Don Reilly - CFO Martin Kits van Heyningen - CEO.

Ric Prentiss - Raymond James Rich Valera - Needham & Company Chris Quilty - Quilty Analytics.

Good day, and welcome to the KVH Industries’ Q4 and Year-End 2016 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Don Reilly, Chief Financial Officer. Please go ahead, sir..

Hey, thanks operator. Good morning, everybody. Thanks for joining us today to discuss KVH Industries’ fourth quarter results and our guidance for the 2017 first quarter and the full year, all of which is included in the earnings release we published this morning.

With me on the call this morning is Martin Kits van Heyningen, the Company’s Chief Executive Officer. The earnings release is available on our website and also from our Investor Relations department. If you would like to listen to a recording of today’s call, you can access a webcast replay on our website.

If you are listening via the web, feel free to submit questions to ir@kvh.com. This conference call will contain certain forward-looking statements that are subject to a number of 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 forward-looking 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 form 10-Q filed on November 3, 2016 and the Company’s SEC filings available directly from Investor Information section on our website. So, at this time, I would like to turn the call over to Martin.

Martin?.

Thanks you Don, good morning everyone and thank you for joining us today. I'm pleased to report that we ended 2016 on a positive note coming in at the top of our guidance range for revenue and beating our adjusted EPS and EBITDA.

Fourth quarter revenues were 43.9 million and our non-GAAP earnings of $0.13 per share exceeded our guidance range which is $0.05 to $0.10.

Don will cover the numbers in detail shortly, but first let's take a look at our key business areas starting off with mobile broadband, which going forward we'll call our mobile connectivity business to better reflect the wide range of products, content and value added services we offer beyond just broadband communications.

As we discussed in past calls, 2016 was a challenging year in the global commercial maritime markets. As a result, VSAT airtime revenues were up but just slightly year over year. Many shipping companies are losing money and don't have a lot of capital to invest in broadband solutions even if it will eventually save the money.

We have a new program that addresses that and I'll be talking a lot more about that in a minute. But despite the short-term economic challenges, KVH’s position in the maritime market continues to be very strong. I'm proud of what we've accomplished since launching our maritime broadband service ten years ago.

I'm excited about the new initiatives to build upon our success in the years ahead. We've now fielded more than 7,000 maritime VSAT systems.

The latest research report from NSR released last spring concludes the KVH has a market share of 29% of maritime Ku-band VSAT units just still the largest share by far even after the significant merger and acquisition activity of our competitors. Our compound annual growth rate of our maritime VSAT revenue over the past five years has been about 10%.

We believe we have an excellent competitive position and will be able to maintain our market share as a larger numbers of vessels convert from legacy services to faster lower price maritime VSAT service.

As the overall markets start to recover, we're well positioned to take advantage of that with our leading market share and our new programs and services will be launching this year. KVH’s content and training businesses are also doing well, they were up 4% in the fourth quarter on a constant currency basis.

Videotel training services are now used in more than 12,000 vessels and our news link and movie services on more than 10,000 vessels. This reach provides us with a lot of strong customer relationships to leverage for cross-selling existing services and introducing new ones. Our new bundling approach will take advantage of this.

To make sure KVH remains the maritime connectivity market leader and to take advantage of our unique capabilities, I’d like to share a few of the new plans that we're rolling out this year to help grow our business even though the maritime market might remain challenged.

From a product perspective, KVH is the only maritime broadband company that also manufactures its own hardware. This provides our customers with a fully integrated solution that is significantly smaller, easier to install and less costly than our competition.

Every one of our products features a compact below decks unit that includes the antenna controller, modem and an onboard server and content manager, which is also a great platform for offering our next generation of services and we're going to leverage these advantages now.

For many of our potential customers, CapEx investments or engineering into multi-year lease or maritime contracts is often difficult through the duration of the commitment. Ship owners often contract out the day to day operations of the vessels to specialize ship management companies.

The ship managers understand the benefits of equipping vessels with broadband services to enhance the efficiency of their operations but often have annual contract with ship owners to make long term commitments or major capital investments in practical.

In 2017, we're going to eliminate the requirement for them to buy hardware or enter into long-term lease and airtime commitments by offering a simple subscription program. We’ll leverage the inherent cost advantage that KVH enjoy both in terms of our lower cost product designs and the fact we manufacture our own hardware.

We believe the added flexibility of commitment free hardware subscription programs coupled with our existing disruptive airtime plans that offer the fastest speeds and highest quality service will create a differentiating advantage for KVH that will be inherently more expensive for our competition to copy.

A key part of this new offering will be a bundle IP mobile cast with NEWSlink TV, CHARTlink and FORECASTlink as well as Videotel training in every package. These are unique features that we can add to help further differentiate our product offering. These software and value added features cost us little but provide incredible value to our customers.

To remain successful in the maritime VSAT business we also need to make sure that we offer the fastest most competitively priced services available, which means we need to take advantage of new satellite and communications technology and create new services that are faster, more capable and less costly.

Our current mini-VSAT network is robust and fully global, delivered by 23 Ku-band satellite transponders and three C-band transponders using more than a dozen Earth stations around the world all connected by secure high-quality terrestrial NPLS network.

In 2017, we’ll be rolling out new high throughput satellite services, HTS services to complement our existing network and enable KVH to support the dramatic surge in demand for data the shipping industry is projected to experience over the next ten years.

Now during the first ten years of our maritime VSAT service we built the maritime industry's best connectivity, data delivery and content distribution platform.

Using this great foundation, we’ll lead the industry into the next major evolution bringing the benefits of connected applications, big data analytics, and ultimately the secured connectivity required to support automated vessels in the maritime industry.

No other company in the maritime connectivity market is as well positioned and we’ll continue to pull ahead with exciting new products and services. Our new HTS-ready antennas are in production now. These new higher speed systems and services will make a compelling case for those without VSAT or with aging broadband solutions to make the upgrade.

Global maritime broadband revenue is expected to grow to $3.3 billion in five years with only 10% of the 250,000 vessels deployed globally today equipped with VSAT and with over 40,000 vessels still utilizing L-band technology.

We think the availability of the new HTS products will be a catalyst in attracting many new subscribers to VSAT technology and away from antiquated legacy systems. Moving on to our guidance and stabilization business, which going forward we’ll call our inertial navigation business.

We continue to be extremely optimistic about the inertial nav portion of our business. In our navigation segment we believe we're ideally positioned to supply the rapidly growing world of autonomous platforms with key enabling products and technology.

Our fiber optic gyros are fundamentally important to the functionality of autonomous everything from vehicles to drones to ships. Analysts in the auto industry project that 15% of automobiles will be autonomous by 2030. And the component sales for driverless cars will be approximately $42 billion.

While we've already supplied over 500 fiber optic gyros to makers of driverless cars today, we're investing in the technology in 2017 that will significantly reduce the cost of FOGs for this application by an order of magnitude.

As I've mentioned in previous calls, KVH is doing well in this market, it's been supporting companies around the world for their self-driving vehicle development efforts in testing.

While we can't mention specific customers due to strict non-disclosure agreements, I'm confident in saying that KVH certainly enjoys a leadership position in the market of providing gyros for self-driving cars selling to major car companies, tier-1 suppliers and to start-ups looking to lead the self-driving revolution.

Winning gyro sales for the trial units used in beta tests is not the end goal. And I'm determined to advance our technology to meet the needs of this potentially huge new market.

To do this we're developing new photonic optical chip technologies that will enable KVH to mass produce new gyro designs that will meet the performance, quality and cost goals of the automotive industry. We've been working on this in our R&D department and I've just received the first prototype optical chips from our fab house.

We're making it clear to our customers in this market that KVH intends to develop the new technology needed to make their next generation products a reality.

This new generation of optical gyro technology is extremely exciting implications for KVH’ inertial nav business overall bringing the high-end performance of FOGs to customers in other large autonomous platform markets like material handling equipment, farming, trucking, even package delivery drones.

On the military front, we continue to receive very positive indications [indiscernible] large TACNAV orders we’re expecting. The end customer has now selected the prime contractor and we've been informed that were designed into the program and the requirement is firm.

We anticipate positive macroeconomic conditions based on increased defense spending both here and abroad. The good news for KVH is that the more customers become dependent upon the precision provided by satellite navigation, the greater their vulnerability if GPS is blocked, jammed or worst case spoofed into providing the wrong position.

Military customers around the world now openly admit that the standalone satellite-based navigation solutions are vulnerable which continuously create new interest in complementing GPS with inertial navigation systems like KVH’s TACNAV products.

Our TACNAV systems are ideally suited to provide the desired redundancy in these situations and the enhancements we're investing in during 2017 for these products such as integrating with M-code receivers, chip-scale atomic clocks, moving map displays will further increase demand for these systems.

Well most of the large orders in the pipeline relate to Middle East allies, the US military is by far the largest opportunity for this technology. And we're optimistic that starting in 2018, we'll see a more balanced order flow between domestic and international defense sales.

Looking at the big picture, 2017 will be a transition year for KVH as we invest in strategic initiatives. These important initiatives will hire incremental investments in operating cost and capital expenditures in 2017 in order to generate significant revenue and profits in 2018 and beyond.

While some will have a near term payoff, but others like our OneWeb Low Earth satellite antenna development, Low Earth Orbit Satellite antenna development will not generate revenue for several years.

Together, the new strategic initiatives put us on a path that could significantly boost revenues for the next three to four years with substantial growth in EBITDA. We expect improving performance throughout 2017 after a slow first quarter where they returned to profitability by the second half of 2017.

Coming online in the second half of this our new HCF network overlay will more than triple speeds while reducing cost. Coupled with the hardware subscription model, which should drive airtime revenue growth starting in 2017, with a goal of returning to double digit growth like we've seen over the previous five-year period.

While we expect top line growth in 2017, it’s important to realize that since the VSAT hardware will be recognized on a monthly basis, they will reduce the reported revenue in 2017 since the full-value of the hardware is not all recognized at the time of sale.

In 2018, we’ll be recording new subscriptions plus the ones that started in 2017, so its compounds. Growing our subscription based business is an important goal and this will help towards that end and each year the base of revenue should grow.

The Assured PNT initiatives for the US and foreign defense allies are expected to drive growth in our navigation business. Although we did not forecast the large TACNAV contract to all book and ship in 2017, we still have high confidence in this program based on information as recent as last week.

Nevertheless, we're being more conservative in our outlook for 2017 TACNAV revenue and essentially forecasted it to be flat with last year. The move towards autonomous everything to drive our FOG sale in a particular self-driving car initiative should show significant growth potential in the years ahead.

So in summary, we've got a lot of exciting projects underway, I've never been more excited about our opportunities and I'm confident that the investments we're making are prudent and will lead to increasing long-term shareholder value. And now I'd like to turn the call over to Don who will review the numbers.

Don?.

Thank you, Martin. So now I'd like to discuss in more detail the financial results of the company for the fourth quarter.

To start with, I’d to call your attention to the fact that we've changed our segment reporting this quarter, where previously we viewed ourselves as operating in two geographic segments, in the fourth quarter based on a number of organizational and other changes we've implemented, we determine that we have two reportable operating segments based on product lines that’s mobile connectivity and inertial navigation.

In our 10-K that we’ll file in a few days, you’ll see us discuss our business more along the lines of our two segments.

As Martin mentioned earlier, our fourth quarter revenues were $43.9 million which is at the high-end of the guidance range we gave previously and was 19% lower than the fourth quarter of 2015, which was anticipated due to the large TACNAV shipments we recorded last year and due to currency exchange fluctuations in the British pound.

The British pound adversely impacted our fourth quarter revenues by approximately $1.6 million or 17% of content and training revenues and 4% of total fourth quarter revenues. On a constant currency basis, content and training revenues actually increased 4% year over year.

Product revenues for the fourth quarter decreased $8.6 million or 32% to 18.6 million from 27.3 million in the fourth quarter of 2015, due to a decrease in mobile connectivity product revenues of 1.7 million or 16% and a decrease in inertial navigation product revenues of $7 million or 41%.

Service revenues for the fourth quarter decreased $1.4 million or 5% to 25.3 million from 26.8 million in 2015, mostly due to a decrease in our content and training revenues again due to the weakness in the British pound.

Our broadband airtime revenues were up - just about 3% year over year, however our Inmarsat FleetBroadband revenues were down about 26%. In the fourth quarter, we reported a consolidated gross profit margin of 44% which compares to 48% in the fourth quarter of 2015. This decrease correlates with the decrease in the TACNAV product revenues.

Product margins in the fourth quarter of 2016 were 37% compared to 46% in the fourth quarter of 2015. Overall service margin was 48% for this quarter and 50% in the fourth quarter of last year. Our broadband airtime gross margin held steady at about 36%.

As it relates to our fourth quarter operating expenses, we recorded $19.4 million, which was down about 7% primarily due to the decrease in commissions paid on TACNAV revenues from the prior year.

In addition, we favorably settled certain co-production royalty agreements in our Videotel business which resulted in a reduction to operating expenses of about $900,000.

So for fourth quarter these changes in revenues, margins and operating expenses resulted in a loss from operations of about $300,000 compared to operating profit of $5.2 million recorded in the fourth quarter of 2015.

As we highlighted in our earnings release, in the fourth quarter, we recorded $7.1 million of discrete non-cash tax charges mostly related to a valuation allowance against certain US deferred tax assets which is reflected in our tax evasion for the quarter.

While we expect we will be able to reverse some or all of this reserve over time, the accepting rules require to provide a reserve against deferred tax assets under certain circumstances such as when we have three years of cumulative losses on our tax return.

It's important to note that the losses are US based, both of our international businesses are generating taxable earnings but those earnings are not currently included in our US tax return. And as this is a discrete item, we exclude this reserve when computing non-GAAP net income and EPS.

For the fourth quarter, our GAAP net loss was $6.8 million as compared to net income of $4.1 million recorded in the same period last year.

Again, the reserve against our deferred tax assets is the largest contributor to the net loss non-GAAP net income which excludes this reserve and other items was $2.2 million compared to $6.8 million in the same period last year, driven by the increase in our operating loss described earlier.

GAAP EPS for the fourth quarter was a net loss of $0.43 per share compared to net income of $0.26 per share recorded in the same period of last year.

The non-GAAP EPS for the fourth quarter which excludes the discrete tax items, intangible amortization, stock-based compensation expense was at $0.13 a share which exceeded the guidance we provided for the quarter which was a range of $0.05 to $0.10.

Our adjusted EBITDA for the fourth quarter was $4.3 million compared to $9.7 million recorded in the same period last year and exceeding the range of $2.4 million to $3.5 million when we last provided guidance.

For a complete reconciliation of GAAP and non-GAAP measures please refer to our earnings press release that was published earlier this morning. Backlog for our total inertial navigation products and services at the end of December was about $5.5 million. Of this amount, approximately $5.1 million is scheduled to be delivered during 2017.

With that I'll turn our attention now for the outlook for 2017. As Martin said, in 2017 we will be investing in certain key strategic initiatives that will have very meaningful implications for our company in the future.

These initiatives include the rollout of the new HTS service and hardware, the introduction of innovative subscription options for the commercial maritime sector, development of a low cost FOG for autonomous vehicles and enhancements to TACNAV technology to support the critical military demand for our shared-position navigation and timing our APNT.

Together these have the potential to significantly increase our revenues for the next three to four years.

However, we expect to see little benefit of the revenue line for these initiatives in 2017 and in fact are likely to see some headwinds initially especially as we roll out new commercial maritime subscription program as the hardware component of the subscription revenue will be recognized over time.

We will make incremental investments in these initiatives this year in order to put ourselves in the best position to benefit from their success in 2018 and beyond. In our guidance, we've been conservative in including only a limited number of TACNAV systems from the anticipated large orders in the pipeline.

We’re taking a more conservative view with respect to near-term TACNAV revenue expectations, but we continue to be extremely optimistic about this part of our business as well. So consequently, our guidance for 2017 anticipates only moderate revenue growth with a fairly large increase in operating expenses as we fund these programs.

So specifically our guidance for first quarter and full-year of 2017 is as follows. So for revenues, in the first quarter, we expect revenues in the neighborhood of $39 million to $41 million and full year the range would be $170 million to $190 million.

Our GAAP EPS for the first quarter would be a loss of $0.38 to a loss of $0.33, and for the full year would be a loss of $0.69 to a loss of $0.38. our non-GAAP EPS in the first quarter would be a loss of $0.13 to a loss of $0.10, but for the full year it would be positive EPS of $0.07 to positive EPS of $0.27.

Our adjusted EBITDA for the first quarter, we expect to be at a loss of $1.5 million to a loss of $700,000 and for the full year, we expect the range to be in the neighborhood $8.5 million to $13.5 million.

Further, the initiatives that we've outlined will require a certain amount of capital investments in 2017 in addition to higher operating expenses. In 2017, we expect our capital expenditures will be in the range of $15 million to $20 million.

Again, we believe 2017 is an important transition year and that the incremental cost and capital expenditures have the potential to transform the company going forward. This guidance assumes there will be no significant changes in foreign currency exchange rates.

So with that, I would like to turn the call over to the operator, so that we can start the Q&A portion of this morning’s call..

[Operator Instructions] And we will take our first question from Ric Prentiss with Raymond James..

Thanks. Good morning. Hey, obviously, a very transitional year, coming up and investing for the future.

One lead question I think would be, you've shown us the view for ‘17 where you’re going to spend the CapEx, you’ll spend some more OpEx to hit the items that you mentioned of high throughput satellites and subscription and low cost FOG and TACNAV APNT, can you give us some color on your visibility in making these investments on what that significant opportunities might be in ‘18, ‘19 and ‘20, just to get a sense of how you guys did your ROIC to look at making these changes?.

Right.

I think one of the things we did is we look at, as I mentioned in my portion of the call, if we look back over the last five years and look at what the growth rates were and really look at the opportunities through the size of market and we think that if we get back to those kind of growth rates, we're getting a very significant growth over the next three to four years.

So, and the changes that we're making now, we're expecting to start to see that this year. So we expect to see the growth in services revenue to be approaching double digits as we exit this year. So that's kind of like at a high level. So we don't - obviously we won’t start giving guidance for ‘18 yet, but we do expect to see a significant payoff here.

So we're pretty optimistic..

Okay. And then on the TACNAV specifically, you mentioned only being a limited number of orders in there.

Is that really a function of when you think it's going to book and ship and that you're being conservative it might hit ‘18 instead of ‘17 or and also maybe if you could update us on the size of that order that's being anticipated?.

Yeah. So the ones that we're not including in the forecast are or including a small portion there are over $40 million. So I think we've been advised by many of our investors to not include these discrete items in guidance, because it just creates problems when the timing changes. So we're trying to be more conservative here.

But to answer your question on timing, we do expect the orders to happen this year. The timing is hard to call and also the delivery schedule would be difficult to forecast.

So that's why we're assuming that we’ll get the orders, but we’ll only ship a little bit this year and we're optimistic that that’s a reasonable assumption, but there's more upside than there is downside in the TACNAV guidance now..

Got you.

And if it didn't quite deliver this year, it would be in the early part or within ‘18?.

Yes. It would be all in ‘18, anything that didn't ship in ‘17 would all be in ‘18..

Okay.

And then the final one for me is, as you look at developing the low cost FOG for autonomous cars and other vehicles, imagine the order of magnitude cost cut, but can give us an idea of how long it's going to take to get the technology to where you want it to be ramping to the scale you want and who else you're facing and competition for that, what looks to be a large market, but just trying to gauge the time to get to be able to deliver it and who the competition is and it's a long sales cycle, the break into somewhere that platform I would expect..

Right. So the good news is that we're already designed into most of these platforms. So we're the incumbent there. We probably will deliver between 1000 and 1500 systems in 2017, as more vehicles start to get out on the road and those are forecasts that we have from our customers.

So we're delivering now and they're perfectly happy with the performance and the size and everything. They're not happy with the cost going forward, but for today's quantities, we're fine.

But we’re anticipating, so what's going to happen is that we’ll continue to deliver, the cost will come down a little bit, but to get this order of magnitude type cost, it will switch to a new design and that will be a running change as soon as it's ready. But in the meantime, we're making incremental cost reductions as the volumes ramp..

Okay.

And the sales cycle as far as how to break in to that, you said you’re the incumbent, but just trying to think of what the ramp or the pacing might look like?.

Yeah. So that’s - I think, we don't see any big ramp in 2017. I think 2018, we've been given forecasts that are in the tens of thousands of units. How real that is, we don't know, but that's what our customers are saying. So - and then it would ramp to hundreds of thousands and we're hopeful that eventually those become millions.

It mean the forecast is that 15% of cars will be self-driving, which would be 15 million vehicles. There's about 100 million vehicles built per year. So it’s a big market, big opportunity and that's why we're - we don't want to just be the incumbent and be designed in for the prototypes..

And we will now hear from Rich Valera with Needham & Company..

Yes. Thank you. Just wanted to follow-up on the disposition of some of your TACNAV orders. You'd specifically talked about 15 million of orders being pushed out of the fourth quarter of last year.

I think seven of that you said was built and sitting in backlog and there was another 8 that had been specked into some vehicles and you were kind of I guess awaiting a final PO on that.

Are those specific orders included in the ‘17 forecast?.

Yes..

Okay.

And that would seemingly cover the whole forecast, if you're going to be flat year-over-year, I mean, and I use my math right on that?.

Yes. I mean not everything is one for one, so some of it is weighted averages, a bunch of different orders, but you're thinking about it exactly the right way. The stuff that got pushed out, we're now assuming happens in 2017. And then we've sort of capped it at last year's actual for the guidance..

Got it. Then wanted to follow-up on the low cost FOG that you're developing, I guess, in January, you had talked about sampling a new low cost FOG, I think clearly not the final low cost FOG, but a low cost FOG in the first quarter.

Where do we stand on that?.

While we have a new design, which is that we've offered to our customers, that roughly half the price they were paying before, so we're making moves in the cost in the right direction as far as they're concerned. And that would be available for - it is available now for sampling and full production would be in Q2 of this year..

And that roughly 1K, I was - prior ones about $2000 and this would be about half that you're saying?.

Directionally, you're correct. It's a little bit more than that, very close to what you're talking about..

And then you mentioned, I think it was one - about 1000 to 1500 as kind of roughly what you expect to ship on those this year.

Is that correct?.

Yes..

Got it. So why don’t we move into the mini-VSAT in the maritime side of things.

So first, what's your expectations for what - the percentage of your new ads that happen on the bundled versus unbundled model?.

It's roughly half, I mean, at a high level. So we think that, a, this will increase the numbers from the run rates we were at and from the increased number, half would be and sort of like a VSAT as a service if you will.

This will be for commercial customers, for fleet customers, so the leisure market will continue to be by the hardware because that’s more traditional more what they're used to. So about half..

Got it.

And then you mentioned bundling in both MobileCast and I think some of your training video - your training stuff as well into some of these packages and I'm just wondering, are you devaluing the products by doing this obviously, you generate a significant revenue stream from say Videotel, you somehow cannibalize that by bundling that into these kind of airtime packagers?.

Yeah. Potentially, but think of it this way. If this is incredibly successful and we cannibalize 100% of our Videotel subscribers and they all switch to VSAT, our VSAT, that's another 12,000 vessels. If you look at our average ARPU now, which is $1500 a month, you're talking about 18000 a year times 12000, it’s a gigantic number, it’s $200 million.

So that wouldn’t be such a bad thing if that happened.

So, but I don't think people will switch, if they’ve already a Videotel customer, I don't think they’ll necessarily switch just to get the free Videotel by buying the VSAT, but what we're trying to do is to make a really compelling bundle that is, as I said, our costs are marginal cost on the software is close to zero.

So it's a pretty compelling product offering. And then also be done in tiers. So it’s a little bit of a premium model to this and really great stuff that’s included, but for example vessel tracking is included, but if you want to see one year's vessel track for your fleet, that's a premium and you have to pay for that.

So same with the NEWSlink TV is included, but if you want movies, well, you have to pay for movies. Those aren’t included..

Understood.

And then I'm not sure, I know it's baked in to your guidance, but can you give us a sense of sort of the year-over-year increase in OpEx we're talking about here if we like baselining it versus ‘16, roughly how much we should think about OpEx increasing in ‘17 in aggregate?.

Yeah. I think round numbers, it’s on the order of $10 million year-over-year increase..

And then should we think of that as going back down in ‘18 or how should we think about that longer term?.

Yeah.

I think that there's an incremental component to this that some of which is one-time, so that if the revenue didn't grow the way we're expecting it to grow, then those numbers would not recur in ‘18, because we are also expecting significant revenue growth, we see those costs, because some of them were people costs and R&D costs will be declining significantly as a percentage of revenue.

But in absolute dollars, they probably won't decline if things go according to plan..

And our next question comes from Chris Quilty with Quilty Analytics..

Thanks. Martin, I had a question about the technology deployment here.

You mentioned that you're already producing new antennas for the HTS service, but what's happening on the modem side?.

We’ll be making product announcements, Chris as we launch the actual products. But you're correct in thinking about modems as a key part of what you need to get the new higher speeds. So the below deck equipment would need a faster modem to get the faster speeds..

Okay.

And you're still thinking of keeping the network Ku-band, I mean there's not any global KA available other than?.

Right. Yeah. We’re very happy with the Ku-band in terms of the cost, the coverage and the speeds that we're getting and the fact that we have an easy upgrade path for all our customers. So if our installed base wants to upgrade, it will be an easy upgrade for them. And very economical upgrade.

So whereas if you switch to Ka-band, as you know, it's a whole new antenna, whole new everything..

All right. And with regard to the modem technology, I mean when you originally launched the mini-VSAT back in 2007, what really stood out was the size of the antenna, relative to competition.

Do you still anticipate having those sort of advantages with the new HTS systems?.

Yes. So we're going to continue to offer smaller and faster..

Got you. On the FOG business and specific to moving into high volume for autonomous vehicle, I think you had talked in the past about to hit those going from tens of thousands to hundreds of thousands to millions, you might look for co-investment with some of your customers or NRE.

Is that still a part of the thought process here or is this something that you think will be KVH only investment?.

No. I think that's something that we're still discussing and, but we're not depending on it. So, we're not waiting for that to happen and that's why we're bumping up our internal R&D spending on this. Actually, we’ve really started. But, yeah, we would certainly consider partnering with one of our key customers..

Okay.

And on the TACNAV product, did you give a backlog for that and could you give us for the quarter sort of the breakdown between TACNAV and FOG sales?.

So for the fourth quarter, FOG products were in the neighborhood of $4.5 million, $4.6 million. TACNAV was in the neighborhood of $5.4 million..

And the backlog?.

The backlog is in total 5.5 million with 5.1 million expected to ship in 2017..

Okay.

And if the large order comes in as expected, would that all drop into the backlog or would you assume that that's going to stretch out past one year and you just take a portion of it into backlog?.

It will depend on when it's received, what - obviously, it was received now and the customer wanted delivery this year, then it would go in and out of backlog in 2017.

But if the - either the order happens late in the year and/or the customer wants delivery spread out over a longer period than one quarter, then it would obviously be carried as backlog going out of 2017. I’m not sure if I'm answering your question..

Kind of. And I guess for Don, when we think about the bundles, are there any special reserves or accounting we should be aware of or think about in that you are now taking retaining ownership of the hardware in this sort of arrangement or is it done on a capitalized lease basis.

I mean how does that flow through on the P&L?.

Sure. So these will be revenue generating assets on our balance sheet. It won't be leases. There won’t be long term leases, there will be month to month short term arrangements. So they'll - we will report them along with our other property plant equipment in our balance sheet.

From a revenue recognition point of view, it should be fairly straightforward. It's a monthly charge to the customer, a monthly all-in charge, they may not even see the component of it that represents hardware, a single charge based on the contract. We will retain ownership of the hardware and we’ll depreciate that over its useful life.

Does that help?.

Yeah. It does.

But from a customer perspective, let's say, they're transitioning from old plants to new plants, I mean at face value, this is going to increase their monthly service cost or subscription cost and they avoid any capital outlay for the equipment on the front end?.

Well. I mean the goal here isn't to make it unattractive. So from a pricing model, the goal is to make it attractive. We're very keen on building our subscription base revenues. Right now, it's about 50%, 60% of our total company revenues. We intend to grow that and be less focused on selling hardware and more focused on subscription.

So I think that the, in all of these, it's sort of the trend in IT today is that you outsource your storage to AWS or your CRM system to SalesForce.com. So this path has been pretty well worn in other areas of IT.

So I think when we present this to the CIOs and the IT managers of the companies, it's an attractive model where you just give them the service that they want without the hassle of figure out what hardware to buy and how to set it up and configure it and all that other stuff..

Great.

And final question, I mean, how do you move forward with this strategy and promote it? I mean it's pretty attractive relative or very differentiated relative to what every other vendor in the industry is doing, right?.

And I think it's also something that would be difficult for others to do, because one of the things, because we make the hardware, we can get the hardware back, we can refurbish it, make sure it's perfect and send it out again, it’s difficult if you're an air time service company in a high rise building somewhere to try and do that.

So I think it's a unique thing that we have and because we own the content, we can offer these bundles in very attractive ways..

Got you.

And how do you promote it?.

Oh, sorry. That's going to be key here and it's - we're having a lot of internal discussions about what they call it from a marketing perspective and how to explain it. So we've got to have - we're going to have a marketing launch here shortly.

This trade show is coming up where we will be announcing it, but we're going to make a big splash out of this..

And there are no questions at this time..

Okay. Well done and I will be available for follow-up calls and thank you all for your time..

And that concludes today's conference. Thank you for your participation. You may now disconnect..