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KVH Industries, Inc. (KVHI)

Q2 2022 Earnings Call· Tue, Aug 9, 2022

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Transcript

Operator

Operator

Hello. My name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to the KVH Industries Reports Second Quarter 2022 Results Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Roger Kuebel. Please go ahead, sir.

Roger Kuebel

Analyst · Raymond James

Thank you, Lisa. Good afternoon, everyone, and thank you for joining us today for KVH Industries second quarter results, which are included in the earnings release we published within the past hour. Joining me on the call are the company's Chief Executive Officer, Brent Bruun; and Chief Technology 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 at www.kvh.com on the Investors page, which can be found by clicking on About KVH, then Investors and then scroll down to the Recent News section. This is also available 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. Finally, this conference call will contain certain forward-looking statements that are subject to numerous risks, assumptions and uncertainties that may cause our actual results to differ materially from those expressed in these statements. We encourage you to review the cautionary statements made in our earnings release and in our SEC filings, specifically those under the heading Risk Factors in our 2021 Form 10-K, which was filed with the SEC on March 11. The company's SEC filings are also available on the company's website in the Investors section, under Financial Information, then under SEC Filings. We undertake no obligation to update or revise any forward-looking statements. We will also discuss certain non-GAAP financial measures, and you'll find definitions of these measures in our earnings release as well as reconciliations of these non-GAAP measures to comparable GAAP measures. Now to walk you through the highlights of our second quarter as well as an important recent development, I'll turn the call over to Brent.

Brent Bruun

Analyst · Raymond James

Thank you, Roger, and good evening, everyone. I'm pleased to share positive results regarding our second quarter and plans for the future. Q2 is a transition period for us, the first full quarter since our restructuring in March. We finalized our leadership and operational reorganization, recorded the remaining material expenses from the restructuring and launched a wide array of new initiatives that reflect our commitment to the future by strengthening our core business through subscriber growth and innovative new products, improving efficiencies for our employees and generating increased value for our shareholders. We've made significant progress in many areas. We have a stable and engaged workforce with limited turnover, and we've introduced new connectivity products that offer unique solutions to mariners. Financially, our revenue was $41.8 million, down from $43.4 million in 2Q last year. Supply chain challenges led directly to the year-over-year decline. We recorded a loss of $1.4 million for the second quarter. This is a significant improvement over last year when we recorded a loss of $5.7 million. Our adjusted EBITDA was $4.1 million, the highest in 5 years. Based on these results and progress in our mobile connectivity business, we entered the third quarter with a robust foundation and a sustained and growing company. Earlier today, we announced the sale of our inertial sensor and tactical navigation business to EMCORE. This is an all-cash deal for $55 million, includes the Tinley Park factory and all inertial navigation intellectual property. In addition, EMCORE has offered employment to all current inertial navigation employees. We are very proud of our innovations and progress after purchasing this business in 1997. However, mobile connectivity has always been our primary business and key driver for revenue and growth. Our commitment and investment in this market is our top priority. Our new technology…

Roger Kuebel

Analyst · Raymond James

Thanks, Brent. As Brent mentioned earlier, our second quarter revenue came in at $41.8 million compared to $43.4 million recorded in the second quarter of 2021. Our consolidated gross profit margin was 37% for the second quarter as compared with 35% in the second quarter of last year. Revenue from our mobile connectivity segment increased $0.8 million with a gross margin of 41%, up 7 percentage points. Revenue from our inertial navigation segment decreased $2.3 million year-over-year, with gross margin decreasing 24 percentage points to 16%. Service revenue for the second quarter was $28.3 million, an increase of $2.2 million or 8% from $26.1 million in the second quarter of last year. By segment, service revenue in mobile connectivity increased by $2.2 million or 9%. This increase was primarily due to a $2.7 million increase in mini-VSAT Broadband airtime revenue. As Brent noted, airtime revenue grew to approximately $25.8 million or approximately 12% over the second quarter of last year despite a 1% decrease in active subscribers as a result of the shutdown of our legacy network on December 31, 2021. Total subscribers, which includes those who are temporarily suspended, was up 1%. As a reminder, suspended subscribers are typically recreational customers who aren't using their boats during the colder months. While we refer to them as suspended, they all still have access to voice services for which they pay by the minute. In addition, Agile customers who suspend also pay a modest monthly fee for the equipment that KVH owns that is on their vessels. Airtime gross margin was 43%, which is up 8 percentage points from a year ago. This increase is due to a combination of factors but is primarily driven by the shutdown of the legacy network. Product revenue for the second quarter was $13.6 million,…

Operator

Operator

[Operator Instructions] Your first question comes from the line of Rick Prentiss with Raymond James.

Ric Prentiss

Analyst · Raymond James

I want to walk through a couple of things. I think I got some at the very end there. If we think about selling the inert business, it sounds like not much EBITDA effect. If I remember right, previous '22 guidance was for $11 million to $15 million for the total company, and you're still assuming about $11 million to $15 million, just the mobile connectivity and corporate. Is that the right way to think about it?

Roger Kuebel

Analyst · Raymond James

Correct. Now just recall that for the full year, it does include 7 months of inertial navigation in it.

Brent Bruun

Analyst · Raymond James

And we've had some good uptick in the airtime business and this 43% profit margin.

Ric Prentiss

Analyst · Raymond James

All right. Is there a way to kind of pull apart and say how much in 2021 actual did the inertial business contribute to adjusted EBITDA? Is there a ballpark frame of reference of what that number was?

Roger Kuebel

Analyst · Raymond James

I have to -- yes, if you had another question, let me look for that while you're -- if you got something else, and I'll come back to that.

Ric Prentiss

Analyst · Raymond James

We've got plenty. The inertial nav business, is that where the autonomous vehicle segment was as well? So when you say the IP is going over with that, is that whole piece of the business then going over to EMCORE?

Brent Bruun

Analyst · Raymond James

Yes. Yes, that's correct.

Ric Prentiss

Analyst · Raymond James

Okay. And what are you expecting the after-tax gain to be on the $55 million sale? Or is there some way to get into what the basis was to understand what your net proceeds would be on the sale?

Brent Bruun

Analyst · Raymond James

I think we need to do a bit of calculations, but we do have a fair amount of credits to roll for it.

Roger Kuebel

Analyst · Raymond James

Yes. As far as -- if you're trying to get at the tax implications, given the net operating loss carryforwards that we have, there's research credits that we have, and there's also foreign tax credits that we have, so we think that at the federal level, we are -- we haven't gone through it. We haven't filed yet, but we think at the federal level, the tax impact is going to be very minimal.

Ric Prentiss

Analyst · Raymond James

And then there will be some state level...

Roger Kuebel

Analyst · Raymond James

It could be something at the state, but we're not expecting that to be huge either. But to get back to your question, the -- as we look at sort of gross margin for inertial nav, first half was around $3.7 million. EBITDA, if you take out the expenses that are -- other expenses that are directly related, I'm not adding back depreciation, which I don't think was a huge item for inertial nav, but it's probably in the 3 to 4 range.

Ric Prentiss

Analyst · Raymond James

Okay. That's helpful. The -- when you think about the use of those proceeds, which [ at that time they're up ] pretty significantly or at least closer to 55. You mentioned strategic alternatives as well as possibility of return to shareholders. What are you thinking that might be interesting from a strategic alternative standpoint because you've got -- I think you said $16 million cash on the balance sheet. Maybe you're bringing $50 million plus. So you're going to have closer to almost $70 million of cash on the balance sheet, which is maybe $3.50 a share. But how should we think about what you might want to be looking at to use that cash for?

Brent Bruun

Analyst · Raymond James

Yes. Right now, we're [ sponsoring ] assessment with our Board of Directors and advisers. And we're determining what we think will be the best path forward. We're not in a position to provide more details at this time.

Ric Prentiss

Analyst · Raymond James

Okay. Understand. Is that something you think that you'll be able to lay out? Is that a 1-quarter process? Is that a 1-year process? I mean how should we think about timeframe as far as when you guys will figure out what you want to do with it versus when you're able to communicate to the Street what you'd like to be able to do with it?

Brent Bruun

Analyst · Raymond James

I would think that -- I don't know if it's a 1-quarter process, but it will be less than a year. That's for sure. So probably more towards the fourth quarter.

Ric Prentiss

Analyst · Raymond James

Great. I'll come back if I have some more questions. I'll give the floor now.

Operator

Operator

Okay. Your next question comes from the line of Ryan Koontz with Needham & Company.

Ryan Koontz

Analyst · Ryan Koontz with Needham & Company

Financial questions. On the navigation business sale, how should we think about the impact on OpEx there, Roger?

Roger Kuebel

Analyst · Ryan Koontz with Needham & Company

I think that inertial navigation from a back office standpoint is sort of not as complicated as the mobile connectivity business. There are a number of people who are transitioning over with the sale. They are primarily on the sales and the R&D side. There is someone from finance and someone in marketing that's going over. But the majority of the folks are here who are staying, who are in the sort of the G&A function for the majority. And so I think that's something that I don't have any guidance that I can sort of provide you specifically on that. But I think Brent's comment -- or my comments around what our EBITDA targets are. We're confident that we're still going to have a good year.

Ryan Koontz

Analyst · Ryan Koontz with Needham & Company

Okay. Great. And on the -- kind of how should we think about the subscriber trends? You talked about 6% to 9% growth on airtime revenue. Is that mostly -- are there any geographic kind of areas you're looking at growth there or different kind of strategic initiatives as you double down in this area that you can expand your reach?

Brent Bruun

Analyst · Ryan Koontz with Needham & Company

As far as growth, we're pretty evenly distributed from the commercial maritime perspective between the EMEA, Americas and Asia Pacific region, probably a little bit more heavily loaded in Asia Pac. And then we also have a pretty robust leisure marine business. We're seeing good uptick in ARPUs with the HTS network and hence why we saw the year-over-year revenue growth without the true subscriber growth. But now that we're -- we anticipate seeing more of a sync up between subscriber growth and airtime growth now that we're -- we have all of our subscribers on one network.

Operator

Operator

Your next question comes from the line of Caleb Henry with Quilty Analytics.

Caleb Henry

Analyst · Caleb Henry with Quilty Analytics

Two questions from me. First, the supply chain has come up on, I think, the past few calls. Wondering if there are any steps that are being taken or perhaps could be taken to kind of get a handle on or control those costs? I realize it's probably out of your control, but is there anything that you guys are trying to do to kind of tame those costs or issues?

Roger Kuebel

Analyst · Caleb Henry with Quilty Analytics

Well, we do a variety of things. I mean we -- one of the things we do is we obviously -- we look at redesigning around some of these things. So to the extent that products become unavailable, we look at what our alternatives are for -- particularly -- and this is kind of chip related. There are certain chips that become unavailable. But there are other chips that will work, but we have to sort of redesign -- rebuild the software to make that work. So we look at those things. We're kind of doing probably a lot of things. The same thing a lot of people are doing. We're looking at alternate sources of supply, but it's still -- it's just tough. And I think you're probably hearing this from a lot of companies. We're in a similar boat. And also, we're not a huge buyer from a lot of these suppliers. So that makes it -- it makes it tough to sort of -- when things are tight in these kind of situations, getting any kind of preferential treatment is tough when you're not a Fortune 500 or Fortune 50 company.

Caleb Henry

Analyst · Caleb Henry with Quilty Analytics

Yes, I understand. And then just a question on the future of your satellite network. You mentioned subscribers moving over to the HTS network. Are there plans to add additional capacity to that anytime in the near term or any other just additional infrastructure? And then especially given the rollouts of NGSO constellations in LEO and MEO, how are you thinking about having a multi-orbit capacity as part of your network?

Brent Bruun

Analyst · Caleb Henry with Quilty Analytics

Well, first and foremost, we add capacity on a regular basis as is required. So that's something that we have a very good footprint and robust footprint. And we just go deeper as we need it as far as number of subscribers anticipated in any particular area. As demonstrated through the launch of our HTS network, we're somewhat network-agnostic to a degree, although it takes some effort to change networks that we've gone from our legacy network, which is on ArcLight, and now we're operating our HTS network. And we're having good success there. We're keeping our eyes wide open with regard to NGSO. We haven't made any definitive plans to what our next move is, but we're assessing what different opportunities are in the market. And as we go forward into the future, we'll be sure to be on the forefront of any changes that -- in the market in order to make -- in order to remain competitive.

Caleb Henry

Analyst · Caleb Henry with Quilty Analytics

Okay. And then just one more question actually, if I can add on. There's been a fair deal of consolidation and rumored consolidation amongst the big satellite operators. There's ViaSat and Inmarsat. There's Eutelsat and OneWeb and possibly Intelsat and SES. What, if any, impact does this consolidation have? Or what does it mean for KVH?

Brent Bruun

Analyst · Caleb Henry with Quilty Analytics

Right now, we're paying attention to everything that's going on in the market, as demonstrated with our most recent results, but we're remaining very competitive. But we need to -- we need to figure out what the best path forward is and how to maximize shareholder value. So right now, we feel that some of the moves we made in particular of divesting the inertial navigation business and looking for strategic alternatives on a go-forward basis, which, as I said to Ric, we can't go into a lot of details on, is we're going through an assessment process. I don't know what the future holds.

Operator

Operator

Your next question comes from the line of Ric Prentiss with Raymond James.

Ric Prentiss

Analyst · Ric Prentiss with Raymond James

I come back with a couple of extras. I think, Roger, you mentioned mobile connectivity revenue growth, 6% to 9% pro forma for -- adjusting for the radio sale. Was that about $0.6 million in revenue a quarter then we should kind of take out for 1Q? And I think the sale was -- was that the very big [ difference ] that you had in Q2?

Roger Kuebel

Analyst · Ric Prentiss with Raymond James

Radio, yes. Radio was about $2.3 million a year in revenue.

Brent Bruun

Analyst · Ric Prentiss with Raymond James

Yes. So I didn't hear his number. Yes, but roughly $600,000 a quarter, if that's what you said.

Ric Prentiss

Analyst · Ric Prentiss with Raymond James

Okay. Good. And then I appreciate the metrics on subscribers. It sounds like you're going to continue to report that. No good deed goes unpunished. Are you going to be able to help us understand how many of those subscribers are Agile customers so we can kind of monitor what's going on in that front?

Brent Bruun

Analyst · Ric Prentiss with Raymond James

I don't have the number readily available. You can give it as a -- okay.

Roger Kuebel

Analyst · Ric Prentiss with Raymond James

As a percentage, I mean, Agile as a percentage of total subscribers at the end of Q2 was a bit over 50%.

Ric Prentiss

Analyst · Ric Prentiss with Raymond James

Okay. And last year, that's similar kind of percent number?

Roger Kuebel

Analyst · Ric Prentiss with Raymond James

As of a year ago, it was less than 50%.

Ric Prentiss

Analyst · Ric Prentiss with Raymond James

Okay. And following on the previous question, how should we think about R&D spending? Because obviously, the inert side had a lot of R&D, but there's some obviously that needs to continue probably on mobile connectivity as you develop the new products and new services. How should we think about that kind of correct run rate that you want to spend, whether it's a dollar value or a revenue -- or a percent of revenue value in the remaining business?

Roger Kuebel

Analyst · Ric Prentiss with Raymond James

Well, I think we want to look at what are the projects that are going to create value for shareholders. And I think as we look forward, one of the questions that came up was an NGSO strategy, and that's something we've got to think about and what's the right way. So in terms of what we -- how big the R&D is going to be, what we need to do is something we need to sort of understand what the future -- what we think...

Brent Bruun

Analyst · Ric Prentiss with Raymond James

[ What the ] future holds. But as far as a run rate perspective, the R&D that we report -- and we break that out separately. And that was part of our restructuring that we pulled it down a bit. We wouldn't anticipate pulling it down further. We anticipate keeping that in place. But with the inertial navigation, we do have a bit of our engineering team which went with that business. And when we report mobile connectivity individually, you'll see an R&D number. I don't know if we have that readily available. And this is all happening so fast, splitting out a certain number of employees.

Ric Prentiss

Analyst · Ric Prentiss with Raymond James

Yes. That makes sense. And obviously, the deal closed -- signed and closed today. On the question then on MGOs. What services are your customers asking for that you think require low latency? On ViaSat call last night, there was a debate on how much low-latency service is actually needed. Do you need other network for it? But what kind of services are you anticipating that needs low latency that your customers might want just so we can kind of keep our ears open?

Brent Bruun

Analyst · Ric Prentiss with Raymond James

Yes. I mean really, it's -- you're 2-way video chatting, right? And that's really about the biggest thing that I'm hearing. A lot of people are doing Teams, for example, or Zoom on board vessels. And the latency does have a bit of an impact on that, but still not that much. What are we talking, 700 milliseconds...

Unknown Executive

Analyst · Ric Prentiss with Raymond James

Not much. It's not a game changer, so like the average person would really -- would make that a buying decision...

Brent Bruun

Analyst · Ric Prentiss with Raymond James

I think a lot of the GSO comes down to cost per bit delivered, right? And if we can do it at a cheaper rate and higher speeds, latency aside, it's more of the focus from our perspective.

Ric Prentiss

Analyst · Ric Prentiss with Raymond James

And final one for me. You guys have been in the satellite space a long time. What do you attribute finally the logjam maybe clearing and getting several mergers, consolidations, combinations together? What do you think is driving that? And how do you see that affecting just the industry at large rather than just KVH?

Brent Bruun

Analyst · Ric Prentiss with Raymond James

That's a good question. I can almost -- you study the industry pretty closely yourself, Ric. So what do you think the answer is?

Ric Prentiss

Analyst · Ric Prentiss with Raymond James

We'll take that one offline. But I think clearly, it depends which transaction you look at. Some people have cash cow. Some people need cash. Some people are trying to figure out how to pivot the business to get to growth. And some people, like we see with kind of the pay TV business, it's a declining business. How do you manage that, how do you take out costs and how do you get positioned for growth is probably a lot of what people are trying to figure out.

Brent Bruun

Analyst · Ric Prentiss with Raymond James

Yes. I mean if you look at the pay TV business, you look at the traditional FSS operators and their media businesses have come down quite a bit. SES just reported a 7% decline in their media business and a 2% increase in their network business, which obviously, that means a contraction in revenue. And I think that might be something that's pushing them. If they have a decrease in revenue on a year-over-year basis, they might need to create some more synergies, and maybe that's what's stimulating some of the merger talks between them.

Ric Prentiss

Analyst · Ric Prentiss with Raymond James

Good to see it finally. Good to see the logjam finally happening where people realize that it's a high-cost business. They got to make sure how to earn their returns.

Brent Bruun

Analyst · Ric Prentiss with Raymond James

Right.

Operator

Operator

And at this time, there are no further questions.

Brent Bruun

Analyst · Raymond James

Okay. Thank you, operator. Thank you all. Have a good evening.

Operator

Operator

This concludes today's conference. You may now disconnect.