KVH Industries Inc (KVHI) 2005 Q2 法說會逐字稿

Good day, everyone, and welcome to the KVH Industries second-quarter 2005 earnings conference call. As a reminder, today's call is being recorded. At this time for opening remarks and introductions, I would now like to turn the call over to Mr. Patrick Spratt, Chief Financial Officer.

Good morning. 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 filed with the SEC on May 10, 2005. 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. Thank you all for joining us today. As you have seen from earnings release this morning, the second quarter was a very strong one for KVH, marked with record revenues, growth in profits and cash and improvements in almost all aspects of our business.

I would like to start our prepared remarks with a recap of our second-quarter and year-to-date operations and discuss some of our plans going forward. Then I'll turn the call back over to Pat for the financial results for the quarter. After that, we will take your questions.

So let's get started. Strong defense sales coupled with solid satcom revenues helped us achieve the highest quarterly revenues in the Company's history, $18.8 million. This represents a 29% increase over the second quarter of 2004. Year-to-date, revenues are up 13% to 36.7 million. We also posted our third consecutive quarter of positive earnings, with a net profit of about $1 million or $0.06 per diluted share. That's a $0.04 sequential increase over the first quarter of 2005 and a $0.40 improvement over the second quarter of last year.

The continued improvement in our earnings is a result of the financial and operational controls we have implemented, improvements in our overall efficiency throughout the Company, and very solid sales growth in all areas. This progress reflects well on our efforts to further strengthen KVH's financial and operational foundations. We have achieved record sales, sustained and strengthened our profitability, and reached significant milestones in each of our business areas. I'm going to go into those details now, starting with the satellite business.

Sales of our mobile satellite products were strong, with total revenues of 13.8 million. That's a 10% increase over the second quarter of 2004. Marine sales led the way with a 15% increase over last year's second quarter, with both our North American and European sales showing good results. We're seeing a great response to the new high-performance marine TracVision system, the HP Series, that we introduced in Q1.

Sales in our land mobile market increased 4% over the second quarter of last year despite a decline in sales to the RV market. Sales of Class A RVs themselves, the primary platforms for our TracVision system, were down more than 14% for the first four months of the year according to the Recreational Vehicle Industry Association. As a result, we're experiencing softness in TracVision sales to the RV OEMs as they scale back production. I think it is safe to say that gas prices are one of the factors having an impact on this marketplace.

We will continue to carefully monitor RV vehicle sales to assess the ongoing trends in the industry and refine our sales expectations going forward. As of now, the RV business is a bit of a challenge and we expect it to be so for the foreseeable future.

On the other hand, sales of the TracVision A5 increased strongly year-over-year and helped offset the decline in sales to the RV space. Satellite TV for cars continues to generate lots of interest in the media as well. For example, our TracVision product are prominently featured on the SUVs in the popular TV show "CSI," and just this Monday we were featured on the CBS Evening News.

On the distribution side, we continue to generate good sales through our established aftermarket retail network and we are also seeing interest from other markets, such as limousines and new car dealerships. Among those new car dealers are a growing number of Cadillac dealerships around the country. As we announced in mid-April, Cadillac has endorsed the sale of the TracVision A5 through its dealers as an aftermarket accessory option. And we're now making good progress in our efforts to enroll Cadillac dealers around the country as authorized A5 retailers.

Our sales and marketing teams are equipping these dealers with a wide range of materials for their showrooms and vehicles, and every nearly enroll Cadillac dealer is taking part in training, either online or on-site led by KVH personal. We are also connecting our national expediter network with those Cadillac dealers that might need additional support to install these TracVision A5s.

We're seeing lots of positive indicators of the potential offered by sales through this auto dealer channel. Now the process to bring dealers online takes time, so the sales impact will not be immediate. However, the benefit to KVH in the market will increase through 2005 as more and more Cadillac dealers are added to the network and begin actively promoting the TracVision to their customers.

In recent weeks, we also increased the visibility of TracVision among automotive consumers by bringing the A5 to the rental car market in cooperation with Avis Rent A Car. As part of the Avis pilot program, we have equipped all their Hummer H3s in Phoenix with the TracVision A5, as well as with headrest displays for the passengers. The hardware and programming services were installed as part of a revenue-sharing agreement between Avis and KVH. Avis is handling all the advertising and marketing efforts, which are currently focused on travelers passing through the airport in Phoenix. This is the first phase in a program that has the potential to expand nationally to additional Avis locations and on to other vehicle models.

Besides the obvious revenue potential, we believe this is a great promotional opportunity. Rental fleets have historically been an excellent means of introducing consumers to new automotive accessories, enabling those consumers to try the technology without buying. The combination of market leaders like Avis, DirecTV, Hummer, and KVH creates a unique car rental experience. At the same time, we have established a strong working relationship with one of the leaders in the car rental market, we've linked KVH and TracVision with the highly recognizable and well-respected Avis and summer brands, and we are benefiting from the marketing and sales organization fielded by Avis.

So we're working closely with Avis to ensure that the Phoenix pilot is a success and hope to expand the program elsewhere. At the same time, though, we are pursuing similar opportunities with other car rental companies. The rental car market holds tremendous potential for generating visibility for the TracVision or increasing consumer awareness and reinforcing our leadership position in the mobile satellite TV markets.

Now of course our leadership position also depends on continued technology advancement, and while our established mobile satellite products continue to perform well in the marketplace, we want to build on them to ensure that we maintain our position, not only as a sales leader but also as a technology innovator. So we're dedicating the resources necessary to support the development of new products for all of our mobile satellite business areas, and expect that we will begin to introduce some of these new products before the end of 2005.

Now moving on to our defense business, we have had an excellent second quarter. Defense-related revenues were up 146% year-over-year to $5 million, driven by significant increases in both our military navigation and fiber-optic sales. On a year-to-date basis, defense sales were up 54% compared to the first six months of last year. In total, defense revenues represented 27% of our total revenues for the second quarter, up from only 14% last year. We are really pleased with this mix. Internally, we target 25% as our goal for defense sales as a percentage of total revenues.

In addition to those orders that shipped during Q2, we have also continued to receive new orders that are sustaining and building our backlog for 2005 and beyond. During Q2, we announced 3.4 million in new contracts for TACNAV vehicle navigation systems and components. In addition, we are pursuing significant new opportunities for TACNAV systems, both domestically and overseas.

Sales of our fiber optics products also were strong. During last quarter's conference call, I mentioned that the DSP 3000 had been selected for use in the new Common Remotely Operated Weapons Station, which is also known as CROWS. The new CROWS unit allows vehicle gunners in armored vehicles and Humvees to accurately shoot from inside the safety of their vehicle. Two of our DSP-3000 gyros are installed in every CROWS' turret, and our gyros provide the image and gun stabilization necessary to ensure that the weapon remains aimed at its target.

As I mentioned during the Q1 call, we have been operating under the terms of a letter contract and had already started making deliveries to the prime contractor. Well, during this quarter, we actually received a formal contract which is valued at $1.5 million for the first year of what is planned as a five-year program. Our success on this program has also spurred interest in our FOGs from makers of similar systems, both here and abroad. In addition, the success of the CROWS turrets has significantly increased the possibility that these units will be fielded on an even larger number of vehicles than initially expected.

In other news, our TG 6000 Inertial Measurement Unit was successfully qualified for use in the Mark 54 torpedo during the second quarter. As a result, we have just received a multiyear production contact for the TG 6000 from Raytheon, the prime contractor for the Mark 54. Details of the contract will be made public with the next few weeks, once the press release is approved by the U.S. Navy and by our customer.

The TG 6000 IMU, which precisely measures rate and acceleration in three dimensions, is the most technically advanced guidance product KVH has ever created. Raytheon's selection of the TG 6000 is a major validation of our strategic decision to apply our fiber-optic technology for use in high-performance integrated systems for smart munitions and other applications. We are now able to offer a fully integrated precision navigation unit with potential applications throughout the military and commercial marketplaces.

So in conclusion, we're beginning to see the benefits of the strategic initiatives that we have undertaken over the last few years. During Q2, several long-term program opportunities came to fruition in the defense area, and we are continuing to build momentum in the auto market. I am extremely pleased with our results for the second quarter as well as for the first half of the year. In fact, year-to-date results are somewhat better than we originally expected.

We anticipate that we will continue to achieve our goals for the second half of the year, keeping in mind that seasonally, the marine business does slow down considerably compared to the first half of the year. As a result, we remain comfortable with our earlier guidance of 10 to 20% revenue growth for the year as a whole, and we continue to work to sustain our profitable.

Now I would like to turn the call back over to Pat, who is going to give you some of the financial details.

Thank you, Martin. First, a housekeeping reminder before I begin the review of results. As I mentioned on our first-quarter call, sales that we had historically classified as legacy are now combined with defense sales and satellite communication sales, as appropriate. This change started with our Q1 results and will be our standard reporting structure going forward. To ensure accurate period-to-period comparisons, we have applied the same adjustments to the 2004 results that we're referencing today.

Now I would like to review our operational results. As Martin mentioned, the successful execution of our operational improvement program continues to show results. We've achieved tighter spending management, reductions in product costs, and efficiency improvements in every part of the company. The result is increased profitability, a strong balance sheet, and the overall financial strength to help drive additional technological advances in future growth.

Looking at the bottom line, the second quarter was another in which we achieved a sizable sequential improvement in operating margins, which was 5% of revenue. The second-quarter results reflects a 3 percentage point improvement compared to the first quarter and a 10 point improvement compared to the fourth quarter of last year. We are working towards a financial model that targets operating margins in excess of 10% of revenue. Our second quarter results give evidence that we're making good progress toward that goal.

We also made very good progress in booking new defense business, as the order backlog nearly doubled to $11.4 million compared the level of the end of Q1. This backlog includes tactical navigation and fiber-optic gyros systems, as well as funded engineering projects. It also includes the initial production volumes for the CROWS weapon system and Mark 54 torpedo programs. Our growing backlog reflects an improvement in both the base of business and the time period covered. Some of this backlog extends through 2006 and is improving our visibility over a longer period.

On the cost side, gross margin was 41.4%, our highest level since mid 2003. The Q2 gross margin reflects a 1.7 percentage point sequential improvement, the result of continuing manufacturing efficiencies and product cost reductions, and a relatively favorable product mix of higher margin defense products. Operating expenses at $6.8 million were roughly flat sequentially, and we are down more than $300,000 on a year-over-year basis.

As a percentage of sales, operating expenses were 36%, down almost 2 points sequentially and 13 points year-over-year. Even as we have tightened our overall expense controls, we remain fully committed to funding the research and development that is necessary to expand our technology base and bring new products to market. This is the foundation of our future and we intend to grow investments roughly in line with revenue to ensure an ongoing flow of new leadership products.

Second quarter R&D spending increased to just under $2 million and was up 9% compared the same quarter last year. This Q2 investment was 10.5% of revenue. Second-quarter sales and marketing expenses declined to $3.3 million, representing just under 18% of our revenues, down from 26% during the second quarter last year. Sales and marketing spending in the second quarter was 13% lower than last year, while revenue increased 29%. We are pleased with progress we have made to efficiently leverage these resources.

Second-quarter administration expense was $1.5 million, roughly flat compared to last year and up $200,000 on a sequential basis. Professional fees related to public company compliance regulations are among the more challenging variables in our administration activities.

Now the balance sheet. We have a strong balance sheet and it continues to improve. Cash and marketable securities at the end of Q2 were $47.1 million, up $1.9 million sequentially. Cash flow from operations was $2.3 million. This positive performance can be attributed to a continuation of good asset management and stronger earnings. We are doing a good job converting sales to cash.

Accounts Receivable declined $600,000 from the March level to $10.4 million. This decrease is a direct result of improved aging of the account balances. Our Days Sales Outstanding, or DSO, for Q2 was 50, one of our lowest levels ever. This is down 6 days from the first quarter and 8 days below the same period last year. Our near-term objective is to sustain DSO within the range that we have achieved over the last several quarters; that is about 50 to 55 days.

Inventory declined by almost $300,000 from last quarter to $8 million. Inventory turns were 5.4 annualized, roughly flat with the first quarter. We expect to achieve additional improvement in turns performance as we go forward by continuing to leverage lean operations concepts across the organization.

Looking ahead to the third quarter, we expect that revenue will show very positive year-over-year growth, but could be down as much as 10% compared to the second quarter just ended. We anticipate year-over-year growth in both satellite communications and defense sales. Historically, however, satellite communications sales in the marine market are seasonally much lower in the second half of the year compared the first half. In fact, second half marine sales typically account for only 40% of the full year volume. This is the reason we expect the third quarter Company revenue to be down sequentially.

We also expect that the sequential reduction in sales will have a resulting impact on the bottom line. We anticipate that earnings will be more or less in line with what we reported in the first quarter of this year. A profit at that level, although less than Q2, would represent about a $0.13 per share improvement compared to the quarter of 2004.

In keeping with our stated practice, we are only including in our projections confirmed military orders that have a high probability of shipping this quarter. We expect that gross margin will decline somewhat compared to the second quarter due to the impact of lower overall revenue. Also, compared to the quarter just ended, operating expenses could show a modest sequential decline in absolute dollars, but increase as a percent of sales.

For the full year, we continue to believe we will show solid year-over-year growth in the 10 to 20% range. We are continuing to pursue new programs and sales opportunities that could provide some measure of additional potential.

The guidance that I just provided does not include any effects of the new SEC requirement for public companies to directly expense compensation-related stock option programs. KVH's first quarter for implementation will be Q1 2006. We will provide further insight in the future.

With the conclusion of the first half of the year, we have built upon improvements that began during the second half of 2004. This reinforces our confidence and our expectations for ongoing longer-term financial performance improvements.

Now we would like to take your questions. Operator, could you please open the call for questions?

(OPERATOR INSTRUCTIONS) Rich Valera, Needham & Company.

On the military backlog, just wondering -- it sounds like the Mark 54, which you have not really announced yet, was in that backlog, as it was quite a bit larger than was expected based on announced orders. The question is are there any other unannounced orders in that backlog that you have not talked about?

There might be some small things in there, Rich. We do not announce every order that we receive. But it is a fair assumption to assume that in that number is the first production order for the Mark 54 torpedo.

Great. And in terms of the delivery timeframe for the backlog, can you say how much you expect to ship within this calendar year? In other words in the second half of '05, and how much is within the next 12 months?

I don't think I should break it out quite that finely. We are looking for our defense revenue to grow strongly on a year-over-year basis in the third quarter, and it could be up on a sequential basis as well, if that helps in any way. But I would rather not get into breaking the backlog down into specific timeframes.

That was helpful. Finally, on the RV side, just wanted to maybe get a little color on your thoughts on that segment going forward. You were down off of a quarter last year when you had had a pretty major inventory correction going on with one of your large customers. Do you think these levels here are the levels we should expect for the balance of the year or do you think there could potentially be more weakness in RV? I'm just wondering if you add any more color on that.

It is a little bit hard for us to say. I think that we are looking to see what the RV companies announce; a lot of those are public companies as well, and I think some of those have already started to give lowered guidance. So it is really a question of last year it was an issue with retail customers. This year, it is the RV OEMs primarily that either scaling back production or going on plant shutdowns to reduce their output. So that's what we have seen so far -- it has been more of an OEM issue than an aftermarket issue.

Okay, thanks. I will yield the floor.

Tom Watts, SG Cowen.

You mentioned you're going to work towards a new financial model, targeting operating income margins in the 10% range. How long do you think before you're going to be there?

I think, Tom, what we have said for a while now is we're targeting that on a run rate basis by roughly the middle of 2006. So if we can stay the course, then I think we are probably about four quarters away from being able to achieve that, as I said, on a run rate basis.

Secondly, RaySat recently won an award for best innovative new product in the satellite industry, which you certainly have won your share of those. Have you seen them in the market or Winegard in the market or any other competitors? And can you give us a little more sense of what is happening at the retail level with the A5?

To the best of my knowledge. they still have not delivered any product, so it is very (multiple speakers) --

That was my belief also.

So they continue to be very active on the PR front, but we have yet to see a product from them. So on the retail level, we continue to have 100% market share.

Okay. And in terms of retailers, have there been any additional promotions or discounting? How have you seen the retailer relationships or their activities changed over the last quarter?

I don't think we've seen any substantial changes. We've continued to expand our dealer base a bit, we continued to move into some of the more -- the regional chains and things like that. We are working on our promotional effort in terms of delivering better in-store point-of-sale material and continuing to focus on those types of promotional efforts. We have scaled back a bit on our advertising post-launch, so we're still living off some of the work we did more than six months ago now, because that was just part of the launch.

We continue to get some good PR, though, As I mentioned on the call. I don't know if you saw that in the news. So that's great in terms of generating positive spin on the whole technology. And the thing with Avis -- we're really excited about that because we have already gotten very positive feedback. They've been doing customer surveys for people who have rented the vehicles and they think it's great. So I think that is a great way for us to -- I know the satellite radio guys like XM did this in the beginning as well, so it is good for us. It generates revenue and it gets us in front of lots and lots of people.

Can you give us any more color on potential mass-market relationships and those discussions?

That's ongoing, so we hope to have something in place this year.

Good numbers for this quarter, so thanks very much.

Mike Hickey, Janco Partners.

Congratulations on your quarter. Fantastic to see the top line growth, the record and your profitability. That's a good combination. And also congrats on the success of the DSP-3000 with the CROWS program. It is nice that you can produce a product to better protect our troops in combat.

Question in regards to that program in particular. Over the next five years, it looks like there's some potential upside on an annual basis there. Can you give us more insight on what your expectations are in terms of growth?

And then can you give us some more insight on your dealer install option with Good morning -- there's about 1000 dealerships. Can you give us an estimate of your current penetration in terms of enrollment, in addition to where you anticipate being in 2005 and 2006?

And lastly, in previous calls you had mentioned your intent or the potential, I guess, for a factory install introduction for model year 2007. Obviously, the timing on that is imminent. That is going to happen. If you could update us on your efforts there, that would be great.

Let me start with the questions in the order you asked them. On the CROWS, the upside there is that we have now been designed into their system. It's a company called Recon/Optical; it's a prime contractor. They also have a new system which is a lighter version, if you will, called CROWS Light. We're also designed into that. And there are a number of companies, both here and in Europe, that are designing similar systems because it is a great idea and it is very effective. We are bidding on those programs as well, and because we have been selected and qualified for this one, I think we have a very good chance of winning at least one of those. So I do see significant upside in that since it's an optical turret-based system and our gyros view are just perfect for that.

On the GM side, in terms of dealers, our original goal was to target their top dealers, in other words the dealers that generate most of the volume. So we are starting -- we're not trying to reach all 1000 or 1200 or 1500 dealers that they have. Typically, their top 20%, I think, which is around 300 dealers, 350 dealers, do about 80% of their volume. So that is what we're targeting initially, and we're starting at the top and working our way down.

And it is a fairly time-consuming process, as you would expect, to go into a new car dealership and educate them on the product and concepts and how to install it and how to merchandise it and how to sell it as part of the vehicle, which is a little bit out of the ordinary for these dealers. In other words, they are not normally accustomed to adding this type of feature, so there's a little bit of an educational process that has to happen. But once we get through that, it seems to be pretty effective. So we have had some good successes with a couple of the early dealers who have sold a couple and had great feedback from the customer and then started to do it more regularly. But it is taking time, and it is fairly labor-intensive on the part of our sales force.

On the factory install on the GM side, what they are working on is a factory pre-wire program, which will be part of the new GM T900 vehicle so that the vehicle will be wired, ready to accept satellite television. And that would be either 2007 or 2008 model year, and that could be as many as 250,000 vehicles that would then be prewired to accept the antenna and the receiver.

So that is what is going on at GM, and we are also talking to all of the other major car companies, including some of the European car companies, as well as the domestic ones, about factory installed programs.

Thanks.

Chris Quilty, Raymond James and Associates.

Just a follow-up to the topic you are just speaking on there. I assume in addition to the prewiring, that you are also continuing the development and prototyping of the in-roofers and that would actually be factory installed rather than just running wiring for the current roof mount.

Yes. And the prewire, if it is done correctly, could accommodate both. So part of the prewire program is actually to connect to the vehicle's stereo system and the monitors that are in the vehicle so once those wires are run, it makes it very easy to either add the antenna at the dealership level, which would be a bolt-on with a connector available right in the roof, or as a drop-in install at the factory, again with a connector available right there. So we are pursuing both aggressively.

So they would basically dead-end a wire right into the roof line?

Yes. What they have proposed and what they have discussed publicly, so I can mentioned it, is that they want to prewire --they said all their SUVs. But I think what they mean is all the SUVs that have video screens, which is most of their SUVs. And that's not just Cadillac. That is all the GM SUVs.

That's like a million vehicles?

That would be around a million vehicles. I think the ones that have video screens today are about 250,000, and I am not sure what the percentage will be in a couple of years. Because that percentage, as you know, it has been increasing. Video screens are continuing to be a larger and larger percentage of new vehicles.

Okay. Also, you had mentioned with the Avis arrangement that there was a revenue sharing. Does that mean you are fronting the capital cost of installing into the vehicle and then also managing the DirecTV subscriber and just charging Avis a certain amount?

Yes, that is exactly what we're doing. So we are buying and installing the hardware, and then they are paying us per vehicle rental day.

Okay. And obviously the install isn't going to break the bank for Avis. Is this just a way for them to offload some of the risk of it -- let me put it this way -- if they were to move forward with this on a more broadbased approach, do you think they would continue to use that same template or would they simply buy the hardware from you and deal with the service on their own time?

The way the contract is written, both parties have the option to extend the current arrangement. So if we expanded it, it would go in this manner. So in other words, we would continue to do what we're doing now, which is providing the turnkey solution and then it becomes part of that vehicle, and whenever that vehicle rents, we get paid.

Got you. And so you're actually exposed to some degree because you are paying us service for DirecTV on a fixed basis and you don't know how much it is actually going to rent.

Exactly. So in fact the pilot was more for our benefit then for theirs. So we want to get a sense for what the rental utilization would be and make sure the economics work out. Because I think it is great from a promotional point of view, but we also want it to make money for us. And right now, it is looking pretty good, but it is still very early days.

And I assume it is probably too early to get any statistics, but at some point in the future, would you be able to tell us that the vehicle is rented at -- I don't know what even the statistical measure would be -- at a higher rate than a comparably non-equipped vehicle or how many days a month it's out on the road versus a non-equipped?

Right. The good thing about the current situation is that we're on all the vehicles of this type, which is the Hummer H3. So if you want a Hummer H3, you get it with a TracVision and we get paid.

Got you, very good. You had not talked specifically about the limo market, which has always looked very promising. I know recently you did a big trade show and introduced a model specifically for limousines. Can you give us any more details or outlook there?

I think that is going to continue to be a good market for us. And right now we are considering whether we should go into production with the embedded version initially developed for Cadillac for the limo market, because we have had a lot of interest from that market for that product as opposed to the bolt-on ones. So limousine may actually be the first market segment to get the embedded product.

Okay. And I have a couple quick numbers questions here. One is -- maybe this is for Pat. When you reported the year-over-year growth in the marine and land mobile, did those percentages include the service revenues that you used to segregate separately for providing TracNet service and others?

Yes, they do.

Okay. And with regard to the RV market, if I run the numbers, last year, you had a 65% sequential sales decline Q2 over Q1, and that was due to the big inventory fill that happened in Q1 of last year. But again, if I'm looking at this year, it almost looks like you have a similar order of magnitude decline here in the second quarter from what was a pretty good first quarter. Is that because the OEM market has just totally shut down or did you get too much inventory in the channel again, and is that the type of pattern we should look for on a go-forward basis, a strong Q1 and then softer the balance of the year?

I don't know if it is a pattern going forward, Chris. I don't know if it is the beginnings of a pattern. Last year was just as you said -- it was a significant inventory buildup by one of our largest customers and then bleeding that out over the course of the next couple quarters. This year we had another good strong first quarter with respect to RV, but it looked like it was a more normal pull-through from our customers. And then, as Martin noted in his remarks, the RV industry itself in terms of vehicles being sold and being built, especially on the OEM side, has been down fairly significantly on a year-over-year basis over the last several months.

So part of this is probably a natural adjustment to seeing those kinds of figures in the marketplace. But as I said, as far as looking forward, whether this is the beginning of a new pattern for RV, I cannot say that I know the answer to that yet.

And on the defense business, can you comment on -- in any given quarter, I know you have moved to a more of a quick turn, just in time sort of delivery with the military. Over the last year or two years, what percent of your business in any given quarter tends to be book-and-ship?

Right now, our goal is zero, so that part of our strategy for being a little bit more predictable is that we will only plan for revenue that is already in backlog going into the quarter. So in effect, almost the entire quarter is booked for our internal projections for what we expect our revenues to be.

See, my question is, it looks like you had a real good buildup in the backlog, and I know it seems like you must be understating the case here on the defense business because in the past you have had a decent amount of activity and certainly it tends to accelerate in the end of the fiscal year, which is your upcoming third quarter, where orders come in and move in the same quarter.

I understand your question now. The difference is that in the past, a lot of these orders were single shipment orders. What we're seeing now is that when we have big backlog it's for an annual production and things like these CROWS, we're making monthly shipments to them as they are built. So it's not like some of these NAV orders where we built -- shipped a single $2 million order all in one month or one quarter. So these backlogs you should really think of them as being spread out over longer periods than in the past.

And some of the big ones out there that you're still waiting on like the Selcom order?

Yes, they are still out there and there are some Mideast orders that are out there, so those are not included in the current backlog.

Very good, thank you.

Jim McIlree with Unterberg, Towbin.

Can you give us an update on the A5 channel partnerships that you have in terms of either the number of outlets that are currently signed up? And more specifically I'm looking at the composition, how that might have changed from specialty retailers to the chain stores to the expeditors.

I don't have an exact dealer count, but I don't think it has changed significantly. I think we've perhaps changed the composition somewhat. Initially, there were some of the very small, sort of mom-and-pop type stores that they started with. We've moved a little bit away from some of those outlets, consolidating a little bit with expeditors and distributors who might service some of those smaller accounts, which is a normal progression as the productline matures and the product becomes better known and easier to install.

We have not signed up any of the big box retailers yet, so that is still probably the next step or the final step in our distribution model. So we are still in that middle zone where we are selling to specialty retailers, some of the regional chains. I think overall we have upgraded our dealers. We were getting into a brand-new market for us, so there was a little bit of a learning curve in terms of who the good retailers are in each of the different markets geographically. So I think we have been sorting through that, and of course we have been adding the car dealers as well, so that has been an expansion of our dealer base.

Did you mention how many of the Cadillac dealers you have actually trained today?

I did not mention and I don't know the exact number, but I would say it's probably maybe the top 10% so far have been physically trained. We also have online training, which all the Cadillac dealers have access to through our dealer portal, which allows them to go in and view a step-by-step installation video and all that type of training. And I don't know how many have accessed that online.

Do you have access to the dealers that are making a hit (indiscernible) online?

Yes.

So you can follow up if you think it's appropriate?

Absolutely. We actually given them the password, so we know -- they have to do something in order to get in there, so we are in contact with them.

Okay, great. Thank you.

J.P. Mark, Farmhouse Equity Research.

Just a couple of quick questions. One is on the TracNet service and being a service operator. It seems as though that business has not really been as strong as you were hoping for. Where do you see that going over the next year or so?

Right now, we have just introduced a new product, the TracNet 3.0, which is being launched in Europe. And it really depends -- it's a little more geographic based is the answer to your question. Here in the U.S., we have actually discontinued the TracNet. The satellite service provider, which was Expressview in Canada, is discontinuing the service. And satellite Internet over here is not as popular as it is in Europe, so right now we're focusing on the European market.

For the marine market, we introduced three new products in the last 12 months, the Fleet Series, from Fleet 33, 55, and 77, which offer global broadband Internet coverage, and those products are selling well. And we are also selling the service for that, so we are an (indiscernible) at ISP, so we are selling both the voice minutes and the data -- what we call packet data service for the marine market. And that is becoming, I wouldn't say very significant, but a significant part of our business and we are looking for ways to expand that recurring revenue model.

What happened to the customers that you had in the U.S.? Did they migrate to somewhere else or do they not have service now?

The service is still available now. We have given them about an eight or nine months heads up that this was coming, and we have transitioned some of them to our Fleet product. And we also have a cell-based product for guys that are more local as opposed to global.

Also briefly, I knew in conference calls past you've talked about the current sensor. I noticed I got heads up from one of your shareholders who noted that ABB now has its own version of the current sensor, which looks a lot like yours. Did they basically take your idea and your product and then decide to do it themselves and leave you high and dry, or what's the status of that?

We are still working with them. They have a very -- the product that they have introduced is just a DC current sensor, so it's not actually the product that we're working with them on. So we continue to work on that at a low-level, but it is a little bit lower priority than some of the other things we're working on. But it is not dead. We just don't talk about it much anymore because it is not an immediate opportunity.

It sounds, though, as if ABB is making some noise about it and they think it's a big market, at least for their product (multiple speakers) --

It is a huge market. There is no question about it. I think that is why people continue to talk about it. The issue is that it requires an upgrade to the power stations in order to become a digital substation, in order to accept the input from a digital current sensor. And that is the issue from a market point of view, is that we have a great new digital current sensor, but there is nothing to plug it into because all of the substations are 50-year-old analog technology that are accepting meter inputs, analog meter inputs.

Okay, great. Thank you very much.

(OPERATOR INSTRUCTIONS) A follow-up from Rich Valera.

In past calls, Martin, you've talked about both the year-over-year and sequential trends in A5 shipments. Could you say if the A5 was up sequentially in the second quarter?

The automotive market for us was up sequentially, as well as year-over-year.

Great. And with respect to the prewiring that GM is doing, is there anything that is proprietary about that with respect to the A5 or in theory if RaySat or someone else had a product eventually, would it work for their product as well?

That is hard to answer because they've never shipped a product; I don't what their architecture. Sorry -- I really can't comment, and I'm not trying to be funny. I just don't know what they are going to do. But our product is pretty well-defined and that is the product that we -- that the current wiring and architecture is designed around.

But to answer your question, in the future, I don't see why anybody else could not work around whatever wiring is in the vehicle and connect something else. So I don't think the wiring, as much as we would like to make it proprietary, I don't think we realistically could, because our wiring is so simple. It is just a single coax cable going to the antenna.

Right. And Martin -- or I guess this is really for Pat, with respect to the 10% operating margin target, I think that you talked about for the middle of next year, can you say what that embeds with respect to broad risk on A5 cost reductions and where we would think that the A5 gross margins would be by that point to hit those types of numbers?

Yes. Overall, to achieve that type of performance we need to make additional improvement in gross margin generally across the board for the Company. Included in that model is a gross margin that is in roughly -- around 44%. The A5 is certainly a key portion of that improvement. The last we had talked about the gross margins for the A5, we had indicated it was in the low 20s. We have made a bit of improvement since that time. We are now in the 25 to 30% range.

And our intent is to continue to work on design changes and on material pricing reductions with our vendors that will allow us to continue to move toward our target for the A5, which is coincidentally also roughly at about 40% gross margin. And we see our way to be able to achieve that kind of performance over the next several quarters, so that is what we're working very hard to get to.

And would that presume prices flat at current level? There is no significant price reductions in the A5?

It does assume that there is not any really significant price change. Obviously if there were, then we may have to adjust our thinking relative to the model, but our long-term goal with the A5 and with any other product is to continue to work cost out of the products so that we are in a position, as competitive and market requirements dictate, to reduce prices and not see a material hit to the gross margins.

That is helpful. Thank you.

Gentleman, there are further question at this time. I will turn the conference back over to you for any final and closing remarks.

Great. Thanks very much for listening and, as always, we are available for private questions. Thank you.

Thank you. That does conclude today's teleconference and thank you all for your participation. At this time, you may disconnect.