KVH Industries Inc (KVHI) 2011 Q3 法說會逐字稿

Good day, everyone, and welcome to the KVH Industries third-quarter 2011 conference call. Just a reminder, 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.

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 4, 2011. 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. Good morning, everyone, and thank you for joining us today. Although overall revenues for the third quarter were somewhat disappointing, we did see continued strong growth in our mini-VSAT broadband business which increased more than 50% year over year. Unit sales of our TracPhone mini-VSAT systems were up 77% compared to last year's third quarter.

Offsetting this, revenue from our fiber-optic gyro solutions was well below our expectations due primarily to the delays in customer programs. Revenue for the third quarter was $25.6 million and that's down 8% from last year. Diluted earnings per share for the quarter totaled $0.04 which was exactly the same as a year ago.

Now Pat will cover the numbers in more detail shortly, but first let's take a look at our key business areas. Starting with our Guidance & Stabilization business where overall revenues for the quarter were down about 38% compared to last year, this was due mostly to a reduction in our CROWS remote weapon station business.

Although we have some recurring revenues under the existing contract, they continue at a much slower pace which is commensurate with the slower pace of production for the newer weapon stations. The upcoming CROWS III procurement has both been scaled back and delayed meaning that our revenues from this program will likely be at or below the reduced level that we've seen recently for the last -- sorry, for the next few quarters.

However, we've been working closely with [Tonsberg], the prime contractor of record on this program, and we're currently discussing production options and pricing.

Fortunately we have an exciting new fiber optic gyro product in the DSP-1750, which is the world's smallest high precision gyro. We've seen a number of new applications developed such as for use in drivers' thermal viewers, missile and bomb IMUs and stabilization sensors for optical and thermal cameras, which we believe will lead to significant programs.

This is a breakthrough product for us with performance an order of magnitude better than competitive products. As always these OEM opportunities take some time to develop, but we believe that we should start seeing significant revenue from these in the near future.

During the quarter we produced our 50,000th fiber optic gyro, and new products like the 1750 and an upcoming three axis version should help us maintain our leadership role in this important market.

We also recently learned that Raytheon was awarded a new production contract to the Mark 54 torpedo that uses our TG-6000 inertial measurement unit. We expect that this will soon lead to new production orders for KVH which will help boost FOG sales.

On the TACNAV front we're seeing a number of new opportunities for vehicle navigation come to fruition. The biggest near-term opportunity is an acceleration of a foreign military sale into Q4 which adds about $6 million over and above what we were anticipating for Q4 TACNAV sales. We've also just been awarded a new order for $8.6 million to be delivered over the next few years which we announced this morning.

And finally, we've received indications that a $22 million fallow-on order for a TACNAV program, which has already generated about $3.4 million in revenues this year, has high potential and could become a reality over the next few quarters. So overall we're seeing signs of strong growth in this part of our defense business.

Turning to SATCOM, our mini-VSAT broadband business continues to grow robustly. For the quarter we saw unit sales increase by 77% and total air time and hardware revenues increase 51% year over year. Although growth was less than we had anticipated, we believe this is more a function of timing and forecasting than anything else.

The economic situation, particularly in Europe, is having an effect on our commercial shipping customers. Oversupply of vessels puts pressure on freight rates as the total world trade is not growing at the pace that anybody would like. This has the effect of making customers somewhat more cautious in the decision-making process and it slows the pace of deployments even after the decisions have been made.

We continue to win more than ever share of competitive bids and we feel terrific about our value proposition and our product positioning. In fact, over the last two quarters system sales have averaged around 250 units per quarter and the long-term trend is up. Our mini-VSAT broadband business has grown at a 50-plus-percent compounded annual growth rate over the last four years.

The TracPhone V7 is now the market leader in terms of new orders and installed base in the VSAT category compared to any other VSAT provider. And we're addressing an entirely new VSAT market with our TracPhone V3. Here the ultra small size and low meter rate pricing competes directly with L-band providers alike Inmarsat.

Our V3 hardware that retails for about $17,000 is priced within the range of L-band terminals, but the air time costs about one-tenth as much and our data speeds are about 10 times faster than the typical Inmarsat or iridium solution. We're also offering attractive leasing options now which provide customers both the hardware and 1 gigabyte of data for $9.95 a month.

Just four years ago we kicked off our mini-VSAT service here in the US. During the last quarter we added the final piece of our global coverage, the west coast of South America. We now have completed the vision we had and have created a seamless global network we set out to put in place.

We now have on the order of 100 million square miles of the earth covered in broadband connectivity. Total coverage is a key differentiator for our customers, particularly the larger global fleets. We've been making lots of customer presentations and are busy bidding on some of the major opportunities based on our complete coverage. This includes some coming out of Asia where we're starting to have some additional success now.

We've been participating in a number of important trials, some of which, like the recent MOL announcement this quarter, have resulted in orders. With our focus on Asia, I just returned from Singapore where we had our open house for our new Asia-Pacific headquarters. It was great to meet directly with many ship owners and to be able to demo our equipment in our new test lab.

We're looking for significant growth coming out of this part of the world as Asia continues to grow rapidly and we expect that growth there will help offset any potential softness in Europe or the US.

Offering Internet access to ship crews requires a number of additional features that we now provide through our CommBox product. Vessel owners want to be able to filter content, control access, prioritize bandwidth, compress and optimize data and offer features like crew calling and Internet cafes. This can all be done with our value-added software features.

VPN tunneling, back-office management, prioritization of vessel operations traffic over crew Internet -- all these things are now mission-critical. Very few RFPs only mention bandwidth anymore, it's all about the solution, and KVH has the best solution. So it's not just small and inexpensive and fast and easy to install, it's also about sophisticated IT solutions and crew welfare management.

On the satellite TV front, we just introduced our best TV product ever, the TracVision HD11. It features a 1 meter DISH and a fully programmable LNB that's the first Marine TV antenna in the world that can receive any Ku- or Ka-band satellite broadcast service anywhere in the world. So for the first time vessel owners can travel where they like and not worry about being the inconvenience and cost of switching out LNBs or set-top boxes.

Oftentimes we introduce incremental upgrades for our products, but only occasionally do we introduce a truly new platform. The HD11 is such a truly new platform. It has a revolutionary new robotic drive mechanism that eliminates belts, it has a completely programmable local oscillator and switchable polarizer to be compatible with all satellites, it has a unique below deck system that can switch between banks of receivers.

Best of all, the new system is completely Internet enabled so that you can control it from any browser and it even has an iPad app -- you can select your favorite satellites and control the entire system effortlessly.

This new product has a number of core technology features that will set a new bar for our competitors and it will be incorporated into future KVH products. The international launch of this product was in Southampton in the UK in September and the US launch is later this week in Fort Lauderdale at the international boat show there.

This product is significant because it represents a new market for KVH. We never had a product in the 1 meter category before, and we're now able to address TV services on both larger than 100 feet for both leisure and commercial markets.

True welfare above commercial ships is now becoming more and more important, TV as well as Internet access are becoming requirements. Given the continued softness in the leisure markets, expanding into new areas provides a means for us to continue to grow our TV business even as the market is flat or declining overall.

So in summary, although we're somewhat disappointed by our results in Q3, we're optimistic that based on backlog for Q4 we'll be able to make up much of the shortfall prior to year end and we'll close out the year with a very solid Q4 performance. We have continuing momentum in our mini-VSAT business, and we have exciting new products in the pipeline.

Our new TracPhone V3 continues to set the bar for high-performance and small size in the VSAT market. Fiber-optic gyro sales are expected to return to solid growth with the growing adoption of our new DSP-1750 and the resumption of TG-6000 production next year.

Although the timing and quantity of the CROWS III program is still uncertain, we're confident in our ability to be a major supplier to the prime contractor for this important system. Pat?

Thank you, Martin. Although total revenue did not meet our expectations for the quarter, we are very pleased with the continuing strong growth of our VSAT business and of the newer commercial and defense applications for our fiber optic gyros. These offerings along with renewed demand for our TACNAV products are expected to help drive our growth.

The summary for revenue by business area for the third quarter is as follows -- total marine SATCOM was $15.9 million and the VSAT business was about two-thirds of that. Total marine sales were up 22% year over year. Land SATCOM was $1.9 million, down 17%. FOG was $5.3 million, down 50% year over year. And all other Guidance & Stabilization including TACNAV was $2.5 million, up 29%.

Gross margin was 40.6%; this was 140 basis points better than Q2. This was also better than our expectation in spite of the relatively low level of revenue. Continuing improvements in production efficiencies, as well as a relatively beneficial mix of product sales, were the primary contributors to this improvement. About 40 basis points of the improvement related to a reclassification of prior period cost to operating expense.

Total service gross margin improved sequentially 1,000 basis points; this was primarily driven by the improvement in the gross margin of our mini-VSAT air time services. Just as in Q2, the gross margin from the sequential incremental VSAT air time revenue was well in excess of 50%.

The gross margin of our VSAT air time has now improved by about 1,500 basis points since the first quarter of this year. This has been driven by the leverage we are getting from the portion of our network infrastructure cost that is relatively fixed.

Service gross margin related to other services, those being Inmarsat air time repair services and engineering projects also increased sequentially. This was partially due to the mix. For these other services we expect that the mix in the fourth quarter will result in a lower gross margin compared to Q3.

Operating expenses were below our expectation as we constrained spending once we saw an indication of a potential revenue shortfall. Although they were 4% higher than the Q3 2010 level, which included the cost to acquire Virtek Communication. Excluding those acquisition costs, operating expenses increased year over year by 10%. This increase was driven by investments in our strategic growth businesses.

Engineering expenses decreased 5% year over year while sales and marketing spending increased 28%. We have incurred additional sales and marketing expenses as we globally expand our sales channel and our support services presence for the mini-VSAT business.

Reported administration spending decreased 22% year over year and even after excluding the Q3 2010 cost to acquire Virtek, administration expenses decreased year over year and sequentially by 6% and 9% respectively.

We reported a modest tax benefit for the quarter. As reported last quarter, our profit expectation for 2011 indicates that accumulated tax credits will more than offset tax expenses. As a result we now expect that our effective tax rate for the full year will result in a modest tax benefit.

On the balance sheet, cash and marketable securities were $32.9 million. Cash flow from operations was approximately $0.1 million. EBITDA adjusted for equity compensation expense was $2.5 million and EBITDA margin was 9.7%.

During the third quarter we repurchased 282,000 shares of stock consuming $2.3 million. We have repurchased an additional 165,000 shares since the end of September bringing the total purchased amount to 447,000 shares using $3.6 million of cash. There are 351,000 shares remaining under the current authorization.

Accounts receivable decreased sequentially to $19.3 million, days sales outstanding was 68. During the first week of October we received payment for the $3.4 million foreign military TACNAV order that we shipped in late June. Since this amount was still in our receivables balance as of the end of September, it accounted for close to 20% of the total dollar balance and the DSO figure.

Inventory increased sequentially to $19.3 million. This increase is directly attributable to the product revenue shortfall versus our expectations. We have adjusted the inflow of vendor materials to support the rebalance of our inventory over the next couple of quarters. We do not foresee any risk with respect to consuming the inventory that we have on hand.

Capital expenditures were $4.1 million for the quarter reflecting an increase in construction progress for our new manufacturing and warehouse facility in Rhode Island. We expect to be in the building prior to year end. Year to date CapEx was $8.1 million and is projected to be about $17 million for the year including the full cost of the new facility.

As of the end of September we had drawn $6.5 million on our line of credit to support the construction project. Backlog for guidance and stabilization products and services at the end of September was $12.6 million; this did not include the new $8.6 million TACNAV order that we just announced.

Turning to our outlook for the fourth quarter, ongoing weak global economic conditions, a very low level of consumer confidence and government deficit and budget challenges continue to cause shifts in program timing and demand from our customers and severely limit our visibility with respect to guidance. With that backdrop, I'll review our outlook for Q4.

We expected that the mini-VSAT business will continue to grow at a strong year-over-year rate and that unit shipments will increase sequentially. We do not anticipate much of a sequential increase in VSAT air time revenue and gross margin because we are assuming that there will be a high-level of seasonal temporary suspensions of service for the near-term. This is consistent with what we experienced last year in the fourth quarter.

We expect to ship a significant foreign military order for TACNAV. To help mitigate production integration risk for the prime contractor we have agreed to accelerate the production and shipment of essentially all of the order quantity that was originally scheduled for 2012 and early 2013. This accelerated shipment accounts for approximately $6 million of revenue in Q4.

On the other hand, the outlook for near-term demand of our fiber optic gyros to support the CROWS program is very uncertain. As a result, our assumption is that shipments of gyros for CROWS could be at only nominal levels for the next several months.

Given these factors we expect that Q4 revenue will be in the range of $31 million to $34 million, gross margin should increase compared to Q3; however, operating expenses could increase sequentially by 15% or more as they will be impacted by a large commission payment for the accelerated foreign military TACNAV shipment.

Assuming a modest tax -- income tax benefit we are projecting Q4 EPS to be in the range of $0.08 to $0.14. We expect that EBITDA margin will be 10% or higher for the quarter.

As you know sales for defense programs can be very lumpy quarter to quarter, so the projected fourth-quarter level of revenue for our TACNAV products should not be viewed as a run rate level or direct indicator for future quarters. We expect to provide 2012 guidance for Q1 and the full year when we release our fourth quarter 2011 results.

Overall we continue to be very confident in our future prospects and our ability to achieve our long-term financial growth and margin objectives. Now we will take your questions. Laurie?

(Operator Instructions). Chris Quilty, Raymond James.

First of all, on the mini-VSAT product line, your expectation that your growth rate is actually going to grow in the fourth quarter and I think the actual number of units is also going to be up?

Yes.

That's driven by -- I mean do you have good visibility on that in terms of booked orders? And what drives the sequential uptick or do you think that's just a continuation of the current trajectory?

Well, it's a little bit of both. We've got more backlog going into Q4 than we had going into Q3 for the VSAT products and we have a couple of deals that didn't close right at the end of Q3 that had got pushed into Q4, so that helps. And just generally it seems that Q4 is a better quarter for the commercial market.

For example, in the Pacific Northwest in Q3 everybody's out fishing so there's no -- not much purchasing activity going on. Last year we had some good success in that region in Q4. So it's really a number of factors that give us confidence that Q4 should be better than Q3.

Okay. And did you break out the actual non-CROWS FOG revenues? And you didn't talk specifically about the general commercial activity.

I don't think we gave that figure but I think Pat has (multiple speakers).

I have it, Chris, the total FOG revenue for the quarter, as I said, was $5.3 million. The CROWS portion was about $1.5 million of that, just slightly above that. And so the non-CROWS, if you will, was between $3.5 million and $4 million of the total.

The pricing discussions with Tonsberg should we expect that the pricing and the margins on that are going to come down, or is that just a longer-term agreement put in place?

We're expecting to get some business from them here shortly. So that will give us some better visibility for the balance late Q4 into Q3.

Okay, and (multiple speakers).

Chris, if I may, this is Pat. If I could add one more thing to that, the FOG number. In terms of last year, the year-over-year compare. Last year we were still shipping the Mark 54 torpedo for the current program or the production program at that point in time. So of the number last year and 2010 the non-CROWS portion was about $4.8 million of the total in Q3 and the Mark 54 torpedo itself was approximately $2 million of that non-CROWS portion, just to give you a sense.

And so the other question with the CROWS program, when they took down the total order for the CROWS III from $19,000 to $3,000, did they change the order period from five years to something less and what are your longer-term expectations for that contract?

It's not clear at all, Chris, what's going to happen there because also at the pre-solicitation conference they said that there was going to be a reset of 6,000 units on top of the 3,000. So I'm not sure that the exact quantity is known yet.

And there's also the possibility that this particular program is -- where they're trying to manage the program so it doesn't become a budget cutting target so that they have set the quantities relatively low and then they're going to plus it up every year or every other year. Which is exactly what they did with the CROWS II program which started out small and ended up being three or four times what the original solicitation was for.

Okay. Pat, I think -- I don't know whether you gave it in the speech there, but I know you always have in the Q the mobile communications product revenues.

I don't have the mobile -- the overall service revenue -- the total product revenue for the company was $18 million. And I don't have the exact number here, Chris, but I would say that the products portion of -- I'm trying to back into it quickly here in my mind. I would say that the products portion of the SATCOM -- total SATCOM revenue was $17.9 million and I would say that the products portion of that was around $10 million but I don't have the exact number in front of me.

Okay. And total revenues for the mini-VSAT product service bundle?

As I mentioned, it was -- product and service, it was about two-thirds of our total marine business, and the marine total for the quarter was about $15.9 million, so it would put it around $10.5 million.

Okay, got you. And what are you seeing happen with the monthly ARPUs for the service now that you're blending in lower monthly ARPU for the V3's?

Right. In the future we may start breaking those out. As we said, we expect the V3s to be in the $400 to $600 range and the V7s to be in the $1,800 to $2,000 range. And probably the more accurate way of describing that is that the meter plans would be in that lower price range and the fixed-rate plans would be in the higher one.

And that's still where we are today. Again, with the V3 it's still early days, but that's -- after one or two quarters it seems like it's in that range, which is consistent with what we expected.

And the MOL contract that you signed in Japan, did you size that for us at what you think the opportunity might be?

The initial order wasn't that significant, it was under a dozen units, but it was just an indication of a long-term trial with a big potential customer that was successful. And that's -- actually sort of a pattern that we see is that you go through these trials and you get selected, you get on board and then the pace of rollout can take a while.

So it's a slow and steady growth. So there are some programs that we're working on now that are multiple hundreds of units, but it will take a year or two to get all of those actually installed on the vessels.

And do you know the size of their fleet?

This particular fleet is for the LNG fleet which is not that large, but it's part of a larger group.

Okay. And was that a competition against other VSAT providers or Inmarsat or both?

Both.

Great, I'll step back into the queue.

Rich Valera, Needham & Company.

Pat, I was wondering if you could break down roughly the delta between your original guidance and where you came in for the quarter from a revenue perspective by segment is about a $5 million delta. Can you give us a sense of which segments contributed to that and what proportions?

Yes, in round numbers, Rich, our guidance for the quarter going into the quarter was $29 million to $31 million of revenue. And the misses -- the biggest miss was in the fiber optic gyro area and that was because, as Martin mentioned, the delay in programs by our customers that we are confident we have -- are still there and still available to us, but the timing has slipped to the right.

And then we had a little bit of a miss, a smaller miss in the VSAT business and that was a case where also with the general economic conditions around the world, especially in Europe, customers are taking in some cases a little bit longer to make decisions. And as a result of that I think we just -- we didn't take the economic conditions well enough into consideration for the quarter.

So although the business continues to grow very, very strongly, we were actually hoping that it might grow a little bit more than that. But fundamentally that's where the business was.

How about the leisure businesses, were they -- I know they've been weak, but were they any weaker than you expected?

They were no weaker than what we've been experiencing in the first two quarters. Leisure marine was down about 10% year over year, that's about what we saw in the first two quarters. The land business was down 17% and that's reasonably consistent with what we've been seeing as well early or maybe down a little bit more percentagewise. But overall for the moment anyway it feels that things have not gotten any worse but they certainly haven't gotten any better in those markets either.

Sure. I wonder if you could give me, Pat, the number of -- or the amount of CROWS-related revenue you expect in 2011? It doesn't sound like you expect much in the fourth quarter, can you give us a year-to-date number on the CROWS-related FOG revenue?

Yes, year-to-date for CROWS through the third quarter it's around $6 million. And we expect very little in the fourth quarter, maybe a few hundred thousand dollars. And so as a consequence it looks like the year is projected to be just over $6 million, which interestingly is about what we projected at the start of the year.

Okay. So I know things get a little confused with the large accelerated TACNAV order in the fourth quarter here, but trying to think about how to look at next year. I mean $6 million isn't a lot of CROWS, so even if that was say cut in half that's not a huge delta. But presumably you're expecting growth in your non-CROWS FOG business, sounded like you alluded to that in your prepared remarks.

And then TACNAV, I'm not sure because you'll have a tough comparison now with that big accelerated shipment. So I'm wondering if you can give any color on how to think about Guidance & Stabilization in general next year but maybe breaking it down into FOG and TACNAV as we look to next year?

Right. Well, one of the things is that we don't expect the CROWS business to be down. We've already gotten indications from Tonsberg what they're thinking of for non-CROWS III and it's more than what we had in 2011.

So we do see that going in the right direction next year based on forecasts and preliminary discussions. So we're hoping that's going to go the other way -- not back to where it was two years ago, but certainly not less than 2011.

Okay.

And then any incremental CROWS III stuff would be on top of that of course.

Right.

And then as far as the TACNAV goes, I think Pat cautioned not to run rate this number which is good, but we did get that order today which was $8.6 million and we've got some other things in the pipeline that could hit for 2012. So that's a little bit more of a wild card.

And then looking back over the last four years, the VSAT business has been on a really good growth trajectory. So we expect that to continue next year. As I mentioned, it's been running over 50% on a compounded growth rate. So we expect that to continue into next year.

So I guess the TACNAV, it's a little tough to figure out what kind of run rate we could think of there. Clearly not $6 million -- kind of back out the $6 million there. But you've gotten to something in the $2-million-plus per quarter run rate recently and I'm not sure with this new order if we should assume that maybe goes up or, you know, how we should think about that business on somewhat of a steady-state.

Well, I would say that this business is on a pretty good growth trajectory. So I would say if you take out the spikes the trend is definitely up on a quarterly run rate basis.

Okay, great. And then in terms of the leisure businesses, I mean obviously very tough this year and material year-over-year declines throughout the year. Too soon to tell if we think they stabilize from a year-over-year basis at some level as we head into next year?

Yes, I mean we certainly expected that this year would be marginally up, instead we got marginally down. And even going into this quarter from the time the quarter started to the time the situation in Europe flared up, that sort of happened in the July time frame.

So it does make it difficult to forecast. But as -- from what we saw this quarter it didn't look like things were getting materially worse than what we had seen. And we think with the HD11, which is primarily a leisure product we're expecting growth in our leisure TV business in the current quarter.

And then, Pat, the $6 million of accelerated TACNAV revenue in the fourth quarter, can you -- I don't know if you can give us the expected operating income contribution there. I know there's a sizable commission associated with that, but can you give us maybe the rough operating income contribution expected there so we can get a better feel for the underlying business?

Yes, I can't give it to you in specific numbers, Rich, because we normally don't do that. But as you know, the TACNAV products typically have good healthy gross margins certainly north of 50% typically.

This does come with a fairly healthy commission payment associated with the order and yet it's a suite of products that we've already completed the engineering obviously and there isn't a lot more sales and marketing and admin effort necessary to support this particular order. So the contribution to operating margins should be very helpful.

Right. And if I could, just one final question on the FOG business next year. I think, Martin, you talked about CROWS-related business which you think will actually be up at least somewhat from the roughly $6 million level expected this year. How about non-CROWS-related FOG business next year, any thoughts there?

Well, we're optimistic because we have this new product which has really been a breakthrough and has been very well received. We're starting to get designed into some programs, we also have some new products coming out early in Q1 which we're excited about. Our expectation is that the FOG business should show very strong growth outside of the CROWS business.

And when will you have better visibility to the ramp of some of these? I guess it sounds like first quarter of next year is when some of these newer commercial products start hitting in the first quarter, second quarter of next year when you start getting a better feel for that?

Right. So I think we'll start to get designed in -- so hopefully we'll have some design wins that we can announce during the current quarter that would be in production next year, which has the advantage of spreading out the risk amongst a number of different programs and projects and OEMs so that we're not so dependent on a single program. Having said that, we still have an expectation that CROWS is going to be a big program for us over the next couple years.

Right, right. Okay, that's it for me, thank you.

Laurie, are there other questions, please?

John Bright, Avondale Partners.

This is Jeremy Henrard in for John Bright today. I just wanted to ask you -- I'm sorry if I missed it; did you provide the breakdown between the V3 and the V7 systems?

No, we didn't. But I can tell you generally it's roughly the first two quarters, the product is new so we've only shipping it for two quarters. But we're seeing roughly a 65 V7, 35 V3 kind of split which is pretty consistent.

And are you seeing the same activation lag between the two systems?

It's actually a little bit less for the V3s and I'm not sure if that's because of the new product and they were sort of activated faster. So it's -- but we're still running you should think of in the four-month type of time frame for the body of product before it gets activated with V3s.

Okay great, thank you. And about how many mini-VSAT subscribers do you have today?

We don't have -- we don't report that number directly, but if you look at what we're -- our sales right now which is averaging around 250 a quarter, we hope that right around the end of the year we'll get close to 2,000 units shipped. And if you put in a six-month lag you can see by the end of the year we'll be in the 1,500 range, something like that.

Okay. And is there a modest level of churn we should be thinking about with that?

Yes, it's been surprisingly low, low-single-digit churn on an annual basis kind of thing.

And lastly, could you talk a bit about your gross margin profile going forward and maybe how much additional expansion we could see from the mini-VSAT service revenues?

For that mini-VSAT air time service, on the last call we mentioned that the margins will get more and more healthy as we continue to expand the base of active accounts. And that we had indicated that the margins from that point, when we doubled the number of active accounts, which we had indicated could be approximately midyear next year, the gross margin for the air time services should expand by about 2,000 basis points and the actual gross profit would increase by a factor of about five.

And so, we still expect that that will be the case. We expect that the gross margins for this business on a run rate basis, as we get fully established for the air time services portion, will be as healthy or healthier than the product gross margins.

Coming back to the 2,000 basis point increase, did you provide the number that that would be increasing from?

No, not exactly. But I had indicated in the first quarter of this year that the gross margin for the business was low-single-digits; it was razor thin as I think I mentioned. It expanded in the second quarter and expanded again this quarter. As I said today, it's been up about 1,500 basis points since the first quarter. So you could assume that it's grown from low-single-digits to approximately 20% -- 15$ to 20% range.

Okay, great, thank you. That's all for me.

(Operator Instructions). Chris Quilty.

Gentlemen, you didn't talk about the JetBlue agreement. Does that include the shipment of any new antennas or is that mostly just a service agreement at this point?

It's a service and support agreement, but it also includes negotiated pricing for follow-on orders. So basically it's a renegotiation of -- or a repositioning of the agreement that we had with them before. So if they sign any new customers we'll get additional hardware sales out of it. But they're not obligated to buy any more under this agreement.

So is it fair to assume we should just be modeling nominal six-figure revenue estimates for the time being?

Yes, we're assuming that we'll have a service and support contract and then if we get -- if they land a new -- one of the big carriers that would be great, but we don't have it in our guidance -- we don't have it in our forecast -- our near-term forecast, so I don't think you should either.

Okay. And Pat, the third-quarter service gross margin was way above what I was forecasting. Was there anything in there that was unusual?

The air time -- or the VSAT air time portion was just as we expected it would be. So that portion was certainly in line with what we expected. Now the non-VSAT portion was unusual in the sense that we had a very good mix of the type of service with a very low cost of service for the quarter.

And that's why I mentioned in my prepared remarks, Chris, that we expect the margins for that other non-VSAT service category will probably decline sequentially Q3 to Q4. So it wasn't unusual in the sense it was anything funky, but it was a very positive mix of the type of services that make that up.

So is it fair to assume -- I think you indicated flat service margins or flat-ish for the fourth quarter, but then Q1 through Q3 of next year we should see that steadily expand and then probably flatten again in the fourth quarter of next year?

Yes, I would say that's a fair assumption. And margins I was talking about as being flat-ish in the fourth quarter was the VSAT air time. The other component will probably decline sequentially. So we might actually see a modest decline in overall service gross margins in Q4 compared to Q3, but that is largely temporary because of the seasonal impact of temporary suspensions of accounts.

I think that that effect next year will probably be less because the only people that are suspending seasonally are typically the fishing market and that's -- as the other parts of the commercial business grow that's going to be a smaller percentage of total subscribers. I think it was significant last year and we'll see some effect this year. But as time goes on I don't ever see the seasonal suspensions being as material as they were last year.

I think you gave the number last year, the percent of the installed base that suspended. Can you tell us what it was last year and what it might be this year and the year -- into next year?

Well, (multiple speakers) I don't recall that we gave the exact number of suspensions, but at any point in time the number of suspensions -- suspended accounts -- and again, think of these as it's temporary, it's anywhere from one to three months while the vessel is out of service, in port, whatever. And the percentage is running mid-single-digits as a percent of our total number of active accounts.

And in the fourth quarter last year that the percentage spiked up. And so -- but it spiked up to maybe closer to 10% in total on a temporary basis. And so we're assuming that the same thing is going to happen this year, we may be conservative in our thinking but we're thinking somewhere in that range, 5% up to high-single-digits number of suspensions for the quarter and then in Q1 it should return back to the more normalized rate.

Got it. Great, thanks, guys.

Rich Valera.

Martin, the average 250 net additions for the mini-VSAT service, I'm sorry, that number -- is that a gross number or a net number?

That's just a gross number, it's an average, it's really meant to give a ball park what the number of units being shipped per quarter is just to help provide some guidance on how the business is developing.

Have you -- do you have enough data to talk about a churn number or any kind of churn rate at this point?

We've seen very little churn, so it's in the 1% to 3% range on an annual basis, so it's been pretty small.

So when you say on an annual basis, you mean 1% to 2% per month which is the way it's sort of normally measured or actually --?

No, I was doing it on an annual basis.

If you took the sum of all months through the course of the year that's what -- ball park what we're seeing in terms of churn as a result of customers deciding to either not renew and typically that would be a situation a customer just decides not to renew their air time contract for some reason.

Some of it also, we are seeing a little bit of churn from accounts that become financial risks that we didn't expect to be initially. And so there are a few that we've taken the action to suspend -- to cancel the account.

And then, Martin, did I hear you correctly in response to an earlier question? You said you thought you'd have about 1,500 subscribers at the end of this year or did I miss hear you on that?

Yes, I was -- I was really just sort of working through the math just to help give you the sense that if we're at a run rate of averaging roughly 250 a quarter, the last time we said we sold 1,500 that would put us around 2,000 sometime after the end of the year. And with a four- to six-month lag that would say that you'd expect to have around 1,500 ignoring the suspensions for now, that's --.

So is that consistent with -- last quarter you had talked about expecting to have 2,000 units shipped by the end of the year. Would that be consistent allowing for the maybe couple quarter activation --

Exactly.

-- lag in there?

Yes, that's exactly -- I was really just restating what we had said before. That's right.

Okay. All right, thank you.

(Operator Instructions). And gentlemen. I have no further questions at this time. Mr. Spratt, I'd like to turn the call back over to you for any additional or concluding remarks, sir.

Okay, we want to thank everyone for participating on the call and if you have any additional questions please do not hesitate to give us a call. Thank you.

And once again, ladies and gentlemen, that does conclude our conference for today. I'd like to thank everyone for your participation.