Kvh Industries Inc \De\ Q3 FY2023 Earnings Call

Good day and thank you for standing by. Welcome to the Q3 2023 KVH Industries Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your first speaker today, Roger Kuebel, Chief Financial Officer. Please go ahead.

Thank you, operator. 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 earlier this morning. Joining me on the call are the company's Chief Executive Officer, Brent Bruun; and Chief Operating Officer, Bob Balog. Before we dive in, the usual announcements. First, if you would like a copy of the earnings release or if you would like to listen to a recording of today's call, both 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, which is a non-GAAP financial measure. You'll find a definition of this measure in our press release as well as a reconciliation to comparable GAAP numbers. We encourage you to review the cautionary statements made in our SEC filings, specifically those under the heading, Risk Factors in our 2022 Form 10-K, which was filed on March 16 and Form 10-Q, which we plan to file later today. The company's other SEC filings are available directly from the Investor information section of our website. Now, to walk you through the highlights of our third quarter, I'll turn the call over to Brent.

Thank you, Roger. Good morning, everyone. Let me start by saying, KVH is on the right track, thanks to our successful efforts over the last year and a half. We divested non-strategic businesses, rightsized our staff in 2022 to focus exclusively on mobile connectivity products and services, grew our subscriber base by more than 1,000 vessels and maintained a debt-free balance sheet. In our most recent quarter, our airtime sales grew 3% year over year and we maintained our airtime subscriber base at roughly 7,100 vessels, a slight dip from the all-time high we hit last quarter. Although we are pleased with modest year-over-year growth, it is a bit lower than past quarters due to increased demand for competing data and content streaming services. We are now focused on positioning KVH within a rapidly changing marketplace. Ever since we entered the satellite space with our maritime TV receive-only antennas and then with our VSAT terminals and network, we have succeeded against traditional competitors due to four key differentiators. First, our proprietary terminals; second, our geosynchronous VSAT network; third, our CommBox Integrated Network Management tools; and fourth, our outstanding global service and support. However, the market has changed as communication solutions require faster speeds, highly competitive data rates, lower cost terminals, and multiple communication options. We believe we are well positioned to maintain our mobile connectivity leadership role as we continue our ongoing strategic evolution as an integrated solutions provider. This evolution includes a terminal-agnostic approach that permits us to integrate our VSAT and satellite terminals with new and emerging hardware from Starlink and other manufacturers. A multi-network approach that includes integration of our global VSAT network with cellular, Wi-Fi, LEO, and other services; our seamless approach to network management that delivers versatile bandwidth management tools along with cybersecurity and value-added services; and of course, our global service and support capabilities. In recent months, we have made two major strategic moves critical to our future growth. First, we strengthened our position as a multi-orbit multichannel integrated solutions provider when we entered into an agreement to be a Starlink reseller. We are now offering Starlink both as a standalone solution and as a hybrid companion with our TracNet, TracPhone, and OpenNet terminals. We are activating Starlink terminals through KVH's airtime services group, providing 24/7 live technical support and working with leisure boaters, commercial customers, and boat builders to deploy the Starlink service as part of a comprehensive KVH Solution. Second, we entered into an exclusive maritime distribution agreement with Kognitive Networks, giving us access to their dynamic suite of network and bandwidth management tools. This agreement expands our network management portfolio, which already includes our CommBox bandwidth management suite of services and manage firewall from Fortinet. The Kognitive technology enables us to seamlessly integrate communication channels aboard commercial and leisure vessels, such as LTE, 5G, VSAT, Starlink, and Wi-Fi. We can also deliver sophisticated dead network and bandwidth management for shipboard operations, crew owners, and guests over the KVH ONE global hybrid network. I believe this new technology and service will be integral to KVH's multi-orbit multi-channel communication solutions. We are excited by these two strategic moves and their implications for our long-term strategic direction. Our arrangements with Starlink and Kognitive Networks are examples of how we will continue to expand our position within the Mobile Connectivity market. Looking ahead, we will continue to leverage our strong distribution channel while drawing on our large pool of AgilePlans terminals, which will help us reduce CapEx going forward and support our continued focus on free cash flow. We also plan to continue our efforts to adapt to the changing competitive environment by adjusting our operations to improve profitability where we can. I'll now turn it over to Roger, for some context regarding our results.

Thanks, Brent. First, I would like to note that unless specifically stated otherwise, my comments with respect to Q3 of last year relate to our continuing operations, which exclude the results of the Inertial Navigation business that we sold in August last year. Also, in a change from prior calls, I will not restate data that is in the earnings release or clearly described in our 10-Q. I'll focus my comments on information that either elaborates on or clarifies the published data. Therefore, airtime gross margin, which is not called out in our earnings release, was 42.4%, down from 44.0% last year. However, due to a number of factors, it is still above our near-term expectation of high-30s, which has not changed. Total subscribers were up about 4% from Q3 of last year. However, growth has slowed in Q3; ending subscribers were basically flat from the end of Q2. Product gross profit was negative by about $600,000, and while the MD&A section of our 10-Q describes the change from Q3 of last year, the primary driver of the negative margin was low unit volumes. Operating expenses excluding the impairment charge were $11.6 million. We expect that will tick up in the fourth quarter as we filled several key positions and we also have some normal seasonally higher OpEx in Q4. As such, we continue to expect the normal quarterly run rate to be between $12.5 million and $13 million. The impairment charge of approximately $6 million represents a write-off of all the company's remaining goodwill, as well as approximately $660,000 of Media Group assets. This charge is described in detail within the footnotes in our 10-Q. However, just to clarify, it was non-cash and driven by the decline in our stock price in August when the market value of our equity fell below the book value of our net assets. Our adjusted EBITDA for the quarter was a positive $4.5 million, and our earnings release has the usual reconciliation of that. Capital expenditures for the quarter were $2.4 million, and so adjusted EBITDA less CapEx was positive by over $2 million. Our ending cash balance of $69 million was down $1.8 million from the beginning of the quarter. However, that decrease was due to increases in our inventory and prepaids. So without those, our cash balance would have been up by more than the amount of our interest income. With respect to the full year, given that adjusted EBITDA for the first nine months was $12 million, we are increasing the low end of our guidance from $12 million to $13 million, giving a new range of $13 million to $15 million. For total revenue, we are also narrowing the range to $133 million to $136 million. This concludes our prepared remarks, and I will now turn the call over to the operator to open the line for the Q&A portion of this morning's call. Operator?

Thank you. At this time, we will conduct the question-and-answer session. Your first question comes from Chris Quilty of Quilty Space. Your line is now open.

Thanks, gentlemen. I wanted to follow up a little bit on Starlink. I think originally your plan was to only bundle that with the KVH VSAT suite. It sounds like you're now selling that individually. I have two questions. One, what drove that change? And number two, can you just remind us, when you sell Starlink hardware that is sold at basically no margin, so really it's only the services associated with that. So if you're selling Starlink alone, are you able to actually wrap in services?

Yeah. Hi. Good morning, Chris. To answer the first part of your question, we felt there was a requirement to sell it as a standalone service, particularly for Leisure Marine. Leisure Marine users aren't as focused on having a bundled solution along with the VSAT. So, the majority of our activations that have been standalone have been Leisure Marine. Regarding your second question, yeah, the margins are rather tight. We do add a few other components that aren't necessarily included, such as a longer length cable and other types of options. We do that the installation and we provide other value-added services onboard.

Got you. So, the year-over-year having the subs about flat, is there something seasonal or is it really just a Starlink impact? And I guess a question on how you treat those Starlink subs? Do they count as subs for your total, or do they not count since you're not doing the service revenue?

At this point, they're not a factor as far as our overall subscriber count. We just entered into the arrangement with Starlink at the end of September. So, regarding third-quarter results, Starlink terminals are not included in those subs. As we go forward, we very well may break those out separately. We haven't really crossed that bridge yet.

Got you. Kognitive, could you provide some background on our relationship, the choice to pursue an exclusive agreement, and what was sacrificed to obtain that exclusivity? How does this position you compared to other players in the market? It seems that Starlink provides very little, while many of your larger competitors offer more comprehensive solutions. Do you see this as a significant advancement, or is it simply a way to match what your competitors are doing?

I think it's a bit of both. It's definitely an advancement in our multi-channel multi-orbit strategy, which involves integrating various communication channels. Their network can perform many activities that our core CommBox technology couldn't, like channel bonding, which is vital. They can utilize multiple channels on the vessel, allowing us to seamlessly incorporate competitors' VSAT. We have our own VSAT and our CommBox technology integrated into our design. However, when we integrate terminals from other manufacturers, it allows us to offer onboard bandwidth management tools that are actually more sophisticated than what we previously offered with our CommBox services.

Got you. And the relationship there, how did you come together with them?

They have been active in the maritime market. I have been involved in the satellite industry for a considerable time and am familiar with the market, including GOGO. We collaborated with them concerning some standalone airtime customers who transitioned to our network, discussing competing terminals. This was a natural progression.

Got you.

Yeah. Hey, Chris. An easy way to think about it is, of course, for years we've had CommBox and built-in switching in the H-series to switch between different WAN channels, and it provides a really decent functionality. It automatically does the switching, keeps you connected, and keeps your user experience always in a state where you're online. What the Kognitive Networks devices do is they are really the next generation step up as far as network management goes. They are providing a tiered layered offering. When you upgrade to that performance, now you're getting shared channel bonding, you're getting channel balancing, and that stuff is super important when you throw on multiple, say, and a larger boat multiple Starlink terminals, where you've got blockage on one or the other and you want to make sure the experience stays seamless. They also allow us to provide not just application filtering and data usage monitoring but also allows us to do it all the way down to the device level. So, for example, we could lead one of the ships to turn off a crew member that was using up too much data on a specific application. So, there are several tiers of that offering. So, really, what we're doing is going strong into the value-added services to layer all of that stuff on to give the customers exactly what they're looking for in levels of performance.

Great. That's a good detail. Switching gears on the hardware, we've run negative margins for several quarters now. Do you see a path forward to getting back to profitability? Or are you engaging in some strategic review around what you should do with the manufacturing side of the business on hardware?

I think it's something we've been evaluating. It's a somewhat complicated issue. I would say we're just in the process of evaluating what the right next step is.

Fair enough. And I missed on the forward guidance. I think you gave revenue of $133 million to $136 million. Did you give EBITDA?

Yes, adjusted EBITDA was a $12 million to $15 million. We're moving it to $13 million to $15 million.

Great. And I guess the final question here regarding AgilePlans is that it has historically been a significant capital expenditure component for you? Do you anticipate that it will be as substantial now that you're using competitors' hardware for the KVH ONE service?

We will be backing off on the amount of CapEx in AgilePlans. One of the reasons is using competitors' hardware as you just indicated. Secondly, we had the program in place here for almost 10 years. We've had a bit of churn, which we do in the normal course. So we have a pool of assets that we refurbish and redeploy. As far as the CapEx is concerned, every unit that goes out the door, even though we're activating new agile customers all the time, the CapEx for that unit could have been spent many years ago, two or three years ago. So the answer is going to be reducing CapEx on a go-forward basis.

And have you seen any change in the churn? I mean, you made it through COVID without a big spike in churn? Has Starlink started to impact that at all?

We had an uptick in churn, particularly with Leisure Marine, going back to your original question about selling Starlink on a standalone basis. That's where we've seen the most.

Got you. You're still in a good position regarding satellite capacity, maintaining a 100% KU base. Are you adequately equipped, especially with Intelsat having four software-defined satellites in orbit and Starlink being launched daily?

We're in a fine position regarding the satellite capacity.

Great. And final question, I know I said that before.

You already had the final question there.

I understand. When you bring on the competitor terminals, they simply appear as regular subscriptions, correct? If you switch them out.

Yes.

Okay. And have you had, I know that program was just launched recently and I think last quarter you were just tooling up. Are you starting to see any pickup?

A small amount. Okay. Thank you.

All right. Thank you. One moment for our next question. Next question comes from the line of Ryan Koontz Needham & Company. Your line is open.

Hi. Good morning, thanks. Most of my questions have been answered here, but just follow-up on the Starlink model. Sounds like you're taking a proactive role on the support side there, with Starlink that maybe your customers can't get direct?

Yeah, we're providing 24/7 live technical support for, as we always have. So Starlink is just another component of that support that we provide.

Got it. And on this Kognitive relationship, any more about the company you can share in terms of their position in the market? What are their markets they serve? And any other color you can provide the company?

I think to me the most inroad into the maritime industry. I know they would like to expand beyond maritime into other fixed and enterprise solutions, but I'm really not in a position to speak on behalf of their company.

Got it. All right. And in terms of the seasonality, looking forward any changes we should consider there on the revenue line in terms of your traditional seasonality, would go into the winter…?

We don't see seasonality that we've experienced in the past. We expect to experience again this quarter, the fourth quarter, as well as the first quarter.

Got it. That’s all I got. Thanks, guys.

All right. Thank you. This does conclude the question-and-answer session I'm seeing no further questions. I'd like to thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.