KVH Industries Inc (KVHI) 2011 Q1 法說會逐字稿

Good day, everyone, and welcome to the KVH Industries first quarter 2011 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, sir.

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 first 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 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-K filed with the SEC on March 14, 2011. The Company's SEC filings are available from us, from the SEC, or from the "Investor Information" section of our website.

Now I will turn it over to Martin for today's discussion of results. Martin?

Good morning, everyone and thanks for joining us today.

The first quarter was marked by positive progress in our core VSAT and commercial fiber optic gyro strategic businesses, as well as some greater-than-anticipated challenges. As we expected, VSAT sales were solid for the quarter and airtime activations picked up strongly after a seasonal slowdown in Q4.

Commercial FOG sales also showed strong growth for Q1 and we received two significant defense-related orders. However, satellite TV systems - the leisure marine and RV markets - were far weaker than expected. As a result, our first quarter revenue was lower than anticipated at $24.4 million. That's about a 13% decline from Q1 of last year. The decline in revenue led to a loss of $1.5 million, or $0.10 per share.

While the operating loss was in line with about the midpoint of our guidance provided in February, the resulting tax benefit was less than expected, which made the net loss about $0.2 per share worse, putting it at the low end of our expectations and guidance.

Pat will cover all the numbers in more detail shortly, but first let's take a look at our key business areas.

In our mobile satellite business, total revenue was down 2.0% year-over-year when we include the decline in the aeronautical antenna sales to LiveTV. Excluding the $3 million difference due to LiveTV, however, satellite sales were up 20% and driven entirely by our VSAT business.

Our overall satellite sales failed to meet expectations for the quarter due to an unexpected decline in sales of our satellite TV systems for the leisure marine market, as well as slower-than-anticipated satellite TV sales to the RV market. Contributing to the softness in these leisure markets were lingering challenges with the overall economy during Q1, including a decline in leisure boat sales, as well as the dramatic increase in the price of fuel. We believe our competitive position remains strong on these satellite TV markets, as illustrated by our new exclusive three-year deal with Sea Ray.

The status of our aeronautical satellite TV business is also in flux at this time, as LiveTV has asked us to once again postpone contracted deliveries. Unfortunately, we were unable to reach agreement on delivery dates and as a result, we believe the contract has been terminated. LiveTV disputes our interpretation and we're continuing to negotiate regarding the contract and the placement of orders. However, we cannot be certain that our negotiations will lead to new orders going forward.

On a positive note, the first quarter was marked by continued strong and increasing momentum in our VSAT business where we saw a more than 60% year-over-year increase in airtime revenue and a better-than-50% increase in product revenue, including the sales of the CommBox from KVH Norway.

We're pleased to finally complete the arduous process of getting the mini-VSAT and TracPhone V7 fully licensed in Brazil. At the same time, we established a new Brazilian subsidiary. These steps were critical to our efforts to do business in Brazil and pursue the opportunity it represents, as new vessels and rigs are deployed to support the region's rapidly expanding offshore oil and gas industry.

We also strengthened our presence in Asia with the addition of a new senior executive to lead sales efforts, focused on the large commercial opportunities in the region. We're now in the process of opening a new sales and technical support facility in Singapore to enable us to better serve the large Asian shipping and offshore oil and gas industries. New product trials are already underway with the top Japanese companies, which include some of the largest fleets in the world.

During the first quarter, we signed the Vroon contract, our largest commercial client to date. This was a competitive procurement effort against more than twenty other providers, for both Inmarsat and maritime VSAT services. Vroom evaluated the competitors and selected our fully integrated, comprehensive and affordable mini-VSAT broadband system for more than 125 vessels in its global fleet.

We'll be equipping their vessels with the TracPhone V7 and our CommBox network management system, along with value-added capabilities like prepaid access to crew calling, email and the Internet, as well as DSM cell phone connection. We continue to aggressively pursue other fleet opportunities and we're optimistic that our recent successes will build credibility and momentum.

Along with winning new customers, we continue to receive positive feedback from the industry. A few weeks ago, we were honored to receive the 2011 Innovation Award from the Mobile Satellite Users Association in recognition for the game-changing nature of our mini-VSAT broadband network on the rest of the industry. This is association historically has represented the legacy L-band service providers, so it's quite an honor to have them acknowledge the disruptive nature of our new products and network.

By offering smaller, more affordable hardware, with entry-level communications -- sorry, with enterprise-level communications, faster ship-to-shore uploads and affordable fixed rate airtime packages, KVH has now become one of the largest providers of maritime VSAT services in the world in a little over three year's time.

But we still have room to grow. Last year, approximately 1,000 Maritime VSAT terminals were fielded on ships around the globe, from all suppliers. During that same period, however, Inmarsat sold more than 10,000 fleet broadband terminals. Our newest product, the newest member of the TracPhone family, the TracPhone V3, expands our reach in the maritime world with a solution designed specifically to capture much more of this larger market segment, which Inmarsat has had all to itself.

Our ultra compact TracPhone V3 is the world's smallest Maritime VSAT antenna. Only 14.5 inches in diameter, a price comparably to fleet broadband systems, it offers global communications via the mini-VSAT broadband service, and download speeds as fast as two megabits per second. That's almost five times faster than INMARSAT's best fleet broadband service.

Best of all, the airtime rates, which are a customers' greatest concern, are a tiny fraction of Inmarsat's price. For a monthly commitment starting at $49 a month, commercial and leisure boat owners get Internet access for only $0.99 per megabyte and worldwide voice calls for only $0.49 per minute. So, mariners have an outstanding new option, with our ultra-compact SATCOM solution that's far more affordable and faster than L-band services like Inmarsat.

We're extremely pleased with the customer reaction to the new TracPhone V3, as preorders for the product have been very strong. In addition, the FCC granted commercial license authority for the V3 just in time for the first V3 shipments, which started earlier this week.

Looking ahead within our satellite business, we're pleased with the positive recurring airtime trend in our VSAT business. The new V3 affords us a great opportunity to accelerate our VSAT unit sales, market share and airtime activations. The ARPU will probably trend down somewhat with the addition of the V3, but V3 customers probably use less data. However, these pay-by-the-byte customers have much higher gross margins and utilize far less spectrum.

We also have additional new products in the pipeline that'll be launched this year and we've just broken ground on a new integrated SATCOM manufacturing and warehouse facility here in Rhode Island. This 75,000 square foot facility should be in operation before the end of the year and is designed to meet our expanding needs and anticipated future demand.

Moving on to our guidance and stabilization business, we continue to make good progress in diversifying our FOG business so that we're less dependent on a single program like CROWS. Our success in this regard is reflected in the more than 80% increase in fiber optic gyros sales to commercial and non-CROWS defense applications this quarter.

Our FOG products, especially our higher-value integrated inertial mass system, are increasingly used aboard autonomous vehicles, as well as mobile mapping, camera and Gimbel stabilization applications.

The need for this diversification is illustrated by the year-over-year decline in remote weapons-related FOG sales, which pushed our overall guidance and stabilization revenues down 27%. The latest reports indicate the Army will publish its long-awaited CROWS 3 RFP around the end of this year. Current indications are that this contract could be sole-sourced or split between two prime contractors, with production starting in government fiscal year 2012.

Based on our current visibility in this program, it looks like it'll include roughly 200,000 systems, with three gyros per unit. Depending on final quantities and pricing, the total fiber optic gyro potential could be anywhere between $100 million and $150 million. In the interim, the Army continues to fill its immediate remote weapon-system requirements through extensions to the current CROWS 3 contract with Kongsberg. This led to our announced $2.7 million FOG order, which we received in late March.

At the same time, a new $3.7 million TACNAV order from an international customer is the latest in a series of orders that demonstrate the ongoing sustainability of our TACNAV sales, in response to concerns about vehicles operating in GPS-denied environments. We expect that this new order should ship completely in Q2.

We were also proud to receive Raytheon's Five Star Supplier award this month. This honor, which was given only to fourteen companies out of more than 12,000 eligible suppliers, is a reflection of the quality of our FOG products and our ability to manufacture these precision products in volume and on time.

Looking ahead, we're excited by the upcoming introduction of some new fiber optic gyro products. Over the last several years, our engineers have been working on a new small diameter 170-micron fiber. This exciting, new technology, which allows gyros to be half the size or twice the accuracy for the same size, is now ready to be commercialized.

The resulting ultra compact FOG we expect to bring to market soon will offer breakthrough performance levels that have never been achieved in gyros of comparable size, giving us a major cost and performance advantage. We hope to announce the first products with this new technology during Q2 and then field a whole new family of FOG products, including very high performance, ultra compact inertial navigation systems. I look forward to providing more details on this exciting new product very soon.

So, in conclusion, the weakness in the consumer satellite TV markets is not slowing the strong growth in our VSAT business. Although our near-term expectations have been lowered, this doesn't change our long-term outlook. We expect that the leisure markets will recover eventually and that our FOG business will resume its top line growth as the RWS business returns to previous levels.

Our strategic VSAT and commercial FOG businesses are advancing as expected and they'll drive our growth. As a result, we're still confident in our ability to achieve our goal of annual revenue of $300 million and operating margin of 15% within five years.

Now I'd like to turn the call over to Pat for the numbers. Pat?

Thank you, Martin. Although the leisure markets for marine and RV essentially stalled, all other parts of the business performed as expected, particularly VSAT and fiber optic gyros.

For the quarter, gross margin was 37.2% and was a little better than anticipated. As a result, even though revenue fell short of our expectation, gross profit dollars were about on target. The favorable margin variance was largely driven by improved product manufacturing efficiencies in our SATCOM and FOG operations.

Product gross margin was down about 120 basis points year-over-year, but up about 250 basis points compared to Q4. Service gross margin remained low at just over 13%, but that was in line with our expectation.

As we projected on the fourth quarter call, during Q1 we felt the cost impact of a full quarter of Brazil satellite coverage and of the doubling of capacity for North America to meet increased demand. Consequently, VSAT airtime gross margin was about equal to the fourth quarter level.

Beginning in the second quarter, we should see progressive improvement in airtime margins. We will add capacity in the future to satisfy growing demand and potentially to extend coverage. However, KVH's share of the infrastructure investment in the three-plus year build out of the initial global network is now complete.

The number of new VSAT airtime activations in the quarter was strong. The pace that we reported on our last call for January continued through March. We expect activations to generally keep pace, with some lag in time, with the number of systems sales. During the winter, this did not happen.

It appears things are now back in alignment, but, as we gain more experience over time, we will need to carefully model the expected impact of seasonality and extraordinary events, like oil spills, whether they are positive or negative. So there might be occasional and temporary unevenness in the revenue growth curve, but the upward trend line for our VSAT airtime services is clear.

Operating expenses increased 18% compared to last year. Spending was in line with our expectation, although as a percent of revenue it was higher. A sizable portion of the year-over-year increase in each operating area was due to the inclusion of costs in KVH Norway since the acquisition of Virtek last September.

In sales and marketing, we continued to invest in new staff to support and grow the VSAT and FOG businesses.Q1 also had a heavy volume at trade shows and that related to all of our offerings.

Administration expenses were relatively high compared to recent quarters. In addition some KVH Norway costs, we were active establishing new operating units around the world, including Brazil, which was especially costly.

In addition, we incurred substantial advisory and legal costs to gain regulatory license authority for the new TracPhone V3 and to extend our VSAT license coverage to include more countries. The cost to meet our customers' global business needs extend beyond the physical assets of satellites and ground stations.

The effective tax rate for Q1 was much less than expected, which meant that the tax benefit associated with the pretax loss was also less than expected. The difference in tax rate represented about $0.02 of the reported net loss.

On the balance sheet, cash and marketable securities were $35.4 million. Although cash flow from operations was negative at approximately $1.1 million, EBITDA was positive and a bit better than expected. Accounts receivable decreased, sequentially, to $18 million. DSO was 66 and was skewed high because of a relatively high concentration of sales in March. The pace of collections is in line with expectations.

Inventory increased sequentially to $17.1 million. A contributing factor was the shortfall in satellite TV sales to leisure markets. We also staged materials for the introduction of the TracPhone V3. We have adjusted our materials' inflow to bring inventory back in balance over the next few quarters.

Capital expenditures for the quarter were $800,000. Backlog for guidance and stabilization products and services at the end of March was $17.4 million.

Turning to our future outlook, we have lowered expectations for the top and bottom lines for the near-term. This is primarily due to two things - the much weaker demand that we're seeing in the leisure marine and land satellite TV markets and the uncertainty related to our relationship with LiveTV.

Our long-term growth drivers, namely the VSAT and FOG businesses, are projected to meet our original expectations for the year.

The first quarter results in the leisure TV markets have caused us to be much more cautious about the next several quarters. Whereas we saw modest year-over-year growth in leisure marine throughout 2010, this business declined by about 10% in Q1.

Through 2010 sales in the land market, particularly for RVs, grew strongly, albeit off a relatively small base. Having assessed the current market conditions we now expense land TV sales for 2011 to decline year-over-year. For the marine and RV leisure markets, we have reduced our 2011 product revenue expectations by more than $4.0 million.

Because of the uncertainty with respect to our LiveTV relationship, we have removed the roughly $3.0 million of revenue that had been scheduled for Q3 and Q4. The reduction in projected revenue will have a big impact on the bottom line. We will work to lower fixed costs. However, because our visibility to these changes was so short, the bottom line impact will be driven by the loss of variable margins.

For Q2, we now expect revenue to be between $30 million and $32 million and profit to be between $0.01 and $0.06 per share. Gross margin for both products and services should improve, sequentially, and we expect total gross margin to be about 40%. Operating expenses will increase sequentially, largely due to the variable sales expenses related to our defense business.

For the full year, we now expect revenue to grow in the range of 8.0% to 13% over last year. The variable gross profit reduction from this downward revenue adjustment will largely drop through to the operating profit line. This represents the primary cause for the change in our operating profit projection.

Also contributing, but to a lesser extent, is the TracPhone V3 product margin that will initially be lower than we planned. We accelerated the market introduction of the V3 to more quickly establish it in the market and to support this; we expedited production materials from all suppliers. This means the V3 product cost will be well above our target level for the next few quarters and will depress margins for that period.

Given these dynamics, we now expect operating profit for 2011 to be about 10% lower than what we reported in 2010. However, we expect EBITDA, adjusted for stock compensation expense, will be about 10% above the 2010 level. Our effective tax rate for the year should be about 35%.

In summary, we are being cautious for the reasons mentioned. We don't believe we are leaning too conservative, but that could prove to be the case. Looking to the longer-term, we are very confident in our growth strategy and financial objectives.

Now we will take your questions. Operator?

(Operator Instructions) Jim McIlree, Merriman Curhan Ford

Thank you. Good morning.

Good morning.

Can you talk a little bit about the range of decline that you're expecting for the leisure marine and land business in 2011 versus 2010?

In the land business, we're expecting, on a year-over-year basis, it'll probably be down single-digits and I'd say between 5.0% and 10%. In the maritime business, it looks to be about a fairly comparable percentage decline -- excuse me, I'd say single-digits, but a single-digit decline on a year-over-year basis. That's for the leisure marine, not for VSAT obviously, but for the leisure market and the leisure at land, which land is all leisure.

Right and leisure being satellite television, because VSAT sales in the leisure market have still been strong and actually ahead of expectations in the first quarter.

Okay. Great and then, Martin, in your commentary you were talking about the pricing differential of the V3 versus the fleet broadband and it kind of blew by me. I was hoping I could pester you just to kind of talk again about what you think the price differential is, both on the service level as well as on the unit pricing itself.

Sure.

And then, as kind of a corollary to that, are you subsidizing the units themselves to the end users, or is this just a straight sale to either the end user or distributer and so there's no subsidy on your part?

Okay, great question. On the hardware side, the V3 has a retail price of about $17,000 and that puts it exactly in between the two Inmarsat comparable products. They have an SB 250, which is a little bit less, and they have an SB 500, which is a little bit more, so we're kind of right in the middle of their commercial product portfolio.

And from an airtime perspective, we sell Inmarsat airtime and the cost per megabyte is around $13 per megabyte and we're at $0.99 and the voice is about $1.00 a minute and we're at $0.49, so a tremendous advantage in cost per megabyte of voice pricing and of course the speed is -- an SB 250 has a downlink speed of about 200 kilobits per second, 260 kilobits per second and the 500 is about 480. So, even if you look at their high end product, we're still more than four or five times faster.

As far as subsidizing, no, we're not subsidizing the hardware and although for the startup we are currently using the same modems that are in the V7, so we have a higher cost of goods than we will have, because we have new modems coming that are significantly less expensive. But we've pulled forward the product launch and we decided to launch the new antenna with the V7 modems. From a consumer perspective they're the identical, but it does have a higher cost of goods for the first couple of quarters.

Okay, great. That's very helpful and is the real estate that the V3 takes up, is your expectation that it would just swap out, what, a fleet broadband unit? Or is your expectation that this would go primarily on vessels that have no sort of broadband to begin with?

I think initially it would be the latter, so there're still a lot of vessels out there that don't have any kind of broadband solution and they're in the migration process, so we're now squarely in the mix for that. As for people who already have fleet broadband, this would give them an option to save monthly, on a monthly basis, and then might keep the other system onboard as a backup.

And then real estate. Is there a significant issue with placing these on the vessels or is it small enough that it shouldn't be a big deal?

Yes, it's small enough. If you're familiar with our TV products, this would be the second-smallest TV product we made, so it's the exact same size as our M3, so it's a very compact unit. It's a quarter of the volume of a V7, which is dramatically smaller than the standard VSAT, so it really is a breakthrough product.

Okay, great. I'll stop hogging the line and get back in queue. Thank you.

Okay. Thanks, Jim.

(Operator Instructions) John Bright, Avondale Partners

Thank you and good morning.

Good morning.

Pat, how much of the $2.7 million recent FOG order ended up being booked in Q1?

Well, it was all booked in Q1. I can't disclose, John -- I assume what you're asking is how much was shipped in Q1. A portion was shipped in Q1, but certainly not all of it. That will extend out for -- that order covered a couple of quarter's worth of demand. Now, we don't necessarily expect that that's the only order we're going to get related to that, but that particular order spans beginning March and took us through the latter part of the summer.

Got it. Secondly, on guidance, it looks like you're bringing you guidance down to like $5.0 million to $10 million; correct me if I'm wrong there. I think you talked about $4.0 million of that relating to the marine and LiveTV. If that's accurate, what's the remainder? And if it's not accurate, correct me.

It is accurate.

No. Did you say $4.0 million including LiveTV?

I did.

Oh. No, no, no.

No.

That's not (inaudible - multiple speakers).

That's not accurate.

I'm sorry.

So those were additive, so it was roughly $3.0 million LiveTV and roughly $4.0 million --.

Yes. The reduction in leisure from our prior expectation - leisure, marine and land, primarily RV combined - is a little more than $4.0 million of the reduction and just at -- from our prior guidance.

And then LiveTV is the $3.0 million, so it's roughly $7.0 million?

(Inaudible - multiple speakers) is approximately $3.0 million.

Okay.

The combined of those two things is roughly $7.0 million and if you look at the midpoint of our prior guidance to the midpoint of our current guidance, it's about a $7.5 million swing.

Got it. Are there any OpEx savings opportunities associated with this reduction?

Well, certainly we're going to work diligently to try to find some. I mean, we have brought down our internal spending expectations a bit, but one of the challenges we have, John, as you know, is that our investments are all going into our growth businesses. The VSAT business and the fiber optic gyro business, primarily and so as a consequence, those -- we're going to continue on that path. We're going to continue to invest as aggressively as we feel is necessary to grow the Company long-term.

But we certainly will look for some operating expense reductions and I would expect that over the course of the year we will be able to bring operating expenses down a bit from what our prior expectations had been.

Shifting to CROWS 3, I think you mentioned two comments in the prepared text. One, that you're now anticipating the RFP towards the end of the year and then, two, your expectation is for $100 million to $150 million opportunity. Number one, is the end of the year timeframe for the RFP a change in your expectation from our prior call and then, number two, is the $100 million to $150 million opportunity for KVH, or is that the opportunity in total?

Well, it's not --- the RFP status is not really a change. We expect that the RFP to happen during the government's fiscal year this year, which obviously ends in September, so that's still pretty much in line with what we expected. They are continuing to do interim contracts, which is actually good for us, because we have relationship with the incumbent, so we are getting business and that's where that $2.7 million order came from.

We hope to get more this year and as far as the size of the opportunity, that's the total opportunity and that could be all for us, none for us, partial. So its -- I was just indicating of the CROWS 3 opportunity, how big is the fiber optic gyro opportunity.

Had we talked about a $200 million total opportunity prior or am I mistaken?

Well, the numbers do vary a bit and so I'm just giving a range that's a little bit more conservative, but they haven't announced the exact quantity yet and we haven't announced our exact pricing yet and it is a competitive bid so I don't want to be too specific on that.

Yes, if I can add one thing, John? I think that over the last year, 18 months there have been a few different numbers that have come out from the US Army about how big CROWS 3 is expected to be -- originally it was sized at less than 20,000 gun systems. Then they bumped it up.

There was one communication, they bumped it up to 25,000 and I think that's where the $200 million number came from and in the more recent, they indicated 20,000-gun system, which we assume is partly a reflection of the fact that CROWS 3 has been slipped out in time, from where people were thinking about it maybe a year-and-a-half ago and therefore more systems are being bought under the CROWS 2 program.

So, in terms of total number of systems to be purchased, it probably hasn't changed much, but the CROWS 3 programs have moved around a little bit.

Right, but you should also keep in mind that what they're buying now is coming out of that total, so in other words, as we win business now, during the course of this year, that would not be additive to the CROWS 3. It would probably subtract from the CROWS 3.

Got it. Gentlemen, thank you.

Yes.

Chris Quilty, Raymond James

Good morning, gentlemen.

Hi, Chris.

I wanted to walk through the guidance numbers here and hash through it in a different way. The combined marine/LiveTV you're indicating down $7.0 million, 7.5 million. If I even give that a 50% margin, let's say you're down operating profit $3.5 million, but the guidance as you had given back in February versus what you gave today is down about $4.5 million and I doubt, to the first part of my question, that you're actually banking on 50% margins in the marine and LiveTV business.

So can you help me understand where the bigger part of the delta is in the operating profit forecast coming down by about $4.5 million from your prior forecast?

Right. I'll let Pat answer that, but I do want to comment that the margins in the Marine business are quite good, so -- and when you look at normal, normally when we talk about margins, that includes factory overhead and things like that. So the number you would traditionally use would be a lower number, but when something changes quickly, like a contract is cancelled or something, then you take that out. But your overhead doesn't change, so the variable margin is quite high, so that's one point, but I'll let Pat answer it.

Yes. That's a key point and especially for the marine TV business. As Martin mentioned, Chris, the margins, on a variable basis, are well above 50%. And the other factors, I think, that you need to take into consideration in addition to the margin impact from the loss of revenue from the leisure, marine, and land as well as the LiveTV is the cost impact that we mentioned relative to the TracPhone V3.

In the first few quarters, the cost for the V3 is going to be a fair amount higher than we had originally planned and as we said in the prepared remarks, we accelerated the introduction. We pulled it in quite a bit from what our original thinking was when we first put the plans together and as a result of expediting materials to get them in the door far faster than our vendors or suppliers had been thinking and also related to the modem item that Martin mentioned. We're using the V7 modems, essentially, for the V3.

We have negotiated lower prices for the V3, but they don't kick in for a while and so we're going to be going for the first couple of quarters with a fairly high product cost for the TracPhone V3 and just to give you a general sense, its probably going to be more than $2,000, potentially up to $3,000 more than we expect it will be after that initial period of time. The other factor, which we have built into our guidance, but we have not - just in terms of thinking about it as a potential risk is related to LiveTV.

We also have some inventory, some balance of inventory. It's not a huge number, but it is measured in a few hundred thousand dollars worth that, dependent upon how this works out in terms of continuing negotiations with LiveTV. If they were not to be fully satisfactory, we could potentially have that exposure as well. So that's something that we factored into our guidance just to be thinking more conservatively about that, even though at this moment in time we don't expect that to be an issue.

Just a follow up on that LiveTV point, that relationship seemed to be moving along pretty well. Are the issues here related to product quality of what you're delivering or pricing negotiations or something related to the merger of Continental and United and their desire to roll out?

Well, the real issue is quite simply that we have a contract with them that requires certain quantities on certain schedules and they have kept postponing the deliveries. So they don't have the orders that they were counting on. So we're a supplier to them. We're a sole source supplier to them. But they don't have the demand, apparently, so that's the situation and --.

(Inaudible - multiple speakers)

We have a contract and we have a purchase order, so it was in our guidance and then we're now in a situation where they can't take them, don't want to take them, so we've taken it out of our guidance and feel that we have a contractual dispute. We feel that we have a very strong position, but that doesn't really help us vis-a-vis the guidance for LiveTV for the third and fourth quarters.

Got you. Shifting gears, Pat, can you give us a sense of where the ARPU for the VSAT fell out in the quarter?

It is still in the range of $1,800 to $2,000 per customer, per active user, per month. It's probably, at this point, closer to the $1,800 than it is to the $2,000, but it's still in that range. Now, as Martin said, as the V3 comes to market -- it's already coming to market. We started shipping the other day, but the V3 we expect will have lower ARPU per unit per month because it's a different class of customer. And we've obviously modeled that internally, but how that plays out time will tell.

But for the V7, it's still holding above $1,800 a month per customer, per active. And when I say, "active" account, that's obviously for people who are active during that month. Customers can suspend service, as you know, for up to three months in any -- well, it's in any calendar period of their calendar year of their contract. However, that extends their contract by three months at the same time.

Got you.

Those customers wouldn't be counted in that ARPU number, because they're not active during that period.

Okay and you gave this number on the script. I just missed it. VSAT product revenues were up 50%, service revenues were up what?

62%?

63%.

Yes.

Okay. But I thought the overall VSAT business was up 50 --?

59.

59.

Okay, got it. Those numbers work then. And you also mentioned, Pat, in your script something about the activations keeping pace and I didn't understand. Was it that they kept pace in the first quarter or you expect them to keep pace on a go-forward basis?

No it might -- it's a going forward basis comment. As we've been saying since we got into the business, Chris, we've seen a lag from them time we ship a system to the time it gets activated. That lag in time has ranged -- it's moved around, but it's been anywhere from as short as four months to as long as five months or a little longer.

And what I'm saying is that therefore, when you take that lag in time into consideration, we would expect that the number of activations we see in any given quarter are going to pretty much track with the number of units we had sold a quarter or two prior to that. There'll be a little bit of up and down, but it will pretty much pace with the sales of units, but with a little bit of a lag.

In the winter months we certainly did not see that, as we disclosed on the last conference call. In the first quarter of this year we actually saw more activations than systems we had sold just a quarter or two ago and that is an indication that there was some catch-up going on. So my comment about keeping pace is more forward-looking. We still expect that over a long period to time, obviously, the activations will more or less keep pace with the number of units sold, but with a lag of maybe three-to-five months.

Okay and on this subject of unit shipped or activated. I know in the past you guys have kind of shied away, in the early days, I think understandably, from providing specific numbers. This is clearly one of the key growth drivers for your company. I would hope -- can you give us a sense of is it when you hit $1,500 or $2,000, can we expect at some point in the future you guys will give us sort of quarterly run rate of where we stand on the business?

Well, I don't think we'll provide in unit sales. I think we'll continue to do what we've done in the past, is when we get to the milestones that we feel are worthwhile, we'll talk about that, especially as it helps our credibility in the market. The one thing we have to be careful of now is that we do see the market being very competitive. We have some new products out and we do want to avoid helping our competitors any more than we have to.

Okay, so the next milestone would be 1,500 units shipped and should we expect to hear that sometime before the end of the second quarter?

Well, I think what we're seeing is that we've -- the first 500 took us maybe five quarters, Pat?

Seven quarters.

Seven quarters and then the next 500 was five quarters and then the next 500 might be three quarters or something. So that would put us, on a time scale, of coming up to maybe the end of this quarter or the beginning of next quarter, so, just to give you a general sense. But the business is accelerating and we're making good progress, so if that's helpful at all.

Okay and speaking of competition, Inmarsat buying Ship Equip, can you give us your thoughts on that?

Well that was kind of puzzling, to be honest with you. I'm not quite sure why they're getting into the Ku-band VSAT business. I mean, they just spent a couple billion dollars launching L-band satellites; telling people that it was the new, new thing and then they announced they were going to spend a couple more billion dollars and do Ka-band satellites and that was really the new, new thing. And now they're buying Ship Equip and telling, getting into the one-meter VSAT business, which is a very crowded space.

So, from our perspective, it's not a new competitor. I mean, they just bought an existing competitor of KVH's, so I'm not sure how that's going to impact us, but it was a very expensive acquisition we thought, as well. It's like $200,000 per subscriber or something. I mean, it's a big number, $180,000. So I don't know. I don't see the value in what they've done, so I'm probably not the best person to ask to explain it.

Okay and you recently had an announcement that, with the V7 product line, which had always been sort of a fixed pricing, all-you-can-eat pricing model that you've moved to the same pay-by-the-drink policy that you have with the V3. Can you give us your thoughts behind that?

Well, the V3 was really -- it's a new business model, so it's really the way the product is priced and the way the airtime margins work, it's a very attractive business model for us and, we think, for the customers as well and we wanted to make sure that if somebody wanted a V7 product, which has higher return link speeds, they could get the same kind of pricing plans. We didn't want to disadvantage the V7 in any way with the introduction of the V3.

Okay and circling back to the leisure market, one thing I'm having a hard time squaring is recent earnings reports coming out from the likes of Brunswick and MarineMax and it all seems quite positive and trying to square that with your guidance that you're seeing a significant slowdown?

Right. Well, we saw --.

Is there a possibility that you could be dealing with some inventory-related issues that you're seeing things differently than they are?

Well, I look at that as well, but if you look at new boat sales, retail boat sails, they were down in Q1. I looked at the same info that you did and I agree that there were some boat builders, like MarineMax, that were seeing improvement, but those are at wholesale. At the wholesale level it looks like you're seeing boat builders doing a little bit better, but we don't benefit from that, really. We benefit from the retail boat sales, so if a guy doesn't buy the boat he's not going to put satellite TV on it.

Again, we had been seeing -- throughout 2010, we saw small but steady improvements in this market, so that's why Q1 was a surprise to us. So we were expecting further improvement; instead we got decline, hence the bigger than normal swing, which was not huge but it was on the order of $0.5 million or something. So it's a big, big delta from increase to 10% decrease.

Yes. At this point, Chris, what we're doing is we're taking what we saw in the first quarter, what our sales teams and our dealers in the market are seeing and obviously we're projecting that over the course of the year, and we may be being too conservative in that projection. We don't know yet, but after seeing these markets, the leisure markets especially, back in 2008, 2009 decline the way they did and given the current mood economically and fuel prices and so forth, we just felt it was more approximately than not to take a more conservative posture for the rest of the year.

Okay and on the FOG business, the guidance that you gave I guess on FOG and TACNAV in the fourth quarter earlier this year, does that still hold? I think TACNAV orders were going to be up in the back half of the year and you were looking for about $9.0 million to $10 million quarterly FOG revenues by the back half of the year.

Yes we're still -- .

Any changes?

No. No changes in that. I think we're seeing -- if anything, I'd say we see a little bit less risk in the RWS number. The last time we spoke we hadn't yet figured out what the CROWS 2 extensions would be, so I think we feel better about that now. I think that the Q4 number would start to get into -- we would be building gyros for customers who are already working on 2012 delivery. So, as you move further out, that gets always riskier, but right now I'd say we feel better than we did three months ago about the FOG business.

Okay and does the introduction of a whole class of new FOG products, does that cause any kind of disruption or is that only incremental possibly to your forecast? And a second part to that question, do these new products open up new markets or does it basically help you gain market share from other competitors?

I think it will do both, so this is a new development, really a new class of products addressing some markets that we couldn't address before and so we think it'd be incremental and there are currently not -- we don't have -- with new products we typically don't get aggressive on forecasts. But I think there's significant upside for our FOG business with these new products.

And the products that you couldn't address before, what technology solution is used today, MEMS gyros?

Ring laser gyros, precision closed-loop FOGs, so we're going to be a class of performance that's significantly better than ring laser gyros and for things like JDAMs and closed-loop FOGs for IMUs, so it's really going to put us in a whole new league.

Okay, great. Thanks for all the answers there, gentlemen.

Okay, thanks, Chris.

Rich Valera, Needham & Company

Thank you. A question on the expected growth in the mini-VSAT business this year. Last quarter you'd talked about a target of essentially doubling that business. I was wondering if that target is still active and if you could give us a sense of sort of what's baked into your revised guidance for the year in that business?

Yes. We haven't seen any change in our outlook on that, so we're still looking to double the business year-over-year so we're essentially on track in Q1. So the trajectory looks good. I mean, it's an aggressive target and obviously we're still early in the year, but we're on target for Q1 and we see, with the V3 and some of the wins that we've gotten, we still feel good about that as an overall guidance for the year.

So, in Q1 you were up 59%, so, presumably, for the remaining three quarters you're going to be at something over 100% to hit that target for the year?

Yes. I mean, one of the key factors is going to be the TracPhone V3.

There's no V3 in the first quarter.

There's no V3 in the first quarter and we just started shipping it the other day, so we're anticipating that that is going to contribute quite a bit. We don't have a lot of airtime revenue built in for the V3 yet, mainly because we don't know what the pattern is going to be in terms of actual usage. We don't know whether the lag time in activation is will be similar to the V7. It could potentially be shorter. But the V3 is going to be a substantial contributor and then, obviously, just the continuing overall growth in the business.

Okay. I mean, it certainly doesn't seem like a conservative number and it would just seem kind of if you're de-risking the numbers that that number still seems perhaps on the ambitious side. Just an observation. As we try to get -- frankly, the trajectory of forward numbers has been pretty steadily downward over the last several quarters and I think at this point people would like to have some higher level of conviction that those numbers that you've reset here aren't coming down again, due to, perhaps, over-ambitiousness or whatever. So just kind of curious that that seemingly ambitious target was not maybe reigned in a bit, but I understand you're on track for the first quarter, but.

Well, look, predicting the future is very difficult. The only thing we are doing here is looking at what happened in Q1 and letting people know what happened in Q1 and then forward-looking that number. So the fact is the VSAT business was very strong in Q1, so we didn't see any reason to update our guidance. That doesn't mean it won't happen and I agree with you 100% growth rate is an aggressive number, but it's still consistent with what we're seeing and so we're being pretty transparent about what we see and what we expect.

Understood. Moving on to the defense business, Pat can you give us the FOG versus TACNAV breakdown in the quarter?

Yes. FOG was just about $6.1 million. The total guidance in stabilization business was $8.7 million, so and in terms of TACNAV product sales - and this doesn't included nonrecurring engineering and things like that - but we're about $2.0 million for the quarter.

Got you and in that business, as you move into the back half of the year and I think you talked about sort of $9.0 million to $10 million of, I think, FOG business in the back half of the year per quarter. Can you give a sense of what's expected, from the perspective of additional CROWS-related orders or RWS maybe, to say it more broadly, orders in the back half of the year? It sounds like the delivery of this $2.6 million order takes you through the summer, but what do you need to get in terms of new RWS orders in the back half to make those numbers?

Well, generally, we're expecting sort of $1.0 million to $2.0 million a quarter, in that range, for the RWS, so that's why the growth in non-CROWS business, which was over 80% this quarter, so it was very strong growth. 80% is important, so -- and that's why we had said that by the end of the year we thought we'd get back to the kind of run rates were getting when we were doing $6.0 million or $7.0 million a quarter in CROWS type of business, so. But we aren't expecting a dramatic recovery in the CROWS business until, realistically, next year.

Right, understood. And Pat, anything you can say about your tax expectations for the balance of the year? Obviously if the tax rate of the tax credit was a little less than expected in Q1. Anything you can say, assuming you're profitable for the balance of the year, what kind of tax we should expect?

Yes. It should be -- right now our indication is that the effective tax rate of the entire Company, the consolidated results should be about 35%. So slightly lower than what we had indicated in February and as indicated earlier as well, not related to the tax rate per se, but we expect that EBIT will increase for the year approximately 10%.

Right and so that 35%, that applies to the second quarter as well or is that for the full year?

Yes. It should apply to all quarters.

Okay, very good. Okay. Thank you.

Hamed Khorsand, BWS Financial

Good morning, guys.

Good morning.

Three questions for you. Do you think the LiveTV issue is to do more with Ka-Band than what you guys have with the Ku-Band?

No. LiveTV is a TV system and so our product is a TV system and all the TV satellites that they're using are Ku-Band. So the Ka-Band Internet product is completely separate and we don't have, never have, had a contract with them for Internet products. So this is strictly a satellite television product similar to what you've seen if you've flown Jet Blue or Continental recently.

Okay and do you think there will be some cannibalization of your V7 revenue with V3, or is the V3 service revenue more profitable?

There will be cannibalization and we factor that in, but we price the product and the systems and service, so we're really agnostic as to which product they buy, so the margins were intentionally set so that we don't really care and we don't mind disrupting ourselves as long as we're destroying our competitors.

Okay and any status update on the US field trial you had previously said you were a finalist in?

Can you repeat the question?

The large account trial that we were involved in.

Oh. Yes, we're continuing to make progress there. We've got a number of trials in addition to that one. That one is still active. We're still optimistic on that and we also have a number of other ones underway.

Okay. Thank you.

Yes.

Paul Sagara, OMT Capital

Hey. I was wondering - and sorry if I missed this - if you could talk to where your operating expenses are going to go? I understand investing in the business going forward, but how much of this quarter's were kind of onetime-related, going back to the Brazil setup and V3 licensing?

Well, in terms of -- I don't know if I'd characterize those types of things as onetime-related, because we're going to continue to advance the business and we're going to be continuing to put more and more licensing in place around the world for all of the markets that we serve, which is beneficial to our customers, so that they can be confident that they're fully compliant regardless of where they go. But in terms of operating expenses, the operating expenses for the quarter were pretty much in line. The absolute number was very much in line with what we had expected.

For the full year, as I mentioned earlier, I expect that we'll find a few things to shave out of the operating expenses. But for the year, we're expecting operating expenses will not change materially from the current quarterly run rate.

Okay, thank you.

John [Gruber]

Yes. I'm just sort of perplexed on this, on the 3, why you got behind the eight ball and what did all these components at high prices, so you get profitless prosperity as you're going forward here. Why did you do that?

Well, we pulled the product launch -- you're talking about the TracPhone V3 launch?

Right.

We pulled it forward because as a Company we're making more and more of our profit from the airtime, so by getting more units into the field quickly, we typically expect these customers to be customers for three-to-five years and an airtime customer, whether the ARPU is $1,000 or $2,000 over a 36-to-60- month period, even at $1,000 ARPU generates $60,000 in airtime revenue. So it's incorrect to say that it's profitless.

Well, but why did you have to -- why didn't you plan ahead and order when the V3 was coming out so you wouldn't have this issue of rush orders?

Well, we did. We had been lining up our vendors with material orders, but what we did was we tremendously accelerated the development cycle, which then means that all of our suppliers have to accelerate their processes as well, which makes it more costly for them.

The other thing is that we can't really place orders for materials until we're sure of the product design, meaning that there aren't any tweaks or changes, especially to mechanical and electronic components. And so that even shortened the window further in terms of our ability to be able to keep the initial costs as low as we would have liked to.

Thank you.

Jim McIlree, Merriman Curhan Ford

Yes. Thanks again. Martin, I understand the thought process on accelerating or bringing the products to market as soon as possible, but I'm still a little bit confused as to why you accelerated the V3 versus your prior plans. Was there something going on with the V7, or were you worried about somebody else's new product introduction? What was the catalyst for you guys to say you needed to bring the V3 forward?

Well, the catalyst is that it's a competitive environment and the sooner we can get airtime revenue and hardware revenue. We want to grow the business 100% this year, so whenever you can introduce a new product faster you should do so.

We also had some conservative estimates in there for getting the FCC license, which sounds like a small thing, but it's actually an incredible accomplishment that we got a product this small licensed by the FCC, because all of our competitors were saying this was impossible, it would never happen, and we even had some people, internally, saying it would never happen. So, also, as we were able to get that accomplished and it looked like that was going to happen, it's in our best interest to launch a product as quickly as possible.

And are there other regulatory approvals that you need in order to launch it worldwide, or is the FCC a substitute for other licensing jurisdictions?

It's not a substitute, but it's a key step. So, right now, we're licensed to operate everywhere in the world, although in certain jurisdictions the import license is required as well. So, if you want to use the product, import, in certain countries you need a specific license for that and that's similar to the V7. So there will be ongoing licensing work, but right now we're free to sell the product anywhere in the world.

Okay and lastly, the language that you're using with the LiveTV just seems kind of odd with me where you're saying that the contact has been cancelled but the vendor says no, where the customer says no and I'm just wondering. Are you using that language because it triggers some sort of contractual obligation LiveTV's part or it relieves you of some sort of obligation, is that why you're saying, using that language that the contract's been cancelled or you've deemed the contract cancelled?

Well, it's -- I have to be careful because I don't want to discuss contractual issues out of school here. The issue, as it relates to investors is that we had a significant amount of revenue in the plan for this year based on firm orders and contracts and purchase orders that we expected to be honored. So we're in a situation now where we don't think that's going to happen and that's taking a big chunk out of our revenue forecast.

Okay. Thank you.

Yes.

(Operator Instructions) Chris Quilty, Raymond James

Hey guys, just one final question here. I think for the past couple of quarters you've talked optimistically about some of the Japanese fleet orders and it seems like you have some good relationships in place. Is it reasonable to expect that the current situation in Japan may push some of that out? Or are you still optimistic that you can sign a first contract here sometime this year?

Well, I think that we could still sign it this year. I think we've got -- there were three new trials that started this quarter, as I mentioned. These are some of the biggest fleets in the world, so that's a very exciting opportunity, but as you know, the Japanese are very thorough in their decision-making process and it sometimes takes longer than in other countries, so you have to that into account as well.

Okay. Well, good luck with those.

All right, thanks.

And gentlemen, there are no further questions.

Great Well, thanks for your time today and as always, feel free to contact Pat or myself directly and we'll talk to you soon. Thanks.

And once again, that does conclude today's conference. We thank you for your participation. 12