KVH Industries Inc (KVHI) 2006 Q3 法說會逐字稿

Good day, everyone, and welcome to the KVH Industries' third-quarter 2006 earnings conference call. As a reminder, 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.

Good morning. I'm Pat Spratt, Chief Financial Officer of KVH Industries. With me today is Martin Kits van Heyningen, President and CEO. This call will address the third-quarter earnings release that we issued earlier this morning. Copies of the release are available on our 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 August 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 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 can see from our earnings release this morning, we had another solid quarter, highlighted by strong year-over-year revenue growth, continued profit, and the launch of several exciting new products. I would like to start today's call with a recap of our third-quarter operations, discuss some of our plans going forward, and then I will turn the call back over to Pat for the financial results. As always, we will take your questions at the end.

During Q3, we achieved quarterly revenues of $19.3 million. That is a 15% increase over last year. Earnings were $0.04 per share, including approximately $0.02 per-share impact due to stock option expenses. Year to date, total revenue was $61.5 million, with net earnings of $3.6 million or $0.24 per diluted share.

We achieved these results thinks to continued strong sales in the marine market, growth in the land mobile market, and record quarterly sales for our fiber optic gyro products.

We also evaluated acquisition opportunities and incurred approximately $300,000 or $0.02 per diluted share in professional fees in connection with our pursuit of one such opportunity that arose in Q3. Although we ultimately decided not to complete the transaction, we do intend to be proactive with similar opportunities in the future if we believe they will strengthen our competitive or technological position and offer real value for our shareholders.

In our mobile communications group, we had a strong year-over-year growth, with revenue of $12.9 million. That is an 18% increase from Q3 of last year. Year to date, mobile communications revenue is $44.1 million. That is a 13% increase over the first nine months of last year. Most importantly, that growth was fueled by increased sales in both the marine and land markets.

As you know, we embarked on an aggressive product line overhaul last year. Beginning with our marine products, we phased out older systems, streamlined our product line, and introduced new technology to offer increased capabilities and greater appeal. Our results illustrate that these new products are gaining traction and helping to drive solid sales in each of our mobile communications markets.

In the marine market, we continued our recent trend of excellent sales, with Q3 revenue up approximate 12% in North America and more than 40% overseas. Our international sales effort, which is managed out of Denmark, continues its outstanding performance, as it draws on our traditional sales to Europe and the Middle East, as well as our new distribution channels in Asia, which we announced last quarter.

Here in the U.S., our TracVision M3 continues to be a solid addition to our marine product line, generating incremental sales in support of our larger satellite TV system. The M3 is a fully-stabilized TV antenna and the first to be designed for boats in the 25 to 40-foot range.

Dealers and customers are giving the M3 rave views. Members of the marine press who tested it are actually amazed at its performance. A new section on our website at KVH.com provides easy access to these reviews and other media coverage of all our new products.

Sales in the land mobile market were also up during Q3, rising 16% year-over-year, spurred by renewed growth in our RV business. This again is a clear indication of the appeal of our TracVision R-series antennas. These new systems include a more robust design, more versatile operation than competing systems, all at a comparable price.

For example, all of our TracVision R-series antennas can switch from one satellite to another simply by changing the channel using the remote control, even while the RV is driving. Competing systems require you to pull over, park, and put the antenna into sleep mode before you can switch satellites, something customers don't find very convenient.

Our retailers and customers are recognizing that our new TracVision R-series offers the best combination of price and performance in the market. As a result, we are steadily gaining ground in sales, even as shipments of Class A motorhomes are down almost 18% for the year, according to the Recreational Vehicle Industry Association. Hopefully, the recent drop in gasoline prices will help the RV manufacturers rebound.

Our marine, RV, and automotive sales channels are also offering our new TracNet 100 mobile Internet system, which was developed in cooperation with Microsoft and began shipping in August. This exciting new product brings high-speed Internet access via the MSN TV service right to the TV or video screen in the vehicle or boat. Plus it includes an integrated WiFi hub to offer wireless access for laptops and other devices. Using the EVDO wireless broadband network, the TracNet 100 complements our existing satellite product line by offering easy, affordable mobile Internet access.

Now of course, the big news during Q3 was the introduction of our new TracVision A7 automotive satellite TV system. The A7 is a successor to our award-winning TracVision A5, which has been bringing DIRECTV to automobiles for more than three years. The A7 offers a wide range of improvements and additions. This substantially enhances performance and capabilities. These improvements include a new automotive-grade exterior finish, different color choices, virtually silent motors, improved tracking, and even more rugged and durable design.

However, it is the addition of local channel to the A7 programming lineup that has dealers and consumers most excited. Local programming is tremendously appealing to our customers. In fact, the ability to receive local network channels is one of the most important features people have been asking for since we first introduced the original A5.

It is not hard to see why. With local channels you have access to local news, weather, and traffic. Passengers are able to enjoy network programming. So even if you're lost in the car, the folks in the backseat can stay occupied by watching Lost on ABC. With the baseball World Series and college and pro football upon us, the ability to turn on the game makes tailgating and weekend travel that much more fun.

So we listened to what our customers wanted, and we worked closely with DIRECTV to satisfy the technical and legal requirements to do this. Live, local TV programming on the go is made possible by the A7's integrated GPS system and a new mobile receiver that we developed in cooperation with DIRECTV, to enable the local programming for your particular television market. The TracVision A7 is also now capable of switching among three different DIRECTV satellites on the fly, for a complete slate of national and local programming.

We are very excited about the early feedback on the A7. This new system strengthens our leadership within the automotive entertainment market. While other companies are still trying to figure out how to offer live TV in the car at all, we have already created the next generation of mobile satellite TV technology. Together with DIRECTV, we're working aggressively to take advantage of that competitive lead.

Now turning to our defense business, our fiber optic gyro group continues to perform extremely well and had another great quarter. Quarterly sales of our FOGs topped $2.8 million for the first time. That is an increase of 75% from Q3 of last year, and it's a 36% sequential increase from our previous record set just last quarter.

Overall, Q3 defense revenue, which includes our tactical navigation systems, was up 10% to $6.4 million. Year-to-date defense revenue was $17.5 million, and that is a 20% increase over the first nine months of 2005.

Our strong growth in the fiber optic gyro market is being driven mostly by sales of our DSP-3000 fiber optic gyros for programs like the U.S. Army CROWS program. As you know, two of our fiber optic gyros are built into every stabilized weapons system produced by Recon/Optical, the U.S. military's primary provider of these systems.

During the recent Association of the Army Show in Washington, (technical difficulty) an opportunity to see firsthand the number of vehicles and applications that our proposed to use the CROWS technology. I'm very optimistic about the long-term value of this program and others like it.

In fact, the U.S. Army now has a solicitation out for 3,400 systems at two gyros per system. This is an opportunity -- a potential program of up to about $25 million for KVH.

In addition, we just received notification yesterday that the U.S. Army Tank and Automotive Command -- of an intent to award a sole-source contract to KVH to procure our TACNAV systems for several versions of the Bradley Fighting Vehicle. While we haven't receive the formal order yet and there is no guaranteed minimum value, this contract could potentially been worth several millions of dollars. We will provide more information on this opportunity in the future, hopefully after we receive the order.

As I mentioned on our last call, we are also looking to develop new products to address additional military market opportunities and challenges. One such challenge is the U.S. Army's inability to command, control, and communicate within truck convoys in Iraq. These convoys include as many as 100 vehicles and stretch for many kilometers. Surprisingly, most convoys are lucky if they have two or three vehicles equipped with even basic navigation or communication technology.

The result is that it is virtually impossible for vehicles in one section of the convoy to know what is happening elsewhere; or for a commander to organize and lead in the face of dynamic situations, whether it's a mechanical failure of a vehicle or an ambush by insurgents with improvised explosive devices.

The Army has identified the convoy issue as a major operational gap. Our new intra-convoy communication system closes that gap reliably and affordably. At its core, our convoy comm system is simple, easy to field means of communicating among all the vehicles in a convoy.

(technical difficulty) convoy members in Iraq using rugged PDAs with color touchscreens, icon-based messaging, and audible alerts. Signals are sent using secure radio data bursts via an ad hoc network radio modem. This approach eliminates the need for typing, cuts out unnecessary voice chatter, and links every message sent to that specific vehicle's ID.

In addition, it can interface with our TACNAV products or with the MTS, which is the Movement Tracking System, or the FBCB2, which is the Army's digital battlefield system.

So, using our convoy comm system the convoy commander can assess the status of every vehicle. Convoy members can alert the rest of the convoy to ambushes or other threats, as well as confirm that they have received every message. And all this happens in real-time. The result is a significant enhancement in situation awareness, and it's affordable enough to fit on every vehicle.

The development of our convoy comm system is being funded by development contracts in the U.S. Army. In addition, we're working directly with soldiers who have just returned from Iraq, so our solution is based on their needs assessment and feedback.

Last week we showed the convoy comm system for the first time at the AUSA conference in Washington. We have now started formal testing on an evaluation program within the U.S. Army.

So in a functional convoy comm system like this has tremendous potential both among Army units as well as private contractors such as those firms supporting the military reconstruction overseas. This is a major new initiative for KVH, and one that brings together our core navigation and mobile communications experience. You can check out our website. We have got a great flash demo of this product on our website there, on the military section.

So in conclusion, we had an excellent third quarter with strong year-over-year growth in revenue, driven by increased sales in each of our core markets. Our product line overhaul is already showing great results.

As the introduction of the TracVision A7, TracNet, and convoy comms illustrates, we're not done yet. We are ramping up these new products while we continue to move more new technology through the pipeline. I believe that all of these efforts will help drive KVH's long-term trend of profitable growth.

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

Thank you, Martin. The third-quarter results were quite positive and in line with our expectations, despite some unusually high expenses which I will come back to later.

During the quarter, we continued to see the benefit of our ongoing new product cycle across each of the mobile communications businesses. We also experienced the normal seasonal changes in the marine communications business. This in turn contributed to the expected sequential decline in operating margin.

The impact of stock option expense was approximately $364,000 for the quarter, about $140,000 higher than the second quarter. The increase was the result of outstanding annual option grants to nonexecutive employees and directors.

Overall, we're pleased with the progress that we continue to make toward achieving our objectives for higher levels of sustainable financial performance.

Now, looking at the details for the quarter, gross margin was just above 39% and modestly better than the second quarter. Although this was about 3 percentage points lower than last year, it was in line with our expectations.

This year-over-year percentage decline was primarily driven by the shift in mix away from our relatively higher-margin tactical navigation products; also by new product introduction costs; and by more aggressive pricing for our RV products compared to last year. Yet overall volume growth drove another year-over-year increase in gross profit of almost $500,000 or 7%.

We anticipate that ongoing programs to improve efficiency and use lower-cost suppliers will result in a positive, long-term benefit for future gross margins. The third-quarter cost of goods also included roughly $37,000 of stock option expenses.

For Q3, operating expenses were up 12% or $800,000 compared to last year and represented 39% of sales. About $327,000 or 2% of sales was recorded for stock option expense.

For the third quarter, reported R&D spending was 9% lower than last year. This is simply due to the fact that we had a high level of non-recurring engineering projects for customers, and these absorbed a higher than normal amount of spending. This was also a factor in the sequential comparison for R&D expenses. We have not changed our overall level of investment in engineering, however.

For Q3, reported expenses were 8.4% of revenue. Third-quarter sales and marketing expenses increased only 2% year-over-year and were flat compared to the second quarter. This reflects our continuing focus on being more effective and efficient across all markets.

At less than 18% of revenue, this spending level was more than 2 percentage points below Q3 last year. We believe there is more room for improvement over future periods. As a percentage of revenue, future quarters will reflect variability, however, as we continue to grow and adjust to market conditions and as sales patterns reflect seasonal changes.

Third-quarter administration expenses include the primary factors that drove overall operating expense variances compared to prior periods and compared to expectations going into the quarter. At $2.4 million, administration spending was up 57% compared to last year and 37% sequentially.

Three factors contributed to the high level of spending. First, elevated legal expenses related to patent litigation discovery activities. Second, the impact of stock option expenses; half of the Company total is recorded in administration.

The third factor relates to the substantial amount of professional and legal fees relating to an acquisition opportunity that materialized during the quarter. As Martin said, we ultimately terminated that process. As a result, the entire amount of these expenses was recorded in the third quarter and the total impact to EPS was about $0.02. We had not contemplated this expense in our original third-quarter operating expectations.

Turning to the balance sheet, cash and investments at quarter end were $54.7 million. Cash flow from operations was positive at over $800,000. The key drivers of this cash profile continue to be positive earnings and sound asset management.

At $10.6 million, the accounts receivable level was down sequentially by approximately $800,000. Days Sales Outstanding was 49.

Inventory increased sequentially by about $700,000 to $8.1 million. Inventory turns declined compared to Q2, but are 1 full turn above the comparable period last year. We're pleased with our inventory management, but we will continue to push for additional improvement.

Across the board, asset management is a strong point for the Company and it gives us the financial resources to be aggressive going forward.

Now I would like to review our outlook for the remainder of 2006. We're maintaining our previous revenue guidance for the year while adjusting EPS for the effect of the third-quarter M&A expenses. We expect the fourth-quarter revenue to be in the range of 18.5 to $19.5 million, resulting in full-year growth of about 13%.

For the fourth quarter, we expect a continuation of solid year-over-year increases in all businesses except tactical navigation. Mobile communication sales should show year-over-year strength and also be up modestly compared to Q3.

Defense sales are likely to be down both year-over-year and sequentially. Within the defense business, fiber-optic sales are expected to continue to show strength, but the projected level of sales of tactical navigation products is down substantially compared to the level of Q4 2005, which was unusually high.

September ending backlog for the defense business was stable at about $5.2 million. But we anticipate that there will be a meaningful increase in the backlog position over the next several months. We would like to have a more definitive indication of specific timing; yet our confidence level remains high with respect to selected programs that should be scheduled to ship during 2007 and beyond.

For the fourth quarter, we expect GAAP earnings to be approximately $0.05, including the impact of stock option expenses of approximately $0.02. Compared to Q3, we expect that the gross margin percentage will improve modestly and that the absolute level of operating expenses will decline modestly.

Q4 is always a busy time for industry shows, and this drive incremental sales and marketing expenses. We expect that Q4 engineering and administration expenses will return to absolute levels that are more like what we saw in the first half of the year.

For the year, this profile would result in GAAP earnings of about $0.29, including the $0.02 impact of the third-quarter M&A expenses. The impact of stock option expenses for the year will be about $0.07.

In conclusion, we are pleased with our overall progress, by the market acceptance of our new products, and by our ability to deal with some of the out-of-the-norm events and still maintain positive results and steady improvement forward.

We will continue with strong investment levels for future growth, while striving to maintain an appropriate degree of business flexibility. Now, we would like to take your questions. Christine, could you please open the call for questions?

(OPERATOR INSTRUCTIONS) Mike Hickey.

On your A7, looks like -- thinking back on the A5 -- the real consumer adoption hurdles were price, size, and the installation process. What are you guys doing to reduce these hurdles?

Your A7 sales, is that at the expense of A5 sales, or do you expect a total increase in unit sales there?

Can you update us, Pat, on the margin on these two products?

The A5 was actually phased out. There was a short period of overlap where we offered both products; but as of now, the A5 is no longer being offered. So the A7 is really a successor to that product.

The features in the A7 really came from direct feedback from consumers in terms of what they wanted that wasn't available in the A5. So we actually upgraded some capabilities and offer the product with a features set that is much closer to what people are looking for in this type of a product. We also improved the ease of installation and things like that that you mentioned.

In terms of margin, we expect the margins to be better. I don't know how much you want to comment on that, Pat.

Yes, as indicated, the A7 is a replacement product for the A5. The margins for the A7 as of this moment are fairly comparable to the margins that we saw on the A5. I would say right now, sitting between 70 -- excuse me; between 25 and (technical difficulty) direct gross margin.

However, as Martin just began to indicate, we expect over the next one to two quarters, based on programs we have got underway, to see some improvement in the margin for the TracVision A7. I would rather not say how much just. But we expected the improvement to be fairly meaningful.

Okay, great. Then for the TracNet 100, about $2,000 per unit, $70 to $90 per month for the sub there. How does that product compete to say someone with -- just get a laptop with an EVDO card or a cell phone with a data connection? What is your value proposition there?

Could we expect A7 type sales from this product? I know you're leveraging more markets with the RV and the Marine. But what can we expect in terms of unit sales there?

As far as the product, the real value proposition there is that it enables people not to have a separate data connection for each user. So rather than pay $70 per laptop, it gives you one WiFi connection for the entire vehicle, whether it is RV or boat. So it actually saves them money on the per unit basis for subscription costs.

Also, it offers the ability to do videos on the screen. You can watch YouTube. You can do Internet radio. So there is a lot of value-add in terms of the product without having a laptop. Because a lot of people don't have a laptop running while they are driving.

With this product you can listen to Internet radio; the kids can watch MSN TV, videos, and things like that; do maps, MapQuest, real-time directions, real-time traffic. All in the vehicle without even opening up your laptop.

In terms of unit sales, we think it will be comparable to some of our other products, because it is a three-market product. We're selling it in marine, RV, and automotive, really the same basic system. The antennas are a little different for each market. So we expect good results from that product.

Great. Lastly, Pat, can you give us any color on '07? We are starting to bump into the next year here. Can you just give us any rough color on your operational expectations?

Yes, Mike, at this point, we're not prepared to give guidance for '07. You know, our intent right now would be to do that when we release our full-year results. That is consistent with our past practices.

I know that folks would like to see us give guidance a little sooner, but we would rather get through the fourth quarter first and then give guidance at that point in time.

Got it. Thanks, guys.

Tom Watts, Cowen & Co.

In terms of just reading the guidance, it looks like if we excluded the cost of your M&A activities and the higher stock-based comp, how much change would we have seen in the guidance for this year?

If you exclude those two things?

Right.

That would be on a pro forma basis. In that case, our current projection would be about $0.09 higher. So you would add about $0.09 to the $0.29 GAAP EPS number that we projected for the year. Is that what you're asking?

Well, the guidance hasn't changed. So if your question is -- excluding that item did the guidance change? The answer is no. It would be identical to what we said back in July.

Okay, that is what I had understood. I just wanted to confirm that. Also, in terms of -- I know you're not giving '07 guidance, but in terms of income taxes, do you expect that we will start seeing you recognizing taxes as a statutory rate sometime soon? What sort of timing do you see for that?

That is an interesting question, and I don't know the precise answer to it. I would say that as of -- and this is just a rough estimate, so please take it as that -- but as of the end of this year, I would expect that we would have still remaining maybe in the ballpark of $7 million of taxes that would be covered by valuation allowances. Excuse me; $7 million of pretax profit that would be covered by valuation allowances.

So the question becomes how -- over what period of time do we expect that we could earn $7 million of pretax profit?

The other factor that comes into play is the accounting community will cause us to go back and look at prior periods in a cumulative picture of our earnings over a period of time. Typically, that look is probably going to be about three years' time. So once you get to a cumulative three-year positive position, the pressure will probably begin to assess whether we should take that valuation allowance down.

So the simple answer is, I don't know the precise timing, although I expect during the course of 2007, that will be under discussion as to when would be appropriate to take the remainder of the valuation allowance down.

So it sounds like you might, on the income statement, might start recognizing income taxes late in '07. Is that a fair guess?

Yes, I don't know how fair the guess is Tom, because this will become a factor of when we get to that point where the determination is more likely than not that we will continue to be profitable, you know, we will probably have to look at taking the valuation allowance down all in one lump sum.

So, yes, I mean it could be the latter part of 2007. We might get through 2007. But I would say during the course of the year, we will know more about the status of that position and what we may have to do.

Okay. Then just a last question. On the M&A front, can you give us a little bit more idea of the M&A opportunity you looked at, and what sort of opportunities you will be looking at going forward? Do you have any criteria regarding dilution or size that we should think about?

Right. We look at deals that were -- this particular transaction would have been accretive. So we are looking at transactions that will be EPS positive in the short run. Deals that are complementary in terms of technology and/or market.

This particular one was a complementary technology company. The ones that we're looking at in the future, I would say, would be similar in terms of structure. We are looking for companies that are approximately in our size range or smaller.

But we're not actively looking. This is an opportunity that presented itself. So I don't want to make it sound like we are out shopping right now.

But as a Company, we have a fair amount of cash on the balance sheet. We have got a great management team in place. We really have a great vision of where the Company is going. So I think if we can find companies that fit into that vision, we will certainly be aggressive about it.

Okay, so it sort of looks like everything is on track.

Absolutely.

Great, thank you.

Chris Quilty, Raymond James.

Just as a follow-up there, complementary technology on the defense or the consumer side?

This particular one had aspects of both. I think that in the future, we would look at either. It tends to be easier to find things on the consumer side. But we're getting a lot of exciting new opportunities on defense, so; whereas a year ago, I don't think we saw quite the same number of opportunities that we see today.

So even though the current quarter defense, for example, for tactical navigation is below last year, we are seeing some exciting opportunities on the defense side right now.

Okay, speaking of which, you mention the potential Bradley order. Can you give us an idea of the potential number of vehicles and what your existing penetration is on that particular platform?

Yes, it is in the Commerce Business Daily. It showed up yesterday as an intention to give us a sole-source contract to KVH. The contract value was potentially about 11 or $12 million on that particular one.

The Bradley vehicle -- and that was for maybe 600 systems. So there's, I don't know, 8,000 Bradleys out there, so there's an awful lot of platforms out. I think it is just a good illustration of how quickly your fortunes can change on the defense side of the business. Because the unit prices of these systems are fairly high and the penetration rate is low.

The defense budgets continue to be quite strong. That is on the TACNAV side. We are also seeing a lot of opportunities for SATCOM, SATCOM-on-the-Move, and things like that.

Okay. Also, for FOGs you had talked about other stabilization contracts that might be out there, both domestic and foreign.

Right. The one I mentioned in the prepared remarks is for 6,800 fiber-optic gyros. So that is a big opportunity for us. Because the fiber optic gyros have an ASP of around $,3500, so it is a $25 million, roughly, opportunity. Something like that.

Great. Can you also comment with regard to the RV products? Do those have the integrated GPS capability that the TracVision A7 does?

The R6 does. The R6 has the same capability as the A7.

Okay. With regard to the A5, what is your feeling for how much channel inventory you might have out there that needs to get worked through?

That is a good question. I have not heard that come up as an issue, so I don't think it is a problem.

Okay. Have you had any other discussions? Over the years, you have talked about the fact that you have been in direct discussions with some OEMs. Other than the Cadillac, we haven't seen any announcements. Are those discussions ongoing or have they kind of cooled off?

I would say they're still ongoing. I think that a lot of features that are in the A7 were specifically demanded by some of the OEM partners. So this addresses some of the concerns there were.

Some of the OEMs were concerned about acoustic noise from the motors in the antenna. If the vehicle was parked you could hear the antenna. They didn't like that. Now you cannot hear the antenna.

Was that just a different stepper motor or bearing race design?

A combination of things. A lot of it is new motor drivers, new software, more sophisticated waveforms driving the stepper motors to make it sound more like a servo motor.

Also the locals. That is a big factor when you are demoing the product in Detroit and they can't get any of the four major networks.

Yes. Just some house cleaning for Pat on the tax discussion. Assuming the NOLs are still there, are we okay to model like a 5% tax rate because of the foreign profits that you do get taxed on?

I think that is fair, certainly for the year, Chris. Because as I said, if we get to the point where we have to take that valuation allowance down, that will be a very positive tax benefit for us when that happens.

So I would say if you look at the full year for next year, we will still be at a very low level of taxes for the year. That discussion was really about -- do we get to a point where we have to take what remains on the valuation allowance off the balance sheet?

Okay. Do you have the CapEx and D&A numbers readily available?

I do. CapEx for the quarter was just over $500,000, 506; and depreciation and amortization was 476 -- thousand in both cases.

Got you. Finally, did you give the year-over-year growth rate for the marine products, which I think you typically do?

Marine as a product family, you know, in that market grew 19% year-over-year.

Okay, that is the blended because you did give us the U.S. versus --.

That was 12% in the U.S. and 40% international growth rates, that made up that 19%.

Perfect. Very good, thank you.

James McIlree, Unterberg Towbin.

You guys have spoken for a couple of quarters now about substantial backlog increases by the end of this year. It sounds like the CROWS program is one of those that would result in a large backlog increase. What are the other ones that are potentially awarded leading to the backlog increase?

Well, the one I mentioned on this U.S. Army TACOM is one. That was one of the ones we were looking at. We are also --.

But it kind of sounded like that one was new to you. Or was it just that the announcement was new?

Well, it was new in the sense that it is public now.

Okay. But that was factored into what you were thinking could come along?

Yes, it was (multiple speakers) ones that we think that we could book in the fourth quarter.

Okay.

The other substantial ones are international, in the Middle East. Those we also expect shortly, but the timing on those is less certain.

Okay. Would those be foreign military sales? Or is it straight sales to the foreign governments?

(multiple speakers) either way. Those are FMS programs, and it is currently unclear whether this part of the procurement will be part of the FMS vehicle program or whether it will be a direct purchase.

Okay. I think it was mentioned a couple of times that TACNAV was down year-over-year. Can you fill in, either on a dollar basis what it was for the quarter, or what percent it was down year-over-year?

I think it was down like 30%.

Yes, TACNAV was down just about 30% on a year-over-year basis, the TACNAV products.

Okay, great. That's it. Thank you.

Needham & Company, Rich Valera.

Just a follow-up on the two large defense opportunities. You mentioned that you could book, potentially, it sounds like both of these in the fourth quarter. What would be, at your best guess, the initial booking?

I think the Bradley order you said had sort of the 11 to $12 million type potential. Is that what you would actually book? Or would that become in multiple pieces?

I guess the same question applies to your FOG opportunity; you mentioned the 6,800 units there. Do you think you would get an order for all 6,800 at once? Or do you think that would come in multiple pieces?

Well, the contract -- since we are a subcontractor, it doesn't necessarily follow that even if the prime gets the entire order that we would get the entire order all at once. But if we are selected for this program -- and we are already designed into it, so if one of the -- if we are selected by the prime contractor, then we know that we are designed into the entire program.

But it is not necessarily -- we may not show it all as backlog if we are only given a purchase order for, say, the first 12 months or something. So I can't really say how the order will come to us.

As far as the other contract goes, the TACOM one, that would in all likelihood be in chunks that would be maybe 2 or $3 million. We don't expect to get the full $12 million as a single order from them.

Okay. In terms of delivery time frame, what is your sense for each of these orders?

Both of those would be multi-year programs, so it would be spread out at run rates of maybe 100 or 200 gyros per month for the CROWS one, for example.

How about for the Bradley one?

The Bradley one might be a little bit more lumpy. It might be a deliver-in-one-particular-quarter kind of order. But again, not the full value of the entire contract; but when we do get contracts, they tend to be deliver-all-at-once.

Great. I know you are not giving '07 guidance at this point, but given this type of order or backlog potential exiting the year, you feel pretty comfortable with -- ? Would you be willing to characterize the type of defense growth you might see in '07 or put any kind of [words] around that?

I don't think we're ready to do that yet, Rich. But I would like to point out that year-to-date defense growth has been 20%. So even though this quarter was only 10%, we have had a pretty good growth in our defense business.

It's a little bit difficult when you talk about quarter-to-quarter -- oh, TACNAV was down 30%, and FOG is up 75% -- because the numbers tend to bounce around. But if you look at the growth for the year, it is 20%. So we feel very comfortable with our defense business and the opportunities that we see. So I think that we are expecting '07 to continue to be good for us.

That's helpful. Can you comment just on the A5-A7 combined? You had at one point been talking about whether that was seeing sort of year-over-year growth. Did you see any growth in the combined A5-A7 year-over-year this quarter?

It was approximately flat. So it was a little bit of a transition from the A5 to A7, but we expect continued growth in that part of our business going forward.

Okay, that is it for me. Thanks, guys.

Chris Quilty.

You knew I would be back. Just a follow-up question on the radio convoy. Can you give us an idea on testing time frame; fielding, in terms of how quickly it could be fielded; and funding, where those monies would come from? To give us a sense of -- is there a real opportunity for this being a $X million opportunity next year?

The funding is always the tricky part. Right now, there are two potential contract paths for that type of product.

One is, under the contract that we have, there is a formal testing going on. There is also something called an EMIP, which is -- basically it is something that the Army is sponsoring to try and get new technology rapidly inserted into operations.

There is also an opportunity for this technology to meet some operational need statements, which currently are out of Iraq, to address this problem. That could be funded through programs like MTS, for example. That would be a potential vehicle.

Okay. In terms of the technical state of the product, obviously if you have got it in testing you feel like you have got a fully ready to go to market product. How long is the anticipated testing time frame?

Right, I would say it is probably one step below ready to field. In other words, we have tested it, but we haven't tested it in 100 vehicle convoys yet. Because it is a fairly small number of units, like a dozen units that have been built so far.

So the next step would be if we pass this hurdle to do a full-scale deployment, where they would have to buy at least 100 systems to test the capability with 100 vehicles. But other than that, there are no outstanding software issues or additional work to be done. But there is additional testing to be done.

How about the encryption standards which would probably -- I am sure will be a big issue?

It is encrypted. I do not know the particular methodology.

But not an anticipated sticking point?

No. It is encrypted per their requirement.

Okay. When you talk about this being an affordable-for-every-vehicle solution, I think the Applique computer for the FBCB2 is, ballpark, $10,000. Just the MTS system itself is sort of $10,000. The sort of SINCGARS radio is $10,000. So is fair to assume it is something well below that number?

Yes, our goal was to be 10% of the alternative cost.

Okay.

So it is a dramatically less-expensive solution, because they can't afford the other system. So we're looking for something that is to be a tiny fraction of that.

Okay. One order you didn't mention is that long-standing SOCOM order for TACNAV.

Right.

Any visibility on the funding or when --?

We didn't mention it because we don't have it.

Fair enough. So it is still a requirement statement?

Yes, again, it is not one of the ones that is in our guidance. Let's put it that way.

Okay. You also didn't mention anything about -- switching gears to the automotive -- the Cadillac. Have you seen increased activity or increased penetration within the dealer network there? Or again, has that sort of hit a trough?

We haven't seen any increase in that. I think our conclusion now is that it hasn't been an effective sales channel. In other words, it is doing what it did from the start; but it hasn't grown.

It is just a difficult way to sell high-tech electronics, is through car salesmen. So even though Cadillac was pushing it as a way to get into the system.

So I think the benefit to us was that it validated the product concept; it validated that consumers would buy like to buy it at the dealership, if they could. And it validated that customers after they bought it were delighted with the product.

So that was an important milestone for us and it gave us credibility with General Motors. But it didn't provide any kind of a sales boost or a growth rate that we could point to as to say, hey, this is an effective sales channel for us going forward.

So what does that say, in terms of what is the most effective or ideal sales channel? For this product to really work, does it have to be factory installed?

To get to the big numbers, yes. People want this. They love the feature. They love the product. But they would like it to be part of their car when they buy it.

Okay. But do you anticipate seeing OEM activity any time soon? Or is that still based upon model year design? Something you could not expect, even if there was a commitment today, that it wouldn't happen for two years?

Right; going forward, I think the real homerun play is to do a combination product that is tightly coupled with the service provider, to create a service that is more appropriate for vehicles. That is probably all I can say about that at this point.

That didn't tell me anything. Okay, I guess we will wait until we hear more. Thank you very much.

Rich Valera.

In reference to your convoy program, you have mentioned possibly integrating that with the MTS. As you guys probably know, the MTS program as it stands now is actually up sort of for expiration in July of next year. Presumably there is some kind of next generation program being looked at for MTS.

Are you sort of contemplating linking with the current one? Or are you also involved in a potential MTS successor program that may or may not be underway at this point?

Both. We want to be backwards compatible with what is out there; and we also want to shape what the future system will look like. So we are looking at potentially participating in that program going forward. We would certainly like to.

Do you have a view of how the next-gen system for MTS might differ from the current one?

Well, interestingly, we actually spoke to the MTS program manager. I spoke to her directly. There is to be a requirement for communication between vehicles. So this is actually something that is going to be a requirement going forward.

That's very interesting. Thank you.

At this time, there appears to be no further questions in the queue.

Great. At this point, we are done, and feel free to contact either Pat or myself directly for any follow-up.

That does conclude our teleconference for today. We would like to thank everyone for your participation and have a wonderful day.