KVH Industries Inc (KVHI) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the KVH Industries' third-quarter earnings conference call. Today's call is being recorded.

Now 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, Chief Executive Officer. 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 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 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 8, 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 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. You know, during times like these in the global economy, a company's health and long-term prospects depend on being well positioned. Overall, KVH is probably more diversified and better positioned to weather these economic storms than any company our size, since we address multiple market segments like military, marine, land mobile, and even commercial aviation. In fact, our military group is further diversified into satellite, fiber optic gyros, and tactical navigation products. In all, because we are not dependent on a single market or product line, we have positioned KVH so that we can weather this recession.

We have managed KVH conservatively for the last few years. We've invested in new business opportunities, but we have also conserved our cash. With nearly $50 million on hand and virtually no debt, we have the financial strength some of our competitors lack. All in all, I feel very comfortable about where we are and what we have in our portfolio.

Not that that KVH won't be impacted just like everyone else, but we have the diversity of products, markets, and customers to fare better than most. We have a strong backlog going into Q4 and into 2009. Right now, the easing of fuel prices could help some of these segments recover, while the credit crisis and the stock market crash are hurting other parts of our business.

We do expect continued growth in the fourth quarter and a return to profitability, despite some of our markets declining dramatically -- declines that are being more than offset by dramatic growth in other parts of our business. While I feel comfortable saying that about Q4, obviously, the markets are far too volatile to give any specific guidance for 2009 at this point. We'll just have to wait and see how things develop.

As for the quarter we just finished, there were a number of things that went well and a couple that didn't. The most important point about Q3 is that most of the revenue miss came from the fiber optic group, where we had two major programs that were delayed. We expect both of these to be sorted out shortly and be back on track for Q4. In fact, we expect to begin shipping the remote weapon station gyro orders that didn't ship in Q3 in the next few weeks.

On the satellite side, the marine business held up surprisingly well. Overall revenues were up 22% year-over-year. We did see some softness right at the end of September that coincided with the acceleration of the world's macroeconomic problems. Even so, our new TracPhone V7 is selling well, driving our growth for Q3, a trend that we expect to continue in Q4.

These products also address the commercial marine markets and are less volatile than the recreational or leisure markets. Our expansion into the Pacific Ocean should also help grow the shipping market segment.

On the land side, revenue was down 56% year-over-year, and the RV portion of it was down even more than that. At this point, the land business represents only about 10% of total revenue. So it's not nearly as meaningful as it was just a couple of years ago.

The total Q3 revenues were $15.7 million, and that was down about 10% from the prior year. On the bottom line, we had a net loss of $800,000 or $0.06 per share, compared to breakeven results during Q3 of last year.

For the first nine months of the year, our total revenue was $61.2 million, roughly flat with last year. However, our net income of $2.8 million or $0.19 per share is a marked improvement from the same period last year, when we had net income of $1.5 million or $0.10 a share.

In the mobile communications market, our total sales for the quarter were $12.3 million, a decline of 6% year-over-year. Obviously, this was due to the land business. Shipments of new recreational vehicles reached an 11-year low at the end of August. Virtually all major RV manufacturers have shut down at least a portion of their manufacturing capacity; and aftermarket sales are slowing as well.

Looking at the marine market, revenues were up 22% in the quarter thanks to strong sales both internationally and domestically. But at the lower end of the market, the credit crunch is also causing stress within the leisure marine side. Leading boat builders like Brunswick halted production for part of the summer to reduce inventory levels in the channel. As a result, we did experience a year-over-year decline in our marine TracVision sales. However, this was more than offset by the performance of our TracPhone V7 system and the growth of our airtime service, which is steadily becoming a substantial recurring revenue source for the Company.

During Q3, we saw significant new interest in the V7,, especially within the commercial market. Our message that choosing the V7 will save you money is getting the attention of commercial operators faced with high fuel prices and other economic challenges. Thanks to our smaller antenna and more efficient service, we are able to offer these commercial customers lower hardware costs, lower installation costs, and lower airtime costs compared to other products in the market. Because of this, we are seeing V7s installed on an increasing number of working vessels, and we have several major fleet opportunities pending.

The V7 is also providing us with the opportunity to present commercial customers with our complete commercial satellite TV and communications solutions. We are able to offer a unique single source for a range of systems and services, including the V7, the mini-VSAT broadband service, our Inmarsat-compatible TracPhones and airtime, and our TracVision satellite TV systems.

For example Unicom, a Russian fleet operator, recently selected our top-of-the-line TracVision M9 satellite TV system for crew entertainment onboard. Unicom purchased 60 TracVision M9s for its fleet, the single largest marine order we have ever received. Had we not been in the commercial marine market, thanks to the V7, we never would have won this type of order.

In the commercial market, broadband connections at sea are essential for shipboard business activities, more efficient operations, and compliance with regulatory requirements. In addition, affordable Internet, e-mail, and phone service are vital as a means for improving the quality of life and morale of the crew. Global coverage, then, becomes a key requirement for any broadband system.

We are now generating more interest from these customers with our recent announcement that Pacific coverage for the mini-VSAT service will be available soon. Our new five-year lease agreement with SAT-GE gives us capacity on the GE-23 satellite, which is ideally positioned to provide coverage in the Pacific Ocean. The new coverage area will include Alaska, the West Coast of the US and Canada, Hawaii, and extend all the way to Asia.

The extension of the mini-VSAT's broadband coverage into the Pacific will allow us to cover a significant portion of the world's shipping lanes, including some of the busiest and most important routes between Asia and North America. We are now in the process of installing the new network hub in Hawaii, which should go online for service testing in November, with live service beginning in December.

At the same time, we are aggressively pursuing the mini-VSAT rollout plan, and we are in the process of negotiating access to additional satellites around the globe. As we expand our VSAT coverage area, we will also generate airtime revenue from business jets traveling through our networks.

And speaking of jets, we are nearing completion of the development of our commercial airline satellite TV system. With over $20 million in backlog, this unit represents a new growth area for KVH, as we begin providing equipment for narrowbody jets like the Boeing 737 and the Airbus A320. FAA certification will begin during the current quarter. We were also recently asked to provide pricing for a new European program as well, so we see some nice potential upside in this part of our business.

Moving on to defense, our guidance and stabilization sales for Q3 were down 23% year-over-year to about $3.4 million. While revenue from TACNAV shipments and product repair activities were up during the third quarter, those gains were offset by two delays within our fiber-optic business.

First, the qualification process for our fiber object gyros for use in Kongsberg's remote weapon station has taken longer than expected, which prevented shipments during the third quarter. We have been working closely with Kongsberg and it made excellent progress towards the completion of the qualification process. In fact, we expect to be in full production of our remote weapon station FOGs before the end of this month.

The other delay involved an anticipated follow-on order for our TG-6000 inertial measurement units. As you may know, these are used by Raytheon in the guidance system for the Mark 54 torpedo. New orders for the TG-6000 have been on hold as Raytheon and the US Navy negotiated a new contract. Unfortunately, that contract was not signed in Q3 and Raytheon was unable to pass the order along to us.

However, just in the last few days, the Navy has placed its new Mark 54 order with Raytheon, and we expect to receive an order from them shortly, at which point we will begin production of the TG-6000.

So in conclusion, Q3 was clearly a challenge and the economic climate is uncertain going forward. However, we are upbeat about KVH's position in our markets. We expect to resume our growth path in Q4. We are well diversified, allowing us to weather difficult times in some of our markets. We are continuing to invest in new products and satellite infrastructure. And even in our most challenging markets, we have a strong position compared to our competition.

We have exciting products and services that are clearly still in demand, and we've got the financial resources to give us stability and the flexibility to take advantage of new opportunities as they arise.

Now I would like to turn the call back over to Pat to fill in some of the numbers. Pat?

Thank you, Martin. The financial results for the third quarter were clearly not up to our expectations. However, in the face of very weak economic conditions, we feel that we are continuing to make very good headway toward executing our strategic initiatives for the long term, for growth, and for profit. Now, to some of the specifics.

The gross margin was just over 41%. Contributing to this result was a favorable mix of marine and military products and continuing progress with product cost improvements. We continued to ramp our FOG production capacity to meet the indicated strong demand for remote weapons systems.

For Q3, operating expenses were down 5% compared to last year. We have continued to carefully control discretionary spending.

For the third quarter, reported R&D spending was 20% lower than last year. This reflects the impact of the capitalization of the antenna development for the live TV in-flight entertainment system. Although we saw a reduction in the reported engineering expense, we have actually increased the total absolute level of investment by approximately 15%. This has been necessary to accomplish the live TV development objectives while also sustaining our other strategic new product initiatives.

Third-quarter sales and marketing expenses increased 1% year-over-year, but were down sequentially due in part to the seasonal slowdown in consumer marine activities. In the face of the tough economic conditions and depressed RV expectations, we continue to take steps to selectively reduce spending programs.

The mini-VSAT business is one area in which we will grow investments, and we anticipate quarter-to-quarter increases in spending to drive V7-related sales initiatives.

Administration expenses were also up 1% compared to last year. The administration spending was higher than the second quarter, and this is largely due to the timing of accruals for compensation-related expenses.

Turning to the balance sheet, cash and marketable securities were $49.4 million. Cash flow from operations was modestly negative at about $200,000. Capital expenditures were approximately $990,000. A majority of this total was in support of the capacity increase for FOG production. We anticipate the fourth quarter will be even higher as we step up investments for the installation of 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 September 30, we had repurchased 967,000 shares at a cost of approximately $8.2 million.

Accounts receivable at $9.1 million was almost $3 million lower than Q2. Days sales outstanding increased modestly to 52. We continue to be very pleased with our ability to achieve such a positive performance level in spite of the difficult economic environment.

This good cash management performance is a credit to our internal discipline, and it also reflects the fact that we partner with some of the best dealers and distributors in the world.

Inventory increased substantially by about $3.4 million to just over $15 million. There were two primary contributors to this. First, we did not ship any FOGs to Kongsberg, but continued to pre-build subassemblies to support the high level of shipments that will be necessary once we clear qualification.

Second, the dramatic weakening of consumer confidence in the general economy during the quarter caused even more falloff in the demand for our RV products. It will take several quarters to reduce the RV inventory to more normal levels if the current level of demand continues.

Annualized inventory turns were approximately 3. This is well below our target performance.

Now, I will turn to our expectations for the fourth quarter. To start, this is a very weak environment in which to project performance. The economic and stock market conditions are so volatile that prospects change quite a bit almost every day. We believe we are being appropriately cautious in our outlook, but time will tell.

We fully expect to be shipping the DSP-3100 fiber optic gyro in volume to Kongsberg. We expect to achieve continued progress in developing the mini-VSAT business. But we also expect the consumer markets to continue to be quite weak, especially for RV products. Although we have seen year-over-year weakness in the consumer space for marine TV products for quite some time, the trend line has not fallen off like it has for the RV market.

Revenue in Q4 should grow year-over-year and be within the range of $20 million to $23 million. We anticipate that satcom sales will be down year-over-year, driven by the continuing weak demand for RV products. On the other hand, as has been the case over the last several quarters, we expect to see continuing progress in our sales of the TracPhone V7 products and growth in the mini-VSAT airtime revenue.

The defense business should grow strongly, assuming we achieve full qualification with Kongsberg within the next few weeks. Although we expect to receive our next order for the Raytheon Mark 54 torpedo program very shortly, any Q4 shipments of the TG-6000 inertial measurement unit will be at a modest level. Sales of TACNAV products should also show a year-over-year increase. Our defense backlog at the end of September was $16 million. We expect that shipments of the live TV antenna system will not begin until early 2009.

For Q4, we expect that gross margin will be at or below 39%. The expected decrease compared to Q3 is due to the buildout of the mini-VSAT network infrastructure, the continuing ramp of the FOG manufacturing capacity, and the below-normal utilization of satcom capacity due to the weakness in consumer demand.

Operating expenses are expected to be higher than Q3, also largely due to investments that will be made for expanding the sales channel and customer support for the mini-VSAT business.

Below operating margin, we expect that interest income will be lower than in Q3 due to lower interest rates and cash balances. This profile should result in EPS of $0.01 to $0.05.

Although the current economic conditions are very challenging, we are excited about the long-term prospects for our new growth businesses. We are making very good progress with our strategic initiatives, and we believe that we are getting stronger relative to our key competitors during this period. We're using our strong financial condition to be aggressive in developing the growth drivers for the future.

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

(Operator Instructions) Chris Quilty, Raymond James.

I was hoping you could give us perhaps a little bit more color on the mini-VSAT service in terms of perhaps number of ships deployed; or at least when we look at the service revenue or as I guess you call it now the nonproduct or non-hardware revenue. How much of that is actually starting to be generated from mini-VSAT?

Well, we don't want to talk about specific numbers of units for competitive reasons, but I think Pat may be able to give you a better detail, but certainly the majority of the service revenue now for the airtime business is coming from the mini-VSAT. So we have seen a very rapid growth there in terms of subscriber revenue growth.

Okay. In terms of -- I think you mentioned there's a couple of other fleet opportunities. Presumably the recent one, where you announced the M9 sales was around 60 units, is it fair to assume a fleet deal is in the order of 60, 100 units?

Some of the fleets are bigger than that. But yes, that is what we would call a fleet deal. We have already won some fleet orders that were 10 to 20 at a time for the V7. But when I'm talking about a big fleet order, it would be in the range of 50 to 200, somewhere in there.

Okay, great. Last quarter you gave us some metrics on the monthly ARPU; and it had trended from 1800 up to 2000. Is that a trend you are still seeing?

I don't think we have seen any further increases. But certainly it is still above 2000 last time I checked.

Okay. In terms of any competitive response you have seen out there, or other indicators in the channel that competitors may try to match the service? Or do you think there are major competitive risks?

I think probably the most significant new competitor would be Iridium, with their OpenPort system. I think that's -- but it's an L-band system, so it's really more of a competitor for Inmarsat, because they are still paying by the megabyte and it's fairly expensive to get started. But I think that is probably the most significant new competitor in the market.

Okay. Pat, from your guidance with regard to the Mark 54, is it fair to assume that in your guidance you're not assuming any Mark 54 FOG shipments for the fourth quarter?

In the guidance, Chris, we're assuming a very small quantity of shipments in the quarter. But it is not a material amount.

Obviously on the remote weapon system, your guidance would include the fact that you expect shipments to begin in the next several weeks and then pick up pace through the end of the year.

That is correct.

Okay. Again, I missed it and I missed the front part of the conference call. Did you give the backlog number?

Yes.

The backlog, and this is for defense only, is $16 million, as of the end of September.

That is up from -- what was it in the second quarter?

At the end of June it was about $13 million. Shortly after the start of the quarter, we received another order from Kongsberg. But the quarter-to-quarter comparable, it is up about $3 million quarter-to-quarter.

So again, the guidance you had previously given, about -- obviously you may not be exiting the year at $4 million to $6 million quarterly run rate on RWS systems, because you got a later start. But that still seems to be sort of a sustainable production rate through next year?

That is certainly our goal, yes, from a production point of view. Just to get back to your earlier question, we are capacity constrained in the current quarter, so if for some reason there was a further delay on one program, we would ramp up with the other program.

So the reason that we are not shipping more Raytheon units is that we're production constrained, not that we're -- we don't expect to be order constrained in Q4. So there is that level of backstop there.

Okay. Biggest area of concern here for the Company is your demand picture for the marine TracVision business, which as your traditional business is probably roundabout order of magnitude 50% of Company sales. We've obviously seen a slowing trend there. Can't tell exactly how much, because you are now blending in the positive impact of the TracPhone V7 product line.

But given all the announcements we are hearing from MarineMax and Brunswick and other public companies in the space, is it fair to assume that as you look out into the fourth quarter and perhaps into next year you are going to go from what had traditionally been sort of midteens growth comps to perhaps negative?

Well, what we are seeing is that the marine market has not been growing quickly; but we haven't seen any difference between Q3 and Q2. So when we look internally at the year-over-year sales figures, we see sort of more of the same, which is very different from the pattern we saw in the land mobile market, where you just see these dramatic declines.

So right now, looking at the first couple weeks of October and what we saw in Q3, we see sort of steady business in the marine TracVision part of our business. Meaning it is not robust growth; you may see some modest decline like we did in Q3. But nothing dramatic, and that is built into those numbers.

Okay. Now if we scratched out the incremental positive you have picked up from selling these high-end TracVision systems, and you look just down on the more consumer leisure market, albeit a high-end leisure market, if we just defined it as that, have you seen any weakening trends there?

We have seen weakening trends, but what we haven't seen is a change in the trend line. So in other words what we saw for the last couple quarters is a fairly consistent picture with no rate of change delta. You know what I mean.

So we saw sort of a little bit of softness, but that softness has not gotten worse.

Okay.

Let me add a little bit there, Chris. When you look -- if you were to see the profile of our Marine TV sales, what we saw in the third quarter is quite consistent with what we have seen year-to-date in 2008. So as Martin said, we've seen softness in that market in the consumer space for TV antennas for quite some time, actually dating back all the way to the end of 2006 in the US.

But we haven't seen a falloff in the year-over-year numbers from where they've been now for the last several quarters.

Right. Okay. Well, good. That is good to hear, and keep up the good work, guys.

One other thing I will add to get back to your very first question about airtime, I can give you a little bit of help in terms of total airtime for VSAT and Inmarsat in the third quarter represented certainly the majority of the services revenue, probably roughly two-thirds of it. And, the VSAT revenue is already a greater amount than the Inmarsat revenue for the Company and is growing on a sequential basis quarter-to-quarter.

Great, okay. Thank you very much.

(Operator Instructions) Jim McIlree, Collins Stewart.

Thank you. Good morning. Has the gyro for the Kongsberg remote weapons station been -- is that past qualification now, or are you still working on it?

No, we are still working on that.

So, who needs to sign the document? Is that Kongsberg or Kongsberg's customer or customers?

It is Kongsberg.

Okay, so is there more testing that needs to be done? What has to happen between now and the end of the month for them to sign the document and you start shipping?

As far as we are concerned, we are done with all development type activities and all the key testing is finished. So we are really at a paperwork stage now, where we expect formal signatory approval. So there's no technical issues or no spec parameter issues or anything like that.

There is no -- you don't have to go through more, I don't know, environmental testing or stress testing or anything like that?

No, we are at a stage now where we are just wrapping up the paperwork. So all the testing has been performed. We continue to do testing in-process, so that type of work will continue. But there is no further development work, there are no further specs that need to be improved or performance reliability, quality. To our knowledge, there is nothing further that needs to be done.

Okay, great. I know that '09 is a question mark for just about everybody. But can you try to articulate a little bit how you are viewing your expense growth in R&D, sales and marketing, and G&A for '09, at least from what you can tell so far?

Well, that's an interesting question, Jim. Like you said, at this time because of the difficult environment, it is really tough to get a read on some things. But we think we've got such strong prospects in the mini-VSAT business and in the fiber optic gyro businesses for 2009 that at this point we are looking at some very healthy growth in 2009 on the top line.

We will certainly continue to invest. But I would say that if you looked at our total profile of operating expenses across the Company, our objective will continue to be to invest at a slower pace than the growth of the top line.

So that is not helping you a lot, because it is not giving you the top-line percentage increase numbers; but we will grow our operating spending, but our plan will be to grow it at a slower pace than the top-line growth, so that we can continue to improve the operating margins of the Company.

Right. It sounds like in a sense you are high-grading your OpEx, putting it into areas where there is -- where you do have better growth prospects.

Exactly. We are going through shifts almost on a -- certainly on a very regular basis. Once a month what we are doing is we are shifting some of the operating expenses and some of the investments that we had made historically out of the areas that just are not growing and in fact are declining, like in the land space for satellite television, and moving it into the marine space, into the mini-VSAT business, certainly fiber optic gyroscopes.

So when you look at R&D, I would say that we have felt pretty comfortable at about the net 10% or 11% as a percent of revenue level. I would say that that is a good planning perspective for the foreseeable future. But we will be shifting investments internally within operating expenses to the high-growth businesses.

Right, okay. Last one. The capacity that you are leasing on GE-23, is this a fixed take-or-pay contract? If so, approximately how much is that on an annual basis?

Well, the answer is yes; this is a straight lease. So we are starting with a certain amount of capacity, and then it grows fairly quickly to a full transponder. I don't want to tell you explicitly what this particular satellite cost; but as a rule of thumb, a transponder is on the order of $1.5 million per year, just to put a (multiple speakers) around it.

Okay. So at some point you have a full transponder. Can you go beyond that if need be?

Yes. So there are a number of additional beams on that satellite, and there's still additional capacity which we have options on as well, that we can take more capacity should we need it.

Okay. Very good, thank you.

But just to follow up on your point -- so that is also baked into the Q4 numbers, that we now have some startup costs where we have capacity before we have customers.

Right. Right, that's what I assumed you guys were talking about, at least partially. That is in cost of sales, right, the transponder lease?

It will be when it kicks in, yes. It will be in cost of service.

Right. Okay, awesome. Thank you.

Jim Roumell, Roumell Asset Management.

A couple questions. One is, Martin, any more discussions with any competitors in the space on the V7? I'm thinking primarily of Schlumberger or Raytheon, in terms of them looking at the market and wanting to partner with you in some way, given some of the competitive advantages of the V7.

Part of our sales strategy is to look at various ISPs around the world that might be selling a competitive service, whether that is a VSAT service or Iridium service or Inmarsat, because those companies typically sell more than one type of product.

Now, one of the issues for us is that we normally don't wholesale the products. In other words, this is end-to-end business model is not necessarily conducive to a wholesale plan. And what we don't want to do is we don't want to give away our competitive advantages of being the single provider and guaranteed service and support and having an all-in-one product offering that works really, really well. So we are not willing to compromise on that.

So if we can find a sales outlet where we can not compromise on the service and the price advantages that we offer, and build a wholesale business model around that, that is something that we are definitely considering doing.

So you have had discussions with Schlumberger?

We talk to a lot of different people, so our sales guys are talking to a number of different people in the industry.

I guess I am more referring to you specifically, if you had had any contact with them?

I have spoken to many people. I don't want to get into specifics about which customers we have spoken to.

Okay, all right. Next question was -- and maybe you've provided this in the past, but what do you think the market opportunity is on the V7? In other words, if you kind of add up the number of possible boats in the world as you roll this out in the Pacific, and given that this is really geared toward a kind of big broadband user, and that is where the real savings is if you're a big user. Have you kind of identified a market size, so to speak, on the V7?

Well, I think that we've looked at some various estimates of the market In round numbers, it is a $1 billion a year opportunity in terms of the service revenue, between the broadband services that are out there today from Inmarsat and the services that are out there today from the existing VSAT providers.

So, we look at that opportunity and say, well, that is the airtime component; adding on top of that would be the hardware component, which the hardware right now has a list price of over $30,000. So it is also not an insignificant part of the equation.

Roughly the estimate of what is spent currently for airtime?

Yes, is approximately $1 billion per year.

Okay. Have you done any internal -- do you have -- can you share anything in terms of what realistically you can grab of that? Given where the V7 is most productive in terms of kind of heavy users of broadband and whatnot, do you provide any kind of handicapping of what you expect in terms of a base worst-case/ best-case scenario?

No, we don't have a specific sales forecast to give you, but we do expect to get the majority of that business over time. We also expect that over time that market will grow, meaning that broadband on ships today is not yet prevalent.

So if you look at some of the oil and gas customers that you mentioned, the shipping companies, and all the various aeronautical biz-jet applications, just the whole broadband, the mobile broadband market is still in its infancy.

So even though it sounds big now, it is going to be much bigger than it is today.

Also I would like to comment on your point that only heavy users are VSAT customers. Really the crossover point happens so quickly, if you look at the average monthly consumption of data. If you are using even 100 megabytes a month, which is really nothing, today with Inmarsat that is $1,300 a month, which is more than our base package starts at.

Operator, any other questions?

At this time, we have no other callers in the queue. (Operator Instructions) Rich Valera, Needham & Company.

Thanks, good morning. First just a quick bookkeeping, Pat. Do you have the depreciation and amortization for the quarter?

Yes, I do, Rich. It was $528,000.

Great. Then Pat, in talking about the increase in the inventory, you mentioned you had a buildup on the RV side and that you expected multiple quarters to work that off.

What is the risk of obsolescence? Like what is the typical shelf life of an RV product?

The shelf life is actually quite good. You know, we are selling products today that were designed multiple years ago, and customers are still using products that we sold six, seven years ago. So we are not concerned about the shelf life of the product.

Naturally, we are a bit concerned about carrying that inventory for a length of time and the cost of doing that. But we are not concerned about the actual content of the inventory and our ability to be able to use it over time.

Also, adding to that is that all of our products have the ability to be remotely flashed, both by us as well as by end-users. So if there was an improved feature, 90% of the time it is software, so those software updates are available today for free.

Yes, and another thing, one other thing, Rich, I don't want to leave anybody with the impression that all of this inventory increase is in finished goods, because that is not the case.

Right.

So the inventory increase is a combination -- a little bit of finished goods, not very much at all, but mostly raw material and subassemblies.

And mostly it is fiber optic, not RV.

Overall.

The increase.

-- for the Company, correct.

Great, that's helpful color. Pat, I know that we've talked before about at some point potentially reversing the valuation allowance on your tax, on your NOLs. I know you had a loss this quarter. I don't know where that puts that.

But can you give us any update there on where you think that process stands?

Well, it really stands about where it stood at the end of June. We do look at that every quarter, and we review it with our auditors. At this point in time, we continue to believe that it is more appropriate to keep the valuation allowance on the books.

I don't have a precise number for you, Rich, but there is probably still valuation allowance that would cover potentially around $2 million of profit in the US Company. At this point in time, based on our projection for the fourth quarter, I expect that in the fourth quarter we will look at it again.

It is a combination -- the decision is a combination of not only historical performance, but also our projections and our confidence level going forward. So I can't state when the valuation allowance will either be fully consumed or we will take it down to the P&L. But I would say as of this moment our decision has been to leave it on the balance sheet.

Our decision as of the end of the third quarter is to continue to leave it there on the balance sheet, and we will take another hard look at it at the end of the fourth quarter.

Okay, that's helpful. Thanks very much.

At this time, we have no further questions. I will turn the conference back over to our presenters for closing remarks.

Okay, if you have any follow-up questions, please feel free to contact Pat or myself. Thank you.

Again, thank you all for joining us today. That does conclude our call.