Q2 2023 KVH Industries Inc Earnings Call
Participants
Brent C. Bruun; President, CEO & Director; KVH Industries, Inc.
Roger A. Kuebel; CFO & Principal Accounting Officer; KVH Industries, Inc.
Christopher David Quilty; Research Analyst; Quilty Analytics, Inc., Research Division
Ryan Boyer Koontz; MD & Senior Analyst; Needham & Company, LLC, Research Division
Presentation
Operator
Good day, and thank you for standing by. Welcome to the KVH Industries Second Quarter Earnings Conference. (Operator Instructions) Please be advised that today's conference is being recorded.
I would now like to hand the conference over to your speaker, Roger Kuebel. Please go ahead.
Roger A. Kuebel
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 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, a couple of quick announcements. First, if you'd like a copy of the earnings release, it's 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're listening via the web, feel free to submit questions to ir@kvh.com. 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 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 second quarter, I'll turn the call over to Brent.
Brent C. Bruun
Thanks, Roger. Good morning, everyone. Thank you for joining us today. For starters, we are relatively pleased with our Q2 results, in particular with our growth in our airtime revenue. However, our television and leisure B-side antenna shipments fell short of expectations, which resulted in a quarterly revenue of $34.2 million, down roughly 1% from the same period last year. On a positive note, operating income was $300,000, a substantial improvement from the $1 million loss recorded in the second quarter of 2022.
To dig a bit deeper into the key service metrics, airtime revenue was up 4% year-over-year to $26.9 million, with an associated gross margin of 44%. We also increased our total subscriber base to more than 1,000 -- excuse me, we increased our total subscriber base to more than 7,140 subs. Our balance sheet is solid with a quarter-end cash balance of $70 million, up $2 million sequentially and no debt. While we believe that the resource levels are appropriately aligned with the current size of our business, we are -- and that we possess the talent to grow, we continue to adapt to changing market dynamics and heightened competition. I'll touch on that shortly.
In May, we launched our OpenNet program, which enables vessels with non-KVH antennas to join our global VSAT network and take advantage of our suite of value-added services. With OpenNet, we also created a new service revenue stream that is not reliant on hardware sales or shipments. In the 3 months since we introduced OpenNet, we've built a robust pipeline for OpenNet migrations across the leisure and commercial markets. Each of these migrations will take market share for competitors in an environment where demand for stand-alone VSAT installations is increasingly competitive.
With the collaboration of our service partners, we continue to successfully convert existing Inmarsat FleetBroadband systems to KVH VSAT terminals and service. In addition, we see a steady demand for subscription content offerings driven by the need for crew welfare services.
Additionally, we are in the process of refining our airtime pricing, with the goal of simplifying our offering and making our [Airtime] rate plans more attractive. This initiative is one way we are taking advantage of the additional capacity we have secured following our successful contract extension with Intelsat.
The KVH-Intelsat partnership is mutually beneficial for both companies as our subscribers represent the majority of the users on the Intelsat Flex Maritime HTS network. The extension secures the backbone of our multi-orbit, multichannel global network for the coming years. As I've discussed in the past, we enjoy the flexibility to work with multiple lower and medium earth orbit networks. We continue to offer Starlink terminals as a companion system to our TracNet and TracPhone products. We are also in late-stage negotiations with multiple LEO operators with the goal of adding terminals and airtime from one or more of them to our worldwide hybrid network. We hope wrap these discussions up in the near future.
We are, however, experiencing some competitive headwinds driven by new LEO services. The transition to streaming content rather than satellite TV in the leisure market and a corresponding reduction in satellite TV and leisure and VSAT terminal sales. Given the changing market and competitive environment, we are tempering our guidance for full year.
We now anticipate revenue of $133 million to $139 million, with continued growth in our services revenue and subscribers, along with an adjusted EBITDA between $12 million and $15 million. While these adjustments reflect our response to the changing market, we've made good progress, strategic objectives we set at the start of the year, which are to expand our suite of value-added services, to gain scale through organic growth and to pursue airtime subscriber growth through new hardware agnostic approaches.
On a separate note, I want to report that our Board of Directors has concluded its review of strategic alternatives. We presently intend to continue to operate as a stand-alone company. We are not actively considering any material transactions at the moment, but we plan to continue our usual practice of reviewing opportunities as they may arise.
Now I'll turn it over to Roger for the financial details.
Roger A. Kuebel
Thanks, Brent. First I would like to note that unless specifically stated otherwise, my comments with respect to Q2 of last year related to our continuing operations, which exclude the results of our inertial navigation business, which was sold 1 year ago today. With that, as Brent mentioned earlier, our second quarter revenue came in at $34.2 million, down $0.4 million from the $34.6 million recorded in the second quarter of 2022. Our gross profit margin was 35% for the second quarter of this year as compared with 41% in the second quarter of last year.
Service revenue for the second quarter was $28.7 million, an increase of $0.8 million or 3% from $27.9 million in the second quarter of 2022. This increase was primarily due to a $1.1 million increase in VSAT airtime revenue, primarily offset by $0.2 million decrease in our content service sales, which was largely due to the sale of our radio business in April of last year.
Airtime revenue grew to $26.9 million or approximately 4% over the second quarter of 2022. Airtime gross margin was 44.2%, up from 42.9% last year.
Product revenue for the second quarter was $5.4 million, a decrease of $1.2 million or 18% from the second quarter of last year. This decrease in product revenue was primarily due to a $1.8 million decrease in TV receive-only products, somewhat offset by an increase in VSAT revenue and sales of Starlink antennas, which we just began offering in the second quarter.
As Brent indicated, the transition to streaming video content rather than receiving through satellite TV has had a significant impact on our sales of TV receive-only antennas. From discussions we've had with other providers, it appears that this is affecting the entire industry, not just KVH.
Product gross margin for the second quarter was negative by approximately $1.2 million. This was due to a number of factors that caused manufacturing costs to exceed standard costs, including lower overhead absorption due to lower unit volumes, realization of purchase price variances from higher component costs and a reclass from Q1 between products and services. There continues to be an area of intense focus, and we are evaluating alternatives for improvement.
Operating expenses for the quarter were $11.7 million. This quarter benefited from a number of onetime reserve adjustments, and we continue to expect the normal quarterly run rate to be between $12.5 million and $13 million. At the operating income level, these changes in revenue, margins and operating expenses resulted in a profit from operations of approximately $300,000 compared to last year's loss of about $1 million.
Our bottom line net income from continuing operations was $925,000. And EPS for the second quarter was a net profit of $0.05 per share compared with a net loss of $0.01 per share in the same period of 2022.
Our adjusted EBITDA for the quarter was a positive $4.2 million compared with positive $3.2 million last year. 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 $3.6 million versus approximately $300,000 last year. Capital expenditures for the quarter were $2.6 million and adjusted EBITDA, less CapEx, was positive by over $1.5 million. Cash provided by financing activities was $1.3 million, resulting in an increase in cash of approximately $2.3 million and any cash balance of approximately $71 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?
Question and Answer Session
Operator
(Operator Instructions) Your first question comes from Ryan Koontz of Needham & Co.
Ryan Boyer Koontz
Sounds like the Starlink capacity is really disrupting the market here. Can you speak about kind of the differentiation in the products and maybe how their go-to-market sales model is different from yours? That would be helpful.
Brent C. Bruun
Yes. I mean in regards to Starlink, they do offer a high-speed, low-latency service. They do not offer CIR, committed information rate. So when the service works, it works incredibly well. But with our service, we offer a committed information rate as well as 24/7 phone tech support, field service to repair your units and a number of value-added services, which we go through cybersecurity. So what we're offering is more than just connectivity. And as we talked about the companion plan, it works very well, quite frankly, in combination with Starlink and that's why we're focused on the companion plan.
In regard to go-to-market, we've continued with our historic go-to-market strategy, which includes both direct sales and selling through service providers in regard to commercial market. They are using a number of our competitors to sell their airtime. So I'm not sure that their go-to-market strategy differs all that much from what we're doing, that they are selling through resellers and majority. A significant portion of our sales are through resellers as well.
Ryan Boyer Koontz
Got it. And with the disruption going on, do you have the ability to go back to your partner then with the cost of bandwidth coming down to reduce your cost of capacity?
Brent C. Bruun
Yes. We're not at liberty to talk about our cost of capacity, but we did just enter into a contract extension. With Intelsat, we're bringing down quite a bit more capacity. And as I alluded to in our prepared remarks, we are adjusting our airtime plans.
Ryan Boyer Koontz
So as you adjust your airtime plans, obviously, you're hoping to reverse kind of share loss and such there and -- is that going to much of a gross margin impact going forward.
Brent C. Bruun
Your first statement is accurate where we're talking about maintaining our subscriber base and continue to grow it. And we do anticipate -- and we haven't necessarily said it on this call, but we anticipate a slight contraction in our airtime margins to the high 30s for airtime, where this quarter and last quarter, we're 40% plus.
Ryan Boyer Koontz
I think you've talked about that a little bit before. So high 30s contraction. All right. And with regard to the different kind of segments or verticals you sell into, is the -- are the challenges in what particular area of another, whether it's leisure or commercial fishing, et cetera?
Brent C. Bruun
Leisure and light commercial have been the most impacted. So -- and we would view fishing as like commercial. As far as blue water commercial, our tankers, our carriers, all carriers, we haven't seen as much. And we don't -- we do not sell into the cruise market either, which I understand has been significantly impacted. That's one concern we do not have.
Ryan Boyer Koontz
Got it. And in terms of the cruise market that's served by other players in the space, Inmarsat and guys like this?
Brent C. Bruun
Yes. I mean it's -- Inmarsat didn't have a significant focus there, but others do.
Operator
Your next question comes from Chris Quilty of Quilty Space.
Christopher David Quilty
Guys, wanted to follow up on the airtime plans and maybe a little bit of direction on how you plan to implement that? In other words, automatic changes where you're going to push those down on the customers? Or do you wait for them to sort of price discover. In other words, if you do the former, we would see a pretty immediate impact on margins in Q3, and that seems to be what you're guiding to?
Brent C. Bruun
I wouldn't say you're going to see any significant impact on margins in 3Q, Chris. So it's -- but in regards to the airtime plans, people have become more bandwidth thirsty. So it's really a matter of providing more speed and more raw consumption on a go-forward basis to align with what the end user is looking for.
Christopher David Quilty
So in other words, you're not really changing the pricing, what you're doing is just getting more bandwidth, which has a higher quality to you.
Brent C. Bruun
It potentially could. But right now, as I said, we just entered into a renegotiation, we're pulling down a bit more capacity from Intelsat. So it's -- I think we have it so that we can maintain a reasonable gross profit level. I'll repeat once again, we do anticipate slight contraction to the high 30s, but it's not significant.
Christopher David Quilty
Got you. Switching over to the product side. Obviously, it looks like the consumer products are taking a pretty hard hit. What's the prognosis there? I mean is this a recoverable situation where you either increment capabilities or lower costs relative to a Starlink antenna which has a pretty distant price gap between the sort of legacy services you provide?
Brent C. Bruun
That's a very good question. And something that's the forefront of our minds and in regard -- and as well as our daily activities. We're in the process of assessing that what the overall impact is. We're not necessarily at liberty to disclose what the outcome of that set is going to be since we're in the middle of it. But we do understand that the market dynamics are changing and where our plan is to adjust to these market dynamics in order to position ourselves as effectively as we can on a go-forward basis in the market.
Christopher David Quilty
Got it. And Roger, specifically on the product margins, I mean expected them to be down, but that was way more down. And you seem to indicate there were some onetime issues in there, in addition to just volume. How should we think about product margins looking into the second half of the year?
Roger A. Kuebel
Well, I can say that for the quarter, if you sort of take out the onetime items, it would have been kind of right around the breakeven and what's going to happen for the second quarter will be highly dependent on kind of where -- what happens with volume. We're in a period right now of a lot of uncertainty. We're seeing dramatic kind of changes in the market. It's a little hard to tell whether things are -- whether there's some unusual occurrence going on whether things are going to change. So it's really tough to say. Right now, I would say we would be expecting if I were just sort of midpoint estimate is around breakeven.
Christopher David Quilty
Okay. That was good. And just in terms of other product developments, things like KVH Watch or some of the new pricing plans, are there other developments that you have coming in the second half of the year or other areas that you wanted to make investments?
Brent C. Bruun
When it comes to developing products and R&D, we keep that stuff close to our best, but we still have a very robust engineering department R&D department. So they stay busy on a daily basis. And very well could have some stuff coming out here and later in the year.
Christopher David Quilty
Got you. And final question, which is another forgive me Starlink question. I think one of the challenges at partnering with them is there's no margin for the service providers. So obviously, it's all passed through. Where do you see that product deploying because you're doing it as a bundle with your own system? Is it basically adding it to a lot of your existing customers? Or do you see new market opportunity created by that bundle, albeit most of your competitors now offer that bundle also?
Brent C. Bruun
Yes. I mean it's basically -- for the most part, our current market focus isn't going to change, but definitely, we'll open up if we went down that path completely, other opportunities due to the speeds that associated with the service offering.
Operator
Thank you. I would now like to turn it over to the Chief Executive Officer, Brent Bruun, for closing remarks.
Brent C. Bruun
Okay. Well, thank you very much for joining us today, and enjoy today and the rest of the week. Thank you very much.
Roger A. Kuebel
Thanks, everyone.
Operator
Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.
