Good day, and welcome to the KVH Industries, Inc. Quarter 3 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Don Reilly, Chief Financial Officer. Please go ahead, sir.

Thank you, operator. Good morning, everyone. Thanks for joining us today to discuss KVH Industries' third quarter results, which are included in the earnings release we published this morning. With me on this call is Martin Kits van Heyningen, the company's Chief Executive Officer; and Brent Bruun, our Chief Operating Officer. The earnings release is available on our website and through our Investor Relations department. If you would like to listen to a recording of today's call, you can access a webcast replay on our website. If you are listening via the web, feel free to submit questions to [email protected]. This conference call will contain certain forward-looking statements that are subject to many assumptions and uncertainties that may cause our actual results to differ materially from those expressed in these statements. We undertake no obligation to update or revise any forward-looking statements. We will also discuss certain non-GAAP financial measures and you will find definitions of these measures in our press release as well as reconciliations of these non-GAAP measures to comparable GAAP measures. We encourage you to review the cautionary statements made in our SEC filings, specifically those under the heading Risk Factors and our second quarter Form 10-Q filed on July 31, and our 2019 Form 10-K, which was filed on February 28. The company's other SEC filings are available directly from the Investor Information section of our website. At this time, I'd like to turn the call over to Martin. Martin?

Thanks, everyone, for joining us today. We are very pleased with our results this quarter, which exceeded expectations. Despite the pandemic, we focused on executing our strategy and optimizing operations. Our revenue increased by 5% to $41.1 million compared to Q3 last year, and our gross margins improved significantly. Airtime revenue grew by 9%, and revenue from Inertial Navigation products and services rose by 27% compared to last year. We maintained strict cost management and prioritized our supply chain and partnerships. Due to travel restrictions, we canceled in-person trade shows and scaled back discretionary expenses, which helped reduce costs but limited networking opportunities. We quickly adapted to virtual events, with our marketing team collaborating with sales to shift focus to webinars and online networking. These efforts contributed to one of our strongest third quarters in years, with EBITDA for continuing operations reaching $3.4 million, a $4.6 million increase year-on-year, reflecting solid year-over-year improvement. We maintained a robust cash position of over $40 million and entered Q4 with a nearly $26 million backlog. We have also ended the temporary salary and benefit reductions we implemented six months ago, demonstrating our confidence in our current financial health and operational stability. Our Q3 results validate our diversification strategy, showing strong performance across almost all markets and product lines. With our established global service network, we are well positioned for future growth. In Mobile Connectivity, the leisure and commercial maritime markets are showing resilience against COVID-related challenges. Commercial port calls have stabilized at around 22,000 visits per day, about 15% below historic levels. Leisure marinas are open, and recreational vessels have been active during the summer. The Fort Lauderdale International Boat Show has just commenced. In this gradually improving environment, our Mobile Connectivity revenue was $31.4 million for the quarter, slightly down from last year, while airtime revenue increased by 9% to $21.7 million. Our subscriber base grew by 4%, and airtime margins rose to nearly 39%, an increase of over 2 points from Q2 and more than 4 points from Q3 last year. This reflects our successful initiatives to migrate existing customers and attract new ones to our HTS network. We experienced notable declines in sales for TracVision Satellite TV hardware and cruise ship media subscriptions due to COVID, but TV sales are starting to recover as we enter Q4, while recovery in cruise ship media content is expected to continue through 2021. Demand for our AgilePlans Connectivity as a Service product remains robust, with Q3 revenues up 55% year-over-year. New AgilePlans subscriptions accounted for 78% of our commercial maritime VSAT shipments in the quarter. While some competitors face financial difficulties and installation challenges, we believe we are gaining market share. Our service team has effectively navigated logistical issues to ensure seamless installation of new VSAT systems worldwide, even during the pandemic. We continued to develop new products and services, launching the TracVision TV10 in August, featuring enhanced coverage and connectivity for boat owners. At the Fort Lauderdale show, we introduced a new unlimited-use regional airtime plan for our TracPhone V3-HTS. These plans offer fixed pricing with no overage charges, appealing to smaller boat owners. Our innovation has been recognized with Product Excellence Awards for several of our products from the National Marine Electronics Association. In the Inertial Navigation market, revenue grew by 27% to $9.7 million, driven by our FOG and TACNAV military product lines. Similar to Mobile Connectivity, we shifted from in-person shows to virtual engagements, focusing on webinars and digital marketing to build our sales pipeline. Earlier in Q3, we secured a significant international order for our TACNAV systems, with shipments starting this quarter, which should boost our financial performance. Demand for our FOG technology is strong, and our photonic chip technology is generating interest. We've shipped our first production IMU with this technology and aim to integrate it throughout our core product line by year-end. In summary, our proactive measures during the pandemic have helped us minimize its impact. While market uncertainties persist, we remain committed to our strategic and operational goals, ensuring the health and safety of our employees while providing excellent service to our customers. We are cautiously optimistic about our progress and the capabilities of our team. Now I'll turn the call back to Don for more detailed financial information.

Thank you, Martin. First, as we mentioned in our second quarter call, it's important to provide some context for our third quarter results. The ongoing COVID-19 health crisis continues to affect the world and the industries we work in. Given the impact of COVID-19 on our business, we believe our third quarter results should be viewed favorably. I would now like to discuss our third quarter results in more detail. As Martin noted, our revenue for the third quarter was just over $41 million, compared to $39.3 million in the third quarter of 2019. Revenue from our Inertial Navigation segment grew by over $2 million, while our Mobile Connectivity segment saw a decrease of approximately $300,000 compared to the same quarter last year. Product revenue for the third quarter reached $16.7 million, which is an increase of $1.8 million or over 12% from $14.8 million in the same quarter last year. Breaking it down by segment, product revenues in our Inertial Navigation segment rose to $2.7 million, representing about a 40% increase, largely due to a $1.5 million rise in FOG and OEM sales and a $1.2 million increase in TACNAV product sales compared to the third quarter of 2019. Meanwhile, product revenues in our Mobile Connectivity segment decreased by around $900,000 or 11%, mainly driven by a $500,000 drop in TracVision sales and reduced sales in our land mobile products. Service revenue remained steady at $24.5 million for both this year's and last year's third quarters. Mini-VSAT Broadband airtime revenue grew by $1.8 million compared to 2019, attributed to a 4% rise in subscribers, mainly from AgilePlans, and a one-time amount of $900,000 from a customer related to resolving contractual matters. However, these increases were partially offset by a $900,000 decline in our media business due to travel restrictions linked to COVID-19. I want to highlight that AgilePlans is a significant factor contributing to the rise in our mini-VSAT Broadband airtime revenue, which totaled around $21.7 million in the third quarter, growing approximately 9% from last year. VSAT shipments associated with the AgilePlans program represented about 64% of our total unit shipments, and as Martin stated, 78% of our commercial shipments for the quarter. AgilePlans now accounts for 35% of all mini-VSAT airtime subscribers. In the third quarter, our consolidated gross profit margin was 38.5%, up from 34.2% in the same period last year. By segment, the gross margin for Mobile Connectivity was 37.6%, an increase of about 4 percentage points primarily due to the rise in our mini-VSAT Broadband airtime revenues. Our Inertial Navigation gross margin rose by approximately 3.7 percentage points to 41.2%, mainly due to increased FOG and TACNAV sales. Operating expenses for the quarter were $16.3 million, down nearly 11% from $18.3 million in the third quarter of the prior year, partly due to ongoing cost control measures implemented earlier this year in response to the pandemic. These changes in revenue, margins, and operating expenses led to an operating loss of approximately $500,000, compared to a loss of $4.9 million in the third quarter of 2019. Our Mobile Connectivity segment achieved an operating profit of $2.3 million, a recovery from an operating loss of $300,000 last year, while the Inertial Navigation segment reported an operating profit of $1.4 million compared to an operating loss of $200,000 last year. Our unallocated loss was about $4.2 million, compared to $4.4 million in the third quarter of 2019. For the third quarter, our net loss was about $500,000, an improvement from a net loss of $3.3 million last year. On a non-GAAP basis, which excludes various costs such as amortization of intangibles and stock-based compensation, we recorded net income of $1.1 million compared with a net loss of $2.2 million last year. For the third quarter, our EPS was a net loss of $0.03 per share compared to a net loss of $0.19 per share last year. Our adjusted EBITDA for the quarter was $3.4 million compared to a negative $1.2 million in the third quarter of 2019. For a comprehensive reconciliation of our non-GAAP measures, please refer to our earnings release published earlier today. Our total backlog at the end of the third quarter stood at $25.6 million, with about $14.8 million scheduled for delivery in 2020. The backlog for our Inertial Navigation products and services at the end of September was approximately $25 million, of which around $14 million is set for delivery in 2020. Net cash from operations was close to breakeven for the quarter compared to $4.9 million utilized in operations in the previous year's third quarter. Capital expenditures were approximately $3.2 million for this quarter. In summary, we are pleased with our third quarter results, particularly in light of the COVID-19 pandemic, which continues to disrupt the global economy and significantly affect many areas of our business. While we believe our company has managed the economic challenges posed by the pandemic well, we must acknowledge the ongoing uncertainty it brings. The future duration of the COVID-19 pandemic remains unknown, and perspectives on it are subject to change. As such, our revenues, operational results, and financial condition may still face substantial impact until the COVID-19 situation is resolved. In the meantime, we will remain focused on managing costs and improving efficiencies to ensure we are as prepared as possible until the COVID-19 threat is behind us. This concludes our prepared remarks, and I will now turn the call over to the operator to begin the Q&A section of this morning's call. Thank you.

Our first question comes from Rich Valera of Needham & Co.

Starting off on the mini-VSAT airtime gross margins, there has been really impressive performance there. Last quarter, you mentioned there might be some downward reversion because you experienced a significant increase in Q2. I'm trying to understand the dynamics at play here. Do we believe that these gross margins can be sustained in this high-30% range in the near term?

I think I'll let Don address that question specifically, but we did experience a one-time increase in overage charges that we don't anticipate happening again. Additionally, in Q4, there is some seasonality, particularly in the leisure market, as people prepare their boats for winter storage. This is a typical seasonal shift, which also affects margins since customers often downgrade to lower plans. However, I will allow Don to provide more detail on the margin numbers.

The third quarter was very high for the reasons Martin described. The fourth quarter will not be as high as the third quarter. First, we had a one-time increase. Also, we will add capacity in the fourth quarter. So, it won't be that high; I estimate it will be between 30% and 35% in the fourth quarter.

Okay. That's helpful. And just trying to understand maybe the underlying demand trends in the mini-VSAT business. I mean, historically, you've kind of talked about installs and orders maybe? Is there any color you can give in sort of the cadence of installs and orders as you move from 2Q to 3Q and now into 4Q? Has that been pretty steady? Is it picking up, trailing off? Any color there?

Yes. The surprising thing is that in terms of unit volume, it's ahead of last year for the quarter. So we had very strong bookings and shipment performance. As I mentioned in the prepared remarks, it was logistically a very challenging quarter. Our team did an excellent job managing all the various testing requirements to enter countries and ports. I believe we gained some market share because of that.

That's helpful. And then pivoting to Inertial. So it sounds like you've got about $14 million of backlog there scheduled to ship in the fourth quarter. One, I guess, confidence level on actually shipping that, is there any risk to that production components, anything? And then would we normally expect there to also be some turns business there, so that the revenue in that segment could exceed $14 million in the fourth quarter? Just any color on that would be helpful, Don.

We expect to ship in the fourth quarter, although some shipments may carry over into next year. We are fairly confident about recognizing revenue in the fourth quarter, but under the new revenue recognition rules, we need to consider various factors. Even if we ship in the fourth quarter and believe we will recognize the revenue then, there is a risk that we may have to delay revenue recognition until 2021. However, from a production and shipping perspective, we should be in good shape.

Yes. I will say that there is some risk involved. Generally, supply chains are quite strained, making it difficult to receive parts on time, and lead times for electronic components are increasing, which is unusual. It's becoming tighter than it was during the peak of the pandemic. I'm not sure why this is happening, possibly due to overall demand for consumer electronics, but we are noticing some supply chain constraints. However, as Don mentioned, we believe we are in good shape overall. All parts are expected to arrive on time, so we do anticipate shipping most, if not all, of our products in the fourth quarter.

Okay. That's helpful. And one more just modeling question quick for you, Don. It sounds like OpEx are going to go up in 4Q as you return sort of pay scales to normal, et cetera. Can you give us any sense of the magnitude of increase we might expect in OpEx from Q3 to Q4?

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

Our next question comes from Chris Quilty of Quilty Analytics.

Martin, I just want to follow up on the gross margin question. Understand the seasonality down in Q4 that you expected down. But are you still modeling longer term that this business should be around a 40%-ish type gross margin as you achieve scale?

Yes. If you examine the seasonality from previous years, we don't anticipate any changes. We continue to add subscribers and grow the business, although this growth is balanced by some seasonal suspensions in leisure and commercial fishing. To clarify, we do not expect an increase in seasonality or seasonal suspensions. It is the usual fourth quarter. Regarding the 40% question, the answer is yes. Our long-term models indicate we will reach that figure. As Don mentioned, in any quarter, we may add some capacity. We've seen strong subscriber and usage growth, especially in Asia, and we added capacity in the third quarter as well. You will see the impact of that with a full quarter in Q4.

Great. And Europe, obviously, COVID is kind of raging out of control, worse than even in the spring. Are you seeing any impact on your business?

No, we haven't. Areas of concern would be if the boat builders close again, which would be problematic. However, the restrictions so far seem to be allowing people to go to and from work. It appears to be more focused on bars, restaurants, and theaters this time rather than the lockdowns we experienced in March and April.

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

We prefer not to predict when those will occur, but we're pleased that one of the significant projects has been secured this year and will be delivered this quarter. Our TACNAV business is set to perform exceptionally well this year, and we anticipate another strong year for TACNAV next year. We expect at least one more project to be finalized in 2021. There are numerous opportunities available, and some new prospects have arisen even in the current quarter that could be delivered in 2021. Overall, the TACNAV sales pipeline appears robust, and we are looking forward to another strong year next year.

And any updates on the Assured PNT program?

No, nothing on the production side. Collins has won the development project, which includes delivering only 83 units. It seems to be shifting back to more of a platform-type approach where the higher-value platforms will receive higher-end inertial systems, while the lower platforms will only have GPS, but an enhanced version with M code. The source of funding for this remains uncertain. It will be interesting to see the outcome of the next defense budget since it is now a program of record, but it will require funding.

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

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

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

Yes. So we're talking both the equipment manufacturers as well as IoT companies and, what I call, multi-card service providers, people who serve a number of different pieces of equipment onboard ships. So the overall customer target list is expanding, but it absolutely includes engine manufacturers and turbo manufacturers, scrubbers, all the people who make the key equipment onboard the ships.

And final question for you just on the PIC technology. You're in production with your first product now. Any surprises either positive or negative in what you've seen in terms of the production costs or product integration?

No surprises. We have integrated the technology into the first product and are still on track to include it in the rest of the products by the end of this quarter. We are working with two suppliers, and one is currently outperforming the other. The prices are comparable, so overall, everything is functioning as expected.

Our next question comes from Ric Prentiss of Raymond James.

This is actually Ric's assistant, Brent, on for Ric right now. My first question would be, how do you feel about visibility, not just for 4Q, but for 2021 as you get ready to maybe give some guidance next quarter? Do you think you'll be able to give full year guidance?

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

Got it. Okay. And then the other would be, there's a lot of buzz right now surrounding these upcoming LEO constellations, SpaceX, OneWeb, some other planned ones. How do you view the addressable market for those constellations?

Well, I think it's super exciting. So as a purchaser of satellite bandwidth, we've got more and more options every day. So we're talking to all the companies that are in the LEO and MEO space as well as our current suppliers are launching new satellites that have greater throughput. So it's really a great time to be in the satellite business. Suddenly, we have many, many opportunities, also opportunities terrestrially. So all of these LEO constellations require tracking antennas for the consumer products as well as for the Earth station. So sort of the golden age of space and satellite technology. And a lot of these systems are designed for consumer applications, so they would need to be modified for use in our type of mobile applications through stabilized platforms as well as marine antennas. But we think it's going to be a great opportunity to deliver a lot more bandwidth at better prices.

Okay. And related to that, you guys have obviously done some great work with antennas. Where do you think the antenna cost for those LEO constellations could realistically get down to as far as a cost per antenna?

It depends. If you aim for a true phased array, the costs will be extremely high. The general agreement is that this approach is not practical for most consumer applications; it’s better suited for aviation and commercial use. By using a hybrid or mechanical method, they can be made relatively expensive, but not as affordable as today's antennas. Current antennas for home satellite connectivity consist of a simple fixed dish pointed at a specific spot in the sky, secured to the house. Therefore, they will never be as cheap as that. However, if the technology is developed intelligently and driven by volume, it should become affordable.

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

Operator, before we end the call, I want to correct something I mistakenly said earlier regarding non-GAAP EPS. For the third quarter this year, non-GAAP EPS was a positive $0.06 per share, compared to a non-GAAP EPS loss of $0.12 per share last year. I just wanted to clarify that, as I may have confused some people with my wording. Martin?

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

Thank you.

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