Technology Stocks : KVH Industries, Inc.
KVHI 12.70+1.6%2:39 PM EDTNews

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To: Roy F who wrote (1026)1/10/2002 7:14:59 PM
From: Sector Investor  Read Replies (1) of 7012
Upticked from Yahoo! has transcribed the entire Needham Presentation and posted it! I am posting the entire thing here as one post. Thanks Upticked!

Here is the transcript:

Thank you, Pierre.

<slide1, slide2>
I appreciate having the opportunity to speak with you today, because we're just finishing up a very successful year at KVH. We've made a lot of progress in terms of laying the groundwork for what we're about to do this year. I think 2002 is going to be a breakthrough year for KVH both in terms of rapid revenue growth and also in terms of returning to profitability by the middle of the year, so let me get started here.

KVH is kind of a unique company. We have two technologies-we're currently a market leader in the marine and the RV satellite communications markets and also we're a leading producer of fiber optic gyros for the defense navigation and guidance market. We're an established company with a profitable core business. We've had consistent growth in the hardware side, and we've now got some emerging revenue streams on the satellite services area that will add to our hardware sales. We've been very successful in the markets that we're in, and right now we've got some new products, some new markets that we're entering which should provide us with some exciting growth opportunities in the area of photonic fiber components and in the automotive mobile broadband market, and I'm going to talk about those things today.

<slide5, slide6, slide7>
KVH has two core technologies-the fiber optic technology and the mobile satellite technology. I'm going to start with talking about the fiber optic area which is a technology that we use both in the defense market and also in this new photonics market that we're entering. Our fiber optic group has tremendous experience with over 20 years of developing fiber optic products- a very strong group, very strong intellectual property position. We have over 70 patents in the U.S. and foreign patents. We have about 30 patents that are pending, so very strong unique proprietary technology here. We just built a brand new state-of-the-art facility for both R&D and manufacturing which is in the Chicago area, where we actually make specialty optical fiber. We make optical components like modulators and couplers, and we also make optical systems. We're one of the few companies that makes all three of those things. Currently we're producing fiber optic gyros and sensors. We're in full-scale production, and these are for navigation and stabilization. We're nearing the end of a development project for an electrical current sensing product for the high-voltage utility market. And we're undertaking an exciting new development which we call "photonic fiber" which is an optical component product and the first development of that will be a photonic fiber modulator.

Now our fiber optic gyros are currently meeting key military requirements. This is a very accurate rate sensor. It's all solid-state; there are no moving parts. And it can measure motion very, very precisely. It's accurate enough to measure the spin rate of the earth if you put it stationary on your desk. So it's very precise, reliable, and because it has no moving parts, it's also lower cost than the mechanical products. This product is really an ideal solution for things like navigation for drones, unmanned aerial vehicles, for turret stabilization, and also for guidance packages for smart bombs and missiles. Now this is a very large market. Just yesterday our Defense Secretary talked about increasing the military budget next year by another $20 billion dollars to replace the smart bombs that were used in Afghanistan because they've almost completely depleted the inventory now. These bombs have been so effective that the militaries can use more and more of these. So, it's a very large market-the addressable market is estimated to be over $2.7 billion dollars. And we're starting to see some traction in this market with our new gyros. Our fiber optic gyro sales were up over 164% last year, and we see continued growth in that area.

Now, those are fiber optic gyros as sensors--a stand-alone module, and we're using that same component in our systems that we call TACNAV. And this is to provide precision navigation for armored vehicles. Now, the military's changing role-what they're being asked to do now-puts a premium on precision navigation. Obviously?not just what's happening in Afghanistan, but the Persian Gulf and in Bosnia?the premium requirement is for rapid deployment, high-speed maneuver, and what's called the digital battlefield where everybody can talk to everyone else. And that's what our technology does. The product that you see in the lower right hand corner there is our TACNAV system. It integrates with GPS, provides precision navigation pointing and orientation which allows people to stay integrated with all the information on the battlefield providing continuous position updates automatically. And because we integrate with all these things-our digital compass technology-we're actually the lowest cost solution that provides these capabilities.

So this is kind of an emerging requirement, but there's about 750,000 vehicles worldwide, of those there's about 450,000 vehicles that are in our target market. Our TACNAV typically sells for about $10,000 on average so this is a 4.5 billion dollar addressable market. Now, we're already the leading supplier of this type of nav system. We have about 7,000 systems in the field on vehicles in Afghanistan right now. We have our equipment-actually we're the most widely fielded vehicle navigation system in the world. So, not only have we been designed into a number of key platforms here in the U.S., we're also designed into a number of international military systems-for example, New Zealand, Australia, Saudi Arabia, Great Britain. All these countries have now selected our nav system. In fact, last year more than half of our revenues on the defense side came from the international market. The international market is a very profitable market.

The whole military channel for KVH is a very profitable channel in terms of growth opportunities. We see it's a big market, and it also provides good balance for our company. Although the military is only about between 25-35% of our revenues, it's very good to have that type of balance, because obviously this part of the business is not affected by a recession. So, if you look at the size of the market, the stand-alone gyro market for smart munitions and turrets, which is around 2.7 billion and the vehicle nav market which is 4.5 billion, we're talking about a 7 billion dollar addressable market for this type of technology.

So going into 2002, we already have a very substantial backlog. We have a shippable backlog in the next twelve months that's greater than all our military revenues for last year. We're seeing accelerating demand after September 11th, and at the same time, the military budgets are going up now and are expected to go up again in October. So based on that, we're pretty confident that we'll be able to double our military revenues in the next twelve months.

Now the same technology that we're using in our fiber optic gyros and nav systems is really an ideal platform for the next generation of optical components. We're developing a breakthrough technology which we call "photonic fiber" which is an active fiber, and it's a combination of the specialty D-fiber (which is a patented fiber) and some new proprietary electro-optic polymers. What we're doing is we're building optical components directly into the fiber itself. And the first application of this technology will be an ultra high-speed 40-gigabit data modulator.

Now as most of you know, modulators are a key element in an optical network. Every connection to an optical network needs a modulator. It's really the bridge between the electrical world and the optical world, and it's the device that pulses the light on and off and gets the light into the fiber itself. And these devices are used in really every type of application-multi-channel systems. If you have an 80-channel DWDM system, then you need 80 modulators in order to get the light into the system. Last year, even with the downturn in the optical market, there were still over 100,000 optical modulators sold-the average selling price about $2,000.

But that market is expected to continue its-resume its growth to 1.4 and eventually to 3.7 billion dollars. And this is just the modulator market, not the total component market. Within that-a subsection of that-will be the 40-gigabit market, and although that market has been delayed by a year or so, most analysts now expect that starting towards the end of this year, an increasing percentage of all modulators will be at 40-gigabit, and initially that's going to happen in the metro market where you're going to see very high-speed channels with single data channels.

Now our approach truly is a revolutionary approach. And what we're doing is turning a passive fiber into an active optical component. And the way we're doing that is we're replacing a segment of the fiber (a 2 centimeter segment) of the optical core with an electro-optic polymer. Now, here you see-this is actually an electron micrograph of the fiber itself, and this area is where the core has been removed and it has been replaced where you see the yellow here-the electro-optic polymer. Now this polymer has a unique property in that when it's exposed to an electric field, and here you see an electrode, and that's the electrical data signal-the incoming data signal, the refracted index of the polymer changes directly proportional to the voltage. So if the voltage toggles on and off, both this index changes and the light blinks on and off and that's how you get the coating-the on/off coating of the optical signal. So the advantage of this is that you're completely eliminating now the planar optical chip. So the way it's done today is that you have a crystal which is typically made out of lithium niobate and it's actually glued onto the end of the fiber and that's a very difficult transition to make, and it's a very inefficient production process.

So the advantages of our approach in terms of a competitive advantage is, number one, it's much, much faster. Because the light stays in the fiber all the time, it's very efficient and the polymer has been tested up to 100 gigahertz. So it's a very, very fast material, so you have faster switching speeds and better data integrity.

Now we just heard on the previous presentation on Rambus the importance of low voltages at high switching speeds. They're talking about getting down to .2 volts when they go to 3 gigahertz. Right now, the conventional technology is up around 6 volts at 10 gigahertz. Our technology will be in the 2-3 volt range and then dropping to 1 volt, so you have very easy ability for the chip manufacturers to build devices that can drive this optical component, and that's a key competitive advantage in this market.

I already mentioned a little bit about how with the conventional approach you have to attach the chips to the fiber. The disadvantage of that are twofold: one, most of the light disappears when you do that, so you have about a 70% insertion loss which you don't have with the photonic fiber approach because there is no chip. In terms of packaging today, 60-80% of an optical component's cost is in the packaging of the device. Here we have an enormous advantage because, again, we're doing everything inside the fiber itself, so essentially there's no conventional packaging that's required. And that will give us a major cost advantage from a production point of view. So these are fibers that we are making in large quantities and selling in very small packages. Now, even though it's a very radical approach, we've been very careful to make sure that our device is going to be packaged in a form, fit, and function compatible package with today's technology so that it will literally be a plug and play substitution for what's out there now.

In terms of where we are in the project, it's a development project. We've been working on it for about 18 months now. We have developed a new proprietary electro-optic polymer material. We are fabricating modular prototypes right now, and we've been in discussions with optical networking companies about integrating our modulator with their drivers and lasers to build transponders and other devices. So we're making good progress on this, and we're expecting to introduce this technology during 2002 towards the end of the year.

Also, we have extensions to this technology-it really is a technology platform which means that in addition to the modulators, we have tunable filters, because the fiber itself is now electrically adjustable, so you can have add/drop multiplexers or very high-speed optical switches or it can be used as a phase shifter in antennas for photonic phased array. And, of course, antennas are one of our main technologies where we're currently getting the majority of our revenues and that's what I'm going to talk about next.

<slide18, slide19, slide20>
We've talked about the fiber optic technology-now I'd like to talk a little bit about our mobile satellite antenna technology which is used for the land mobile market, the marine market, and soon to be the automotive market. What our technology does in the antenna space is-it's a stabilized tracking antenna technology so that we have the ability to integrate with a-take a stationary application like for satellite television or for high-speed Internet and make the system work in a mobile environment. So, we're really opening up the mobile markets. Now we can do that despite the vehicle or vessel motion. And in order to do this you need to be pointed at the satellite with an accuracy of about 1 degree, and if you do that you can have very high-speed data links up to 34 megabits per second KU-Band connectivity. And the way we do that is with robotics, very sophisticated gyro sensors, tracking software in an integrated system. Now, we're also developing phased-array antennas which eliminate the mechanical component but keep the orientation sensors and the tracking software but have no moving parts using electronic beam steering. And again, the applications for this are both for mobile satellite television and mobile high-speed Internet.

Now we've already seen very solid demand for the satellite TV products. You may not know this, but right now TVs are standard equipment on virtually all good-sized boats and all RVs. And once this happened-once the TVs were on board-we saw very rapid adoption of the satellite television. In other words, it sounds obvious, but once the screens were on board people very quickly wanted something to watch on those screens, so we saw very quick adoption of satellite TV technology. Right now, virtually every RV manufacturer in the United States and most of the major boat builders are offering satellite TV technology, and also in terms-so that's at the OEM level. And in the aftermarket, this is now a leading consumer product to equip vessels and vehicles with this technology.

So we've seen demand for the satellite TV, and that same customer group, we're now seeing an emerging demand for mobile broadband-for high-speed connections. And the reason for that is fairly obvious, it is that people-a lot of things that people want on the Internet are-simply can't be delivered through cell phone-type connections. Whether it's a weather map or an MP3 file, you just need to have a higher bandwidth connection. And people have come to expect the same type of connectivity at home that they get when they're on their boats or RVs. So what we're doing is we're trying to focus on the mobile aspect of that. So this chart here is showing bandwidth across the bottom scale going from slow to fast, and mobility here going from fixed to mobile. So there's a lot of high bandwidth solutions, but they're fixed-they're for homes and businesses. And there are a lot of mobile solutions like cell phones, PDAs, which are mobile, but they're narrowband-they're slow. What we're trying to do is to stake out this upper right hand quadrant here which is both highly mobile and very high speed.

<slide 23>
And we've recently made some good progress towards doing that. In October, we announced the first mobile high-speed Internet service that's available throughout North America. We're the exclusive provider of this service in an arrangement with DirectPC and ExpressVu, a satellite provider. And we're addressing this at our existing customer base which is the marine and the land mobile markets providing connectivity-seamless connectivity. And the hardware implementation for that, it's currently a-it's a DVD satellite router, and it has a wireless 802.11 connection so you can be anywhere onboard or near your vehicle and still have broadband connections. So, it's a very exciting product. And what we're seeing for the first time-and it's an important product for KVH because in addition to this hardware sale, we're now offering the service and will be having subscription and recurring revenues from both the Internet service and the actual satellite airtime, so it's a new source of revenue for KVH. And the nice thing about this product implementation is that we've designed it to be backwards compatible with all the antennas that we've ever made for the satellite television market. So the legacy systems are compatible with this, so we have a natural installed base that we can begin offering this service to. And that's a pretty large group of users, because we're currently the dominant player in these two markets.

We've been the market leader for several years now. We estimate that we have about 70% market share in the marine and in the RV markets. We've done that by really continuing to innovate-we have innovating products that we're introducing quickly, and we've been able to displace some entrenched competitors in those markets.

Now we've got a worldwide distribution network, so not just in the United States; we're also compatible to satellite systems in Europe. And that's enabled us to maintain a very consistent growth rate. We've had about a 70% compound annual growth rate for the last five years. It's tapered off a bit in the last year, but we've been able to maintain that growth despite what's going on in the economy.

We've been very successful in these markets, and now we're moving on to a new market which is the automotive market. The backseat video systems are amongst the fastest growing automotive accessories really in the history of the automotive market. It's a tremendous new market opportunity for us. Obviously, there's about 200 million cars on the road today. Seventeen million new cars were built last year, and of those, 5.2 million were minivans and SUVs.

And those two groups were the early adopters for on board video and mobile multimedia. So, this product is really becoming a mainstream . . . Now, the carmakers are using this to sell the cars, and it's not just the minivans and the high-end SUVs like the Mercedes. Starting this year, even Saturn is offering it on their cars which is a relatively low-end vehicle. So, it really is becoming a mainstream product.

In fact, this year all minivans and SUVs sold in the United States are offering some type of on board video. And that's significant because as we saw in the marine and the RV markets, once the screens are on board, there quickly follows a demand for real time programming-live TV programming. Last year, 11% of the minivans that actually shipped had video systems on board. But if you look at certain vehicles, the penetration rates were much higher where they actually offered it--it was 97% of Nissan Quests, 28% of Silhouettes, and 23% of Ford Excursions. These are very large numbers and starting to become a mainstream product. In fact, J. D. Powers has reported that 46% of SUV owners plan to buy a video system on their next vehicle.

Now what does that mean to KVH? Well, if you just look at the minivan and SUV market, if 1% of those vehicles get equipped with satellite TV and Internet, we're talking about over $100 million dollars a year.

So, it's a tremendous opportunity, but in order for us to take advantage of that opportunity, there's a key piece of technology that's missing and that's the product that we're developing right now. It's an ultra low profile, automotive satellite antenna-it's a low cost phased-array antenna. Because right now the only content that's available on these vehicles is prerecorded-VCR or DVD. And yet, it's been proven that people want live programming. In fact, surveys have shown that even in cars where they have a CD player and a cassette player, we have only about-about 70% of the time they are listening to-actually listening to the radio. So, consumers prefer live programming.

Now, what we're doing is we're developing this hybrid phased-array antenna which is a very innovative packaging design. We design a roof rack or a flush mount. We've got some secret spy footage here of one of the early prototypes. This is actually showing the roof rack mount. And you can see that this product integrates well with the vehicle, and it's also designed to be built into the on board video system so it works with the video screens that are on board either from the factory or in the after market. So not only will we be enabling satellite television, but also this will be compatible with our high-speed Internet product, so that if you have this in your vehicle, you could be listening to the Needham conference being webcast as you're driving to the office or if your chauffeur is driving you I should say. Okay. We're very excited about this product. We're looking at a market introduction of summer of this year and we're making great progress on it.

<slide30, slide31>
Let me give you some quick financial overview here. Two thousand and one was a pretty good year for us. We managed to grow the business 10% despite what was going on in the economy. Now this is on our consumer side. We haven't seen any growth yet in the military side of the business-that's really coming this year. So this is really our base business. I think we saw the advantage of being a diversified company in terms of stability and diversification that it gave us. The core business is profitable, we've got a strong balance sheet-over $11 million in cash right now. We've been using that cash to accelerate the R&D on these two projects-the photonics and the mobile broadband.

Q4, we did put out a release this morning, so we can talk a little bit about where we think we're going to end up. Revenues are around $9 million which is a record quarter for us. That's up 14% from last quarter. The base business continues to be solid. Gross margins are improving; net loss has been reduced significantly. We should come in ahead of the estimates that are out there. And also, the thing I'd like to point out is that we're now seeing pretty balanced revenues. In the fourth quarter, we had?about 52% of our revenues came from the satellite, 15% from the optics area, and 33% from the military nav system. So that's just right about where we want to be going forward.

I talked a lot about what we've got in terms of growth opportunities. We do have a management team in place to handle that. We've added some significant talent to manage the new initiatives so we can keep the core business growing and profitable while we pursue these new opportunities. We have the management systems in place in terms of ISO 9000 quality, ERP systems, so we're in very good shape in terms of our ability to execute and produce. We have a proven manufacturing capability. We're actually building optical systems, and we have been for a long time. A lot of optical component startup companies can't say that. The key to building optical components is in the manufacturing, and that's where we have an awful lot of experience. So, we're confident that we can double sales without having any significant investment in infrastructure or additional facilities during the next few years.

So looking forward to 2002, it really promises to be a breakthrough year for KVH. We've got new products, new technology, new markets all coming together at the same time. We're entering the year with a solid backlog in our defense business. We've got new hardware products coming online. We also have these new services which should start to generate revenue during the first quarter of this year which should help accelerate our revenue growth. So, we're looking forward to revenue growth in the 30-40% range-that's our goal and to achieve profitability by the middle of the year.

I think you can see that KVH should be hitting on all cylinders this year, and we've got some exciting projects that could give us a tremendous upside in the photonics area and on the automotive side.

So, I look forward to answering any questions you have in the breakout session. Thanks for your time.
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