Good day, and welcome to the KVH Industries Second Quarter 2017 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Don Reilly, Chief Financial Officer. Please go ahead, sir.

Thank you, operator. Good morning, everyone. Thanks for joining us today to discuss KVH Industries' second quarter results and our guidance for the 2017 third 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. 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 will contain certain forward-looking statements that are subject to many assumptions and uncertainties that may cause our actual results to differ materially from those expressed in these statements. We undertake no obligation to update or revise any forward-looking statements. We will also discuss certain non-GAAP financial measures, and you'll find definitions of these measures in our press release, as well as reconciliations of these non-GAAP measures to comparable GAAP measures. We encourage you to review the cautionary statements made in our SEC filings, specifically those under the heading Risk Factors in our form 10-K, filed on March 9th of this year, and the Company's SEC filings available directly from Investor Information section on our website. At this time, I'd like to turn the call over to Martin. Martin?

Thanks, Don. Good morning everyone. Please to report, that we enjoyed successful second quarter with result in line or exceeding our guidance. Second quarter revenue was $40.5 million, while our non-GAAP EPS was $0.03 per share beating our expectations. We also achieved record airtime gross margin for the second consecutive quarter, while simultaneously increasing our subscriber base and airtime revenues by 6%. Our agile plans connectivity is a service product is off to a strong start and we saw robust sales of our inertial nav products as well. We did experience some challenges with the continued delay and the anticipated military order, along with a cold and rainy spring that slowed product orders for lessor boats and particular with our TracVision in mind. But overall the second quarter was positive both from a strategic and a financial perspective. And Don is going to cover the numbers in detail later. But before he does, I'll just go through some of the highlights and touch on some of our new initiatives. So starting with our Mobile Connectivity business, our airtime business grew $1 million or 6% year-over-year. Airtime gross margins for second quarter were 39% percent and that was a record for the second consecutive quarter. As I mentioned earlier, our subscriber base was also up 6%. Long term and new strategic initiatives are playing a part in the success. One major factor has been the growth of our usage based airtime plans which we launched two years ago, as part of our mini-VSAT Broadband 2.0 initiative, while other satellite service providers were focused on delivering unlimited plans that were in fact limited and throttled. We set out to differentiate ourselves from the pack and take full advantage of the speeds and savings that mini-VSAT Broadband offered. Our new usage based plans…

Thank you, Martin. So now I'd like to discuss in more detail the financial results of the company for the second quarter. As you know our business operates in two reportable operating segments based on product lines, mobile connectivity and inertial [ph] navigation. The last page of our earnings release includes a summary of our operating results by segment for the second quarter and year to date periods. As Martin mentioned earlier, our second quarter revenue was $40.5 million, which was within our previously announced guidance range. And this compares to $46 million recorded in the second quarter of 2016. Revenue from mobile connectivity segment decreased $2.8 million and our inertial navigation revenue decreased $2.7 million. In constant currency, our revenues declined by about 10%. Product revenue for the second quarter of 2017 was $14.3 million, a decrease of $5.7 million or 29% from the $20 million in the second quarter for the prior year. By segment, product revenues and our inertial navigation segment decreased to $3 million or 36% and our mobile connectivity segment decreased by $2.7 million or 23%. Within our inertial navigation segment, our FOG business continued its solid top line revenue growth growing 11% this quarter, and TACNAV sales declined this quarter, as the prior year included the initial deliveries on a large TACNAV contract that concluded in the fourth quarter of 2016. In our mobile connectivity segment, the decline in product sales was partly driven by the launch of our agile plan subscription model. As Martin mentioned approximately 20% of our unit shipments this quarter were in connection with this new offering and as previously communicated, we do not recognize revenue - product revenue on shipment of agile plant products, as we continue to retain ownership of the products. Also challenging weather conditions, particularly on…

Thank you. [Operator Instructions] We'll take the first question from the line of Ric Prentiss from Raymond James. Please go ahead.

Yeah. Hi, guys. It's Alan actually in for Rick.

Hey, Alan.

So looking at the 2017 guidance you took down the high end you know, by about $6 million and I believe previously you guys had assume that TACNAV orders would be flat from '16 and '17. So I guess my question is what's baked into the guidance now in terms of like revenues from TACNAV?

So we haven't changed our TACNAV forecast. We think the upside of new TACNAV is probably less than it was, but we're still assuming overall TACNAV sales about $16 million for the year.

Right, but we have booked some other orders. So we've actually decreased a little bit the amount within that $16 million that was based on the orders we don't have in hand. So we just kept it flat at the $16. So going into the year, we've got a lot of different parts to our business between mobile connectivity and V-SAT and TracVision and training and content. So you know, there is pluses and minuses. So half way through the year we're tightening the range a little bit.

Okay. And then you know if I look at your product gross margin consolidated, it's been kind of 30% to 40% range. How should we think about the gross margin profile of those TACNAV revenues when they do come in?

While TACNAV margins are much higher than the average.

Okay, great. And then my final question is, you talked a little bit about you know, to encourage demand in terms of I believe the ARPU that you're seeing from the agile plans. So in the range of ARPU it's pretty wide I think from about like 500 to like 5000 a month. So I guess are those ARPUs different that you would have seen from kind of your historical subscribers and I guess what where I'm going with the question is are you seeing some of the customers that you have kind of using the savings that they generated from avoiding the upfront capital cost, kind of redeploying those savings to take on more bandwidth and more service than they would have historically?

That's a great question and that's what we said, is in fact what we're seeing, but it's so early we don't want to you know, count on that. So you know, as Don mentioned that we - you know, we record revenue from the time the units installed and activated and that takes some time and planning to get the ship in port. So you know, it's early days, but so far it's much better than you know traditional and better than we were thinking, so. But we'll wait and see whether that is a trend or just you know an anomaly for early adopters, but so far so good.

Okay, great. Thank you so much for answering my questions.

Thank you. And we'll take the next question from Rich Valera from Needham & Company. Please go ahead.

Thank you. First, just wanted to follow up on your answer to that last question Martin. So could just clarify what is much better than traditional when you do an agile plan versus the historical plan?

Well, you know, our ARPUs have been in 1300 range traditionally. So these were better than that, which was not what we're counting on. And really just answering the question as it was asked, you know, we don't want to make a point of saying that you know agile plans are going to be double the ARPU. We are counting on them being similar and initial they look better. So that's you know, I don't want to overstate, it's just answering the question that we were pleasantly surprised. But you know, we weren't counting on that.

Right. So could you just refresh us on the benefit to KVH of selling a unit as an agile plan versus a traditional plan, obviously you're giving up the upfront revenue for the equipment. What is the expectation of the benefit that you get if not higher ARPU?

Higher margins. So the margins on the agile plans you know, I think it common misconception people think oh they're giving the hardware away. So how are they going to make that up? We're you know, we don't use this word in our marketing, but in fact it's a rental program, so we're renting the hardware. So we have higher gross margins you know, are built into the agile plans for the hardware and the service. So it's a high margin sale compared to the other model where you sell the equipment at relatively low margins and then you know sell their time plans at you know the 39% average margin that we're reporting today.

Okay. I guess I thought that the monthly rate or the month the amount paid by the subscriber was similar under both plans is that not the case?

It's similar….

By additional plan?

Yes, it is similar. But the quantities are different. So in other words the - there's a certain component of the monthly bill that covers the hardware and then there's a certain component that you know internally allocated for all the various components, including the content and the gigabytes of data usage. So under the agile model, we see the data usage being incremental to the plans because they are fixed quantity plans.

And you know, the ARPUs - that the margin, the ARPU included in the component of the ARPU allows us to recover the investment in hardware in 18 to 24 months. And I think we've - that's consistent with what we've said in the past and we're seeing that. We're off to a very good start. The ARPUs are running - the ARPUs are running higher and higher, nicely higher. But and you know, we're up, we hope that continues, but it's very early days.

Got it. Thanks for the clarification. Appreciate that. And also just wanted to follow up on TACNAV order that you expect to receive and ship this year. I mean, you haven't - if I'm correct, year to date you've seen very little TACNAV revenue. It looks like you know, on the order of a million plus dollars. So I'm looking at this correctly, but you're still looking for 16 for the year, so how should we think of that split between these last two quarters?

We think the big - we still don't expect and our guidance doesn't anticipate large TACNAV in the third quarter. In fact, we expect you know, the big bump we're going to get in the fourth quarter.

Got it. I mean…

And you're right, our total year-to-date TACNAV sales were about $1.3 million.

Right. So $16 million seems like a pretty big, not for the fourth quarter. And color you can give around. I think I understand you have a good chunk of that I believe already built in and sitting in inventory. But can you give any color, other color around you know, what would enable you to ship such a large amount in one quarter?

Yes, I think you know, off the top my head I think around $9 million is un-booked $9 million or $10 million rather is un-booked. So we do have other backlog that will ship in Q3 and Q4.

Got it. Okay. And Martin I just wonder if you can give us an update on the photonics base FOG, just you know, I think you gave some update last, were about - I think you built the prototype with the second spin of the of the photonics, I see any further progress to share with us there?

Yeah, nothing - no big breakthroughs to report yet. You know, during the quarter we did actually installed one of the prototype chips into a gyro. So we're getting you know, core functionality and that's the last time there the problem to be solved now. Continues to be insertion loss and we've got some new foundries who have committed to meeting our specification which is encouraging. So we're continuing to make steady progress.

Got it. And then Mark, I just wonder if you could give us some high level views of the application of FOG's into the ADAS market and kind of the - what level of automation in the ADAS hierarchy you see requiring FOG's and kind of your best guess as to the timing of when cars start shipping commercially with that level of automation?

Yeah, I think you know, for us its level 3 and higher. So - and you know as I've mentioned in the past, there's every single car company and you know dozens of start-ups are all focused on this. You know, and all of them have a mixture of different technologies and they vary the emphasis on each component. Some people are doing you know, pure inertial NAV type solutions with you know, collision avoidance. Other people are trying to do pure vision systems. But most of them are using a mix of inertial LIDAR, RADAR vision kilometres just to you know, a real center of fusion, which coupled with AI is really you know, in my opinion the most likely method that's going to succeed. So you know, and today the vast majority of those are using high end inertial NAV systems as a key component of that. So most of the ones that you read about or seen are using kind of very accurate inertial. So - and that's the part where we intend to compete. And you know, as you know as things transition to automotive production cost becomes the main driver. So while we think that we've got a great solution today, we don't have the right price point for volume and that was true with the LIDAR. You know, when they started and it's true with the fiber optic gyrus as well. So but we think that if we can get the cost down to you know $200 to $400 price point, we think that is will be very attractive. You know, as far as timing, we see this happening because it's such a large opportunity. We think that there will be some significant volumes, even in the early prototype stages you know. 100 million cars built today, you could see a thousand or 10000 cars you know being prototyped or experimental cars that are small, fleets that operate in cities you know, for you know autonomous, passenger delivery if you will rather than cars being sold. I think that'll happen sooner rather than later. So you know, internally we're thinking 2018 2019 we'll start to see some decent volumes out of this.

Got it. And the expectations for this year, I know you'd ship to a decent number I think close to a thousand into this market last year, any thoughts on this year versus last year?

No I don't think we're going to see much this year. You know, no significant revenues this year. I think that sort of - you know we've satisfied kind of the prototype markets and I think that you know, all hands on deck for the next gen product to transition to this you know, higher quantities of early stage deliveries. So we see this as a next year type thing.

Got it. Okay. That does it for me. Thank you.

Thanks.

Thank you. We'll take the next question from the line of Jim McIlree from Chardan Capital. Please go ahead.

Yes. Thank you and good morning. If I can just follow up on some of Rich's questions on the economists market side. Martin you talked about getting the cost down to $2 to $400 million price point. Were you talking about for one FOG or for the collection of FOGs that would go into an IMU for that market?

Yeah, that would be for one. So I think that as you know well they have three axis solutions. Now I think that you know in production you're probably able to get away with single super high precision sensor and to lower accuracy sensors. So you know, we're - but everybody has a different solution. Some people are using you know, our three axes FOG's, but you know, in our mind we think that's probably where the market will evolve to just for cost reasons. So the answer is right –single access, $200 per single access.

So you think your total content per vehicle would be 200 plus depending on the solution at specific customer is do you think?

Right. And today a lot of them are - have fully redundant system, so they put two of everything. I mean, two batteries, two sensors, two motor I mean, it's just fully redundant. So whether that continues or not, I don't really know.

Right. And so the timing on the completion of the photonic base is that this year event or is that more early or mid-next year that you would…

Yeah. You know, I just want to reiterate that this is an R&D project, so there's you know there's no guarantee that it will ever be completed. You know this is an important strategic initiative, but it's in the lab. So we think this is going to work. We think it's a great idea, but you know, as you know with any new technology there are no guarantees here. So I don't want to give the impression that this is you know merely an execution. You know, it's still R&D.

Okay, understood. And thank you for that clarification. But I'm still going to ask the question, so you know it noted that it is an R&D project and we do have risks associated with it. You know kind of like if all went well, it would be done by this time…

Yeah, I mean.

What kind of things would be done by this time…

Yes I think if it's not working by next year. Then it's probably not going to work. So I think that you know, I think we're at a stage now where we think we've got a path and we've got some founders who say they can do it and we expect you know, we're iterating samples and you know it should work and if it doesn't work then it's probably not going to, so I think 2018 is still our time frame.

Right. Okay. All right. And I want to make sure I understand what's happening with the agile plan. It kind of sounds like it's going faster than - where the take up is faster than you expected. First of all is that correct. And then secondly, I know it's early, but we do have an estimate or can you share an estimate as and when you think the agile plans as a percent of total shipments would max. So I got a when and at what level?

Well, our long-term goal was 50%. We thought we'd be successful of half our sales were agile plans. Now keep in mind that it's not often the leisure market because leisure is a fleet product for commercial customers and leisure markets really don't - you know, we don't think it's the right product offering for you know the private boat owner and then today those are about 40% of our sales. So we expect that the majority of the commercial market will go that way and we're off to a really good start in commercial.

Right. But just from a - and I'm asking from a modeling standpoint, as it seems like it's taking up for the penetration of agile plans is - as it heads up more as a steeper curve. Then we'll probably see bigger than originally estimated drops on a year-on-year basis but that will recover sooner as well and that's all I'm thinking of it. Is that…

Right…

That's how we're thinking of it as well because you know since this isn't free hardware deal, it's a recurring revenue hardware deal. So that as you know time marches on, you know, every month now you're recording the hardware revenue from everything you sold in the previous month and then month 3 it adds to that. So you're definitely thinking about it the right way. So eventually it will equal even if sales don't increase, it will - after call it you know, four years the hardware portion of our reported revenue is identical to what it was if you were selling them,

Like any software subscription model you know, compounds. So new activations this month you know, and this compounds next month, so we have new activations next month, plus those month and this continues go on that way. So over time you know, we get to a point which not just described our - a good portion of our revenue, significant portion of our revenue will be from the subscription model.

Okay. And Martin, you talked about an HTS product, is there an introduction date that you can share with us?

No, we were thinking you know, this is something that we're working on for launch, later this year, towards the end of the year. So it's good to be a smooth transition as an overlay, bringing higher speeds and you know lower costs for us and the expectation is that you know, all of our product offerings eventually will be part of our agile plans. So it'll really be a continuum and we expect those two things to work together hopefully to make the offering even more attractive.

Right. That make sense. Okay and just one more back to the FOG and the autonomous vehicle. So let's assume the worst that the R&D project doesn't succeed. Then what are you just stuck with the stock, but you're going to have a niche product or that will be a niche market for you, the autonomous market or is there a…

Yeah, I think that you know for maybe for larger platforms like you know, self-driving 18 wheelers or buses or people movers you know, then a $2000 solution might be fine, but for the mass market you know we're talking millions or tens of millions. You know, realistically I don't think that would fly. So I hope that answers your question.

It does, it does. Thank you so much. And here's hoping for the best from that one. So good luck with that break, guys. I appreciate it.

All right. Thanks very much.

Thank you. [Operator Instructions] And we'll pick the next question from Chris Quilty from Quilty Analytics. Please go ahead.

Thanks. Don, I was hoping you could give us maybe a little bit more granularity on Q3 revenue guidance as revenues up sequentially, but profitability down significantly and you had really good OpEx performance in Q2 is that just moving back up to more historical levels or things going on here in the gross margins?

Yeah, but it's still - moving back I guess, a little bit to historic lows. So we're also you know, we've said all year long, we expect our operating expenses to increase year over year by about $10 million. We kept that back in the first half of the year, but we expect that we'll see some of the spending increases that we talked about coming in the third quarter. So that you know, probably the biggest reason why quarter-to-quarter revenues will be higher. But you know, our profitability will be below. Last year to revenues will be - I'll take that back, revenues will be lower, profit will be much lower. Last year we had some significant TACNAV business which I mentioned already is very high margin business. So that makes the year-on-year comparison a bit more of a challenge, but was your question sequentially Chris or year-over-year?

Well, no, just on an absolute basis, the net loss you guided to is much wider and I was just trying to figure whether that's more on the cost side or on the margin side that's driving it on a sequential basis Q2 sequential?

That's sequentially, okay. So I'd say, it's more on the cost side. Our margins should be - our margin in the third quarter will be consistent with the second quarter. So it's - but we expect higher operating expenses in the third quarter, higher R&D - I'm still here that somebody is...

Operator Can you kill that line.

Maybe it was the operator that got lost.

Okay, Shifting gears that maybe this metric isn't as important anymore. But you know, the net additions that you brought in the quarter I think you said that the overall year-over-year ship count was up 6% on a quarterly basis. Are you still kind of running in that 2 to 250 range?

Yes, we're still in that range and I think that's you know, the big goal is to start to gain momentum with agile plans and start to break out of that range. And you know, it with the HTS we'll help with that as well. And you know, we are still operating as you know in a challenging market. So we are still in the marine market which you know, commercial shipping is not doing that well in the oil and gas which is stabilized. You know, I don't think anybody would say its recovery.

Got you. And with regard to the competitive situation have you seen anybody offer capabilities similar to what you've done with the agile plan? Or response in the market?

No we haven't. You know I think that the - you know our bundle it's pretty unique and I don't think anyone else is going to be able to offer what we're offering. So you know, the only alternative is you know they can drop prices further and that really speaks to why we did this, is that we have a differentiated service offering and we intend to keep selling on our features and not you know, try and get into a price war on you know, who's got the cheapest megabyte. So it's really a - and it's starting to resonate with customers, who were really encouraged, sales teams excited, customers love it. So you know, we think we've done the right thing here.

Got you. And on the agile plans, I did this math in my head, so maybe dangerous, but it sounds like about you know 80% of the people that could take an agile plan did in the quarter is that first of all is that correct?

No, no that's not correct. I think it's around 40%. So you exclude leisure and you exclude B-3. You know, so it was about 40% in two thirds of the quarter when we started from the time we announced it in mid-April.

Got you. And you know, what's the reason why somebody would not take up the plan?

Some people have a CapEx budget and they want to buy it and they want to own it. They want you know, they don't need the flexibility because you know they own their own fleet. The people who really like this are fleet management companies where they're operating. And that's a big segment of the market. The ship management companies they don't have three year contracts with their customers. You know they may have you know, balance for another nine months and they expect it to be renewed, but they - you know there's no guarantee. So they can't go out and buy you know CapEx and put it on for three year - and a three year plan because they may not have the vessel after nine months. So - but there are still people who own their own fleet and they like to buy and you know we have no trouble selling them the hardware to. Like you know like the SaaS model, software companies you know - we just did a deal with IBM and they said hey you wanted it on-premise or do you want in the cloud. And they offered it both ways and we made a decision. So I think its fine for people who want to buy the hardware.

Okay. All right. Don, did you give the number for the mini-VSAT revenues in the quarter, airtime revenues?

I don't know if I did, I can give it to you I think, hold on a second. About $16.5 million of memory serves

Okay.

Yeah, $16.5 million for the quarter.

And those up…

Those up in line versus last year.

That's all I need for now. Thank you, gentlemen.

Great.

Thank you.

Thank you. It appears there are no further questions at this time. Mr. Reilly, I'd like to turn the conference back to you for any additional or closing remarks.

Okay. Well, thank you everybody for your interest in being on the call today. Martin and I'd be happy to take any calls later or answer any questions that may come through.

Thank you.

And this concludes today's call. Thank you for your participation. You may now disconnect.