KVH Industries' CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: KVH Industries, (KVHI)

KVH Industries, Inc. (NASDAQ:KVHI)

Q3 2013 Earnings Conference Call

October 30, 2013 10:30 AM ET

Executives

Martin A. Kits van Heyningen – President, Chief Executive Officer and Chairman

Peter Rendall – Chief Financial Officer

Analysts

Rich Valera – Needham & Company

Jim McIlree – Chardan Capital

Chris Quilty – Raymond James & Associates, Inc.

Operator

Good day everyone and welcome to the KVH Third Quarter 2013 Earnings 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 Peter Rendall. Please go ahead.

Peter Rendall

Good morning. I’m Peter Rendall, the Chief Financial Officer of KVH Industries and with me today is Martin Kits van Heyningen, the Chief Executive Officer of KVH. 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 most recent Form 10-Q, filed with the SEC on August 9, 2013. The Company’s SEC filings are directly available from us, from the SEC, or from the Investor Information section of our website.

Now, I would like to turn it over to Martin for today’s discussion or results. Martin?

Martin A. Kits van Heyningen

Thanks, Peter, and thank you all for joining us today. I’m pleased to report our third quarter revenues and EPS are right in line with our guidance coming in at $40.2 million and $0.09. The overall revenue growth, which was attributable to continued success in our Mobile Broadband business, which partially offset by the decline in our TACNAV sales having shipped all the product related to our record order last year to Saudi Arabia and lower than expected fiber optic gyros sales.

Our maritime VSAT revenues were up 34% from the same period last year, and we’re pleased to see a 5% improvement in our maritime satellite TV business as well. As we had anticipated, our guidance and stabilization revenues were down about 33% year-over-year.

Looking at each segment in greater detail, our overall mobile broadband revenues, not including Headland Media were $25.7 million that’s up 16% year-over-year. Headland Media’s contribution to revenues in the third quarter totaled $3.3 million.

The mini-VSAT broadband portion of the business was up 25% overall year-over-year, reflecting strong airtime growth of 34% versus the third quarter of 2012 and a growth of 11% sequentially from the second quarter of this year.

In the third quarter, monthly airtime revenues from our new dual-mode TracPhone V11 reach the level where they now cover the monthly cost of the three global C-band transponders release to provide the global service. Pretty remarkable that we’re able to enhance our network with global C-band coverage providing a major competitive advantage and then win enough customers to pay for this new service in less than a year.

During the third quarter, we also began rolling out another upgrade to the transmission technology of the mini-VSAT Broadband network called ACSM or Adaptive Coding, Spreading and Modulation, which will increase the forward link capacity of our network by between 50% and a 100% without adding any additional satellite capacity. This is improvement is on top of the significant gain, we received from deploying VCSM modulation at the beginning of the year.

Now this increase in forward link capability will be utilized for our IP-MobileCast services. Our mini-VSAT Broadband hardware sales grew 14% this year, year-over-year. This growth came from higher sales in the Americas, North and South America and the Asia-Pacific region.

We continue to see soft sales in Europe, but we believe the continuing poor economic conditions in the EU are causing shipping companies to delay equipment upgrades. Our new TracPhone VIP products, which were introduced at the end of the second quarter are performing well in the field, at the top of our mini-VSAT Broadband product line, the new TracPhone V11 is representing about 10% to 15% of unit sales with 25% of hardware revenues.

And ARPUs for the V11 are running more than double the V7s. And we’re not sure if this trend is going to continue or whether it’s a bit of self selection by early adopters, we’re also tend to be higher ARPU customers, but it’s good news and it’s better than we had anticipated. We already being rolled out on some medium size fleets with the V11 and customer level feedback, so far has been excellent.

Our smallest product, the TracPhone V3 is also selling very well and we’re selected by members of the influential National Marine Electronics Association as the best communications products for 2013 at their Annual Convention last month. This is the second year in a row that a variant of the TracPhone V3 has won this award.

Moving on to our satellite TV business, TracVision revenues were up 5% year-over-year in the marine market. As we reported in past calls, we believe our competitive position in the maritime satellite TV market continues to be strong. The overall leisure marine market has been soft, due to poor economic conditions in the key U.S. and European markets.

As the global economy recovers and the maritime market rebounds, we believe that our sales will also grow. We have a number of new TracVision products in the pipeline and we’re confident that we will maintain our leadership position in a global maritime satellite TV market.

Our new Flagship product, the TracVision HD-11 won the 2013 NMEA Product Award for the Best Marine Entertainment Product of 2013. This is the 16 year in a row that one of our TracVision products has won a prestigious NMEA Product Award, which we feel quite an accomplishment for our product line about to celebrate its 20 anniversary.

On the development front, we’ve been very busy over the past few months, working on our new IP-MobileCast content delivery service. We believe this is going to really enhance the appeal of our mini-VSAT Broadband service well also providing us with great opportunities to increase our revenues per subscriber.

As you recall, the IP-MobileCast service will obviously deliver large file like movies, TV shows, chart databases, weather forecast and training video to take advantage of our unused capacity in the mini-VSAT Broadband network. For sport news and movies, the content will come from our own Headland Media group. Since acquiring Headland Media, we’ve negotiated the rights to distribute several new daily for a news programs to IP-MobileCast customers, which will also be available upon the launch of the service.

For applications like electronic charting, weather and voyage optimization, and training, the content will come from industry leading partners, interested in taking their services to the next level by delivering them over our network. Our business development efforts and recruiting new application provider partners has gone well. We announced our collaboration with electronic charting industry leader Jeppesen, which is a Boeing company in June. And we further expect announcement of additional partners during the fourth quarter.

Supporting the IP-MobileCast capabilities on the mini-VSAT network involves enhancing the forward link capacity of our network, which we’re accomplishing through the modulation technologies I just described, as well as adding the onboard network management capabilities to our onboard terminals, which was largely accomplished with our TracPhone VIP series product line, which we launched in June.

And the final mini-VSAT network enhancement to support the IP-MobileCast, which we expect to be completed by the end of the fourth quarter, involves connecting our hubs via points of presence in each region connected with a fiber-optic backbone. This will allow us to efficiently move large amounts of content to our hubs around the world to support the MobileCast service.

Now to create the actual IP-MobileCast content delivery service, we’ve assembled the team of industry leaders in the fields of efficient, and secured multicasting of very large multimedia files, digital rights management, optimize user interfaces and content display and onboard content distribution to devices like iPads, iPhones and Smart TVs.

The team has been working continuously to build and test prototypes with the new service. And so far we’ve designed and successfully test the multicasting technology over liable with mini-VSAT satellite network. We’ve integrated a digital rights management solution for premium content and we’ve visited one initial approval of many key studios and news organizations around the world for a new service. This is a crucial requirement needed to legally distribute digital content to shift and then once onboard to individual devices.

We’re also prototyping the onboard content distribution platform, which is an application, which will run on the TracPhone, IP series Integrated CommBox Modem and also as an option on a new media server, which will be rolling out with the new service.

Overall, we believe the IP-MobileCast represents a very exciting opportunity to help us differentiate our mini-VSAT Broadband Service and make it more sticky with our customers to protect against future churn. Teaming with leading application providers will give us the opportunity to network with their customer bases, helped with our future sales efforts.

And finally we see the revenue opportunities to both selling our own content and facilitating our partners’ efforts to sell their content to mini-VSAT customers. In fact, we’re optimistic that some of this content will be compelling enough that customers will buy mini-VSAT just to get it then also create demand for Internet service as well.

Moving on to our guidance and stabilization business, our TACNAV product revenues were $2.6 million for the quarter and that’s down nearly 60% year-over-year. But this was expected as we approach the completion of our record $39 million contract, the Saudi Arabian National Guard.

We also had $2.2 million in our resales, a 27% decline from the third quarter of 2012, which were associated with the low margin facility and installation support contract; it was part of the larger Saudi order. And despite the lumpy nature of this business, we’re still very optimistic about the future of TACNAV, TACNAV sales and there is continuing to be a large number of programs we’re pursuing internationally and some of these could begin as early as the first half of 2014.

Turning to our fiber optic gyro business, our revenues were $5.8 million in the third quarter and was down 17% year-over-year. This decline was caused almost entirely by decrease in orders from Kongsberg, who uses our gyros and remote weapon stations most of which are sold to the U.S. Army. The sequestration and the confusion over the U.S. federal government budget are adversely impacting the army’s ability to upgrade their vehicles.

On the positive side, the third quarter sales of our new 1750 IMU increased 37% sequentially over the second quarter and the products has been tested by OEMs and are designed into prototypes of a number of autonomous platforms to augment their navigation systems.

We’re also receiving good interest for this product from number of GPS manufacturers and from independent system integrators. Both groups are combining the KVH IMU with GPS receivers to create hybrid GPS Inertial map systems.

On the product development front, we just introduced a new multi-access variant of our DSP-1750 gyro called the 1760. The earlier product is sold well with over 1,000 gyros shipped so far. And we’re excited about the opportunities for the 1760, which will be well suited for use in emerging markets like robotics, directional drilling, stabilized radar and optical devices.

In addition to the new gyro, we’ve also made good progress integrating the 1760s technology into new higher-end systems combining gyros with accelerometers and in some cases digital compasses and GPS were applications like three dimensional orientation, navigation in northfinding.

We’ll introduce the number of these higher-end systems in 2014 including an enhanced version of our TACNAV product. These higher end systems sell for considerably more than standalone gyros, we’re anticipating a good opportunity to use them to grow our FOG business. We’re looking forward to the remainder of the year. We’re very excited about the opportunities and comfortable with our prospects for continued success in each of our strategic areas of business.

For the mobile broadband business, we feel positive momentum in both our maritime VSAT and our satellite TV business. We believe the new IP-MobileCast service is going to be a real asset to help us win an even larger share of the maritime VSAT market. Our new colleagues from Headland Media have been successfully integrated into overall operations and as contributed a lot of enthusiasm and good sales contacts.

This quarter, we’ll begin a series of events held in major shipping centers around the world or we bring together mini-VSAT customers and prospects and Headland Media customers and prospects to introduce them to our new IP-MobileCast service and take advantage of cross selling opportunities. We’re really excited about the new multicasting content business and we will be making incremental investments to this quarter in order to bring this new technology to our customers.

For our guidance and stabilization business, our new FOG products like the DSP-1760 and the higher-end systems we plan to introduce, they help overcome headwind due to sequestration, while we still see significant international sales opportunities on the horizon for our TACNAV products.

Now I’ll turn the call back over to Peter for the detailed financial results. Peter?

Peter Rendall

Thank you, Martin. As Martin has already said, we’ve reported revenues of $40.2 million for the third quarter, which included $3.3 million from Headland Media, the acquisition we completed in the second quarter. Our mobile communication revenues, which include Headland Media were $29 million, representing a 31% increase year-over-year, when our guidance and stabilization business reported $11.2 million in revenues, which was a 33% lower than the same period from last year.

Our VSAT business recorded $18.1 million in quarterly revenues of which airtime services represented $12.6 million, which was 34% higher than the third quarter last year. Total VSAT products and service revenues increased 25% year-over-year, while ARPUs for by-the-megabyte plans continue to be in the $600 to $700 per month range and ARPUs for our fixed rate plans continue to be around the $1,900 per month level.

As Martin mentioned earlier, our TracPhone V3 has been selling very well. And as a result in the current quarter, V3 sales represented 48% of the total unit sales, while V7 sales were 40% and V11 were 12%. All other SATCOM revenue including TV Systems and Inmarsat Systems and airtime was $7.5 million. Within that amount, we saw 5% increase in satellite TV product sales year-over-year to $3.7 million while LAN based systems declined 24% to $1.2 million as we had previously anticipated.

TACNAV product revenues of $2.6 million saw almost a 60% decline year-over-year as product shipments related to the Saudi Arabian National Guard Program ended in the second quarter. Until that program, we did record $2.2 million in service revenues, mainly related to equipment installations and program management services.

FOG sales of $5.8 million were at the low end of our expectations and 17% lower than the same period last year. Almost all of the decrease can be attributed to a sharp slowdown in spending under the CROWS program. Revenues of our FOG products were split evenly between those used in commercial application versus defense applications, a trend we’ve seen in recent quarters.

In terms of the split between products and services, our current quarter revenues of $40.2 million included service revenues of almost $20 million. Of that amount, 68% related to airtime, 11% related to services performed under the Saudi National Guard Program and 17% related – 13% related to Headland Media.

In the third quarter last year, we reported service revenues of $14.2 million, 73% of which related to airtime and 20% related to the Saudi contract. The gross profit margin we recorded of 41% was in line with our expectations and 120 basis points higher than that we reported in the third quarter last year. The gross profit margin reported for VSAT airtime in the third quarter was 36%, which compares favorably to the 31% recorded in the 2012 third quarter and it’s up sequentially from 35% in the second quarter of this year.

As we’ve discussed previously, construction, installation and program management services associated with the Saudi National Guard Program recorded a gross margin of less than 10%. As I noted earlier, $2.2 million of this quarter’s revenue related to such services.

Total operating expenses in the third quarter are $14.4 million were in line with our expectations. Compared to the third quarter last year, operating expenses were up 17%, the majority of which related to the addition of Headland Media’s operating expenses.

The reported tax expense for the quarter was 40% of pretax income. We expect our effective tax rate for the full year to be close to 35%. As we’ve discussed before taxes are always difficult to forecast since there can be so many variables and unanticipated discrete items. Our diluted EPS for the quarter was $0.09 on net income of $1.4 million, compared to the $1.7 million net profit and EPS of $0.12, we reported in the same period last year.

Relative to this quarter, in the third quarter of last year, we reported higher revenues of our TACNAV products, which historically carry higher gross profit margins in our other product lines. The EBITDA adjusted for equity compensation expense was $4.6 million and the adjusted EBITDA margin was 11%, depreciation and amortization was $1.5 million and the equity expense was approximately $1 million.

Now moving on to the balance sheet; at September 30, we had cash and marketable securities of $57.6 million, an increase of $3.3 million from the end of the prior quarter. Our debt as of September 30 was $37.4 million, which was $300,000 less than what we were carrying at June 30.

At quarter end, accounts receivable balance was $25.7 million and days sales outstanding were 57, which was consistent with what we reported at June 30. At quarter end, inventory balance stood at $18.1 million, which was up by approximately $800,000 from net on hand at June 30.

Our capital expenditures were approximately $1.6 million for the quarter, bringing our total year-to-date at almost $4 million. We still expect our capital expenditures for the year to be in the range of $5 million to $6 million. Backlog for our guidance and stabilization, products and services at the end of September was $22 million, down by almost $8 million from June 30.

Now turning to our outlook for the fourth quarter and the rest of the year, we expect our VSAT business will continue to grow at a strong year-over-year pace, driven by combination of product sales as well as new airtime subscribers being add into our network.

We do though continue to remain cautious as it relates to the leisure markets for our mobile communications business particularly after experiencing ongoing softness in Europe this quarter. With uncertainties surrounding defense budgets, we are not projecting any new TACNAV wins in 2013 that we’ll ship in 2013.

We do though expect bulk product sales to show solid year-over-year growth. Operating expenses are expected to be a bit higher in the fourth quarter as we rolled out our new IP-MobileCast service and we expect to have effective tax rate for the fourth quarter to be approximately 40%.

So considering all of these factors, and guidance for the fourth quarter is as follows: We expect revenue will be in the range of $38 million to $42 million with an EPS in the range of $0.05 to $0.09 per share, which means that revenues for the full year will be in the range of $161 million to $165 million and on a GAAP basis our EPS will be in the range of $0.37 to $0.41.

Excluding the Headland Media acquisition related costs, non-GAAP EPS is expected to be in the range of $0.42 to $0.46 per share. So in conclusion, I have confidence in our strategic growth businesses and operating fundamentals remain strong.

And now, we will take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And we will take our first question from Rich Valera with Needham & Company.

Rich Valera – Needham & Company

Thanks, good morning gentlemen.

Martin A. Kits van Heyningen

Good morning.

Rich Valera – Needham & Company

Now I think you had a solid quarter on the mini-VSAT sub I’m just wondering Martin if you can confirm that the additions were within that kind of 25300 [ph] unit window. If any maybe could you give any color maybe on where they sell within that range if so?

Martin A. Kits van Heyningen

Yeah, they’re we’re still in that range, we are at the low end of that range which is kind of where we’ve been running, so it’s been very steady and Q3 is typically not a big quarter for the marine market. So it’s we do expect to see sequential and year-over-year growth in that number in the Q4?

Rich Valera – Needham & Company

Got you, and then just wondering what you’re seeing competitively out there if you’re seeing any change in the competitive landscape, as Global Express you obviously still far from operational but maybe getting closer are there any tactics trying to pre-sell that or anything that’s changing your competitive outlook?

Martin A. Kits van Heyningen

I would say during the quarter we haven’t seen any change in the competitive landscape so the competitors have been out there doing what they have been doing that’s been fairly consistent, so we don’t feel that we’ve lost any big deals to competitors. So I think that the general our real concern I’d say concern is that this is a market overall continues to not improve. So market has been soft and our target customers they’ve been in a challenging economic environment for years. So it’s really more of an economic issue for them to invest more money into their fleets, I would say that’s our bigger challenge than competitors. So when we go and talk to target customers it’s all about economics and saving the money and today the budgets still to do it in and the horsepower to get it done.

Rich Valera – Needham & Company

Right, right.

Martin A. Kits van Heyningen

Really so much of the competitors prices or new satellites or something like that, I think we got a really compelling product line right now, we’ve got great features and people are excited about the new content we’re going to be providing, so I think that also I think will help because one of the strategies with the IP-MobileCast product is that we’re selling to HR department and the crew staffing department as opposed to selling to the IT department, with IT department as a cause and this is really a benefit to increasing their ability to retain people and to attract people to work on these vessels.

Rich Valera – Needham & Company

Got it and sort of if you could give us an – and I didn’t really hear a update on kind of the timing of the rollout of the multicast service, can you give us, I mean it sounds like you are making progress there but is that going to be live in the fourth quarter or is that really a first quarter next year event for really going live?

Martin A. Kits van Heyningen

We still anticipate that during this quarter we’ll be going live with transmissions to customers what we’re thinking is initially we will probably do a free trial, we push it out to customers getting 30 day trial that type of thing. So but the full service will go live in Q1 in terms of revenue service.

Rich Valera – Needham & Company

Is that consistent with what you expected previously?

Martin A. Kits van Heyningen

Yeah, we expected to launch in the fourth quarter and we still expect to launch so got you…

Rich Valera – Needham & Company

Let’s see if we can just trying to change topics to the guidance and stabilization just trying to understand maybe the outlook here. You’ve talked about for a while that you had pretty low expectations for CROWS. You just had a fairly small amount in backlog this year and I thought that was kind of all you expected, clearly it doesn’t sound like things have gotten better there.

But just wondering about the outlook for FOG, you’ve obviously got the new products, commercial products growing while you’ve got challenges on the defense side. So just wondering can we think about that business is kind of stable at Q3 levels? Do we think there could be any growth from Q3 levels, given the current spending environment and any help on that will be great?

Martin A. Kits van Heyningen

Sure. So just to be clear the year-over-year decline was due to CROWS. But as you point out, we kind of already knew that that was going to be low. So in addition to that, yes that was kind of baked in and that still – so we don’t anticipate any impact from CROWS in Q4 because as you’ve said we had low expectations there.

So but we did see we were disappointed with sales for FOG in Q3. So we baked into our guidance kind of this level or slightly better for Q4, which is about $1 million less than we would have expected. So and that’s really just based on what happened in Q3.

Now year-to-date, our FOG sales are actually on plan because we’re ahead in both Q1 and Q2. So we’re being a little conservative with our Q4 forecast, but we think that’s prudent. But we don’t see any fundamental shift. We’ve got really good products. We’ve got more new products coming and higher level system products coming. So we feel pretty good about where we are and so we’re still optimistic overall in the FOG business.

Rich Valera – Needham & Company

Okay. That’s helpful. A kind of a bookkeeping one, just cash flow from operations for the quarter?

Peter Rendall

So represented roughly $4 million, $4.5 million, which is similar to our EBITDA for the quarter.

Rich Valera – Needham & Company

Okay. Well that’s it for me. I’ll get back in the queue. Thanks guys.

Martin A. Kits van Heyningen

Thanks, Rich.

Operator

We will go next to Jim McIlree with Chardan.

Jim McIlree – Chardan Capital

Yeah, thanks a lot and good morning.

Martin A. Kits van Heyningen

Good morning, Jim.

Jim McIlree – Chardan Capital

You talked about an increase in expenses in Q4 it’s a rollout in multicast product. Are you talking along the lines of like $0.5 million to $1 million bucks extra in Q4 versus Q3?

Peter Rendall

Will be at the lower end, I would suggest.

Jim McIlree – Chardan Capital

And is that something that we’ll maintain throughout 2014 or is that more along the lines of one time expenses and then it drops back down to previous levels?

Peter Rendall

We would definitely tail off, but obviously as we launch more products and more services under the IP-MobileCast platform. There will be incremental costs, but the main development for launching this services going on at this time.

Jim McIlree – Chardan Capital

Okay. Can you help me understand maybe my math is wrong, but can you help me understand the airtime revenues? If my math is right, you did $10.4 million, airtime for the mini-VSAT product in Q2, but $9.3 million in Q3. First of all is my math right and secondly if it is why the drop?

Peter Rendall

So we did use $11.3 million of VSAT airtime in Q2.

Jim McIlree – Chardan Capital

Yeah, I’m sorry Peter. I’m excluding headwinds in both quarters. So if I look at…

Martin A. Kits van Heyningen

Yes, I think that’s your math, you are taking the Headland out of the VSAT. VSAT airtime was up sequentially 11%, I believe the number was Q2 to Q3.

Peter Rendall

Right, but 11.3% to 12.6%.

Jim McIlree – Chardan Capital

Okay. I’ll go with that. So let me ask in a different way. Was airtime revenue up quarter-to-quarter?

Peter Rendall

Yes. Correct.

Martin A. Kits van Heyningen

It was up 11% sequentially and 34% year-over-year.

Jim McIlree – Chardan Capital

Okay, fantastic. And then I’m just a little bit surprised about FOG business. That the FOG-X CROWS was also lower than you expected and lower quarter-to-quarter, is that right on both counts?

Martin A. Kits van Heyningen

Yes. That’s correct. So this quarter, really the only surprise in our any part of our business was the FOG. The FOG was below our expectations and below our guidance for Q3. But as I mentioned, year-to-date is actually still ahead of internal plan and budget. So for Q3…

Jim McIlree – Chardan Capital

Right and is that can you attribute that lower than expected amount to a customer or a product, or market. Can you just give us a little bit of detail…?

Martin A. Kits van Heyningen

Yeah, the biggest area was in our CNS-5000 product line, which had been growing very rapidly and I think we’ve probably made some assumptions about run rate that included, because we’re selling this to GPS integrators and they are selling it to customers. We don’t have a lot of visibility there, because it’s not a DIREC customer sale. So that part of the business was disappointing in Q3.

Jim McIlree – Chardan Capital

Okay. And I think finally obviously the government markets going to be in turmoil for Q4 as well. Is there any reason to think that 2014 wouldn’t have a similar kind of tumultuous outlook for it? That sequester may or may not be listed even if we did fiscal 2014 budget might be challenging for many vendors? When you’re putting together your plans for 2014 and the defense market, are you trying to be taking discount from cautiousness?

Martin A. Kits van Heyningen

Yes, we are. But keep in mind that year-to-date, more than half of our business is actually not military for FOG and that a big part of our military business is international. So for example our TACNAV business is almost exclusively international. So – but you’re right, for the lot of our 1Z military business for FOG does get impacted by that. So we definitely will take that into account.

Jim McIlree – Chardan Capital

Right. And I’m sorry, I just have one more. So in Q4 Saudi contract is expected to deliver how much? And I’m assuming that that’s going to be almost all services as well?

Peter Rendall

We expect it to deliver similar levels to what we saw in Q3. So approximately $2 million or so, and you’re correct. It is all service related.

Jim McIlree – Chardan Capital

Okay, great. Thanks a lot. I appreciate.

Peter Rendall

Yeah.

Jim McIlree – Chardan Capital

Appreciate the answers and good luck with everything.

Martin A. Kits van Heyningen

Thank you.

Operator

(Operator Instructions) We’ll take our next question from Chris Quilty with Raymond James.

Chris Quilty – Raymond James & Associates, Inc.

Martin, just a follow-up with the commercial FOG being really the biggest disappointment or a surprise in the quarter, was that the primary or the only issue leading you to lower the top end of your prior guidance?

Peter Rendall

Yes. Yes, the FOG is the only part of the business that we are being cautious about in Q4.

Chris Quilty – Raymond James & Associates, Inc.

Okay. And the new 1760 that you announced, should that be meaningful one in our expectations?

Martin A. Kits van Heyningen

I think it will not be meaningful in Q4, because these are OEM products. It gets designed into other people systems. So there is a time lag for that. But we have in the pipeline for 1750 IMUs in which is really the IMU in the integrated 1760. We have probably a 100 top prospects that are designing into it, everything from stabilized radars to undersea systems, products are involved in oil and gas is just a ton of opportunities there. So we’re more confident in that part of the business than ever. So as far as that particular product in Q4, no, I don’t think it will be meaningful in Q4.

Chris Quilty – Raymond James & Associates, Inc.

Okay. I know you’re not providing guidance for 2014 yet, but based upon the product pipeline and things in the market. Is this still the type of business where you think on the commercial side, it should be a double-digit growing business?

Martin A. Kits van Heyningen

Yes. I mean like the 1750 even sequentially was up 37%. So it’s becoming our best selling product very quickly and we’ve got improvements to that product coming that we expect to launch early in Q1, which will further enhance the overall product line. So as we mentioned in the script, we’re integrating it into our TACNAV business coming up with a new product there, which we think is going to be really game changers for our TACNAV business. So we’re using in our own products now as well.

Chris Quilty – Raymond James & Associates, Inc.

And margins on the business are they still relatively the same or is there some opportunity for upside as you scale back or get greater leverage on all the R&D you’re spending?

Martin A. Kits van Heyningen

Well, the good news on the part of the sales that are soft – are the low margin part of the FOG business because we’re integrating other peoples components for example with the CNS-5000, and the new 1750 IMU is our highest margin product. So we are moving towards higher margin systems and they are commanding premium prices in the market, even though they are less expensive than alternatives. So that’s very encouraging.

Chris Quilty – Raymond James & Associates, Inc.

Okay. Peter, question for you with the roll out of the fiber backbone in the fourth quarter. Can you give us a sense of what that might add in the cost of service and I assume that’s where at lands?

Peter Rendall

Correct. So it will go against that airtime cost of goods, and it’s going to be less than a $100,000 for the quarter.

Chris Quilty – Raymond James & Associates, Inc.

Okay. Not nearly as much as I had thought and just to…

Peter Rendall

So just – but at time goes on it will increase in the future quarters, but it’s not going to be material like adding an entire new C-band network for example, but so in Q4 it will be about 100K.

Chris Quilty – Raymond James & Associates, Inc.

Gotcha. And the cost of assembling all these industry experts in visiting trade shows, all of that is baked into your guidance?

Martin A. Kits van Heyningen

Yes. Yeah.

Chris Quilty – Raymond James & Associates, Inc.

Okay. And a clarification on Jim’s question, I think that disconnect maybe when you provide the headwind revenues that’s as a separate line item not part of the mini-VSAT, is that correct?

Martin A. Kits van Heyningen

Correct. It’s included within our mobile communications business.

Chris Quilty – Raymond James & Associates, Inc.

Right.

Martin A. Kits van Heyningen

So when we talk about 25.7 million of mobile comps revenue that includes the $3.3 million from Headland Media. So that is not included within the VSAT.

Chris Quilty – Raymond James & Associates, Inc.

Okay. Give us some help on trending both the type of customer that signing up for mini-VSAT service commercial high-end leisure as well as some of the underlying trends towards the V11 product versus V3 and V7?

Martin A. Kits van Heyningen

Yeah, I think there is two interesting trends going on and it’s a little bit puzzling to us. One is that the low end product is selling better and there is more interest in the high-end products. So most of our fleet quotes now are for V11, so it’s kind of little bit different from what we expected. But since the sell price in the V11 is higher and the ARPUs are higher that’s fine. But so it seems like the low-end of the market is doing well and the high-end of the market is doing well and the middle end of the market is not doing as well.

Chris Quilty – Raymond James & Associates, Inc.

Gotcha. And any impact from recent Inmarsat price increases or are those price increases on the old E&E service just too far removed from part of the market you play in?

Martin A. Kits van Heyningen

That it’s an interesting point, because as soon as you asked that question, I was thinking that that might have some impact on the V3 sales, which we definitely saw spike in Q3. So it could be that those customers are finally being pushed over because the V3, the nice thing about our V3 product is not going to be impacted by Global Express in anyway, because it’s volume product, it competes perfectly with the fleet broadband and it offers two megabits per second instead of 200 kilobits per second and it’s dramatically less expensive to use.

So I think that that part of the market, thinking about it logically, there is 40,000 fleet broadband units out there that will it should be V3 customers. And those customers are not going to buy V11 and they’re not going to buy Global Express.

Chris Quilty – Raymond James & Associates, Inc.

Gotcha. Actually shifting back to a prior question about Headland Media, if that is going, and this is just an accounting question in terms of how we model this. If you’re going to segregate that as a separate line item, will it have an impact on ARPUs on a go forward basis. I mean will you pull out the portion of that that impacts existing service plans and pull it into a single line.

Peter Rendall

So first of all, we just need to clarify Headland Media will not be pulled out of the separate line going forward. However, in the way we report our ARPUs then there will be some clarification around what is traditional VSAT airtime service revenue versus what is coming from content. It is not just Headland. There were other content services we’re delivering, which will have an impact on ARPUs.

Chris Quilty – Raymond James & Associates, Inc.

Gotcha. Another fun thing to track, well good, I appreciate the details and good luck going into the end of the year.

Martin A. Kits van Heyningen

Okay. Thanks Chris.

Operator

And at this time, we have no further questions in the queue.

Martin A. Kits van Heyningen

Okay. And as always if anybody has any follow-up questions, feel free to call or e-mail us directly. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s conference. We thank you for your participation.

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