Kvh Industries Inc \De\ Q4 FY2022 Earnings Call

Hello, and welcome to the Quarter Four Year 2022 Earnings Conference Call. My name is Caroline, and I will be your coordinator for today's event. I will now hand over the call to your host, Mr. Roger Kuebel, to begin today's conference. Thank you.

Thank you, Caroline. Good morning, everyone, and thank you for joining us today for KVH Industries' fourth 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 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 [email protected]. 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 third quarter Form 10-Q filed on December 6, 2022, and our 2022 Form 10-K, which we expect to file sometime this afternoon. 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 fourth quarter, I'll turn the call over to Brent.

Thank you, Roger. Good morning, everyone. I am tremendously excited to be with you today and to discuss our remarkable turnaround and our plans going forward. In March of 2022, we set out to reshape KVH. To do so, we knew we needed to pursue several goals. First, to bring our operating expenses in line with revenue; second, to focus the company on our core businesses; third, to grow our subscriber base and airtime revenue; and fourth, to put our company on the road to sustained and increasing profitability. I'm extremely pleased to inform you that we have delivered on every one of those goals. In the fourth quarter, we achieved our first operating profit in more than six years. We divested our inertial navigation and radio businesses earlier this year. We focused all of our efforts on mobile connectivity and value-added services, including the successful launch of our unique hybrid connectivity solution and three new services that meet vital customer needs and enhance their experience. Our fourth quarter revenue was $36 million, a 2% increase year-over-year, and our operating income for the quarter was $600,000 versus an operating loss of $3.9 million in the fourth quarter of 2021. As I mentioned a few moments ago, that's our first operating profit in over six years. Additionally, our adjusted EBITDA was $4.3 million compared to $700,000 in the fourth quarter of 2021. Our airtime revenue for the quarter increased by 12% to $26.8 million with an associated gross profit margin of 43.5%. We also continue to add airtime subscribers, ending 2022 with roughly 6,900 users on our network. We continued our expansion into India, an exciting new market for us. We're currently shipping our legacy TracPhone V7-HTS systems into India, but we will shift our TracNet H-series when we receive regulatory approvals. We're also thrilled by the recent recognition of TracNet's innovative design, superior performance, and critical user benefits. We recently received the SMART4SEA Communications Award while the editors of Cruising World, Yachting, Boating, and Saltwater Fisherman named TracNet the Editor's Choice in their Best Marine Electronics award. We appreciate this recognition from industry leaders and the positive feedback and demand from our channel partners and customers. We're launching a significant new initiative that will enable us to convert VSAT antennas made by companies like Intellian and Cobham to work on our VSAT network. We will now be able to do this with no hardware changes, making conversions quick, convenient, and easy. We're currently in the process of transitioning approximately 15 new super yacht customers from a network integrator. These new vessels, all of which use third-party antennas, can potentially add $1.5 million in annual airtime revenue without any hardware changes. Additionally, we are receiving requests from a number of our airtime service providers to begin converting terminals onboard several commercial vessels. We look forward to expanding this program in the coming months. In an industry with a growing list of competitors, airtime services can't be our sole driver for growth. We offer far more than a simple data pipe. Our value-added services are a vital differentiator in the market as we provide a full future end-to-end solution. We recently launched three new services: our enterprise-grade managed firewall for enhanced cybersecurity and network management, all powered by industry leaders Fortinet; our new cloud email solution, which offers flexibility and security for fleets and crew; and expanded crew Internet services for our TracNet H-Series terminals. This is only the start of our strategic focus on value-added services. We plan to add new services through in-house development and partnerships. These additions are an opportunity to upsell our existing customers and increase the appeal for new sales. Doing so will enable us to retain and grow our subscriber base by making KVH airtime services even more integral to the operations and success of our customers. We recognize, however, that our actions are not happening in isolation. Non-geostationary orbit or NGSO services like Starlink, OneWeb, mPOWER, and others are already beginning to deliver service or are on the horizon. They offer benefits such as higher speeds and lower latency to commercial and leisure operations. But they also face challenges related to performance and coverage and the fact that they are data pipes with none of the vital features and services that seafarers use every day. Those challenges can be solved by a hybrid solution using our TracNet terminals. TracNet offers a fully integrated hybrid hub design for companion systems. The combination of our terminals with integrated VSAT, 5G, and WiFi, together with new LEO and MEO services, will enable us to offer robust, affordable, multichannel, multi-orbit hybrid solutions. That's why we are now beginning to resell Starlink high-performance marine terminals as a companion to our TracNet and TracPhone systems. We are only selling these terminals in tandem with new TracNet sales or for existing TracNet and TracPhone systems. Subscribers must have an active KVH VSAT data plan to access our advanced intelligent hybrid switching. At the same time, Starlink service activation will be handled directly by Starlink. We're anticipating adding new LEO and MEO partners as e-services launch, with the hybrid approach delivering benefits above and beyond what NGSO services offer on their own. These benefits include committed information rates for guaranteed data speeds, service level agreements for reliable performance, sophisticated end-user network management tools, multiple channels and satellites to overcome blockage and signal loss, and our expanding suite of value-added services. We believe that the future for onboard connectivity will not be a single solution or service. The future is multichannel and multi-orbit, and we are well positioned to deliver that. Looking ahead to 2023, we have set aggressive goals to drive growth, increase our subscriber base, and build long-term value for our shareholders. Among these are to expand our suite of value-added services, gain scale through organic growth, and pursue airtime subscriber growth through new hardware-agnostic approaches. All of these support our overarching vision of obtaining sustained revenue growth and consistent profitability through innovation, a commitment to superior service, and a focus on strategic and wise investments. In summary, 2022 was a challenging year for us, but one in which we made exciting forward-focused progress. We've achieved tremendous success in turning the company around financially, launching new products and services that will drive subscriber and revenue growth, and putting KVH on the road to sustained profitability. I'm immensely proud of our global team, their efforts, and their commitment that has delivered on the promises we made to our investors last March. I'm excited about our prospects for the future. And now I'll turn the call over to Roger for the financial details.

Thanks, Brent. First, I would like to note that unless specifically stated otherwise, my comments relate to our continuing operations, which exclude the results of our inertial navigation business, which was sold on August 9 of last year. With that, as Brent mentioned earlier, our fourth quarter revenue came in at $36.0 million, increasing $0.7 million from the $35.3 million recorded in the fourth quarter of 2021. Our gross profit margin was 35% for the fourth quarter, compared with 33% in the fourth quarter of the prior year. Service revenue for the fourth quarter was $28.8 million, an increase of $1.8 million or 7% from $27.0 million in the fourth quarter of 2021. This increase was primarily due to a $3.0 million increase in mini-VSAT broadband airtime revenue, primarily offset by a $1.2 million decrease in our content service sales, which was largely due to the sale of our radio business in April of last year. As Brent noted, airtime revenue grew to $26.8 million, or approximately 12% over the fourth quarter of 2021, and total subscribers reached almost 6,900. As a reminder, total subscribers include those who have temporarily suspended their primary airtime service but continue to pay minimum fees. Airtime gross margin was 43.5%, which is up 9 percentage points from the prior year. This increase is due to a combination of factors, primarily the growth in our subscriber base and the shutdown of our legacy network at the end of 2021. We are very pleased with these results. However, as I mentioned on our last call, we expect that going forward, our target for airtime margins will be in the high 30s. Product revenue for the fourth quarter was $7.2 million, a decrease of $1.1 million or 13% from the $8.2 million in the fourth quarter of the prior year. This decrease in product sales was due to a $1.6 million decrease in VSAT product sales, offset by a $0.5 million increase in TV receive-only product sales. The decline in VSAT sales was primarily due to the high level of unit sales in the prior year to customers migrating to our HTS network. We sold almost 300 units to these customers in Q4 of 2021. Operating expenses for the quarter were $12 million, down $3.6 million or 23% from the fourth quarter of 2021. While the $12 million for Q4 would seem to imply a run rate of $48 million exiting the year, there were a few unusual favorable items such that a normalized run rate would be more like $13 million. I should also note that year-over-year comparisons are difficult, as the sale of the inertial navigation business required us to estimate the allocation of prior expenses that were shared between the two businesses. Even with that taken into account, the actions we took in March and September have led to a very significant savings and have reset operating expenses to an appropriate level. At the operating income level, these changes in revenue, margins, and operating expenses resulted in a profit from operations of approximately $600,000. This was the first time since the third quarter of 2016 that KVH has had a quarterly operating profit. While this was a major accomplishment, we cannot be content with merely breaking even. Our task now is to grow profitability so that we earn an appropriate return on the capital we are using. Our bottom line net income from continuing operations was $0.6 million compared to the prior year's net loss of $2.7 million. EPS for the fourth quarter was a net profit of $0.03 per share compared with a net loss of $0.15 per share in 2021. You will note that we are no longer reporting non-GAAP income or EPS, as we have come to believe that it is a less reliable metric given all the subjective assumptions required to measure it. Our adjusted EBITDA for the quarter was a positive $4.3 million compared with a positive $0.7 million in the fourth quarter of 2021. 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 $10.4 million. However, I need to caveat that by adding that changes in working capital provided $5 million to $7 million of that, due to an unusual increase in accounts payable at year-end. Without the change in working capital, cash from operations would have still been over $4.6 million. Capital expenditures for the quarter were $3.4 million. So even without the benefit from working capital, our operational cash flow, including CapEx, was positive by over $1 million. Cash used in investing activities, other than CapEx, was $0.5 million, and cash provided by financing activities was $0.1 million, resulting in an ending cash balance of approximately $76 million. We expect that to come down in the first quarter as our accounts payable returns to a normal level. Before wrapping up 2022, I'd like to take a moment to reflect on what has been accomplished. In 2021, the company had an operating loss of $20 million, which followed a $23 million loss the prior year. When we announced the restructuring and new strategic direction in March of 2022, we set a goal of breaking even in the second half of the year for operating profit, assuming that supply chain problems didn't persist. Unfortunately, they did. However, despite that, we only came up $400,000 short and we turned an operating profit in Q4 without any big windfall. While, as I said earlier, we can't be content with just breaking even, I hope you agree that this was a pretty amazing turnaround, and it was all due to the hard work of a dedicated leadership team and amazing employees. 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. Caroline, please proceed with Q&A.

We will take the first question from Chris Quilty.

Congratulations, guys, and impressive EBITDA guidance for the year going ahead. Just maybe, Roger, if you can talk through, obviously, we know the revenue assumptions, but are there additional cost-cutting actions? Or have you just found that the run rate on the OpEx has been better than expected? Because if I understood correctly, you're still sort of guiding margins to the same level.

Yes. I think we were pretty conservative when I gave the guidance back when we did the March announcement, and I think maybe it was in response to a question, I said we were expecting like $5 million to $6 million. It's actually turned out to be more like up closer to $10 million. So that's been good. We don't see any sort of restructuring going forward. Obviously, we reserve the right to make changes in the business just as any normal business would regarding costs. But in terms of structuring the business, we feel like we're now in a good position. We did some work and made some changes in September after we sold the inertial navigation business, but now we feel like we're in a good position. We've got the right team in place, and we're going to move forward with the initiatives that Brent talked about.

Got you. And so maybe just shifting gears, over to a little bit more high level, and excuse me, I'm at the satellite show now, and one of the bigger topics here has been Starlink and their enterprise rollout. They have a very aggressive model that they're working with partners, not a lot of ways for them to give profitability to the channel. As you look out and guide the expectations for next year, does that Starlink to the degree we see broader adoption impact your overall reported margins? Or do you see ways to offset that with the bundled services that you offer associated with the Starlink service?

Yes. Chris, it's Brent. It's primarily the latter. It's the bundled service. It's the full feature of services that we provide. We're being a bit conservative regarding airtime margins, as Roger alluded to. The main reason for the margin conservativeness is in anticipation that we might have a bit of erosion, but we're hopeful that we can avoid it.

Got you. So the other big trend or the largest announcement here was Amazon coming out with their new antennas, electronically steel flat-panel antennas, and they're implying costs in the hundreds of dollars, whereas typically with VSAT terminals, we're talking five figures. Where do you see the technology evolution on the antenna side going in the future, both in terms of pricing and type of units used? But in the maritime market where you guys live and work every day, can a flat-panel antenna actually deal with the maritime environment, given ships move around a lot and there's a lot of roll-off with those flat-panel antennas? Or are they simply cheap enough that you're going to blanket the deck with multiple antennas so that you've always got a look angle? Is that a reasonable way to think about it? Or are there challenges from a wiring engineering perspective that flat panels will be more of a marginal technology in the long term?

I'll let Bob answer the detailed question. But I think you correctly summarized the situation. If you have one, you probably have a lot of roll-off, and if you have space where you can have multiple and you can switch from one to the other, you could probably mitigate that quite a bit. But I'll pass it to Bob to elaborate.

Yes, the solution we are currently pursuing is a hybrid integration of those panels into our systems. The reason for this is that you might have multiple antennas on a vessel, but you typically need at least five panels to adequately cover your pitch and roll. Moreover, it’s not just about pitch and roll; there are also geographic coverage limitations and issues with blockage. Therefore, for commercial or high-reliability applications, it is essential to ensure connectivity. We will continue to integrate these panels into our existing solutions and are confident that this will deliver the best and most reliable outcome.

Great. And when you think about the macro environment here with COVID ending in China, shipping demand is picking up. Where are you seeing demand signals of strength on the maritime side? And in terms of the leisure market where you've had a good position, again, to flat panels, I think certainly in the RV market, you've seen some challenges there. But in the broader consumer market or consumer leisure, do you see any different metrics in terms of the enterprise where clearly operational performance matters and targeting the consumer market might be more successful for something like a Starlink or a Kuiper service?

I would say, to answer your last question, that market is most exposed from our perspective to shifting over to some of the new services. You had a question to begin with as to where do we see new market opportunity. As I alluded to, India is a huge market, and they have just recently enabled Ku-band VSAT in that market where it has been an L-band market for a number of years. And as we move on, talking about L-band, there's still a tremendous number of L-band terminals out there that are still transitioning to better communication systems.

Is there sufficient capacity? Because ISRO has historically been the sole capacity provider. I know there have been many challenges for operators to actually get Ku capacity to provide services in that market.

Yes, yes. Through our partnership with Intelsat, we're completely set regarding capacity.

Got you. And is there a prospect for new capacity coming online in the future that you can actually drive some incremental growth in that market?

There is going to be new capacity coming online, whether it comes from Intelsat or others. You see how many satellites are under construction, whether it's geo or NGSO. So I don't think capacity is a concern.

Okay. Great. And thank you for the feedback.

We will take the next question from Ryan Koontz from Needham.

Real quick clarification. You talked about that $5 million to $6 million becoming $10 million. That was the EBITDA from the cost adjustments you made.

No, it was the savings from the reduction in operating expenses, which relates to the comment I made earlier or last year, when we still had inertial navigation.

Got it.

Yes. So it's OpEx.

Got it. And then if you could dive down for me a little bit on the kind of the value proposition of Starlink versus your VSAT product. Is Starlink a lower cost per bit? Does it provide additional coverage? Can you clarify how it fits in the value prop there for the Starlink partnership?

Yes, it's a lower cost per bit and has slightly lower latency, but there can be issues with dropouts, packet loss, and jitter. The combined service with what we already provide—a strong service—integrated with our geo, LTE/5G, and WiFi will deliver a robust offering. I mentioned some of our back-end tools and the service level agreements that come together through the VSAT component of our offering. Would you like to add anything?

Yes. I mean, it's kind of to follow the concept behind our H-Series products, right? We're delivering VSAT services with those products. And when available, we're latching on to 5G or LTE services because that will give the end user a little better throughput and performance. And when available from there, we'll also bridge over to available marina WiFis. If you think about this concept, if you have a Starlink available and it's working in the marina, why not use it? Why not give the user that opportunity? The real value that we add is the way we actively monitor, switch, and make all of this happen seamlessly, so that no one has to think about it. No one has to worry about switching connections or what's available. We just make sure that the end user experience is the best it can possibly be.

Got it. That's really helpful. Do you also manage the Starlink subscription and billing?

No. As I mentioned in my remarks, the activation for the Starlink terminal will be handled between the end user and Starlink directly.

Got it. That's helpful. And you talked about some development partners as well in terms of bringing new products to market. Can you clarify what sort of applications that will help you in?

It's value-added services to make onboard operations more efficient. We can't really go into a lot of details at this point, but we will in due course.

It's probably sufficient to say we're looking at partners. We've mentioned Fortinet a few times, security, and firewalling—that's what they do best. They do it on large-scale commercial networks, so we want to look for applications and value adds that are being developed for a broader market and then bring them to the marine specialization of what we're delivering. We want to make sure we're utilizing best-in-class technology rather than trying to develop something and do it on our own. Often, some of that just needs to be adapted.

Sure. That's kind of enterprise caliber. Got you. That's really helpful. That's all the questions I had. Congrats on the operating profit, really great work today.

Thank you. There's no further question at this time.

Okay. All right. Well, thank you, operator. Thank you, everyone. Given that there are no questions, I appreciate everyone joining the call today. Thank you, and have a good day.

Thank you.

Thanks, everyone.

Thank you for joining today's call. You may now disconnect.