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Edited Transcript of KVHI earnings conference call or presentation 1-Mar-19 2:30pm GMT

Q4 2018 KVH Industries Inc Earnings Call

MIDDLETOWN Mar 8, 2019 (Thomson StreetEvents) -- Edited Transcript of KVH Industries Inc earnings conference call or presentation Friday, March 1, 2019 at 2:30:00pm 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. - 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. Fourth Quarter and Year-end 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Don Reilly, CFO.

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

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Thank you, operator. Good morning, everyone. Thank you for joining us today, to discuss KVH Industries Fourth Quarter Results and our guidance for the 2019 first 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, the company's Chief Operating Officer. The earnings release is available on our website, and also from our Investor Relations department. If you would like to listen a recording of today's call, you can access our webcast replay on our website. If you're listening via the web, feel free to submit questions to IR at 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 risks -- under the heading Risk Factors in our third quarter Form 10-Q filed on October 31; and our 2018 Form 10-K, which we expect to file later today, and the company's other 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. Thank you for joining us. Overall, we had a very good quarter with revenues of $43.8 million. That's a 12% increase from Q4 last year.

This was driven by our FOG product revenues, which increased 33%, along with an 87% increase in VSAT shipments compared to the fourth quarter of 2017. There was a $1.2 million FOG order that we were counting on in Q4 that came in as planned, but the customer pushed deliveries out into 2019. Had that shipped, we would have been within our guidance range for revenues and EBITDA. Everything else mostly came in as expected for the quarter. For 2018 as a whole, we delivered solid performance with revenue up 7% to $170.8 million despite the fact that we don't recognize any immediate revenue on VSAT shipments into our new AgilePlans program. In addition, we ended the year with 4 key strategic goals and successfully delivered on all of them. We launched a new global HTS satellite network, pioneered and rapidly grew a new service driven business model, made significant headway in our TACNAV, A-PNT projects and achieved a technological breakthrough in our photonic chip technology. Now let's take a look at each of these initiatives in our Q4 results in a bit more detail. In our mobile connectivity business, we continue to see rapid uptake in our AgilePlans subscriptions. In the fourth quarter, AgilePlans shipments increased 94% over the fourth quarter of 2017, and represented 62% of commercial maritime VSAT shipments.

Monthly ARPUs and margins for AgilePlans subscriptions continue to be higher than traditional sales. Traditional hardware sales remain a vital part of our business, and I'm happy to report that fourth quarter VSAT product sales also increased more than 80% over Q4 of 2017. As a result, we shipped a record number of VSAT systems with an increase of more than 87% for the fourth quarter, and more than 90% for the full year compared to the same period in 2017.

We are also beginning to see the benefits of compounding AgilePlans subscriptions. Together, these led to an increase in quarterly airtime revenue of $2.1 million, or 13% year-over-year.

Rolling out our new global HTS network and aggressively building our AgilePlans connectivity as a service business model were the top 2 strategic initiatives for our Mobile Connectivity business. The combination of these 2 has proven to be incredibly popular with our customers. We also expect that the margins will continue to grow as our subscriber mix continues to shift towards our mini VSAT broadband HTS network and towards AgilePlans in 2019. With the rapid growth of our AgilePlans program, we expect the new business model to be cash-flow breakeven by the middle of the year, just 24 months after launch. In fact, we expect the whole AgilePlans program to be cash flow positive for the full year 2019.

To help accelerate the shift to our HTS network, we have continued our transition to an all HTS product family. In late 2017, we launched our 60-centimeter, 24-inch, TracPhone V7 HTS. Since then, it's become the fastest growing SATCOM product in our history thanks to the appeal of the downloads as fast as 10 megabits per second worldwide and simultaneous high speed and unlimited use data channels.

More recently, we introduced our new TracPhone V3 HTS in November. This 15-inch system is the world's fastest, lightest, smallest marine VSAT antenna. It offers download speeds as fast as 5 megabits per second, which is faster than many competing 1-meter VSAT antennas. Its size and price range are perfect for smaller leisure, fishing and commercial vessels. In near future, we expect to complete the shift to our all HTS suite of products. During 2018, we had to carefully manage our cost and capacities as we launched the HTS network, while maintaining our high quality of service on our existing network. As we increase subscribers, we've grown our bandwidth plans for HTS. At the same time, we've managed our cost of customers' upgrade from the legacy network onto the new HTS network. While there's been a bit of margin pressure along the way, we expect that we should see increase in margin starting in the second quarter, and ending the year significantly higher. This is about a seamless transition as we could have hoped for.

In our training business, we've been very successful in launching new products and capabilities in 2018. The pace at which existing maritime training customers are upgrading toward our new Videotel Performance Manager continues to accelerate. We've already migrated more than 6,500 vessels to the new platform. The capabilities of this system are resulting in high levels of customer satisfaction, reduced churn, and stabilized subscriber levels. And a competitive edge over our competition. This business has been declining in recent years, and we're optimistic that the new software capabilities will stabilize this business and return us to growth in 2019.

On the leisure marine side, we had a very strong quarter for our TracVision in-motion satellite TV antenna systems. Bucking the trend of cord cutters on land, we saw sales of our TracVision marine satellite TV systems hit a record high in the fourth quarter.

Moving on to our Inertial Navigation business. Our run of double-digit revenue growth for our FOG products continued for the eighth consecutive quarter, with a 33% increase over Q4 of 2017. Our strong Inertial sales growth is built on an increasingly diverse customer base. For example, the fiber optic gyro base products we shipped in Q4 are being deployed on applications ranging from remote weapon stations and high-end camera stabilization to autonomous people movers and driverless cars. Demand is strong for our entire product line, including fiber optic gyros, inertial measurement units, and our premier Inertial Navigation systems. Our customers encompass established firms, startups, commercial and military users, initiatives on land, sea and air and both domestic and international buyers. Result is much more consistent sales pipeline, supported by a broader foundation than we've had in the past.

We also continue to make good progress in our pursuit of several military, significant military opportunities. In 2018, our TACNAV 3D system was tested in multiple field trials and outperformed the program specs on every occasion. And during the fourth quarter, we received an order for around 20 TACNAV 3D, FOG based systems that will be part of a formal competition for a large U.S. Army program, which is part of their assured position navigation and timing initiatives. We'll be delivering these systems later this month, at which time, testing will begin. This program represents an opportunity for many thousands of units, larger than any program we've ever been involved with. While not in our formal guidance, we've also seen significant activity in the large Middle Eastern TACNAV project, that's been delayed for several years. We've received formal RFPs from 5 different prime contractors, all asking for the same KVH equipment with firm delivery dates. We hope to have further developments to report on this as the year progresses.

And finally, a key strategic initiative for 2018, was the successful development of our photonic chip technology. As promised, we shipped the first prototypes of our photonic chip based IMU before the end of the year to autonomous vehicle developers for testing. These were our first IMUs built with our photonic chips, and I'm thrilled to announce that they were also the best-performing IMUs we've ever produced.

We have key automotive OEMs, now doing side-by-side testing with this new prototype with a photonic chip inside, against our standard fiber optic gyros that they're using today.

Our existing FOG and FOG-based IMUs already provide a higher level of precision than MEMS space inertial systems. That's why our current products are in use or being tested on more than 20 different autonomous vehicle platforms today. With the development of the photonic chip-based FOGs, we expect it will be able to provide an inertial sensor with equal or greater precision to our existing products but at a price that we anticipate will be competitive with MEMS systems when produced at high volumes. We believe that this is truly a disruptive technology for safe, precise, autonomous navigation. And it will also transform our fiber optic gyros and inertial systems for other applications. We recently received our first patent on this technology and have several more in the pipeline.

We're accelerating our investment in this technology now, and we're pushing towards commercialization and mass production. We are now in discussion with several potential strategic partners that can help us scale, and become a supplier to automotive companies. We hope to conclude that effort in 2019. So in conclusion, we ended 2018 having made outstanding progress in our critical strategic initiatives. Now, we're in execution mode. Building on those developments, looking ahead to the rest of 2019, we've set aggressive strategic goals for the company. Among them: to accelerate our subscriber growth on our HTS network, both through new customer acquisitions and upgrading existing customers; push into marine IoT market, with the new subscription service; commercialize our photonic chip-based FOGs by the end of this year; maintain our momentum in pursuit of military A-PNT programs; and to improve profitability in earnings. I believe, we've got the right products, the right services and the right people to achieve these goals. Our strategy and plans have positioned KVH well for the future. And we will be focused on delivering long-term shareholder value. Now I'd like to turn the call back to Don for the numbers. Don?

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

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Thank you, Martin. As Martin mentioned earlier, our fourth quarter revenue came in at $43.8 million, which was slightly below our guidance range, primarily due to timing of a large FOG order, which was in fact received during the quarter but scheduled for shipment in 2019. This compares to $39 million recorded in the fourth quarter of 2017. Revenue from our Mobile Connectivity segment increased $2.6 million, and our Inertial Navigation revenue increased $2.2 million from the prior year fourth quarter.

Product revenue for the fourth quarter was $16.8 million, an increase of $3.1 million, or 23% from $13.7 million in the fourth quarter the prior year. By segment, product revenues in our Inertial Navigation segment increased $1.6 million, or about 22%. And in Mobile Connectivity segment increased by $1.5 million, or 24%. Within our Inertial Navigation segment, our FOG business continued at solid top line revenue growth, growing approximately 33% this quarter, while TACNAV sales decreased by 6% compared to the 2017 fourth quarter.

In our Mobile Connectivity segment, the increase in product sales was driven primarily by a $1.6 million increase in marine product sales. With respect to the Agile program, shipments increased 94% compared to the fourth quarter of 2017, and approximately 47% of our total unit shipments this quarter and 62% of our commercial shipments were in connection with this offering. Service revenue for the fourth quarter was $27 million, a $1.7 million increase or 7% from $25.3 million for the prior year. Mini-VSAT broadband airtime revenue was up approximately 13% from the prior year fourth quarter, offset somewhat by lower content and training revenue.

For the fourth quarter, our consolidated gross profit margin decreased to 39.1% as compared with 46% in the fourth quarter of last year. From a segment perspective, our Mobile Connectivity gross margin was about 39%, down 7 points from last year, mostly due to the impact of our new HTS network. While our Inertial Navigation gross margin decreased about 6 percentage points to 41%. Mostly, or somewhat due to product mix, particularly the impact that, that mix had on the overhead absorption in our factories but also due to much lower margins on our NRE business this year.

Operating expenses for the fourth quarter were $19 million, down slightly from $19.1 million in the fourth quarter of the prior year. For the fourth quarter, these changes in revenue, margins and operating expenses resulted in a loss from operations of $1.9 million compared to the loss of $1.1 million recorded in Q4 2017. The Mobile Connectivity segment generated an operating profit of $0.5 million compared with $2 million last year, while our Inertial Navigation segment had an operating profit of $1.1 million for the quarter, compared with an operating loss of $100,000 last year. Our unallocated loss increased $500,000.

For the fourth quarter, our net loss is $1.8 million, as compared with a net loss of $1.7 million recorded in the same period last year. On a non-GAAP basis, which excludes amortization of intangibles, stock-based compensation, employee termination and other nonrecurring costs, transaction-related fees, foreign exchange transaction gains and losses, tax effect of the foregoing and the change in our valuation allowance and certain tax adjustments, we had net income of $200,000 compared with $2 million last year.

EPS for the fourth quarter was a net loss of $0.11 per share compared with the net loss of $0.10 per share the same period last year. Non-GAAP EPS for the fourth quarter was income of $0.01 per share compared to $0.13 per share last year. The decrease in non-GAAP EPS was due to the impact of a Tax Cut and Jobs Act, passed in December last year. For non-GAAP purposes last year, we excluded the impact of the TCJA from EPS, which approximately was $0.10. Our adjusted EBITDA for the quarter was $2.6 million, compared with $3.8 million recorded in the fourth quarter of last year. And for our 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 2018 was a very robust $14.5 million. Backlog for our Inertial Navigation products and services at the end of December was $11.5 million and for our Mobile Connectivity segment was $3 million. Of that total backlog amount, approximately $10.5 million is scheduled to be delivered during 2019. Our cash flow from operations was $3.4 million, an increase of $1.3 million compared to the 2017 fourth quarter. Capital expenditures were $4.4 million, and our net debt was $13.8 million, up $9.7 million from the end of 2017.

With that, I'll now turn to our outlook for the first quarter and full year, 2019. The guidance for the first quarter is as follows: Revenue is estimated to be in the range of $41 million to $43 million; and GAAP EPS to be in the range of a negative $0.33 to negative $0.22 per share. Non-GAAP EPS is expected to be in the range of negative $0.15 to negative $0.08 per share, and adjusted EBITDA is estimated to be between negative $1 million and positive $1 million.

For the full year, guidance is 108 -- revenue guidance is $180 million to $195 million. Our expectations for full-year GAAP EPS is a range of negative $0.56 to negative $0.22 per share. Our non-GAAP EPS is expected to be from negative $0.07 to positive $0.17. And adjusted EBITDA range is from $10 million to $16 million. At the midpoint, our 2019 revenue guidance represents an increase of about 10% compared with 2018, and our EBITDA guidance represents an increase of 35%. Paraphrasing our earnings release somewhat, we'll be highly focused on migrating legacy VSAT customers to our new HTS service over the course of the year, which we expect will positively impact our gross margins. Our AgilePlans program enters 2019 with great momentum, and by the end of the year should be a cash generator. Our FOG business continues to grow, and we have a strong backlog entering the year. As Martin said, we have very positive feedback coming from our Middle East customer, regarding the large TACNAV orders we have been anticipating. But we've not included those orders in our guidance. And we will be highly focused on investing in our new photonic chip-based FOG in order to commercialize this new product by the end of the year. We expect the first quarter to be the lowest of the year, and expect to see improvements in both revenues and earnings as the year progresses. This guidance assumes that there will be no significant changes in foreign currency exchange rates. For 2019, we expect our capital expenditures will be in the range of $15 million to $20 million.

This concludes our prepared remarks, and I'll now turn the call over to Martin -- to the operator to open the line for Q&A session 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) And our first question comes from Rick Prentiss of Raymond James.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [2]

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A couple of quick ones to start off. So the -- obviously, the 1 order that slipped the customer side but pushed it into 2019, $1.2 million. Is that coming in 1Q or is that expected later in the year?

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

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It's going to be spread through the year. So it's their program -- it's for a defense program and their program slipped to the right a little bit. So it's all going to be in 2019.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [4]

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Okay. And obviously, the Middle East TACNAV orders that we've been watching for a while, sound still positive on it. Can you remind us of what the current thought is, what the scale of that combined orders might be on a revenue basis? And since there are local partners, what should we expect kind of the margins that you would get on that equipment might be just as we watch to see if they can come in.

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

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Yes, so in terms of overall scale, we still expect it to be in the $40 million to $50 million range. The local partners, depending on whether there is any local content required, which is unclear at this stage. So I don't have a really good comment on margin. But overall, our -- because these -- this type of business is somewhat episodic the margins are above our traditional product and hardware sales. So we expect it to be better than the corporate average margin for sure.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [6]

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That helps and that's good. And obviously, it's a big order that -- a big elephant so if you get it that would be good. Boring down into some of the strategic initiatives for '19, obviously, highly focused on getting the move to the high throughput satellite area. And you mentioned positive gross margins, what are the upfront costs though as far as kind of encouraging customers to move over with some incentives on the equipment? Or how should we think about the path through the year, that focus to get people on to high throughput satellite so you can kind of turn off the other network side?

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

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Yes, so that's in our -- you're correct, and that is baked into our guidance. So we are -- that's why you see -- we saw lower margins in Q4, and we expect lower margins in Q1. But the impact throughout the year, we expect to be really dramatic in terms of the improvement in gross margin for our VSAT airtime. So, yes, it's -- we may support them through upgrade plans but we'll be doing it selectively with customers who are big customers. So the net-net of that is it's going to be improving margins.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [8]

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Right. It just might be a little dampened in the first part of the year and then assume VSAT will move over?

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

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Exactly. Yes.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [10]

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Okay, okay. And then final one for me on the rapid fire questions was you also mentioned, you're going to invest in the photonic chip. Is that OpEx, is that CapEx? What does investment mean and again, kind of the scaling and timing of what that is? Is it something with the production?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [11]

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Yet, so, it's OpEx on the R&D line. So transitioning it from working prototype to ready for prime time use in some of our standard products. So our first -- before it goes to automotive, it'll be -- we want to build it into our own gyros for use in our standard product line. So we start to get experience with it and scale. And then there's also CapEx required for -- but that would be for the automotive side. And that would be scaling for production and that would be somewhat upfront, but it also would be somewhat contingent upon actually landing large orders. So that CapEx requirement is not necessarily significant this year, but there is a CapEx component.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [12]

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Okay, and actually there was one other one. Yes, go ahead.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [13]

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Yes, I was also going to mention that, as I said in my script, we're also looking for some strategic partners so that may reduce or eliminate some of that CapEx requirement. In other words, if we have someone else do some of the manufacturing, for example.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [14]

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Makes sense. And the final for me was you also mentioned the customer-facing aspect for the recurring service model. Is that bringing on customer care people? And is that, kind of -- just trying to think of what that magnitude of cost might be. Obviously, you said you're going to be positive -- breakeven then positive on the segment. But just take me through where that would hit. And how much we might be looking at?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [15]

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I'll let Don answer the cost side of the question. But you're right, so it's customer service people, it's also -- we actually created new senior position for customer care and service and customer experience because as -- even though we're not seeing a lot of revenue through these AgilePlans, because they're compounding monthly, it's a lot of units. So we're really focused on making sure that we are delivering great customer experience. Our churn on AgilePlans has been almost 0 in terms of percent. So we need to keep that because as you know, we don't have long-term contracts with these customers. So we're sort of earning their business every day. But I'll let Don answer the cost impact question.

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Donald W. Reilly, KVH Industries, Inc. - CFO [16]

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So the cost is included in our budget for 2019. And it's upwards of $0.5 million, less than $1 million. So between a $0.5 million and $1 million.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [17]

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On an annual basis?

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Donald W. Reilly, KVH Industries, Inc. - CFO [18]

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Yes.

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Operator [19]

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We will now take our next question from Rich Valera of Needham & Company.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [20]

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So Martin, you had a -- you obviously had a great year for mini VSAT shipments, both Agile and non-Agile. And nice to see that converting into some nice service growth accelerations. So just wanted to know how you're thinking about that business for 2019. I mean, you obviously, have a tough comparison on the unit shipments. I don't think you will be likely to be generating 90% or 100% sort of unit growth numbers. So how do you think about unit shipments potentially this year? And then, with service growth now you've gotten over that sort of double-digit hump, do you think that's sustainable as we move through 2019?

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

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Well, I think, on the unit shipments, you're right. So I mean this quarter, I think, off the top of my head, I believe, the year-earlier number was like a 6 -- it was already growing double digits. So this 90% came on top of a double-digit growth. So -- but we expect to continue double-digit growth for unit shipments in 2019, but you're absolutely right, it's not going to be 100%, triple-digit growth. But that should translate into double-digit airtime growth, services growth continuing throughout the year.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [22]

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Got it. And then you mentioned the A-PNT program, and it's something you got your first, you got 20 unit order related to that. What are the next steps to getting toward, sort of a major order on A-PNT? What do you think the time line is there?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [23]

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So, this is part of a rapid development program for the Army. So, but rapid in the world of defense is not the same thing as you and I think of as rapid. So realistically, you're looking at a 2020 event, not a 2019 event.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [24]

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Got it. So are there any milestones or -- that we should look for in 2019 towards getting there?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [25]

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Yes. So I think there are 2 or 3 primes being evaluated. So the purpose is -- it's really a technology bake-off to see, which one works best. We're optimistic that ours works best, so -- but you never know in these things. So I think, we'll get feedback by year-end, how we're doing.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [26]

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Got it. And then, with the photonics-based FOG, again, any milestones we can look for this year? I know your goal is to get that, sort of, to a commercial -- fully manufacturable commercial solution. Is there any -- is there interim steps we can look for to, sort of, gauge your progress as we move through the year?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [27]

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Yes, I think, we'll be updating on a quarterly basis, but we do expect to cut it into a product this year. So that'll be a good milestone. And there's also a large development contract that we are working on for a military customer, and we are also anticipating we'll be cutting it into that as well, which was sort of an unanticipated benefit of this development as it turns out it works really, really well. So actually, the very highest end product that we're developing for a military application, we'll probably put in that as well. That's a very large funded development program.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [28]

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What do you think the qualification would be like for this product? Since it's fairly I guess, revolutionary relative to the FOGs the military has traditionally used. Do you think you can get this qualified in, kind of, a typical amount of time? Or what do you think that process is going to be like?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [29]

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Well, the hard thing is to get it in at time of qualification. Because once -- as you know for a military program, once that product is fully qualified, it's almost impossible to get them to look at anything new again. So that's why we are planning on cutting it in during -- before the qualification phase so the entire product will be qualified with this in it. So it'll go through the full battery. And it's a aerospace application. So it's probably the most demanding one. So I think, if we qualify for this, we'll be highly confident.

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Operator [30]

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We will now take our next question from Jim McIlree of Chardan Capital.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [31]

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Martin, you talked in response to Rich's question about the A-PNT, you talked about 2 to 3 primes being evaluated. Are you bidding with those primes, or are you just attached to 1 or 2 of them?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [32]

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We are teamed with one of them, or I shouldn't say team we are aligned with one of those. We are working with the other 2. So depending on how it goes, we're optimistic that we might participate no matter who wins. Depending if the technology trial goes well. So, but that remains to be seen. One other thing I'd like to point out is that, we have these trials, we have all this great stuff going on. But we've been doing a lot of development work. All of that's been expensed in 2018. It's always challenging when you have expense but no revenues. So we're really encouraged by a, that there's a formal test going on, b, that the programs in the Middle East are heating up and, c, we're actually getting orders for TACNAV FOG. It's not a material contract, but it was between $1 million and $2 million. We got just the other day for TACNAV 3D, it's fiber optic gyro based. So this market finally seems to be developing and I think, we're pretty well positioned for that now.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [33]

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Okay, great that's helpful. And then, Don, is it possible to indicate for the annual guidance, the annual revenue guidance, how much of that is from Mobile Connectivity and how much from Inertial Nav?

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

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Yes, I think so. Just -- it's a range so it gets hard because we didn't break the range down by segment. Just give me a second I can give you kind of, or at least a rough estimate.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [35]

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Yea, ballpark will be fine.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [36]

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Traditionally, it's been about 20%, I think, with some of these programs. And the growth in FOG, it might increase, if you went at percent-wise, might be up to 25% would be a range, off the top of my head.

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Donald W. Reilly, KVH Industries, Inc. - CFO [37]

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Yes I think, that's accurate. I would say, 75-25 split is probably accurate.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [38]

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Okay, that's great. And then Martin, earlier you talked about cash flow breakeven on the AgilePlans. I just want to understand better how you get there. Is this all a function of scaling the network? Or is there some, let's say, upfront -- not necessarily upfront, but duplicative costs that you would be able to eliminate as the transition takes place? Is this mostly a function of scaling it, or is there also a meaningful element of cost reduction?

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

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There are really 2 separate points there. One is the cash flow breakeven really just talks about the installed base of Agile customers generates enough cash, positive cash flow to fund the growth in new customers for which we supply the equipment. So that's been a cash drain for us for the last 24 months or so, and we expect that to change by midyear. So that's on the cash flow side. On the network side, the issue there really is one of margin. So we're effectively running 2 networks now, and as people move over, the margins will be increasing because yes, we'll be decreasing our spend on the old network as we upgrade customers. So it's been a tricky thing to manage in terms of how much bandwidth we buy in the new network as we migrate customers over. But I think it's gone really well. And I'd say, people are adopting the new network faster than we anticipated, which is great. So that also means that we've scaled cost a little bit faster than we thought originally, and that's what we're pointing to for Q1 of this year, but by year-end, and throughout the year, we're expecting strong growth in airtime margins.

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Donald W. Reilly, KVH Industries, Inc. - CFO [40]

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From a scaling perspective, maybe it's helpful to think about it this way. So we've shipped a significant number of VSATs into the Agile program over the last couple of years, cash flow drain. But those units are now cash-generating in 2019. We'll obviously ship more units but the units that we'll ship will all be cash flow negative. We have the positive cash flow from the last 2 years of deployments. That will offset that. So we should increase like that going forward too.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [41]

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I see. I see. That's very helpful. And so the old network, is that turned off or de minimis by the end of the year?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [42]

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No, I think, for legacy customers, we're going to continue that for at least 3 years. And the network is not going to go dark on anybody. So we're just encouraging people to migrate. It improves our margins, it improves their customer experience and speed, but we're not doing any type of a force migration. So if the people are happy with their data speeds, they can keep them.

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Operator [43]

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Christopher Quilty of Quilty Analytics.

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [44]

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First some quick numbers questions. Don, can you give us the exact mini VSAT revenues and margins?

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Donald W. Reilly, KVH Industries, Inc. - CFO [45]

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Airtime, you mean?

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [46]

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Yes.

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Donald W. Reilly, KVH Industries, Inc. - CFO [47]

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Yes. Okay, airtime revenues were just over $18 million, and the margins on those were about 30%.

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [48]

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Okay. And so you expect that 30% to move up over the longer term as you migrate the networks to what sort of level? I mean, is it going to 40% or 45%, or 50%? Or by the end of '19, should we be at a certain level?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [49]

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I think, you're thinking about it the right way and by the end of 2019, we're internally targeting margins of 40% or so. And then again, that will be a weighted average across all customers from both networks. So -- but that's a huge improvement and it would have a very significant impact.

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [50]

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Got you. And I mean, as you migrate the networks, I mean, historically, you were leasing transponders over multi-year periods for the old network and presumably with the new network, you are able to procure in, I'll call it, smaller chunks as a managed service. Is that true? First. And second part of the question is, given the fact that this transition is happening quicker than expected, did you get potentially stuck with longer-term leases than you anticipated on the old transponder services, and is there a way to resell that capacity if need be?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [51]

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So, no to both your questions. So the HTS network when we created it, of course, we wanted to have a global coverage, we wanted to have super high speeds everywhere. So we bought enough capacity that was independent of the number of subscribers. So obviously, on day 1, we had 0 subscribers, and we had a global network that was 10 megabits per second by 3. So we're now at a point, where that network is sized correctly for the number of subscribers we have, and we are anticipating adding a lot more subscribers and at that point, yes, you're correct, we'll be buying bandwidth incrementally as the subscribers get added. And no, we didn't get stuck with any unwanted bandwidth on the old network. And we've got a business arrangement in place that allows us to wind that down very elegantly as we migrate customers, while still maintaining the global coverage. So we also have some government customers on there and some VVIP customers in aeronautical, so it's important that we maintain the existence of that network.

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [52]

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Understand. And I think you mentioned that you've seen very little churn on the AgilePlans, but I know you've got at least 1 competitor out there that's offering $10,000 bounties for KVH and [penance]. Are you seeing any impact from those type of efforts?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [53]

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We have not yet. Our AgilePlans, the irony is that the potential Achilles' heel of the AgilePlans was, and the reason that we were reluctant to try it before we did, is that without a long-term contract, churn would go through the roof. Instead, it's been the exact opposite. The AgilePlans program has by far the lowest churn of any of our services. And it's not only below single-digit percentage, it's below -- it's single-digit units. So it's really worked out great for us. And no, we have not seen any traction. And the market reaction to that $10,000 bounty has really, I think, kind of backfired on them because the perception is that their product must really be bad if they have to pay somebody $10,000 to take it. So ...

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [54]

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Understand. I think also, last quarter, you were still fighting some manufacturing capacity issues on the antennas. Are you through those issues at this point?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [55]

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Yes, we have no -- factories, done a great job, both factories, in keeping up with demand. We did carry a pretty substantial backlog into 2019. So we've got a lot of installations to do. So that's -- but most of that is driven by customer availability of vessel. So it's not being held up by us delivering products.

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [56]

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Okay. And so 2 years into the -- well, collectively, the HTS product and AgilePlans, I think originally, you hit a lot more of the leisure and yachting market. How successful are you seeing the product in larger enterprise customers and commercial customers?

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [57]

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The vast majority of our VSAT business now is enterprise commercial customers. So leisure, as a percent, has continued to decline. So it's still around 25% to 30% of our installed base. But in terms of new subscribers, it's the vast majority is large commercial fleet customers. And just to correct that, the HTS network has only been around for a year, not for 2 years. So it's ...

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [58]

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Right. Follow back on one issue, when you mentioned 2 to 3 -- sorry, on the PNT effort and you are in testing, you mentioned 2 to 3 competitors. Are they competing with a FOG-like technology or an entirely different technology? Just as a clarification.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [59]

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Yes, so not 100% sure what everybody else is using. But they're also testing different systems. So there are different anti-jam antennas, different distribution systems, different GPSs, so there's -- it's a system, not a single -- so not -- they are not testing just our product, they're testing our product built into something larger.

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [60]

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Understand. And Don, just a question as I model out the, both the R&D and SG&A going into 2019. It sounds like you've had, on the R&D side, a good portion of development work on the photonic side. Should we look for a little bit more moderation in the R&D growth? And if you can give us maybe a ballpark of either growth in OpEx or individual items?

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Donald W. Reilly, KVH Industries, Inc. - CFO [61]

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Yes, so, R&D, we don't expect R&D to come down in '19. We are continuing to invest in the commercialization of the photonic chip. That will take an additional investment. It's not going to be up double-digits, but it's -- well it could be up double digits, but in the neighborhood of $1 million to $2 million in 2019.

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [62]

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And on the SG&A side?

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Donald W. Reilly, KVH Industries, Inc. - CFO [63]

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On the engineering side. On SG&A, we expect marketing will, we think, be up a little bit. Martin, I think, described on an answer to another question or described on the call that we are investing in our services organization as part of our, let's say, ongoing migration to becoming more of a service-driven company with a greater portion of our revenues coming from service activities. We're investing in our service organization to make sure our customers' experiences are as good as can be. That's an additional investment. I think, I might have answered that. It's the neighborhood of $0.5 million to $1 million next year.

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Christopher David Quilty, Quilty Analytics, Inc. - Founder & Partner [64]

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Okay. And final question here, just macro level, you got a pretty wide EBITDA forecast, $10 million to $16 million for 2019. Obviously, if a big TACNAV order comes in, that's 1 item that can move it. But what are the other issues as you look at 2019 that can, kind of, push it towards the upper end of that range?

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Donald W. Reilly, KVH Industries, Inc. - CFO [65]

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ARPUs, the -- we're expecting a significant growth in FOG business. I mean, all of the indications support that but FOG can come in lower than we expect, or greater than we expect, and clearly it's in our budget, so that's a big variable .

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [66]

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Also the mix between HTS and the old networks, so I think, the pace of migrations will have an impact on -- so all of those are estimates that are built into that somewhat wider than normal range. And as you mentioned, there's Military and FOG orders that are somewhat binary.

Operator, if there are no other questions...

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Operator [67]

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There are no further questions in the queue, sir.

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Martin A. Kits Van Heyningen, KVH Industries, Inc. - Co-Founder, Chairman, CEO & President [68]

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Okay, great. Thank you very much.

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Donald W. Reilly, KVH Industries, Inc. - CFO [69]

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Thanks, everyone.

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Operator [70]

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Thank you. That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.