KVH Industries Inc (KVHI) 2010 Q3 法說會逐字稿

Good day, everyone, and welcome to the KVH Industries third-quarter 2010 conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Patrick Spratt, Chief Financial Officer. Please go ahead.

Thank you and good morning. I am Pat Spratt, Chief Financial Officer of KVH Industries, and with me is Martin Kits van Heyningen, Chief Executive Officer.

This call will address the third-quarter earnings release that we issued earlier today. 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 be archived on our website for future reference. If you are listening via the web, feel free to submit questions to ir@KVH.com, and we will answer them following this call.

This conference call will contain certain forward-looking statements that involve risk and uncertainty. 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 6, 2010. 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 the call over to Martin to begin today's discussion of results. Martin.

Thanks, Pat, and thank you all for joining us today. Well, the third quarter was another very solid one for us at KVH, with revenue growth coming in right on plan and earnings coming in ahead of our expectations. We achieved some major advances for our global mini-VSAT broadband network, and we won major new contracts that will result in significant financial benefits starting in 2011.

First of all, we recorded $27.8 million in sales for the quarter. That's a 23% increase over the third quarter of last year. And adjusted net income was $1.6 million or $0.11 per share. During the same period last year, we reported net income of $0.03 per share on revenues of $22.6 million.

For the first nine months of the year, revenue was $85.3 million. That is a 36% increase over the same period last year, with a net profit of $8 million or $0.54 per share. Comparing adjusted net income to last year, EPS was a plus $0.34 compared to a loss of $0.14 in 2009.

Global satellite communications and fiber-optic gyros continued to drive our overall growth during the third quarter. During the quarter, we also received both the largest TracPhone V7 and the largest TACNAV orders in the Company's history. Now I will touch on some of the highlights.

In our guidance and stabilization business, revenue from fiber-optic gyro sales was $10.5 million. That's a 33% increase year-over-year and just below the revenue record we set last quarter. While sales of our tactical navigation products were down somewhat during the quarter, our military sales team landed our largest ever TACNAV order for products during Q3. We will begin to ship this $13 million order for TACNAV systems in early 2011 and will continue into 2012. Follow-on orders for this program are expected in the next few quarters.

On the fiber-optic gyros side of the business, we elected to buy the facility in Tinley Park, Illinois, the home to our fiber-optic gyros and defense manufacturing plant. The total facility is approximately 100,000 square feet, and this gives us the additional space we need for further expansion of our FOG manufacturing capacity. We incurred no debt in this transaction, and our operating costs will actually be the same or less than we were paying to rent less than half the facility.

As you know, remote weapons systems have played a prominent role in the growth of our FOG business, and we believe they will continue to play a major role in the future. Nevertheless, we also recognize that it is vital to the health of our business that we not rely solely on remote weapons systems for the fiber-optic gyro revenue stream. This will be especially important in Q4 since we expect a much smaller volume from our primary remote weapons system customer as they work down inventory levels in November and December.

We do expect orders for continuing production starting again in January under the existing CROWS II contracts. However, we still don't have any visibility on the CROWS III procurement.

That is why the broad base of business we've worked so hard for our fiber-optic gyro business products is still valuable right now. In Q4 last year, FOGs for CROWS remote weapons systems represented over 75% of our total FOG revenue. In Q4 this year, we expect that percentage to be down to around 15%, but we still anticipate the total FOG revenues will be around $9 million for the quarter, which is what they were last year.

We've diversified and tripled sales for new products and new applications. Just this morning, we announced a new $1.1 million order to provide FOGs for use in the Javelin Basic Skills Trainer, which is used by the U.S. Army to train soldiers to operate the Javelin anti-tank missile system.

And our new high-precision inertial navigation systems have rapidly become a significant new source of FOG revenue. These IMUs are an ideal solution for the real-time navigation and positioning required for things like dynamic mapping. A great example of this is the augmented reality system developed by Churchill Navigation.

This real-time mapping system gives airborne law enforcement teams the ability to overlay street maps and other data on live video feeds from a moving helicopter, making coordination with ground units more effective. Real-time data overlay on video requires incredible precision and super-high-sensor bandwidth, capabilities our CNS-5000 IMU delivers.

Our FOGs are also playing a key role in mobile survey technology that supports applications like Google Maps Street View, autonomous vehicles, like Google's new prototype self-driving cars, precision agriculture and drone navigation.

We're on our way toward achieving our goal of a healthy balance within our FOG business, reflecting a split among remote weapons systems, inertial navigation applications and a wide range of commercial uses. Once we achieve this, the resumption of strong RWS sales will be incremental, not integral, to our business plan.

Now turning to our mobile satellite business, Q3 revenue was up 28% year-over-year, with increases internationally, domestically and within both the Marine and Land mobile markets. The biggest driver here was the stellar growth of our mini-VSAT broadband business. In only three years, mini-VSAT has transformed KVH and our business model. Since launching the mini-VSAT network in late 2007, we've shipped approximately 1000 TracPhone V7 systems, making us the fastest-growing maritime VSAT solution in the industry.

Hardware sales remain a vital part of our business, of course. However, it is the airtime that is the engine of our Company's growth right now. In the third quarter, mini-VSAT airtime revenue was up more than 90% compared to the third quarter last year. Clearly, commercial, government and leisure mariners appreciate our combination of speed, reliability and affordability.

Marine professionals apparently feel the same way. Just a few weeks ago, we were honored when the TracPhone V7 was named the Best Communications Technology by the National Marine Electronics Association. This marks the first time that the NMEA has given this award to a product other than a radio or an Inmarsat system, and marks a remarkable shift in the thinking of marine dealers, who now see the power of our mini-VSAT broadband system as the preferred solution for all types of vessels.

We are working hard to expand that appeal even further. A few weeks ago, we introduced a suite of new airtime packages designed to make us even more competitive in the marketplace. In addition to our existing fixed-rate speed-based plans, we are now offering metered-rate options that permit commercial and leisure boaters to choose a service plan based on how much data they expect to use during the quarter, while getting the benefit of our 2-megabit-per-second speeds.

The new metered-pricing options also include a lease and airtime bundle that makes the V7 hardware, mini-VSAT Service, GlobalCare Premium Support Program and 100 megabytes of monthly data available for only $995 a month. This approach gives crew and passengers access to data rates up to four times faster than Inmarsat fleet broadband, as well as five times the monthly capacity you would receive in a comparable Inmarsat hardware and service bundle.

We recently enhanced the mini-VSAT network itself, both in terms of coverage and capacity. After months of work, we succeeded in getting satellite capacity agreement and teleports in place for Brazil, which will be going live in the next few weeks. With the addition of coverage for Brazilian waters, we will dramatically expand our sales opportunities for both our hardware and our airtime to the offshore oil and gas industry in the region, including the rigs, supply ships and other vessels that support this industry.

We also increased capacity for subscribers around North America by 500%. We achieved this through a major upgrade to the spread-spectrum technology at the heart of the network, along with an additional transponder. We just announced a few days ago that we doubled capacity for the European market. Similar technology-only enhancements are being queued up for our service in the rest of the world. This new waveform is a software upgrade which doubles capacity with no increase in operating costs for KVH.

While the strength of our network is key, we also recognize that we must expand the capabilities that we offer our customers in other ways. Commercial maritime SATCOM users require powerful integration capabilities to support mission-critical IT requirements. Generally, this requires a network appliance product and a middleware software solution to provide this functionality.

After a year-long assessment of middleware providers, we determined that Virtek Communication was the best in the business in terms of technology, existing customer base and value. That is why we are very pleased to complete our acquisition of Virtek just a few weeks ago.

Now, their CommBox solution provides key features like onboard e-mail servers, least-cost routing, firewalls, file distribution, antivirus protection and Internet cafe solutions. Vessel owners want to retain their crews, so they need to improve crew welfare and morale by offering voice, e-mail and web browsing. Commercial fleets are increasingly connected to their company networks, making it critical for IT departments onshore to have comprehensive remote access to their shipboard networks, enabling them to minimize their cost and improve their efficiency.

We are now able to bring that network and data management expertise and proven CommBox technology in-house. We are committed to supporting Virtek's existing customers and offering the CommBox technology as a standalone product for vessel owners, even if they don't use our airtime. However, the powerful CommBox software will now be built into the TracPhone V7 and our mini-VSAT solution.

We are already seeing marketing synergies, in addition to the incremental benefit of Virtek's existing revenue stream. CommBox customers are potential converts to the mini-VSAT broadband and V7. And V7 customers may wish to add the CommBox features to their installations.

When we created the V7 and the mini-VSAT network, our goal was to offer an end-to-end solution that covered not only basic voice and broadband communications, but also value-added capabilities that would make our global SATCOM service even more appealing, more useful and more competitive. Adding Virtek and its talented team and the CommBox technology to our SATCOM offering is a big step in that direction.

We now offer mariners a unique satellite communications solution, a fully-integrated service from one company that owns and operates a global network, manufactures the antenna hardware, provides worldwide support and incorporates a powerful suite of value-added software capabilities.

Last but not least, our biggest news of the quarter was our big win with the US Coast Guard. In September, we won a 10-year $42 million IDIQ contract to install TracPhone V7 and provide broadband service on as many as 216 Coast Guard cutters. It is our understanding this may be the single largest maritime VSAT contract in history in terms of quantity.

So we are thrilled to win this contract and work is now under way. While we won't see any substantial revenues from this contract in Q4, we already have $3 million in hardware and airtime task orders in hand for initial shipment scheduled to begin in early 2011.

Winning the Coast Guard contract is a major credibility boost for KVH and for our broadband network. It opens a wide range of potentially new military and government opportunities, both domestically and overseas. And in addition, commercial customers we are meeting with now appreciate the fact that we have a 10-year contract with the Coast Guard, which confirms for them that we are stable, reliable and we will be here for the long run.

This endorsement of our technology, together with our integrated solution and recent network enhancements, is enabling us to make a compelling case as we aggressively pursue some very large new commercial opportunities. We are hopeful that this may lead to some more good news in Q4.

In conclusion, our performance in Q3 was right on track and we continue to execute well. We took some huge steps forward in our VSAT business and we continue to diversify and expand our growing fiber-optic gyro business. We also strengthened our foundation for the future, thanks to large new orders that are in-house and queued up for 2011.

Our diversification strategy is once again helping us, as we expect to continue to grow and be profitable in Q4, despite a $5.5 million reduction in the CROWS business and a $3.5 million drop in live TV. Overall, FOG revenues should be flat year-over-year and SATCOM should be up strongly. While we expect a drop in RWS shipments in Q4, we see this as a short-term issue in an otherwise robust fiber-optic business.

Now I would like to turn the call back over to Pat to give you a closer look at the numbers. Pat.

Thank you, Martin. We are pleased to report that results met our expectations and again show that we continue to make good progress strategically and operationally. The macroeconomic conditions continue to be very uncertain and challenging, yet we are making excellent progress in spite of that.

For the quarter, gross margin was 41.6%. This was up about 260 basis points sequentially, and it was much improved over the third quarter of last year. Gross margin was better than we had projected at the start of the quarter, largely due to a more favorable mix of products and services. We also experienced some benefit from a reduction in inventory reserves.

Both product and service gross margins showed strength sequentially and year-over-year. After three years of building out the initial global network for mini-VSAT, we expect that we are now on track to show improving margins for airtime services. Coverage for the Brazil region is coming on line, so the fourth quarter will be the first quarter in which we incur those costs. However, the continuing growth of VSAT airtime services revenue worldwide should be sufficient to offset that and show some additional year-over-year improvement in the fourth quarter.

Many VSAT Airtime services continued the pattern of strong year-over-year and sequential growth. Inmarsat Airtime services revenue was flat sequentially, but did show growth year-over-year. Other services from nonrecurring engineering and repairs declined both year-over-year and sequentially.

For Q3, operating expenses, excluding the acquisition costs related to acquiring Virtek, were up 15% compared to last year. A key year-over-year driver of this percentage increase was reported R&D, which increased 28%. In Q3 of last year, we were in the final stage of completing the development of the aviation antenna system and capitalizing those costs, and that resulted in lower-than-normal reported engineering spending for that period.

As a percentage of revenue, reported R&D spending was 10.6% for the third quarter. We expect R&D to be about 9% to 10% of revenue on average over the next several quarters.

Second-quarter sales -- excuse me -- third-quarter sales and marketing expenses decreased sequentially, and increased only modestly year-over-year. During the quarter, there was some growth in sales staffing, along with preparation for upcoming industry events. Seasonality, especially in leisure markets, can cause sales and marketing expenses to be uneven quarter to quarter. We expect that sales and marketing will increase sequentially in the fourth quarter, in part due to the integration of Virtek.

Administration expenses, including the acquisition costs related to acquiring Virtek, increased 6% sequentially and 26% year-over-year. Costs for professional services related to acquiring VSAT licenses and establishing operations in multiple countries for the buildout of the network were again a key factor.

All of the costs associated with the acquisition of Virtek flowed through the administration expense line. These were $500,000 in Q3, causing the reported administration expense to be almost $3 million.

The third quarter was a bit unusual with respect to tax expenses. We recorded a $441,000 expense from a change in the deferred tax asset valuation allowance. This was the result of a change in the projected effect of timing differences with respect to deferred stock compensation and other temporary book-to-tax adjustments. Because of the timing of these items, we were not able to capture the full effect of the projected future tax benefit.

As a result, we recorded a reduction in the valuation allowance adjustment that had been booked in the second quarter. We do not expect to experience this type of adjustment in the fourth quarter. However, the variability of the effect of temporary timing differences for things like deferred stock compensation are not easily predictable.

We expect that our fourth-quarter effective tax rate will be approximately 20% to 25%. Beginning with Q1 2011, we expect our effective tax rate will increase to approximately 40%.

Turning to the balance sheet, cash and marketable securities were $37.3 million. This reflects a sizable reduction compared to the second-quarter balance. During the quarter, we acquiring Virtek for cash, and we purchased our production facility in Tinley Park, Illinois. Together, these consumed about $11 million.

In terms of cash generation, we continue to experience a strong cash conversion cycle for accounts receivable. For Q3, cash flow from operations was positive at about $3.5 million. Year-to-date it is $9.8 million.

Accounts receivable decreased to $17.2 million. Days sales outstanding was 56. Inventory increased sequentially by about $1 million to $15.2 million. Capital expenditures were approximately $6.8 million for the quarter, including the Tinley Park facility, and were $10.5 million year to date. We project that we will spend about $1 million to $2 million for capital expenditures in the fourth quarter.

With normal operating requirements, we expect our cash balance to remain close to its current level for the near-term, even though we will be making additional investments for mini-VSAT network support and for internal productivity test and manufacturing capabilities for our operations. Our backlog for guidance and stabilization products and services at the end of September was $24 million.

Now, I will review our expectations going forward. At the start of 2010, we did not provide specific financial guidance for the full year, but we did indicate that we expected to see strong top-line growth and improving bottom-line results, albeit in the context of the first-half loading of the aviation antenna sales and the second-half seasonal weakness in the leisure marine markets.

We expect the full-year results to be a little better than our original expectation, although the fourth quarter will be more challenging than we thought one quarter ago. For the fourth quarter, we expect revenue growth to be in the range of 1% to 8% compared to the same quarter in 2009. This more modest expectation is due to the fact that our largest remote weapons system customer has significantly reduced demand for the very near term. Indications are that this is due to changes in their production schedule.

The sequential decline in FOG production from Q3 for this customer is about $4 million. Although we have been filling in orders for other FOG applications quite well, it will not be enough to offset this entire amount. We expect the total sales of fiber-optic gyroscopes will be about $1.5 million below the Q3 level. We expect to see new orders to support the remote weapons station customers' production in the first quarter of 2011.

In last year's fourth quarter, we also saw the benefit of $3.5 million of revenue for our aviation product. Growth in our mini-VSAT business and other core businesses is expected to more than offset this year-over-year impact. Virtek operations are now included in our guidance, although they represent only a modest portion of our projections in the fourth quarter.

We expect net profit for the quarter to be in the range of $0.02 to $0.06 per share. Gross margin will likely be modestly lower than the third quarter. This is largely a result of the lower level of FOG revenue. Operating expenses are expected to increase sequentially, in part due to the concentration of industry shows.

In summary, we expect our strategic growth businesses to continue to build momentum, and we believe that as we enter 2011, we will experience continuing growth in revenue and profit.

Now, Elizabeth, we would like to take the questions from the participants. Thank you.

(Operator Instructions) Hamed Khorsand, BWS Financial.

A couple questions here. What kind of cost [needs] come out of the OpEx over the next couple of quarters because of the Virtek acquisition?

What kind of costs will be increased (multiple speakers)?

Yes, what kind of synergies.

Oh, synergies. I would expect from a direct synergy standpoint the greatest benefit is going to be not on the cost side or the expense side, but in the opportunity to leverage sales going forward, both of the CommBox product and also the V7 systems and Airtime.

The other, more significant leverage effect is our ability to be able to come to market much more quickly with the functionality of that product offering, which is what the maritime industry is looking for, as the alternative, if we had not purchased Virtek, being to develop something ourselves or to license the capability to be able to resell somebody's product.

So I think you should look at this as the leverage is in the time to market with the functionality for the product, as well as the leverage effect for incremental sales going forward, and not from a cost savings standpoint.

Okay. And then just a follow-up -- one of your last comments was should we assume that it is about $1 million that is pretty much one-time related to those conferences in Q4 that won't occur in Q1?

I would rather not put a number on it, but we do have a significant concentration of shows in the fourth quarter, and they can be reasonably costly in terms of preparation and participation. We have Ft. Lauderdale Boat Show coming up here this week. Then we have the METS show in Amsterdam. And AUSA is also this week, and that is a defense show in Washington DC. But you should not think of it as being a $1 million impact for the quarter, certainly.

Okay. And then two more questions. How much of the initial Coast Guard fleet order from last year has been fulfilled?

From the one we just signed, or for the one that (multiple speakers)?

No, from the one last year, when you -- I think it was September of 2009.

Those were filled immediately when we did it. There was about 38 systems, I think.

Okay, so you are generating revenue from those right now then?

Yes.

Yes, absolutely.

Okay. And then, is there any seasonality in installing the TracPhone V7 in Q4? I'm just looking at it from a weather standpoint, more ships are at port. Would it benefit you?

No, the seasonality is really more for the leisure market. For the commercial market, which is our prime focus with the V7, there really isn't any seasonality.

Okay. All right. That's it for me. Thank you.

Rich Valera, Needham & Company.

Question on the FOG business. It sounds like you're going to do about $9 million in the fourth quarter, with minimal contribution from CROWS, that you cited around 15% of revenue.

So what is your confidence level in maintaining the business at that level going forward? I'm assuming you expect some rebound maybe in the first quarter, pending receipt of additional CROWS orders. But what is your confidence level on sort of the high-single-digit type of revenue level with the FOG business, given the expectations of variability in CROWS demand?

Well, we expect it to improve in -- starting in Q1. So our expectation is that our CROWS business will increase. So we don't see this -- we don't see any risk, at least today, that it would decline into the single-digit percentages.

Okay. And then you mentioned you are still operating under CROWS II, obviously, and these orders you will be getting in the near term are CROWS III orders. Any update on CROWS III? Any thoughts on timing of the formal RFP here and how that might play out over the next year or so?

No, we haven't got any new information on that. But as Pat mentioned, we have this major US Army show starting tomorrow, and oftentimes there are announcements at that type of those conferences, so the Army may announce their intentions soon.

How long do you think CROWS II demand could support your business, or they can continue to issue orders against CROWS II? Do you think that could extend well into 2011, if there is no resolution on CROWS III, which it doesn't sound like there is actually likely to be?

Right, I think there's -- yes. So I think sort of the low-level production could continue through, say, at least the next three quarters, into the third -- through the third quarter of 2011. And I think that generally with these types of programs, one of two things happens. Either the program moves ahead quickly and then you'd start CROWS III, or it is so delayed that they decide to fund additional CROWS II.

So I think if it is going to be more than a year late, then they will probably do another interim order of CROWS II. That is usually how these things work.

Great. And one final one on CROWS, if I could. How would you define sort of low-level? Obviously not at the sort of levels you saw in Q3, but any guidance on how you think about low-level production for CROWS II?

We haven't got an update yet, so we expect it to be better than Q4. But as you say, it probably won't be at the pace it was a year ago, when we were doing $7 million a quarter in CROWS. So I think it is going to be steady until CROWS III comes out.

So I think that the slowdown we have right now, starting in November and December, we don't expect that to repeat. We expect to have a sort of uniform rate of production going -- starting in January again, but what that level is, we don't really have guidance for you yet.

Great. And then if I could just move over to the gross margin line, in particular on the services side. Pat, I think you made reference to the gross margin on the service side being up year-over-year, but I was wondering sequentially what you think of that. I know you are layering in the Brazil expenses, but you should be gaining leverage on the other part of the business. Any thoughts there on the gross margin trajectory of the service business?

I would guess on the -- if you are asking about Q4, Rich, compared to sequentially Q3, I would say it is probably going to be flattish if you look at total gross margin for services. But the airtime portion should improve. We are expecting another modest reduction in the non-airtime service portion of --. But, yes, the non-airtime services, for example, nonrecurring engineering and repair services and so forth.

So we are expecting a sequential reduction in the level -- the amount of that revenue, and that is going to have a drag effect on the overall gross margin for services. But the airtime margin should actually improve modestly on a sequential basis.

And Pat, are you willing to say anything about the expectations for the service gross margin as we head into 2011? Presumably, you are at a point now where you can start getting leverage kind of layered on all of your sort of regional costs. Any commentary you're willing to provide there?

Given what we know today and the way things have been built out and the way the airtime revenue is growing, we would expect that the airtime service margins are going to continue to show progressive improvement. They should show progressive improvement quarter-to-quarter and certainly on a year-over-year basis.

And so what we will ultimately achieve in service gross margins, I am not prepared to comment on that specifically right now. But we should continue to see improvement over the course of 2011.

Great. Thanks for taking my questions.

John Bright, Avondale Partners.

Martin, mini-VSAT subscribers seemed to come in line with your expectations for the quarter. Are these additions still primarily word-of-mouth additions, or are you beginning to do anything to increase sales and marketing efforts?

Well, we've always done a tremendous amount of sales and marketing, both through trade shows, through customer visits, advertising, electronic media outreach. So we've got a very focused marketing team that is generating a ton of leads for us.

Nothing from the standpoint of subsidizing the equipment or looking at doing that?

Well, we don't subsidize equipment per se, but we do have these new lease bundles, where we have hardware and airtime packages now for as little as $995. It includes the hardware, the GlobalCare, the airtime, in a single monthly fee, which is pretty attractive.

Have you seen any change in the time to activations post a sale, and/or have you seen any change in potentially churn?

I think the time to activation has improved. So we are seeing a little bit faster. And that could be just that initially we had inventory that was in the channel and it seemed like it was a long time. But it's starting to -- the time from sale to activation improved. It may also be related to our leasing program, so that when people lease hardware, it gets activated immediately.

And then churn still remains very small, correct?

Yes, churn is not a big factor.

You mentioned -- go ahead.

No, I was going to say, primarily, if we lose a customer, the most common reason is the vessel is sold, that type of thing.

You mentioned in your prepared remarks a very large commercial opportunity, with possible news in the fourth quarter. How would you characterize those type opportunities, as government opportunities or do you think more --?

No, these are all commercial. These are all commercial opportunities. So I was just relating it to the government. I think we've gotten some positive bounce from the Coast Guard selection. So it seems to help us with commercial customers, as you would expect.

But the big opportunities that we are chasing now are all commercial, and these take very -- they always take a very long time. But we've been pursuing some of these for a long time. So I think we are starting to get into the part of the V7 sales cycle where we are -- where we started out with a lots of small orders, and we are pursuing big ones. And hopefully, we will get to the stage in the not-too-distant future here where we are set to land some of the large orders as well.

Has there been an increased competitive response to your success in any of (multiple speakers)?

I would say yes. I would say we are not under the radar anymore. So I think we are getting specific responses from all types of competitors. So I think we are gathering attention from competitors.

And then Martin, or Pat, what is your thought process on starting to disclose exact subscribers so people can get a better sense and feel for the traction you are making there?

Well, we have continued, John, to feel that we would rather not get into the specific numbers quarter-to-quarter or month-to-month because it tends to become the only focus.

But, you know, we are -- as you know, we have said that we have now shipped approximately 1000 systems. Martin just said that the gap is closing in terms of the time from shipment to time of activation. So over -- I mean, I think that you can probably surmise with a rough approximation approximately how many active accounts we have, based on the fact that lag from time of shipment is somewhere probably now between three and four months or so.

So about a quarter's worth, maybe slightly more of a given quarter, shipments are unactivated. And beyond that, the activations are tracking in line with the sales tracking, just three to four months behind it.

Last two questions. ARPU still remaining in the $1800, number one. And then number two, would you give any range or thought for expectations of subscribers in 2011?

Well, to the last question, I think consistent with what Pat is saying, we are probably not going to give a specific subscriber count, either results or forecasts. But as far as ARPU goes, ARPU has continued to hold up well, and it is slightly better than the figure you mentioned.

All right. Thank you.

(Operator Instructions) Jim McIlree, Merriman.

Pat, you talked about OpEx up sequentially in Q4, and you are comparing that to the Q3 OpEx that includes the $0.5 million or so of Virtek acquisition costs. Is that correct?

No, that's a great question. I should have been more clear about that. It is up, excluding that Virtek acquisition cost.

So when we look at Q4, the factors driving that OpEx, the costs would be the inclusion of Virtek's OpEx (multiple speakers)?

That is a factor, albeit modest. Some of it is the heavy concentration of industry shows in the quarter.

Okay.

Some of it is -- engineering, actually, will be up on a year-over-year basis modestly. And in the last year, 2009, we had completed the live TV antenna system development. And so that year-over-year comparison will be a little bit more normal now as we go forward. But that will be up modestly as well.

Great. On live TV, is it reasonable to expect that they come back in 2011?

We certainly hope so. I think that, as you know, their big customer is Continental. Continental just merged with United. And we are hopeful that the new United will standardize on the technology that Continental had. And if that were to happen, then we would see significant new business.

If that doesn't happen, then I think we are on their -- they have to go out and sell to other fleets. So I think that is probably the biggest short-term opportunity for them, and in turn for us, since we are their exclusive antenna provider.

Is there any comment you can make in terms of timing when that decision might be made?

I don't have any insight into that. And the other thing, the other opportunity with live TV, is they just announced a JetBlue deal with ViaSat for Ka-band two-way VSAT. So there may be an opportunity there for us to participate on the hardware side and develop a new antenna for them for that application.

I think just one more. The amount of revenue that was generated by marine products this year, was that disclosed? And if not, would you?

Yes, we normally do, so --.

Well, not for the products separately. But if you are asking about total marine, including the VSAT, the revenue number was just a shade under $13 million for the quarter for the third quarter.

Okay. Can you give some commentary about leisure marine and the land (multiple speakers)?

I will. I will give you -- the land revenue in total, RV and auto, was $2.3 million for the quarter. That was actually up 23%. We are seeing some reasonable growth now in the RV portion of that. And keeping in mind that is all very small numbers in the prior year, but it does seem to be showing some signs of life.

And then in the core marine market, mainly satellite television, but this would also be where Inmarsat antenna systems would be captured, it was up nicely, actually, on a year-over-year basis. And whether or not that will continue into future quarters is something that we are being fairly conservative in our outlook, because it is -- as we've said many times before, the indicators seem to be very uneven right now as far as the general economy and the way that the leisure markets are reacting. But we did see some reasonable growth on a year-over-year basis in the core marine business.

Okay. Let me try it one more time then on that core marine business. Usually, you have a seasonal decline in the leisure marine in the second half. But since the economy is, as you pointed out, somewhat erratic right now, did you see that normal seasonal decline, or is that being offset or accelerated by the --?

No, we did see a seasonal decline.

Okay. Great. Thank you.

Chris Quilty, Raymond James.

I have a question on the mini-VSAT. I mean, your service revenues were up tremendously on a sequential basis, and yet your NRE, I think, Pat, you said was actually down on a sequential basis, and there was no significant impact in Inmarsat revenue. So that implies that either you shipped or turned on a large number of units in the quarter, on the order of magnitude of 200 or so, or, as Martin was implying, it might not have been a huge shipment quarter, but they are just turning on a lot quicker. Can you help us understand what other elements might be in there to lead to that large sequential increase?

Well, I can start it. I think that your logic is correct. It was a good quarter in terms of activations. Some of them related to, as Martin said, the time that it is taking on average from shipment to activation is shortening a little bit. It was a good quarter in terms of product shipments; not as strong on a year-over-year basis as some other quarters we've seen. But that is the nature of this business, I think, at this point, is that the product sales, although the trend line is nicely up, strongly up over an extended period quarter to quarter, the numbers can be a little bit uneven, just because of the nature of the types of customers that we are working with.

But we did see a very good quarter in terms of number of new activations and the general value of each of those activations that we do have. When I say value, I'm talking about ARPU.

And we also have some variable revenue which is related to the aviation business and to some customers that are paying on metered services. So we are starting to get revenue from those sources, which helps drive up the monthly service revenue line.

Okay. And can you characterize, just in general terms, maybe like big percentages, how your installed base looks, to the best of your knowledge, in terms of leisure versus commercial versus government?

And a second part to that question, presumably, your leisure customers are the ones looking for the seasonal type packages. How will that impact your monthly ARPU on a go-forward basis? Are we going to see seasonal swings in your ARPU as that segment of the market grows?

Well, I hope not. But I think the seasonal packages that you are referring to were developed for, I think, the next tier of leisure customers. Right now, we have customers who don't use their boat all year and they don't want to buy V7 and pay for service for 12 months when they use their boat for four months. The people who use their boat 12 months out of the year won't be buying the seasonal packages. So we see this as an incremental revenue opportunity.

Getting back to your first question, I think just off the top of my head, big-picture percentages, I would say leisure is probably 20% to 25%; military is maybe 15%; and the balance, which is 60% or so, 65% or so, is commercial, meaning shipping and work boats.

Okay. When you talked about potential large orders in the fourth quarter, commercial orders, relative to the magnitude of your Coast Guard order, are they things that are of that size or half that size?

Well, the Coast Guard order was unusual because it was a very long-term period. But in a commercial shipping world, the quantities could be larger. So some of these programs are a large number of units, larger than the Coast Guard in terms of quantities. But the term period probably wouldn't be extended out over 10 years. Typically, in the commercial markets, they look for a 36- to 60-month type of commitment.

Okay. And for Pat, I mean, you had the network expansions that you have mentioned. Some of those were software-based, so there was no real incremental cost. But I think one major region on the western side of South America needs to get added. Are we about, as reflected in the Q3 numbers, about where we are going to be on a steady-state basis for the network operating costs, or is there one more bump-up we are going to see yet?

I would say that with Brazil, we will be about there. Certainly over time, there could be capacity increases that are driven -- are cost-related. But that would be pure demand-driven. But those will happen at times over the next several years, and they all won't happen at once. Every region won't happen at once. So I think in terms of building out the footprint that we had originally envisioned back when we first got into this business as the global footprint with Brazil, we will be essentially there.

And the other caveat I'd throw out is that there is always -- there could be other developments in the business over time that may affect us or that may cause us to think differently, but that is what we see right now.

Okay, and Brazil doesn't get reflected until Q4?

Q4.

And was there demand-related reasons for increasing the bandwidth so much in other regions, or was it more strategic, in terms of transponder pricing or availability or those sort of issues?

Well, the expansion in other regions was opportunistic in the sense that these are software upgrades, so we are continually improving the technology. And as long as it doesn't add to the cost base but it doubles capacity, then it obviously makes sense to do that.

We did add a transponder in CONUS, but that was more -- you know, we've been shifting around between a Caribbean beam and another -- we're on another transponder on the satellite we are on now, and we consolidated into a new transponder. But we are finished with that network tweaking in the CONUS.

And also, we had some -- we were hopeful of getting the Coast Guard, so this is helpful as part of their capacity requirements.

Okay. And the network buyout that ViaSat just announced last week of their ARINC partnership, how does that impact you?

Well, that could be a net positive for us, in that our agreement with ViaSat is that they can roam into all of our regions, and then we have a revenue share arrangement in place. So to the extent that more plans are on the network, that's good for us.

Okay. And Pat, a clarification -- that $2.3 million in land, was that product and service or just product?

That is product. There is only a nominal amount of what you might think of as service there for commission payments or new accounts and that type of thing. But think of it as almost exclusively product.

Okay. And final direction here on the defense and stabilization. It was only a quarter or two ago that you talked about sort of a baseline $10 million of revenue in the FOG business, and presumably that was based upon expected levels of Kongsberg business. And you seem to have been surprised in the current quarter here by this inventory-related issue.

Was that something on the back end or the demand side that surprised Kongsberg, or just the management of their inventories or lack of communication between you guys and Kongsberg? Have you been able to identify where the surprise came from?

Well, 0I think it comes from their decision. And I think that what they are planning to do, although I haven't heard this explicitly, is I think that they are trying to match their production run rate so that they don't have any shutdown of their factories while they're waiting for CROWS III.

So it would seem like they are changing their rate of production to continue to build what they have on order at a pace that allows them to keep the factory running until CROWS III happens.

Okay. And then I'm recalling now, didn't they do some advanced production of CROWS systems around the time of the big MATV awards, even though (multiple speakers)?

Yes, that is why a year ago, it was artificially fast production. In other words, when we were doing 7 million a quarter, that was an acceleration for vehicles that were heading over to Iraq and Afghanistan, at a rate that was faster than their customer required for the base CROWS business.

So I think now what they are doing is slowing down to match, perhaps, their expectation of when CROWS III might be awarded, but that is speculation on my part.

Okay. And yet we did have -- I mean, this past summer, they reprogrammed what -- another $10 million or $15 million -- I can't remember -- to buy more CROWS systems. That is -- I guess that is reflected in what you're already seeing. But it would seem like there hasn't really been too much of a demand slowdown at the end-user level.

Right. I think that's true, and that is why we don't expect our RWS business to go away. We are just expecting that in November and December we won't have any significant deliveries to Kongsberg.

Okay. So when you do get an order, that will probably be a press release?

Yes, absolutely.

Okay. In January timeframe?

Yes, I think that is what we are expecting.

Okay. Very good. Thanks, guys.

Jason Nelson, Roumell Asset Management.

Just a quick question. I guess I heard you guys are somewhere in the ballpark of 1000 shipments, and still seeing roughly a quarter lag between shipments and activation. Just quickly for my edification. How do you define ship?

Revenue shipments, sales.

Okay, so shift is synonymous with sales?

Yes.

Okay, thank you. And moving on then to the commercial space, I know you guys, I think, were in the running for a deal with Peter Doehle, which I think GE SatLink got the award.

Just wonder if you could comment what you learned in the process and maybe why you ultimately didn't get the award. And I know you -- the Coast Guard is certainly a confirmation of the quality of the product, but just wondering what this one commercial customer saw.

To be honest with you, I don't know what you're talking about. I've never heard of that company.

Okay. All right. And I guess last, one thing we often take a look at is insider selling, and I guess I just have to ask you guys -- we see your head of sales has sold a real meaningful portion of his stock in the last half year or so.

No, the head of sales has (multiple speakers).

Head of sales has been buying.

Pardon me, then Mr. Dodez has. Pardon me. Just any color on Mr. Dodez's sales? As someone looking at the stock, that is not comforting.

I think that is an entirely private matter for him. I wouldn't comment on that in any way, shape or form, because that would be highly inappropriate.

Okay. Thanks, guys.

[Steve Krueger], Foresight Investing.

A couple of questions. In the past, you've indicated that you thought most FOG revenues would come from the defense sector. And yet in the press release this morning, you talked about some of the FOG revenues in this past quarter coming from commercial applications, and I think you've indicated that you see growing commercial opportunities.

Has your thinking changed about where the opportunities are on the commercial side? Are there any significant applications that are emerging that would be meaningful for FOG in the commercial sector?

Yes, I think it has changed a little bit in that we are now seeing some of these commercial applications, like the ones I mentioned, like the mapping systems, Google Street Maps and those types of things.

But overall, the big opportunities are still on the defense side. And I think that when we talk about diversification, we are really saying that we are not dependent on a single customer or a single application, so we are getting diversification, even within government application.

So although we do see more commercial opportunities than we thought we would see maybe a year ago, we still see the defense business, drone guidance, all these types of things, as being either government or military, as really the prime driver to the growth.

And going forward, in terms of development priorities and opportunities, you still see going forward the same kind of mix, mostly defense-oriented kinds of applications represent a larger share of the market for FOG?

Yes.

Have you seen any meaningful change in the rate of increase in demand for the mini-VSAT product? You know, when you brought TracVision to the market for RVs, you started out at zero, and very impressively within a pretty short period of time, went from about zero to 90% market share. And so you've had the experience of going through a product that has a big tipping point like that.

Right.

Do you get the sense that V7 is likely to experience the same kind of explosive growth going forward in the near future?

I would say explosive growth is probably not what we expect, I think, because these are commercial markets and because they tend to be more conservative. Traditional shipping companies are fairly conservative.

So I think what we've seen is we really had to earn their respect. They wanted to see that we are going to be around, that we've built out the network the way we said we were going to, that the product is reliable, that people who were early adopters are happy with it and continue their rollouts. And I think we've been checking all those boxes.

So I think we are at a point now where we believe we are the fastest-growing maritime VSAT company in the world, that we are gaining momentum. But I wouldn't say it is going to be explosive. I would say we are going to just hopefully continue to grow the business and get the compounding effect of the airtime.

It sounds like with all those boxes checked, one would reasonably expect a significant increase -- or change -- an uptick in the rate of increase and demand.

Yes, especially if you compare it on a year-over-year basis. In other words, as Pat mentioned, you go from quarter to quarter could still be kind of lumpy. You get this order, you don't get an order, the guy hasn't made a decision yet.

But if you look year-over-year, our expectations for Q4 compared to Q4 a year ago is more than doubling the hardware sale. So we are looking at significant acceleration compared to a year ago.

Okay. What is your sense about what that curve is going to look like in 2011? Do you expect to see the slope continuing to rise?

I think so. I think we are going to continue to gain momentum, and I think just a steady growth. And as you know, it's always easier to sell to an existing customer. So a lot of the sales that we've had so far have been to new customers for some of their vessels. And as they continue to expand, that becomes an easier sale, because they already tried it, they are happy with it. So I think that type of compounding on the sales side will help us as well.

Talking about that, Martin, the larger opportunities you have alluded to for the current quarter, is it safe for us to assume that these are all customers who have already had the product on some of their vessels for a while?

Some of them are. Some of them are people who have simply been trialing the system and other ones are brand-new.

Okay, thanks very much. Good luck.

Jim McIlree.

Pat, what was depreciation and amortization for the quarter?

$1 million, Jim.

And incremental amortization charges for the Virtek acquisition, what are those going to be?

Gee, I don't know that -- you will -- I've got to think off the top of my head. They are not going to be significant. Probably under $100,000 per quarter.

Great. And then the $6.8 million of CapEx that you cited earlier in the call, does that include the Virtek acquisition?

No, but it includes the acquisition of the building.

Of just the Tinley Park building?

Yes.

Okay, great. Thank you.

Chris McDonald, Kennedy Capital.

Pat, with the addition of the Brazil region and the transponder costs that will go along with that, is it fair to think about the run rate of the cost of service sales line on a quarterly basis as being about plus or minus $5 million on a go-forward basis -- quarterly?

No, I mean, without getting into disclosing too much precision here in terms of the nature of the business. But it is not that high, no.

Okay, I'm just trying to understand, now that the Company will have basically all regions that have intended to be covered in play, I would imagine at least that we will see a flattening out of the quarterly increases in cost of service sales going forward. Once you hit this fourth-quarter run rate, then I presume it flattens pretty materially from the --

Okay. Now, understanding your question, yes, there will be a downward bend in the slope of the -- not downward bend -- but I mean the slope of the cost increases on a quarter-to-quarter basis as we built out the network will diminish as we go forward.

However, it won't flatten completely, and the reason is there are some regions, namely Europe and the North Atlantic, where, as you may know, we are in what we call a revenue-sharing arrangement with ViaSat, where they have responsibility for those regions, and we calculate a percentage of our revenue that we pay to them to cover their cost for those regions. So those regions are variable in terms of our cost structure.

We also have some costs associated with the management of the network itself, some of which we pay to ViaSat and some of which we incur internally. So the cost structure is not 100% fixed, but you can presume that the larger portion of it, greater than 50% of it, is fixed.

Okay, very good. And then I just want to make sure I heard Martin correctly. Did you -- Martin, I thought you said that you expected Q4 TracPhone V7 hardware sales to be double that of last year's fourth quarter.

Yes.

Okay, very good. Then lastly, to the FOG business. Outside of the CROWS program, is there meaningful customer concentration in any of the rest of the $88 million or so revenue that we might expect for the non-CROWS business?

No, not significantly. Not -- the rest tends to be much more spread out, both in terms of applications, in terms of products and customers, so (multiple speakers).

It sounds like you would expect that part of the business -- if we were to just kind of set CROWS aside and look at that part of the business, that run rate looks sustainable and probably has some growth opportunities, when we think about this over maybe a little longer term, intermediate term. Is that fair?

Right. Yes, that's absolutely fair, and that's our goal. When we looked at the business a year ago, of course, are delighted to have large customers, delighted to have 100% growth rates. But we looked at that and saw a potential problem, that one day, you might get a quarter where you don't have that business, as we just have coming up in Q4. I think the difference is that had this happened a year ago, it would have been a disaster for us. The fact that it happens now is unfortunate, but it is not a disaster.

Okay, great. Lastly, I presume it is a little difficult to try to eyeball what the run rate, even at this lower CROWS volume, that might be expected going forward, as the primary customer there tries to manage production and transition between CROWS II and CROWS III. But I presume it is somewhere between the roughly $1 million, $1.5 million that the Company will experience in Q4 and the $5 million plus that the Company experienced on that program in Q3.

You certainly bounded it. Yes.

Okay, great. Thank you.

Gentlemen, with no questions remaining, I would like to turn the call back over to you for any closing comments.

If anyone has any follow-up questions, as always, please feel free to contact us directly, either by phone or e-mail. Thanks for listening.

Ladies and gentlemen, that does conclude today's conference call, and we thank you for your participation.