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Edited Transcript of KVHI earnings conference call or presentation 30-Oct-19 1:00pm GMT

Q3 2019 KVH Industries Inc Earnings Call

MIDDLETOWN Nov 5, 2019 (Thomson StreetEvents) -- Edited Transcript of KVH Industries Inc earnings conference call or presentation Wednesday, October 30, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Donald W. Reilly

KVH Industries, Inc. - CFO

* Martin A. Kits Van Heyningen

KVH Industries, Inc. - Co-Founder, Chairman, CEO & President

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Conference Call Participants

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* Christopher David Quilty

Quilty Analytics, Inc., Research Division - Founder & Partner

* James Patrick McIlree

Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology

* Richard Frank Valera

Needham & Company, LLC, Research Division - Senior Analyst

* Richard Hamilton Prentiss

Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research

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Presentation

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Operator [1]

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Good day, and welcome to the KVH Industries, Inc. Third Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Don Reilly, Chief Financial Officer. Please go ahead, sir.

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Donald W. Reilly, KVH Industries, Inc. - CFO [2]

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Thank you, operator. Good morning, everyone. Thanks for joining us today to discuss KVH Industries' third quarter results and our guidance for the 2019 fourth quarter and full year, all of which is 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 also from our Investor Relations department. If you'd like to listen to a recording of today's call, you can access our 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'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 heading Risk Factors in our Form 10-K filed on March 1, and our 10-Q, which is expected to be filed this afternoon 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?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [3]

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Thanks, Don, and good morning, everyone. Thanks for joining us. Q3 was a busy one for us as we made solid progress in several strategic areas of our business. Results were generally in line with our guidance. Total revenue for the quarter was $39.3 million. It was about flat with the third quarter of 2018.

Net loss was $0.19 per share compared to a net loss of $0.11 per share in Q3 last year. Now last quarter, we announced the sale of Videotel, our training business for $90 million. And in our last earnings call, discussed how we plan to begin investing a small portion of the proceeds in the key strategic initiatives that will drive long-term revenue and profitability growth.

I'd like to share an update on each of those initiatives, including AgilePlans, our new KVH Watch, IoT Connectivity as a service offering and our photonic chip technology.

In our Mobile Connectivity business, we continue to achieve excellent results. For the third quarter, airtime revenues were up 11% year-over-year, an increase of $1.9 million.

Airtime subscribers were up 15% year-over-year. Airtime margins were up more than 2 points year-over-year, and we expect to see continued improvement in Q4. We still expect to have margins around 40% as we exit the year.

Our AgilePlans Connectivity as a Service Program continues to enjoy high demand among commercial fleets. Thanks to its unique, all-inclusive, no commitment value proposition as well as the speed and capabilities of our global HTS network. As a result, AgilePlans revenue was up 100% compared to Q3 of last year. It represented 70% of total commercial maritime VSAT shipments for the quarter. AgilePlans subscribers now make up 24% of our entire VSAT subscriber base. And this is remarkable, given that we launched AgilePlans just over 2 years ago.

We set out to reduce the barriers to next-generation communications at sea through a revolutionary business model and our results and strong demand showed that it's worked. We're now investing in expanding marketing and demand-generation initiatives for AgilePlans, especially with our key service providers around the globe. In addition, we're digitizing our business platforms to enable us to scale efficiency -- efficiently and improve margins.

Our success in both the commercial and the leisure market enabled us to achieve an exciting milestone last week as we celebrated the shipment of our 10,000th VSAT system. When we launched our TracPhone VSAT systems and our network, our goal was to make maritime satellite communications more reliable, more cost-effective and more accessible to seafarers. The accelerating adoption of our TracPhone systems and connectivity reflects the demand for the affordable airtime, fast data speeds, network security, IoT proactive monitoring and value-added services that we deliver.

Our ability to offer a fully integrated solution, which we see as a KVH advantage is desirable both to leisure boaters as well as commercial -- as well as to the commercial industry, in which the connected ship is rapidly becoming a reality.

The leisure market remains a tremendously valuable part of our business. We believe we offer the best solutions for the full range of leisure boaters, as our 22 consecutive product of excellence awards from the National Marine Electronics Association will attest. And today, at the Fort Lauderdale International Boat Show, we'll unveil our newest satellite TV system, the TracVision UHD7. This new antenna offers full support for DIRECTV's 4K Ultra HD programming. Thanks to our exclusive TriAD antenna technology, which receives signals from 3 different DIRECTV satellite simultaneously. The result is an at-home TV experience on the water, including full DVR support and local channels, plus improved support for DISH Network in waters around the U.S., Central America and the Caribbean.

The yachting market, particularly at the highest level, is also seeing growing demand for VSAT connectivity. Our new KVH Elite streaming option enables yacht owners and charter operators to subscribe either weekly or monthly to a high-speed dedicated bandwidth service with unlimited data and no overages. KVH Elite will be available starting in November, with coverage from Florida through the Caribbean, including the islands of the Eastern Caribbean.

Mediterranean service is expected to follow in 2020, in time for the charter season there. The service is supported by both our 60-centimeter TracPhone V7 and the 1-meter V11-HTS. Unlike competing services, KVH HTS subscribers don't need to buy new equipment to simply activate the new Elite service through our Superyacht Concierge team. This enables us to pursue additional business with high-value customers, increase our VSAT ARPU and optimize the use of our HTS network.

Our new IoT initiative, KVH Watch, also leverages our end-to-end maritime connectivity service, the HTS network, and our successful AgilePlans style business model. This IoT Connectivity as a Service Product is a unique communication solution for remote equipment monitoring and intervention by maritime equipment manufacturers and IoT application providers. Manufacturers will be able to act in real time, minimizing expensive service calls and ensuring optimal equipment performance. When we introduced KVH Watch in June, we're very pleased to also announce that Kongsberg would be our first partner for KVH Watch IoT connectivity. Since that time, we've been working closely together with them and completing the development of the service. Now installation is underway with Kongsberg for the first live pilot aboard a commercial vessel.

And lastly, in Mobile Connectivity. We were pleased to announce last month that we are an official supplier for American Magic in its challenge for the America's Cup. There's a special meeting for us since the America's Cup is part of KVH's heritage with our very first product developed for a 12-meter yacht preparing for the 1980 America's Cup. Now we're supporting their efforts with the most advanced systems available, including our VSAT, our LTL -- our LTE communications equipment for the team's chase boats and our high-performance fiberoptic gyros and sensors to aid in the performance for the team's race boats.

Moving on to our Inertial Navigation business. Fiber optic gyro sales were down 1.7% compared to last year. This was partly result of timing of some large orders.

We have a solid backlog for Q4 shipments, and we expect to see a rebound in our FOG business this quarter. Our total backlog for Inertial Navigation systems currently stands at $22 million. That's the highest level in more than 5 years. We received a $4 million order for our FOG from Kongsberg Defense & Aerospace for use in the U.S. Army's Common Remotely Operated Weapon Station, known as CROWS. Our FOGs have been part of the CROWS program for many years, thanks to their ability to provide precision stabilization and weapon control, even while the vehicle is moving at high speed. And shipments for this order are expected to be completed by the end of next year.

Our TACNAV business also had some notable success during Q3. We announced 2 new orders, totaling $6.7 million for our FOG-based TACNAV systems for use by military customers. Shipments from one of these orders will be completed in Q4 of this year, while the other one is expected to continue shipping in -- starting in the fourth quarter and continuing through 2021.

And finally, I'm pleased to report that we've made outstanding progress in the development and productization of our photonic chip technology. We've invested in engineering talent and manufacturing equipment that's enabled us to move ahead rapidly in our efforts to bring this new technology to market.

Our photonic chip is currently in design verification testing in a military aviation product, and we expect it to be qualified by year-end. We've begun integrating this technology into our existing products and expect to see both performance and cost improvements. While our existing Inertial systems offer the size, weight, power and performance required for a wide range of application, the integration of our photonic chip technology is expected to deliver performance and reliability enhancements for our customers along with manufacturing and margin benefits for us. The primary focus of this development is to provide high-end Inertial system performance at MEMS pricing levels for the automotive self-driving car market.

So in conclusion, we have great confidence in our strategy and our innovative technology and services and our business model. We've a very strong balance sheet with no debt and $55 million in cash.

Our Board of Directors recently authorized a share repurchase program of up to 1 million shares of the company's outstanding common stock. With a solid Inertial NAV backlog and continued strength in our VSAT business, we expect significant improvements in Q4.

Also I'd like to mention that on November 14, I'll be joined by members of our senior management team for our first ever Analyst and Investor Day here at KVH, during which we'll showcase our newest technologies and discuss how we intend to leverage our strategic growth initiatives to accelerate progress towards building long-term shareholder value.

Now I'd like to turn the call back over to Don for the numbers.

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Donald W. Reilly, KVH Industries, Inc. - CFO [4]

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Thank you, Martin. As you know, we concluded the Videotel disposition in the second quarter of 2019, we concluded that -- the Videotel disposition of -- in the second quarter, met the criteria of a discontinued operation, and we've reflected it that way in our earnings release and in our 10-Q. The change in the discontinued operations this quarter is due to the finalization of the final -- financial statements for that business and the change in certain estimates used when determining the preliminary gain.

As Martin mentioned earlier, our third quarter revenue was $39.3 million, which includes a positive prior period adjustment of $0.5 million relating to sales-type leases.

In short, in the implementation of ASC 606, we treated our VSAT sales-type lease transactions in the same manner as other combined VSAT and airtime transactions, which means we were recognizing the hardware component of the transaction over the lease term instead of immediately upon shipment. Going forward, revenue generated under lease arrangements will be recognized upfront as it was prior to ASC 606, even when it's bundled with air time. This is really just a technical correction and is not significant to any past or future period.

Without this accounting correction, third quarter revenue would have been slightly lower than compared to the $39.3 million we recorded in the third quarter of 2018.

Product revenue for the third quarter of 2019 was $14.8 million, a decrease of $1.6 million or 10% from the $16.4 million in the third quarter of the prior year. Service revenue for the third quarter was $24.5 million, an increase of $1.6 million or 7% from $22.9 million in the third quarter of last year. Revenue from our Inertial Navigation segment decreased $2.4 million, and in our Mobile Connectivity segment increased $2.4 million.

By segment, in our Inertial Navigation segment, product revenues decreased $2 million or 23%, primarily due to a $1.7 million decrease in our FOG product sales this quarter.

In our Mobile Connectivity segment, product revenues increased by $0.5 million or 7%. This increase was primarily due to a $700,000 increase in mobile -- in marine mobile communication product sales, which includes the adjustment that I discussed, partially offset by a $200,000 decrease in sales of our land mobile communication product sales.

Service revenues in our Mobile Connectivity segment increased $1.9 million due to an increase in mini-VSAT broadband airtime service revenue of $1.9 million or 11%. Sequentially, mini-VSAT broadband airtime revenues were up 4% from Q2 of this year, 9% from Q1 of this year, and on a year-to-date basis, 11% -- higher by 11% compared to the same period of last year, driven primarily to the continued success of AgilePlans on the HTS network.

With respect to the Agile program, approximately 53% of our total unit shipments this quarter and 70% of our commercial shipments were Agile orders, which helped us to achieve our 10,000th VSAT shipment, which was announced just a few days ago. Agile now represents 24% of all of our subscribers. For the third quarter, our consolidated gross profit margin decreased to 35.5%, excluding the adjustment as compared to 39.2% in the third quarter of last year.

From a segment perspective, our Mobile Connectivity gross margin was 35%, again, adjusted compared to 36.9% last year, while our Inertial Navigation gross margin approximated 37.5% compared to 45.9% last year.

Operating expenses for the third quarter of 2019 were $18.3 million, up 6% from $17.3 million in the third quarter of the prior year, primarily due to increased spending to support our focus on service delivery and our key initiatives such as the photonic chip-based gyro. In the third quarter, these changes in revenue, margins and operating expenses resulted in a loss from operations of $4.8 million compared to the loss of $1.9 million recorded in Q3 of 2018.

The Mobile Connectivity segment generated an operating loss of $200,000 compared with a profit of $500,000 last year, while our Inertial Navigation segment had an operating loss of $200,000 for the quarter compared with $1.9 million of profit last year.

Our unallocated loss from operations increased $100,000 to $4.4 million this year from the $4.3 million recorded last year.

Our effective tax rate for the third quarter was a benefit of 12.9% and was impacted by the release of the valuation allowance against the discontinued operations tax expense resulted from the sale of Videotel.

For the third quarter, our net loss from continuing operations was $3.3 million as compared with a net loss of $1.9 million recorded in the same period last year.

On a non-GAAP basis, which excludes amortization of intangibles, stock-based compensation, foreign exchange transaction gains and losses, the tax effect of the foregoing and the change in the valuation allowance, we had a net loss of $2.2 million compared with $700,000 last year.

And EPS for the quarter was a net loss of $0.19 per share compared with a net loss of $0.11 per share last year. Non-GAAP EPS for the third quarter was a loss of $0.12 per share compared to $0.04 per share last year.

The third quarter results were unfavorably impacted by $300,000 or $0.02 due to the adjustment that I described earlier.

Our adjusted EBITDA for the third quarter was a loss of $1.2 million compared with a gain of $1.1 million recorded last year. However, there are a couple of things to note here. First, the third quarter EBITDA was unfavorably impacted by $300,000 due to the adjustment. If we had included a further adjustment in our EBITDA calculation for this out-of-period catchup, our EBITDA would have been a loss of about $800,000. Further, we continue to adjust out of our EBITDA calculation, the impact of foreign exchange gains and losses. In the third quarter, that was a gain of about $600,000 that we had backed out. If we had not made this adjustment, EBITDA would have been a loss of only $200,000.

For a complete reconciliation of our non-GAAP measures, please refer to our earnings release that was published earlier this morning.

From a continuing operations perspective, net cash used in operations was $4.9 million, an increase of $5.4 million compared to the third quarter of last year.

Capital expenditures were $2.6 million for the quarter. We are virtually debt-free at the end of the quarter and earning cash balance approximates $56 million.

Total backlog at the end of September was $24 million, of which approximately $10 million is scheduled to be delivered during the remainder of 2019. Backlog for our Inertial Navigation products and services at the end of September was approximately $22 million, of which approximately $9 million is scheduled to be delivered during the remainder of 2019.

With that, I'll now turn our outlook to the fourth quarter and full year. We've reduced our full year guidance for revenues and earnings, primarily due to lower-than-expected third quarter sales of FOG products and a reduction in our estimated FOG sales for the rest -- for the remainder of the year.

Our guidance for the fourth quarter is as follows: Fourth quarter revenue is estimated to be in the range of $41 million to $45 million, and GAAP EPS to be in the range of negative $0.15 to negative $0.04 per share. Non-GAAP EPS is expected to be in the range of negative $0.06 to positive $0.02 per share, and adjusted EBITDA is estimated to be from positive $500,000 to positive $2.5 million.

For the full year, our revenue guidance is $156.3 million to $160.3 million. Our expectations for full year GAAP EPS is a range of negative $0.90 to negative $0.79 per share, and our non-GAAP EPS is expected to be from negative $0.50 to negative $0.41 per share, and our adjusted EBITDA is expected to be in the range of negative $4.4 million to negative $2.4 million.

We continue to expect our airtime gross margin will continue to grow throughout the year and that our AgilePlans program will be cash flow-positive in the fourth quarter. As a reminder, this guidance is based on continuing operations only, and therefore, excludes Videotel completely, including historical amounts for prior periods.

For 2019, we expect our capital expenditures will be in the range of $13 million to $16 million. This guidance assumes -- also assumes there will be no significant changes in foreign currency exchange rates and no large international orders to be booked and shipped in the quarter.

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. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions). Our first question comes from Rich Valera with Needham.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [2]

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First question on the photonic FOG development there. Martin, can you give any color on the timing of incorporating that into your current products?

It sounds like from your prepared remarks, you're sort of heading down that path. But can we start seeing these lower cost FOGs in your products at the beginning of next year? And what does that do to your, kind of, competitive price performance metrics?

And what might that do for the business?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [3]

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Yes. So we are incorporating that now. So we're making the transition of manufacturing. We've purchased manufacturing equipment that's being delivered in November to December time frame. So we expect that starting in Q1, this will be in the majority of our -- not the majority, but 100% of our high-end products, like the all the IMUs in 1700 series products.

And it also is being qualified right now for a program that we've been funded for the last 2 years, which is a military program. So it's a sort of parallel track, release of the product, both into our commercial products and into this super high-end military product. So we should expect to see margin improvement starting in Q1 as these products get released.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [4]

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And just from a competitive standpoint, I mean, I would think that this would give you a significant cost advantage. Do you plan on sort of taking that in margins, in higher margins? Or do you think you can actually be more aggressive on price relative to competition?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [5]

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I think we've got both opportunities. So I think that we'll -- the higher-end products, we're focusing on the performance improvements. I think we'll -- we have the opportunity to maintain prices and improve our margins.

And we also have the opportunity to introduce some new products that have still 5-level performance, but are much more cost-effective, which we think will open up the market and help us increase our volumes and overall total company revenues.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [6]

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Great. And then just a question on the FOG business, if I could. Last quarter, you talked about the commercial side of the FOG. Is this being -- activity just being lighter than expected? And that you were hopeful that, that would pick up as you headed into next year.

Are you seeing any evidence that, that could be the case? And can you give us any thoughts on how we should think about FOG next year?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [7]

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Yes. So overall, FOG sales for the quarter were disappointing. We did build backlog significantly. So that's good, and that's why we feel pretty confident that Q4 will be significantly better. But I think that the real thing that needs to happen to jump-start the FOG business is the release of these new products. So our current product line, the IMU series is about 5 years old. So this next-gen product should dramatically sort of revitalize the product line. So I think it's kind of -- my sense is it's going to be status quo for another quarter or 2 until those new products hit the market.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [8]

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Got it. And then specifically, it's more of a TACNAV question, I think but -- I think you talked last quarter about the A-PNT program and a potential down select happening subsequent, can we talk about any status there?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [9]

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Yes. So Collins Aerospace announced that they were the winner of that, which is good for us. So we anticipate working with them on this program. And their overall schedule is starting between now and the next 12 months. There's going to be prototypes delivered and qualified.

So as part of their press release, they announced that the total program could be up to 8,000 systems. So we don't know if all of those will have our FOGs in them or what, depending on which vehicles are being deployed. So it's a good step for us. It's a good step forward in the program. And the only caveat is that I read yesterday that as part of the merger with Raytheon United Technologies was asked to divest the Collins GPS group. I don't know if that means anything for us, probably not. But it's -- could introduce some delay, I imagine.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [10]

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Got it. And just one final one, probably for Don. But just wanted to make sure I was clear on the accounting treatment for hardware associated with AgilePlans going forward under 606, will you still be amortizing that? Or is that now going to be recognized upfront?

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Donald W. Reilly, KVH Industries, Inc. - CFO [11]

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Well, Agile is not a product sale. Agile is always service revenue. So we would never recognized in any guidance, old or new, we would never recognize a product sale on Agile. So we retain ownership of the equipment and depreciate it over 5 years. We recognize service revenue on a monthly basis.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [12]

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So this adjustment had nothing to do with AgilePlans.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [13]

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Got it. Okay. Understood.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [14]

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It only has to do with leases and -- yes. So we took the more conservative approach, and said, if it's a lease, we're being paid over time and it's bundled with airtime, then we shouldn't recognize that revenue upfront. Because if a guy buys the antenna for $20,000 and pays us in cash, it's determined to be a bundled sale. If he has airtime, then we recognize that over time. So we recognize the lease bundle the same way. But the accounting rules apparently have decided that if the guy is paying us over time, we're going to recognize revenue all upfront for leases. So...

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Operator [15]

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Our next question comes from Jim McIlree with Chardan Capital.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [16]

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Martin, in response to Rich's question, you -- about the photonic rollout, you said something about 100% high-end products. And I was hoping if you could clarify over what time frame you thought 100% of the high-end products would incorporate the technology.

Is that something that takes place during the year? Or you hope to have that at the end of Q1 next year.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [17]

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Well, we hope to launch it in Q1. So -- and once it's launched, it will be in what we call a 1700 series products. And those are what's used in all our high-end products. So barring any residual inventory, the plan is to, once we launch it, it will be in all our high-end products, and the plan for that is in Q1.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [18]

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And you mentioned that a military program has to be, I don't know if you said requalified, but you said qualified, is that going to have to take place for other products that would be using the new photonic chip?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [19]

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Yes. So this particular program has never been qualified. So this is -- so we intentionally did this as an opportunity to get it qualified. So this was a new product that we were developing for a customer under funded development, it was over the period, it's over -- it's a $6 million program of funded work. And it's just a perfect opportunity for us to interject this new technology and really get it super tested and qualified in probably the most demanding application there is for Inertial sensors.

So we thought that would be a great endorsement of the technology and a great way to prove that it's reliable and it works great in all that kind of stuff. So that's a new qual.

For existing products, generally, if it doesn't affect form, fit or function, you don't need to requalify it. So that would probably be on a case-by-case basis with any specific customer. But generally, the products that I'm talking about are 1700 series, are sold as a commercial off-the-shelf product. So it's -- we have full discretion to change what goes inside the product.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [20]

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Right. Okay. And the migration to the rest of the product line, the non-high-end? Is that something that...

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [21]

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That will happen over the course of the year, it should be fairly quickly as well.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [22]

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Okay. All right, great. And then, Don, can you address operating expenses for Q4? And any insight as to what might happen next year, if there are any special marketing R&D programs that would -- that are coming off or being contemplated to be added that would affect 2020 operating expenses?

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Donald W. Reilly, KVH Industries, Inc. - CFO [23]

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Sure. I think you can expect operating expenses in the fourth quarter of this year to be higher than any quarter of this year. We've talked about the number of initiatives that we're investing in R&D initiatives, marketing initiatives, trying to -- the photonic chip continued development with the, let's say, increased support for Agile through promotion programs, support the development of the IoT program. So you can expect the fourth quarter of this year to be higher. Reasonably, I won't say, significantly higher, but certainly higher than the third quarter or any other quarter this year.

That run rate will be higher going into 2020 for the same reasons. It's a little bit premature. We have quite a bit of work to do there. But certainly, our current indications are that our operating expenses will increase in 2020 for the same reasons where just -- where we're just -- the things that we're developing, the initiatives that we're working on.

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Operator [24]

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Our next question comes from Rick Prentiss with Raymond James.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [25]

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Couple of questions, if I could. On the AgilePlans, I think you said you're up to now 24% of your subscribers. It was 70% of the commercial shipments, how should we think about those sales, is there any seasonality as far as that take rate on the AgilePlans into the commercial that might cause that to change in fourth quarter?

And then as we look out, is there any reason to think it drops back down into the 60s at any point in time? Or is this, kind of, like the appetite stays strong for this product.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [26]

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Starting with your last question, no, we don't expect any reason that it would go down. I think that as far as seasonality goes, Q3 is not really a seasonal business, but particularly a lot of the commercial shipping in Europe, there's vacations in July and August. So that tends to be slower than other times of the year just for that reason. But there really is no seasonality in our commercial maritime business. So we don't, sort of -- we do expect Q4 to be stronger than Q3 for our -- both for Agile and for our general VSAT business.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [27]

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Okay. And the take rate is, kind of, like this is -- last several quarters, you've been at, I think, 77%, 69%, now 70%. So this kind of 70% range should continue.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [28]

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That's right. Yes. So we don't see -- we still have some customers who prefer to purchase, which is, obviously, fine with us just because they have -- they make their CapEx versus OpEx decisions. So I don't think it's going to go to 100%. I think after 2 years, I'd say, 70% is probably where it's going to stay. But the most important thing for us is that subscriber growth was up 15%, and whether they purchase or lease or use Agile, we don't really care as long as we get the subscribers. That's why we're doing this. So...

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [29]

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So it seems to be you have struck a nerve or hit a sweet spot as far as getting interest going up.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [30]

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Yes, Richard.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [31]

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The second question, you guys mentioned how you've adjusted out FX, but this time, it actually was a gain. Any thoughts on reporting or providing EBITDA without adjusting? Or how do we get at those FX numbers to, kind of, see on a non-adjusted FX basis, kind of, what EBITDA has been?

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Donald W. Reilly, KVH Industries, Inc. - CFO [32]

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Well, since we started excluding FX gains and losses, it was about 2 years ago. There've been gains that we've been backing out of EBITDA every quarter. Yes, so...

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [33]

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There actually might be a case to be made. And one of the reasons that we did it is that Videotel was selling in British pounds. So it had a -- an outsized impact on our results. So I think next year, it might be something that we consider not doing because the business has changed now, almost all of our sales are in U.S. dollars. So -- but I think Don didn't want to do that in midyear.

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Donald W. Reilly, KVH Industries, Inc. - CFO [34]

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Yes. I think -- exactly right. So we'll reconsider that fourth quarter -- first quarter.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [35]

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Right. So I think the good news is that you see from this accounting adjustment, we were overly conservative. I think this is a 2018 prior period adjustment. We took it, we didn't take it out of the EBITDA number, we didn't adjust it out. So it's a -- I think we're being very conservative and clean with our -- and transparent with our reporting here. So -- even though it didn't help us this time.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [36]

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Didn't help this time, hasn't helped for a little while. And it's -- yes.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [37]

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Right.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [38]

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Okay. And then, obviously, the Board has authorized a stock buyback program, can you talk a little bit about what triggered that? And how you came up with the size? And obviously, liquidity is not huge on your name, but were you trying to send a message with there, what do you hope to achieve?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [39]

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Yes, I think that we've had a lot of shareholder interest in doing a buyback with the question we get all the time. And the Board looked at our current balance sheet and the fact that AgilePlans is going cash flow-positive now, so it will be generating cash instead of consuming cash. So we felt that it was a good time to send a message to the market, we feel the stock is undervalued. We like our prospects. We don't see a need for cash that's dramatic. Given the amount of cash that we have, we still have a bank line of credit.

Of course, that could change if there's acquisition, if there's -- something else changes. These programs can be adjusted along the way. But we just felt it was appropriate time to send a positive message about where we think the stock's going.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [40]

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Okay. And how do you think the right way is to consider valuing the stock and the potential of the future of these growth initiatives?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [41]

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Well, I think that we're on the right path in terms of increasing our EBITDA in Q4. I think 2020, we're not giving guidance yet, but we think it's going to be a good year. So we see the direction of the company as very strong, AgilePlans has been a success. It continues to grow, subscribers up 15%. Inertial Nav backlog is strong. A-PNT, we think, is going our way, which is good. We still have these foreign TACNAV orders in the pipeline. So overall, we're very happy with the direction of the business. And I think at some point, we're going to get rewarded for that.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [42]

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And you think it shows up on the EBITDA line then as well fairly quickly.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [43]

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Yes. I mean that's our goal. We have made the conscious decision here to -- when we sold Videotel business, we got a great price for it, but we sold a very profitable marine business that we've build up, it was generating $8 million to $9 million of EBITDA. So our goal is to quickly replace that as the regular business grows through organic growth.

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Operator [44]

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Our final question comes from Chris Quilty with Quilty Analytics.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Founder & Partner [45]

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I was late to the call, so forgive me if you've already addressed this, but you had talked last quarter about in addition to the photonic chipset going ahead and taking some of the electronics associated with that and developing a chipset around that. Question is, how are you going on that development and could that be a gating factor on some of the product rollouts? Or is that done later on, again, not impacting form, fit and function, a feature that you just work into the device design later?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [46]

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That's a great question. So when I say we're going to be releasing the product to production starting in Q1, this is for our current products. It's not the new integrated automotive products. So that product for the automotive market is where we need the new electronics and the single-chip electronics that will replace today's printed circuit board. So that's on a different time scale with qualification and everything else. So that work is still ongoing, but that's going to take more time. So that's probably at least a year away.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Founder & Partner [47]

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Got you. And I don't know if you had earlier comments about some of the automotive OEMs, but it's been -- I think a couple of quarters since you did a real deep dive on your thoughts on that market and the types of technologies that the automakers are trending for. How secure do you feel now relative to, let's say, a year ago or 2 years ago when you undertook this effort that a FOG-based solution will be a primary or -- a secondary technology used for a majority or a significant portion of the automotive solutions that get deployed?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [48]

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Well, we know from the people that we're working with that they are happy with the performance and are planning on using it. I think there's going to be multiple different solutions as time goes on. I think that people are now looking at Level 4 and 5 autonomy for automotive, general public-type applications as being pushed out.

But what we're seeing is that now people are focusing on delivery vehicles and people movers and other things actually being pulled forward a little bit. So I think there's going to be a good market for this product sooner than we thought, but the gigantic opportunity is probably later than we thought. So I think it's, kind of, a mixed bag there in terms of timing.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Founder & Partner [49]

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Got you. If I also switch over, again, to the A-PNT opportunity, we're seeing the DoD talking about a lot of different solutions to address that market, including bringing back the old [RAN] network.

Again, how secure are you in the programs that you're involved with that they're going to be fully funded and that there's institutional support behind them?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [50]

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Well, they've -- I don't know if you caught that in the beginning, but they have made the down-select now. They've selected Collins Aerospace as a sole winner of that program. So that's good news. It's moving forward. They've got a, as I mentioned earlier, a 12-month schedule for testing and deployment. And that's up to 8,000 systems. So I think that program is very secure, very solid.

They've been working this for, I'd say, a decade. So I think that they're finally in the deployment phase on that. And unlike automotive, there's really 0 appetite for trying to find alternate solutions because the solution we have just absolutely delivers what it needs to for that application.

So -- and we've delivered 20,000 TACNAV systems to armored vehicles around the world. So this is a very mature, very well-developed product that just absolutely works for their application. And it can't be spoofed, and it can't be jammed.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Founder & Partner [51]

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Yes, I did not -- I missed that earlier comment so I'll go back and check the transcript.

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Operator [52]

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This does conclude today's question-and-answer session. I will now turn the conference back over to Mr. Reilly.

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Donald W. Reilly, KVH Industries, Inc. - CFO [53]

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Okay. Thank you, everybody. Martin and I and Brent, of course, will be available for any questions you may have later or any questions that may come to our IR site. Thanks very much.

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Operator [54]

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Thank you, everyone. This concludes today's teleconference. You may now disconnect.