore-based Wi-Fi, an industry first. These channels are managed by our unique intelligent channel switching technology, which considers the cost of service, data throughput, and connection quality. The result is a seamless and automatic process that enables users to enjoy connectivity without having to worry about what service is active. TrackNet is the long-term foundation for what we believe will be a vibrant hybrid connectivity ecosystem that takes advantage of faster-to-celerator services and new technologies to support the growing demand for data. That's why every TrackNet system is capable of integrating additional third-party channels, such as user-supplied SIM cards for local cellular services, L-band backup services, such as Iridium service, and in the future, LEO and MEO constellations. All these features are managed with our automatic hybrid switching to deliver a multi-channel communication service that will support future connectivity solutions. TrackNet is shipping and feedback from customers is positive. The systems are easy to install, offer affordable airtime plans that are easy to understand, and delivers a seamless hybrid experience. Financially, we continue to make progress in our connectivity business. We recorded airtime revenue of $27 million, an 8% increase in comparison to the same period last year. We achieved record airtime margins of more than 44 percent, and third quarter KVH Elite subscriptions were up 60 percent over Q3 of last year. However, during the quarter, we faced lower than anticipated VSAT and satellite TV terminal orders and shipments because of the dual impact of ongoing supply chain challenges and inflationary pressures. As a result, with the supply chain issues, We entered Q4 with more than $2.1 million in TVRO and $300,000 in VSAT systems backlog. The supply chain issues are steadily clearing, and we expect any backlog we have entering Q1 will be based on customers not wanting or needing delivery until next year. We're also seeing challenges in the market. For example, in Alaska, where we support a large portion of fishing fleets, the king crab season was canceled due to unexpected and significant declines in crab stocks. The Baltic Index, a leading indicator for the commercial markets, has been cut by two-thirds since the beginning of the year. And we are experiencing competitive pressure from new entrants into the market, especially in the leisure market. As a result, we will be slightly more conservative with our expectations for the remainder of the year and as we look at 2023. Roger will share additional insights on this in his comments. Nevertheless, we remain confident and enthusiastic about our business. We continue to roll out new features to expand the capabilities of the TrackNet H series. These include value-added services such as an ultra-compact DC-powered below-deck unit, ideal for smaller yachts and regional commercial vessels. The ability to support both alternate primary and backup communication channels, all managed through our intelligent hybrid hub. A new enterprise-grade cybersecurity option. A new cloud-based email system that will offer tremendous flexibility and customer self-service. And SportsLink Stats. our new real-time sports statistics news service for crew morale and entertainment. We're also in discussions with other third-party providers to deliver additional services over our network. These are vital competitive differentiators for our KVH-1 hybrid network and TrackNet systems, especially as new connectivity services are rolling out. It's important to remember that these new services are simply data pipes. with none of the critical tools and services required by commercial fleets and other customers. KVH-1 offers tools as well as integration with these new services. We're making the maritime hybrid connectivity ecosystem a reality. To wrap things up, our restructuring efforts are building a healthy foundation for KVH's sustained growth. We are steadily moving toward profitability. and we can now focus entirely on our core business and strengths. Customers are thrilled with our innovative hybrid product line, and we continue to introduce complimentary value-added services and expanded integrations with third-party services. We are carrying out these strategic efforts with the goal of returning value to shareholders, and I believe our results demonstrate that we are on the right path. Now I'll turn it over to Roger for the financial details.

Thanks, Brent. First, I'd like to note that unless I specifically state otherwise, my comments will relate to our continuing operations, which exclude the results of the inertial navigation business prior to the sale. With that, as Brent mentioned earlier, our third quarter revenue came in at $35.2 million, increasing $0.8 million from the $34.4 million recorded in the third quarter of 2021. Our gross profit margin was 37% for the third quarter of this year as compared with 35% in the third quarter of last year. Service revenue for the third quarter was $28.5 million, an increase of $1 million or 4% from $27.5 million in the third quarter of last year. This increase was primarily due to a $2.1 million increase in mini VSAT broadband airtime revenue primarily offset by a $1 million decrease in content service sales, which was largely due to the sale of our radio business in April of this year. As Brent noted, airtime revenue grew to $26.7 million, approximately 8% over the third quarter of last year, and total subscribers passed 6,800. As a reminder, total subscribers include those who have temporarily suspended their service. Airtime gross margin was 44%, which is up 8 percentage points from a year ago. This increase is due to a combination of factors, primarily the growth in our subscriber base. Although we are very pleased with the results, we expect that going forward, our target for airtime margins will continue to be in the high 30s. Product revenue for the third quarter was $6.6 million, a decrease of $0.2 million or 3% from $6.9 million in the third quarter of the prior year. This decrease in product sales was primarily due to a $0.4 million decrease in VSAT product sales and a $0.2 million decrease in TV land product sales, partially offset by a $0.4 million increase in maritime TV product sales. The decrease in land-based TV receive-only units was primarily due to supply chain issues, which led us to allocate scarce raw materials to our higher margin marine TV products. The decline in VSAT sales was primarily due to the level of last year's sales of units for customers migrating to our HTS network. We sold 138 units in Q3 of last year to these customers. However, supply chain issues also impacted our VSAT sales, and we believe that we could have shipped an additional 90 units if sufficient raw materials had been available. Operating expenses for the quarter were $14 million, down $1.6 million, or 11% from the third quarter of last year. This quarter includes approximately $450,000 in costs related to our September restructuring, so on a recurring basis, we were about $2 million less than a year ago. You may recall that for Q2, we were about 1.9 million less on a recurring basis. These improvements are a direct result of changes we made in March, and we are now seeing the full benefit of those actions. I should note that consistent with past practice, We did allocate a portion of our corporate OPEX to the inertial navigation business prior to the sale. Absent any changes in our remaining business, those costs would have come back to continuing operations in Q4. However, the cost reduction actions we took in September will more than offset those. At the operating income level, these changes in revenue margins and operating expenses resulted in a net loss from operations of $1 million, which was a $2.5 million improvement compared with the $3.5 million loss recorded in the third quarter of 2021. The $1 million loss included the $450,000 of costs associated with the September restructuring, and so adjusting for that, a recurring loss would be $500,000 to $600,000. Our bottom line net loss from continuing operations was $0.1 million compared to last year's net income of $3.7 million. However, last year's income included $7 million of other income due to the forgiveness of our PPP loan. On a non-GAAP basis, which excludes amortization of intangibles, stock-based compensation, and other non-recurring costs such as unusual non-operating fees, foreign exchange transaction gains and losses, and employee termination costs, related tax effects and changes in our valuation accounts and other tax adjustments, after those adjustments, we had net income of $1.2 million compared with a net loss of $1.4 million last year. EPS for the third quarter was a net loss of $0.01 per share compared with net income of $0.20 per share in the same period last year. Non-GAAP EPS for the third quarter was income of $0.07 per share compared to a net loss of $0.07 per share last year. Our adjusted EBITDA for the quarter was a positive $4.1 million compared with a positive $0.8 million in the third quarter of last year. For a complete reconciliation of our non-GAAP measures, please refer to the earnings release that we published earlier this morning. Net cash used in operations was $1.5 million compared to $1.9 million provided by operations for the third quarter of last year. Capital expenditures for the quarter were $3 million, and for the full year, we expect capital expenditures will be in the range of $14 to $16 million, the majority of which is driven by Agile plan shipments. Cash provided by financing activities was $0.6 million, and cash received from the sale of the inertial navigations business was $55 million, resulting in an ending cash balance of approximately $70 million, which includes approximately $2.4 million of cash collected from inertial navigation customers after the sale and is therefore owed to MCOR. With respect to our outlook for the full year, in our second quarter earnings release, I had said that we expected adjusted EBITDA to be between $11 and $15 million. Our first half, on a consolidated basis, including inertial navigation, was $6 million. And with $4.1 million from continuing operations this quarter, that would give us $10.1 million year-to-date. Even taking just continuing operations for the first nine months, we're at 9.5. As such, we remain comfortable that we will be over 11 million. However, the high end of the range is looking more like 14 million than 15 million. With respect to revenue, I had said that we expected mobile connectivity revenue growth between 6% and 9% on a pro forma basis adjusted for the sale of the radio business. Brent described a number of challenges that we're seeing related to demand, and as a result, we are being a bit more conservative and expect revenue growth between 5% and 6% for our continuing operations. Finally, we continue to make progress towards our goal of operating income profitability. Last year, we lost $8.5 million in the second half of the year. We had a goal of breaking even in the second half of this year, assuming supply chain problems didn't persist. Unfortunately, they did, and as previously noted, our revenue expectations for the full year have come down a bit. As such, we do not expect a break even for the second half. If Q4 comes in similar to Q3, we'd have a second half loss of around $2 million, and while there's risk in that, there is certainly opportunity to do better as well, and we're working very hard to do so. 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. Laura?

Thank you. Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. We'll now take our first question from Rick Prentice at Raymond James. Your line is open. Please go ahead.

Thanks. Good morning, everyone. Hi, Rick. Great. A couple questions. First, you mentioned that you are targeting the service margins in the high 30s versus what's been coming up in the more like mid 40s. What do you attribute that to as far as it, you know, what's the main items driving that?

Well, the main items are we want to generate more pure revenue and margin dollars. So it's really a focus on market penetration and being able to effectively price our services in line or with market expectations as well as to try to generate more volume.

Okay. It really is the volume driving it. And appreciate the color on the guidance update. Do you have the visibility that you're starting to see what 23 could be looking like now that we're sitting here in early December?

I'll let Roger answer the detail, but we're in the midst of pulling our budget together. Yeah, we're not really in a position to provide any type of guidance for 23 at this point.

I think that's exactly what I was going to say is that, you know, we are finalizing it. There's still some things kind of moving around a little bit, you know, but we're obviously working on that. And as Brent said, though, it's kind of premature at this point to provide any guidance publicly.

All right. But supply chain pressure is still kind of continuing out there. You called out some competition pressure as well. So we should, I think, assume maybe those are going to continue for at least a little while on supply chain and then maybe longer term on the competition.

Yeah, on the supply chain side, I don't want to jinx ourselves, but it seems to be easing up a bit. We see within certain areas things easing up, being easier to find parts, scarce parts, but that could change. Considering what's going on in China with COVID, it's still really hard to say.

It's hard to say, but what we anticipate is being able to clear our backlog, and as I indicated in my comments, any backlog that we go into next year with will be based on customer timing as opposed to us not being able to ship any product. Bob Balog is with us, and he actually runs our operations team. So do you have anything you want to add?

Yeah. I mean, aside from that, we've also taken some pretty aggressive steps for component management, critical component sourcing, and things like that to sort of ensure that we don't run into or minimize unexpected problems. So we've taken some pretty serious steps there.

Okay. And last one for me is the $64,000 question, I guess $69 million question. You're sitting with a lot of cash on the balance sheet. It sounds like some needs to go with the sale since you got paid after the close. But what's the timeframe to be looking at strategic alternatives? What's on the table as far as potential things that might be in the realm of being considered? Yeah.

I think that you should probably guess the realm. We want to generate growth for the business, as I indicated through the margins. We're not in a position to disclose specifically what we're considering. I think that we'll probably be in a better position for the next call three months from now. That's about as much as we can say.

Yeah, I think, you know, the board's still evaluating everything, and so there's really kind of no change. So I'm just sort of reiterating what we said before, that the board's evaluating all strategic alternatives. Nothing is off the table. Everything's being considered, and obviously the objective is to, you know, create the most value for shareholders.

Great. Thanks so much, everyone. Have a great day.

Okay, thanks.

Thank you. We'll now take our next question from Ryan Coons at Needham. Your line is open. Please go ahead.

Hi, thanks for the question. Clarification on your Coast Guard win. How does that compare versus your historical business there with that fleet? Is it pretty similar? It's very much similar.

So it's very similar. It's a renewal, but it also includes some opportunity to sort of grow the relationship with respect to a program they have called Morale Welfare Recreation. which we've provided some to them in the past, but there's an opportunity under this to sort of expand that.

Got it. Great. And in terms of your new kind of OpEx levels you hit in the quarter, some great progress there toward profitability. With the cut in R&D, is that something you feel is sustainable going forward? And are there any impacts there on kind of your roadmap forward from the changes there?

When you say the cut in R&D, I mean, one thing to recognize is that the R&D group had historically supported both, you know, the inertial nav and the mobile connectivity sides of the business. Obviously, with the sale, a number of folks in the R&D side moved over to MCOR, and so the remaining folks we have here are solely focused on mobile connectivity. But I'll let Bob... Hang on, let me just... Okay, so, you know, in regard to...

R&D, we took some measures earlier in the year to focus, and we reduced it both with universal navigation and mobile connectivity. We feel that the team that we have in place is more than capable of fulfilling our service and product roadmap, and on a go-forward basis, as indicated by some of the product releases and additional services that we're introducing with KVH-1 and the TrackNet series, that they're more than properly staffed.

Yeah, I would echo. All I can add to that is I can echo exactly what Brent just said. We're more focused. We're delivering products on schedule. We're pretty comfortable about that going forward. Yeah, we're in pretty good shape.

Okay, great. And on the competitive front, you talked about leisure. Is this coming from some of the larger players, like the Inmarsats and Marlakes and guys like this? Or is it new entrants?

It's more new entrants.

Got it. Helpful. And then in terms of the last question, in terms of the macro, how should investors think about the macro impact on the, I guess, specifically leisure, probably that is the most impacted by potential macro headwinds, whether that's inflation or or just, you know, recessional type impacts?

Yeah, I think when you talk about, you know, inflation and recession, which we're not in one yet, and hopefully we don't go into one, the leisure marine market is definitely impacted, right? Because these are for entertainment and leisure, you know, by definition is monies that are spent to for recreation. Yeah. The nice thing about our business is the vast majority of our revenues are generated through both commercial, and then we talk about the Coast Guard with our military and government business. So although we're very focused on that piece of the business, it's a very small portion of our overall revenue, or small portion. I wouldn't say very, but a small portion.

Got it. Okay, no question about it.

Thank you. We'll now take our last question from Chris Quilty at Quilty Analytics. Your line is open. Please go ahead.

Thanks, Brent. I just want to follow up on that last point. You used to report a mix of commercial versus, well, I should say commercial as a percentage of many VSAT shipments. I remember the last time you reported it was order magnitude 65%. Does that mix – is that still indicative of the mix you're seeing today?

We can – 65 is probably a bit low for merchant. It's probably closer to – I don't have the exact numbers, so, Roger, maybe you do, but I know it's, you know, it's over 80%. The ask order. Well, Agile has a percentage. Yeah, because it's Agile, too. You know, the Agile shipments are almost all predominantly – predominantly commercial. Right.

And when you talk about the Baltic index being down, and obviously that's an indication of some commercial market weakness, shipping market, are you still seeing the same number of RFPs out there, or have you seen that come down? And how, if in any way, has the competitive market changed for those larger deals?

I'd say it's pretty consistent on a year-over-year basis. You know, RFPs have actually come down quite a bit over the last five years or so. But on a year-over-year basis, I'd say it's pretty consistent.

Great. And the overall guidance for mobile connectivity, taking it down, is that primarily product or is it evenly split between product and service?

Well, here again, you know, when we talk about product sales, that's truly units that we've sold, right? Many of our product shipments are agile-based, and they're included within our airtime components. But to answer your question concisely, it would be both, and it's just a slight decrease, not a significant decrease.

Great. And your network operating costs, having made the crossover here, do you see those being relatively stable or, you know, growing in accordance with new customer ads, or do you have large block buys that are planned? How should we think about that on a go-forward basis?

We'd be pulling down bandwidth proportionate with customer requirements, not in big blocks.

Yeah, no large blocks. block buys.

Great. And I missed on the very front end of the call. Did you provide the gross margin specifically for the mini VSAT service?

Is it airtime? The airtime gross margin is 44%.

Gotcha. And that's why you were indicating that airtime margin should return back to more of the high 30s.

Right. Yeah. We Yeah, over time. It won't be this quarter.

Well, good. And I guess, you know, final question here. When you think about some of the strategic alternatives at hand, obviously there's a lot of smaller maritime service providers out there. That's one path. But You've historically been more focused on product line extension, things like KVH watch. Is there a philosophical preference for one direction over another?

Our philosophical direction right now is that we've built this new age series. We have the KVH hybrid network, which we have our own dedicated 5G or LTE capacity. As I indicated earlier, From a cost perspective, a customer can go buy a local SIM, and many times that can be very competitive. But we feel we have the right data pipe, the right tools internally with what we're rolling out to expand those, whether it be through internal development efforts or through working with other third-party value-added service providers.

I think with the question about a philosophical preference, it's really around what's going to maximize value, where can we create value. And I think one of the things that we're looking at is that, you know, the suite of value-added services that we provide, which are sort of, you know, more or less unique to us and where we have a competitive, you know, a strong competitive advantage, and enhancing that suite of value-added services.

Great. Appreciate the feedback. Thank you.

Okay. Great.

Thank you. There are no further questions in queue. I will now hand it back to Roger Keeble for any additional or closing remarks.

I think that's all. Thank you. I appreciate everyone joining the call. I appreciate the questions and look forward to continuing to deliver great value for shareholders. Thanks all. Thank you very much.

Thank you. Ladies and gentlemen, this concludes today's call. Thank you for your participation. Stay safe. You may now disconnect.