KVH Industries Inc (KVHI) 2004 Q2 法說會逐字稿

Good day, everyone, and welcome to the KVH Industries second-quarter 2004 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. Patrick Spratt, Chief Financial Officer. Mr. Spratt, please go ahead, sir.

Good morning, and thank you for joining us today. I am Pat Spratt, Chief Financial Officer of KVH Industries, and with me today is Martin Kits Van Heyningen, our President and CEO. This call will address the second-quarter earnings release that we issued earlier this morning. Copies of the release are available on our website, 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 website for future reference.

I need to inform you that this conference call will contain certain forward-looking statements that involve risks and uncertainties. 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 -- excuse me -- Form 10-Q filed with the SEC on May 7, 2004. The Company's SEC filings are directly available from us, from the SEC or from the investor information section of our website.

Now I would 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 quarter, and today we will be filling in the details. I will start with a recap of our quarterly and yearly operations in our key business areas, and discuss our plans going forward. Pat will then elaborate on the financial results of the quarter, and after that we will take your questions as usual.

The second quarter was a difficult one. Total revenue was 14.5 million, which is an increase of only 1 percent over the same period last year. While marine satellite sales remained strong, our other core business areas performed below expectations, resulting in a net loss of 34 cents a share for the quarter. This loss also included the impact of the $2.4 million revaluation we took on the TracVision A5 inventory. Year-to-date, revenues were up 18 percent to 32.5 million, with a loss of 35 cents per share.

Our results for the second quarter were significantly lower than our expectations due to an unusual convergence of factors. We believe some were onetime events, such as the channel inventory adjustments by a major RV customer and several fiber-optic product orders that were rescheduled for the third quarter at a customer's request, but also issues that we must continue to address in the coming months, including the slower growth of the TracVision A5 sales and potential key military programs where purchasing decisions have been delayed.

As I said in our update several weeks ago, I am disappointed with the results of the quarter. KVH has a powerful set of tools, technology and resources at its disposal, and we must capitalize on them. Although a number of challenges lie ahead, we're committed to restoring the Company to profitability and continued growth. Doing so will require consistent contributions from each of our core business areas. I believe that the milestones we have reached in recent months and the steps we are now taking will enable us to reach those goals.

In our satellite communications business, strong sales in the marine market during the quarter helped us increase total satellite sales 33 percent year-over-year to 12.3 million. Our European operations played a significant role in this, as our international sales grew almost 70 percent. Year-to-date our total satellite revenues are up a healthy 55 percent to 26.3 million over the same period last year. Sales in the LAN mobile marketplace were up 12 percent for the quarter, versus the same period last year. This slower growth was primarily the result of the unusual purchasing pattern of one of our major RV aftermarket customers. This customer placed significant orders in the first quarter, but only modest orders during Q2. As a result, their Q2 purchases were almost $2 million lower than in Q1. However, we now believe that their inventory levels and reorder schedule have normalized. This one customer was responsible for almost the total difference in sales between Q1 and Q2 in the RV segment.

We've also taken significant steps to strengthen the market position and sales ramp (ph) for the TracVision A5, our low-profile satellite TV antenna for automobiles. Our new business developer director is moving aggressively to build relationships with a number of auto manufacturers. During Q2 we entered a new market when Regency Conversions, the Company's largest manufacturer of conversion vans, began offering the TracVision A5 as a factory option on its new vehicles. Sales to new car dealerships are also proving to be an increasingly important part of the A5 distribution strategy.

We've also made the TracVision A5 more affordable. Thanks to its successful and aggressive cost reduction program during the first half of the year, we are able to reduce the suggested retail price for the TracVision from 2295 from 3495, and some dealers are already offering the TracVision for 1995, putting it on a par with other automotive aftermarket products like navigation and sound systems which are already selling in large volumes. In tandem with this price reduction, our new national advertising campaign is now rolling out. Billboards and radio ads will be used in several target markets, while print ads will begin appearing in the August issues of national magazines like Newsweek and Business 2.0.

One of our key strategies in marketing the TracVision in the automotive market was to enlist the support of one of the major service providers. I'm very pleased that we've achieved this milestone and have signed an agreement with a leading player, DIRECTV. We plan on promoting live DIRECTV in cars and TracVision A5 through our website, through advertisements and communications with DIRECTV's more than 12 million subscribers.

We also work closely with DIRECTV as they developed a new DIRECTV Total Choice mobile programming package. This is DIRECTV's first subscription package developed specifically for use in passenger vehicles, and it is now available to TracVision A5 customers. We're extremely pleased to be collaborating with DIRECTV to bring Total Choice mobile and live DIRECTV programming to consumers virtually anywhere they travel in the continental United States. The monthly service costs just $4.99 for DIRECTV subscribers and 39.99 for non-DIRECTV customers. As part of our agreement with DIRECTV, we will be handling the initial activation of all Total Choice mobile accounts. This allows us to offer a streamlined process for DIRECTV customers to purchase a TracVision A5 and activate their satellite programming package directly through us.

The net result of this partnership is that we've clearly linked the TracVision A5 with DIRECTV satellite TV service, one of the country's most recognized brands and a formidable marketing and sales organization. This agreement and the Total Choice mobile package are clear endorsements by DIRECTV of both the viability and value of the mobile satellite TV marketplace and of KVH's technology and products. In addition, it strengthens our competitive position should another company manage to bring a competing product to market at some point in the future.

I think it's important to put our progress in perspective. TracVision A5 has only been on the market for 9 months, but as of today we've got breakthrough pricing on the A5; sales have grown steadily since the beginning of the year. We've just received our first design patent on the A5. There are no competing products available yet. We're seeing solid interest from many of the major car companies, and now we've got a deal with DIRECTV. We've got a lot more to do, but we truly are making excellent progress.

Moving onto defense, our military business continues to defy short-term predictability. Total defense revenue was $1.9 million, down 56 percent from the second quarter last year. Revenue within the business area was almost evenly split between tactical navigation systems and fiber-optic products. Year-to-date, defense revenues were down 41 percent compared with the first 6 months of 2003, which had been relatively strong due to the war in Iraq. Our tactical navigation sales have been slowed in part by the rapidly changing funding priorities required to support the U.S. Army's continued deployment of troops in Iraq. Two weeks ago, I had the opportunity to visit with a number of senators and congressmen and military officials in Washington, and during these visits it became apparent that while the Department of Defense overall is well funded, the U.S. Army in particular has severe budget constraints. They've been forced to defer a wide range of new requirements and technology programs in favor of paying for the fundamentals of troops, food, armor and maintenance items to support extended operations in Iraq.

Unfortunately, we believe that has had an adverse effect on our near-term sales to the U.S. Army. Even so, we continue to see long-term interest in our products as evidenced by the recent $1 million engineering contract awarded to us by the U.S. Special Operations Command. Integration within the U.S. Army's digital battlefield system remains a high priority for them, and to ensure that SOCOM vehicles can interact with this system, SOCOM is paying us to enhance and expand the integration capabilities of our TACNAV M100 navigation system, and this development program will be completed in about 9 months. At its conclusion, we will have significantly increased the sales opportunities for our M100 beyond the special forces and into the regular U.S. Army. In fact, we've been told directly that the U.S. Army wants our TACNAV system to be able to integrate with their FBCB2 digital battlefield system prior to deployment within the main army.

On the international front, foreign military sales have remained steady, and many of our anticipated near-term bookings are from customers outside the U.S. However, with only limited visibility for near-term military navigation sales for the next 2 quarters, we believe it is prudent to assume no change will occur in the second half of 2004 for military navigation system revenues compared to the level of business we experienced in the first half of the year. Now we do expect to see significant new bookings during the next 6 months that should build our backlog for 2005 and beyond, and our fiber-optic products have continued to sell well. We've built a strong backlog of orders for the third quarter. The backlog includes primarily our new DSP-3000 fiber-optic gyro, along with our TG-6000 inertial measurement unit. The DSP-3000 especially has been a very solid success. Customers are extremely pleased by the its combination of small size, outstanding accuracy, and relatively low price. I believe that our Fi (ph) business is showing signs of steady expansion and increased contributions to both our top and bottom line.

As a final note, we learned late yesterday that a complaint with respect to a punitive class-action lawsuit has been filed against the Company and certain officers in the U.S. District Court of Rhode Island, asserting claims under Section 10-B and 20-A of the Securities Exchange Act of 1934 and Rule 10b-5 under that act. We've not been served with any complaint, but we have referred the matter to our counsel. We would expect to defend any such lawsuit vigorously.

So, in conclusion, we recognize that for KVH to achieve consistent revenue growth and profit, we must execute on our plans in a timely manner. We've made enormous investments in product and market development in bringing the A5 to the automotive market, and although the product launch is taking longer than initially expected, we are confident that this market will develop into a major opportunity for KVH. We don't intend to squander our lead or shrink away from this market because it's taking a bit longer. We also must be certain that we're dedicating resources to those initiatives that have the greatest short and long-term benefits for the Company. I'm confident we can achieve these goals. We do not see any fundamental weakness in the business or in the demand for our products going forward.

Our marine and RV sales have demonstrated good, solid growth throughout the first half of the year, and I'm very encouraged by the progress we've made in positioning the TracVision A5 for stronger growth in the future. Our fiber-optic business is strengthening with new orders being placed and a growing demand for the DSP-3000, and even in the military market we continue to see strong interest and demand for our products. Re-establishing our backlog for the TACNAV system will help stabilize that business. And doing so will allow us to weather the short-term uncertainties in the defense procurement process and enable our military products to begin making a more significant contribution to our overall revenue growth and profit in the future.

Now I'd like to turn the call over to Pat who will provide you with the details on the numbers.

Thank you, Martin. It is important to note that the second quarter reflected many challenging factors that simultaneously contributed to results that were unexpected and disappointing. Number 1, we are investing heavily to establish the TracVision A5 for a completely new and uncharted market. We're also investing in new markets for our fiber-optic gyro systems. The second, we're responding to the substantial reduction in current shipments of TACNAV systems, while continuing to invest to enhance the product value. And third, we are accommodating dynamic channel inventory adjustments by our largest RV partners, because it strengthens partnerships.

Although these are necessary conditions to ensure strategic health, they cause near-term strain. Yet, we do not use them as an excuse. We must perform better. 18 months ago, military customers more demanding same-quarter delivery in preparation for conflicts in Afghanistan and Iraq. However, that condition has changed a lot over the past few quarters as the demands and priorities of our military customers have changed, and we will change with it. Going forward, we will base our defense business growth expectations for the immediate near-term on backlog in hand. We will not use projections that assume we will book and ship orders in the same quarter.

We will continue to invest to achieve long-term growth in all of our strategic business areas, but we will take a more prudent approach to building the infrastructure to support that growth, restraining expansion of our operations until we get clearer visibility for new business trends.

Now I'll review some additional content for the second-quarter results. Defense-related backlog at quarter end was approximately $2.7 million. This backlog represents funded engineering projects, and tactical navigation and fiber-optic gyro systems. Some portion of it of this backlog is for orders that are scheduled for shipment after the third quarter. On the cost side, gross margin was 15 percent, down from 46 percent last year. The significant factor in this decline was the $2.4 million inventory revaluation for the TracVision A5. This revaluation primarily covered inventory on hand at KVH and firm purchase commitments with our component suppliers.

Another key factor was product mix. Sales of our higher margin defense products only represented 13 percent of total sales in the second quarter whereas they were 30 percent in the second quarter last year. Tactical navigation systems are now contributing about $2 million less gross profit per quarter than just four to six quarters ago. TracVision A5, direct gross margin was approximately 20 percent as projected while our recent cost reduction program exceeded expectations, we anticipate that our margins for the TracVision A5 will remain at approximately 20 percent for the remainder of the year, reflecting the coincident impact of the retail price reduction.

Operating expenses at $7.1 million were up about $400,000 on a sequential basis. And 19 percent year-over-year. As a percentage of sales, operating expenses rose 7 points 49 percent. This primarily reflects increased investments to support the market introduction of the TracVision A5 and in balance of sales and support costs with lower-than-expected revenues, and a higher level of professional service fees.

Second-quarter research and development expenses declined approximately $500,000 or 22 percent from last year to $1.8 million. Sequentially R&D was flat. Second-quarter sales and marketing expenses increased to $3.8 million, up 47 percent from last year. As a percentage of sales they were 26 percent. We anticipate that sales and marketing expenses as a percentage of revenue will show a modest reduction during the second half. Even with the incremental expense, of the $1 million TracVision advertising campaign.

The expense impact of this ad campaign is more heavily weighted toward the third quarter. Second-quarter administration expense was $1.5 million, up 37 percent from the same period last year and up $400,000 sequentially from the first quarter. This is where the incremental professional service fees were absorbed. Now to the balance sheet.

The second-quarter cash balance was $47.1 million, up $100,000 sequentially. Accounts receivable decreased sequentially $5 million to $9.3 million while days sales outstanding or DSO was down 13 days to 58. This decline is the result of ongoing efforts to improve account aging as well as a more balanced sequence of orders throughout the quarter.

Inventory increased to $11.1 million, a sequential increase of 2.8 million. Inventory turns on an annualized basis were just over 5, including the impact of the TracVision revaluation. This increase in inventory and decrease in turns resulted largely from a buildup of raw material and some finished goods in anticipation of higher levels of sales. We had not anticipated the sizeable late quarter reduction in shipment requirements by several key customers. We have taken action to trim our production levels for very near-term and consume the excess inventory over the course of this quarter.

Looking ahead to the third quarter and remainder of the year, although we expect improvement in operating performance, we do anticipate that we will incur a net loss for the third quarter. We base this projection in part on the assumption that there will be no sequential growth in the sales of tactical navigation products, that overall gross margin will be in the low 30s percent range due to sales mix, and we will incur additional sales and marketing expenses for the new TracVisionA5 advertising campaign. We are working hard toward achieving our objective of returning to profitability in the fourth quarter. We expect to see sequential revenue growth for the Company in both the third and fourth quarters. We anticipate that the year-over-year revenue growth rate for the second half will be in the 10 to 20 percent range.

KVH is an established Company, but it is still small and developing. We are opening new markets while simultaneously dealing with what we believe to be a temporary but frustrating shrinking of our high margin defense tactical navigation business. These factors present unique near-term challenges and uncertainty. But we are confident that we will improve the quality and predictability of our financial performance and maintain the strategic commitment that we will grow revenue and sustain profits over the long-term.

Now we would like to take your questions. We ask each participant to limit the number of initial questions so that everyone in the queue has a turn. You are welcome to re-enter the queue for additional questions. Operator, could you now please open the call for questions?

(OPERATOR INSTRUCTIONS) Steve Krueger with Foresight Investments. (ph)

Can you talk about what basis you might have for thinking that even with the price reduction on the A5 that demand will be stimulated significantly? Have you done any test marketing at the lower price, or any kind of other work to ascertain what kind of elasticity of demand there may be with the price reduction?

We have been in the market with the product for about nine months, so we got pretty good feedback from our sales reps and from dealers and from attending trade shows. And so it hasn't been formal testing, but it has certainly been a number of data points. And also in terms of the price reduction, we felt it was a good time to sort of gain momentum because we have the DirecTV announcement. We have the ad campaign starting and we did not want to be in a position where were bring a lot of people into the stores and then for them to find out that the price was more than they were expecting to pay or willing to pay. So we really didn't want to spend the ad money when we had a pretty good idea that this new price point would be much more attractive.

Do you have a sense as to how much additional demand -- what the elasticity of demand curve looks like with a price reduction of this magnitude?

I don't have a specific percentage for you, and I think that is part of our difficulty in launching a new product is that you don't have good history for demand, so we don't really have the data point to draw the curve yet. So we only have the one data point, which is the price point we were at. So but I think if you look at consumer electronics in general, one of the things that we found is that there are a lot of other products that are priced in this $2000 price point. For example, navigation systems for cars. Even though it is not a competing product, we do see a lot of other products like premium stereo systems that are priced in that range, so it appears at least that is a price point that consumers are willing to pay for other items. Whereas at the $3500 price point we were sort of alone; there weren't a lot of other items out there at that price point.

Tom Watts of SG Cowen.

Could you give us a little more -- you mentioned the DOD is in the process of reassessing how they might use TACNAV or that's how I interpret it, and maybe you were expecting more orders in 2005. What are the major factors that they are thinking of? You mentioned that they are doing some integration of TACNAV with other devices. Is there, are there other competing products? Are they thinking that they may not need this at all? And what is the (indiscernible) of recovery of orders for that in '05?

We are actually hopeful that those orders will start to happen over the next two quarters, so we are not expecting these orders to start in '05, although some of the deliveries will be in '05. But the factors within the U.S. Army is that they have a number of different systems, for example they have an MTS system which is called a movement tracking system for supply vehicles. They have digital battlefield system which is called FBCB2 for combat vehicles. They have tried to extend the range of that by adding a satellite transponder and in that configuration it is called a blue force tracker. One of the problems they have a number of different systems that are not compatible in terms of their data path. So we've actually been one of the companies that is supplying equipment that does make that interoperable. For example, we were on board the U.S. Army Bradley vehicles and they've recently been buying FBCB2 interfaces for that product for our TACNAV TLS.

So one of the strong comments that we've gotten back is that they want the FBCB2 compatibility with our new product that we are building, the TACNAV Light, which is also called the M100, which we're doing for the U.S. special forces. So now we will be doing an FBCB2 interface for that so the special forces their nav system will be able to communicate with the FBCB2 system, and we think that is what is required to penetrate the main U.S. Army vehicles, as well.

And if you also had some foreign military looking at TACNAV as well and it was named the standard navigational product for Germany. Are those orders on hold as well?

No, no. The foreign military stuff we see accelerating in terms of the pace, especially in the Middle East. So we expect those orders to remain on track so they don't, they are not affected by this funding issue at all. So going forward we are expecting more and more of our business to be international.

Rich Valera with Needham.

With respect to the military backlog, Pat, I think you said you had 2.7 million, and a portion of that was expected to be shipped in the third quarter. Could you give a sense of how much that of that shipped in the third quarter?

Well, I can speak to the -- I don't have the fiber-optic gyro numbers at my fingertips, but I can speak to the piece, the portion that is tactical navigation related. And that portion we expect that the shipments in the third quarter -- in other words backlog that is shippable in the third quarter, only equals what we shipped in the second quarter. And Martin said that that was roughly half of the $1.9 million of total defense business. So it is -- that is the best I can offer at this point. There's a good portion of that backlog which is scheduled for fourth quarter and beyond.

I think you mentioned you expected TACNAV sales essentially flat for the next two quarters so that was how you were forecasting. You expect total military sales also flat for the next couple of quarters, including the fiber-optic stuff?

No, and actually what I said was TACNAV sales we anticipate that they will be flat for the third quarter. At this point we are expecting that we should see some sequential growth in the fourth quarter, but as I said with the way we are going to approach this in terms of projections is as we enter each quarter all we're going to count on for tactical navigation, especially is what is in backlog for that quarter. But right now we do expect to build some backlog in the third quarter that will be shippable in the fourth.

In fiber-optic gyros we do expect to see some growth over the second half of the year, as well. So we expect the second half for our defense business overall will roughly approximate what we saw in the first half in terms of total sales.

James McIlree what Unterberg Tobin.

The marketing spending that you are doing in the second half of this year, does that go away completely in 2005, or is it diminished or do you just get a new marketing program that you have to start engaging in?

It will be diminished. Typically this is part of an aggressive launch, in which we had been scheduled at this time so that we could use the DirecTV logo in all the ads. So all the billboards, all the radio spots, all the national print ads heavily feature DirecTV, which is what we have been waiting for to get that out. So that's the reason on the timing for this, Jim. But a launch is just that. It is a launch, and then we expect it to drop to a more normalized percentage of revenue, similar to what we are doing in our other markets.

And what is the timing on when the average consumer would see something like you are contemplating, and were would the consumer see it? Are we talking national TV or Time magazine or is it more specialized advertising medium?

It's a little of both. We are in magazines like Newsweek, Business 2.0 and some specialty magazines for car buffs and things like that, as well as we're targeting some of the (indiscernible)magazines where people already familiar with our products and have high net income. So we are advertising the TracVisionA5 in some of those books. And we are doing two test markets, one in Florida, one in Texas where we're focusing some billboards and some radio spots and then testing that in conjunction with dealers, as well, for the radio ads referring to specific dealers where they can go and buy the product.

JP Mark with Farmhouse Equity.

A question for you about the truck market. I wonder to what extent are you addressing that market or planning to address that market, and does the ad campaign you are planning touch on that market at all, or what are your expectations there?

When you say trucks, you talking about pickup trucks or 18 wheelers?

18 wheeler kind of trucks.

It doesn't not address that market. We have addressed that market in the past with our RV products, and we have had some success there, but not as much as we would have liked. And we believe that is true because the average income is only around the mid $40,000 for the owner operators and truck drivers. So we think there is sort of a mismatch between what they want and what they can afford.

Okay. Have you done demographic surveys of people who bought your product already, and what is the profile of the average A5 buyer right now?

Right now it's very high in terms of income, very high net worth, high income Escalade owner, Hummer H2 owner, Lincoln Navigator owner, those types of that profile. What we are hoping to do is drop it into the next tier which is still the big SUV owners or more of the Ford Explorer, suburban Denali, which are larger numbers. And it's just a progression that we're looking for.

Steve Krueger with Foresight Investments.

Martin can you tell us how many A5 units you did sell in the first half?

No. We are not breaking out our product sales by specific product. We just report by category, we break it out into defense sales, fiber-optic sales, RV sales and land sales in total. The A5 has also sold in the RV market as well as marine sales. So those are the four major categories that we report, but we don't report individual products.

Can you tell us what you expect your average selling price today for the A5? With this new cost structure and new lower suggested retail price, what is your expected average selling price?

I think the weighted average will probably be somewhere around 1600, something like that. Plus or minus 5 percent, 10 percent from that number.

Okay, and can you give us a little more detail on the DirectTV deal? Just to make sure I understood, if I am currently a DirecTV subscriber in my home, I can add DirecTV units and subscription for my vehicle for 499 a month?

That is correct, and you can either be an existing DirectTv subscriber or a new subscriber who also gets it for his home, and then it is $4.99 to active the TracVision A5. And don't forget the RA5 comes with the DirecTV receiver built-in, so you don't need to buy a separate receiver.

And last question, the inventory buildup that you saw was pretty substantial, but inventories jumped in the neighborhood of $5 million from the end of the year, and that was after writing down a couple million or so. Can you give us a little more flavor on what was behind that big buildup? I know you said you had bought raw materials and stuff in anticipation of sales but that seems like an awful big buildup. Can you give us a little more detail there?

I can address that to some extent. First of all, the $2.4 million revaluation was only in part for inventory that KVH has on hand. Approximately one-third of that number was for inventory that KVH had. Most of the rest of it is actually commitments we have with our suppliers noncancelable commitments we have with our suppliers to take inventory in over the next several months as we ship more A5 units. So and then in terms of the inventory buildup itself, you are correct, it is much higher than it should have been.

We had brought inventory inhouse in part in anticipation of what we expected to be higher volumes for the A5, so we've got a fair amount of A5 raw material inventory inhouse as well as some level of finished goods. And as we mentioned in the second quarter, we were surprised by some fairly substantial channel management changes that our largest RV customer decided to employ, and we had prebuilt some level of satellite communications products for the RV market or brought the inventory in hand in anticipation of building and shipping those units, which in turn did not happen.

The third factor -- and we have mentioned this in the past -- is we are still carrying because our tactical navigation sales have been as low as they have been for the last couple of quarters we are still carrying some level of finished goods that we had prebuilt all the way back in December for what we had expected to be shipments to the U.S. Army or the GMENS product that never happened. So the three -- those three things are what make up the majority of that change in inventory since the end of the year.

Chris Quilty with Raymond James associates.

Good morning, gentlemen. A follow-up question on the DirecTV relationship. You mentioned the fact that the total choice mobile package is out but I checked the website and I can't find it on there. Is it something that will eventually be on their website, or just addressable when you call them and inquire?

Yes, it will be, right now there were the mechanics of it are being handled by us, so that -- if you call their 800 number they refer you to us, and we do the activations and set it up here through, so that is the way its being worked out mechanically. But yes, we do anticipate that we will, it will be on their website and they will be promoting it along with us. So this is brand new.

And to that end you mentioned the advertising campaign is all going to include DirecTV. Does that mean that they're doing any, putting in any co-op advertising dollars, or billboards and other print or is this all on your dollar?

The roughly $1 million is what we're spending. Hopefully going forward we will see DirecTV's promotional budget and hopefully that will be on top of what we're doing.

Tom Watts with SG Cowen.

Could you give us any competitive update on the TracVision, I know Weinguard (ph) is stepped-up some of their efforts. (indiscernible) I forgot what their new name is now, announced a product and I know each of those products, I believe their products also works with Echo Star. Have you seen advances there?

We haven't seen probably anything more than what you've seen. I've seen products on websites, but we haven't seen products in the field or no news on whether those products are going to be available soon or not.

I think one of them also already has broad upflat (ph) products for the vehicles. Is that something that you see bringing into the A5 capability?

The issue with the broadband capability is the satellite service providers. One of our concerns is that the service providers like ExpressView are switching to kVA band services and as you know HNS is been bought as part of the DirectTV deal and now the Direct Way group is for sale. So it looks like some of those KU (ph) band services are going to be (indiscernible) discontinued. And that would make it difficult. So we haven't seen a very strong demand for satellite-based Internet capabilities in the automotive market primarily because of the cost. People are comparing it to WiFi connections or 3G connections, and they are just not prepared to pay the cost for satellite broadband, which typically you are charged by the minute.

Would the, for example Wild Blue, their satellite just went up last week and then the Ka-Band (ph) Would yours tend to be able to work Ka-band with a different receiver? Or would it require a different design?

I think the Ka-band has some significant potential for the mobile market. The antennas are a little bit large. The Wild Blue antenna is about a 28 inch antenna. So it is bigger than the antennas that are out there for satellite television. But on the other hand, it's a high-speed service, its two-way, and I think it would probably be a better choice. But more for a fixed mobile than a true in motion product. And by fixed mobile I mean antennas that are used in RV's and boats primarily when you are stationary. And there is also -- that's also to meet certain requirements, for example Wild Blue depends on knowing your location, so they currently can't support a mobile application the way they assigned the spot beams to individual users, it depends on them being stationary.

Thanks very much.

Rich Valera with Needham.

Wondering to get the A5 margin above 20 percent would that require sort of a major redesign, or how do you push up those margins? It sounds like you expect them 20 percent for at least the next couple quarters?

Yes, our strategy is to continue to push the costs down. So if you look at where we started, we dropped the cost of the product almost 50 percent since we started the introduction nine months ago. So we've really exceeded our internal cost targets, but we haven't stopped. We have an ongoing cost reduction program and product team that's working on the next generation of cost reduction right now. And we're hoping that this price point will stick. So we don't see having to reduce the price further from where we are today. We are thinking that street price of 1999 will have some legs to it. We don't really see any major competitive threats on pricing today, so what we're hoping is that going forward that the price point will stay and our costs will continue to come down.

Okay, and just with respect to the inventory or the write downs that you mentioned with respect to future purchase commitments of the components for the A5 it seems like those essentially give you access to components where for some period of time at a discount to market rates as they flow-through income statement. 0What happens when those written down commitments expire, do you then try to negotiate new lower rates or do your component costs effectively go up from where they were previously?

Basically, Rich, the revaluation was structured in such a way that we revalued down to -- excuse me we revalue down to the cost levels that our current cost reduction programs will allow us to achieve. So we've already discussed with all of the vendors who are party to where the cost reductions are coming from to what the price, the cost points will be for the new parts when we phase them in. So essentially we will consume what is already committed at a lower cost than our profit and loss statement, lower cost than it had been before, and that will be -- those purchases will go against -- we will consume them at that committed price, but the difference between the revaluation and that price will go against the reserve, and then once we phase in the new parts, we will be at those lower cost levels.

That's helpful. Thank you.

(OPERATOR INSTRUCTIONS) Chris Quilty with Raymond James and Associates.

As a follow-up to that question with the price cut you made in the recommended MSRP how do you protect or do you protect the channel out there that took inventory at much higher levels?

Our policy is not to provide price protection, and from what we've seen we do not see a lot of inventory that's out there in the channel. So I don't know if that answers your question.

Just in terms of if you had someone that took inventory at a higher price and maybe was forced to sell it at probably close to what they bought it for are you going to lose some channel partners possibly?

I think we anticipated that issue, and I think we would deal with it on a case-by-case basis, but we have -- we have made some small reserves for that, as well, and that has already been included in the numbers for Q2. So we believe we have that covered.

Okay, and at the new price point what does the likelihood look of adding a major consumer electronics chain before the end of the year, or is their lineup already set for the holiday selling season and it's unlikely you'll be able to get in any major new outlets?

That is one of our goals this year to get one of the major national guys on board, and I think you're right. I think that this price point we are -- let's go this way, it is a price point. The 3500 was an introductory number, but it's not really a consumer price point, per se. And in order to be in some of the big box retailers we feel that we have to be where we are now. So I think we are in terms of pricing we are now able to be in with those type of retailers. And it is our goal to sign one of those guys up before the end of this year.

Okay. Different topic on the marine, I think you said the European sales grew 7 percent. Was that correct?

Yes.

What is round about the mix between domestic and European in the marine market?

The mix traditionally has been about 50-50. So I think that the European sales are for the marine products -- we have a couple products domestically that are being sold in Europe, and to some extent they sell more the bigger products like the G8 because of signal strength issues in Europe and those are also more expensive products. So that tends to even out a bit.

For the second quarter, Chris, the rough split was about 40 percent of the marine sales were in Europe and about 60 percent in the U.S.

Okay, was the larger factor driving the sales increase in the quarter just unusual strength in Europe, or was a contribution from new products?

The U.S. sales were up in the '40s as well so we had strong growth in marine here. We have some new product, but the marine market in general has been performing well. And so has the RV market. I think if you look year-to-date the -- our total satellite sales are up 55 percent for the first half. Even the customer that we talked about that didn't order as much in Q2 as we had expected, if you look at the first half of the year their purchases from us, as well as their sell through in their stores is up dramatically. So more than 30 percent. So we are continuing to see strong growth in our base business.

Okay, and any pickup in order or inquiry activity for the eTrac product, the ship security alert system following the Miami incident I guess July first when the Coast Guard started blocking some ships?

We have seen some interest, and we all got a new application for that where, as you know, there has been obviously all this kidnappings going on in Iraq and also in Saudi. We recently quoted some fairly large numbers of those for use on trucks and other vehicles because it has a panic button. It has the ability to track, as well as the ability to push a panic button which then sends out an alert which includes your position. So we've been quoting that now for some U.S. military type applications for the Middle East. In addition to the marine application that you're talking about. But the same product.

Final question out of the blue here, have you ever been able to resurrect anything with the fiber-optic gyro productline? I mean the current sensor?

We haven't done anything with that.

Okay. Good enough. Thank you.

Jim Clinton with Barret & Co. (ph)

You might have answered this, I had to go off the call for a minute. On the DirectTV deal did they just get the subscription revenue or do they share in the selling price of the A5 system?

We are compensated with what are called prepaid commissions where we get hardware buydown credits, as well as commissions for activating new customers. That is part of our agreement.

But the 1995 price is all to you, right?

DirecTV gets no portion of our sale of the TracVisionA5 product.

Did you share with us earlier as to how many A5 systems are now out in the field and do you have any projections at all in the next twelve months as to how many units you would like or you could count on maybe being sold in the next twelve months?

We haven't given any updated projections. What we have simply done is reported that sales have been slower than we had anticipated. But we are confident that the steps we are taking are going to stimulate demand going forward and really the product is so new in the market that the category is new, so we are just going to have to wait and see how things play out here.

(OPERATOR INSTRUCTIONS)

Time for one more question.

Rich Valera with Needham.

I was actually bumped off the call for a minute. I missed your guidance. Could you just quickly review that?

I can. Hold on one second. I got it here somewhere I'm sure. What I said was we expect to even though we expect to show some improvement in operating performance in the third quarter, we do anticipate that we will incur a net loss in the third quarter. We are assuming that we will see some modest improvement with meeting reduction in sales and marketing expenses, a percent of revenue over the second half in spite of the fact that we are spending an additional $1 million for the TracVision A5. So we are going to try to offset that to some extent to the best of our ability.

We believe that gross margins for the third quarter, anyway will be in the low 30s percent range. For the year, for the second half we expect that growth in revenue will likely be in the 10 to 20 percent range overall.

That is very helpful. Thank you.

With that, Mr. Spratt, I will turn the conference back over to you for any closing remarks.

We want to thank everyone for participating on the call today, and we welcome your questions and the opportunity to talk to you again in the near future. Thank you very much.

Ladies and gentlemen, this does conclude today's KVH Industries second-quarter 2004 earnings release conference call. We do appreciate your participation and you may disconnect at this time.