KVH Industries Inc (KVHI) 2009 Q2 法說會逐字稿

Well, good day, everyone and welcome to the KVH Industries' second-quarter conference call. Today's conference is being recorded. Now it is my pleasure to turn the conference over to Mr. Patrick Spratt, Chief Financial Officer. Please go ahead, sir.

Thank you and good morning. I am Pat Spratt, Chief Financial Officer of KVH Industries. 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 and also 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 to IR@KVH.com and we will be happy to answer them following this 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 May 6, 2009. The Company's SEC filings are directly available from us, from the SEC or from the Investor Information section of our website. Now I will turn it over to Martin to begin today's discussion.

Thanks, Pat. Thank you for joining us today. After a very challenging first quarter, we set a series of aggressive goals for our operations with the aim of achieving a strong sequential improvement in our results for Q2. And I am pleased to say that we met and exceeded many of those goals. Despite the continuing economic volatility, we continue to see compelling evidence that our strategic growth drivers are gaining ground and setting us on a course for long-term success.

In Q2, we achieved our third consecutive record quarter for fiber optic gyro sales. We took major steps in the expansion of our maritime broadband network and the revenue contribution from our broadband airtime services continue to grow. We also shipped our first production satellite TV antenna for the aviation market, further adding to our diversified portfolio of products to now include land, sea and air.

Together, these strategic initiatives help to counterbalance the continuing pressures that the economic environment put on sales of our satellite products, especially to the consumer market. The result was a stronger-than-anticipated second quarter with revenue for the quarter totaling $21.9 million, down only 2% compared to Q2 of last year. Profit for the quarter was approximately $200,000, or $0.01 per share. We are very pleased with the strong sequential improvement.

2009 continues to be a challenging year for KVH and many other companies and in this environment, we are focused on ensuring KVH's long-term financial health. At the same time, we are committed to investing aggressively when necessary to strengthen our competitive and technological positions and to expand our strategic initiative.

Looking at our key business areas, our guidance and stabilization business enjoyed rapid growth in an outstanding quarter with revenue of $9.3 million. That is a 130% increase from Q2 of last year. Sales of our tactical navigation products were down 22%, but our fiber optic gyro business picked up the slack with an impressive 435% increase in sales year-over-year and a 50% sequential increase over Q1 of this year. This makes the third consecutive quarter of record fiber optic gyro sales.

During the second quarter, we shipped our 25,000th fiber optic gyro evidence of the steady growing demand for these products and the value of the investment in the R&D that we have made over the past 10 years. FOG sales have become an increasingly valuable revenue stream for KVH. Expanding this part of our business is one of our primary and most successful strategic initiatives.

One obvious area of growth has been the continued strong demand for our FOGs for use in remote weapon stations. We recently received another $2.5 million order for our DSP-3100 FOGs for use in these mission-critical weapon systems raising our total in the last several quarters to more than $17 million with additional major orders expected in the coming weeks. However, it is important to recognize that the strength of our fiber optic gyro business does not stem solely from these weapons programs. In fact, sales of FOGs to remote weapon station manufacturers all combined currently represent about half of our total sales volume and the percentage of sales for other applications is growing.

We have a diverse group of customers supporting commercial and defense applications worldwide and in the coming quarters, we expect to diversify our customer base further. For example, our CNS-5000 inertial measurement unit is rapidly becoming a major contributor thanks to sales in the commercial market by both KVH and our collaborator, NovAtel. This self-contained navigation system is gaining acceptance in a broad array of applications, including surveying, autonomous vehicle navigation and precision mapping systems.

During Q2, we also expanded our productline with the introduction of our newest product, the DSP-1500, the world's smallest precision fiber optic gyro. With about 100 meters of polarization maintaining optical fiber wound into a housing only 1.5 inches in diameter, the DSP-1500 offers outstanding performance in an ultra compact, lightweight package. The unique combination of size and weight and precision will enable a number of new stabilization and pointing applications.

The DSP-1500 offers engineers and systems integrators tremendous flexibility in designing the sensor into a variety of systems. As a result, we are able to offer precision FOGs suitable for applications previously unable to use fiber optic gyros due to size and weight restrictions. Among these are night vision and thermal imaging cameras, aircraft mounted gimbaled systems, for law enforcement and homeland security and shipboard optical systems.

Turning to our mobile satellite business, our Q2 revenue was $12.5 million, a decline of 31% compared to Q2 of last year as a result of continued pressure on sales of satellite products in land mobile and recreational marine markets. Our land mobile business saw a sales decline of 51% versus Q2 of last year, which, believe it or not, is actually an improvement from where we have been. And we even saw a modest Q2 sequential uptick in land sales.

While I am not prepared to predict a recovery in the RV market quite yet, I do think it is worth noting that this market is showing some signs of life. Two of our major OEM customers, Monaco and Fleetwood, who entered bankruptcy in Q1, these companies have since been purchased and their new owners appear to be making commitments to resume production in the coming months. This is certainly a welcome bit of news for everyone in the RV industry.

So within our marine business, sales were down 28% overall during Q2 as we continued to experience fundamentally the same challenges -- credit problems with both dealers and consumers resulting in pressure on sales of boats to consumers. Now consumers continue to upgrade and retrofit boat they already own, but even there, they are focusing more on value. With that in mind, we are taking steps to make our products and services more affordable to a wider audience while also increasing their value and versatility.

Our new TracVision M1, which is both smaller and less expensive, has quickly become one of our best-selling TV products. We are taking a similar approach on our data products with the introduction of our new TracPhone FB150 satellite communications system. This compact system offers more mariners access to Inmarsat's global fleet broadband service with the hardware costs dramatically lower than our existing fleet broadband systems.

In addition, we have recently rolled out a new bundled airtime pricing model that makes satellite communications as easy to buy as a cell phone subscription. We believe that this new approach will help commercial and leisure boat owners manage their communication costs and make it more affordable to bring broadband onboard.

This product is complementary to our main thrust, which is establishing a global Ku-band mini VSAT network. We recently reached a major milestone as we shipped our 500th TracPhone V7. This represents close to 10% of the total installed base of maritime VSAT systems based on estimates by market analysts, [COMSYS].

To become one of the world's leading maritime VSAT operators in less than two years is a testament to the convenience, affordability and reliability offered by our fully integrated, 24-inch TracPhone V7 and the powerful mini-VSAT broadband network.

Our success to date in the face of long-established legacy solutions clearly illustrates that ship captains, commercial fleet managers and leisure boaters desire a new and more affordable, more reliable and more versatile approach to maritime satellite communications.

Now having said that, it is important to realize that the commercial shipping and maritime industry has been extremely hard hit by the global recession. Expenditures on new equipment are very low indicating that we have a tremendous opportunity to grow this business as the market recovers.

Since activations typically lag hardware shipments by at least one quarter due to movement through the channel, installation schedules and newbuild schedules, we can count on rising airtime revenues as the hardware units already shipped come online.

Critical to the continued growth of our mini-VSAT business is the ongoing expansion of the network. As you know, it is our goal to be the first seamless global Ku-band broadband network. We took several steps in that direction during the second quarter.

First, we assumed control of the North American and Caribbean networks from SES AMERICOM by buying their hub in Miami and leasing transponders directly. This will ensure that we are able to manage the network for our customers and maximize our margins and revenue. We now have a substantial number of subscribers in North America, enabling us to go it alone in this region.

At the same time, we signed a multiyear agreement with SKY Perfect JSAT in Japan to lease satellite capacity that will provide broadband service coverage in Asia Pacific waters and in the Indian Ocean. As part of this arrangement, we will be working with SP-JSAT to pursue hardware sales and airtime sales in Asia. We have granted SP-JSAT exclusive rights for sale to Japanese flags and Japanese-owned vessels while we focus on all other vessels in the region.

This expansion will also dramatically increase our ability to support the world's commercial shipping market. In fact, 13 of the world's 20 busiest cargo ports are within this new coverage area offering us significant new hardware and service sales opportunities. The Asian regional service is expected to go live in Q3 once JSAT obtains the necessary commercial licensing.

We are also expecting that the mini-VSAT broadband service will be activated for Australia and New Zealand waters very shortly. We are carrying out testing right now and we will be offering live demonstrations later this week at the Sydney International Boat Show in Australia in anticipation of live commercial service coming online in August.

The next steps in our network rollout effort are directed at expanding coverage over the Atlantic Ocean all the way down to Brazil, as well as finalizing plans for African coverage to support shipping routes all the way to Cape Town in South Africa. This will provide coverage for the oil platform off the West Coast of Africa and their offshore support vessels.

While the network expansion does add incremental bottom-line pressure until sufficient subscribers are active on the network, this investment is critical to our success in the commercial market. With global operations, our prospective customers need to know they will have broadband connectivity they require at all times.

As we gain subscribers, recurring airtime revenue is an increasingly valuable revenue stream. Quarterly airtime revenues in total were up 88% year-over-year to approximately $3 million with a significant majority of that being from mini-VSAT. We are very pleased to be meeting our expectations for the value of our new broadband business endeavors even during this difficult economy.

One of the themes I have continued to stress both internally and externally is the importance of diversification. This has really helped KVH during the current recession. We took another step towards diversification this quarter by finishing the design and qualification testing of our new satellite TV antenna for commercial airliners. I am pleased to announce that we shipped the initial production units of our TV system to LiveTV at the end of Q2, full DOE 160 testing is complete and flight tests of these antennas are scheduled to begin next week. We expect significant hardware sales from this product to start in the current quarter.

So in conclusion, our key strategic initiatives are clearly on a growth trajectory. While we still face challenges and pressure in many of our markets, the diversity of our product portfolio and increasing contributions of our key strategic initiatives are helping us weather the current recession.

Looking forward, we will be building on these efforts with exciting new products scheduled for introduction this fall. We will continue to expand our global network and make investments that are required for this business to be a success. We are on course to have the first truly global broadband VSAT network for both ships and planes. We are doing our best to make these investments wisely with an eye towards the immediate health of the Company, as well as our long-term prospects. I believe that we will continue to see the benefits of this approach in the coming months. Now I'd like to turn the call back over to Pat to talk about some of the numbers. Pat?

Thank you, Martin. The second quarter was very encouraging. Our financial results were better than expected. We've continued to make significant progress with our strategic growth initiatives and this was accomplished in spite of the very weak economies in every geographic area in which we operate.

Gross margin improved from Q1 to 35.6%. We had projected a sequential improvement due to an expected higher overall level of revenue, but the actual result was a bit better than anticipated. The most significant driver was the performance of our fiber optic gyro business, which also generates relatively stronger direct gross margins. Continuing investments in the mini-VSAT global infrastructure contributed to push overall gross margin below the prior year level.

For Q2, operating expenses were up about $300,000 compared to last year, but down sequentially by about $500,000. The sequential decline was due in part to the first-quarter reduction in employee population. For the quarter, reported R&D spending was only 8.5% of revenue. This reported level of engineering spending was somewhat lower than anticipated.

During the quarter, we completed the development project for the LiveTV in-flight entertainment system and this cost was capitalized. Now that this aeronautical antenna project is complete, we will see a sequential increase in reported engineering expenses in Q3 and subsequent quarters.

Second-quarter sales and marketing expense decreased 5% sequentially and year-over-year. Yet, we continue to expand our capabilities and market presence for each of our strategic businesses while continuing to scrutinize spending in areas that are showing weakest demand and in those areas that are not as strategic.

Administration expenses were down sequentially, but up 20% compared to last year. The year-over-year increase is due in part to consulting, legal and license costs for the mini-VSAT business expansion and other various tax and financial analysis projects.

Turning to the balance sheet, cash and marketable securities were $42.2 million. This was approximately $5 million higher than the Q1 level. This increase was primarily the result of closing the new $4 million mortgage for our headquarters building, a much better net margin and a significant prepayment for airtime services by a US government customer.

For the quarter, cash flow from operations was about $2.8 million. Capital expenditures were approximately $1.8 million. As noted previously, we expect the capital expenditures for the full year could exceed $6 million to support the purchase of hubs and other network management tools for the mini-VSAT network deployment.

Accounts receivable increased sequentially to $12.8 million reflecting the much higher revenue level. Days sales outstanding actually declined to 53, six days better than Q1. The weak economy continues to put pressure on collections and we will continue to closely monitor the condition of all of our accounts.

Inventory decreased to $13.8 million. During the quarter, we continued to rebalance our supply and materials with the current level of demand and to scrutinize potential exposure for excess or obsolete inventory. We increased inventory reserves as a result of this ongoing assessment. This process is a high priority due to the severity of the macroeconomic conditions in which we are operating.

Now I will turn to our expectations going forward. On our last earnings conference call, we indicated that the lack of visibility totally inhibited our ability to provide quantitative guidance. That condition has not changed materially. However, as we now enter the second half of the year, we will do our best to describe what we see for the next couple of quarters.

As of today, our outlook for the third quarter is that we should see a revenue level that is approximately equal to the second quarter. While sequentially sales should increase for our mini-VSAT products and airtime services for the aeronautical antenna system and to a modest degree for fiber optic gyroscopes, we will likely see a seasonal decrease for the maritime leisure business.

For the fourth quarter, we expect that overall sales could reflect a sequential increase compared to Q3. Keeping in mind that it continues to be very difficult to accurately forecast consumer and commercial demand in this environment.

For the second half of the year, we expect net margins to be about breakeven. This could develop as a modest loss in Q3 and then turn to a modest profit in Q4. High levels of ongoing investment in the mini-VSAT business infrastructure will continue to pressure our margins over the next few quarters.

Although we are hopeful that the worst of the economic decline is behind us, it is still far too soon to tell. We will continue to invest for our future while also being cautious with respect to all discretionary activities.

Our backlog for guidance and stabilization products and services at the end of June was $12 million. During the first week of July, we received a new $2.5 million order for fiber optic gyroscopes. In addition, we have only just begun shipping against the initial $3.6 million backlog for our aeronautical antenna systems. Combined, the backlog for our defense, commercial stabilization and aeronautical products and services is now approximately $18 million.

We are also still awaiting the next production order for our FOG-based TG-6000 inertial measurement unit for the Mark 54 torpedo program, but we are not including it in our near-term projections.

In closing, we will continue to take advantage of our diversified portfolio of products and services. We will execute growth strategies that play to our strengths and we will use our financial resources to continue investing while many of our competitors cannot. Long-term revenue and profit growth should follow. Now we would like to take your questions. Kelsey, could you please open the call?

(Operator Instructions). Chris Quilty, Raymond James.

Hi, gentlemen. Congratulations on the good results. I have got some questions for you on the TracPhone V7. I don't think you gave a number of units in service, but you did say that you are typically looking at a one-quarter decline or a delay in terms of initiation.

Yes, it is sort of at least that and sometimes it varies a bit. And that has to do with whether units are purchased for boats that are being built or whether they are in the channel. So we just want to make it clear that we don't have the same number of subscribers as we do units sold. That will always lag.

And do you have a sense if any of your dealers or systems integrators are creating some channel sale in there or do you think these things pretty much (multiple speakers)?

This has been very steady and it is pretty consistent with all our other products that have this sort of lag between shipment and the time the unit is actually activated.

Okay. And in the past, you have given us an ARPU number. Can you give us a sense of what it may have been in the quarter and how you think it is trending?

Yes, Chris, it has still been tracking pretty close to the $2000 number that we originally were estimating. And actually, we have seen it tracking at roughly that level throughout. So plus or minus a little bit, but it is right around that $2000 level.

Okay. And have you gotten any feedback from end users that would allow you to figure out either the types of end markets that are going into for large commercial shipping versus pleasure yachts or the types of applications where they are getting used?

Yes, I mean the nice thing about our business model is that we have direct contact with the end-user because they activate directly through us so we know exactly what kind of boats are going on and who is using it and how much they are using it and how often they use it. The mix is pretty much what we expected. I think initially we saw strong demand in the leisure market side because that is where our background was. And then as we have continued to market on the commercial side, especially in Europe where a lot of the shipping companies are located, we're getting good traction with the shipping. At the same time, we are pushing into the oil industry in US Gulf Coast. And as we expand off the coast of Africa, we are targeting the oil rigs there as well. So we actually have really good visibility into where they are going and how they are being used.

And in terms of new activations or geographical service area, are you still adding new subscribers in your older Atlantic and Caribbean basin or are all of the new additions coming on in the new geographic regions?

No, it is actually -- we'll probably still adding more in the old regions than we are in the new ones, which on the one hand is encouraging. On the other hand, it is frustrating because you are adding costs in a new area and you're not necessarily generating all the new revenue in the new area. But having said that, the way the business model works, it doesn't really matter where the subscriber is because it is adding -- so for example, if we add Asia Pacific and Australia, that might generate more sales in Europe because those are global shipping companies. And even if that guy never goes to Australia, the fact that you create a sale there because he wants a global system still helps us.

Okay. One clarification, on the defense backlog, you gave us $18 million, but I think your description of it may have been different from what you have given us in the past, including aeronautical broadband I think into that.

Yes, actually that was the same that I gave the last quarter. The defense backlog, defense only, guidance and stabilization at the end of June was $12 million. So I think what my comment was is that subsequent to that, we did receive another $2.5 million order in early July for fiber optic gyroscopes. So that would have brought the then current backlog in early July for defense up to $14.5 million.

The nautical backlog that we have is just the first production order for the contract that we signed a little more than a year ago for $20 million in total, but we have a current backlog of about $3.5 million for the aeronautical.

And it appears you are getting fairly steady order rate from Kongsberg on the FOG side of the business. Defense budget seems to have gotten tossed up a little bit in terms of units. Where are you in the sort of production ramp for the program? Have you or sort of hit a steady state yet based upon your order rate?

Well, we still expect to grow sequentially, not at the same kind of rates. We had a 50% sequential increase, but we are looking -- we are going into the year, we were hoping to get to that $4 million to $6 million a quarter rate. Now we are looking at more being in the $7 million to $8 million run rate per quarter.

Okay. So that is actually up above the sort of $4 million to $6 million you were talking about last year.

Yes, it is going better than we had expected.

And is that due to demand with that customer or other customers or the addition of things like precision nav?

All of the above. So that customer is ordering more and there were also other remote weapon station manufacturers that are building under license and they are about half the size of Kongsberg now. So we expect sequential growth and of course, big year-over-year growth.

And in terms of the competitive situation, have you seen any of the early competitors trying to come back into the market?

No, we certainly haven't lost any business. Maybe we should let another caller question, Chris and come back to you if you have any more follow-up.

(Operator Instructions). Rich Valera, Needham & Co.

Thank you, good morning. Pat, I was wondering if you could give the equivalent backlog figure in the first quarter for the $18 million aggregate backlog that you reported in the second quarter.

Gee, I wish I had that with me at hand. I recall, Rich, that it was a comparable number at the end of March, but then we got some new orders very early in April that brought the backlog up a couple million dollars from that point and then the LiveTV again brought it up to something I think that approached $20 million in total. So I think if you looked at it on an apples-to-apples basis, it was probably a case that we were down -- we have seen about a $2 million decline in apples-to-apples backlog from March to June.

Okay, that's helpful.

But understand that a lot of that is due to timing, of course and how they come in and as Martin just said, with remote weapon stations for example and Kongsberg being our primary customer right now, they are giving us -- we get a steady flow of new orders essentially that are on a rolling basis. So now it is just a matter of what the timing of those orders are and when they happen to show up.

Right. Understood. And then with the V7, I saw you put out a release on sort of a promotion effort you were going to undergo on that where you -- essentially it sounds like you have a hardware subsidy, as well as an airtime subsidy, which I don't think really costs you anything. But how aggressive do you plan to be on the hardware subsidy program and sort of what might that cost you and how would that be rolled through your margins? Would that be sort of capitalized or how should we think about that impacting the upfront equipment revenue stream associated with V7?

Well, I would say it is a little bit hard to tell exactly what the impact may be in terms of subsidies as you call them because of the fact that we will react on a case-by-case basis depending -- especially for larger commercial customers and the opportunities there. But if we do choose to discount the hardware to help subsidize the ongoing account overall and also the flow of airtime services over the long term, that generally, that discount would be applied to all of the revenue that we would receive over whatever the contract period is for that account.

So if they sign a three-year contract for airtime and we've given a discount for the product, we would actually amortize that over the entire revenue stream. And so a portion of the discount -- we'd calculate a portion of the discount going to product and a portion of the discount going to airtime. But the product portion of the revenue, whatever we calculate to be the net revenue for that sale, would be recognized upfront. So that would be recognized at the time of the sale.

Right. And typically this is in conjunction with a three-year lease commitment. So you are looking at airtime over the 36-month period of something like $72,000. So if you discount the hardware from $30,000 to $20,000, it is not -- you should look at it in the context of the total revenue stream.

Sure. No, that is very helpful perspective on that. Thank you. And Pat, just trying to think about the sequential trajectory of the income statement -- so it sounds like we have flattish revenue. You mentioned R&D. It sounds like it picks up because you are not capitalizing the airborne development. Is there anything else we should think about in terms of OpEx for gross margin as we move into the third quarter?

Well, I'd say our outlook right now for the third quarter is that gross margin may be down slightly sequentially, potentially 100 basis points. As I mentioned and as you just said, Rich, R&D will be up in absolute terms and up as a percentage of revenue. And that is largely the result of the fact that the LiveTV development is now behind us so we will be expensing everything from here on. Sales and marketing and administration collectively are probably flattish sequentially. So between gross margin being down a bit and R&D being up, that is the significant change if you compare to the second quarter.

Great. And one final one, if I could just, Pat, do you have the depreciation and amortization number for the quarter?

Yes, I do. It was $675,000.

Great. Thank you very much.

Hamed Khorsand, BWS Financial.

Good morning. Just a couple of questions. How big is the largest fleet using the V7 right now?

Well, some of the fleets have more than 100 ships and they are currently either in a trial phase or they are doing 10 or 20 prior to roll-out of an entire fleet. But typically a shipping company that we target would have anywhere between 25 and 200 vessels.

Okay. But of that 500 that is being used right now, what is the largest fleet size?

Well, they are typically under -- the largest one would be, commercial one, would be say under I would say under 25. So most of them are still in roll-out phase of either trials or small deployments.

Does the Company take a loss on any of the hardware when you are signing up anyone for the V7 service?

No.

Okay. So there is immediate profit from the airtime and the equipment then?

Well, there's -- certainly if you look at the product on a gross margin, a direct gross margin basis, there is immediate profit. The airtime, as we said, we don't disclose profit or margins specifically by product area or by service area, but we are building the airtime infrastructure around the globe and that is adding substantial cost to our P&L. And so as we build the airtime over time, we will see improving margins. But at the moment, those are under pressure because of the fact that we are in the process of building this infrastructure out.

Right, so for example when we add a region like Australia, the day we add the region, we have zero subscriber revenue and we have fixed costs. So any particular region, by definition, the day it comes online would not be profitable. But we look at the global business as a whole. In the aggregate, it is, of course, making money.

Are you doing any pre-marketing of the product in markets like Australia before they come on or do you wait until the market is online and then start marketing the service?

We do a pre-marketing. In fact, I mentioned in the call that we are doing a promotion at the Sydney Boat Show, which is starting I believe this week and we will be doing live demonstrations down there even though the service is not live and available yet.

And then lastly, do you have any customers for the aeronautical products that you recently finished testing?

Yes, we have signed a $20 million firm contract for that.

That contract is with LiveTV, which is the company that is actually the system integrator and installing those systems on commercial airplanes.

Okay, sounds good. Thank you.

Okay, before we move on. I would like to correct a number. I just realized that when Rich Valera asked me about depreciation and amortization, the number is $625,000. I think I erroneously said $675,000. So I just wanted to correct that.

Aaron Edelheit, Sabre Value Management.

Yes, I wanted to ask how important is it to offer -- for your customers for the TracPhone V7 -- to offer global coverage and I was just wondering if you could describe if your customers are waiting for this? And as you get closer to adding the final kind of geographies, do you think that you would see some purchases or people stepping up around the Q4 area, the Q1? What I am asking is is there kind of a pent-up demand for people who are just waiting for you to offer the whole thing?

That's an excellent question. And it varies by customer type. So we have customers for example that are oil service vessels in the Gulf, off the coast of the US. They could care a less about global coverage. On the other hand, they care a lot about coverage of the coast of West Africa if they have operations there as well.

On the other hand, most shipping companies -- container shipping companies, oil tankers -- they care every much about global coverage. So even though you have half the world covered and we probably have, I don't know the exact number, something like 50 million square miles covered already, they want to see a global coverage in place before they buy anything. So it varies by customer type, but it is clear that once we have it in place, there will be a much, much larger addressable market than we have today.

Okay, and in terms of your distributors kind of getting ramped up, I know that you had a big win in February with Thrane & Thrane. I am wondering if you could describe just how your efforts are in getting distributors kind of ramped up to full kind of potential to sell. And specifically if you can comment how things are going with Thrane & Thrane with them, when do you think they will be at full force if they aren't already in terms of selling the -- I think it is the SAILOR 500?

700.

700. Sorry.

Yes, so let me start with your last question first. The relationship with Thrane is a good one because it is symmetrical. Meaning that they are selling a private-label version of our V7. We are selling a private-label version of their fleet broadband product. So we have very similar interests and we are dependent on each other for those two products.

So they are -- the VSAT business is new to them, so they are coming up to speed and we are doing sales training with them and they are rolling it out out to their -- they just had a dealer conference in Denmark, which we attended. So we will be doing additional work with them on the training side, but they are very well-established in the commercial shipping market, so they have a very strong brand there. They have a global support and service, which is a very important thing. So they should be able to do a very good job with that product.

Would it be accurate to say that we will see the kind of full effects of the partner, the distributor relationships including Thrane & Thrane next year?

Yes, I think that my own sense is that our sales ramp rate is a lot more tied to the global economy than we think because when we started this Company, it was 1982 and we were launching products into the marine market in the midst of this giant recession back then. People would say, well, how can you sell products into the midst of this recession and for us, it was all incremental. We were starting from zero so everything all seemed good to us.

I think we are a little bit the same thing that is going on here with the V7. We have never been in a commercial market. We didn't have any VSAT, so this is all incremental revenue. So we think we are doing fine. But the reality is that I think the economy -- these shipping companies are under tremendous pressure. 10% of their fleet is laid up in anchor. The shipping prices are down dramatically. Capital budgets have been frozen. So I think that what really is going to drive the sales of the V7 is the economic recovery of global trade.

Got you. My last question is, looking out to 2010, just in terms of your expenses and R&D or just your general operating expenses once you are fully rolled out with the TracPhone in terms of coverage, do you expect it to level out outside of just the variable expenses of increased airtime? I am just wondering if you could describe like once you get fully kind of up and running just a rough -- could you give us a rough outline of how you see things looking at least expensewise next year?

I will let Pat answer the specifics on the expense, but in general, you should think of the buildout of the network as somewhat of a fixed cost. So at the macro level, to go from 500 to 5000 will require very little, if any, additional expenses in terms of a network architecture. So we have got a lot of flexibility and a lot of capacity built into the way the product is architected and through efficiency improvement in the broadband services. So we should see increasing net margins because of the fixed nature of the network costs.

And to give a little bit of an additional sense, during the course of 2010, we would expect that our gross margins would show improvement compared to this year. And that is fundamentally very much driven by what Martin just discussed in terms of once we have the infrastructure for the mini-VSAT business in place, at least for the foreseeable future, that is pretty much a fixed cost. And until we have the need to increase that capacity, which would be a good thing, those expenses will be fairly steady.

On the operating expense line, we have got a target to get our operating expenses as a percent of revenue down into the roughly 28% ballpark and this last quarter, we were at 35%. We have fluctuated as high as 40% and more and as low as the low 30%s, but our goal is to get our operating expenses down below 30%. And I would say during 2010, you should see us making good progress toward that goal.

Thank you very much.

Mr. Spratt, we have no further questions. I will turn it back to you for closing or additional remarks.

Okay. Well, we would like to thank you all very much for your participation and your interest in KVH and if you have any other further questions, please do not hesitate to give us a call. Thank you.

Thank you again, ladies and gentlemen. That does conclude our conference for today. We thank you all for your participation.