Good day, and welcome to the KVH Industries, Inc. Q3 2021 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Roger Kuebel. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us today for KVH Industries' third quarter results, which are included in the earnings release we published this morning. Joining me on the call are the company's Chief Operating Officer, Brent Bruun; and CEO, Martin Kits van Heyningen. Before we dive in, a couple of quick announcements. First, if you would like a copy of the earnings release, it is available on our website from our Investor Relations team. If you would like to listen to a recording of today's call, it will be available on our website. If you're listening via the web, feel free to submit questions to ir@kvh.com. Finally, this conference call will contain certain forward-looking statements that are subject to numerous 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 of these 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 in our SEC filings, specifically those under the heading Risk Factors in our 2020 Form 10-K, which was filed on March 3 and our Form 10-Q, which is expected to be filed sometime this afternoon. The company's other SEC filings are available directly from the Investor Information section of our website. Now to walk you through the highlights of our third quarter, I'll turn the call over to Martin.

Thanks, Roger. Good morning, everyone. Thank you for joining us today. We achieved another strong quarter, reflecting our success in implementing our strategic initiatives. Total revenues increased by 5% in the third quarter to $43 million from $41.1 million in the third quarter of 2020. And our non-GAAP adjusted EBITDA for the quarter was $1.5 million compared to $3.4 million in the third quarter last year. Contributing to these results were a 13% increase in airtime revenue, record Q3 VSAT shipments in our mobile connectivity business and continuing careful management of operating expenses. Like many companies, we feel the effects of ongoing supply chain disruptions and the increased cost of goods. These global issues, slow deliveries of our products in both mobile connectivity and inertial navigation. While we could have shipped more, if it not for these constraints, we're able to shift the bulk of these orders into Q4. Demand continues to be strong and outpaced production capacity. Our team here did an outstanding job of adapting to the supply chain challenges our engineers identified alternative technical approaches and our procurement and logistical teams worked hard to track down necessary parts to get them to our factories and managed to get products shipped to customers around the globe. We did see increased costs related to purchasing hard-to-get chips, and of course, incoming freight was higher. In response, we've begun to raise prices on select products and services in Q4 and we expect to implement additional price increases on January 1 in 2022. So despite these challenges, our lead times have remained reasonable for our customers and we're able to ship out a record number of VSAT units in Q3. Now let's look at the details of our segments. Starting with mobile connectivity. Q3 is historically a slower quarter in the…

Thanks, Martin. As Martin mentioned earlier, our third quarter revenue came in at $43 million even compared to $41.1 million recorded in the third quarter of 2020. Our consolidated gross profit margin was 35% for the third quarter as compared with 38% in the third quarter of last year. Revenue from our Mobile Connectivity segment increased $3.0 million with a gross margin of 35%, which was down 2 percentage points. Revenue from our Inertial Navigation segment decreased $1.1 million year-over-year with the gross margin decreasing 5 percentage points to 36%. Service revenue for the third quarter was $27.7 million, an increase of $3.3 million or 13% from $24 million in the third quarter of last year. By segment, service revenue in our mobile connectivity segment increased by $3.4 million or 14%. This increase was primarily due to a $2.9 million increase in mini-VSAT broadband airtime revenue. As Martin noted, airtime revenue grew to $24.6 million or approximately 13% over the third quarter of last year and the related gross margin was 36%. Product revenue for the third quarter was $15.2 million, a decrease of $1.4 million or 8% from $16.7 million in the third quarter of the prior year. By segment, our mobile connectivity product revenue decreased by $0.4 million or 5%, primarily due to a decrease in TracPhone product revenue. Inertial Navigation product revenue decreased approximately $1 million or 11%. Within this segment, TACNAV sales decreased by $0.6 million this quarter compared to last year's third quarter, while our combined FOG and OEM revenues decreased by $0.5 million. In our Inertial Navigation segment, service revenue was down by less than $100,000. Operating expenses for the quarter were $18.4 million up $2.1 million from the third quarter of last year. Almost half of that increase was compensation related as we…

Our first question comes from Rick Prentiss with Raymond James.

A couple of questions. First, Martin, I want to go back to kind of the end of your prepared remarks. You mentioned something about adjusted EBITDA margins and some revenue set, so not just the guidance that Roger gave. But at the end of the remarks, Martin, what were you referencing as far as revenue and adjusted EBITDA?

We had given some sort of midterm guidance or outlook back in June and -- which was double-digit revenue growth and mid-teens EBITDA margins, adjusted EBITDA margins. So that's kind of our business model targets that we're working towards. And based on everything we're seeing today, we feel like we're on a very good path to achieve those.

Just let me clear, those are sort of midterm targets, that's not intended to be guidance for next year.

Yes, or for this quarter for that matter, that's something we have -- I'm just restating something that we had put out there in a presentation.

I just want -- so midterm means over the next several years, not like a 10-year plan, but something that's not a...

Yes. Long term would be 3 to 5 years, midterm would be 2 to 3 years.

Then also some interesting and exciting news on the autonomous trucking and autonomous vehicle areas in general. What can you share as far as looking at that addressable market, your ability to go into that addressable market? And what steps do you need to make to like scale up to hit those numbers?

Well, the autonomous trucking market, those numbers are not tens of millions of units like the automotive market. So it's actually an easier step for us than going straight to automotive volume. So as this ramps over the next year or 2, we feel very comfortable that we'll be able to keep pace with our production. -- for that. And as I pointed out, that this is not something that is 3 to 5 years away, we expect starting now early next year, 20% of our FOG revenues will be coming from autonomous vehicle platforms.

And we've been hearing from some of the logistics transportation companies about something when you call it, teleops, where it's kind of like small drone-like vehicles that are maybe remotely controlled. Have you made some progress into that as well? What can you share us on that kind of submarket?

No, I can't say that we have. So most of our customers are autonomous. But sometimes autonomy means that there's a lead vehicle and then there are 3 or 4 follower vehicles, for example, that are self-driving. But the lead vehicle might have a human driver in it. But none of these platforms are teleoperated per se, but not the ones that we're on.

And then we also noted cost of service came in a little lighter than we were looking for, obviously, being ready to move over the customer base. But how should we think about that cost of service transition going from third quarter to fourth quarter and looking into next year?

Did you say it was a little lighter than you thought? I didn't hear you.

Yes, I think it was a little lighter than we thought. I mean we had content report this morning. So we're still a bit of a blur.

So it came in -- I think our overall margin was a little bit better than we expected as well, fairly consistent with last quarter. So we've been adding capacity as we've been adding subs. So we've been adding a lot of sub to the HTS network. So keep in mind that when we say the net subscriber growth number of 12% and airtime revenue was up 13%. And that is -- doesn't indicate how much capacity we're adding to HTS as people migrate off. About 90% of all the revenue is already on the HTS network. So in that that's really what's driving the cost savings for next year, especially. So come January, we'll shed an immediate $10 million plus of cost, making the year-over-year cost reduction on the order of $12 million. And where we are now, we've already incurred a fair amount almost of the increase in the HTS network. So it's a long answer, but saying that this migration is going well. As long as we don't strand too many customers come January, it's going to be a big net positive for us next year. So we should see improving margins is my point.

Our next question comes from Chris Quilty with Quilty Analytics.

I wanted to follow up on that -- I wanted to follow up on the autonomous vehicle. If you're targeting 20% next year, what does that compare to either this year or in recent years, the contribution?

It's significantly larger. I don't have the exact number for this year, but it's -- my guess will be more than double next year.

And most of the historic shipments were sort of legacy designs and hardware that was relatively expensive. Are you looking at the contribution next year being more PIC derived products and higher volume?

Yes, 100% of everything we ship next year is PIC-based. So the answer is yes. So it will be our new photonic chip-based products and they're primarily IMUs as opposed to single sensor. So that's another difference from what we've seen in automotive is that for these trucking type applications, they're looking for a 3-axis IMU, not just a single access yacht sensor.

And I think historically, you've talked about a set last year or historically was order of magnitude, thousands of dollars and presumably, you're coming down to hundreds of dollars or high hundreds of dollars. So you're implying at least significant volume increase if those numbers are still accurate?

Well, the short answer is no. We're not in the dropping-prices-into-the-hundreds-of-dollars yet that would require significant volume, as you point out. So we'll scale the price as the self-driving trucking ramps up. But there's no -- from a competitive perspective, there's no need for us to be, in order of magnitude cheaper than we are today, for example. So we intend to maintain the margins next year and as we grow into this market with our customers.

And can you give an update on where you are in terms of your production capacity? Because I know you've been dropping a new production line in the past year. And what sort of volume you're scaling for?

It's kind of ironic. We've done everything to be able to build units quickly the invention of the photonic chip. We've added some optical automated assembly equipment. And that's the only thing that we're not having production issues with. And now it's all trying to get chips in. And when you finally get the chips, it's late in the quarter and you have to try and build things and you have work in process on the floor. It's just a horribly inefficient way to manufacture. And that's especially true in our Chicago facility and -- but it's also true here in Middletown. It's even when we get the parts, oftentimes, they're not sequenced correctly. So it really is disrupting manufacturing in a way that's worse than what you're seeing in terms of our ability to get product out the door. It's just not an efficient way to build. So from an optical component point of view, we're in fantastic shape for large-scale production.

Question on the TACNAV order you said you expect in Q4. Is that the sort of 7-digit or is that an 8-digit type of order in terms of scale?

It's a big one.

It's a large program over time. I mean, over time, it's going to be a very large program by historical standards. How much is actually ordered that will be delivered in next year. It's still sort of up in the air. I mean, we know the program is very large, but they're still working through what would be in next year versus future years.

So yes, it's north of $10 million. And as Roger said, whether they take it all in 2022 remains to be seen.

And this is one of the well-known programs that you've been working on for the past couple of years, prototyping and testing?

So it's a repeat customer.

And switching over to the mobile connectivity side, you talked about some potential price increases that you're going to implement both this year and going into next year. Is that something that you're seeing amongst your competitors already or expect to see amongst them? Or do you feel like you're having to step out in front in terms of those pricing increases?

Well, it's mostly due to the hardware cost, and it's unclear whether that's going to be a permanent change. For example, we've -- in order to keep production lines going, we've ended up buying chips from what are affectionately known as scalpers, where you're paying 10x the price of a chip, just so you don't shut down and can't ship a $20,000 antenna. But you're paying $100 for a $10 part, for example. So there are definitely increases in our cost of goods sold. And going forward, we're going to pass those along to our customers. in order for us to be able to keep delivery. So our customers are more interested in getting the product than waiting 6 months, which is the lead time on some of these chips.

With respect to competitors, I mean it's kind of a mixed bag. We've heard about some price increases, we don't have perfect information, but we have heard about some increases by other providers.

So I should have been stocking up on chips when I was stocking up on toilet paper?

Yes, everybody had the wrong…

The HTS shift that will happen January 1. Can you give us an idea of whether there are any potential incremental cost of the transition you've talked about in the past, possibly having to really subsidize customers or other costs that you may incur in Q4 to get that transition done?

There may be some costs, Chris, but it won't be overly material. We're talking $100,000 or $200,000. So we're not talking like a significant expense going out the door. And it's more like upgrade kits and upgrading their existing equipment and giving them deals on hardware.

And final question, just in terms of CapEx. I think, either for this year or if you can step out and think about next year and what you may incur in terms of AgilePlan related CapEx or KVH Watch, related CapEx expenditures? Do we stay in the same sort of levels as 2021? Or do you expect a step up?

We're not really ready to talk about next year yet. I think it's on a relative basis. Obviously, as we grow subscribers on the AgilePlans, we're putting -- that's good CapEx. It's all revenue generating. So I think you can sort of think about it, the CapEx sort of being proportional to sort of Agile revenue growth. But we haven't really -- we're not really prepared to put out anything specific about next year at this point.

I think the business model isn't changing for Agile. The growth continues to be very, very strong there. And we've got strong backlog as well for Agile as we entered this quarter and for next year. So directionally, I think you're going to see something similar next year. And then as far as watch goes as Brent and Roger just said, everything is success-based. So the more successful, potentially the higher the CapEx, but that would mean that we're successful.

That will conclude today's question-and-answer session. Mr. Kuebel, at this time, I will turn the conference back to you for any final remarks.

Thanks, operator. We have no final remarks here. I want to thank everyone for joining us for the call. We appreciate it, and we look forward to a successful end of the year.

Thanks, everyone.

Thank you.

This concludes today's conference. All participants may now disconnect.