KVH Industries Inc (KVHI) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to the KVH Industries' Q2 conference call. Today's conference is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Mr. Pat Spratt, Chief Financial Officer. Please go ahead, sir.

Thank you and good morning. I am Pat Spratt, Chief Financial Officer of KVH Industries, and with me today is Martin Kits van Heyningen, Chief Executive Officer. 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 call is being simulcast on the Internet and will also be archived on our website for future reference. For those of you listening via the Web, feel free to submit questions related to the content of today's discussion to IR@KVH.com and we'll be happy to answer them following the call.

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 discussions. 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 7, 2008.

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. Martin?

Thanks, Pat. Thank you all for joining us today. So despite challenging economic conditions we achieved solid topline results and earned record profits during the second quarter as our long-term strategic growth drivers began to hit their stride. We received new orders for our fiber-optic gyros to help meet the growing demand for remote weapon stations; our air time business started to become a significant contributor to our revenues; and we take a major step towards the global expansion of the mini-VSAT broadband service.

Our diversification with multiple markets and emerging revenue sources enabled us to meet or beat our expectations despite many fewer challenges in some markets. As a result I'm very pleased with our overall performance.

For the quarter we achieve revenues of $22.3 million and generated EPS of $0.14 per share on a record profit of $2.0 million. For the first half of the year total revenue was up 4% to $45.4 million with net profit of $3.6 million. Earnings per share for the first six months were $0.24 and that's a $0.14 increase over the first half of 2007. In fact, we're on track to double EPS this year.

In the mobile communications market revenue increased 4% over last year. Land mobile sales were down 37% year-over-year, a reflection of the current challenges faced by the RV industry. Sales of Class A recreational vehicles are down 40% this year as a result of record high fuel prices, declining consumer confidence and challenging consumer credit markets.

Consumer behavior is also changing with RV owners traveling regionally rather than nationally and spending more time camping rather than driving, meaning RV'ers still enjoy and want satellite television on their vehicles, but nevertheless we see this market continuing to be a challenge going forward.

However, our overall positive results for the quarter, in spite of the decline in our RV business, speak to the strength of the diversification of our business model. Currently the land business represents about 15% of total company revenues.

In the marine market for Q2, our marine satellite sales were up 22% with good growth both domestically and internationally. While the same economic factors affecting the RV market are at work in the marine sector, primarily at the lower end of the market, strong sales of our TracPhone satellite communications system and rapidly expanding airtime revenue more than offset a modest year-over-year decline in satellite TV sales.

During Q2 we shipped our Inmarsat compatible TracPhone FB250 system for the first time, but the real highlight was the continued success of the TracPhone V7 and the mini-VSAT broadband service. During the second quarter we saw continued strong demand and were meeting our sales and production goals.

Maritime businesses, like land-based businesses, continue to integrate the Internet and mobile communications into every facet of their operations. This is a long-term trend that benefits us and spurs demand for high-speed data systems. Response from commercial operators has been extremely positive.

The TracPhone V7, with its relatively low hardware cost, high data speed and affordable air time, is proving itself more than capable of supporting two key requirements for commercial operators, for supporting shipboard operations and maintaining crew morale by enabling e-mail and Internet access.

Airtime revenue, led by the mini-VSAT broadband and Inmarsat subscriptions, is a rapidly growing and very exciting part of our business. During the second quarter we took an important step to accelerate the expansion of the mini-VSAT service. We achieved a major strategic milestone in this effort when we signed a new 10-year agreement with ViaSat to roll out the mini-VSAT globally.

As you may know, we've worked closely with ViaSat to develop the V7 which includes the maritime version of ViaSat's ArcLight spread spectrum modem. This enabling technology allows us to build smaller systems suitable for a variety of mobile platforms.

Now we're building on that partnership by jointly investing in the network infrastructure that will open new regions to the TracPhone V7 and our airtime service. Under the terms of our agreement we are immediately investing in three new regional satellite hubs. Each satellite hub consists of a very sophisticated mix of hardware and software necessary to manage the network communications.

As the expansion continues the number of hubs in our network satellite capacity will grow in parallel with KVH and ViaSat both investing in the necessary hardware. Global coverage will initially require roughly 10 transponders and hubs while supplemental hubs and transponders will be added as needed to support additional subscriber growth in each region. KVH will earn revenue from ViaSat aviation customers roaming through our network, and similarly we'll share a portion of our maritime revenue with ViaSat if our customers roam into one of their regions.

KVH is now actively working to acquire network capacity from Ku band satellite operators. These arrangements could range from buying capacity with multi-year commitments to a revenue-sharing model that's pay-as-you-go, similar to our current arrangements.

However, since we're capturing new regional markets for both hardware sales and air time sales, our goal is for each new region to achieve breakeven within three to six months of coming online. We also anticipate increased sales in regions where we already have service since many of our target customers are looking for a system that has global reach.

Our goal is to roll out new coverage areas starting this year, late 2008, and throughout 2009 to support not only recreational vessels but also commercial shipping lines and offshore oil and gas fields. The first priority will be the Pacific Ocean region which is critical for the major transpacific shipping companies. This coverage will also include all of the Alaskan fishing industry as well as the leisure boat market in Hawaii.

As we roll out our expanded service we'll be able to support sales in new regions using our established maritime distribution network which already includes multiple distributors throughout Asia. We continue to work on expanding our distribution model and we'll be targeting the sales infrastructure development at least three months ahead of launch of service in each market.

And now one final topic on mobile satellite communications before I move on to defense. During the first quarter we announced a new contract from LiveTV to design and manufacture their new satellite TV antenna for commercial airliners. Happy to report that product development is going well, we're on schedule and we remain on track to begin production at the end of the year.

It's also worth noting that our antenna, together with the next-generation in-flight entertainment system being developed by LiveTV, will be significantly lighter than the systems currently in use. This will help minimize fuel consumption by the airlines which is obviously their current top priority.

Moving on to defense, this quarter was characterized by some big orders but very few big shipments. Our guidance and stabilization sales were down 30% in the second quarter compared to Q2 last year, TACNAV product shipments were well below the prior year level. But as anticipated, Inertial Measurement Units for the MK54 torpedo program were minimal as Raytheon carried out new contract discussions with the Navy. We are awaiting a very large order for our TG-6000 IMU system sometime during Q3 with shipments ramping in Q4.

In our last conference call we brought you up to speed on the major new program for our fiber-optic gyros. Kongsberg, one of the world's leading manufacturers of remote weapon stations, selected our FOGs to provide the stabilization and precision pointing input to their systems. FOG shipments to Kongsberg were minimal in Q2, but, with a new $2 million order announced two weeks ago, we now have $8 million in backlog. The majority of the first order is expected to ship in Q4 and the second order should be completed during January of 2009.

Based on feedback from our customer, demand for remote weapon stations remains strong and we anticipate a steady stream of additional orders that could sustain a $4 million to $6 million per quarter run rate through 2009.

During Q2 we also expanded our opportunities in the commercial market with the introduction of our first -- several new fiber-optic gyro products. The new CNS-5000 is a result of a joint development effort by KVH and NovAtel, a leading precision GPS manufacturer. It's a fully integrated continuous navigation system that combines three of our DSP 3000 fiber-optic gyros with accelerometers and NovAtel's RTK GPS receiver. The result is the first self-contained system to offer low-cost three-dimensional positioning, velocity and attitude measurement.

While it follows in the steps of our tactical grade TG-6000 IMU for military use, this product is classified as a commercial system, significantly expanding the opportunities for export sales as well as sales by both KVH and NovAtel since both companies are going to be marketing this product.

Now initial response to the CNS-5000 is among the strongest we've seen for one of our FOG products. It looks like we're meeting a previously unfulfilled need for an affordable, self-contained positioning system. Shipments of the CNS-5000 are expected to begin later this year.

So in conclusion, we just completed a very strong quarter and we're well positioned for the future. Growth in our strategic business areas is allowing us to weather the current economic climate and we look forward to new revenue streams having an increasingly positive impact as we move through the second half of 2008. We see revenue growth accelerating in the second half of this year with earnings growth following suit.

But these are clearly very uncertain times and the difficulty of forecasting is compounded by uncertainty in the direction of the price of fuel. We were surprised by the sudden drop off in RV sales in Q2 after having been flat for Q1 and are therefore taking a cautious view towards Q3. Given the large FOG backlog that we have for Q4 we feel we actually have better visibility for Q4 than we normally would have at this time of year.

And overall our outlook assumes that the current economic environment will continue as it is, won't get better but won't get worse. Now I'd like to turn the call over to Pat and he'll fill you in on some of the numbers. Pat?

Thank you, Martin. The financial results for the second quarter were gratifying, especially given the very weak economic conditions that became far more challenging over the last several months even though sales were just below the low end of the expected range our operating margin was just shy of 9%.

Now to some of the specifics. Gross margin was just under 42%. Contributing to this result were the continuing strong sales of TracPhone marine products and the benefit of our ongoing cost improvement programs. In the quarter we also recorded a one-time catch up for the recognition of commissions earned for TV receiver activations in prior periods. This generated a benefit of less than 1 point of gross margin.

For Q2 operating expenses were down 15% compared to last year. We continue to tightly control discretionary spending. In addition, this result includes the impact of capitalizing the development expenses for the antenna system that we are developing for LiveTV. Because we have a firm order for these systems it is more appropriate to amortize the cost of development to be aligned with the future revenue recognition.

For the second quarter R&D spending as reported was 35% lower than last year. This reflects the impact of the capitalization that I just mentioned and the fact that other customer funded engineering projects exceeded last year's level. It's important to note that we have added engineering resources to contribute to fulfilling the LiveTV commitment and to sustain our other strategic initiatives. Consequently, although we saw a reduction in the reported engineering expense, we have actually increased the absolute level of effort.

Second-quarter sales and marketing expenses increased 10% year-over-year, but were up only slightly compared to Q1. In the face of the tough economic conditions and depressed RV expectations we have taken steps to selectively reduce spending. However, we will not compromise the expansion of our mini-VSAT service as we intend to take advantage of what we see as very strong sales growth potential.

Administration expenses were down about 34% compared to last year. As a percentage of revenue this was below 7%. This level was a little below our expectation and reflects the quarter-to-quarter variability of some expenses.

Turning to the balance sheet, cash and marketable securities were $52.6 million, cash flow from operations was positive at $3.3 million. Capital expenditures were $520,000. We anticipate a step up in capital expenditures likely beginning in Q4 as we acquire and install hub equipment for the mini-VSAT global deployment.

We continued the stock repurchase program that was authorized last year for up to 1 million shares. As of June 30th, we had repurchased 725,000 shares at a cost of approximately $6.2 million. The program is proceeding within the structure of our 10b5 stock repurchase plan.

Accounts receivable at $12 million was almost $3 million lower than Q1. Days sales outstanding decreased to 48. Given the current difficult conditions in the general economy we are really pleased with our ability to achieve such a positive performance level.

Inventory increased sequentially by about $1.7 million to $11.8 million. There were two primary contributors to this. First, we purposely prebuilt subassemblies for our standard DSP 3000 fiber-optic gyros so that we can continue to meet demand from run rate customers while we put the vast majority of our new production emphasis on satisfying the rapid ramp of DSP 3100 systems for Kongsberg.

Second, the dramatic increase in fuel prices and the weakening of consumer confidence during the quarter left us with a higher level of satellite TV inventory, especially for the RV market. We fully expect to work this inventory down to more normal levels over the next couple of quarters. Annualized inventory turns were just below 5.

Now I will turn to our expectations for the third quarter and the full year. To start we are being appropriately cautious in our outlook given the very challenging economic conditions that exist in the leisure land and marine markets. Revenue in Q3 should grow nicely year-over-year and be within the approximate range of $19 million to $20.5 million.

We anticipate growth in both the satcom and defense businesses. As in the second quarter, mobile communications revenue is expected to be spurred by our new TracPhone V7 products and mini-VSAT airtime services. Sales of LAN products are expected to be down year-over-year by a magnitude comparable to what we saw in Q2.

We expect that defense sales will show a good increase compared to last year. This is largely due to the fact that fiber-optic gyro sales for Kongsberg remote weapon stations will begin to ramp during the quarter and we are seeing an elevated level of refurb work for TACNAV systems that have been deployed on vehicles in war zones. This guidance also assumes that we will receive the renewal order for the Raytheon MK54 torpedo program soon and restart shipments of the TG-6000 Inertial Measurement Units.

Our defense backlog at the end of June was $13 million. We received the additional $2 million order from Kongsberg during week one of July, increasing our backlog to $15 million. For Q3 we expect that gross margin will be between 38% and 39%. The expected decrease compared to Q2 is due in part to the seasonal decline in the leisure marine business and to the significant buildup of FOG production capacity that will be required for remote weapon stations.

The cost growth of the capacity buildup during Q3 is expected to outpace the shipment growth until we get into the fourth quarter. Operating expenses should be about equal to or slightly below the Q2 level. Below the operating margin line we expect that interest income will be lower than Q2.

The combination of a lower level of revenue sequentially, a shift in the mix of sales and FOG capacity increases is expected to result in EPS of $0.01 to $0.05. For the year we have lowered our revenue growth expectation to about 10%, this is the direct result of much lower expectations for satellite TV system sales into the [LAN] markets and a more cautious outlook for leisure marine TV sales.

On the positive side, we expect continuing strong sales performance with our TracPhone products and services and upside potential for the fiber-optic gyro business. We have not included the initial shipments of the LiveTV antenna system in our guidance since there are a number of critical development milestones still to be achieved. We are confident that we will successfully satisfy each step, but we have decided to postpone including this in the revenue projection until we have a very clear path to the finish line.

We expect full-year gross margin to be slightly above 40% and operating margin to be between 5% and 6%. The net result should be 2008 full-year EPS of approximately $0.36, operating profit for 2008 is expected to be about $4.5 million better than 2007 or the equivalent of $0.31 better on a pretax per-share basis.

We are pleased that the second-quarter results show solid operating improvements. We are excited about the long-term prospects for our new growth businesses and we foresee more positives in the future as we push forward with the transition of the Company's business profile. Now we'd like to take your questions. Beth, please open the call for questions.

(OPERATOR INSTRUCTIONS). Jim McIlree, Collins Stewart.

On the services revenue, is the increase in services revenue on a quarter-to-quarter and year-to-year basis primarily related to the mini-VSAT service or was there growth in let's call it the legacy services business also?

There was growth, Jim, let me just check a couple numbers. The biggest absolute growth percentagewise was certainly in the VSAT air time service, especially since last year we didn't have it.

Right, right. I guess I was speaking more quarter-to-quarter. You're seeing --.

We saw growth in Inmarsat air time, we saw a substantial, obviously, increase in the VSAT air time. We also saw -- included in that service number is also non-warranty repair work and we saw some increase there as well.

Okay. I think last time around you talked about the amount of airtime that customers are taking, at least your initial experience with that. Has that changed at all, up or down?

Yes, it has changed a bit. It seems to be drifting higher or now. So I'd say that we're seeing customers use more of these service than we expected.

Like 10% more, 20% more, a little bit more?

In that range. We were thinking it would be 1,800 and then we're seeing 2,000, it's going a little bit above that now. So I'd say 10% is a reasonable --.

Okay, great. And Pat, you mentioned the TACNAV refurbishment, that's primarily a US customer?

Yes, it is, and that is for TACNAV systems that were deployed on vehicles that have been in Iraq and Afghanistan. It is part of a normal refit and refurb program that they go through.

So that service category includes not just airtime; it also includes government-funded engineering services, as Pat mentioned, the nonwarranty repair service. Anything that is not product is put in that category now.

I see. Okay, great. Thank you very much.

Chris Quilty, Raymond James.

Good morning, gentlemen. Just wanted to follow up. You had mentioned a requirement for 10 transponders, and I think you had previously mentioned with the initial announcement with ViaSat that you would be adding three hubs. Does that indicate you are buying more than one transponder per hub, or does that also include the transponders that you are currently using for your existing coverage pattern?

It includes the ones we have now. So there is one transponder per hub roughly, so it is a 1-for-1 ratio. So when I say there is 10 required for global coverage, that includes the ones we already have now plus the ones we are buying, plus the ones ViaSat is buying themselves. So that would be 10 gets you the baseline global coverage, and then additional capacity would only be added if you sold out of transponders. So that is sort of the success scenario. You would add capacity, but only because you've got too much business in that region.

Okay. If I am looking at what happens in sort of the single site VSAT market, I think they are able to put 7000 to 8000 customers per transponder. Are those the type of numbers that you think each region would be able to support before you would have to add excess capacity?

Well, I don't think so. I think those numbers sound very high, by like a factor of 10 roughly. So it really depends on the usage patterns because don't forget, we are not charging $49 a month. We are charging $2000 a month. So these customers are getting and buying a fairly high level of capacity and service.

So it is a different business model than the home use where they try to cram a lot of people on, and whatever the level of service they get is what they get.

That's fair enough. And a question in terms of the capital expense for building out the hubs -- ballpark general cost, time to completion and how you'll end up depreciating that?

I'll let Pat answer the depreciation question. Just a ballpark, this is a $3 million to $5 million initial capital investment over the next 18 months.

And does that mean you're not going to have the service availability for 18 months or when would you first be able to launch service? I think you indicated end of the year.

yes, I meant the entire effort would be done over 18 months, but we do expect the first region to go live this year, at the end of this year.

Okay.

And our intention as far as depreciation goes is to generally use a five-year straight-line period.

Okay. And your thoughts at this point given what you've seen in demand of taking a low-risk, lower reward approach of a teaming arrangement or just out and out buying a transponder, which I think will cost you, depending on the region, $1 million, $1.5 million a year.

Yes, that's right. I think we're at a stage now where we're comfortable enough with the demand for the product that we're somewhat indifferent to the approach. Meaning the pay-as-you-go helps with startup but you make less money in the long run and either model works well for us. We no longer see the risk of the service and product not being successful as a major determining factor. So right now it's purely an economic decision what's the best deal you can negotiate with a satellite provider if that answers your question.

No, but I know where you're going.

What I'm saying is we are definitely looking at buying satellite capacity and we're prepared to buy it. But if a satellite operator says, hey, I'd rather prefer to do a revenue share, we'll look at the economic trade-off and if that comes out better for us we'll do it that way. But we're not making these decisions now based on risk because we don't see this as -- now that the product has been in the market for a while we have pretty good confidence in the take rate. So we're not doing it to reduce risk.

Okay. And speaking of the take rate and going back to Jim's question earlier, your service revenues were up about $1.3 million year-over-year and if you divide that by $5,500 per quarter per ship it gets you to around 240 ships on average that you would have had demanding service. Again, assuming that all the incremental revenue came from the service.

Does that put us in the general ballpark of where we are for ships in service? And I think you said in your earlier statements or in the press release that you expect the service rate to continue growing at a similar pace. Does that mean if you're adding -- at a 70% growth rate it should stay at that growth rate for the balance of the year or were you talking number of ships?

The average revenue is closer to $2,000, $2,100, $2,200, not $5,000 if that's the number you were using.

Per month -- per quarter.

I was [kidding].

Sorry, never mind. I thought you were talking about on a monthly basis. I think you were in the right order of magnitude, Chris. As you know, we don't like to talk about specific sales of a product. Also included in near-term revenue is the Inmarsat numbers which we've been doing for years. So that subscriber base obviously is a lot larger still than the VSAT numbers. That's in thousands as opposed to hundreds.

But you're not getting an actual split on the revenue air time for the Inmarsat service, just an initiation?

No, we're an Inmarsat ISP. So we sell Inmarsat air time. So we make percentagewise similar numbers on the Inmarsat that we'd make on the VSAT roughly. So every Inmarsat system we sell we activate and we have a sales group focused on that.

Got it. Shifting back to the core marine business, I think -- did you indicate that most of the weakness was centered in the low end; I think is it the M3 product line?

It's actually doing pretty well. But what I was trying to say is that it's not that the marine market is immune to what's going on in the general economy, but like in the general economy it seems to be focused more at the low end. And fortunately for us, those typically aren't our core customers. So we do have some products that start at the low end, but it's not the biggest part of our business.

And actually within the land side interestingly we sort of see the same thing. For example, the automotive segment is down a little bit, but nothing compared to what's down in the RV. And that's because the automotive products sell to the high-end customer and that's a difference. Even in the land we see the same sort of phenomenon going on where the low-end of the market is hurting a lot more than the high-end. And the marine market is already a high-end market and within that we tend to sell to the higher end of that.

Okay. And the dramatic falloff that you saw in the land market in the quarter, clearly things weren't nearly this bad in the first quarter and, yes, oil prices are up, but what do you attribute the falloff to? Is it just your customers, your OEM customers and channel partners being much more conservative in the channel inventories that they're holding? Or do you think it was really a bleedthrough of the actual demand level?

Obviously we were -- we mentioned that we were surprised and management should never be surprised by anything, but we were. Q1 the RV business was flat and the RV market has been down for a long time. So we expected gas prices to erode demand, but we didn't expect it to happen this quickly.

So part of it is OEMs were shut down for a period to get their inventories in line, part of it is when sales are down the channel partners overreact by not ordering so that they can work their own inventories down.

So there is the possibility that what we saw in Q2 was sort of inventory related because, unlike the marine market, in the RV market we sell through distributors who sell to dealers, and we sell to distributors who sell to OEMs, which is different from the marine market where we sell direct to dealers primarily and we sell direct to boat builders. So you do have that inventory situation. But nevertheless, for guidance purposes we just assume that what we saw in Q2 will continue in Q3.

Okay. But did you see a different action by your dealers than your OEM in the RV channel or did they both act in concert?

I would say they both acted in concert.

Okay. One other question just to shift back to the TracPhone V7, I think you had mentioned last quarter about some potential large orders, Turkish navy, Russian shipping fleet, and was there any news on either of those two? And I guess the broader question, how well is the effort moving along at targeting large shipping fleets?

Yes, both of those actually came in. We started shipping some this quarter and so I think that in general the product strategy is working incredibly well. I will probably send this out to you, Chris; this survey was done recently on shipping companies and for what they need for crew retention and crew morale. What people want on board vessels and we had four of the top five things. Number one was Internet access, number two was e-mail, number three was voice calling -- or number two was satellite television.

So it was pretty impressive. So we've got really a suite of products now that address that market very well. The key things we have to continue to do is put in more coverage so that people can use it throughout their operating areas. So even though a company might be located in Europe, if they go to the Middle East or if they go to China they want coverage over there as well. So that's why I was saying that when you add a region you don't just have to sell in that region to make it profitable, you can sell units in Germany because you added coverage in China.

Got it. And a final question on the defense business. You still have what looks like some pretty good expectations going into 2009 of a $4 million to $6 million sort of run rate, and yet the only big industry-wide CROWS RWS type contract we've seen was the U.S. Army's CROWS contract. Are there other contracts out there internationally perhaps that have been awarded that I haven't picked up on or are these things that you still believe are pending?

There are -- I'm not aware of any order as big as CROWS that's for U.S. Army. So I think that's the (technical difficulty) out there.

Okay. Very good. Thank you.

Rich Valera, Needham & Co.

Good morning. If I could just circle back to the year-over-year increase in service revenue of about $1.3 million; could you give any granularity regarding how much of that was from V7? It sounds like clearly maybe not all of it was, but is it sort of roughly half of that or any sort of granularity on that would be helpful.

Let me try to add a couple things that might give you a sense without us doing more than we'd like. Of that number -- of the total number of $3.1 million in terms of service revenue, as a (technical difficulty) the airtime portion is roughly half of it in total and that's Inmarsat and VSAT combined. And the growth -- the growth drivers year-over-year or the biggest growth driver was clearly the VSAT air time portion of that. So I probably can't go more deeply than that, but we had some growth and some repair services work, but the big drivers were the air time and specifically the VSAT air time.

Great. And then you didn't mention any update on your qualification process with Kongsberg. I thought you had expected to be qualified and shipping within this third quarter. Can you just give us an update there? How is that going and when you expect to be shipping your first FOGs to Kongsberg under the $6 million order?

Well, we've shipped the units for qualification and it's my understanding that the way this process is working is that they have a customer who works with them on changes, and some of the changes get approved ahead of formal qualification which sounds strange, but --.

So there is the possibility that we will actually be delivering long before the qualification process is completed. So we're clear to ship, so we're shipping to Kongsberg. Their qualification process with their customers is really separate from our delivery requirements. I know that sounds strange but that's the way it's working right now.

Right. So do you have any revenue to Kongsberg for FOGs baked into the third quarter at this point?

Yes, yes.

So that's not contingent on the final qualification. And then that big ramp you expect in the fourth quarter, is that contingent on the final qualification?

No, no. We've been cleared to build and we are building as we speak. In other words, what formal qualification they do is not something that we're awaiting final word on in the sense that they haven't said, don't build until we go through our own internal process. Because they've been internally testing the product for six months or more, nine months.

Okay. And the $4 million to $6 million per quarter revenue level you referred to in your prepared remarks, was that just FOGs or overall defense revenue?

That would be just for this DSP 3100.

Which is the product being used by Kongsberg for remote weapon stations.

Right. So obviously if that were the case you would expect overall defense revenue to be higher than that level per quarter?

Right. So another way to think of it is -- think of that $2 million as one additional month production.

Right. And to Chris's question, that's a pretty high run rate. Do you sort of have any visibility to the end program this is going into that that level of demand could be sustained throughout '09?

Our customers asked us not to talk about specific programs, but I think Chris made the observation that he's only aware of one program that's of that size.

Right. Okay, that's helpful. You mentioned in your prepared or actually in your release about a new leasing program for the V7. Pat, can you give us any sense for the potential working capital implications of the V7 lease?

Well, first of all we do have a lease program. We've had some folks who have leased units, but it's been a fairly small percentage of the total so far. We don't expect it to ever be a very large percentage. We put this in place primarily just to offer an alternative stream of financing.

Essentially the way it works is the lease is typically a three-year lease and, although we recognize the revenue at the front end of the lease, we are obviously financing the cost of the product over the term of that three years. So essentially what's being financed in the working capital that we're putting up is to cover the cost of the product itself. The air time is recognized and paid for as we move through the lease. And then certainly we have to collect on a monthly basis from those customers, but it's the cost of the product that is being financed.

Okay. And just a final one. Pat, do you have both the quarter ending defense backlog and then your current backlog including that $2 million order?

Yes, I don't have the exact numbers but the ballpark it's the number I gave, Rich. We were at $13 million on June 30th, a few days later we were at $15 million and I would estimate it's still right around that $15 million.

Great, that's helpful. Thanks very much.

Tom Watts, Cowen and Company.

You guys have a lot of questions. Can you just comment a little more on the LiveTV, that there is no revenue assumption for that in the guidance and there were some remaining development milestones? Could you talk about the milestones a little bit and how we should think about that moving into the revenue stream?

I'll answer the first part of that. This fairly big product development program we've got a large team of people working on it and it's a formal development process where you have a preliminary design review and then a critical design review. Right now we finished the preliminary design review with the customer about a month or so ago and we're probably about a month away from the critical design review.

And we expect to start FAA STC type testing here in the next few months and the product development program is on schedule. And the reason we don't have it in our revenue forecast, even though contractually their delivery says here, is that we haven't gone through that certification process before and we just think it's better to be a little conservative on that with our customer. So there is some upside there.

As far as the revenue goes, we will clearly begin to recognize revenue as we ship product to LiveTV. As Martin said, contractually we're expected to begin shipping before the end of this year, but it's very late in the year. It's during the month of December and mostly in the back half of the month of December.

So as Martin said, because of the milestones that we still have to move through, and we have high confidence that we will be very successful there, but also because of the fact that the timing is such that it's right on the boundary of the end of the year, we just didn't want to get too aggressive in terms of assuming that everything is going to go perfectly well.

So it's not in our current forecast. If we do ship it could add in excess of $1 million of revenue to the year for the units that we would ship to LiveTV. And as we said, that's not in the projection and if it does happen then certainly we would add that to the projection.

Okay. And then maybe I missed it, could you give us CapEx for the quarter?

Yes, sure. CapEx was $520,000.

Okay. And you had mentioned that you -- are you expecting similar levels in Q3 before the ramp in Q4?

Q3 will probably be similar, it might be slightly higher, Q4 I expect it will probably take a step up because we'll be beginning to install the first hub for the roll out of the VSAT service. So as we rollout the additional geographies over the course of the next 18 months we will see a bit of an increase in our CapEx for that hub equipment.

And then finally, You have a healthy cash balance on the balance sheet, you're not burning any cash here. Is there -- please remind us of your philosophy on cash, are there any other things you would consider doing with that?

As you know, we're buying back some stock so we're using some cash for that. And even with that we've been able to generate more cash than we've been using. If you're asking about acquisitions or M&A activity or anything like that, there isn't anything that we're aggressively pursuing. We always do keep our eyes and ears open. But right now I think our primary focus is on making sure that we build out the VSAT capability on a global basis so that we have full success there.

The cash levels are more than we need on an operating basis if you look out long term, but in environments like we see today with poor economic conditions and so forth it's actually nice to have the extra cash. But we're looking to invest it in the Company as we go forward and we foresee opportunities with fiber-optic gyroscopes and VSAT global rollout as well as some other things that we think are going to consume some portion of that over the next year or so.

Great, thanks very much.

(OPERATOR INSTRUCTIONS). Chris Quilty, Raymond James.

Two for you, Pat. First of all, the 22% marine growth that you reported in the press release, does that include the service?

It includes the service core of the marine business. Yes, it does.

So that's a mix number there. And if I were just to make some general assumptions about, again, as we talked earlier, how much of the service revenue is coming from the V7 it would still look like you're probably hitting around double-digit, low double-digit growth on the product side in marine?

Well, again, in the marine we've seen some softness in the TV portion, in the US anyway. In Europe it's still looking good. And the TracPhone business, the non-VSAT TracPhone business has continued to do well also. So that's probably the extent of the detail I'd like to give. But the biggest chunk of our growth year-over-year is absolutely the VSAT product and service.

Okay. And can you give us either now or off-line the Q3/Q4 revenue breakdown for last year just for modeling purposes since it looks like you're going to break that out on a go-forward basis?

You mean what they were as a percentage of the business or dollars?

Or you're talking about service?

You broke out revenue for both Q1 and with the six-month Q2 into products and services and the cost -- the product cost of service. That's something you hadn't done previously. And so, just so we can model the back half of the year, can we get that for Q3 and Q4 of last year to look at (multiple speakers)?

That's something I'd have to work out, but I can do that. I can get that to you if you'd like.

And the final question on the LiveTV opportunity, how confident are you in that FAA certification process and how much effort have you looked into it? As I understand it, it's not a simple process. And the second part of that, if I'm not mistaken, haven't you already sold that system for some business jet applications?

No, this is a brand-new design; this is a ground up new design. The bizjet version is really a customer modified A7. So we're applying standard A7s and then modifying it themselves. The requirement for the FAA and the FCC certification is actually LiveTV's requirement, not our requirement. So we are actually building and delivering to a very detailed specification. So it's really their process to go through and we will support them, but we actually don't do the certification ourselves.

So if this is a new design, does it draw from any of the previous hardware architectures that you've done before either for the A7 or any of the TracVision productline?

Yes, this is one of those classic -- it's exactly like one of our standard products except the array and the circuit board and the motors and the radome and everything is different. So it draws on the product architecture of the M3, the array is a [borsite] array but it's an array like an A7 but it's not an offset array like the A7. And then everything about the mechanism is brand-new, designed to work at minus 55, gear-driven, precision bearing. So it's quite a different product. It's really designed from the ground up for commercial aviation.

And a radome type device or more of a flush mount?

It's a low profile radome. It actually will fit into the existing radome that's out there and that's one of the key requirements so that they can get quick approval. So they're not changing anything on the exterior of the aircraft or the way it's mounted to the aircraft, so it's just changing something that's inside the radome.

So are you talking about a replacement market of replacing in-service units?

Yes, you can absolutely do that and they are looking at that as well. But the main motivation for them is that they don't want to have to go through the extensive testing you have to do if you bolt something on the outside of an airplane. In other words, this is already done, that's already there, it's completely certified, we're just changing what's inside that radome.

Got you. And they have certified that radome profile for how many different types of narrowbody, wide-body aircraft?

They've got the Boeing 737, the Airbus 320 and the Embraer 170, 180 series. So there are three narrowbody jets that it's already type approved for.

Got you.

Those are the two that make up 90% of the market.

Okay. Awesome. Thank you very much.

(OPERATOR INSTRUCTIONS). There are no further questions. I'll turn it back over to you, Mr. Spratt.

Well, we just wanted to thank you all very much for listening in and participating and we look forward to talking to again. Please don't hesitate to give us a call if you have further questions. Thank you.

That does conclude our conference for today. Thank you for your participation and have a wonderful day.