KVH Industries Inc (KVHI) 2006 Q2 法說會逐字稿

Good day everyone and welcome to the KVH Industries second-quarter 2006 earnings conference call. 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. Please go ahead, sir.

Good morning, I am Pat Spratt, Chief Financial Officer of KVH Industries and with me today is Martin Kits van Heyningen, 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.

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 9, 2006. The Company's SEC filings are directly available from us, from the SEC or from the investor information section of our website.

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

Thanks, Pat. And thank you all for joining us today. As you've seen from our earnings release this morning we had a terrific quarter highlighted by record revenue, record net income and enthusiastic feedback on our new products. I'd like to start today's call with a recap of our second-quarter operations and discuss some of our plans going forward and then I will turn the call back over to Pat for the quarter's financial results. And as always, we will take your questions at the end.

So let's get started. During Q2 we achieved record quarterly revenue of $22 million, that is a 17% increase over last year. Net income rose 77% to a record of $1.7 million, which is $0.11 per diluted share. And we achieved these results thanks to continued strong sales in the marine market, growth in the both the RV and automotive channels and record quarterly sales of our fiber-optic gyro products. You should note that our $0.11 EPS for the second quarter includes approximately $0.02 per share impact due to stock option expenses.

Year-to-date total revenue was $42.3 million with net earnings of $2.9 million or $0.20 per diluted share. In our mobile communications group, we had record revenues of $16.8 million which is a 22% increase year-over-year. Year-to-date, mobile communications revenue was $31.1 million and that is a 12% increase over the first six months of last year.

The key to our recent success has been the introduction of a number of new products in the mobile communications market. New satellite TV systems like our TracVision R6 for RVs and our TracVision M3 for boats offer small, simple and powerful entertainment options to an increasingly broad audience of consumers who went live mobile media even while on the move. Our new technology together with our expansion into new segments of the mobile communications market is strengthening our position as the leading system provider connecting our customers to live content on their onboard video screen.

In Q2, we continued our recent trend of excellent sales in the marine market with revenue up approximately 23% in North America and 35% overseas. Our new TracVision M3, which is in its second full quarter of shipment, continues to be a largely incremental revenue driver building on our established foundation of larger marine antennas. The M3 was designed as the first stabilized marine satellite TV antenna fit for boats and the 25- to 40-foot range. These smaller vessels represent a significant untapped market segment. And the strength of M3 sales together without the limited cannibalization of sales of our other products indicates that we are successful seizing this opportunity.

A great example of this was yesterday's announcement that SeaRay, the world's largest manufacturer of inboard recreational boats, is offering the TracVision M3 on their 29- to 44-foot boats. SeaRay has been a valued customer of ours for many years and offers our high-performance TracVision 4 HP on boats 45 feet and longer. With the addition of the M3, SeaRay is now offering satellite TV to its smaller vessels for the first time while still maintaining its demand for our larger antenna systems. We're also working with the other small boat manufacturers and expect that a number of them will begin using the M3 to provide satellite TV to their customers.

In addition to expanding our U.S. market, we took steps in Q2 to broaden our worldwide reach with the addition of two Asian distributors for our consumer products. This expansion builds on the success of our existing marine satellite TV distribution network in North America, Europe, the Middle East, Australia and New Zealand. We're very excited about the prospects for growth in Asia, among both recreational and commercial marine sectors.

Sales in the land mobile market were also up rising 12% year-over-year spurred by growth not only in the automotive segment but also in the sale of products to the RV market. In the automotive market, the TracVision A5 continues to do well maintaining steady revenue growth trend and we're now working with DirecTV on some new programming and set-top box initiatives so we expect we will add additional functionality in the near future.

On the marketing side, DirecTV is now promoting the mobile market and KVH on their website. Links for programming and for marine, RV, and automotive purchase info now point directly to KVH's website.

But perhaps the best news in our satcom group this quarter is the turnaround in the RV market. Our aggressive productline overhaul and exciting new technology drove the resumption of year-over-year growth in the RV market a full quarter earlier than we expected. The RV segment has been tough for us recently and it's great to see it back on a growth path. We've now been shipping the TracVision R4 and R5 systems for two full quarters, while Q2 was the first full quarter of shipments for the TracVision R6, which is our new flagship product. We expect to continue this positive trend in the back half of the year even though Class A motorhome sales declined to 9% in May and 18% year-to-date through May.

So it's obvious our recent results have benefited from new product introductions. Fortunately we've got additional products in the pipeline. Now that we've revamped our marine and RV satellite TV products, we're focusing on broadband Internet technology highlighted by our new TracNet 100 Mobile Internet system which will begin shipping this quarter. This exciting new product developed in cooperation with Microsoft, offers high-speed Internet via MSN TV to our onboard video screen along with Wi-Fi access for laptop and other devices. Using the EVDO wireless broadband network, it complements our existing satellite based productline, takes advantage of the best technology and services for mobile Internet access.

We will be offering three different versions of the system, one each optimized for cars, boats or RVs and each system will include the TracNet 100 receiver, a wireless keyboard, signal booster amplifier for the cellular external cellular antenna and that's to ensure the best possible service and to give extended range for our customers. In addition to the retail launch this quarter, we're also in discussions with RV, marine and automotive OEMs regarding the sale of TracNet as a factory option. Other new products are also making their way through the pipeline, both for introduction later this quarter as well as over the next six to eight months.

Turning to our defense navigation business, our fiber optic gyro group continues to perform extremely well and had another great quarter. Quarterly sales of our fiber optic gyros topped $2 million for the first time. That's an increase of 39% from Q2 of last year. Overall, Q2 defense revenue, including our tactical navigation systems, was up 3% to $5.2 million. But year-to-date, defense revenue was $11.1 million and that's a 26% increase over the first six months of 2005.

Our strong growth in the fiber optic gyro market is being driven by the broad acceptance of our DSP FOG technology for a range of critical applications including major defense programs such as the U.S. Navy's Mark 54 torpedo which uses our TG-6000 inertial measurement unit and stabilized remotely operated weapons systems that rely on our DSP-3000 FOGs. Now these programs are now in full production and they are fully funded. In fact, production of the weapons system is actually accelerating due to urgent requirements in Iraq driving additional increases in FOG revenue in the future.

We are now involved in a major new product development cycle for our defense business in an effort to refresh our productlines as we did in the marine and RV satellite markets in order to increase the value we offer to our defense customers. For example, we're currently working on a development contract from the U.S. Army to provide prototypes to the secured text messaging communication system for truck convoys. These new products can work with our TACNAV system or they can be used as a low-cost stand-alone product. Our integration of navigation and communication offers some very interesting possibilities. Although sales of TACNAV systems were below last year for Q2, we're expecting substantial orders from existing customers prior to year end.

In addition, we're working towards leveraging our satellite business experience by developing militarized satellite communication systems. By transferring our proven commercial technology into mobile military applications, we are well-positioned to bring small affordable high bandwidth antennas suitable for military vehicles to market.

So in conclusion, we had a great second quarter with record revenue and stronger earnings. Nearly all parts of the business are performing extremely well. Our new products are making significant contributions and receiving strong interest from consumers and OEMs alike. And we have several new products that will be hitting the shelves later in the third quarter as well as more in the pipeline. So we expect that these efforts will help drive the long-term trend of profitable growth.

And now I'd like to turn the call back over to Pat to fill you in on some of the numbers. Pat?

Thank you, Martin. The second quarter results were very positive and better than our expectations in many areas. As was the case during the first quarter, we experienced the benefit of having several new products in the market and this coupled with the strength of demand for our existing productlines led to a very satisfying result.

In the second quarter, we achieved solid year-over-year improvement in operating margin. At 6.4%, it was more than a full percentage point better than the second quarter last year. And this includes the 2006 impact of stock option expense that totaled approximately $233,000 for the quarter. We continued to make good progress toward achieving our objectives for a higher level of sustainable financial performance.

Now looking at the details for the quarter, gross margin was just above 39%. This was slightly below our expectations and was down compared to both last year and the first quarter of this year. This percentage decline was primarily driven by the shift in mix away from our relatively higher margin tactical navigation products and a greater-than-anticipated increase in sales of RV products. Yet overall volume drove -- excuse me. Yet overall, volume drove a year-over-year increase in gross profit dollars of more than $800,000 or 11%. We will continue to aggressively work to improve our operations efficiency and to use lower cost sources for selected product components. We anticipate that these actions will result in a positive long-term benefit for future gross margins.

The second quarter cost of goods included roughly $27,000 of stock option expenses. For Q2, operating expenses were up 5% or less than $400,000 compared to last year and represented 33% of sales. About $206,000 or 1% of sales was recorded for stock option expense.

For the second quarter, research and development spending was about equal to last year. This Q2 level was 9% of revenue and it was a little below our run rate target percentage due to the seasonal strength of the Q2 revenue. Sequentially, engineering expenses were a bit lower due to the fact that during the first quarter we were in the final stages of launching our new TracVision R6 product.

Second-quarter sales and marketing expenses increased only 2% year-over-year and were down compared to the first quarter. This is the result of successful efforts to be both more effective and efficient across all markets. At 16% of revenue, this spending level was more than 2 percentage points below Q2 last year. However, we will continue to be aggressive when it comes to taking advantage of market opportunities and new product introductions. As a percentage of revenue, future quarters will reflect variability as we continue to grow and adjust to market conditions and if sales patterns reflect seasonal changes.

Second-quarter administration expense again increased substantially year-over-year. At $1.8 million this was up 20% compared to last year although it was down 5% sequentially. Two factors contributed to the year-over-year increase, ongoing legal expenses related to litigation activities and the impact of charging nearly one-half of the Company's total stock option expense to administration. We will likely see administration expenses continue at a relatively high level for the near term.

Turning to the balance sheet, cash and investments at quarter end were $54 million, up nearly $4 million compared to the first quarter. Cash flow from operations exceeded $4 million in the quarter. Two of the key drivers of the positive cash flow profile were earnings and sound asset management. At $11.4 million, the accounts receivable level was down sequentially by approximately $300,000 even though sales grew sequentially by 8%. Days sales outstanding was 47. Inventory also declined sequentially by almost $200,000 to $7.4 million. Inventory turns were up strongly to 7.1 annualized. This level is well above our minimum objective and reflects many initiatives across the Company to further improve our lean operating processes and provide even better service to our customers. Across the board, asset management has been a strong point for the Company and it gives us the financial basis for being aggressive going forward.

Now I'd like to review our outlook for 2006. First I'll address the year and then take a look at the third quarter. For the full year, we are raising our guidance for both revenue and earnings compared to what we had provided in April. We now expect revenue will grow in the range of 12% to 15% for the full year. We experienced a stronger than expected first half especially in the areas of mobile communications to the marine and RV businesses. Sales for automotive and fiber-optic products have been on track with our expectations. For the remainder of the year, we expect that military tactical navigation sales will remain near the level we saw in Q2. Although our June ending backlog for the defense business was down to about $5.5 million, we anticipate that there will be a meaningful increase in the backlog position toward the end of the year. Our confidence level has increased with respect to selected program awards that should be scheduled to ship during 2007.

For the year, our earnings guidance has also increased from what we said previously. We expect GAAP earnings per share to be in the range of 33 -- excuse me -- in the range of $0.30 to $0.33 including approximately $0.06 to $0.07 of stock option expenses. This is up substantially from our prior guidance of $0.24 per share.

For Q3, we expect that total revenue will show solid year-over-year growth of approximately 12% to 15%. The mix will change quite a bit compared to Q2. We expect that defense sales will be down modestly on a year-over-year basis although they should increase sequentially. It's important to note that when comparing to the second half of 2005, that period represented one of the highest levels of defense revenue we have ever had driven in large part by military navigation product sales which generally show an uneven pattern. Sales of fiber optic products are expected to continue to be strong.

For mobile communications in Q3, we expect to see a continuation of solid year-over-year growth that should be about in line with the greater than 20% growth that we experienced in Q2. We expect that marine sales growth will be strong compared to last year but that the absolute revenue level will be well below the second quarter of this year reflecting normal seasonal patterns. We anticipate that sales of land mobile products will also show solid year-over-year growth in the quarter.

Given the shift in sales mix that this projection represents, we expect the Q3 gross margin will be about equal to the second quarter or below 40%. We expect that gross margin will recover somewhat in the fourth quarter. We will work to hold the line with operating expenses and expect to show only a modest sequential increase in Q3. Given these assumptions, we anticipate that EPS for the third quarter will be approximately $0.05 per share on a GAAP basis. This estimate includes approximately $250,000 of non-cash stock option expense or $0.02 per share.

In conclusion, we are pleased with our overall progress and by the market acceptance of our new products. We will continue to maintain strong investment levels for future growth while also striving to maintain an appropriate degree of business flexibility and improving financial performance.

Now we'd like to take your questions. Julie, please open the call for questions.

Thank you, sir. (OPERATOR INSTRUCTIONS) Mike Hickey with Janco Partners.

Congratulations on your quarter. Just a question on your car broadband, who exactly are you going to be shipping that to? Is that the same dealer network that we see with the A5? And what sort of impact do you expect that to have on sales and marketing for the next quarter?

Well, the first question, we're shipping not just to the A5 dealer network. It's really a three market product so it is kind of unique. In fact, it is really the first product that we've had that we expect to be able to sell to all three of our channels, the RV, marine and automotive. There's also a possibility because it is smaller and easier to install that it would actually go into a broader distribution in the automotive market because it doesn't require the same level of installation expertise that the satellite TV products do.

To answer your question about the impact on sales and marketing, we don't disclose specifically individual programs. But as I mentioned in the guidance, our intent is to fairly tightly control our operating expenses for the quarter and we've got the launch expenses from a sales and marketing perspective for this new product encompassed in that guidance.

Okay. And then on the defense side, with the new product introductions in the I'm guessing the next six to 12 months, do you expect that to impact your R&D? Or -- obviously we saw a sequential and year-over-year decline in R&D. Can we expect that to go back to normal growth patterns?

Let me answer that one. Some of these new products are funded by our customers so it actually doesn't show up in the R&D expense line. So that is one of the nice things about developing a defense product.

Okay.

Another factor in part to again, help with the answer to the question, we've said pretty consistently, Mike, that our intent is to manage R&D to be in the range of 10% to 11% of revenue and it will grow with the growth of the Company. And so our intention will be to continue to grow those investments over time as the Company grows.

Okay, thanks, guys.

Tom Watts with Cowen.com.

Congratulations on the record quarter. First just a couple of detailed questions. Pat, could you give us D&A expense and also break out the stock option expense by line item?

I can if you give me one second. The depreciation and amortization expense was 533,000 -- excuse me -- $533,000 for the quarter and I have to look here for the stock option expense. So, Tom, if you have another question, why don't you ask that and I will --

Sure. And then also it sounds like gross margins may be a little bit lower in Q3 so will it be difficult -- you'd originally hoped to get gross margin up a point year-over-year for the full year. It sounds like that will be difficult to do without a strong rebound in Q4. And how should we think about gross margins in out years?

While Pat is looking for that, I will take a stab at the gross margin. We expect this quarter, as Pat said, to be about the same as last quarter. And that is partly due to again some new product introductions. Typically the first quarter is a little bit lower than where you'll normally end up. So we don't see any structural change that will prevent us from getting to our target. It is just as Pat mentioned as well, as the mix changes quarter to quarter you may see some anomalies but there has really been no change in terms of our ability to get to our gross margin targets by business segment.

Okay.

Tom, back to your question about the stock option expense by functional group. I mentioned that in the cost of goods, I was $27,000 for the quarter; sales and marketing $33,000; R&D, 59,000; and G&A, $114,000 and that should add to about $233,000.

Okay. And then it sounds like both your marine and the RV segments were quite -- were generally strong. Are we seeing a rebound in the underlying industries there? I know that we saw some slowdown with the higher interest rates. Is growth looking better underlying or is this just increased penetration of your new products?

I think we would have to say it's increased penetration. So if you look at the RV market, the rate of decline seems to have slowed. The last numbers I saw were for May and new RV Class A shipments were down about 9% but that is actually less than it has been. I think it was down about 18% for year-to-date. So that could be sort of flattening out a bit. But the thing to remember is that these RVs -- we're actually adding to the installed base so even though the rate of addition is small, most of our sales come from the aftermarket as opposed to the OEM side in general for all our products. And that helps us to be a little bit less sensitive to the actual new vehicle sales for example for SUVs, new boat sales, or RV sales. But to get back to your fundamental question, we don't see any big improvement in the markets per se. We just see increased demand for our products.

Okay. And then finally just as we look out to '07, what other new products should we think about being on the horizon, new product introductions?

Well, we can't tell you what we are doing in '07. So no new products that we've announced but you should see some products announcements this quarter that should help us significantly in '07.

Okay, thanks very much and again a great job.

(OPERATOR INSTRUCTIONS) Chris Quilty with Raymond James.

Good morning, gentlemen. Just a clarification on a couple of numbers. The earnings guidance you provided I'm presuming that is with no tax? 0% tax rate?

It's minimal tax for us. Again, the taxes we currently pay are on the profits we earn in our European operation and then if there is any alternative minimum tax which is typically fairly small.

Okay. And I think you gave marine growth by geography but can you give us the overall growth rate for the marine?

The overall growth rate for the marine on a year-over-year basis was about 28%.

Okay. And can you give us a sense of with a couple quarters under your belt on the M3, is that kind of like 10% of the sales mix or where do you think that as a product offering can go within the marine group over the next year?

Well, as we do with the A5, we don't like to break out individual products. But it certainly has a lot of growth potential in the various segments. I think the announcement yesterday from SeaRay is very exciting because the boat market is very much like the typical pyramid. As you go down in size, the volumes get larger. So we see a lot of opportunities for that product and we're very excited about it, doing very well in the market. And it's not just the smaller antenna, it is a very well conceived product concept in that it for the first time it sort of includes everything you need right out of the box including the DirecTV receiver and we're getting 100% of the activations as well. So we're getting activation credits from DirecTV. So and for the marine dealer base, it allows us to sell to dealers that normally companies like West Marine that in the past have not been big dealers of ours because of the complexity of installation, this is much simpler. It's a single cable, single box so they are able to install it or consumers themselves install even.

Okay. Switching gears over to the automotive. You had mentioned with the TracNet product that you think there is an opportunity to go directly towards the OEM market. Is there anything that would give you confidence that you'd be able to make that entry given all your efforts to date on the A5 have been unsuccessful?

Well, we've had good feedback from OEMs on the product. So I would say that the efforts with the A5 have taught us that it takes longer than we thought. So I think the same pattern would be true here. That it is not a quick entry into the OEM market. And when I say OEM, I'm not just referring to the automotive though. Keep in mind that we do a lot of OEM business in the RV market and in the marine as well.

Okay. And you had mentioned on the product announcement about $1000 price point. Has anything changed with that? And can you give us an idea of how much commonality there is in the components of that product and other products that you make that you might be able to leverage some volume and cost reduction as the thing begins to ramp?

Right. I think there has been change in the product costing. We are now bundling it with these amplifiers and external antennas. Because we got feedback from the market that again they want sort of a complete system solution. So we will be announcing the price points for the various markets. But it will be a different bundle than we originally envisioned. There's a lot of commonality within those three product categories but there's not a lot of commonality between the other products we make with the exception possibly of the integrated receiver for the automotive market because it sort of looks like a set-top box. So there is commonality with that.

Okay. Who are you using for the cellular amplifier?

We are I believe using Digital Antenna. That supplier or it could be Wilson, we've tested both. I'm not sure we've made a final decision on that but I think it is Digital Antenna.

Okay. And switching over to -- oh, one final question on the automotive market. Any progress you've seen on the limousine channel?

Nothing out of the ordinary. We do attend some limousine trade shows and markets in that category. But no -- nothing substantial there.

Okay. And final questions on the defense market. The FOG productline seems to be showing some pretty steady growth. Given the fact that you got a production program on the market before and it looks like fairly steady production on the CROWS program. Is it fair to assume that most of those revenues now kind of appear as recurring revenues for you?

Yes, recurring as opposed to --?

Like the TACNAV business where catch is catch can with the orders.

Right. Yes, so I think that what has happened is we now have a really good base business and that the normal product growth is really on top of that base so you see a nice steady business and then layering a new contract award on top of that.

Okay. And with the TACNAV you had indicated that you expect substantial orders by year end. Is that based upon indications from customers and knowing that they have funding?

Yes.

Okay.

Yes, and also it is from customers -- some of our customers build vehicles and they have production schedules that they've shared with us. So we have better visibility now which is why we made that statement so they actually have a production schedule showing when they are starting production of vehicles and we know that we are on those vehicles. But we don't have the order.

Okay.

That is where that confidence comes from.

Chris, if you have several more questions, if you could, if we could allow somebody else to ask a few and if you wouldn't mind getting back in the queue unless you're right at the end.

That was it.

James McIlree with Unterberg, Towbin.

Thank you, good morning. Do you need to -- in order to make your defense revenue estimates, do you need to get revenue from any new products or is that solely from the existing productline that you have?

For the guidance that we've given, we're assuming no new products.

Is there any shot that some new products would show up in second half of this year?

If it did, it would be part of an urgent operational requirement. So that would be the only way that could happen this calendar year.

Okay.

So the orders that we are expecting are for existing products, not for new products that aren't qualified yet.

And you did mention in your commentary something that you are working on that would have an urgent operational requirement associated with it? That was the text messaging for truck convoys, is that correct?

That could be one and also we see an increased demand for this CROWS which is the crew station remotely operated weapon system that's going on Humvees that are in Iraq. And that program has been accelerating on a regular basis due to these urgent operational requirements.

Okay. Relative to CROWS, I saw something recently saying the Army was looking at remote operated weapons for the future combat system. Would you have any involvement in that?

Yes, there are a number of programs that they're looking to add capability to now and we are actively working with all the various manufacturers who build those systems. They are also talking about the M1 tank and a number of other platforms.

Okay. And Pat, I don't want you to give me the hook, so just two more. Why is it operating expenses go up in Q3 with revenues going down versus the prior quarter?

It's just really a function, Jim, to some extent to seasonality of trade shows and various programs that we are involved in, some of it is the launch related to new products. That question was asked earlier as to whether we had that -- how that would affect sales and marketing in the quarter. And we have it encompassed in our guidance but as Martin said, we do have a few new products that will be coming to market this quarter so it includes that. And when you look at administration, as I mentioned the factors that are going on there, that is mostly fixed at this point and so there really isn't a lot of variability there.

And from an R&D standpoint, speaking about that lastly, that is one where it can vary a little bit quarter to quarter but we are looking at managing our R&D on a long-term trend line to grow with the Company and so consequently we're not going to take it up and take it down each quarter as the revenue changes a bit. A lot of it is related to the fixed structure of the makeup of the operating expenses but also to the launch of new products primarily.

Okay. And then lastly, was there a significant channel fill for the R series during the quarter? Was part of the revenue strength that you saw merely due to filling a channel?

Yes, I think that is always true when you launch a new product. And so even though we started to ship the R6 at the very end Q1, a lot of what we shipped in Q2 were orders that had already been placed in Q1 as well as orders that were being placed in Q2. Having said that, the R4 and 5, this was the second full quarter for those products so there was zero channel fill for those products. But we've taken all that into account and we expect to see strong year-over-year growth in the RV market segment in Q3.

Great. Thanks a lot.

Rich Valera with Needham & Co.

Thanks. Pat, first a quick one. Did you give the CapEx number for the quarter?

I did not. It was approximately $918,000.

Great. Just getting back into the defense sort of order pipeline, I think last quarter you talked about the potential for several large defense orders to come in the second half. It sounds like one of them you're talking about is a TACNAV order which you have a good amount of confidence will come. Maybe there is also a CROWS order in there. Is there anything else besides the potential large TACNAV and CROWS orders that is sort of in that pipeline of potential large orders for the second half?

Yes, there is sort of two. There is two different TACNAV orders that we are expecting so really -- and those are our two main product lines for the defense side. And those are out of the ordinary orders in terms of -- what we've seen recently has been sort of a steady pattern of smaller orders that we normally don't announce because they are less than $2 million. So the backlog that we have in place now has been a series of small orders. So we continue to expect those to come in.

Great. And Martin I think you mentioned in your prepared remarks that you expected to continue to see sort of A5 growth here going I think into the second half. But could you just give sort of comments -- I think you saw a couple quarters or at least one quarter where you actually saw sort of down year-over-year growth in the A5 -- or it was flat or down. I think you alluded to the fact that you actually had some year-over-year growth this quarter. Can you put some words around how you see the trend for that product? I mean it doesn't same like it has grown a lot here over the last few quarters. Do you see that materially changing here over the next year or so?

Well, I think that what we've seen has been -- we describe it as steady growth. And so that over time it continues to be a significant part of our revenues and as the company grows, it continues to grow along with it. I think like any of our channels, we are looking to add more products. Right now we have one product for that market which is always difficult. It's difficult to be a vendor that sells one product so the addition of the TracNet product I think will help. A lot of our customers want both. They don't want just satellite TV but the combination of satellite TV and Internet together. Kind of pushes them over the hump. Meaning that they take action and like to buy the product.

So I think our strategy there is to continue doing what we are doing, improving the performance of the products, adding new products, adding different categories of products and we are very confident that that channel could be successful for us. There is nothing that we are seeing that has changed our mind that this isn't going to be a good product in the product category for us.

Great, thank you.

(OPERATOR INSTRUCTIONS) Greg Weaver with Kern Capital.

What percent of revenue in the quarter was marine?

For the total Company or for the communications business? Let me -- I can give you both. For the total Company, marine represented about 50% of the revenue and for the communications business, it was about two-thirds.

Okay. So other than marine, nothing is declining in Q3 versus Q2, right? You said defense was up. RV is up.

Yes, we are expecting that -- marine is the business that has that seasonal pattern to it where it declines in the third quarter otherwise we are expecting to see growth.

And remind us again what the historic pattern has been Q2 to Q3 sequentially declining revenue?

It is not the same every year and there is new products involved this year as well. But looking back the last few years, Greg, the first half of the year has typically represented 55% to 60% of the total revenue for marine for the year.

Right, but the Q2 to Q3 -- I mean you shouldn't kind of average that figure but --

Well, again it tends to step down significantly from the second quarter to the third quarter and then the fourth quarter is either growth year-over-year obviously but not necessarily reflecting much change from the third quarter.

All right. Okay. And do you expect any type of material TracNet revenue in the current quarter in terms of any kind of initial orders there?

Well we do -- we can't disclose exactly what we have in the plan but we do have TracNet revenue built into our expectations and our guidance.

Okay, would you characterize it as material or its just kind of a starter thing?

I would say it is not material.

Okay. And then I guess just lastly for me, did DirecTV -- I know you mentioned Mark about them pointing you to your website -- I mean -- I guess that's only been going on for a few weeks, right? Is it kind of too early to tell how that might impact your A5 opportunity?

I think it helps significantly on the A5 but the nice thing about what they've done is that if you do anything -- they have the programming package now so if you select the programming package, it gets you the mobile page or if you go to the mobile page directly, it lists all three markets. And for each one of those, if you click on where to buy, there is only one link and it goes directly to our website. So it is good, not just for the automotive but for the other markets as well.

So you can get some real-time feedback there obviously if there's any type of orders. Can they order direct or you just recommend you go to some particular channel?

What we do is we go through our dealer channel but we can and do track our Web traffic by referral. So I haven't seen the report on that since they've made that change but we are tracking that.

Okay, thanks. Nice quarter.

Chris Quilty with Raymond James.

Just a follow-up on the defense orders you talked about earlier. Is it fair to assume these are both domestic orders or do you have anything international?

They are international and partly international meaning that domestic company for international customer in one case, international customer in another case. And one is just purely domestic. So of the three big ones that is the pattern.

Okay. And you mentioned that in one case customer is producing a vehicle in a known production schedule, does that imply that that TACNAV is going to be speced into a vehicle and you're going to get some regular production?

Yes. Yes, it is speced in and so it is an order that has a very high probability. It is just that as you know with the defense business, the timing is the part that is always tough to pick.

Okay. And I guess my final question just with the new Asian distribution, does that imply a need for perhaps some higher inventory levels for product availability?

Not materially so. I think that normally our distributors stock inventory locally so it should be -- if there is an increase in inventory it would be sold inventory by us to the distributor and he would keep it locally. That is all our distributors do.

Okay. Great. And congratulations on the quarter again.

Julie, do you have any other questions?

Yes we do have another follow-up question from James McIlree with Unterberg, Towbin.

Thank you. I'm a little bit confused on the defense outlook. I think you characterized the CROWS and Mark 54 as kind of this steady recurring business and then you've also said that the TACNAV you have these kind of smaller orders that leak in that's kind of steady also. But then you are looking for these big orders to come in. So why wouldn't the defense business accelerate from current levels?

Well the 5 will accelerate from current levels. The TACNAV business, the orders that we're talking about we expect to be in backlog by year end. We didn't necessarily expect them to be shipping by year end. So that might be the confusion there.

Oh, I see. So if they come earlier then maybe you get some revenue this year?

Right, that would be incremental. But the guidance that we have given assumes that steady-state on TACNAV business growth in the FOG business so that is sort of the general outline because as you know because the timing is difficult to predict, we like to sort of concentrate on what is in backlog for the current quarter than give more temperate outlook for the out quarters since the timing is often variable.

So does that imply then that 2007 could be a pretty good year for the defense business if you continue with the steady-states, steady-state business with FOGs and TACNAVs and then you get these larger TACNAV orders and larger CROWS orders out there?

Yes, we would expect that 2007 on the defense side would be substantially better than 2006.

Okay. That is great. Thanks a lot.

Rich Valera with Needham & Co.

Thanks. Pat, just wanted to make sure I have the year-over-year growth rates right for the land mobile business and the marine in total. Were those 12% and 28% respectively?

The land mobile business grew 12, correct. And the marine business grew 28, correct.

Okay, thank you.

It appears that we have no further questions. At this time I'd like to turn the conference back over to our presenters.

Great, well that's it from this end. If you have any additional questions, feel free to call us directly. Thank you.

That concludes today's conference call. Thank you for your participation and have a great day.