Good day, and welcome to the KVH Industries, Inc. Q2 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..

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 ir@kvh.com..

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..

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..

We'll now move to our first question over the phone which comes from Ric Prentiss from Raymond James..

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?.

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..

Okay. 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?.

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..

Okay.

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?.

Yes. I'll let Roger answer that..

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..

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..

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

Yes, yes..

Yes..

Okay. 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?.

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..

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..

We'll now move on to our next question over the phone which comes from Chris Quilty from Quilty Analytics..

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?.

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..

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?.

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..

Got you.

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

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..

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?.

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..

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?.

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..

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..

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?.

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..

We have no further questions queued at this time. .

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..

Thanks, everyone. Appreciate everyone joining..

Ladies and gentlemen, this does conclude today's call. Thank you very much for your participation. You may now disconnect..