Martin Kits van Heyningen - CEO Don Reilly - CFO.

Rich Valera - Needham & Company Jim McIlree - Chardan Capital.

Good day, and welcome to the KVH Industries, Inc. Third Quarter 2017 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..

Thank you, operator. Good morning, everyone. Thanks for joining us today to discuss KVH Industries’ third quarter results and our guidance for the 2017 fourth quarter and full year, all of which is included in the earnings release we published this morning. With me on the call 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’re listening via the web, feel free to submit questions through ir@kvh.com.

This conference call will contain certain forward-looking statements that are subject to many 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 will 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 this morning and the company’s SEC filings available directly from the Investor Information section of our website. At this time, I would like to turn the call over to Martin.

Martin?.

Thanks, Don. Good morning, everyone, and thank you for joining us today. Let’s get started. Our third quarter revenue was $40.5 million, which is slightly below our guidance range, while our EBITDA of $1.6 million and adjusted EPS of $0.02 were both well within our range. In many ways, this was a difficult quarter.

For our maritime group, the three different hurricanes impacted our airtime business in the Caribbean and the Gulf. And the Florida storm hurt our leisure, marine and dealer business there during the final weeks of the quarter. But despite the storms, airtime service revenues were up, but not as much as we’ve seen in prior quarters.

And of course, the continued delay in our TACNAV international orders was a disappointment this quarter. We still have very high confidence that we will get the order, but since it’s not in backlog as of today, we are removing it from our Q4 guidance. We saw strong shipments of our FOG systems, in particular, our inertial navigation system.

FOG revenues were up 25% compared to last year, as we continue to gain traction in higher end drones and other exciting new applications. The big news from Tuesday, of course, is about our new satellite network and our new high-speed TracPhone V7-HTS system.

This is, by far, the biggest product of service launch for KVH, since we launched the original mini-VSAT broadband service 10 years ago. We’ve been working on the network and the hardware nonstop for the last two plus years. I’ll be touching more on that in a moment.

And I also like to bring you up the speed on what I believe is a significant breakthrough that we’ve made in our effort to bring a photonic chip-based solution to the FOG autonomous automotive market. Starting with our VSAT business, we’re seeing a very positive reaction to our new AgilePlans business model.

We signed some major new fleet deals, continuing the successful rollout of our AgilePlans subscription product, and we have a healthy pipeline. AgilePlans orders represented 45% of our commercial maritime shipments in Q3. That’s up five points from the second quarter, and we’re seeing that upward trend continue.

Based on the feedback we are receiving, commercial fleets are finding our unique all-inclusive, no-commitment subscription model very appealing. For example, we recently won an AgilePlans deal for a 60-vessel fleet and another for a 50-vessel fleet.

But we also have a significant level of what I call soft commitments which represent 100 of vessels already. With AgilePlans, we don’t sign a contract for an entire fleet. So what typically happens is that the customer takes one unit, tries it for a month or two, and then says, great, I’m going to roll this out to my whole fleet.

And then we start the logistics of planning the installations and working through the details for each vessel. So while this isn’t as good as having a PO for an entire fleet or signed contracts, it’s important to realize that we are succeeding in building momentum, and we’re very pleased with the reaction of this new business model from the market.

So we’re now completing the rollout onto fleets that we started right after launch. And to-date, not a single unit has been returned, so even though there is no commitment or contracts that prevent them from doing so. This brings to life some of the assumptions that we had and we brought this new connectivity as a service model to market.

For example, even with our no-risk, no-commitment terms, new customers still want to test the system before moving ahead with the fleet-wide roll out. This process can take a matter of weeks or months depending on the company.

No in addition, we’ve made installations as convenient as possible, the process so while we’ve done that, the process still depends on customer logistics and vessel availability.

So what we’ve learned is the AgilePlan subscription installation program is rapidly growing in popularity but the process requires roughly the same amount of time as when a fleet purchases or leases a system. We’d expect that the process to be quicker, given that no commitment is required by the customer.

So what we found is the initial unit sale is in fact quicker, but the fleet rollout still takes time. While we believe that AgilePlans is a game changer for the maritime SATCOM business model, we believe that our newest product and service represents a quantum leap in performance that mariners expect from their communication system.

As I mentioned, on Tuesday night, we are thrilled to announce a new high-speed global network and our TracPhone V7-HTS. We are showing it live at the Fort Lauderdale International Boat Show, which started yesterday. Our new HTS service is the largest Maritime Ku-band network we have ever offered.

We increased our coverage by an additional 25 million square miles, above and beyond, what our existing mini-VSAT Broadband maritime network delivers. We’ve incorporated new advanced Intelsat Epic Satellites, new terrestrial infrastructure, traffic shapers, all the optimized bandwidth allocations.

We’ve also increased Asian satellite capacity in partnership with SKY Perfect JSAT. Virtually everything about the new network and service and hardware is brand new and state-of-the-art. Our new 24-inch V7-HTS antenna system is the first product to bring the full benefits of our new network to market.

It delivers global download speeds as fast as 10 megabits per second and upload speeds as fast as 3 megabits per second. Now this is three times faster for downloads and six times faster for uploads than our current product.

These new speeds are great for streaming, simultaneous channels of HD content, video conferencing and, of course, normal web browsing. We believe that we will now be offering the best Internet experience that has ever been possible at sea.

For existing customers, we’re offering an easy upgrade path to HTS capabilities for all existing TracPhone V7-IP systems. Another innovation is our new hybrid rate plans. There are two channels in our below our decks ports. Now, one has the super high-speed 10/3 output that’s build by the gigabyte, and the other has a slower but an unlimited use port.

These two data channels operate very simultaneously, giving customers the best of both worlds. The high speed channel is modeled after our popular Open Plans, in which a customer purchases a monthly bucket of data, sufficient for their needs, and that’s always delivered at the highest network speeds available.

The unlimited use data channel is speed base, and it starts at 128 kilobits per second and goes up to 4 megabits per second, with no overdues for a fixed monthly cost.

We’ve also added the TracPhone V7-HTS through our AgilePlans program, giving commercial fleets the ability to bring a high-speed, all-inclusive SATCOM solution onboard, and now it’s even faster and has the unlimited use channel as well. We think this will be further huge incentive for people to switch to KVH and AgilePlans.

TracPhone V7-HTS shipments will begin beginning of December, and at the same time, the network will go live. So moving on to our inertial navigation business. We have strong IMU sales that drove fiber optic gyro product revenue higher by 25%, while contracted engineering services revenue doubled in the third quarter of 2017 compared to last year.

Now these gains were offset by the continued delay of the large international TACNAV order. We still expect to receive the order but probably not in time to ship before the end of the year. During our last earnings call in July, we discussed our successful completion of extensive independent testing of our TACNAV 3D navigation system for U.S.

Army program managers. This was crucial to our fiber optic gyro-based TACNAV 3D system, as it will play a significant part in our ability to meet the upcoming requirements for assured position navigation and timing or A-PNT. Now we’re moving on to additional testing. In a few months, we expect to be on-site a U.S.

military test range for a new round of field testing of the TACNAV 3D and the inertial navigation component in a formal A-PNT solution. Here, the Army will be using the latest GPS jammers and spoofers to test the ability of our system to overcome various levels of cyber warfare threats.

Given that our system is not dependent on GPS for any outside signals, we hope to demonstrate the clear value of being able to provide uninterruptible position and navigation information on the battlefield. Looking a bit further out, we continue to make progress on our automotive gyro efforts. In fact, I’m really thrilled with our progress.

Our latest batch of photonic chips have reduced the insertion loss, which was the key parameter that we’ve been struggling with by more than an order of magnitude from the previous samples. In fact, it’s now a factor 4 better than what we set as our requirement. So -- although we’re not done, there is still more work to do.

I’m now convinced that this approach is going to work. And we’ve established feasibility of our approach. So we are moving now from the pure research phase into product development. This new chip and the benefits we hope to achieve are key to the mass production necessary to enter the automotive and driverless vehicle markets.

We also are now looking at whether this new approach not only gives us cost benefits, but in fact, provide a significant performance boost as well. That could have positive implications not only for market expansion but also for reducing the cost of our existing fiber optic gyro product.

So in summary with one quarter to go in the year, we have made a lot of progress on the key initiatives that we’ve been investing in all year. We launched our Connectivity as a Service solution. We launched our global HTS network and a new terminal. We’ve made a major progress on our photonic chip research.

And we positioned ourselves to be part of key U.S. Army trials, involving assured PNT. While the push out of TACNAV -- the TACNAV order into 2018 is disappointing, we remained extremely excited about our new products and services and the opportunities ahead. Now I’m going to turn the call back over to Don for the numbers.

Don?.

fourth quarter revenue is estimated to be in the range of $39 million to $42 million. GAAP EPS to be in the range of negative $0.24 to negative $0.18 per share. Non-GAAP EPS is expected to be in the range of $0.02 to $0.06 per diluted share. And adjusted EBITDA is estimated to be between $1.1 million to $2.1 million.

At the midpoint, our Q4 2017 revenue guidance represents a decline of about 7.7% compared with Q4 2016 and is primarily due to lower expected TACNAV sales. For full year, our TACNAV adjusted revenue guidance is $160 million to $163 million. Our expectations for full year GAAP EPS is a range of negative $0.81 to negative $0.75 per share.

Our non-GAAP EPS is to be from negative $0.02 to positive $0.02 per diluted share. And our adjusted EBITDA range is from $4 million to $5 million. This guidance assumes, there will be no significant changes in foreign currency exchange rates. For 2017, we expect our capital expenditures will be in the range of $12 million to $15 million.

As Martin said, we continue to make really great progress on key strategic initiatives that we’ve been working on during the year, that we believe will have meaningful applications for our company in the future.

The rollout of the new HTS or high through-put satellite service and hardware is on track, the introduction of AgilePlans is going really well. We made really good progress toward developing the low-cost FOG for autonomous vehicles. We are on track with our TACNAV technology to support the critical military demand for A-PNT.

As we’ve said, 2017 continues to be an important transition year. These initiatives have the potential to transform the company going forward. This concludes our prepared remarks. And I will now turn the call over to the operator to open the line for the question-and-answer portion of this morning’s call..

Thank you. [Operator Instructions] We’ll take our first question from Rich Valera with Needham & Company..

Martin, with respect to your low-cost FOG development, I think you said that your latest iteration of your photonics IC had 4x better insertion loss and I guess the previous iteration.

Can you say where that puts you relative to where you need to be to have a commercially viable product?.

Actually, with more than an order of magnitude better and it’s now a factor of four better than it needs to be for insertion loss. So that was sort of a critical parameter that we’ve been chasing, so we’ve nailed that. So there’s no further improvement required there. In fact, it’s better than it needs to be.

So we’re now moving on to other elements of the integration and testing, but it’s with a huge technical breakthrough that -- with a big blocker for us. So that was the thing that we were concerned about the very feasibility.

When you do research and development, you can’t say when some things going to happen or even if it’s don’t work because it’s still R&D. So for me it was a threshold that we crossed. We’re now convinced that it’s feasible..

Got it. So I think earlier this year when we talked about the time line for commercial availability, you’d said you’d be disappointed if you didn’t have it commercially available by the end of next year ‘18.

Is that still your thoughts?.

Yes, I think that this is -- this continues to test well, that time line could be pulled in. I think it depends on what we’ve seen so far. I mean this batch literally came in a few days ago, so it’s a big news, and we haven’t fully tested it yet. So -- but I think that 2018 is definitely our target..

And can you give us a sense of how -- what would be the next step? So let’s say, you kind of get through this current process and then everything checks out.

Would the perspective customers should have -- what are the next steps for them? What have they told you in terms of how quickly they would be ready to kind of take these products and then presumably put them into production?.

That part is different for every company and a lot of their plans are kept very close and they don’t actually tell us what their production plans are, what their new models are. But we have been told that 2018 is a critical date. So that’s what we’re shooting for..

Got it. And then if I could move on to the TACNAV. So it sounds like another push-out of TACNAV orders. And my understanding if you had roughly 15 million of orders that has been pending for I think about three years now, I think this is the third year of running that, we’ve kind of push them out as we headed late in the year.

So just trying to understand why we should still have confidence.

Those orders are going to come in, do you have any specific anecdotal evidence you can give us that would suggest that they’re going to come in either later this quarter or early next year?.

Right. Well, don’t make it worse than it is. It was two years and one year for one order and two years for the other order, and they’ve now been merged into a larger program. But your point is well taken.

So we continue to monitor things at the micro level every contract, clause, negotiation, funding decision, vehicles being contracted, vehicles being delivered. So we’re very close to it. We still have confidence that it’s going to happen, but we completely understand the frustration and not being able to predict these things.

So we’ve purchased materials. We’re proceeding with production. So we’re very confident it’s going to happen, and we’re disappointed that it’s going to be 2018..

And one more, sir, if I could. Just on the HTS product, you spoke pretty optimistically about how this potentially changes your competitive situation in the market.

Can you give us a little color on that? I mean do you feel like you’ve potentially losing business because you didn’t have an HTS product? Or does this kind of help you to leapfrog ahead of your most direct competition? If you can give us some sense of where you think this put you in the market?.

Yes, existing technology is very well established, is very reliable, good coverage, but what we have now gives us really a big leg up over our competitors. So we’ve got better coverage. We’ve got almost as good coverage with Ku-band that we have with our C-band before.

So now it’s single antenna or small product to 60-centimeter product has speeds that are almost more than double the V11 which is a 1-year product. We’ve got the dual airtime packages now where you’ve got the high-speed and unlimited plans.

And from a competitive perspective, this new architecture, the hardware is less expensive than our old hardware and the airtime is much more competitive so our costs are coming down significantly. So on a cost-per-megabyte basis, as delivered to a customer, our cost is approaching half what it was.

So we’re offering higher speeds and our costs are going down. We’ve got better coverage. So it’s really -- for us, it’s been a mammoth effort over the last year 2.5 years to pull this together. So it’s not just a new product, it’s not just additional transponder, it’s a completely new architecture.

So long answer, but the second part of your question is correct. This leapfrogs the competition in a big way..

And our next question will come from Jim McIlree with Chardan Capital..

Don, I think you said that 45% of shipments in Q3 were to agile, did I hear that correctly?.

You did, yes..

And is that....

Commercial shipment..

Yes, is that a number that it’s -- is that ratio likely to increase or stay at that kind of rate going forward?.

I don’t think it’s going to increase, yes. I had to increase in the third quarter versus the second quarter. The run rate into the fourth quarter has been very strong. Pipeline has been building, so now we could [indiscernible] the center is going to increase..

All right. So from a product sale perspective, when I’m looking at product sales for mobile connectivity, if my AgilePlan shipments are increasing, that implies that I’m going to have continued pressure on the product sales growth as long as that number increases.

Is that correct?.

Yes, there will be some pressure on cellular shipments to commercial customers who the Agile product is -- or program is targeted for. We still expect a fair amount, a significant amount of VSAT sales to leisure and other areas of the market. But I think you’re right, there’ll be pressure on them, on product sales.

We won’t see the -- and don’t anticipate the same level of growth in VSAT product sales that we may have seen in prior years..

Right, I just want to make sure I understand the dynamics there. We get a better long-term service revenue, but at the expense of short-term product sales is kind of how I’m....

Yes, you’re exactly right, and this is the transition moving to this Connectivity as a Service model is it’s always risky. You’re giving up the guaranteed hardware sale for growth and service revenues. And for the first couple of quarters, it’s definitely a leap of faith. So we’re actually pretty pleased with the way it’s going.

I think we’re probably a quarter or maybe 2 quarters behind where we thought we’d be, but we can definitely see that it was the right move and it’s going to be a successful program for us..

And when you say, Martin, that you’re maybe a quarter or 2 behind where you wanted to be at that, is that due to something internal or the market is just taking longer to respond to this?.

Well, the market actually responded quickly, which is what we had hoped. So people are quickly saying, "Hey, this is great. I’ll do it." And -- but they do want. And then they try it for a couple of months and then say, "Great, now we’re going to roll out the fleet." So the fleet rollout isn’t going any faster than when they buy them.

So the initial decision is quicker, which is great, but they still want to try it before they roll it out to their entire fleet, and that’s probably something that we didn’t really anticipate. We thought that since they had no commitment, they would just go for it.

But in hindsight, I think it make sense because if you’re an IT Manager, you don’t want to rollout something that isn’t going to work even if you can send it back. It’s just too disruptive. So the good news is that no one returned any units. So the people have tried them and now rolling out to their fleet. So, it’s working..

Got it. Okay. And then on the FOGs, so you say you have a -- it sounds like you have a technology breakthrough or you’ve crossed the threshold.

What about production? Is that still a -- or cost, cost to manufacture, is that still an issue that you need to overcome? Is that like the next step in what’s happening here?.

Well, the cost part was always fine with these new chips. In other words, this replaces the individual fibers that are built in the couplers and then the individual fibers that are built in the polarizers and then into second couplers, and all that gets placed together. It replaces all of that, and that is a huge cost saving on day one.

So the issue before was it just didn’t work. It wasn’t that it wasn’t inexpensive. So once we get the photonic part completely finished, we’ll have this photonic chip that we’ll just attach to the fiber coil, then the rest of the stuff in terms of scaling our production is very straightforward.

So beyond that, it’s also reducing the size and cost of the electronics. But that’s not R&D, that’s just normal cost reduction and scaling. So....

Okay. So just to reiterate that, there’s no particular new technologies that need to be created in order for the production to take place and the cost reductions from that? That’s just, what I want to call it, easy, but that’s the normal....

Yes, for their -- right, there’ll be packaging and other things, but we have -- part of this design and part of our concept does specifically addresses that issue. So it’s no, we don’t see that -- once the device works, we don’t see transitioning to production to be difficult..

Right, right. Okay. And....

Because the whole point of it is to make it -- we already have something that’s relatively difficult to manufacture, so the whole point is to design something that’s already easy to manufacture..

Right. And I’m assuming that this is something that the customers are keenly aware of and monitoring as well? I know that’s kind of sad question, but I just wanted to make sure..

Yes. I think that there was a healthy amount of skepticism that we’d be able to pull this off, so I think we’re feeling pretty good right now..

Okay, great. And to Richard’s point about TACNAV, I don’t want to beat you guys up about it. I mean, we all know that the orders there are lumpy and oftentimes pushed to the right. I would just suggest that keep it out of guidance until it’s a hard order. That’s just my one man’s opinion..

Yes. Well, it’s officially out of our guidance..

Yes, I was talking about 2018 because I’m sure there’s going to be at least some follow-up, putting it back in, yes..

Point taken. Point taken..

And it appears there are no further questions at this time. I’ll turn the conference back over to management for any additional or closing remarks..

Great. Well, if you have anything some follow-up conversations with some people who couldn’t make this call and if anyone has any direct questions, feel free to call us or email at irkvh.com. Thank you..

And that concludes today’s call. Thank you all for your participation. You may now disconnect..