KVH Industries Inc (KVHI) 2003 Q3 法說會逐字稿

Good day everyone and welcome to the KVH Industries third quarter 2003 earnings release. Today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Pat Spratt, Chief Financial Officer.

Please go ahead sir.

Thank you very much. Good morning, and thank you to everyone for joining us today.

I'm Pat Spratt, Chief Financial Officer for KVH Industries and with me today is Martin Kits van Heyningen, our President and CEO.

This call will address the third quarter earnings release that we issued earlier this morning. Copies of the release are available on our web site, kvh.com, and are also available from our Investor Relations Department.

This conference call is being simulcast on the Internet and will also be archived on our web site for future reference.

Before we proceed, I need to inform you that this conference call will contain certain forward-looking statements that involve risks and uncertainties. For example, statements regarding the company's financial and product development goals are forward-looking. The company's future results may differ materially from the projections described in today's discussions.

Factors that might cause these differences include, but are not limited to, those mentioned in today's call and the risk factors described in our SEC Form 10-K, dated March 23rd, 2003. The company's SEC filings are available directly from us, from the SEC, or through the investor information section of our web site.

Now I'd like to turn the call over to Martin to begin today's discussion of results. Martin?

Thanks Pat.

Two weeks ago we provided an update regarding our progress during the third quarter, so today we'll be filling in the details and we'll start with a recant of our quarterly and yearly operations in each of our business areas and then discuss the new product introductions and other new developments.

I'll turn the call back over to Pat so we can elaborate on the financial results for the quarter, and after that we'll of course take your questions.

OK, let's get started.

During the third quarter we saw moderate growth overall, driven by strong revenues in our satellite markets, which helped offset a large decline in military revenues. Total revenue for the quarter was 13.5 million, an increase of nine percent over the same period last year. A delayed military order led to a decline in military sales and a corresponding drop in margin and earnings and we posted a small net loss of one cent versus a profit of one cent during the third quarter of 2002. Year-to-date, revenues were up 18 percent to 41 million, with earnings of four cents per share.

At the same time, we strengthened KVH's competitive and strategic position in every one of our markets during Q3, with new satellite and fiber-optic product introductions and a major milestone achieved in our military business, we're well positioned to achieve our targets of substantial revenue growth beginning in the fourth quarter.

Overall, our satellite communication sales continue to be very strong. Satellite products generated revenues of 9.1 million for the quarter, an increase of 44% from the same period a year ago.

Our overall satellite sales were split about 50-50 between marine and land-mobile sales, reflecting continued strength in both segments.

The third quarter of 2003 also marked a major strategic milestone for KVH. Just over three years ago, we started a project that would become the largest and most ambitious new product effort we've ever undertaken. The development of an automotive phased array antennae for satellite television.

This was a product that many major electronic companies had tried to develop, but all of them had failed. I'm pleased to say that we succeeded and began shipping our TracVision A5 in Q3 to our dealers throughout the country. KVH is now the first company in the world to develop, produce and ship a low-profile in-motion phase array antennae for consumers. As the first to market, we have an excellent opportunity to secure a strong and lasting competitive position in the automotive multi-media market.

As we prepare to begin shipping, we also began to ramp up our TracVision A5 marketing efforts through our dealers, through advertising and in the news media. The TracVision A5 is generating a lot of excitement. In fact it was featured on several national news shows including CNN Headline News and NBC's The Today Show.

The initial response from dealers to consumer has also been extremely positive. We now have approximately 740 retail outlets and expect to have between eight and 900 dealers by the end of the year.

We're continuing the ramp for A5 production. By the end of Q3 we shipped approximately 150 A5 systems. As of today, we can build them at a rate of about 250 per week. The production level that we're at now enables us to produce and ship our fourth quarter target of two to 3,000 TracVision A5 systems. So we don't have any production constraints.

As product volumes ramp, we're confident that TracVision A5 margins will come in line with our other land-mobile satellite products, in fact, higher volumes are already helping us to negotiate more favorable pricing with suppliers, and our ongoing refinement to the design will further reduce our overall cost.

We expect to see incremental benefits from these efforts in Q4, and a significant improvement in product margins during Q1 and by the second quarter 2004, we anticipate the A5 margins will be comparable to or better than those of our existing land-mobile satellite TV products.

The TracVision A5 is not our only new product introduction during Q3. We also shipped our new marine antennae, the TracVision G8, equipped with a carbon fiber reflector, and our military great fiber optic Gyro. The TracVision G8 is the most advanced marine satellite TV antennae available.

The G8 consolidates our position as the premier supplier of Mari-time satellite TV systems, enabling us to support larger yachts and commercial vessels with extended cruising areas.

On the military side, we entered the quarter expecting our Q3 defense revenues to be somewhat lower than those the same period last year, which was consistent with our guidance of roughly flat military sales for the year. However, in Q3, a follow-on order in excess of $1 million from existing U.S. military customer was delayed. As a result of our overall military sales for the quarter were about 1.4 million below the third quarter of 2002 and that's about a 40% decline.

However, we received word in September that the U.S. Army Special Operations Command had formerly certified our TACNAV Light vehicle NAV system for full-rate production and fielding of aboard SOCOM vehicles.

As part of this decision, SOCOM also approved TACNAV light as a standard Army system, giving it the designation the M100 Ground Mobility Enhanced Navigation System or M100.

So these two announcements paved the way for the M100 to be fielded by any U.S. Army vehicle program. Now obtaining this type of classification is invaluable in our efforts to equip U.S. and allied forces with our precision NAV systems. As with other products that had been aware this type classification, the M16 rifle and the M100 tank for example, the M100 is now a standard Army product that has completed all formal testing, has logistics and training support in place and is available to any vehicle program with the need and the budget.

As a result, the procurement process has been streamlined tremendously. In fact, since achieving the M100 designation six weeks ago, we've already seen a significant increase in interest for military planners and program managers of the Army.

We're also working to add additional capabilities to our TACNAV to increase its versatility and value to U.S. and Allied Military Forces. The most important of these features is the ability to send and receive position and target data as well as messages via satellite. With this enhancement, when this enhancement becomes available, our TACNAV products will be able to serve as the vehicle-base hub to supply critical data for each of the Army's digital battlefield systems, including FBCB2, Force Tracker and the movement tracing system.

I'm also pleased to announce that during Q3, our TACNAV systems were selected on Taiwan's Amphibious Combat Vehicle Fleet. This small industry order will ship in 2004, carries a possibility of substantial follow-on business. In addition it marks the first use of our tactical navigation system by Taiwan, and adds them to the growing list of military customers worldwide.

So while our military business continues to be difficult to forecast on a quarterly basis, the overall long-term trend continues to be extremely positive for our military sales. The M100 designation and our new digital battlefield features and satellite connectivity will insure the strength of our military business in the long-term.

On the Fiber Optic products, our Gyro sales were steady during the third quarter at 1.2 million. Third quarter Gyro sales of component systems were roughly equal to where they were in the third quarter of 2002.

The recent introduction of the DSP-3000 Fiber Optic Gyro and our TG-6000 Inertial Measurement Unit or IMU are important strategic additions to our Fiber Optic product lines. The DSP-3000 is our latest tactical grade open loop phase. It's about the size of a deck of cards and its rugged design is suitable for both military and commercial applications.

And the TG-6000, that's the first use of our Fiber Optic Technology in a high-performance integrated system for applications like Smart Bombs.

Now previously we supplied three access fog sensors for a third party IMU, but now we're building the complete IMU ourselves. This new KVH IMU is a fully integrated, low-cost precision inertial measurement unit that includes accelerometers, and offers outstanding performance, higher reliability and lower costs than the systems are using today.

And last week, we announced that we received our first production order, our IMU will be used by Raytheon as a guidance package aboard the U.S. Navy's next generation Mark 54 torpedoes. Deliveries of the initial production units will begin in January and the program has the potential value of about $10 million over the life of the contract.

The rapid qualification of our IMU for production marks a milestone for KVH, as we apply our Fiber Optic Technology for use in high-performance, integrated systems like Smart Munitions.

So looking ahead to Q4, I believe that we'll see strong year-over-year revenue growth in the range of 30-50% driven largely by sales with TracVision A5 and our other satellite products. We expect fourth quarter earnings to show a small profit, results of low percentage of military sales and the lower initial TracVision A5 margin.

However, as the cost reduction process takes effect over the next several quarters, we should see a substantial rise in earnings to compliment the significant revenue growth driven by the A5.

And now I'd like to turn it back to Pat who'll provide the details on the financial side of the quarter.

Pat?

Thank you Martin. In the third quarter we made great strides in several strategic and operating areas. At the same time, we faced a number of issues that are having a short-term impact on the company's financial progress.

Quarterly revenues of $13.5 million were up 9% over last year. The delay of a military order, the end of quarter timing of the first TracVision A5 shipment, and higher than anticipated TracVision A5 start-up expenses, and initial unit production costs, all contributed to an operating loss of $373,000.00 and a net loss of $161,000.00 or one cent per share.

Satellite communications grew to $9.1 million, up 44 percent, driven by solid growth in both our marine and land mobile markets. Year-to-date satellite revenues are up 30% to $26.1 million.

Defense revenue primarily made up of tactical navigation, declined 40% year over year, to $2.6 million. This was caused mostly by the delay of a follow-on order from an existing as well as an anticipated year-over-year decline that we discussed during the last conference call. Year-to-date defense revenues was now up only 2% at $10 million.

Defense-related backlog at quarter end was approximately $1 million. During the past year, our defense business has become must less backlog driven, increasing the potential for an uneven flow of orders. We certainly experienced this during Q3.

Fiber Optic component sales were approximately $1.2 million on par with the third quarter of 2002, while year-to-date sales were up 11 percent to $2.9 million.

The majority of our Fiber Optic sales are for defense-related applications, and we expect that this will continue as we integrate Fiber Optic Gyros into TACNAV and guided munitions solutions.

Legacy products, including OEM sensors and marine compasses, decline approximately 7% to $550,000.00. Legacy sales for the first nine months were roughly $2 million, a 9% decrease from the same period last year and consistent with the long-term trend line for this product set.

Turning to the cost side of our results, gross margin was 43%, down from 45% last year. We anticipated that gross margin would be under pressure during the quarter, on a lower percentage of high-margin military products in our sales mix; however the drop in military sales and the decline in margin were greater than expected. High start up and early volume production costs for the TracVision A5 was also a contributing factor.

Operating expenses at $6.1 million were up slightly on a sequential basis, but increased 14% year-over-year.

As a percentage of sales, operating expenses rose two percentage points to 45%. This reflects the effect of variable sales and marketing expenses associated with the strong satellite communication sales growth and the initial programs for the launch of the TracVision A5.

Third quarter research and development expenses declined approximately $100,000.00 or 4% from last year to $2.1 million. Sequentially R&D decreased $200,000.00.

Third quarter sales and marketing expenses increased to $2.9 million, up 26% from last year. As a percentage of sales, they were 22% compared to 19% last year, largely due to the shortfall in revenue.

Our TracVision A5 sales an marketing campaign began in Q3 and will be an important investment area for the next several quarters, resulting in an expected sequential increase in absolute spending in Q4.

Third quarter administration expense was $1.1 million, up 27% from the same period last year, but about equal to last quarter.

Partially offsetting the resultant operating loss was a one-time net tax adjustment of $235,000.00 to reflect the recovery of prior taxes paid. This resulted from the favorable outcome of an IRS audit of the company's income tax returns for the periods 1996 through 1998.

We have substantial corporate tax assets and valuation reserves on the books. Until they are depleted, these reserves will be used to offset future taxable income.

Now to the balance sheet, the third quarter cash balance was $7.6 million, down $800,000.00 sequentially. Cash flow from operations was a positive $400,000.00.

Capital expenditures for the quarter were $1.4 million. Most of this spending was to establish the A5 production capability both in our facility and at our vendors. The major capital items included parts tooling, text, excuse me, test fixtures, precision measurement equipment and facility fit-up.

Accounts receivable decreased sequentially $1 million to $9.5 million, while day sales outstanding or DSO, was down three days to 63. We expect an increase in accounts receivable in absolute dollars in Q4, reflecting our expectation of strong TracVision A5 sales and overall company growth. DSO should show some improvement in the fourth quarter.

Inventory increased to $6.4 million, a sequentially increase of 2.2 million. Inventory turns on an annualized basis were at six. This increase in inventory and the decrease in turns resulted largely from two factors. First, we established the necessary levels of raw materials for TracVision A5 production. Second, we bought at-risk, a portion of the military order that was delayed. We expect that inventory turns will improve to seven or better in the near future.

Looking ahead to the fourth quarter, we expect revenue growth in the range of 30-%50 compared with the same period last year. This will be driven by sales of the TracVision A5, and our other existing satellite products.

This range is understandably wide, because we are just beginning to build an experience base for A5 demand and growth. We expect that Q4 military sales will be well below last year's fourth quarter, yet up compared to the quarter just ended. In spite of this very solid revenue growth, we expect our fourth quarter to show only a small profit. The high startup in early in early volume production costs of the TracVision A5 will continue to be a factor. A continuing low percentage of military in our sales mix compared to the second half of last year and also to the first half of this year will also put pressure on overall gross margin.

Cash is expected to decline in the fourth quarter by as much as $2-3 million as we ramp the TracVision A5 and meet working capital requirements. Having our existing $15 million line of credit provides a sufficient for capital to support near-term growth needs. I want to reiterate that this financial guidance is based upon the presumption that we will book and ship a variety of military business that is not yet in hand. As we experienced in the third quarter, military orders can always be subject to procurement issues and shifts in near-term military priorities.

In summary, we achieved several strategic milestones during the quarter, we are sustaining top-line growth and our balance sheet is fundamentally strong. We expect to achieve solid revenue growth in Q4 thanks to the expansion of the TracVision A5 sales, and continued growth in our other satellite markets. At the same time, we will continue to pursue military opportunities and aggressively reduce TracVision A5 product costs to achieve our target margins during the first half of 2004.

Now we'd like to take your questions. We ask that each person restrict the number of initial questions. This will help ensure that everyone has the chance to participate. You are encouraged to get back into the queue for additional questions.

Operator, please open the call for questions.

Thank you, Mr. Spratt.

If you would like to ask a question today, please press the star key, followed by the digit one on your touchtone phone. Once again, that's star one to ask a question. We will take the questions in the order you signal and take as many as time permits. Once again, please do limit your initial question to one question.

We'll go first to Richard Valera with Needham & Company.

Thanks, good afternoon, gentlemen. With respect to your military orders, I'm wondering if you can maybe characterize your pipeline any better in terms of what you're expecting to get in the quarter, sort of the magnitude of those orders. Have you booked any to date in the quarter. I guess you gave your backlog at the end of the quarter, but not today. Just any more color you could provide in terms of that military number. And then sort of as a follow up, you mentioned I think military substantially down year over year. I was wondering if you could maybe give us a little more color. I think you did $5.5 million last year in the fourth quarter in military.

Thanks.

Sure. On the military pipeline, I think Pat gave an outline of what's actually in backlog, which is about $1 million, and we have pretty good visibility on the majority of the business we expect for the quarter, but as we saw last quarter, one of our existing customers -- which probably had the highest probability of coming in for the quarter actually didn't come in. And the military really doesn't care that much about our quarterly revenue patterns, so that's just the way it is. And we don't really have anything more to add in terms of visibility. Our confidence that we will eventually get this order is close to 100%. So there's really no risk in our minds that we'll lose that order, but just having missed it for Q3, we don't want to come out and count on it again for Q4.

So I think that's sort of the basis for our guidance is we are going to get a fair amount of military, more than we had last quarter, maybe a couple million less than what we had in Q4 last year. And that's sort of baked into those guidance numbers that we've been trying to give. So I don't know if that answers your question.

Yes, that was helpful. And just, sorry, one quick follow up on the military side. And the Taiwan army order, do you know the size -- the number of vehicles in the Taiwan army that could potentially be outfitted with this product?

There are a couple of different programs there, and the initial one was a small order, but it has fairly significant follow on potential that could be on the order of $10 million, but it doesn't have -- this is for an amphibious vehicle, and there are some other programs in Taiwan that we now have a better chance of winning since we've now been selected for this one particular class of vehicles.

Great. Thanks. I'll yield the floor.

Thank you. Next we'll go to James Mcllree with Unterberg Towbin.

Thank you. Given the standardization of the TACNAV light the IMU orders, it seems like '04 could rival the '02 defense revenue. Could you get as much as $15 million in '04 from military?

I think that '04 should be a very strong year for our military business. I think that we have a pretty good track record of forecasting military revenues on an annual basis as opposed to a quarterly basis. On an annual basis, we feel pretty confident that next year will be a very strong year for military, probably our best year ever.

OK, great. Thank you.

Thank you. Next we'll go to with Raymond James.

Good morning, gentlemen. Question on the TracVision A5. At what point would you expect to transition out of a capacity-constrained situation. And as sort of a corollary to that, how much of the two to three thousand that you said you expect to ship in the fourth quarter are things that are pre-orders versus new orders you need to generate.

Well, on the capacity side, we are working through our backlog right now, so we're building at a pretty good clip and we expect to, probably middle of the quarter -- before the middle of the quarter, I would expect to work through the backlog of orders certainly that we entered the quarter with. So we'd like to be in a position where we can ship orders, because part of the demand cycle comes from being able to fulfill open orders. Our sales guys in Q3, once the retail outlets had already brooked orders, it was difficult to go back to them and ask for more orders when they'd simply say, "Why don't you ship what we already have on order?"

So what we're doing now is -- so by the middle of the quarter we expect to have cleared the older backlog, which I don't want to give an exact number, but it was more than 1000 units, and we don't expect to be production constrained in this quarter.

OK. And it seems like from the last quarter you reported the number of retail outlets went up. Were there any major adds there, and when you talk about going up by a couple hundred other, are there any major retailers you're moving into yet?

Yes, we'll have a couple announcements on specifics, and until we do that, I don't want to mention names, but we've just been -- our sales guys have been on the road with our TracVision A5 vehicle, visiting all the dealers and signing up new ones. So it's a very powerful demo. Once people see this product, the reaction is people compare it to the first time they used a cell phone or the first time they had WiFi on their laptop. It's just a great, powerful demo, and the people are really just blown away by it. So it's a great way to open up new dealers is to drive in and show them the product, and that's what we're doing.

OK, thank you all. I'll slip back in the queue.

Thank you. Peter with WR Hambrecht has our next question.

Hi guys. So, a question regarding the A5, just if you could talk about any feedback that you have from customers who actually have the product. Are they happy with it? Maybe you could talk a little bit about return levels. Have you seen returns or just any kind of color there?

No, the initial feedback has been overwhelmingly positive. The initial reaction is the product works far better than people expected it to. And that's a great thing, so people are just amazed at the way the product works and we spent some time during the beta test cycle going back, making sure that the product is perfect, and we fine-tuned software and all kinds of features right up until the end. So we really had a good test cycle, which is part of the reason the product shipped when it did. And we're really delighted with the reaction.

We've had zero returns for product issues. We've had some returns for shipping damage, which was less than ten units, and we've addressed that through better packaging and that's a non-issue now.

So far so good. But of course the product is an installed product, so there is some lag between shipping units and getting them installed on cars. So we're really getting early feedback now.

And then just on the margin side on that product, so if you could just talk about where do you think your opportunities are to take costs out?

Yes, we have a very specific list of things that we're doing that were in our plan originally to do and we're just simply probably about a quarter behind where we expected to be in terms of the product manufacturing maturity, but we didn't want to delay the product launch to wait for that. So what we're doing now is what we expected to do, we're just doing it in higher volumes than we expected. So there's really no invention here. We're just plugging away at all of the things that we normally do when we launch a new product.

OK, thanks guys.

Yes.

Thank you. And once again, if you'd like to ask a question today, please press the star key followed by the digit one. And we'll move next to Steve Levenson with Advest.

Good morning Mart and Pat.

Good morning.

Two questions. First is on the TracVision A5. I know it's a little early, but are you getting any indications back from your retailers on sell through?

We're starting to, and that of course is the key question. Some of the orders we have now, the dealer might buy, say, eight pieces and what we're looking for exactly what you're asking, is are they selling through? And we've already had some reorders and people are working through their initial inventories. And that's what we're really looking for to give us better visibility going forward. At the same time, most consumers don't know about this product yet, so we haven't done any kind of national ad campaign. We've had some great PR, which has of course been free on Headline News and the Today Show, so we're starting to get the word out.

But it's still a brand-new product and we're not driving people into showrooms yet, so the fact that they already have preorders and are selling the product that they have we think is a great sign. And they're very confident that the product is going to sell well.

OK, thank you. Second item is, last week Raytheon announced that they got the contract to work on an anti-jam navigation unit, and it's going to contain an advanced inertial measurement unit. And with your recent work with Raytheon, can you let us know is this something you're participating in?

To the best of my knowledge, we are not participating in that. In fact, I'm not familiar. Is this a missile program that you're referring to?

It says it's for the Air Force. It doesn't specifically indicate just ...

No, we don't have any Air Force contracts, so ...

OK, thank you.

Thank you, next we'll go to with Ameritech.

Yes, my question today is, with the recent problems with the electric grid, it would seem that your fiber optic current sense might be an extremely needed product at this moment. Have you gotten any more progress in dealing with ABBB on this introduction of the current sensor?

No, we really don't have anything new to report there. I agree with you that you would think that these types of things, which happen not only in the Northeast, but also recently in the U.K. and in Italy that you start to see a lot of interest in this product. So I don't have anything more to add other than we haven't seen any big movement on their part, and it may be time for us to work with some other people in developing that product.

Do you have the freedom to do so?

Yes

Thank you very much.

Thank you, and we'll move forward to with .

Hi, Martin, how are you.

Good, Jim.

I think most of my questions had been answered regarding the sell through and so forth, but I was just wondering, the initial shipment for like 150 on the A5 system, has that been increased from the 150 level?

Yes, we're producing at a rate now of around 250 a week and we're shipping every day.

Now, when you estimated possibility of two to three thousand units in the first quarter, did you have any internal guidelines as to what the percentage might increase in Q2 and Q3, or is it too early for that?

Well, we were actually talking about two to three thousand in Q4.

Q4, I'm sorry.

Yes, the quarter that we're in. So it's too early for us to give guidance for Q1 and beyond. We're really going to take a look at the sell-through rate, because our internal estimates would not include an actual sell through on the retail side as yet. Because we know what we're selling and booking and shipping, but we don't have realtime feedback from every single stores and a lot of these are single stores. So until we get that, it will be difficult for us to prepare a forecast for you for next year.

Thanks very much.

Thank you. And as a final reminder, if you'd like to ask a question today, please press the star key followed by the digit one.

And we'll move on to Tom Watts with SG Cowen.

Hello, gentlemen.

Hi, Tom.

Just on both the TACNAV and the IMU product. Can you talk a little bit more about the -- I'll say the authorization process. Are these likely to -- is this like an IDIQ contract, are we going to get a series of production orders? What are the typical sizes? And what's the process to actually get them incorporated into the specific programs?

Well, what we've seen just in the few weeks since we got the classification is that all of a sudden there's a large interest from all kinds of programs that need it. As an example, there's an ambulance corps where they need to get somewhere quickly, now. That type of program has a large number of vehicles, but they don't have a program manager that has the ability to go out and specify a product and test it and qualify it and do navigation trials and do all of the things that you have to do when you're designing a NAV system for the Army. Now they can simply buy it.

And there's all kinds of other vehicles, like within the Army Materiel Command for support vehicles, for other Humvees, for trucks. If you look at what happened in Iraq outside of Nasiryah with the 507 Maintenance Group. We're talking to the groups that supply those vehicles to provide a NAV system to help them get safely to where they need to go with the supply trucks.

So all of a sudden, these vehicle program managers can simply buy it the same way they buy bullets and gasoline without having to qualify it. So it sounds like a small thing, but it's a huge thing in terms of working your way through the bureaucracy of the military.

So do they actually put in production orders to you, or do they just -- is this a book and ship type thing?

Now it's a book and ship through the part number, they order it and we deliver it.

So we're not likely to see announcements of big orders, it's more of a ...

No, I think it has the potential to come in larger increments now, so you can get large orders.

So how should we look for these on a quarterly -- is there any predictability to this on a quarterly basis?

Well, I think we've just demonstrated that there isn't.

OK.

But seriously, we will -- the good thing about what's happening now is that we're being spread across a larger number of platforms, and that should actually reduce the variability. In other words, as you increase the number of programs and vehicle types and countries that you're working with, it should decrease the volatility. So despite the last quarter, I think that going into next year, we'll have more programs, more vehicles and better visibility as we go forward.

OK, thanks very much.

Thank you. We'll now go to a follow up question from Rich Valera with Needham & Company.

Thanks. Martin, I was just wondering if you could comment on your relationships with DirecTV and Echostar, if sort of anything has been formalized in terms of the pricing with them and if there's any potential for any joint marketing with activities with either of those?

Yes, I don't have anything specific to announce, but one of the last hurdles for both companies is they want to see final production product, which of course makes sense from a marketing point of view. If they were planning to do marketing, they would want to make sure the product worked and if they were going to help support it. So we have been doing that and they've got final production product in their hands. So hopefully we'll have something to say about that shortly.

OK, thank you.

Thank you. Next we'll go from Cramer Rosenthal.

Yes, hi. Of the units that you expect to ship in Q4, how many of those are, I guess, demonstration units versus units that will actually kind of represent normalized revenue to you?

I'd say close to 100% will be revenue units. There might be a couple of units for demos, but even all the celebrities that are buying them, they're paying full price. We're not doing any extensive demos or free units.

OK, so if you took kind of the midpoint of the two to three thousand I think you guys have said in the past that it's sort of -- in terms of what you've realized, it's sort of two thousand units, you're talking about somewhere in the neighborhood of $5 million in incremental revenues?

That sounds about right.

So if you sort of take what you expected year over year for military, which you said was down a couple million dollars, which will be down a couple million dollars year over year, what is the sort of breakdown in terms of how much you have to get in revenues in the satellite area to sort of hit your revenue range.

Well, I think you can work the math out and -- but if you pick the midpoint of the range, I think what we're saying with our guidance is that it's not going to be the midpoint of every range. We have three different product lines, the fiber-optic products, the military products and the satellite products, and within that you have variability. So it's not as simple in terms of forecasting as to take the midpoint of the A5 numbers and then the estimate for military and then back and do everything else.

Right.

So what we're trying to say is that there's a fairly wide range, but it's still incredibly positive even at the low end of the range, we'll have 30% revneue growth.

Right, right.

So I think we'll have more clarity as the quarter progresses in terms of the actual A5 sell-through rates.

Right. I guess my question is, the variability in the 30% or 50%, is that variability predicated -- I guess what I'm hearing is, is it sort of predicated across all the businesses? In other words, it's not as though you sort of have better visibility necessarily in military and you're kind of waiting to see how the A5 ships, it's sort of across the board?

Right, it's a blend -- you're exactly right. It's a blend of the risk factors in each of the three areas.

Now, looking at satellite product sales for existing products -- forget the A5, the existing products were up over 40% in Q3, so we had very strong growth in our base satellite business. So I think that we expect -- if your question is, where do we expect to be with satellite, I think the base satellite business should continue to be strong.

And I guess the last question is, in terms of installation, is this a -- when you say it's an installed product, is this a product that the consumer can install themselves, or is this really sort of like a satellite radio antenna where I guess technically you could install it yourself but it's a lot easier to pay to have somebody else do it.

Yes, I think that's probably a great comparison, is it's similar to satellite radio. There's a part that has to go on the roof, a roof rack, and there's a part that goes inside the car, and you have to connect it to a TV screen. So certainly consumers can do it themselves, and they are, but I would say 95%, or 90% or they are will be dealer-installed just because most people prefer to have somebody else do that kind of work.

OK, great. Thank you.

Thank you, we'll now go to a follow up with .

Hey guys. By the way, congratulations on the Marine RV part of the business that we kind of all glossed over it, but some pretty impressive growth there.

Anything you want to characterize about the nature of sales into those markets, either on a seasonal basis or new OEMs or other trends that we should be aware of?

Well I think that, you know, that's sort of an example of just good execution on our part from the sales, and as our quality point of view, we've just been quietly improving the products and gaining market share and the products have been gaining acceptance.

We've expanded our product line a bit. Now with the G8 as well. So, you know, we're just continuing to make good strides there and that's really what we're counting on to happen with the A5 as well, as we gain experience and build more and more product and continuing to improve it and cost reduce it over time, come out with new models in variance.

So, you know, we're very encouraged by that and that's really our roadmap to what we're going to do in the automotive market.

I would assume that a fair portion of the growth was coming out of a new OEM relationship from, on the RV side?

Yes, yes, we've got, you know, the OEM business continues to be strong. The RV industry is doing well. The marine industry seems to be recovering a bit as well. And we're coming into now, into the fall boat show seasons, so the marine business should pick up a bit.

OK and the TRACNET portion of the product line, I presume you're not really expecting any tremendous growth out of that, given the cost structures appropriate for probably more high-end users?

Yes, this is a high-end product. We had some interesting OEM activity in Q3 that helped. We had some big orders for TRACNET at the OEM level.

On the marine side?

This was on the land-mobile side.

Oh, OK.

And we introduced a product in Europe. So we started shipping that product in Q3 in volume. So I think that that's going to be a good steady product for us and it really helps the brand, because our products have that upgrade pass, so that even if people don't necessarily buy it on day one, they prefer the brand that has that upgrade pass. So it's a great feature to have in your product set, from a product line strategy point of view.

OK, and a final question on the TAC, I assume we're in the multiple question part of the Q&A now, so. On the TRACNET product, I think in past quarters you said, characterized it as you know, we're talking with dozens or, you know, hundred potential opportunities if you took it down to the unit level, about potential sales activity. Has anything changed from that perspective?

Nothing's really changed, you know, and the difficulty for us, you know, when we talk about these programs, you know, we have all these opportunities and our military business has never looked more promising than it does today. You know, and then you say that, and at the same time you have to give caution that, you know, we're counting on some orders for this quarter that we don't have in hand yet.

So it's, you know, we're trying to strike a balance between, you know, being excited about a military business and the prospects and reminding people that you know, this is not a quarter-to-quarter kind of business.

So the military overall as a declining percentage of sales today, because the satellite business is growing so rapidly. So the impact going forward, especially as the A5 margins get back to where we expect them to be, say starting in Q1. I think the impact of that quarter-to-quarter variability will be left, be less of a concern going forward.

OK, and well, very good. Thank you.

OK, thanks.

Thank you. Our next question comes from James Mcllree with Unterberg.

Thank you. Martin, you talked about adding a messaging feature to the TACNAV, when would that be accomplished and what frequency is that operating over? And then does that mean you have to recert, or does that mean the Army has to recertify it?

Well this is a feature that we're adding, would be an add-on capability to the standard product with the small add-on interface box. It's an L-Band satellite and there's a couple different transceivers options to capability that we'll be demoing in the next couple weeks. And it's just one of those features that people really want and it adds a whole lot of functionality to our product, because the existing displays have the capability to display messages that are received from outside the system. So now you can, you know, back in headquarters or the mobile command center, you can click on the icon for vehicle, type in a text message and it will pop up on the drivers' display or the commander's display inside the vehicle.

OK, and is that something that you've developed on your own, or have you partnered with somebody to get that feature?

That's something that we're developing on our own, but we're working with the standard satellite uplink systems that are out there, which are the MPS and Blue Force Tracker and the , which is a radio-based system.

OK, great, and Pat, can you just help me with the trajectory of R&D expenses over the next few quarters?

Yes, I can give a little bit of insight to that Jim. In the fourth quarter our expectation is that R&D will show you know, some reductions, compared to the third quarter. In the third quarter we spent approximately $2.1 million and I would expect it'll be down a bit from that. And in the first quarter, as I've indicated in a couple prior conference calls, our intention is to bring R&D down into, you know, the low double-digit area of revenue and then begin to grow it again in absolute terms as the company grows, and naturally we want to stay ahead of the technology curve.

So I'd say from here, we're about at the point of stabilizing R&D and then you should see some beginning absolute growth during the course of 2004.

Great, OK, thank you.

Thank you. We'll now go to with SunTrust.

Good morning. I was wondering if you could, if you had any idea of what volume would be necessary on the A5 product line before you start considering price reductions?

That's a good question. We haven't really thought about reducing the price at this point, given the fact that, you know, the demand's been very strong. But I would say probably, in a consumer electronics scenarios, typically six to nine months after a product introduction would be the time you would start to look at the data, whether you thought you could really increase either penetration or net profitability by dropping the price, you know, which would have to be offset by, obviously a very large increase in volume.

So, but that would be the time frame that we would probably consider something like that.

So at this point, you don't have any quantitative idea in mind of what the quarterly volume might need to be to consider that?

No, I think, you know, the, our cost reduction efforts are not driven so much by volume. In other words, there's some, some of the costs, the costs will go down at certain points in time rather than with specific volumes. In other words, there's, either new vendors being cut in or a new part that's plastic versus metal. Those types of things that get cut in on certain dates, and that's almost irrespective of volume, so you know, we have a plan to get the cost down and once we're there, obviously, as volumes continue to ramp, you have your normal learning curve, you know, where, you know, in our experience and similar to a lot of companies that your costs go down by 15% every time you double the total number of units that have ever been built. You know, and that's a fairly typical learning curve.

OK, and second question, more of an R&D type of question, what is the risk of fiber optic technology being displayed by micro-electro-mechanical systems technology at some point, and do you have any R&D efforts going on in MEMS technology?

Well we don't have any R&D technology in MEMS per say. There are some micromachining that we're doing on the fiber itself, you know, which is, sort of a nanotechnology, nanofabrication for Gyro modulators. But the key point with the MEMS devices is that they are quite a big less accurate today than they Fiber Optic Gyros and what happens is that what we've seen is that our Fiber Optic Gyros are always not quite accurate enough.

And by that I mean that whatever our accuracy gets to and we've been continuously improving the accuracy of our products, our customers want more accurate.

So I think what'll happen is that the MEMS technology will continually be a few years away forever, because you know, the accuracy requirements, especially if you look at what they're being used for, things like guided bombs, smart bombs, they want them more accurate. You know, the accuracy and the penalty from a PR and a human, you know, life point of view of hitting the wrong building and hitting a school or hospital is just so high that they really want to use smaller and smaller bombs that are more and more accurate.

We're nowhere close to the accuracy that they'd like to have today.

On the fog technology or on MEMS?

On any technology. There is, the accuracy that they would like to have does not exist today. So they're accepting accuracies, you know, which are the best they can get.

OK, thanks.

Yes.

Thank you and our final question will come from J. P. Mark with Farmhouse Equity Research.

Hi, good morning. I've had some technical difficulties with my line, so I apologize if my questions have already been asked and answered.

You said that you were entering the quarter at a rate of 250 a week, and I'm wondering whether you see some acceleration in production capability over the quarter and if so, what would you think an exit rate might be?

Well I think our, you know, what will happen is that we will work as quickly as we can to burn through the backlog, and at that point, we will match our production rate to the sales rate, you know, which is the way we manage our business for all our other products.

So, you know, the real, the answer is that we will build as many as we're selling. So that's our plan.

So at this point, you don't see any other obstacles in the production phase of it, is that right?

No, you know, there's nothing today that we know about that from building you know, what we're selling.

OK, and then I wanted to ask quickly about the sales and marketing in the fourth quarter. There will, I think you're anticipating a large ramp in sales and marketing. Can you talk a little bit about where you expect to spend those dollars and how many dollars you're going to spend, you know, in excess of what you're already spending right now.

I'll let Pat answer the specific dollar question, if he's inclined, but as to where we're spending it, in general, we're trying to leverage our marketing money by working with the retailers. So for example, already did a direct mail piece, sorry, newspaper stuffer piece on the A5, which was nationwide. It reached, I think you know, nine or 10 million people.

So you know, we pay for parts of that through co-op advertising where that's offset against retail, against their purchases as a percentage discount. So we leverage our advertising money with the retailer to split the cost of those types of things, which are very effective and they're very targeted and they're, you know, bring people in the stores to buy the product.

So I think a lot of our advertising will be done as co-op with retailers. We're also doing some advertising in magazines where our existing customers are. As you know, in the marine market and the RV market, we have a lot of affluent customers. So we're doing some advertising in those types of trade publications to reach people who are, you know, big SUV owners and luxury SUV owners, early adopters.

So a lot of our marketing is focused on getting the early adopters on board and then working our way down the pyramid from there.

And what about your existing customer base for boats and RVs? Are you targeting, are you doing a direct mail piece to them or?

Yes, we're actually doing magazine advertise?

That's the target then?

Yes.

It's magazines, not direct?

We're doing advertising in, you know, Yachting, Sailing World, Motor Boating, lots of magazines?

But you won't do a direct mail piece then, is that right?

Not to those, well that's a good question. I won't say we won't do it. I'll have to check with the marketing folks on that.

OK. And Pat did you want to comment on the?

Yes, I will and I didn't want to leave the impression that sales and marketing in absolute terms is going to go up a great deal sequentially, but it will increase third quarter to fourth quarter.

In the, you know, the best reference I could probably give is back in the second quarter we spent sales and marketing I believe, was around 18% of revenue in that quarter. In the third quarter it jumped up to approximately 22%, and I would expect that in, on a percentage basis, now keep in mind that we're expecting a very substantial growth in revenue, but on a percentage basis, I would expect that sales and marketing could be back near the second quarter percentage, around 18% or so.

OK, great.

So that's absolute dollar increase, but are, you know, pretty meaningful reduction as a percentage of sales.

That might include some redirection of marketing monies away from standard products and new products. And that's something we do every time we launch a new product, that tends to get the focus for the ad money.

OK, thank you very much.

Thanks J. P.

Thank you and that's all the time we have for questions today. Mr. Spratt, I'll turn it back over to you for closing comments.

Well, you know, we want to thank everyone for your time and your interest and your support. And at this point, we'll conclude the call. Thank you very much.

Thank you and that does conclude today's teleconference. We appreciate your participation and you may now disconnect.