Peter Rendall – Chief Financial Officer Martin Kits van Heyningen – President and Chief Executive Officer.

Rich Valera – Needham & Company.

Good day, everyone and welcome to the KVH Q3 2014 Earnings Call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Peter Rendall. Please go ahead, sir..

Good morning, everyone. I’m Peter Rendall and with me is Martin Kits van Heyningen, Chief Executive Officer of KVH Industries. This call will address the third quarter earnings release that we issued earlier today. Copies of this release are available on our website and also from our Investor Relations department.

This call is being simulcast on the Internet and will be archived on our website for future reference. If you’re listening via the Web, feel free to submit questions to ir@kvh.com and we will answer them following this call. This conference call will contain certain forward-looking statements that involve risk and uncertainty.

For example, statements regarding financial and product development goals are forward-looking. The company’s future results may differ materially from the projections described in today’s discussion.

Factors that might cause these differences include, but are not limited to, those mentioned in today’s call and risk factors described in our most recent Form 10-K filed with the SEC on March 17, 2014. The company’s SEC filings are directly available from us, from the SEC or from the Investor Information section of our website.

At this point, I’d like to turn it over to Martin for today’s discussion of results.

Martin?.

Thanks, Peter, and thank you all for joining us today. Overall, we’re very pleased with our third quarter results. Although the mix is a bit different, we came in as expected for revenue and earnings.

Revenues were $44.3 million, 10% increase year-over-year with an EPS of $0.01 on a GAAP basis, but adjusting for the Videotel acquisition expense and purchase accounting, revenues were $44.9 million and EPS was $0.07 on non-GAAP basis. Adjusted EBITDA was up to $5.9 million this quarter from $4.9 million in the year-ago quarter.

Overall, this is an incredibly productive quarter for KVH. We finished the roll out of our entire Ku-band and C-band IP-MobileCast network. We completed beta trials and launched our new media server and we delivered the World Cup finals to over 1,000 seafarers back in July.

We’ve continued to acquire additional content rights for films, TV shows and additional foreign news channels. We truly have developed a compelling end-to-end service here and we’re very excited about it. And others are too. We’re attracting more content partners as evidenced by our Transas and AWT deals announced in September.

We recently finished our patent application that covers many of the unique aspects of our service. Because we believe that this is going to give us a competitive advantage in the marketplace. This quarter, we also completed our acquisition of Videotel, the leading supplier of e-Learning and training services in the marine market.

And we feel that the group is now fully integrated into our organization. They’re already making a positive contribution to our bottom line. On the VSAT side, we had a strong quarter for hardware and unit sales coupled with very strong air time revenues and record ARPUs for our V7 Series products.

Air time revenues were up 24% year-over-year and 12% sequentially. And shortly after the quarter ended, we received two major military navigation orders worth $23 million. The largest of which was for $19 million and was based on our new integrated fiber optic gyro solutions.

The transition of KVH’s mobile broadband business from hardware to services continues with 71% of our mobile broadband revenues originating from subscription-based services including airtime and value-added services like our media content and Videotel training services.

This recurring service revenue is up 51% year-over-year when including our new Videotel training business.

Adding value-added services to our communications portfolio strengthens our competitive position by allowing KVH to offer our customers fundamentally simpler more economical solutions to do a better job in solving important business challenges than our competitors who don’t design and manufacture their own hardware and operate their own networks.

Most of the maritime market continues to be underserved in terms of capabilities and broadband capacity, representing a significant opportunity for KVH going forward.

During the third quarter, we began shipping our IP-MobileCast media server and started offering commercially licensed movies, TV shows, music, news and sporting events to our mini-VSAT customers. These servers are very powerful with 4 terabytes of storage and a streaming capability capable of serving over 100 simultaneous users on board.

The reaction of our early customers has been fantastic, and we’re receiving a lot of great press in the marine publications and consumer feedback on social media.

Our IP-MobileCast service allows mariners to enjoy the same types of services we’re all used to on land, created by the convergence of wireless connectivity, on-demand media and cloud-based applications.

IP-MobileCast provides today’s news from home in 14 languages and media entertainment and Internet services to mariners who often spend weeks at sea without setting foot ashore.

On the operation side of IP-MobileCast, as I mentioned, we completed our acquisition of the maritime training solution leader, Videotel, during the third quarter; training and periodic testing and certification of seafarers are now mandated by international law and the regulations are rapidly increasing.

Our new colleagues at Videotel have close relationships within the IMO and hold standing meetings to discuss the types of new training that need to be created to help the IMO meet their objectives in areas like safety, pollution reduction, health and labor relations.

Videotel’s computer-based training and distance learning courses combined with their learning management system that help plan and track individual seafarer training offer shipping companies a cost-effective solution to meet their training requirements and prove to the various authorities who regularly inspect their vessels that they’re in compliance with international law.

Vessels that cannot prove they have complied with trading regulations can be delayed in port which can cause a shipping company tens of thousands of dollars per day. So it’s an important problem that they need to solve.

We’re adding Videotel’s training content and training management software to the new IP-MobileCast media server will be updating it over the air using the IP-MobileCast media server and we’ll be updating it over the air using the IP-MobileCast content delivery service, so our customers will be able to subscribe to our Videotel services and be able to instantly access them on any mini- VSAT-equipped ship.

In September, we also announced two new partners for IP-MobileCast for the content delivery service. Our electronic navigation system leader, Transas, and weather services leader, AWT, which is Applied Weather Technology. These two market leaders will join Jeppesen in delivering updates to their electronic charts and weather services over our service.

New regulations on ships to switch to electronic charts and dramatically reduce greenhouse gas emissions which will often require using a more expensive fuel will create significant demand for the services of our new CHARTlink and FORECASTlink partners.

While KVH will charge a monthly fee to mini-VSAT Broadband subscribers to receive the Transas or Jeppesen chart updates, or the AWT weather forecast, our customers can potentially save thousands of dollars per month using many mini-VSAT to deliver this content, over most competing satellite services.

So it’s an important differentiating advantage that should help us sell more many VSAT systems.

This rollout of new capabilities to our many VSAT Broadband extended service offering creates a lot of exciting opportunities to cross-sell the mini-VSAT hardware and airtime with other value added services for new customers, as well as upsell our existing customers which now includes over 11,000 Videotel vessels and over 10,000 KVH Media Group vessels.

A key part of our 2015 marketing strategy is getting these groups of KVH and our IP mobile cast partners, customers together to learn about the power of our end-to-end solution. We’ve created an insight sales department in our Liverpool office to focus on this.

We’re also hosting a series of special events in many of the major shipping cities around the world to introduce the benefits of the integrated service offering. On the hardware side of our satellite business, our new TracVision TV series product line is being very well received.

In fact, we were supply constrained throughout the quarter which impacted revenue and reduced our margins as we scramble to catch up. These new products were the most significant upgrade to our TVRO product line in more than five years. We believe they’ll really help keep us a step ahead of our competitors.

Sales of our TracVision VIP series products for the mini-VSAT have also rebounded back into the 250 to 300 unit per month range from a slow Q2. In October, KVH won two product awards from the National Marine Electronics Association where TracVision won for best satellite TV product and the TracPhone V3-IP won for best communications product.

This is the 17th year in a row we’ve won one of these prestigious awards.

At last week’s Fort Lauderdale Boat Show, which is the largest yachting event of its kind in the world, with over 1,000 boats in the water, our physical dome count showed that a full 85% of all satellite antennas in our key area were manufactured by KVH, and that’s the highest it’s ever been.

Moving on to our guidance in stabilization business, our TACNAV product revenues were $2 million for the quarter, and that’s down nearly 23% year-over-year. Part of this decline was due to the deferral of a shipment of one of our ongoing contracts caused by a program delay in a vehicle assembly plant not related to KVH or the TACNAV product.

Fortunately, we should be able to offset this in Q4 with the previously mentioned large TACNAV orders. These orders will have a positive impact on the fourth quarter and give us significant backlog for 2015 and 2016. It also sets a great precedent for our TACNAV 3D product going forward.

The integration of fiber optic gyros into our military navigation products is ongoing. As we improve the accuracy of our new IMUs, this translates directly into improved navigation precision and pointing accuracy for military vehicles using our TACNAV systems on the battlefield.

With these significant improvements in precision, we believe we are gaining good momentum in the military navigation market. Despite the macroeconomic defense environment and the lumpy nature of the military business, we’re still very optimistic about future TACNAV sales and there continued to be several large programs we’re pursuing internationally.

Turning to her fiber optic gyro business, our revenues were $4.3 million in the third quarter, and that was down 27% year-over-year. This decline was caused by continuing soft defense sales, especially in the important remote weapon station market and the slower orders for some of our older products in the surveying market.

On the other hand, our new 1750 IMU was selling well. We had record shipments in Q3. These higher-margin products helped us achieve our gross profit target for FOG, even though overall revenues were down due to fewer sales of our lower-margin sensor products.

We’re getting designed into many interesting applications, including many of the humanoid robots and the new self-driving cars and other autonomous vehicles and stabilized cameras used in aircraft and drones.

But we’re often prevented by our customers from publicizing the use of our products and their applications for competitive reasons, which limits her ability to disclose details of some of these opportunities.

The quality and performance of our FOGs continue to improve, and we’re exploring design modifications that allow us to ramp up our production, if and when one of these emerging applications really takes off.

This past quarter, we extended our IMU product line with the addition of two new products, the 1725 IMU targeting markets with less stringent performance requirements and the need for a lower price point than the 1750 IMU, and we also introduced a new 1775 IMU which will offer significantly better performance than the 1750 and sell for a premium price.

With these product line extensions, we believe we’ll be better able to address the market and compete for a wider group of customers that we can capture the 1750 IMU alone.

So looking forward to the remainder of the year, we’re very excited about the opportunities and comfortable with our previous financial guidance and our prospects for continued success in each of our strategic business area. For the mobile broadband business, we feel positive momentum in both our maritime VSAT and satellite TV business.

We believe the new IP-MobileCast service offers our customers a game-changing capability to affordably move large amounts of data from shore to their ships which is leading to a whole new generation of applications from our own KVH Media Group and Videotel services and from our application partners.

This is going to be a real asset to help us win an even larger share of the Maritime VSAT market. We’re encouraged by both of the large military sales we’ve seen for our TACNAV product line over the past few years and by the potentially larger projects in the pipeline we’re hoping to win.

And finally the integration of our FOGs and IMUs into new applications with high growth potential because optimistic that we’ll soon see a return of growth in this area of our business as well. And now, I’d like to turn the call back over to Peter for the financial details. Peter..

Thank you, Martin. Now I’d like to turn your attention to our third quarter financial results. This morning we reported record third quarter GAAP revenues of $44.3 million which was 10% higher year-over-year and 8% higher sequentially.

With the acquisition of Videotel on July 2, our subscription-based service revenues for the quarter were 58% of total revenues representing a 51% increase year-over-year and 36% sequentially. In the third quarter, we were unable to recognize approximately $600,000 of Videotel revenue because of the application of the purchase accounting.

Taking this adjustment into account, our non-GAAP revenues for the third quarter was $44.9 million.

Looking at our service revenues more closely, we have now broken them out into a time which includes both VSAT and Inmarsat revenues and another category we call value-added services which includes revenues associated with entertainment and e-learning content, as well as professional services.

In the third quarter, we recorded $16.4 million of airtime service revenues, which were up 20% from a year ago, and within that, the year-over-year growth in VSAT service revenue was 24%.

Our VSAT ARPUs during the quarter for fixed and meter plans was solid with fixed rate plan ARPUs recording approximately $2,000 per month while our meter plans came in around $700 per month. Our value-added services in the quarter of $11 million which includes Videotel subscription revenues were, as expected, 75% higher than a year ago.

Our product revenues in the third quarter was $16.9 million which was 17% lower than the same period last year and 20% lower sequentially. Both of these decreases were primarily attributable to guidance and stabilization product revenues which had generally been incorporated into our third quarter guidance.

Guidance in stabilization hardware revenues of $6.6 million were 29% lower than the prior year, primarily reflecting the impact of one significant FOG customer order in the third quarter last year.

Our mobile broadband product revenues, which include VSAT and our marine and land TV products, was $10.3 million during the third quarter, which was 3% lower year-over-year and 10% higher sequentially. Our VSAT unit sales returned to a more historical normal of 200 to 300 levels up to seeing an unexpected dip in the second quarter.

Turning to our gross profit margin for the third quarter, our consolidated gross profit margin was 42%, which was in line with our expectations and slightly higher from the 41% we recorded in the third quarter of 2013. Our overall services margin was 46% compared to 40% in the third quarter last year.

And our VSAT airtime gross profit margin was 34% for the third quarter, which was slightly down from the 35% we reported in the second quarter as we’d added some additional bandwidth capacity.

For product hardware, we recorded a gross profit margin of 36% compared to 42% a year earlier, reflecting some product mix and lower margins on our marine TV products that were anticipated but are expected to improve to more normal levels over the next couple of quarters.

As it relates to our third-quarter operating expenses, we recorded $18.3 million in the third quarter, which was up 27% year-over-year. Almost all of this increase was attributed to the addition of Videotel’s operating expenses and intangible’s amortization together with higher-than-expected one-time Videotel transaction costs.

As set out in our press release we issued earlier today, our non-GAAP adjusted EBITDA for the third quarter and the respective components that comprise that number was $5.9 million, which was 32% higher than the same period last year. So moving to our balance sheet.

At September 30, we had cash and marketable securities of $50.4 million, a decrease of approximately $4 million from the end of the prior quarter that was attributed to the cash used in the acquisition of Videotel.

It should be noted that approximately $6.5 million of this cash balance will be transferred to an escrow account related to the Videotel acquisition. Accordingly, there’s an equivalent liability on our September 30 balance sheet to reflect this.

As we’ve previously stated, we entered into a new five-year credit facility to fund part of the Videotel acquisition and extinguish the previous credit facility we had, as well as provide a $15 million line of credit which remains unused as of this date.

The total debt outstanding at the end of September was approximately $71 million compared to approximately $38 million immediately prior to the Videotel acquisition. At quarter end, our inventory balance to the $20.6 million which was 2% higher than that on-hand as of June 30.

And our capital expenditures during the third quarter were $1.7 million, making the total year-to-date total stand of $3.5 million. Backlog for our guidance and stabilization products and services at the end of September were approximately $19.7 million, up by $6 million from June 30.

Of that amount, $13 million is scheduled for fulfillment in the fourth quarter. The two large TACNAV orders were $23 million that we recently announced were not included in this quarter end backlog number. Now, I’ll turn to our outlook for the fourth quarter and the full year.

From a revenue perspective, we expect to see a significant increase in TACNAV revenues compared to the third quarter which we anticipate will drive slightly higher gross profit margins.

Operating expenses are expected to increase in the fourth quarter primarily reflecting the incremental third party commissions on our higher TACNAV revenues and a seasonal increase for trade show events. Our tax rate for the fourth quarter is expected to be approximately 33% subject to the effect of any unforeseen discrete tax items.

With this context, we are reaffirming our prior guidance for the fourth quarter with a revenue expected to be in the range of $47 million to $51 million and we expect to have GAAP EPS for the fourth quarter to be in the range of $0.10 to $0.15 per share. And with that, we would now take your questions.

Operator?.

Question-and-Answer Section:.

Thank you, sir. [Operator Instructions] We’ll go now to Rich Valera of Needham & Company..

Thank you. Good morning..

Good morning..

On your airtime revenue increase quarter-over-quarter, you took about 12% quarter-over-quarter increase.

Is that all organic or was there something else in there to drive that increase which was bigger than I would have expected?.

Yes. That was all organic. So there’s a little bit of seasonality in that. The summer tends to be better, but the Q2 number was a little bit lower than we expected and Q3 came in stronger than we expected..

So, to this year with the sort of non-contract, the variation and it’s really on the kind of month-to-month usage.

Is that fair or?.

Yeah, I mean that you’re talking specifically about the sequential increase..

Yeah..

The part of that is....

Yeah, and the weaker than expected 2Q stronger than expected 3Q..

Right. So, there is a variable component in there that’s a somewhat significant. I’d say approximately 40% to 50% of our subscribers are now have some variable component in our airtime revenue..

Okay. Fair enough. So, it sounds like your kind of early days trying to kind of cross-sell between IP-MobileCast and some of the new content you’ve procured here in the last year plus. Can you give us any sense of, one, have you actually seen any initial success in trying to do that? I know it’s early, but I’d be curious to get your color on that.

And then any sense of what impact that might have next year? Probably too early to quantify, but sort of color on that would be helpful. Thanks..

Right. From a sort of just a general feedback point of view, what we’ve seen is that our sales teams are now making joint sale calls, and the people that we’re calling on really get it. They really like the fact that they have – that we’re solving a problem for them.

In other words, they’re getting their charts updated automatically in the background where they don’t have to do anything. That adds real value. The fact that the training is being able to be updated, again, automatically, adds real value. You don’t have to worry about air time costs for that. So, the entertainment problem on board is a real thing.

So, I think what we’re seeing is that when we go in and present sort of a unified presentation of all the new capabilities, people really get it, and they like it.

So, I think that, as you say, it’s early days yet, but at the macro level, we’re getting confirmation that what we’ve done here makes an awful lot of sense, and people appreciate the value add that we’re bringing..

Got you. Then on the guidance in stabilization business, I just wanted to hear that number again. How much of that backlog – I think the backlog is $19 million. How much of that was expected to shift in 4Q..

About $13 million scheduled..

Okay. And then, Peter, you said that doesn’t include the two orders you announced, the $19 million and the $4 million.

Is that correct?.

The backlog does not include that..

Right. Okay. But the $13 million does include some shipments of....

Correct..

...one or both of those orders?.

That’s correct, yeah..

Okay. Got it. And then, if you look to next year, obviously FOG has been pretty soft this year.

How should we think of that business going forward? I don’t know if it’s too early, but in terms of year-over-year or is that business flat now to the near term and then start growing at some point, but just wondering how you’re thinking about FOG as we look at the next year..

Yeah. I think, we’re not ready to give our 2015 guidance yet, but at a high level, we definitely see the FOG business recovering next year. So we were sort of planning for low Q4 again, but we’ve got some new products. We’ve got a number of programs that were designed into that should start to hit in 2015.

We’re also – some of these big TACNAV orders include FOG, like the $19 million TACNAV order as a FOG-based solution. So that’s also part of the reason that we’re beginning to merge some of the ways that we talk about these things because the TACNAV contract is FOG, but then we’re saying the FOG was really low last quarter.

So, we’re going to have to just start blending and talking more about guidance and stabilization business as those two product lines start to merge. But to answer your question, we do see it growing. We’re investing in it. We’ve got new products coming. So we think it’s going to be a growth business next year..

Got it.

And then, Peter, would you give a non-GAAP EPS number, I know we kind of look at the company on both the GAAP and non-GAAP and you gave the GAAP for fourth quarter, but is there an equivalent non-GAAP number you’d be willing to provide us?.

So, it depends obviously on the impact of discrete tax items which we don’t know about today, so we can’t forecast those and there will be some purchase accounting adjustment related to the Videotel acquisition in the fourth quarter that’s less than what we recorded in the current quarter.

So non-GAAP should be slightly higher, but we haven’t put a figure on that..

Great. And one more, did you give the CapEx and cash flow from operations numbers or if you could give them, that’d be great..

We do not give the cash flow from operations number. But the CapEx was $1.7 million in the quarter..

Do you have a rough CFO number?.

Not of this second..

Okay. Fair enough. Thank you very much..

Thank you. With no further questions, I’d like to turn the conference back over for any additional or closing remarks..

Okay, if – I know there were a couple of conflicts with other earnings calls, so I will take some of these questions offline. If anybody has anything, feel free to call us directly or e-mail us. Thanks for your time..

Thank you for your participation. That does conclude today’s conference..