Good day, and welcome to the KVH Industries, Inc. Quarter 3 2020 Earnings Conference Call. Today's conference is being recorded. .

At this time, I'd like to turn the conference over to Don Reilly, Chief Financial Officer. Please go ahead, sir. .

Thank you, operator. Good morning, everyone. Thanks for joining us today to discuss KVH Industries' third quarter results, which are included in the earnings release we published this morning. With me on this call is Martin Kits van Heyningen, the company's Chief Executive Officer; and Brent Bruun, our Chief Operating Officer. .

The earnings release is available on our website and through 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 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 and our second quarter Form 10-Q filed on July 31, and our 2019 Form 10-K, which was filed on February 28. The company's other SEC filings are available directly from the Investor Information section of our website. .

At this time, I'd like to turn the call over to Martin.

Martin?.

Thanks, Don. Good morning, everyone, and thanks for joining us today. Overall, we're very pleased with our results this quarter, which came in much better than expected. Despite the pandemic, we stayed focused on executing our strategy and optimizing operations during the quarter.

The quarter's revenue total was up 5% to $41.1 million compared to Q3 of last year. Our gross margins rose significantly compared to the previous quarter. Airtime revenue was up 9%, and Inertial Navigation product and services revenue rose 27% compared to last year. .

We maintained our cost management discipline throughout the quarter and prioritize managing our supply chain and our sales and service partners worldwide. Due to travel and gathering restrictions, we eliminated in-person trade shows and business travel and scaled back other discretionary costs.

The lack of in-person trade shows offer the means of reducing cost, but it also reduced opportunities for conversations with new prospects and building our pipeline. However, we adapted rapidly to the world of virtual trade shows and conferences.

Our in-house marketing team worked closely with sales, and was able to pivot to focus on alternative in-person events, focusing instead on webinars and panels while maintaining a strong digital and networking presence at these online events. .

All these efforts paid off with one of our strongest third quarters in many years. Our EBITDA for continuing operations was $3.4 million, and that's a $4.6 million increase year-over-year. So it's not merely an improvement over low revised COVID estimate.

We maintained a strong cash position of more than $40 million and entered Q4 with a backlog of almost $26 million. .

At the start of the fourth quarter, we also ended the temporary salary and benefit reductions we put in place 6 months ago as we have confidence in our current financial situation, the sales pipeline and operational stability. Our Q3 results validate our strategy of diversification with strong results across virtually all markets and product lines.

And with our established worldwide service and support network, we're well positioned for the future. .

Now let's look at the details of our core markets, starting with Mobile Connectivity. The leisure and commercial maritime markets appear to be withstanding the challenges caused by COVID over the last few quarters. Commercial port calls have stabilized with an average of roughly 22,000 board visits a day, and that's about 15% below historic levels. .

Leisure marinas are open, recreational boats around the water throughout the summer. And the Fort Lauderdale International Boat Show, the world's largest in-water boat show, opened yesterday.

In this steadily improving business environment, our overall Mobile Connectivity revenue was $31.4 million for the quarter, and that's just slightly down compared to Q3 of last year. But airtime revenue increased 9% or $1.8 million to $21.7 million quarter-over-quarter -- year-over-year rather.

As we increased our subscriber base by 4%, the airtime margins rose to almost 39%, and that's up more than 2 points compared to Q2 of this year and more than 4 points versus Q3 of last year. This improvement reflects the success of our ongoing efforts to migrate existing customers and add new customers to our HTS network. .

TracVision Satellite TV hardware sales in the leisure market and media subscriptions for cruise ships were the 2 areas that had significant COVID-related declines. TV sales are starting to rebound as we move into Q4, but the recovery of the cruise ship media content will likely continue throughout 2021. .

Demand for our AgilePlans Connectivity as a Service product remains strong as Q3 AgilePlans revenues were up 55% compared to the same period last year. New AgilePlans subscriptions amounted to 78% of our commercial maritime VSAT shipments in the quarter.

And some of our commercial maritime competitors report financial challenges, bankruptcies and issues with getting onboard ships for installations and service, we believe we continue to gain market share.

Drawing on more than 3 years of AgilePlans installations, we have safely deployed new VSAT systems on vessels around the world with only minimal interruption since the pandemic. .

Our in-house service delivery group did an outstanding job in working through the myriad logistical problems and tightly managed our in-country partners. This team oversees a sophisticated installation management process and works directly with customers and in-country resources to manage shipping, customs, installation and service activation. .

Our new product and service development efforts continued throughout the quarter as well. In August, we introduced the TracVision TV10, the 1-meter ultra-high efficiency marine satellite TV antenna. The TV10 offers the biggest coverage footprint of -- for our entire TracVision product line.

It also connects boat owners, charter guests and commercial crews to live news, local channels and television and movie programming from leading satellite TV providers worldwide. .

Yesterday, at the Fort Lauderdale show, we rolled out a new unlimited-use regional airtime plan for our smallest TracPhone V3-HTS. Subscribers select a high-speed data package with speeds as fast as 5 megabits per second. And these packages range from 200 megabytes to 10 gigabytes a month.

If the subscriber runs out of high-speed data before the end of the month, the system automatically shifts to a slower managed rate that provides continuous service with no overage charges. We believe that these fixed price no overage plans will be very popular with owners of smaller boats, just as they have with our AgilePlans regional product. .

Together with the 37-centimeter V3-HTS, they are a very compelling solution for the leisure and commercial vessels currently equipped with old, slow and very expensive L-band sat phones.

Our track record of innovation was recognized recently when the National Marine Electronics Association bestowed Product Excellent Awards on our TracPhone V3, our TracVision UHD7 and our TracPhone LTE1. .

Recipients are selected by members of NMEA, which is an industry group comprising more than 600 manufacturers, dealers and boat builders, all of whom are experts in the industry. We're very gratified by their recognition. .

And finally, in Mobile Connectivity, we're making excellent progress with KVH Watch, our IoT Connectivity as a Service solution. We just completed our product launch, hardware and service readiness review, and we're now ready to deliver watch flow and watch remote expert services.

Commercial vessels are prime candidates for data-driven optimization and remote support. These are complex machines operating in the middle of the ocean, offshore for long periods of time, where even the smallest adjustments can have tremendous ramifications. .

With optimization and efficiencies relying on getting real-time data, the data has held aboard the vessel and is only accessible in port, it's fine for historical analysis. But real-time visibility at affordable cost enables IoT to provide cost savings that have never existed before.

The importance of remote data, intervention and support has never been more apparent than during the pandemic as access to vessels is restricted and remote surveys have suddenly become the norm. And the demand for remote tech support has increased. .

So shipowners and managers recently spoke at the SHIPPINGInsight Conference about the growing need for equipment manufacturers to have remote access to their onboard equipment even in a post-COVID world. We've seen our sales funnel and partner funnel for KVH Watch expand during the quarter. And it's well beyond just equipment manufacturers.

Now includes IoT service companies, multi-card service providers, charter party and insurance players and others.

So what's unique about our service is that it's designed in a multi-tenancy model where many different companies can subscribe to our service on the same ship and make use of our software and our dedicated high-speed VSAT antenna on board. .

KVH Watch is an ideal solution for these applications. The system delivers 24/7, ship-to-shore data for remote monitoring and analytics as well as high bandwidth on demand remote interventions that enable experts onshore to work directly with the crew even during deep-sea time. .

Plus, we designed KVH Watch with cybersecurity in mind, including the stand-alone air gap VSAT terminal, isolated onboard local area network, multifactor authentication and satellite network security. Throughout this quarter, we've continued to build a strong pipeline. We're very excited about the prospects for this strategic initiative. .

Moving on to our Inertial Navigation market. Revenue for the quarter increased 27% to $9.7 million from $7.7 million in Q3 of last year, thanks to growth from both our FOG and TACNAV military product lines. Similar to Mobile Connectivity, Q3 saw a pivot from in-person trade shows to virtual engagement for the Inertial Nav market.

Attendance and engagement were low for virtual shows, so we focused our efforts on webinars and speaking opportunities, case studies and digital advertising to build the sales pipeline. .

Early in Q3, we announced a new international order worth more than $10 million for our TACNAV tactical navigation systems. Shipment of that order are beginning this quarter, Q4, which should help further improve our overall financial performance. .

On the FOG side of the business, we saw a reinvigorated demand across multiple applications and markets. New autonomous solutions that need our level of performance are launching all the time. And we continue to see strong interest in our photonic chip or PIC technology.

After making strategic investments in this groundbreaking technology, we shipped our first production IMU at the end of Q2 that had a PIC inside, and we're actively working to incorporate the PIC technology in the remainder of our core product line by the end of this year. .

Beyond this year's rollout of the PIC, this patented technology enables a whole new platforms of performance, so we can target incremental new markets and applications. Our multiyear product development roadmap for PIC is quite extensive, and the impact of this innovation is only just beginning.

So even as we incorporate the PIC in today's products, we are developing new optical engine, which will have -- which will provide even more integration and hopefully improve performance and even lower costs. .

So in summary, aggressive and early actions during the pandemic helped us mitigate the impact of the global economic situation. Despite the uncertainties in the markets, we continue to focus on executing well on our strategic and operational plans, keeping our employees healthy and delivering a premium experience to our customers.

We know that the pandemic is far from over, and we remain vigilant. And we're proceeding cautiously, but with confidence in our outstanding team worldwide, our business model and the progress that we've made on our strategic initiatives. .

And now I'm going to turn the call back to Don for more detail on the numbers.

Don?.

Thank you, Martin. First, as we said in our second quarter call, some perspective is required in order to put our third quarter results in context. Much of the world and the industries we serve continue to be impacted by the COVID-19 health crisis.

Given the impact that COVID-19 has had throughout our business, we believe our third quarter results should be viewed quite positively. .

Having said that, I would like to walk through our third quarter results in more detail. As Martin mentioned earlier, our third quarter revenue came in at just over $41 million. This is -- this compares to $39.3 million recorded in the third quarter of 2019.

The revenue from our Inertial Navigation segment increased over $2 million, while revenues in our Mobile Connectivity segment decreased about $300,000 from the prior year third quarter. Product revenue for the third quarter was $16.7 million, an increase of $1.8 million or over 12% from $14.8 million in the third quarter of the prior year. .

By segment, product revenues in our Inertial Navigation segment increased to $2.7 million or about 40%, primarily due to a $1.5 million increase in our FOG and OEM sales and a $1.2 million increase in our TACNAV product sales compared to the 2019 third quarter. .

Product revenues in our Mobile Connectivity segment decreased about $900,000 or 11%, driven mostly by a $500,000 decrease in TracVision sales and a decrease in our land mobile product sales. .

Service revenue for the third quarter was flat at $24.5 million for both the third quarter of this year and the prior year.

Mini-VSAT Broadband airtime revenue increased $1.8 million compared to in 2019, driven by a 4% increase in subscribers, primarily as a result of AgilePlans and a $900,000 onetime amount from a customer in connection with the resolution of certain contractual matters. .

These increases were partially offset by a $900,000 decrease in our media business, which was significantly impacted by the travel restrictions associated with COVID-19.

As I mentioned, AgilePlans is a significant driver of the increase in our mini-VSAT Broadband airtime revenue, which approximated $21.7 million in the third quarter, growing approximately 9% from the prior year.

VSAT shipments in connection with the AgilePlans program approximated 64% of our total unit shipments, and as Martin said, 78% of our commercial shipments for the quarter. AgilePlans now represents 35% of all mini-VSAT airtime subscribers. .

For the third quarter, our consolidated gross profit margin was 38.5% compared to 34.2% at third quarter of last year. From a segment perspective, our Mobile Connectivity gross margin was 37.6%, up about 4 percentage points primarily due to the impact of the increase in our mini-VSAT Broadband airtime revenues.

Our Inertial Navigation gross margin increased about 3.7 percentage points to 41.2%, primarily due to higher FOG and TACNAV sales. .

Operating expenses for the quarter were $16.3 million, down almost 11% from $18.3 million in the third quarter of the prior year, in part due to the continuation of the cost control measures that has been put in place earlier in the year to mitigate the impact of the pandemic.

For the third quarter, these changes in revenue, margins and operating expenses resulted in a loss from operations of about $500,000 compared with the loss of $4.9 million recorded in the third quarter of 2019. .

Our Mobile Connectivity segment generated an operating profit of $2.3 million compared with an operating loss of $300,000 last year, while our Inertial Navigation segment had an operating profit of $1.4 million compared to an operating loss of $200,000 last year. .

And our unallocated loss was about $4.2 million compared to $4.4 million in the 2019 third quarter. For the third quarter, our net loss was about $500,000 compared to a net loss last year of $3.3 million.

On a non-GAAP basis, which excludes amortization of intangibles, stock-based compensation, employee termination and other nonrecurring costs, nonrecurring legal fees, foreign exchange transaction gains and losses, the tax effect of the foregoing and changes in our valuation allowance and other tax adjustments, we had net income of $1.1 million compared with a net loss of $2.2 million last year.

.

EPS for the third quarter was a net loss of $0.03 per share compared to a net loss of $0.19 per share last year. And non-GAAP EPS for the third quarter was -- excuse me, was -- non-GAAP EPS of third quarter last year was $0.19, I believe. .

Our adjusted EBITDA for the quarter was $3.4 million compared to a negative $1.2 million recorded in the 2019 third quarter. For a complete reconciliation of our non-GAAP measures, please refer to our earnings release that was published earlier this morning. .

Total backlog at the end of the third quarter was $25.6 million, of which approximately $14.8 million is scheduled to be delivered during 2020. Backlog for our Inertial Navigation products and services at the end of September was approximately $25 million, of which approximately $14 million was scheduled to be delivered during 2020. .

Net cash from operations was about breakeven for the quarter compared to $4.9 million used in operations for the third quarter of the prior year. Capital expenditures were about $3.2 million for the quarter. .

So to wrap up, I would like to say that we are pleased with our third quarter results, especially in the context of the COVID-19 pandemic, which continues to affect the global economy in general and many aspects of our business in particular.

Although we believe our business continues to withstand the economic turbulence caused by the pandemic very well, we need to recognize the ongoing uncertainty caused by the global health crisis. .

The duration of the COVID-19 pandemic is still unknown and opinions on the matter vary and change daily. Accordingly, our revenues, results of operations and financial condition may still be materially impacted in the future until COVID-19 is finally eradicated. .

In the meantime, we will continue to focus on costs and efficiencies to ensure that we continue to be as well prepared as we can be until the COVID-19 threat is resolved. .

This concludes our prepared remarks. And I'll now turn the call over to the operator to open the line for the Q&A portion of this morning's call. Thank you.

Operator?.

[Operator Instructions] Our first question comes from Rich Valera of Needham & Co. .

Starting off on the mini-VSAT gross -- airtime gross margins, really impressive performance there. And I thought last quarter, you said you might see some downward reversion there because you had a bit of -- a pretty significant pop, I think, in Q2. So just trying to understand the dynamics there.

And do we think that gross margins are sustainable in this high-30% range over the near term?.

Well, I think, I'll let Don answer that question specifically, but we did have a sort of a onetime pickup on some overage charges that we don't expect to recur. And also Q4, there's some seasonality, especially in the leisure market, where people put their boats away for the winter. So that's the normal seasonal change.

And so -- and that also has an impact on margins because they downgrade to lower plans. But I'll let Don answer on the detail on the margin number. .

Right. So we -- the third quarter was very high for the reasons some Martin attribute -- just described. The fourth quarter will not be as high as the third quarter. First, we had that onetime bump. Also, we'll add capacity in the fourth quarter. So no, it won't be that high, probably between 30% and 35% in the fourth quarter is my guess. .

Okay. That's helpful. And just trying to understand maybe the underlying demand trends in the mini-VSAT business.

I mean, historically, you've kind of talked about installs and orders maybe? Is there any color you can give in sort of the cadence of installs and orders as you move from 2Q to 3Q and now into 4Q? Has that been pretty steady? Is it picking up, trailing off? Any color there?.

Yes. The surprising thing is, in terms of unit volume, it's ahead of last year for the quarter. So very strong bookings and installation or shipment quarter. So -- and as I mentioned in the sort of prepared remarks, it's logistically was super challenging quarter.

So our team did a really nice job managing all the various testing requirements to enter countries and ports. So -- and I think we did gain some market share because of that. .

That's helpful. And then pivoting to Inertial. So it sounds like you've got about $14 million of backlog there scheduled to ship in the fourth quarter.

One, I guess, confidence level on actually shipping that, is there any risk to that production components, anything? And then would we normally expect there to also be some turns business there, so that the revenue in that segment could exceed $14 million in the fourth quarter? Just any color on that would be helpful, Don. .

So the -- we do expect to ship it in the fourth quarter. And ship most of the fourth quarter could carry over to next year. But revenue recognition in the fourth quarter, we're pretty confident in -- but under the new revenue recognition rules, we have to consider lots of factors.

So even if we may ship it in the fourth quarter, and we think we will recognize the revenue in the fourth quarter, there is a risk from a revenue recognition point of view, we may have to postpone revenue recognition until sometime in 2021. But I think from a production point of view, we should be fine.

From a shipping point of view, we should be fine. .

Yes. I will say that there is -- just to put some risk on it, what we have seen is, in general, supply chains are pretty strained. So getting parts on time and lead times are pushing out for electronic components, which is odd. But it is getting tighter than it was even sort of at the height of the pandemic.

So -- and I'm not sure why that is, whether it's just general demand for consumer electronics, but we are seeing some tightening of supply chain. So as Don said, right now, we look like -- we think we're in pretty good shape. We've got all the parts promised to come in on time. So we do expect to ship, if not all of it, the vast majority of it in Q4. .

Okay. That's helpful. And one more just modeling question quick for you, Don. It sounds like OpEx are going to go up in 4Q as you return sort of pay scales to normal, et cetera.

Can you give us any sense of the magnitude of increase we might expect in OpEx from Q3 to Q4?.

Sure, one second. So I'd say operating expenses in the fourth quarter will be at least a couple of million dollars higher than the third quarter, and maybe comparable to the fourth quarter of last year. .

Our next question comes from Chris Quilty of Quilty Analytics. .

Martin, I just want to follow up on the gross margin question. Understand the seasonality down in Q4 that you expected down.

But are you still modeling longer term that this business should be around a 40%-ish type gross margin as you achieve scale?.

Yes. Yes. And if you look at the seasonality of prior years, we don't expect it to be any different. So you have adding subs and continuing to grow the business and then that's offset with some seasonal suspensions in leisure and in commercial fishing as well.

So -- but just to be clear, there's no increase in seasonality or seasonal suspensions that we expect. So -- but it is the normal Q4. .

So -- but get back to 40% question, the answer is yes. So our long-term models have us driving to that number. And as Don said, in any given quarter, you might have where you add some capacity. And we've had some very strong subscriber growth and usage growth, particularly in Asia.

So we're adding capacity, and we've added some in the third quarter as well. So -- and you'll see some of that in the -- we'll have a full quarter of that in Q4. .

Great. And Europe, obviously, COVID is kind of raging out of control, worse than even in the spring.

Are you seeing any impact on your business?.

No, we haven't. And we were -- obviously, areas of concern would be if the boat builders close again, that would be problematic. But so far, the restrictions seem to be allowing people to go to and from work. Kind of seems to be more on the bars and restaurants and theaters this time as opposed to the lockdowns that we had in March and April. .

Understand. And switching gears over to the Inertial side.

The large TACNAV programs that still sit out there that you haven't yet landed, any update on whether they're continuing to move to the right? Or are any of those getting closer to closing?.

Well, we've -- as I've said before, we like to stop trying to forecast when those will hit. So we're happy that one of the biggest ones landed this year and it will be shipping this quarter. So our TACNAV business is going to be very strong this year. We expect another strong TACNAV year next year. So we do expect 1 or more of those to land in '21.

So there's a lot of opportunities there, and there's some new opportunities that have popped up even in the current quarter that could ship in '21. So I'd say overall, the TACNAV sales pipeline looks very strong, and we should have a strong year again next year. .

And any updates on the Assured PNT program?.

No, nothing on the production side. Collins has won the development project. And I believe part of that includes delivering only 83 units. So the -- it seems to be sort of devolving into more of a platform-type play again where the higher-value platforms will get higher-end inertial systems, and the lowest platforms will get just GPS.

But enhanced GPS with M code. So unclear where the funding is going to come out on that. So be interesting to see what the next defense budget comes out because it is a program of record now. So it should be -- but it needs funding. .

Okay. Shifting over to KVH Watch. I think last quarter, you said you hope to actually get a commercial customer signed up either Q3 or by the end of the year.

Making any progress there?.

We are. And you should expect to see a flurry of announcements there this quarter. So we're making great progress there. .

And how about on the other side in terms of signing up or aligning with the Caterpillars of the world and other systems companies that might choose to sign up for the service?.

Yes. So we're talking both the equipment manufacturers as well as IoT companies and, what I call, multi-card service provider, people who serve as a number of different pieces of equipment onboard ships.

So the overall customer target list is expanding, but it absolutely includes engine manufacturers and turbo manufacturers, scrubbers, all the people who make the key equipment onboard the ships. .

And final question for you just on the PIC technology. You're in production with your first product now.

Any surprises either positive or negative in what you've seen in terms of the production costs or product integration?.

No, no surprises. We've integrated, as you said, in the first product, we're now -- we're still on schedule to design it into the rest of the products by the end of this quarter. We have 2 suppliers, one of which is currently doing better than the other one in terms of performance. Prices are similar.

So we're -- I would say, overall, it's behaving as expected. .

[Operator Instructions] Our next question comes from Ric Prentiss of Raymond James. .

This is actually Ric's assistant, [ Brent ], on for Ric right now.

My first question would be, how do you feel about visibility, not just for 4Q, but for 2021 as you get ready to maybe give some guidance next quarter? Do you think you'll be able to give full year guidance?.

We hope so. I think that it really depends on how things shake out in terms of what's going on in terms of various lockdowns and the economy. So as the vaccine rolls out and things start to return to normal, then we expect to be able to return to giving guidance. So I think at this point, it's more of a macro question than a KVH question. .

Got it. Okay. And then the other would be, there's a lot of buzz right now surrounding these upcoming LEO constellations, SpaceX, OneWeb, some other planned ones.

How do you view the addressable market for those constellations?.

Well, I think it's super exciting. So as a purchaser of satellite bandwidth, we've got more and more options every day. So we're talking to all the companies that are in the LEO and MEO space as well as our current suppliers are launching new satellites that have greater throughput. So It's really a great time to be a -- in the satellite business.

Suddenly, we have many, many opportunities, also opportunities terrestrially. So all of these LEO constellations require tracking antennas for the consumer products as well as for the Earth station. .

So sort of the golden age of space and satellite technology. And a lot of these systems are designed for consumer applications, so they would need to be modified for use in our type of mobile applications through stabilized platforms as well as marine antennas.

But we think it's going to be a great opportunity to deliver a lot more bandwidth at better prices. .

Okay. And related to that, you guys have obviously done some great work with antennas.

Where do you think the antenna cost for those LEO constellations could realistically get down to as far as a cost per antenna?.

Well, it depends. I think if you try to do a true phased array, they're going to be astronomically high. I think the general consensus is that that's not practical for most consumer business type applications. It's more appropriate for aviation, commercial aviation.

So if you use a hybrid approach or a mechanical approach, they can be made relatively expensive, not as inexpensive as today's antennas, right?.

So today's antennas, for people who provide satellite connectivity to the home, it's a simple fixed dish pointed at 1 spot in the sky, it's nailed to the house. So it will never be as cheap as that. But the technology in general, driven by volumes, if they're smart about it, will be -- should be affordable. .

And at this time, we have no further questions in queue. And I would like to turn it back to today's speakers. .

Operator, before we -- and this is Don Reilly. When I was going through my prepared remarks, I misspoke some a little -- when I was describing non-GAAP EPS. I'd like to correct that before we end the call. Non-GAAP EPS for the third quarter was a positive $0.06 per share this year compared to non-GAAP EPS loss of $0.12 per share last year.

So just to clarify that. I'm sure people might be confused as I stumbled over those words.

Martin?.

Thanks, Don. Thanks for clearing that up. And as always, we'll be available after the call and available by e-mail as well. Thanks, everyone. .

Thank you. .

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect..