Good day, and welcome to the KVH Industries Inc. Q1 2021 Earnings Conference Call. Today's conference is being recorded. This time, I would like to turn the call over to Roger Kuebel. Please go ahead, sir.

Thank you, operator. Good morning everyone, and thank you for joining us today for KVH Industries' first quarter results which are included in the earnings release we published this morning. Joining me on the call are the company's Chief Operating Officer, Brent Bruun, and CEO, Martin Kits van Heyningen. Before we dive in, a couple of quick announcements. First, if you'd like a copy of the earnings release, it is available on our website and from our Investor Relations team. If you'd like to listen to the 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 [email protected].

Thanks, Roger. Good morning, everyone. Thank you for joining us today. Our strong first quarter sustained the momentum we built during the second half of last year, exceeded many of our expectations and reinforced our confidence for 2021 and beyond. Total revenues increased 16% in the first quarter to $42.3 million from $36.6 million in the first quarter of 2020. Non-GAAP adjusted EBITDA in Q1 was $1.1 million compared to a loss of $3.7 million in the first quarter of 2020. Thanks to increasing airtime margins, strong shipments of high margin inertial navigation products and continued cost containment, we were cash flow positive from operations. We also achieved positive results in our key business areas and continued to make progress against our strategic initiatives. We set our second consecutive record quarter for VSAT shipments. We completed the shipment of a significant TACNAV order and made outstanding progress on our photonic chip technology, with the recent announcement of an all-new inertial product line for our IMUs. So, now I'm going to go into some of the details on each of our core markets. Q1 airtime revenue increased 11% compared to the first quarter of last year, driven primarily by a 7% increase in subscribers and almost a 7% increase in ARPU. While our media and NEWSlink business continues to be negatively affected by the shutdown of cruise ship operations worldwide, our revenues for AgilePlans, our Connectivity as a Service program for the commercial market, were up 48% compared to the first quarter of 2020. The continued strong demand for AgilePlans is a significant indicator of the robust health of our business. Since launching AgilePlans four years ago, we've expanded our target market to include smaller commercial vessels. This long-term growth strategy is paying off as AgilePlans amounted to 84% of our total commercial maritime VSAT shipments this quarter and 67% of total VSAT shipments. AgilePlans now represents 41% of our VSAT subscriber base.

Thanks Martin. As Martin mentioned earlier, our first quarter revenue came in at $42.3 million compared to $36.6 million recorded in the first quarter of 2020. Our consolidated gross profit margin was 37% compared with 32.1% in the first quarter of last year. Revenue from our inertial navigation segment increased $4.1 million year over year with gross margin increasing about 14.5 percentage points to 44.1%. Revenue from our mobile connectivity segment increased $1.6 million with a gross margin of 34.2%, up around 1.5 percentage points. Product revenue for the first quarter was $18.4 million, an increase of $5.3 million or 41% from $13.1 million in the first quarter of the prior year. By segment, product revenue in our inertial navigation segment increased $5 million or 77%. In our mobile connectivity segment, product revenue increased by $0.3 million or 5%. Within our inertial navigation segment, TACNAV sales increased by $4.2 million this quarter compared to the prior year's first quarter, while our FOG revenues increased by $0.9 million compared to the prior year's first quarter. The increase in mobile connectivity product sales was primarily due to a $0.4 million increase in mini-VSAT product sales. Service revenue for the first quarter was $23.9 million, an increase of $0.4 million or 2% from $23.5 million in the first quarter of the prior year. By segment, service revenue in our mobile connectivity segment increased by $1.3 million or 6%. This increase was primarily due to a $2.2 million increase in mini-VSAT broadband airtime revenue. Airtime revenue grew to $21.4 million or approximately 11% over the first quarter of last year and the related gross margin was 34%. As Martin noted, this was driven in part by a 7% increase in subscribers, primarily as a result of AgilePlans, with AgilePlans now representing 41% of all mini-VSAT airtime subscribers. The increase in airtime revenue was partially offset by a $0.9 million decline in our media business, which has been significantly impacted by the travel restrictions associated with COVID-19. In our inertial navigation segment, service revenue decreased by $0.9 million, primarily due to the prior completion of a project for a major US defense customer, which has resulted in lower contract engineering service revenue in this quarter compared to last year. Operating expenses for the quarter were $19.3 million, down 1% from $19.4 million in the first quarter of the prior year, as we have continued to hold the line on operating expenses as revenue grows.

Roger, welcome. Wanted to get a sense of what have you learned in the first few months on the job that's got you excited or got you nervous?

Yes, well I think the company has great products. We're in great markets. I've been really impressed by the team here. I think everyone's doing a great job. I'm very happy, particularly with the finance team. When you come in as the new CFO, I think you're always concerned, is everything buttoned up? I think it really is. And so I feel very good about that. Obviously I'm still learning a lot about the company. Two months is really not a lot of time to sort of learn, but I think there are great prospects ahead. I think there's a great opportunity here, and we're in a great industry. It's not like a situation where we've got an industry that's just in a terrible place and it's tough to make any money. I think we're in good spaces, we're in good markets and we've got really good products. So I think all those things are extremely positive. I think the challenge that we have is sort of executing on our strategy as we move forward and looking at our various opportunities, picking the right ones to pursue.

Okay. And the guidance was maintained, but it kind of says, assuming that early in the third quarter, we get back to a more normal level with customer activity, we're sitting here on Cinco de Mayo, which means the second quarter is almost halfway done. How should we think about the visibility of that customer return activity by early in the third quarter?

I think overall it's looking better and better. I think that it's been a couple of months since we issued that statement originally, and since then we've seen a great uptick in our demand for VSAT products, ARPU's are up, and there's a great response to our new products, so it seems like the markets are coming back strongly. The only part of our business that's still down significantly is the cruise business with our media, but rumor is that will start to pick up again in the third quarter. So I think generally everything that we thought was going to happen is on track. It looks like we should be in good shape for the second half of the year.

Makes sense. The industry has gone through some interesting items, M&A, JVs, Orbcomm got an offer to go private, ViaSat did close its Reg Net deal last Friday. How are you thinking about your balance sheet and what you see as far as opportunities in the space, given joint ventures, M&A or other items?

Yes. I think you're mentioning things that we internally think about a lot. I think that the industry is consolidating. A lot of our competitors have gone out of business, gone bankrupt, or been acquired, primarily because they had too much debt. But we've been growing market share, we're growing revenues, we have a very strong balance sheet with positive net cash. I think we're in a very strong position and we continue to evaluate opportunities, but unlike our competitors, our entire VSAT business was built with 100% organic growth. So we never required a single VSAT subscriber. We're continuing to gain market share, and we feel pretty good about where we are.

Some activist shareholders are beginning to take an interest. Could you share your thoughts on what the key pressure points are and how you plan to address them, especially in light of the board refresh announcement?

Yes. So primarily today, I'd like to talk about the Q1 earnings and the great progress we're making there. We did put out a press release announcing we have two fantastic new directors, if you haven't seen it, I'd encourage everyone to take a look at that. They have really strong backgrounds in maritime, as well as in telecommunications. We've also put out our preliminary proxy so you can get the details on that.

Our next question comes from Chris Quilty, Quilty Analytics.

Wanted to follow up on a point that you made in terms of network cost and migration. I thought last quarter you had mentioned cost savings of $4 million to $5 million, and now you're saying $12 million. First of all, is that correct?

Yes. So let me clarify that. The total network costs that we'll be shedding will be around $12 million. If every single one of those customers moves over to the HCS, we will be adding capacity on HCS in the order of, let's call it half that. So the net savings, if there were no additional subscribers, if everything stayed status quo, would be probably closer to $6 million than the $4 million to $5 million I mentioned previously. But of course, we're adding subscribers, we're adding bandwidth, but that's independent of the actual migration. So what I was talking about with the $12 million savings is, come December 31, that network is going dark and those costs go to zero, come January 1, and that's a $12 million difference.

Got you. And should we expect like a big bump in Q1 of next year in margins, and then they kind of go down a little bit as you continue to add capacity onto the network?

No, I don't expect the margins to go down. I think the margins will go up next year and then they should increase every quarter. We don't anticipate any step function increases in network costs and it will be incremental as subscribers grow. So we should see a nice bump in margins next year and that should translate into the bottom line.

And again, still sort of longer term trending towards the 40% level from what was it? 34% this quarter?

Yes. Yes. That's still a good internal metric that we use. The reason for that is that as we add subscribers, the costs per subscriber go down for us in terms of whatever the fixed costs are. Also, in terms of maintaining our competitive pricing in the marketplace, we probably won't see margins higher than 40%. We'll use that to gain additional market share. We think 40% is a healthy, sustainable margin for us.

Understand and sticking with the margin theme, product margins overall were up substantially, and I guess most of that was product mix with the benefit of TACNAV sales. But more generally, as you look across the product lines and certainly with the shift to the new pic, should we see a sustained lift in margins across many of the product lines?

Well, I'll let Roger answer that in detail, but at the macro level, we have fixed overhead and factory costs, and factory utilization is a big part of our margin calculation. What we're seeing is increased demand, both in our fiber-optic facility and in our SATCOM facility. That fixed component is going to continue to go down. Offsetting that is, we want to keep the product affordable so that we get the airtime revenue. Generally, we sell those at margins that are lower than you would for a standalone product because these products have a very long tail. The units that go out typically result in us having a subscriber for five to ten years. Our ARPU is around $1,200 to $1,250, which is a very nice business model. Therefore, we don't focus as much on hardware margins, but having said that, we do expect them to increase generally.

Yes. And I will say, I've really just started digging into this issue and, honestly, it would be premature for me to make any comments on it yet. But hopefully by the next call, I can say more regarding that.

I understand. You mentioned ARPU. I mean, typically you haven't, for at least the last couple of years, mentioned ARPU. The fact that it was up this quarter, would you attribute that to just a lift in usage patterns or is it the type of service plans that individuals are signing up for?

Well, we've seen a big increase in usage. That's number one. Number two, we have some new rate plans that are intentionally designed to be more attractive as you go up in plans. Our HCS entry points are a little bit higher than the exiting, old ArcLight legacy network entry points. I think that helps. As I mentioned, it was probably a six or 7% increase in ARPU, year over year. That number does bounce around a little bit. I wouldn't put too much importance on that, but the point is, it's going up as opposed to going down, which is a very healthy metric for us. For the last ten years, we've been monitoring to ensure that ARPUs aren't going down due to price pressure from competitors. We're really happy that it's stable and actually increasing a little.

As Martin said, the number does bounce around a bit. He also made reference to our new V30, which is a 37-centimeter product. Typically, the average 37-centimeter customer has an ARPU lower than the overall average. As we see some more success with that product, we hope to see a lot of success, it may somewhat impact your ARPU number that Martin just spoke about.

Right. That's absolutely right, even though it will drive total airtime revenues up.

Yes. And total margin dollars up.

Right.

Great. Just a question on network capacity as you shift from mini-VSAT to the HTS network. There is somewhat limited global Ku-band HTS capacity. A handful of new satellites are coming online over the next several years. Any concerns around capacity constraints and any plans in the future to add a Ka-Band type network?

Well, we don't have any plans to do a Ka network today. As you know, we also have a C-band network that we use, as well as the Ku-band network for our dual mode product, like the V11. We have Ka-band products, like our UHC7 for the satellite television market. But where we are today, we've got a lot of capacity available to us, and there are many providers who want to sell Ku-band capacity. So, I think we're in a pretty good spot today. Frankly, we'd love to be in the position where that becomes our major hurdle.

Great. And final question, TACNAV, large orders, pipeline, how's it shaping up this year?

It's, I'd say, okay. We have about 70% of our annual forecast already in backlog, which is good. We still have some to book and ship this year. I think we're about where we expected to be, but we're not done yet.

We have no further questions in the queue at this time.

Okay. Well, we'll follow up with some of the other analysts directly after this call. Thanks everyone for listening.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.