KVH Industries, Inc.

Good morning. I’m Pat Spratt, and with me is Martin Kits van Heyningen, Chief Executive Officer; and Peter Rendall, Chief Financial Officer.

This call will address the third quarter earnings release that we issued earlier today. Copies of the release are available on our website and also from our Investor Relations department.

This call is being simulcast on the Internet and will be archived on our website for future reference. If you are listening via the web, feel free to submit questions to [email protected], and we will answer them following this call.

This conference call will contain certain forward-looking statements that involve risk and uncertainty. For example, statements regarding financial and product development goals are forward-looking.

The company’s future results may differ materially from the projections described in today’s discussion.

Factors that might cause these differences include, but are not limited to, those mentioned in today’s call and risk factors described in our quarterly report on Form 10-Q, filed with the SEC on August 8, 2012. The company’s SEC filings are directly available from us, from the SEC or from our Investor Information section of our website.

Now, I will turn it over to Martin for today’s discussion. Martin?

Thanks, Pat. And thank you all for joining us today.

I’m pleased to report that KVH achieved record results during the third quarter. Revenues of $38.8 million were 52% above the same period last and 21% higher than the previous record quarter.

This exceeded the high end of our previous guidance by almost $2 million. We reported EPS for the quarter of $0.12 per share which was in line with our guidance.

Our strong revenue growth during the quarter was a result of several factors. We continue to sell successfully in the global VSAT market.

We began to ship our TACNAV navigation systems and bill management services under the Saudi Arabian National Guard contract and we also saw an uptick in new orders for our fiber optic gyros both from our remote weapon station customers and from new customers.

Regarding our mini-VSAT Broadband business we added many new customers during the quarter and saw a solid follow-on business from our existing customers, resulted in sales of over 250 new TracPhone V3 and V7 systems. The majority of which were the higher price V7 system.

Our airtime revenues continue to grow and were $9.5 million for the quarter that’s up 56% year-over-year. While our unit sales were up 36% over the third quarter of 2011.

Our leadership position in the maritime VSAT market was reaffirmed in September, in a report published by leading satellite market research company COMSYS, who named KVH as the global market share leader in fielded maritime VSAT systems.

We’re working hard to solidify our leadership position with regular network upgrades and the introduction of new innovative products that will position us for future growth as we continue to expand our global customer base.

Our previously announced expansion of our mini-VSAT Broadband network with 3 new global C-band beams to overlay our Ku-band service was brought online during the quarter, it’s now fully operational.

We began to shipping our new dual-mode TracPhone V11 earlier this month, which makes KVH the only company in the world to offer a global maritime VSAT service with a single one-meter antenna. The new TracPhone V11 can seamlessly switch between C and Ku-band, and represents one of the most ambitious product development efforts we have ever undertaken.

This is a truly unique product. We now have several patent applications pending.

During the third quarter, we also introduced our new TracPhone V7-IP system. This groundbreaking product features a new robust free access antenna mechanism that can track satellites from horizon to horizon, including those directly overhead.

In addition we’ve combined our CommBox Network Manager, our antenna control unit, WAP adapters, Wifi and Ethernet switches all into a single 1.5U rack mountable enclosure.

We’ve taken the belowdeck GSM service modem and put that inside the antenna. So the result is a dramatically smaller and simplified belowdecks equipment package, which in turn will simplify the installation and speed deployment of our new TracPhone V7-IP and V11 systems.

This end-to-end solution will also extend the functionality of our mini-VSAT Broadband Service to include onboard networking and create a delivery vehicle for a new value-added service, which we had envision when we acquired Vertex in 2010. The CommBox hardware technology is now built into all the V7-IPs and all V11s.

From a competitive perspective, KVH continues to pull away from other maritime VSAT competitors, while gaining ground on the MSS market leader Inmarsat. It’s interesting to note that in order to be able to be provide reliable service, Inmarsat is marketing their upcoming global express Ka-band satellite service as a dual antenna solution that will require both the one meter Ka-band VSAT antenna and a 60 centimeter L-band antenna.

Satellite provider Intelsat who supplies KVH’s C-band capacity, as well as some of our Ku-band transponders is now openly competing with Inmarsat in the mobile broadband market.

From our perspective, access to readily available commercial satellite capacity from Intelsat and others enables us to continue to incrementally add to our network in exactly those regions where we have customer concentrations offering a very flexible growth path in our business model.

Moving onto our satellite TV business, TracVision revenues were up 17% in the third quarter over the same period in 2011. As a maritime satellite television market continues to show signs of modest improvement.

Received a very good reaction from dealers and customers to our new TracVision HD-11 global dual-band antenna, which accounted for about half of the year-over-year increase in our satellite TV sales this past quarter.

Our premium TracVision HD7 also sold well and was recognized by the National Marine Electronics Association last month winning the annual award for the best entertainment product in the maritime industry. This was the 14th year in a row KVH has won this award for our TracVision product.

This year we also won the NMEA’s Best Communications Product award for the TracPhone V3 mini-VSAT Broadband system.

So globally, we continue to strengthen our sales network and make inroads in new international markets especially for a mini-VSAT system.

We opened subsidiary office in Japan this quarter to better service our Japanese customers in conjunction with our partners SKY Perfect JSAT, FURUNO and Japan Radio Company.

The Japan office will coordinate with our regional headquarters in Singapore to continue to reinforce KVH’s commitment to be a recognize supplier to the important Asia-Pacific market. We’ve already some notable sale success like the recent contract announcement with NYK and we have a number of other important trials underway in Japan and Singapore.

In South America, our new partners Andesat and Tesacom are starting to win customers, particularly in the commercial fishing market and we continue to gain traction in the emerging Brazilian oil and gas market.

The TracPhone V3 has just been approved by the Brazilian regulatory agency Anatel, so now both the TracPhone V3 and the TracPhone V7 can be used with the mini-VSAT Broadband service anywhere in Brazil and in surrounding waters.

Moving on to our guidance and stabilization business. Our TACNAV product revenues were $6.4 million for the third quarter, that’s up more than 200% year-over-year as we began to ship the recently announced contract for the Saudi Arabian National Guard.

Overall, we recognized just over $7 million of product in service revenue in the third quarter for the Saudi Arabian retrofit contact, of which product revenue was roughly 60%. The non-product portion of revenue related to product management and building construction milestones for a new installation facility in Saudi.

TACNAV prospects for a new business continue to look strong. Earlier this month we received authorization to start work under the Canadian Army’s Tactical Armoured Patrol Vehicle program.

This program could ultimately involve the installation of our TACNAV system on between 500 to 600 vehicles.

In addition to TACNAV systems, these vehicles will also be equipped with the CROWS systems. So this has a potential to be a double win for us.

We could end up with our FOGs and the stabilized remote weapon station and our TACNAV system as a navigation solution on these vehicles.

Turing to KVH’s fiber optic gyro business, our revenues grew to $7.1 million in the third quarter, that’s up 34% year-over-year. We continue to enjoy success in Remote Weapon Station applications which accounted for about 40% of our FOG revenues in the third quarter.

One of our RWS customers Kongsberg won the $1 billion U.S. Army CROWS III program.

The initial award to Kongsberg from the U.S. Army was up to 3,000 systems plus additional repair and refit systems.

We expect this program to result in substantial FOG sales for KVH.

For applications other than remote weapon stations, our FOG revenues were up 12% for the quarter compared to last year. Feedback from initial customer trials using engineering samples of the upcoming Series 1750 IMU have been very positive.

And we’ve received initial orders for several exciting new applications.

Now these early design wins are what leads to successful production in the future. That’s been the pattern with our FOG products historically.

And we’re hoping this trend will continue in the emerging markets, some of the emerging markets like autonomous vehicles and robotics.

So looking forward to the remainder of this year, we’re comfortable with our prospects for our continued success in each of the strategic areas of our business. For the mobile broadband business, our new TracPhone V11 is a breakthrough product introducing a new global capability and customers are starting to trial the service on their vessels.

Our TracPhone V7-IP will provide another significant advantage by making our maritime VSAT products faster and easier to install than the much larger and complex competitive solutions. The value-added service capabilities enabled by our CommBox-ACU represents an interesting new business opportunities for KVH to provide additional service offerings to our existing mini-VSAT customers.

We have a strong pipeline of opportunities. And we’re on the verge of concluding some large trials that we hope will lead to substantial fleet orders.

For our guidance and stabilization business, we continue to have a strong backlog and expect to see significant new orders being signed in the coming weeks.

Our important relationship with Kongsberg has been solidified. And we believe we’ll enjoy growing orders in CROWS 3 programs as it goes into production.

And lastly emerging applications suggest promising future growth for our fiber optic gyro business.

And now, I’ll turn the call over to Pat for a detailed financial results of Q3. And then he’ll hand the baton to Peter to talk about the outlook for Q4.

Pat?

Thank you, Martin. The following summarizes our Q3 revenue by business.

The total VSAT business was approximately $14.5 million, of which airtime services was about $9.5 million, and up 56% year-over-year. Total VSAT product and service revenue increased 38% year-over-year.

ARPU for by-the-megabyte plans continue to be in the $600 to $700 per month range. And fixed rate plan ARPU moved above the $1,900 per month level.

The mix of VSAT unit sales for the quarter was about in line with prior periods with about 35% V3 systems and 65% V7.

All other marine SATCOM revenue including TV systems and Inmarsat systems and airtime was about $5.8 million. Within that amount, marine satellite TV sales increased 17% while sales of Inmarsat L-band satellite systems declined more than 50% on an ever shrinking base.

Land SATCOM and aviation system maintenance services combined was $1.9 million, down 4% year-over-year. TACNAV product revenue was $6.4 million and that was up 200 -- over 200% year-over-year.

FOG was $7.1 million, up 34%. Other guidance to stabilization products and services was $3.2 million, compared with only $0.4 million last year.

Gross margin was 39.9%. This was a little lower than our expectation.

Even though total revenue was stronger than expected, the mix included a relatively large amount of low margin service revenue relating to the construction of the vehicle facility in Saudi Arabia.

Gross margins for other products and services generally met our expectations. Gross margin for VSAT airtime was approximately 31% for the quarter and down modestly compared to Q2.

This was expected because this was the first quarter in which we experienced the full impact of C-band satellite capacity costs.

For the near-term, we will absorb the full run rate cost impact of the C-band network by only having a nominal level of new C-band airtime revenue. So VSAT airtime gross margin will likely move about sideways through the fourth quarter before resuming an upward trend during the first half of 2013.

Revenue and gross margin for all other services including non-recurring engineering repairs, Inmarsat airtime and services related to our Saudi Arabia contract were about $4.8 million and 28% respectively. Gross margin for these other services was much lower than in the prior few quarters because of the relatively high content of the facility construction services of Saudi Arabia.

These construction services had a gross margin of less than 10%.

Operating expenses were up 15% year-over-year and up 7% sequentially. The increase was largely driven by sales commissions that directly relate to the TACNAV contract with Saudi Arabia.

These commissions are in sales and marketing expense, which increase sequentially 15%. Also on a sequential basis, engineering expense declined 4% while administration expense increased 4%.

The reported tax expense was about 46% of pretax income. Taxes were always difficult to forecast since there can be so many variables and unanticipated discrete events.

Based on current visibility, we now expect the full-year rate could be in excess of 50%.

On the balance sheet, cash and marketable securities were $32.9 million. Cash flow from operations was approximately $2.6 million.

EBITDA, adjusted for equity compensation expense, was $5.2 million and EBITDA margin was 13.4%.

Depreciation and amortization was $1.17 million and equity expense was about $880,000 in the quarter. Accounts receivable was $28.6 million and day sales outstanding was 66.

A large portion of these shipments for the Saudi Arabia order occurred very late in the quarter thus pushing the DSO figure up a little higher than normal.

Inventory increased sequentially to $17.8 million. Capital expenditures were $0.7 million for the quarter and are now $5.2 million year-to-date.

We now expect the CapEx for the full year will be approximately $6 million, a little less than we had previously projected.

Backlog for guidance and stabilization products and services at end of September was $45.8 million down approximately $11 million because of the large Saudi Arabia shipments.

At this point, I will turn it over to Peter to review our outlook for the full year and the fourth quarter. Peter?

Thank you, Pat. When we last provided guidance in July, we said that we were confident that we would ship a substantial quantity of the TACNAV product for the Saudi Arabian order before year end and that we would initiate the facility and program management services for this program.

We had less clarity at that time about how much of this revenue would occur in Q3. Given the substantial amount of revenue that we actually reported in Q3 relating to milestones for the building construction we now don’t expect to record much additional construction or project management service revenue until early 2013.

The expected total value of the TACNAV product and service revenue to be recognized for 2012 is in line with our prior guidance assumption but the Q4 amount could be a little bit less than recorded in Q3. For our other businesses and also consistent with prior guidance, we expect the VSAT business to continue to grow at a strong year-over-year pace.

We expect FOG product sales will show solid year-over-year growth with a sales level about equal to the third quarter result. We remain cautious with respect to the leisure markets.

In summary, the total company profile for the second half of the 2012 is coming together as we expected it would. We did a bit better in Q3 on the top line while EPS was at the midpoint of our guidance.

Considering all of these factors, our guidance for the full-year is essentially unchanged from what we provided in July with the exception of the impact of taxes.

We expect that revenue will be in the range of $133 million to $138 million and the EPS will be in the range of $0.21 to $0.26. The full year effective tax rate is expected to be 500 basis points or more higher than we were assuming in July.

This change in tax rate reduced our full year EPS projection by $0.03.

On the other hand, our projections for the full-year operating profit and EBITDA are in line with our prior expectations. The resulting profile for fourth quarter guidance is for revenue in the range of $35.5 million to $40.5 million and the EPS in the range of $0.15 to $0.20.

And in conclusion, our confidence in our strategic growth businesses and operating fundamentals is quite strong.

And now, we will take your questions. Operator?

I wanted to follow-up on the mini-VSAT business and just a clarification. I think last year at this time, you were shipping on average about 250 antenna systems per quarter, if I apply the unit growth rate here is it fair to assume, you were somewhere in the 320 to 350 unit type level?

No. No.

Last year, we were in the 150 to 200 range. And this quarter, we were in the 250 to 300 range.

So, we had a unit increase year-over-year of about 36% for the quarter.

Okay. And again, the mix there was 35% with the V3 antenna?

That is approximately correct. I didn’t give the exact number.

But it was mostly V7 and the mix hasn’t really changed. So, that’s pretty close to…

Yes. I did provide that, 35% for the quarter approximately 35%, V3.

In terms of units, not in terms of revenue dollars.

And any shift in the type of customer accounts commercial versus leisure, large shipping fleets versus coastal that where you’re seeing the units go?

No. That we haven’t really seen any change.

It’s -- this quarter basically materialized exactly as we had planned. There is no substantial change in mix or customer trends.

So, it was a pretty steady quarter. Q3 is traditionally a little bit of a slow quarter for our commercial business because of all the European vacations and everything.

So Q3 for the last 3 or 4 years has been kind of a low point for the year. So, but we took that into account when we gave our guidance and did our internal projections.

So, Q3 was up over last year but below Q2 and hopefully below Q4.

Okay. And competitive -- competitively you had both VSAT competitors lowering prices and you had Inmarsat raising prices.

Can you give us any sense of where you think you’re taking business either new installations or displacing VSAT or Inmarsat competitors?

Yes. I think in the VSAT competitors, we -- to be honest, we see sort of less and less of that.

So, we’ve kind of moved on now and are really focused on what’s traditionally being called the MSS market, the L-band market, that Inmarsat is in. And their response has been raising prices for the small customers and lowering prices for the big customers.

So, they’ve been very aggressive on the high-end in terms of price discounts. And they’ve been raising prices on the entry level folks.

So we see that as being an opportunity for us with the V3. And we’re seeing good growth in the V3 business.

And it is putting competitive pressure on pricing at the high end.

Okay. In terms of distribution channel, I think you year-to-date have signed up a good half dozen new distributors or you’re seeing some tangible traction with those partners?

We are starting to see that now. It was slow in the first half of the year and now we are starting to see some good traction with some of the distributors that we signed up.

Particularly, the ISPs that are also selling competitive products, that was a distribution channel that we had avoided in the beginning, because of the conflict and about 6 months ago we started opening some of those guys up, really to see how that would work and we are starting to see that pay off now.

Great. And I think you mentioned several trials underway that could result in large fleet orders are these of the size of NYK and BRUUN or smaller in nature?

Yes. That’s what we call large is sort of 80 to a 100 or 200 in that size range is, what I call large.

So, they’re in that scale same as BRUUN or these ships in NYK so.

And you think you could get some wins before the end of the year with rollouts beginning sort of middle of next year?

I would hope so. But how these programs go, it’s the decision making cycle can be tortuously long.

Though, even if they lean your way just getting contracts closed and it’s difficult to predict the timing of it. So, I would hope it would happen in Q4, but I wouldn’t be shocked if it didn’t.

Okay. And any -- do any of those involve the V11 antenna system?

Yes.

So these would suppose, I guess they would be larger vessels larger in size?

Exactly. So, the V11 just to recap on that, we’ve got some trials underway, we shipped the product a little bit later than we wanted.

We’re hoping to get it out in at the end of September, it ended up being in the first week in October. But some of those units now are being installed and doing trial.

So, we’re optimistic that that's going to lead to some good future business.

Great. Shifting gears on the…

Chris, if I may interrupt. I just want to add a little color on the VSAT unit shipments.

Last year, you’re correct in assuming in 2011 that we averaged between 200 and 250 units per quarter. It happened to be that in the third quarter it was lower than that.

And as you know, the trend line for our VSAT sales is strongly up over time. However, every quarter is not, there is a bit of unevenness to it quarter-to-quarter.

So, in Martin’s answer he was specifically referring to the third quarter of last year in terms of the number that you should use as the base line for Q3, 2011, okay.

Got you. Fair enough.

And if I recall wasn’t the year ago, the prior Q2, when you began shipping the V3…

Correct.

That cause some timing issues?

Which was a very strong quarter for unit shipments in Q2 of last year, yes.

Right. Right.

I will ask one more and move on. Just on the FOG-related business and specifically remote weapon stations.

Now that Kongsberg has been awarded the contract, what does the timing of orders look like for you? And given the size of the contract they were awarded in the backlog in place.

Where does the steady state move, if you’re doing $1 million to $1.5 million a quarter of RWS related revenues, clearly it’s not going back to the $7 million to $8 million type of surge revenues as you saw in years past. But is there a steady state somewhere in between you might be able to target?

Well, we don’t really have visibility into that yet. I can say that Q4 is looking larger than Q3.

And we have basically everything in backlog already for Q4 that’s in our guidance. So, we’ve seen in acceleration.

But at this point, we don’t have any CROWS III visibility for 2012 yet, so -- sorry, 2013. Sorry, I meant to say we don’t have visibility for 2013 for Q4, it’s all in backlog.

Okay. So, we should, we’ll have to wait for specific order from Kongsberg in order to judge that?

Right. Yes, because their contract was an IDIQ type contract, so they’ll just get POs and drawdown similar to the way they have been operating for the last 4 years, so.

In that typically, we get 3 to 6 months visibility at a time, based on to steady factory run rates. Okay.

Chris, I assume with the pause that you’ve completed your questions. Jason, could you move on to the next questioner, please?

Just follow-up first on the FOG business. First, Pat, I wanted to clarify.

You said you thought that would be flat quarter-over-quarter in Q4, is that correct?

Peter actually said that.

Sorry. Peter, that’s right.

Our current expectation is that it would be up nicely year-over-year, but probably roughly flat to maybe slightly up in the fourth quarter compared to the third quarter of this year.

Right. And then I understand you don’t have a lot of CROWS III visibility into next year, but are you willing to say anything about your non-CROWS business next year?

How you think that might trend given some of your new product initiatives? And I don’t know if you’re going to be willing to give us kind of a FOG number -- I’m sorry a CROWS number for 2012, sort of an actual at this point?

I am going to let Pat or Peter talked about the actual number for 2012.

I can do that.

In terms of next year visibility, we do have a number of new products. The DSP-1750 is getting designed into some new applications that should help.

We have this new IMU which we announced and we expect to start shipping in Q4, that’s the 3-axis fiber optic gyro and 3-axis MEMS accelerometers and a very small package with flexible digital output. So we’re excited about that product.

So we see the trend for commercial applications for that growing very nicely next year.

And just to give you a sense, Rich, of the CROWS program shipments this year. Year-to-date through the third quarter, it’s now at about $6 million just a shade under $6 million.

We had averaged $1.5 million a quarter in the first 2 quarters, and then it actually bumped up in the third quarter to close to $3 million. Right now, we essentially have a good picture of the fourth quarter.

We would expect the fourth quarter to be more or less in line with what we did in the third quarter, so probably in the $2 million to $3 million range. So that would put the full year at around $8 million to $9 million for the year, a bit higher than our original expectation when we started the year.

That’s helpful. Very good.

And with respect to TACNAV, certainly some encouraging commentary there around the Canadian opportunity, I guess that applies for both TACNAV and CROWS there. Can you give us any other color on your near-term pipeline for TACNAV, and or CROWS?

It sounded like in some of your other remarks, that you expected there could be some relatively near-term orders in either both of those in the guidance stabilization. So just any color in terms of timing, or other opportunities out there and your pipeline would be appreciated?

Yes. Just in terms of timing, some of those are actually very short-term.

So we’re expecting contracts in the next few weeks as opposed to months or years where military program, it is unusual, so that’s good. As far as looking out into next year, we’re going to carry a fairly significant backlog into next year.

So overall we should see strong TACNAV by next year as well. It will be a mix of programs, some of which we’ve got in backlog now.

Some of which will be new program, and some of which are kind of baseline business from contracts that we signed a year ago that are now getting in the production. So we see the TACNAV business being fairly predictable now in the sense that their multi-year programs.

And we’re getting enough of them together that it’s starting to be a little bit less volatile than it has been in the past.

I know this is looking out quite aways, but I guess one possible concern would be that there might be somewhat of a letdown in that TACNAV business post the Saudi -- fulfillment of the Saudi order. Anything you can say on that, I know it’s a long way out but just in terms of other things in the pipeline that might sort of back fill as that gets delivered?

Yes. We do have, some of the programs that are in the pipeline we think could be comparable to what we have now with the exception of the facility business, which we don’t expect to recur.

And that was really just enabling contract feature that we agreed to do to help them get these, get this program underway. But we don’t envision that part recurring.

But that’s kind of a low margin thing anyway so. But as far as unit sales, we do see additional TACNAV programs, some of which is in the Middle East, some of which is elsewhere that taken together should allow us to continue the TACNAV business after this Saudi lab retro program winds up.

Great. And could you just refresh me, refresh memory -- how much memory, how much revenue did you get from the service portion of the Saudi program this quarter?

I have that. Let me…

It's on the order of $2 million, I think.

Yes.

Little over $2 million.

Yes.

And you didn’t expect much more of that in the fourth, is that correct?

Correct. And we actually in our original projection, we had thought that most of that revenue that we recognized in the third quarter would have actually been in the fourth quarter.

So it was just a switch more or less between quarters.

Great. And with respect to tax rate, I know it’s tough to predict.

But since we’re all modeling next year in numbers, I’m wondering if we should assume maybe a somewhat higher tax rate than what historically assumed here given whatever dynamics you recently experienced here. And any thoughts at all on sort of a normalized future tax rate?

So this is Peter speaking. Yes.

So we definitely think that the tax rate is going to be higher than what we had experienced in the past probably will be in the order of magnitude that we’re seeing and projecting for the full year.

So a 50 percent-ish type of tax rate?

That hopefully will come in below that, but again the one-time event and our regional business flows will dictate that.

Other than that, there is some discreet -- just to put some color around, it seems like the R&D tax credit that hasn’t been approved yet for this year. If that does happen, that would have a big impact on our taxes this year and of course next year as well.

So it’s a little bit difficult to forecast what we don’t know, what the tax situation is going to be for items like that, that would take significant percentage off our tax rate.

Sure. Just one final one for me, just could you restate what your guidance and stabilization backlog was at the end of the quarter?

It’s approximately $46 million. I have the exact number if you want it.

46 is close enough.

Okay. It’s $45.8 million.

Okay. Well, anybody who wants to dial in, we’ll give you a few more seconds here otherwise you can reach us afterwards, or you can e-mail questions as Pat mentioned to [email protected].

Pat is going to be continuing on as a consultant here for the next 6 months or so. And in the meantime, Peter has taken over as CFO.

We all thank Pat for doing a great job and Peter’s got difficult shoes to fill, especially coming off a record quarter. So we thank, Pat and we will talk to you all next time and feel free to contact us directly by phone after this call.

Thank you.