Earnings Labs

KVH Industries, Inc. (KVHI)

Q3 2016 Earnings Call· Wed, Nov 2, 2016

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Transcript

Operator

Operator

Good day, and welcome to the KVH Industries’ Q3 2016 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to John McCarthy, Chief Financial Officer. Please go ahead, sir.

John McCarthy

Management

Okay, thank you. Good morning, everybody. Thanks for joining us today to discuss KVH Industries’ third quarter results and our guidance for the fourth quarter and the 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. The earnings release is available on our website and also from our Investor Relations department. If you would like to listen to a recording of today’s call, you can access a webcast replay on our website. If you 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 a number of 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 the heading Risk Factors in our form 10-K filed on March 14th of this year. And the company’s SEC filings available directly from Investor Information section on our website. So, at this time, I would like to turn it over to Martin. Martin?

Martin Kits van Heyningen

Management

Thanks, John, and thank you all for joining us today. I’m pleased to report very solid third quarter results. Revenues were at the high-end of our guidance at $45.8 million, which is up 3% from $44.5 million in Q3 of last year. For the quarter, our adjusted non-GAAP earnings exceeded our expectations coming in at $0.27 per share, which is more than double the $0.12 per share, we achieved in the third quarter of 2015 and well above our guidance. This solid performance is reassuring as a momentum of our growing business was able to offset short-term economic challenges. The impact of the currency exchange rates reduced our revenues by $1.2 million in the third quarter, due to the fact that many of our value-added training and entertainment services are built in British pounds. On a broader basis, global economic issues have adversely impacted shipping rates due to lower demand, leading to reduced investment and new services and technology by some commercial shipping customers. The low price of oil has also been a factor, hurting our mobile broadband customers in the offshore service vessel market. The good news is that we’re finally seeing some signs of stabilization, if not an improvement in these areas. The Baltic Dry Index, a popular assessment of the cost of shipping raw materials by sea has doubled since the beginning of the year. Customers in the commercial shipping market are beginning to explore the cost-saving benefits of better broadband services, which are both considerable and wide-ranging. We’ve also seen encouraging improvements in crude oil prices have recently received sizable orders from fleets of offshore vessels and workboats, which hasn’t happened for a while. In our guidance and stabilization business, we continue to see the good interest and new sales coming from emerging markets for self-driving…

John McCarthy

Management

All right, thank you, Martin. I would now like to discuss some more detail of the financial results of the company for the third quarter. As Martin mentioned earlier, our third quarter revenues of $45.8 million were at the high end of our guidance and a 3% higher than the third quarter of 2015. The primary drivers for this growth were a 66% year-over-year increase in guidance and stabilization product revenues and partially offset by a 75% decrease in our engineering services revenue and an 11% decrease in our content and training revenues. It’s important to note that recent weakness in the British pound adversely impacted our third quarter content and training revenues by approximately $1.2 million or 14% of content and training revenues and 3% of total third quarter revenues. On a constant currency basis, content and training revenues actually increased 3% year-over-year. Third quarter service revenues to $26.8 million decreased 7% year-over-year mainly due to decrease in our engineering services and content and training revenues. In the third quarter of 2015, we provided a significant level of engineering services that pertain to a large sale of non-standard [ph] products that were delivered in the fourth quarter of 2015 and throughout 2016. In the current quarter, we did not have a similar sized project underway. And as previously mentioned, our content and training revenue decreased year-over-year due to the weakness in the British pound. Looking at the airtime subscription portion of our service revenues in the third quarter, airtime revenues was 17.1 million, which was flat from the prior year with the prior year. We said airtime revenues were slightly up from the prior year. However, continuing its trend, Inmarsat FleetBroadband revenues were down 17%. So, when compared to Q2 of 2016, the airtime revenues were up 7% with…

Operator

Operator

[Operator Instructions]. And we’ll take our first question from Ric Prentiss from Raymond James. Please go ahead.

Martin Kits van Heyningen

Management

Hey, Ric?

Operator

Operator

Mr. Prentiss, please check the mute function on your phone.

Martin Kits van Heyningen

Management

All right, next question.

Operator

Operator

All right, we’ll take our next question from Jim [ph] from Chardon [ph]. Please go ahead.

Unidentified Analyst

Analyst

Yeah, thank you and good morning. Martin, you talked about a big growth rate in the IP-MobileCast in percentage terms, can you just kind of frame how big IP-MobileCast is right now in dollar terms?

Martin Kits van Heyningen

Management

We’re not going to talk about revenue till it’s material, so it’s a significant part of the product offering, but it’s still small in terms of total revenue. So, we’re not going to break it out for competitive reasons, but what we’re seeing is that it’s a big differentiator when people are selecting the service and also it’s encouraging the people who don’t buy it, a year or later they do buy it. So, people are coming around even after the fact, which is also very encouraging. One thing we’ve done just recently with it, which company is really appreciated, so we’ve been able to multi-cast our corporate videos, so in one case, we had more of better customers that had an important safety video that they prepared, they want to send that out to their entire fleet. We had multi-casting that out and people can watch on their iPad’s or on the TVs in the common areas, right. That’s a really unique capability that the people appreciate.

Unidentified Analyst

Analyst

Okay. You mentioned the self-driving, the autonomous vehicles and I think you said that you’re at like a $3 million annualized run rate, is that correct?

Martin Kits van Heyningen

Management

Yes.

Unidentified Analyst

Analyst

Okay, can you discuss how you think that might will allow for you, is this a market where it’s going to be your modest growth until you - modest growth for let’s say, a couple of years and then you get a big hockey stick or is this something where you’re close to getting a big deployment and that we can see a big step function upwards in revenues? Just trying to kind of understand how the market might develop for you?

Martin Kits van Heyningen

Management

Yeah, so typically with these kind of market-changing innovations, it’s very difficult to predict the adoption patterns, so sometimes there is a step function probably, where all of a sudden nobody wants to buy a car, they don’t have the feature and other times, it’s a slow growth and a lot of pilots and trials, then it takes years to roll out. We’re not really sure which one this is going to be, but in terms of scale for us even when major automotive car company starts doing pilot production, a limited release those are still big, big numbers as far as we’re concerned. So, tens of thousands or hundreds of thousands is still huge for us even though that’s tiny compared to the $90 million or $100 million cars that are produced every year.

Unidentified Analyst

Analyst

And along that track, it seems like this is the kind of product that would follow the typical automobile introduction, where they deliver it or they put it on the high-end vehicles and then migrated downwards as prices and demand.

Martin Kits van Heyningen

Management

I think that's true, yes. But then you've also got car companies and independent startups that have different ideas. Obviously, the startup companies are doing it from day one, and it's just part of the product. And you also have the ride-sharing market where people are going to not necessarily sale cars per se, but sell rides. So, that's a different business model. So, I think there are so many moving parts here. It's kind of hard to predict the take rate, but it's definitely exciting place to be.

Unidentified Analyst

Analyst

Okay, I got it. And I know you didn't say Uber, Lyft, and Tesla, but I'll just say it. So, it sounds like if you get those disruptive either manufacturers or providers trying to come up with the new model or to change the market than that could have a different kind of implication for you versus if you are just selling it to...

John McCarthy

Management

Yeah, so I think that at the high level, the new entrants don't care about disrupting their current business because they don't have a current business. Entrenched incumbents, we'd like to add those features so they can continue to sell cars as opposed to nobody owning a car, but you just buying rides. And I think it's going to be a mix. So, I don't see why anybody would not want this feature in the future if it's safer and better than doing at the old fashion way.

Unidentified Analyst

Analyst

All right, got it. And have you - can you either bracket or help me understand kind of what type of dollar content per vehicle would be reasonable for you to get either in the early stages of this if it's a traditional rollout or in the latter stages of this when it's a ubiquitous product?

John McCarthy

Management

So, there are different approaches. Some customers are putting in our full INS system, some are putting in our INU, which is three axes of fog and three axis rate. Other customers are putting in single axis sensors, but then putting in two of them for redundancy. Most of the systems, system architecture involves two of everything for safety reasons to steering mechanism, to braking mechanisms. So, they're all different approaches, but in general, while you're in the prototype stage the unit prices are still fairly expensive and more than $1000. But our goal is it in production, in high rate production and apply these as high hundreds of thousands or low millions, it would be in the $200 range per axis.

Unidentified Analyst

Analyst

Okay. And then the number of, I'm going get my thorough wrong the number of the axis would be dependent on what it is the customers trying to accomplish.

John McCarthy

Management

Right. If they are putting a three-axis system, obviously be three. If they're doing single axis, it'd be one unless you do redundancy in which case it would be two per vehicle.

Unidentified Analyst

Analyst

Right, okay, okay great. That's really helpful. Thank you. And John, I just want to make sure I understand the guidance for Q4. It kind of sounds like the entire change in guidance is just pulling the TACNAV order. And so, when we look at Q4, the guidance in stabilization business is down a little bit versus Q3? And is there anything in the mobile broadband business that I need to be aware of either on a seasonal or a year-over-year basis on that special this quarter versus again either versus Q3 or Q4 of last year?

John McCarthy

Management

I think at the top level, how I'm thinking about it is sort of the TACNAV came out. And then we have a little bit more currency impact. And that sort of we'll get you to their whole decrease in the revenue guidance. Everything else is sort of like the little pluses and minuses, those will be the two big items I point to.

Unidentified Analyst

Analyst

Okay. Is there any significant change to the OpEx line in Q4 versus Q3?

John McCarthy

Management

No, you know Q3 we had part of a little bit of reversal incentive comp that we won’t have in Q4.

Unidentified Analyst

Analyst

And so, that means that your - that the Q4 sales and marketing for the G&A which - wherever that came from is going to be a little bit higher than Q3 because you don’t have that reversal, am I hearing that correct?

John McCarthy

Management

Right, again there’s a lot of pluses and minuses but that’s true on that play.

Unidentified Analyst

Analyst

Okay. And so as far as that $15 million TACNAV, maybe at this quarter, it seems like a long shot but maybe this quarter and are you confident that’s a first half next year thing, or you just don’t know, it could be first half, it could be second half?

John McCarthy

Management

, Well, I am pretty sure, I have lost all credibility in this. So, but yes, we definitely expected it by now and we certainly expected our level of confidence includes combining the parts and building it. So, we have high level of confidence otherwise, we wouldn’t have done those things.

Martin Kits van Heyningen

Management

Okay, fair enough, that’s good. And I mean to be fair this is the difficult customer that you know this customer set is very difficult so, you know I am - I think we’re all kind of aware that things pretty now yet push to the right, so whether to be so harsh on yourself? Anyway, thanks a lot. Appreciate it.

Unidentified Analyst

Analyst

Thanks.

Operator

Operator

And we’ll take our next question from Rich Valera, with Needham and Company. Please go ahead.

Rich Valera

Analyst

Thank you. Just wanted to ask a question on the mini-VSAT airtime growth which was described I guess as very modest, I am assuming that’s kind of low single-digit. My question is that’s coming off a quite easy comp last year, which was already heavily affected apparently by the oil and gas pressures and really suggests if you're looking at minimal growth year-over-year on a subscriber model that you've added minimal net new subscribers on an annual basis. I am just wondering sort of what is driving that, I mean understood we had some pressures last year from the oil and gas situation but you know we’re now good three-quarters into that and I would have thought by now most of those would have already churned off and wouldn’t be necessarily creating incremental churn. So, what’s going on in that business and why can’t you grow it when you’re adding 200 to 250 or more gross subs per quarter, why isn’t that business growing.

Martin Kits van Heyningen

Management

Well, I think if you look at the sequential, we had pretty good growth sequentially from Q2 both in terms of total dollars, which was off the top of my head, I am going to say double-digit growth sequentially ARPUs have been up, this is now the second or third quarter. So, we are seeing improvement sequentially as we move through this period. But the whole industry, you know it’s not just oil and gas, the shipping industry is also pretty heavily affected, you see major shipping companies, look at Maersk reported those with low results today I think. So, it’s - the industry isn’t in tough shape. So, we think they are doing well, but the ARPUs being up sequentially is a good sign. The growth adds was a good sign, but as I said we are not, we’re not saying that things are getting better here, we’re saying that it looks like things have stabilized. So, that’s for us, that’s good news.

Rich Valera

Analyst

Could you give us what that revenue number was, to me you said airtime revenue just for my own modeling purposes?

John McCarthy

Management

So, yeah it’s - for the third quarter it’s $16.6 million.

Rich Valera

Analyst

Got it. And then just with the overall guidance, you know your old range was 190 to 210, your new range is call it 175-ish, so if you get the $15 million order that brings you $10 million shy of the midpoint of your old range. I understand there is some currency impact there, but I hard to believe there is $10 million of currency impact within one quarter. So, can you bridge the rest of that shortfall relative to the midpoint of your old guidance for me?

Martin Kits van Heyningen

Management

Yeah, the - as far as TACNAV goes the $15 million is what we recently purchased at risk but the order themselves was more than double that size. So, not - going in, back in July we weren't sure whether we would get the total amount of the order, whether we get part of it. So, we chose to build from that risk. And that $15 million represents about 20% of one order and a 100% of a smaller order. So, that's so those two numbers aren't exactly correlated. Also, what happened in the intervening period is that the customer decided to buy one of our newer products which added about to the total order would add about $10 million to it. So, the overall scale of the order is larger than just the $15 million. So, as of today, that's what we would, if we got the order today, we would ship $15 million of that order, which is different than shipping the whole order, which we would have done and we got the order say in August.

Rich Valera

Analyst

And I guess I'm confused is the whole order roughly double the 15 or at one point you said 15 was 20%. I just wanted to be clear on what that will put the entire order size was?

Martin Kits van Heyningen

Management

Yeah, so the total orders that we talked about here are more than $40 million.

Rich Valera

Analyst

Got it. Okay.

Martin Kits van Heyningen

Management

So, it's difficult to reconcile, because you'll have pluses and minuses when you give guidance in terms of airtime and currency and training. But if you just want to focus on the TACNAV piece have the entire order come in and shipped, we would have been above the high end of our guidance range.

Rich Valera

Analyst

Got it. And then just moving on sort of the media side of the business. You brought a couple of properties, and so far, it seems that you've - I mean clearly some currency issues there. But it doesn't sound like we're kind of seeing the growth we would have like to see in that sort of media properties. Just I was hoping you can sort of just talk about how you see them since you brought them. And what maybe have been some impediments that to them growing at the rate you would have liked?

Martin Kits van Heyningen

Management

Yeah. So, there is a couple of different things here. One is, let's call the legacy media business. Part of our goal there is to destroy that business, right. So, we want to take the DVDs by mail and news link by email and convert that to IP-MobileCast. So, when we churn those customers, that comes out of the legacy media business, but that's our strategy. We want all those customers to convert to IP-MobileCast. So, that's the part of the answer. The other part of the answer is they're operating in the same segment as the mobile broadband business is, which is primarily commercial shipping. So, the commercial shipping is 99% of the business for the Videotel training services. And it's a very high percentage of the legacy media business as well. So, we have exposure there to the overall market conditions. But we are actively working on some new products that we think will make a big difference in the training space. We're looking at integrating some exciting new capabilities for training relating to onboard, other onboard activities and the internet of things type activities that we're heavily focused on. So, we think it's a great fit and we're very optimistic about the long-term.

Rich Valera

Analyst

And can you give any color on the economics of switching the customer from the old DVD subscription business to the MobileCast to you? What's the revenue and or profit contribution you see from the customer in those two modes?

Martin Kits van Heyningen

Management

Yeah. So, I mean at the low end, it sorts of a 10 DVD a month customer. They're at $150 to $200 range per month IP-MobileCast Bronze package start at $295 a month. Typically, they also get news link or sports link. So, that adds another 100 to 200 to that. So, it's a higher ARPU customer, it's a higher margin customer. There is no physical media creation, shipping, handling all that stuff goes away so margins are better and the revenue is higher.

Rich Valera

Analyst

Am I sure with the MobileCast customer also be in that media of revenue pocket?

Martin Kits van Heyningen

Management

They are not so right now it’s still part of the mobile broadband VSAT revenue bucket.

Rich Valera

Analyst

Got it. Okay, that’s it for me thank you.

Martin Kits van Heyningen

Management

All right. Thanks, Rich.

Operator

Operator

And we’ll turn it Ric Prentiss again from Raymond James. Please go ahead.

Ric Prentiss

Analyst

Thanks. Can you guys hear me now?

Martin Kits van Heyningen

Management

Yup.

Ric Prentiss

Analyst

Good, I don’t when I went silent and then it drops me off so glad to be back on. Appreciate the color on the autonomous car market what about your thoughts on kind of scaling the drone markets for us, I got two millennial kids and they’re excited about both autonomous car and the drone stuff, so walk us through what the drone opportunity might look like?

Martin Kits van Heyningen

Management

Well, so our products are really expensive so they’re not for the Karma type drone, the Go Pro drone or low-end DGI, so these are for commercial applications, these are people who use the drones every day for work. So, for aerial surveying where you need to take photographs that are geo-reference, so you can take every pic on the photograph and report it flat long. Those kinds of guys need all precision they can get and our products as good as they are, which is barely good enough for those types of application because it’s really a hard application. So, those of the drones itself for more than 40,000 bucks some of them sell for 100,000 bucks and there is thousands of that built year now and that’s going to be growing to 50,000 of those. And then that’s kind of the aerial surveying industrial market and then you’ve got things like packaged delivery, which just really not a market today but potentially could be big someday. So, there’s just a lot of exciting things that people are doing with drones, whether it’s speed to delivery or package delivery or surveying or inspection pipeline, about the ground pipeline or electrical tower inspection, electrical cable so there’s a lot of different applications that require the kind of precision that we have.

Ric Prentiss

Analyst

And when you think about your product going into those type of drones, what kind of SKU price are you talking about?

Martin Kits van Heyningen

Management

Yeah, I mean the lowest price product we have now is about $10,000 and the highest price one we have is about $20,000 in terms of IMU, so it’s in that range right now.

Ric Prentiss

Analyst

Okay, I think during earnings season we all we take the pizza delivery on the sell side.

Martin Kits van Heyningen

Management

We see if I can Vector one in for you.

Ric Prentiss

Analyst

As we…

Martin Kits van Heyningen

Management

Vector 1 there Ric.

Ric Prentiss

Analyst

As we - I think last quarter you mentioned the TACNAV had about a $100 million in the pipeline so as you think about what happened with this order that every day you got commitment you started to build it, how should we think about what the pipeline is looking like then in the ‘17?

Martin Kits van Heyningen

Management

Yeah, I think there is no big change in terms of the pipeline so I think that’s still a good number to use if you look at U.S. opportunities or maybe some new things that we didn’t know about but related to U.S. Army opportunities and requirements that are popping up but I wouldn’t put those in the pipeline yet because there’s no formal funded program that we’ve already won. It’s kind of what we talk about in the other slide, when we talked about pipeline it’s projects that we know about that are apparently funded where we’ve been selective, so that’s kind of what we call the pipeline but U.S. Army stuff is not in those numbers yet.

Ric Prentiss

Analyst

Okay. And given the slipping of the order we all gathered it’s a lumpy business tough here to all lockdown, should we consider that within ‘17 maybe that total order of $40 million for these couple of projects could come in within the calendar year then, at that slow level?

Martin Kits van Heyningen

Management

I would certainly hope so and that would be our expectation yes.

Ric Prentiss

Analyst

Okay. That makes sense. And then one final question from me, obviously, you talked a little bit about the high throughputs - capacity coming online pricing for megabit coming down as customer benefits can you help us scale that part of business what magnitude are you guys paying today for that service in your cost and as we think through with that might be a benefit into the future then as these high throughputs come online.

Martin Kits van Heyningen

Management

I don’t want to disclose our exact cost per megabit per second but in an order, just to put to give you a sense, we are talking about our cost going to have what they are and that’s our internal goal in terms of new capacity. So, it doesn’t mean that the total company cost will go to half and as we add capacity as we get on new satellites, we are looking to cut our cost in half.

Rich Valera

Analyst

That helps a lot. Thanks a lot.

Martin Kits van Heyningen

Management

Great, thanks.

Operator

Operator

And we have no further questions at this time. I’d like to turn the conference over to our speakers for any additional and closing remarks.

Martin Kits van Heyningen

Management

Great, thanks for your time and as always John and I will be available afterward for any 101 discussions. Thank you.

Operator

Operator

This does conclude today’s conference. You may disconnect at any time and have a wonderful day.