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To: Sector Investor who wrote (1516)10/29/2002 1:19:08 PM
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KVH Q3 CC Transcript part 2:


[21:09] Jim McIlree from C.E, Unterberg, Towbin

Q. Thank you. Pat, you were saying that you are comfortable with 40% revenue growth for the year, I think you said greater than 40%, but, if we just use the 40% number, it would imply a Q4 revenue of about $11 million, which would seem, given your commentary, is somewhat low. Is it low, or, when you say exceed 40% you mean you will really beat 40% revenue growth?
A. Jim, the 40% - exceed 40% was probably a little on the conservative side. We are expecting at this point with the visibility that we have, that the revenue growth that we should experience in the 4th quarter should be approximately 50%.

Q. For the quarter or for the year?
A. For the quarter.
Q. Right. OK thanks very much.

[22:21] Greg Weaver, Kern Capital.

Q. Hi. Nice quarter. Just some questions on the Op-Ex side of things. In light of the revenue ramp, do you foresee your spending levels on R&D and SG&A to remain flat in absolute dollars?
A. If your question is more for the very near term, the answer is we expect operating expenses to stay roughly comparable with the levels they were at in the 3rd quarter. We expect to see a sequential reduction in R&D as alluded to by Martin as a result of scaling back on some of the Photonics efforts, but we also expect to see a sequential increase in SG&A expenses, and that’s driven as much by, the 4th quarter is typically a busy quarter for us, there’s lots of shows going on, and we’re positioning ourselves nationally for the close of the year and also for the start of a good year next year.

And also we will see higher commissions in the 4th quarter as a result of the mix of sales that we’ve got, so as of right now, for the very near term we expect to see operating expenses remain roughly comparable with the 3rd quarter, and then during the course of 2003, our objective is to show some improvement on a percentage of revenue basis across the board in operating expenses.

Q. OK. And on the Gross Margin side of things, what’s the outlook there?
A. Well again, for the very near term, I would say that the outlook for Gross Margin is to expect a fairly comparable number in the 4th quarter with what we experienced in the 3rd quarter. The mix of business is actually going to be quite comparable, and that’s the reason for that. Again, over the course of 2003, our objectives right now are to show some improvement in Gross Margins during the course of the year, driven primarily by just continuing to work product costs, our manufacturing efficiencies and just continuing to work the fixed cost structure.

Q. Do you have an overall business model in terms of where you see yourself a couple of years out?
A. Well, certainly we have the beginnings of one. We are just in the very early stages of putting together our business plan for 2003. It’s probably going to take us another month and a half or so to complete that, but, I think that if you look on a year over year basis right now … [Martin: the Business Model? You know percentages?]

Q. Yeah right, right. You know your goal for Gross margin, your goal for Operating Margin?
A. Right, and that’s what I’m saying. We’re in the process of putting together the plan for next year. Our expectations are, and I’m not in a position to talk in hard numbers, about 2003, but certainly in terms of improvements, we expect to show improvements in operating margins long term, and that’s going to driven essentially across the board with improvements in Gross margin and improvements in Operating expenses.
Q. Right, Thank you

[25:40] Richard Cabot, Amertech Financial Group

Q. First of all congratulations on turning profitable, and I think we all look forward to continued success in this area.
A. Thank you.

Q. My first question would be now we can probably talk about the ABB deal a bit more. First is this an exclusive deal with ABB? Would they be the only ones that you would be selling Current Sensors to?
A. Initially that’s true, and I think that as we go forward, you know the plan is to work with them to integrate it into some new products and into some installations, and it’s really a new technology, so they are going to be pioneering it for us.

Q. OK. And can you elaborate a little bit on what the price per unit would be for this Current Sensor to KVH?
A. Well, we haven’t established the price yet, but we expect that since the technology is almost identical to the parts that are in a Fiber Optic Gyro, we expect that our portion of it would be similar, and our FOGs sell for prices between $1,500 and $3,000 per axis. And in a Current Sensor you have 3 phases, so it’s typically what we call a 3-axis product. They call it a three phase product.
Q. Right.
A. So it would be 3 per.

Q. So that will be an improvement over the current technology for the current sensors that are currently out there?
A. Right. The advantages over the existing technology are that it is much smaller, the existing ones are literally the size of an industrial size refrigerator, and our device is roughly the size of a hockey puck, so it’s a big size advantage, cost advantage, installation cost advantage, and also environmental, the conventional technology is typically an oil filled transformer, and there are a number of advantages in terms of bandwidth, how quickly it responds to a change in current, and accuracy, it’s accurate enough to be used for both protection from lightning strikes or over voltage situations, as well as accurate enough to do metering, so it can perform several functions at once, and of course the device is digital, whereas the existing technology merely outputs electricity at a lower voltage, our device outputs a digital message that tells them the current measured in Amps, and are accurate to a couple hundred parts per million, so it’s a big difference in technology.

And, getting back to your first question in terms of exclusivity, we really see that as an advantage in the short term because it allows us to penetrate a market without expanding our sales force, or trying to understand a market that we really know nothing about, so I think it’s a Win-Win situation for both companies.

Q. When do you expect that you will begin the first shipments of actual revenue product?
A. Well, we have been shipping a modest number of systems already, which are being used in actual customer installations. They’ve already sold some to paying customers, but in terms of significant revenue, I would expect that would be sometime in 2003.

Q. OK. And in terms of what’s the potential with ABB, how many units a year do they currently sell of their existing technology, in terms of what you might ultimately be replacing?
A. I don’t know their exact numbers. I’ve seen market figures for the entire market for Current transformers and that’s in dollars is on the order of $500 million per year today.

Q. OK. And certainly at this point you would be the leader in the new technology, my research, one or two companies out there that are coming out with such a product, because it doesn’t look like there are more than a handful of potential competitors here.
A. That’s right. I think there is one or two players, and I think one or two of those are startups, so I think it’s a good new market for us.

Q. My second question would be, could you elaborate a little bit on the L-3 deal. What products you are currently putting together, I know its Defense so you might not be able to talk too much about it.
A. Yeah, I really can’t talk too much about it beyond what they’ve agreed to say about it, mainly that we are working with them to develop a new, miniaturized 3-axis version of our product, and it’s based on our new DSP based technology, which by the way we just got a patent on, so it’s basically a more accurate, smaller version of the products we are making today, and the main difference is it’s a 3-axis product, so it’s one circuit board and three sensors.

Q. Would this be potentially the type of product that might be used for a second source for the smart bomb program.
A. Yes. That’s exactly what these products are targeted for, no pun intended.

Q. Right. And I know that Boeing has been winning contracts there, but you had mentioned that there might be need for a second source next year.
A. That particular program is a huge program, and they currently do have only a single source, but I have not heard officially that they are looking for a second source.

Q. OK. And my last question for right now would be, in the past we’ve talked about the Force XXI Battle Command Brigade as a potential large contract. Is there any updates on that?
A. No updates. I think there’s more money in the Defense budget. We’ve seen the draft Defense bill, but it hasn’t been signed yet by the President, so I think there’s money in the budget for ’03 for that program, so that continues to be a real program that we are chasing.
Q. OK. Thank you.

[32:36] Pierre Maccagno, Needham & Co.

Q. Nice quarter.
A. Thank you.

Q. Tell me, the TACNAV order for $3.6 million, when do you expect to see sales from that?
A. Well we’ve already shipped some of that in Q3, and we should ship the balance in Q4, probably

Q. OK. And in your Navigation, could you give some color, was it driven by foreign or domestic sales mostly?
A. In the TACNAV area? [Yeah] Yes. I would say this quarter was probably more domestic [OK] than usual. With the U.S. Army Special Forces, and we did have some foreign military in there so, … I don’t have the exact split. [OK] But I think going forward we’re seeing a little bit of a swing towards the domestic military, as you might expect. So, whereas in the past we did a lot of foreign military sales, we’re seeing more of the growth in the near term coming from the U.S. [OK] Which actually is a little bit of a good thing for us because it’s a bit more predictable in terms of the timing to get your arms around.

Q. OK. And the backlog that you have now?
A. For military? [yeah]. I’ll let Pat speak to that one. [Pat:] The backlog for military right now Pierre, is approximately $6.3 million.

Q. OK. So it’s grown from the last quarter, which was $4.3 million?
A. That’s right. You are absolutely right.

Q. And that’s your only backlog, or do you have backlog for other products?
A. There is other backlog. We have some backlog in FOGs. We have a little bit of backlog in satellite communications products, but, as you know generally the satellite communications products are pretty rapid turnaround from the time we receive an order to the time that we ship it.

Q. OK. So your total backlog would be, what?
A. Total backlog right now is a bit in excess of $7 million, approaching $7.5 million.

Q. OK. What about your low-profile antenna? When do you think you are really going to start selling that product?
A. I can’t tell you the exact date, really for two reasons. One, for competitive reasons. This will be a major product announcement for us, so I don’t want to be too specific, for competitive reasons. And the second reason is, the product is still in R&D and isn’t finished yet, and until it’s finished there is always risk in terms of schedule, so we really don’t have a firm ship date established yet. But we are continuing to make good progress. We made a lot of progress during the current quarter, and we remain confident that that’s going to be a major product for us.

Q. OK. And did you continue working on the ultra shallow antenna?
A. Yes. Yes.
Q. OK. And for that you still need to continue doing R&D on your fiber optics, correct, because you …
A. That’s right. Photonics as a very high frequency phase shifter is a very exciting technology, and also the PhotonicFiber as a component. Now as you know, all of our optical gyros use modulators today. It’s part of the product. So, there’s an opportunity to take advantage of the work we’ve done in the PhotonicFiber area to use it as a optical modulator in our gyros, and also as a light source for our gyros, an optical amplifier, so there is a lot of technology that is coming out of that, including there is some improved production techniques that we might be able to use to speed the production, and to reduce the component cost of our optical sensors, so you are absolutely right, there is some key technology in there that we are going to need for other products in the short term.

Q. The fact that you are reducing your R&D for that, I mean, does that have any implication on when that ultra shallow antenna will be developed?
A. Well, I think that yes, of course that reducing the R&D does have some impact on schedules, but, what we’ve done as Pat pointed out, is we’ve reduced primarily the work we’ve been doing outside of KVH with various consultants and Universities and paid Engineers, so we are paying the staff internally, so that we are able to continue to do the things that we want, and primarily we are slowing down the products for the optical telecom market, because we just don’t see any near term profitable revenue opportunities there. So that’s really where the slowdown is coming. In fact we are directing more of our resources towards the products we just talked about.

Q. OK. And, in terms of the satellite, what percent of the revenues there was from Marine?
A. Uh, I don’t have that figure handy. Roughly 60% of the revenues are coming from the satellite area. I don’t have the exact split. [Pat:] The approximate split Pierre, between Marine and land based satellite communications products is roughly 47% Marine, and the difference is land based. That percentage, that’s worldwide. The percentages of Marine are a little bit lower in the U.S. and a little bit higher for the land based, and that’s understandable because we don’t do nearly the kind of land based business in Europe.

Q. So you have kind of this typical result that you’ve had, or has the Marine kind of increased here?
A. [Martin:] That’s kind of typical of where we’ve been. The Marine products are lower in total units but higher dollars, and we have also two way products in the Marine market for satellite phones, the Inmarsat products, and really those aren’t sold in the land market, because it’s not needed, so the off shore satellite and data products are only Marine products. [OK] [Pat} And let me also clarify something or correct something that I said earlier Pierre, I mentioned that our backlog is roughly, in total $7.5 million. I actually understated that. I didn’t add in another item that I overlooked. It’s closer to 8 million, in terms of our total backlog, $6.3 of which is military.

Q. OK. And last quarter was how much?
A. Last quarter? [yeah] Last quarter was in the low 7s, so the backlog has increased on a sequential basis, by close to a million dollars.

Q. OK. And finally you mentioned that you are selling to 8 OEMs for satellite antennas. Could you just remind me what those OEMs are?
A. [Martin:] I don’t have the exact list in front of me. We haven’t announced all of the 8, so, but the big ones are Fleetwood and Monaco, and they are probably tied for the top spot. [OK] I can put that list together for you, if you like.

Q. OK. Well thanks Martin, it’s been great, and we’ll talk soon.
A. OK. Thanks Pierre.

[41:00] Follow up question from Greg Weaver.

Q. Just following up on the satellite side? You mentioned the mix between Marine and land based had been consistent, and that surprises me in light of the ramping you’ve had on the RV side?
A. Right. Well as I mentioned, we’ve introduced a bunch of new products on the Marine side that are only sold in the Marine, so if you look at the satellite television market, the mix would be very different, and it would be skewed more in the way that you would expect. But we do sell the Inmarsat products only in the Marine side and a lot of the Mobile Broadband products are sold more in the Marine than in the land, so I think that might be where the confusion is coming from.

Q. OK. And do you have a sense of the inventory at these RV OEMs of your product?
A. Yes. We have very good visibility into that. We have a very close relationship with our customers, so we’re very much on top of their inventory positions. We know that they are not buying too much. If that’s your question.

Q. Right. And do you have a sense, from the land based satellite business, how that breaks between the OEM and the aftermarket?
A. I don’t have the split. If I were to hazard a guess I would say it is still 60-40 with the after market being larger than the OEM. And the other thing to keep in mind in terms of the split between RV and Marine, is we’ve been in the Marine business longer than we’ve been in the RV business, so it’s actually quite an accomplishment for the RV side to be as big as the Marine is already.

Q. In terms of your incremental growth on the satellite side though going forward, would you think that the majority of that is going to come from the RV guys?
A. I think the growth rate there is clearly faster. But even so, the Marine market grew 48% this year over last year so it’s grown quickly as well.

Q. And lastly on the low profile antenna, you mentioned you didn’t want to be more specific on the release due to competitive reasons? Who else might have a competing product there?
A. Well, number one we don’t really know what our competitors are planning. A lot of our competitors are private companies, so we’re at a bit of a competitive disadvantage in that we disclose quite a bit more than they do. But I don’t have any specific knowledge of their introduction times, or even if they are planning to do a competitive product, but we just don’t want to tip our hand too much.

Q. OK. So you haven’t seen anything out there, but you’re just being cautious.
A. Correct.
Q. Right. Thank you.

[44:26] Follow up question by Jim McIlree

Q. Thank you. After the Special Ops contract is filled and it sounds like it is going to be filled in the December quarter? Did I hear that correctly? [Yes.] Or 2/3 of it will be filled.
A. No I think the initial phase will be filled, not the entire $10 million opportunity.

Q. I see. So do you need then to get funded again to get to that $10 million, or, what’s the process between phase one and however many phases there are?
A. Typically in a military program like this they establish the program, and during that they identify which vehicles, establish the price and how many vehicles they are going to buy, and then as they get funding, you get actual purchase orders or contracts in the military so, this is very standard, just the way it happens in the military. We actually got the order during the government’s fiscal ’02 year, and now we are in fiscal ’03, so they would have additional funds in ’03, and when those get allocated, we would see additional orders. But it is of course dependent on funding.

Q. OK. All right. So I guess what I’m really trying to get at is, do you face the potential in 2003 of this gap in revenues because this or other contracts either don’t have the funding or waiting for the President’s signature or something like that that can cause some temporary declines in Defense revenues?
A. That’s always a risk. One of the disadvantages of military business is that it can be difficult to predict, and it can be somewhat lumpy. But, what we are seeing now is that our overall business is growing. We have a larger number of customers and a larger number of programs, and actually having a program like this established in general reduces your risk, because now you’re into the paperwork process, so it tends to be somewhat more predictable, rather than less predictable. In other words, in the stage we’re at now with the Special Forces.

Q. Right. OK. Great.
A. [Pat] Jim, may I interrupt? I’m glad you’re back on the line because you asked a question earlier, I just want to clarify something about operating expenses, and I gave you an answer going forward in the 4th quarter? I think it was you who asked in any case.
Q. No, but go ahead and correct me anyway.
A. I apologize. Then I forget who did. I had mentioned that we expected operating expenses in the 4th quarter to be roughly comparable with the 3rd quarter, and I meant that on a percentage of revenue basis, so I just wanted to make that clarification.

Q. OK. Yeah. I’m glad you said that because in 2003 I think you said that as a percent of revenues, operating expenses are expected to fall, versus 2002
A. We expect to see a decline in 2003, that’s correct, versus 2002.

Q. As a percent of revenues, but still up in absolute dollars.
A. Yes.

Q. OK. On the top line in 2003, I guess it would be optimistic to think that you could continue this 50%+ revenue growth. What’s more reasonable? Is 20% more reasonable? Is 30% reasonable? Is it more like a single digit reasonable? And I know, you know, ranges are fine if you are unwilling to pinpoint numbers.
A. Right. Well, you’re right. It’s hard at this time to really project ourselves that clearly into 2003, and, as Martin mentioned, the unevenness of the military business is one of the biggest unknowns that we have. I’ll give you a number and then I’ll want to give a little bit of explanation, or I’ll give you a range.

Right now we are looking at a range of 20%-30%, that we see as being very doable, in terms of revenue growth on a year over year basis, 2003 compared to 2002. Now a couple of factors that make 2003 a very tough year on a comparison basis, you know we’ve had a VERY strong ramp up this year on our land based RV business, the OEMs and this was really the first full year we’ve had of that business.

We’ve grown dramatically as everyone knows, and consequently next year is going to be a tougher comparable, because we’ll have that base of business especially as we enter the second half of next year. The other thing is our military business this year is going to wind up being close to 100% year over year, 2002 compared to 2001. You know we’re looking at the military business, as you know a lot of uncertainty at this point, but certainly we’re not going to see growth rates like that. It could be that the absolute revenue could be comparable with this year, as opposed to up in any significant way. So when you put all that together, it certainly says to us that, from a planning perspective we’re thinking in terms more of 20%-30%.

Q. And Pat, I think on the military you said that it’s possible that the military growth rate would be the same but you meant the absolute dollar revenues, right?
A. Yes. I meant the absolute dollars. I did not mean the growth rate. In fact I was trying to be clear that the 100% growth rate we saw THIS year, 2002 compared to 2001, we will certainly not see again next year.

Q. Right, right. I just wanted to make sure on that. OK. Very good. Is it possible that ’03 sees a significant, and by that I mean greater than 5% of total revenues, significant amount of the service based revenues that you are trying to develop, or is it still too early for that?
A. I think it’s, uh, you know the nice thing about the service revenue is that it starts to compound, in other words, the more products you sell, as long as you don’t have any churn – and our expectation is we won’t have any churn because it’s a significant hardware investment. You know, we’ll see those subscribers continue to grow. We haven’t done a forecast for our service revenues, but I think something on the order of 5% might be achievable for service revenues, but we’ll see.

Q. OK. Great. Thank you.

[51:35] Richard Cabot follow-up.

Q. As we all know that follow the company closely, we’ve had to sacrifice, and intelligently so, profits to build the R&D program up to get the new products developed, and you have said that, obviously R&D will start declining, the first sequential decline this quarter, going out to next year, and possibly the year after, would a more reasonable percent of sales for R&D be like 12%, or is that too low?
A. I think that’s certainly within our long term target of where we would like to get to as a reasonable number, and it really depends on the ramp in sales because obviously that’s a percentage, but the R&D expenses in reality are relatively fixed quarter to quarter, so the changes as a percentage of sales are driven more by the growth in revenues than by the increase or decline in the R&D number. But, to answer your question, I think 12% is a reasonable objective.

Q. OK. Thank you.

A. [53:00] [Pat] Well let me if I may interject to follow up on that question about R&D, and we were asked an earlier question about our long term operating model, which as I said we are in the process of putting together, and we are going to refine it as we put together our 2003 plan, but, as martin just said, R&D expenses of roughly 12% is certainly a fair target out in time. SG&A expenses in the mid 20s is certainly a fair target for us, potentially even a little better, and we’re looking at the opportunity, potentially to be able to achieve operating margins that are 10% or better. What we can’t determine, or that we can’t indicate at this time, or can’t say at this time because we are still putting the business model together in the plans for next year, is exactly over what period of time we may be able to achieve those numbers, but certainly that’s the direction we are heading.

[54:03] Jim McIlree

Q. Well I think this is going to be my last one. What do you expect on taxes in 2003, still nothing, or is there going to be a nominal tax payment?
A. It really depends in some part, in some measure on the mix of profits between the U.S. and Europe, but, right now I think a fair assumption is that we will not have to pay any taxes in 2003.
Q. OK Thank you.

[54:40] David Loreber with Stanton Capital Management.

Q. Hello Martin, Pat. Actually it’s Peter Dale. Good morning gentlemen. Martin, at the risk of beating this issue to death here with regards to the low profile antenna rollout, would it be fair to say Martin that you will be prepared to have the product available for the important show that is coming in January?
A. Well, I think that this point I don’t want to put any more detail on what I’ve already said, partly it’s because I don’t want to say, and partly it’s because I don’t know. As I’ve said, the product is not finished yet, we don’t have a firm release date, and typically we don’t like to show a product too far in advance of actually shipping the product, so those are all of the things that are going through our mind in terms of when we actually do the announcement. We typically like to have no more than a couple months between showing it and delivering it.
Q. Thank you Martin. [Sorry Peter].

End of Q&A.

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