KVH Industries (KVHI) Q2 2021 Earnings Call Transcript

KVH Industries (KVHI 0.83%)
Q2 2021 Earnings Call
Jul 30, 2021, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the KVH Industries, Inc. Quarter 2 2021 earnings conference call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Mr.

Roger Kuebel, please go ahead, sir.

Roger Kuebel -- Chief Financial Officer

Thank you, operator. Good morning, everyone, and thank you for joining us today for KVH Industries second-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 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]. Finally, 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 2020 Form 10-K, which was filed on March 3, and Form 10-Q, 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 second quarter, I'll turn the call over to Martin.

Martin Kits Van Heyningen -- Chief Executive Officer

Thanks, Roger, and good morning, everyone. Thank you for joining us today. The first quarter was a tough one to follow given the strength of our results, but I'm pleased to report that our second quarter was, in many ways, even better, both sequentially as well as compared to Q2 of last year. Total revenues were $43.4 million.

That's up 17% from $36.9 million in Q2 last year. Non-GAAP adjusted EBITDA in Q2 was $1.5 million compared to breakeven in Q2 of 2020. We achieved these results thanks to record VSAT shipments, double-digit airtime increases, and solid year-over-year growth in inertial navigation product sales. I believe that our success in Q2, along with the momentum over the last four quarters, validates our business model and our long-term strategic initiatives.

Each of these priorities is at a different stage within its life cycle and contributes to our results differently. AgilePlans, for example, is a successful product line with an expanding subscriber base and strong revenue growth, now aided by the launch of regional services for smaller commercial vessels. At the same time, our new photonic chip technology is revitalizing our established inertial navigation product line. We're integrating this groundbreaking technology across our existing product portfolio.

Doing so enables us to boost product reliability, performance and realize new cost savings in our manufacturing processes while establishing a technological foundation for new products. And finally, our IoT Connectivity as a Service solution, KVH Watch, is still in its early days, much like AgilePlans was four years ago. We've launched a disruptive new service for a new market and a new customer base within the commercial maritime industry. We've made good progress assembling a team of solution partners who offer some of the most innovative IoT applications in the maritime industry.

Together, we're building a foundation for dynamic growth. Working with us on all these efforts will be the newest members of our board, Cielo Hernandez and Cathy Martine. Thank you to all of our shareholders for supporting these outstanding nominees so convincingly. We're excited to have them contributing their tremendous experience to the future of the company.

Now let's look at our core markets in more detail. In our mobile connectivity market, we achieved our second consecutive quarter of double-digit airtime growth with revenue up from -- to $23.1 million, which is a 14% increase compared to Q2 of last year. In addition, our active subscriber base grew 13% year over year and 6% sequentially from last quarter. At the same time, we increased our quarterly TracPhone VSAT unit shipments by 87% versus the same period last year, marking our third consecutive quarter with record shipments.

In fact, we shattered Q1's record of more than 500 systems by more than 30% as we shipped more than 700 units in Q2. We also set a new monthly record for AgilePlans VSAT system installations in June, thanks to our expansive global service network. Our subscriber growth and units shipped are excellent leading indicators for future airtime revenue and our key performance indicators. The vast majority of new units shipped represent a future subscriber on the network.

Every new subscriber added during the quarter resulted in new higher airtime revenue base at the start of the next quarter. Our results illustrate the value of compounding growth within our subscription-based business, and despite record shipments, we actually increased our VSAT product backlog heading into Q3. Within the commercial maritime sector, AgilePlans revenue grew more than 54% versus the prior year, and that's due to adding additional new fleets. For example, we added RIX Shipmanagement, which anticipates adding AgilePlans system to approximately 30 vessels over the next 12 months.

And AgilePlans as a whole now represents 44% of our total mini-VSAT broadband active subscriber base. Our media and NEWSlink business is still lagging due to the continued disruption among the cruise lines. This is our highest-margin business, and we look forward to its eventual return as things normalize post-COVID. Nevertheless, we see continued demand for content on the commercial side as fleets like V.Ships Norway purchased our KVH linkHUB and subscribed to our content services to bring movies and TV onboard.

At the same time, Anglo-Eastern selected our NEWSlink special edition sports package as a morale booster for its crew. The growing demand for our SATCOM systems and services parallel the industry trends, both for commercial and leisure marine. Commercial port calls reached 2.2 million in Q2. That's up 400,000 versus Q2 of last year.

This port call total is now within 5% of the pre-pandemic port call numbers, clear evidence that the commercial maritime market is recovering from the disruption of the last 16 months. In the leisure marine sector, Power & Motoryacht magazine reports that newbuild order books for 30- to 60-foot boats are filled through 2023. While SuperYacht Times announced that superyacht brokerage sales increased 150% over the same quarter last year. We've met the corresponding demand for commercial and leisure communications with our proven TracPhone HTS antennas together with new innovative products and services.

We began shipping our newest VSAT system, the TracPhone V30, in the middle of Q2. This 14-inch antenna offers worldwide coverage and download speeds as fast as 6 megabits per second, faster than any other antenna in its size range. It uses DC power and a single cable design for easy installation and is available for purchase and in our AgilePlans regional products. When we announced the V30 at the end of March, we believe it could disrupt the commercial and leisure communications market.

And so far, it's lived up to that expectation. V30 is the most successful new VSAT product introduction in our history. It set records for the highest number of orders and shipments during the first 3 months of launch. During Q2, we also expanded our cellular product line for boats with the launch of the TracPhone LTE-1 Global.

We introduced the original LTE for the U.S. market. However, the need for LTE is worldwide, and it's increasingly a part of commercial boats while demand for LTE among leisure boats is expanding, both as a backup for existing satellite communications or the primary communications for smaller boats. The LTE-1 Global features a dual high-gain array, antenna array, modem, GPS, and Wi-Fi, all inside a single dome plus single cable installation and with a $99 a month introductory air plan -- airtime plan.

It really equips boaters, yachts, and commercial mariners in more than 150 countries with Internet access as far as 20 miles offshore. Leisure customers are also enjoying enhanced services through our popular KVH Elite unlimited streaming service for yachts. Previously only available in the Caribbean and the Med, we expanded the service along the entire Eastern seaboard of the U.S. and Canada during Q2.

We're also doubling the download speeds to 40 megabits per second for superior experience. These moves increase the appeal of the service, improve our competitive position and illustrate the strong collaboration we have with Intelsat, our partner in our global HTS network. We're now six months away from operating solely on our HTS network. As we've discussed previously, we'll be discontinuing our legacy VSAT network as of January 1, 2022.

Our migration efforts are accelerating as we move commercial and leisure customers from the legacy network to the more advanced HTS network. In the next two quarters, we'll ramp our investment in migration incentives and installations. At the same time, the number of legacy network subscribers is declining, resulting in correspondingly lower margins for this legacy network. Starting in January, we expect to shed roughly $12 million in annual legacy network operating expenses while we add back an incremental capacity on the HTS network.

This will result in improved profitability. It's very important for us to focus on this migration effort over the next two quarters so that we have a smooth transition in January and don't lose significant airtime revenue in 2022. Looking now at our maritime IoT business. We continue to actively add Watch solution partners to our ecosystem with multi-card service providers and IoT service companies like StratumFive among the early beta partners.

We also anticipate announcing the first batch of OEM partners in the coming quarters. These OEMs are starting to roll out their own digital platforms, each of which can offer their customers the benefit from the dedicated IoT connectivity offered by KVH Watch. During the second quarter, we completed a successful trial of our Remote Expert Intervention application with a major classification society. This proved the concept of KVH Watch and its high-speed on-demand connectivity as an enabler of new functions such as remote inspections.

We're seeing interest in a wide range of use cases for our Remote Expert Intervention and have orders for new trials covering various Watch solution partner applications, vessels, and geographies. After these successful trials, we expect to convert our first partners and direct customers and paid subscribers with revenue for KVH Watch growing later this year as we add additional subscribers. Our new foundational component of Watch -- a new foundational component of Watch will be launched in the second half of this year, completing our trio of core functionality. Moving on to our inertial navigation business.

It was a strong quarter for our inertial products. Fiber optic gyro product sales increased $1.5 million or 23% in the second quarter of 2021 compared to the second quarter last year. Our TACNAV product sales increased by $0.5 million in Q2 versus Q2 of 2020 despite completing the shipments of the large TACNAV order in Q1. At the same time, we reinforced our foundation for future sales with slightly over $24 million in backlog entering Q3.

Nearly $13 million of that is expected to ship in the second half of this year. From a strategic perspective, our photonic integrated chip technology is now broadly integrated across our product portfolio. We introduced our P-series inertial measurement units in April and recently completed the design validation testing of the PIC within our final standard products. Our newest photonic chip assembly machine is now operational in our Tinley Park, Illinois factory.

This unit is twice as fast as its predecessor, resulting in cycle time more than doubling and more than doubling our PIC gyro production capacity. As I mentioned earlier, these steps are leading to the initial cost reductions that we expected from the PIC technology. With the photonic chips and new accelerometers as the base, we're now moving forward with the development of our next-generation modular inertial systems. We believe that these new products will offer a wide range of unique benefits for our customers and open new applications and markets for us.

So to wrap up, I believe that the results of the last several quarters validate our strategic direction. Despite the ongoing uncertainties caused by COVID, we're delivering strong growth built on a foundation of diverse markets, innovative technology, and a growing pipeline of opportunities. With a strong inertial nav background, double-digit growth in our subscription VSAT business, and new products driving record product shipments and record unit growth, we're optimistic that we're on the right path to deliver long-term shareholder value. And now I'd like to turn the call back to Roger for a more detailed look at the numbers.

Roger?

Roger Kuebel -- Chief Financial Officer

Thanks, Martin. As Martin mentioned earlier, our second-quarter revenue came in at $43.4 million compared to $36.9 million recorded in the second quarter of 2020. Our consolidated gross profit margin was up slightly to 35.4%. Revenue from our mobile connectivity segment increased $4.6 million with a gross margin of 34%, lower by less than 1 percentage point.

Revenue from our inertial navigation segment increased $1.9 million year over year with gross margin increasing over 2 percentage points to 39%. Product revenue for the second quarter was $17.3 million, an increase of $3.3 million or 24% from $13.9 million in the second quarter of last year. By segment, our mobile connectivity product revenue increased by $1.3 million or 20% while our inertial navigation product revenue increased by $2 million even or 27%. The increase in the mobile connectivity product sales was primarily due to a $0.8 million increase in TVRO product sales.

Within our inertial navigation segment, TACNAV sales increased by $0.5 million this quarter compared to last year's second quarter while our FOG revenues increased by $1.5 million. Service revenue for the second quarter was $26.1 million, an increase of $3.1 million or 14% from $23 million in the second quarter of last year. By segment, service revenue from mobile connectivity increased by $3.2 million or 14%. This increase was primarily due to a $2.9 million increase in mini-VSAT broadband airtime revenue.

As Martin noted, airtime revenue grew to $23.1 million or approximately 14% over the second quarter of last year and the related gross margin was 35%. In our inertial navigation segment, service revenue was down by $0.1 million. Operating expenses for the quarter were $21.1 million, up $4.7 million from the second quarter of last year. But more than half of that increase was due to higher professional fees primarily relating to board governance matters.

Of the remaining increase, a majority was compensation related as we restored salary and benefit cuts that were made in Q2 of last year to mitigate the impact of the COVID downturn. At the operating income level, these changes in revenue, margins, and operating expenses resulted in a loss from operations of $5.8 million, which was $2.4 million more than the $3.4 million loss recorded in the second quarter of 2020. Without the professional fees I just mentioned, our operating loss would have been lower than last year's. Our mobile connectivity segment generated an operating profit of $0.6 million for the second quarter of both this year and last year.

At the same time, our inertial navigation segment also had an operating profit of $0.6 million for the quarter, compared with an operating profit of $0.2 million last year. Our unallocated loss was $7 million compared to the previous year's $4.2 million. Our net loss was $5.7 million for the second quarter, compared with a net loss of $3.6 million recorded in the same quarter last year. On a non-GAAP basis, which excludes amortization of intangibles, stock-based compensation, and other nonrecurring costs such as unusual nonoperating fees, foreign exchange transaction gains and losses, related tax effects, and changes in our valuation allowance and other adjustments, after those adjustments, our net loss was $0.8 million, compared with a net loss of $1.6 million last year.

EPS for the second quarter was a net loss of $0.31 per share, compared with a net loss of $0.20 per share in the same period last year. Non-GAAP EPS loss for the second quarter was $0.05 per share, compared to a non-GAAP EPS loss of $0.09 per share last year. Our adjusted EBITDA for the quarter was a positive $1.5 million compared with breakeven in the second quarter of last year. For a complete reconciliation of our non-GAAP measures, please refer to the earnings release published earlier this morning.

Our total backlog at the end of the second quarter was $26.4 million, of which approximately $14.8 million is scheduled to be delivered during 2021. Backlog for our inertial navigation products and services at the end of June was approximately $24.4 million, of which approximately $12.7 million is scheduled to be delivered during 2021 and includes about $11 million for FOG products alone. Net cash used by operations was $0.2 million, compared to $0.1 million provided by operations in the second quarter of last year. Cash flow from operating activities remains positive for the year to date and over the last 12 months.

Capital expenditures were $5.5 million and cash provided by financing activities was $0.8 million, resulting in an ending cash balance of approximately $34.4 million. For 2021, we expect our capital expenditures to be in the range of $18 million to $21 million, the majority of which is driven by AgilePlans shipments. With respect to the remainder of the year, we are maintaining our revenue and adjusted EBITDA growth outlook for the full year. The first half of the year was very strong and exceeded our expectations, and we expect to see continued revenue growth in the second half.

However, due to a number of factors, we expect adjusted EBITDA to moderate in the back half of the year compared to the first half. 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. Simon?

Questions & Answers:

Operator

Thank you very much, sir. [Operator instructions] We'll now move to our first question over the phone which comes from Ric Prentiss from Raymond James. Please go ahead. Your line is open.

Ric Prentiss -- Raymond James -- Analyst

Hey. Good morning, guys.

Martin Kits Van Heyningen -- Chief Executive Officer

Hey, Ric.

Roger Kuebel -- Chief Financial Officer

Hey, Ric.

Ric Prentiss -- Raymond James -- Analyst

Hey. A couple of questions. One, we get a lot of questions in from folks about supply chain. Can you talk to us a little bit about what you're seeing in your supply chain and also how COVID reopenings are occurring? Or are there any closings as we look at the Delta variant out there?

Martin Kits Van Heyningen -- Chief Executive Officer

Sure. On the supply chain side, Q2 was extremely challenging. So as we ramp production for our new product, which is the V30, and we had record demand in shipments, it was very challenging to get the material that we needed. It seemed like every day, there was a different crisis.

But our team was able to do a great job, and we were able to ship everything that we needed to get out. It continues to be a challenge. I think that over the next six months, it's probably not going to improve. So I think that's -- it's sort of an ongoing risk factor, especially as demand is increasing.

But right now, there are no showstoppers where we have any specific parts that we know we can't get, but it is a daily crisis. As far as the second part of your question, in terms of closings, we haven't seen any new closings but the pushout of the -- our media business, which is hotels in Europe and cruise ships, that, I think, is going to be slower than we had anticipated. We kind of thought July 1 initially would be sort of a recovery day for that business.

Ric Prentiss -- Raymond James -- Analyst

OK. And as we look at -- I appreciate the comments on the revenue growth. Obviously, good EBITDA -- adjusted EBITDA in the first half of the year. Should we think about this migration issue as really what's going to weigh on the second half then? And how should we think about the magnitude and pacing of incentives and installing for people to get them moved off of the legacy onto the new systems?

Martin Kits Van Heyningen -- Chief Executive Officer

Yes. So some of the equipment, it's a pretty easy upgrade. It requires a new modem basically. Other equipment is so old, 10, 13 years old, it just needs to be replaced.

And some of those customers are moving directly to AgilePlans, some are buying the new product like the V30. So we had very good unit purchases this quarter as well. So the migrations are a combination of incentives, equipment subsidies and move to Agile. So I think it will be similar to what we saw in Q2, but it will be accelerating in Q3 and Q4.

So that's -- we already saw the impact of those -- some of those migration costs in the Q2 results we just reported.

Ric Prentiss -- Raymond James -- Analyst

OK. And did some of that show up in cost of product sales or as higher cost of product, or how should we like expect it to flow through the income statement?

Martin Kits Van Heyningen -- Chief Executive Officer

Yes. I'll let Roger answer that.

Roger Kuebel -- Chief Financial Officer

Yes. I think you're going to see -- yes, you'll see it like that, the things that Martin mentioned in terms of incentives. The other thing, the ArcLight network needs to stay lit until the end of the year. And just in theory, one way to think about it is if we had migrated everybody already, we would still be paying for ArcLight while we would already have turned them up on the HTS network.

So we do have that issue. So I think that that's going to be -- we're going to see -- we expect to see sort of lower margins here in the second half as we sort of transition and we get everybody -- not everybody but get as many as possible off of the ArcLight network onto the new HTS network but still have costs associated with ArcLight.

Martin Kits Van Heyningen -- Chief Executive Officer

Right. So those migration costs end up in the hardware margins typically. So you'll see that the hardware margins are not as strong as they would be without the migrations.

Ric Prentiss -- Raymond James -- Analyst

Right. I think we saw some of that in this quarter, it seemed to us.

Martin Kits Van Heyningen -- Chief Executive Officer

Yes. Yes.

Roger Kuebel -- Chief Financial Officer

Yes.

Ric Prentiss -- Raymond James -- Analyst

OK. And last one for me. How is visibility as you look into '22 now that we're sitting here days away from August of '21?

Martin Kits Van Heyningen -- Chief Executive Officer

Well, as more and more of our business is subscription-based and recurring, the visibility gets better every quarter. So we feel pretty good about the airtime business continuing to grow. And the churn rate on the HTS network is much lower than on the legacy network, and AgilePlans' churn is lower than both of them. So we feel pretty good about that.

The FOG business is growing, and we've got a huge backlog now. As Roger mentioned, it was $24 million. So we're starting to get good visibility on the FOG side of the business as well. Probably the only part of the business that doesn't have great visibility is the one we always talk about, which is TACNAV, which is purely military.

And those orders tend to be binary so the visibility on those outside of what's in backlog is not as good.

Roger Kuebel -- Chief Financial Officer

And then also, as Martin had mentioned, media, there's still kind of a question mark out there as to what -- when that's going to recover. People keep thinking it's going to happen, it keeps being delayed. And it's really hard to predict because nobody knows exactly what's going to happen with the pandemic.

Ric Prentiss -- Raymond James -- Analyst

Exactly. Right. Well, speedy [Inaudible]. Stay well, guys.

Appreciate your time. We'll talk to you later.

Roger Kuebel -- Chief Financial Officer

OK. All right. Thanks, Ric.

Operator

We'll now move on to our next question over the phone which comes from Chris Quilty from Quilty Analytics. Please go ahead. Your line is open.

Chris Quilty -- Quilty Analytics -- Analyst

Thanks. I know it's sort of early on the V30 given that it just started shipping, but do you have any early indications of whether those are competitive wins or totally new installs or OpenPort swaps?

Martin Kits Van Heyningen -- Chief Executive Officer

So far, it seems like it's a new market. So these are -- most of the time, it's people who have not had a VSAT before or had a -- so a lot of it is new opportunity. Because it's smaller, easier to install, DC-powered, lower-priced, so there's definitely a new market. And then there's also some upgrades from people who previously had a VSAT or even an old V3-IP on the legacy network.

But we're pleased with how many are new market opportunities, which is exactly what we were hoping for, is to address a segment that was underserved.

Chris Quilty -- Quilty Analytics -- Analyst

And it sounds like a lot of your strength recently has been on the leisure side. What are you seeing in some of the other verticals?

Martin Kits Van Heyningen -- Chief Executive Officer

No. Actually, most of the strength has been in commercial. So 70%, 80% of our sales are in the commercial markets today. So we continue to be strong in leisure, but the commercial market is really the growth driver.

Chris Quilty -- Quilty Analytics -- Analyst

Got you. And the V30s, are they going both commercial and leisure?

Martin Kits Van Heyningen -- Chief Executive Officer

They're going both. And initially, we launched it as a product sale first in the leisure market, and then we've added it as an AgilePlans component. So we're seeing more of that in the fishing markets and international fisheries, those types of applications. We don't see the V30 as a replacement for the V7 on commercial ships because they also need enterprise functions like the CommBox and server and those other features, which are part of V7.

Chris Quilty -- Quilty Analytics -- Analyst

Understand. Shifting over to the KVH Watch service. You seem to have had a lot of announcements in the last six months. Where are -- how do you feel about where you are on your growth plan for that service?

Martin Kits Van Heyningen -- Chief Executive Officer

It's going slower than we expected in terms of actual subscribers, but it's going faster than we expected in terms of what I call design wins and partners. So what we've found is that this is sort of similar to our FOG business where you get -- you win the bid, you get designed in, but you don't get revenue until your customers' product ships. So what we're seeing is that as our customers bring their products to market, and we're a part of that, that's what's generating the subscriber growth and the revenue growth in the second half of this year.

Chris Quilty -- Quilty Analytics -- Analyst

Great. Speaking of FOGs, can you give us an update on where you are in terms of the cost savings? It sounds like you're bringing on new capacity. So probably no big pickup here in at least the current quarter, but where do you think margins can go on that product line as you transition over?

Martin Kits Van Heyningen -- Chief Executive Officer

I'll let Roger speak to specific margins, but just I'd like to describe where the cost savings is coming from. So one of the big benefits of this new photonic chip is that it doesn't require the specialty fiber or unique components that the old gyros did. So one of the big cost savers is to the ability for us to shut down our fiber production -- the deep fiber production and that part of the facility, which is a significant overhead item. So that will be happening during the current quarter, and that's going to drive a big chunk of savings on the overhead side.

So we're already seeing the cost savings on the per unit basis, but another big chunk of savings will come from the actual overhead reduction by eliminating entire departments.

Roger Kuebel -- Chief Financial Officer

And to Martin's point, I think year-to-year, we're expecting to see a nice bump in the margin next year. I don't want to give specific numbers, but we are definitely expecting to see a bump in the margin and then some gradual improvement after that. But yes, we definitely do expect to see some improvement.

Chris Quilty -- Quilty Analytics -- Analyst

And a final question, also PIC related. Do you -- or have you engaged with any customers that are designing new products designing in PIC because there's some attribute to its size and performance that you're possibly seeing new market opportunities?

Martin Kits Van Heyningen -- Chief Executive Officer

Yes. So we're getting specific customers who want a smaller product, which we are developing, which enables use in smaller products like smaller drones and missiles and things like that. So those products, we expect to launch at the end of this year.

Chris Quilty -- Quilty Analytics -- Analyst

Very good. Thank you.

Martin Kits Van Heyningen -- Chief Executive Officer

Thanks, Chris.

Operator

We have no further questions queued at this time. [Operator instructions]

Martin Kits Van Heyningen -- Chief Executive Officer

Yes, operator. If there are no further questions, we'll wrap up. And we'll be available to speak to any interested parties directly after this call.

Roger Kuebel -- Chief Financial Officer

Thanks, everyone. Appreciate everyone joining.

Operator

[Operator signoff]

Duration: 40 minutes

Call participants:

Roger Kuebel -- Chief Financial Officer

Martin Kits Van Heyningen -- Chief Executive Officer

Ric Prentiss -- Raymond James -- Analyst

Chris Quilty -- Quilty Analytics -- Analyst

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