This is a great rec. from Canoe money web site...
Initiating Coverage of Kasten Chase Applied Research
Overview
Kasten Chase Applied Research Ltd. (KCA-T) provides data communications solutions, developing mission critical offerings for corporations. The company pursues opportunities in the e-business, wireless data communications and secure remote access markets for governments and large corporations. Its flagship technology, RASP Secure Access, enables users to remotely access secured and classified files from any location. As a result of it being the only solution approved by the National Security Agency (NSA), Kasten Chase's RASP has been adopted by all branches of the U.S. Military, the Department of Defense and the Pentagon. In addition, the solution has been deployed by all nine of the unified commands within the U.S. Military, including Transportation Command, Strategic Command, Space Command, Pacific Command, Joint Forces Command, European Command, Special Operations Command, Southern Command and Central Command. Products and Distribution Strategy
Although its wireless and remote access technologies have numerous applications in many areas, Kasten Chase essentially targets 3 markets:
Secure Remote Access: We believe Kasten Chase enjoys a unique position in this growing but secretive market. According to management, U.S. forces are currently "extensively using RASP Secure Access in major regions of the world, including North America, Europe and the Pacific Rim". From our perspective, the Company's key competitive advantage lies in the NSA approval of its RASP Secure Access technology, as we are aware of no other company with such a clearance. The company is the exclusive provider of the NSA-sanctioned RASP Secure Access solution, with 190 systems deployed.
According to Warren J. Suss Associates of Jenkins, PA, a consulting firm specializing in U.S. government data security, it is still early in the deployment of RASP systems since a large percentage of the total market has yet to be served. However, the sensitive nature of the offered solution makes it difficult for the company to expand internationally. Currently the product is only licensed for Canada, Australia, Great Britain and the U.S.
It is our opinion that non-military interest will expand, although it is likely to first be restricted to the U.S. before going international. Already, the company has deployed the system in the U.S. government's departments of Treasury, Justice and Commerce. We believe RASP Secure Access will attract interest from non-sensitive government agencies as well as large corporations with mission critical requirements. However, we think the company should seek a partner because it is unlikely it can serve the whole market alone, imposing unnecessary strains on its limited financial resources. We believe such a partner could be one of the large U.S. defense contractors, as the U.S. government will certainly have a say in the choice.
Wireless technology: Since the beginning of the year, Springboard Wireless Networks, a wholly owned subsidiary of Kasten Chase, has decided to refocus its wireless networking technology on the areas of Internet access and data security. Data Communications System (DCS) is a wireless device with fully integrated Internet Protocol routing capabilities over fiber-optic backbone networks. This equipment positions the company very well to securely transmit data over the Internet and enables users to remotely access the information. We believe this technology has a great potential in the market for the wireless distribution and access of information over the Web. Furthermore, the Company is moving away from the train business that landed a contract with New York City Transit's Communications-Based Train Control. Kasten Chase intends to capitalize on this new technology by targeting growing markets such as the Internet and data delivery sectors.
Internet access: Kasten Chase's VersaPath enables users to securely conduct e-business transactions, serving as a bridge between host-centric software applications and the Internet. End-to-end encryption and strong authentication capabilities ensure the protection of sensitive data in e-business environments. In our view, one potential opportunity for the company is to target the servers of leading U.S. B2B e-commerce sites such as Ariba or Broadvision. The recent hacker attacks on e-commerce sites in the U.S. raised questions about the security of the transactions conducted online and the reliability of host servers. It is our belief Kasten Chase can capitalize on opportunities in that market.
Recent Achievements
In the past two months the company has made a couple of significant achievements.
On Feb. 2, Kasten Chase announced the availability of KTA (KastenNet Trading Access) MarketBook to provide access to the TSE's Market Book generated from the Toronto Broadcast Feed (TBF). This is a secure and low cost access solution to TBF data via the STAMP-compliant protocol.
On Feb. 11, Kasten Chase announced a $5MM special warrant offering to develop its wireless technology applications and expand sales and marketing initiatives for its VersaPath Internet access product. Each special warrant will be priced at $1.25, carrying a right to acquire one common share and a warrant to acquire one-half of one common share at an exercise price of $1.75 per common share for an exercise period of 6 months from closing. This offering closed on Feb. 24.
On Feb. 14, all branches of the U.S. Military, the Department of Defense and the Pentagon adopted Kasten Chase's RASP Secure Access, ensuring the company has a very strong presence in the U.S. government security market. As well the company announced the largest single sale of RASP Secure Access, involving the sale of 26 RASP Secure Access systems to the U.S. Marine Corps.
On Feb. 25, the U.S. government's National Finance Center (NFC) selected Kasten Chase to implement its VersaPath secure Internet connectivity solution to enable employees to secure Internet access to the NFC's host environment. The NFC provides payroll and accounting services to over 60 U.S. government agencies and departments, with payroll management responsibility for over 600,000 U.S. government employees.
On Feb. 26, Kasten Chase announced an order to supply World Heart Corporation with wireless communications devices for the ongoing trials of WorldHeart's Ventricular Assist Device (VAD) to assist the normal operation of a patient's own heart. KCA's device will reside on the patient to securely transmit the information through wireless connection to a hospital's or doctor's server. It is estimated 12,500 VAD units will be manufactured by 2004 and human trials on are scheduled for the fourth quarter of 2000.
What is RASP Secure Access?
RASP Secure Access is a complete remote access security solution designed to safeguard government mission-critical information. Kasten Chase and the U.S. National Security Agency did the development and testing of the system. RASP may now be used to protect Classified (up to and including the Secret-level) and Sensitive But Unclassified (SBU) data.
RASP Secure Access enables users with secure dial-up connections to local-area-networks (LANs) to remotely access sensitive data. RASP provides user authentication, link encryption and desktop data protection, preventing unauthorized access. As well RASP protects against intercept attacks on data transmitted over public telephone lines. A key component of the system is RASP Secure Media, designed to safeguard the confidentiality and integrity of information stored on a personal computer. Kasten Chase is the single source for RASP Secure Access technology.
More details are available on this system at www.rasp4secret.com.
Applications
Kasten Chase Applied Research has many commercial and governmental applications for its various technologies, including:
Transportation: New York City Transit (NYCT) has already adopted the Company's wireless technology as part of its US$3 billion resignalling project. Kasten Chase will be developing the wireless communications infrastructure for the project. Also KCA's Communications-Based Train Control (CBTC) technology allowed NYCT to achieve interoperability amongst suppliers.
Secure Host Access: IDC estimates the Web-to-Host access market will grow from US$200 MM in 1999 to over US$1 billion in 2002. We believe Kasten Chase is well positioned in this market, with a current installed base of over 50,000 terminals using VersaPath.
Secure Remote Access: It is our belief this is where the company will get most of its resource because it enables to remotely access sensitive data. We believe the NSA approval KCA enjoys constitutes the most significant barrier to entry, one that could take years to crack. The company's RASP technology will provide, support and maintain this service to U.S. military, law enforcement and intelligence agencies.
Competition
We believe the company faces no significant competition in its secure remote access market segment. This should stay the case as long as the National Security Agency does not approve a competing product. For the time being, however, we are not aware of any company seeking such an approval from the NSA. Although many security systems are available on the market, none are really token base. Rather, the vast majority of companies offer software based security products, such as RSA Security (RSA-O) or Certicom Corp. (CIC-T).
On the Internet connectivity front we feel close competitors would include Jacada (JCDA-O) and Pivotal Corp. (), although this company does not offer secure remote access services for e-commerce transactions.
The wireless segment of the market is much more crowded, with potential competition ranging from the likes of Cisco Systems (CSCO-O), Lucent (LU-N), Nortel (NT-T) and Qualcomm (QCOM-O). Other, smaller players in the wireless space include Infowave (IW-T), Metricom (MCOM-O), Proxim (PROX-O), SR Telecom (SRX-T), Waverider () and Wi-Lan (WIN-T). It is our feeling Kasten Chase's distinct competitive advantage lies in its ability to offer secure access on a wireless platform as opposed to just offering wireless Internet access.
Risks and Uncertainties
We believe the Company faces several risks in its different markets.
Market risk: we believe shareholders in the company face significant valuation risks. It is our belief the whole technology sector trades at extremely generous multiples. We believe a market downturn would hurt the company's stock price.
Industry risk: we believe the software industry demands rapid innovations. Industry standards and technologies are evolving and require a very flexible management structure to serve these needs. Frequent new product introduction could hurt Kasten Chase if a company is able to meet NSA demands at a lower cost.
Customer diversification: we believe a dependence on any one single customer would weaken the company. In 1998, revenues decreased 22% compared to 1997 as a result of the loss of Dow Jones Markets, historically the largest customer of the company (22% of revenues in 1998 vs. 54% in 1997). The Company has a real challenge in chasing government contracts, yet maintaining government revenues at a reasonable percentage level of total revenues.
Capital Structure and Ownership
Including the latest two rounds of financings ($5MM in February 00 and $10MM in March 00), the Company has 44.8MM basic shares outstanding. The fully diluted number of shares is 48.8MM. This last figure includes 4.0MM options outstanding, including 2.8MM owned by Temple Ridge and exercisable at $2.23 by July 2001.
The $5MM financing was done in February 2000 through the issue of 4MM warrants exercisable at $1.25 (with one half-warrant exercisable at $1.75), expiring 6 months after the prospectus approval. The $10MM financing is due to close at the end of this month and is comprised of 1.5MM warrants exercisable at $6.75 (with one half-warrant exercisable at $7.75), expiring 18 months after the prospectus approval. We anticipate both prospectuses should be approved around the middle of 2000. Temple Ridge and management each own 25% of the basic shares outstanding, with the rest being in the public float.
Management
Kasten Chase's management can be credited for successfully turning around the business with a new focus on secure data access, Web-to-host connectivity and wireless technology.
Although we cannot single out everybody who deserves credit for these achievements at Kasten Chase, the CEO, CFO and one of the Senior Vice Presidents can be drawn to investors' attention.
Paul N. Hyde, President and CEO. Mr. Hyde joined the Company in 1990. Previously, he was with Nortel as Director of Major Accounts since 1984. Mr. Hyde has been instrumental in executing KCA's strategy into new markets such as web-to-host connectivity, wireless services and secure remote access technology.
Michael J. Milligan, Vice President and CFO. Mr. Milligan joined the Company in July 1996 as Vice President and General Counsel. From July 1986 to January 1996, he was a partner in the law firm of Cunningham, Swan, Carty, Little and Bonham.
Steven J. Ducat, VP Sales and Manager of Secure Access. Mr. Ducat has been with the companies since November 1994. Prior to that, Mr. Ducat was National Sales Director at Bell Canada, where he was employed from 1977. Mr. Ducat has been instrumental in getting RASP Secure Access into various U.S. government agencies.
Financials
During the past 5 years, revenues have decreased from $24.3MM in 1995 to $23.3MM in FY98, despite a peak of $30.4MM in 1996. We anticipate this trend bottomed out last fiscal year. We expect the company revenues to be in the $14-15MM range in FY99, down from $23.3MM in FY98, mainly as a result of the loss two quarters ago of Kasten Chases' largest client: Dow Jones News Agency. We believe the Company has now successfully turned itself around, with revenues anticipated to grow in the 20-25% range in the next three years.
Gross margins should stay above 50% in the period. Since the company is involved in the intelligence industry with the U.S. government as a customer, we expect R&D to stay comfortably above the 30% of revenue-level. For the nine months ending Sep. 30, 1999, the Company lost $11-12MM at the net income level ($0.24 per share). We expect the company to report a $11-12MM loss for the fiscal year ending Dec. 31, 1999. For the year ahead, we expect the company to break-even and then become profitable. We anticipate results for the fiscal year ended Dec. 31, 1999, should be released by the end of the week.
Conclusion and Recommendations
We believe the company is extremely well positioned to achieve its ambition of becoming the leading supplier of secure access solutions. It is our view Kasten Chase's key strength is the approval of its solution by the National Security Agency. Although having the U.S. government as a client is important in terms of revenue stability, it is also a reason for concern to us, as it could account for too high a share of revenues. We believe the company's offering is tremendous, notably bundling the RASP technology with wireless and host-to web connectivity solutions. We are confident the Company can seize the tremendous opportunities arising in the secure access area with major B2B and e-commerce applications in the future.
It is, however, very difficult to have much visibility in such a secretive market, as the values of most --if not all -- contracts cannot be disclosed under U.S. laws. We have a BUY recommendation on the stock and are currently reviewing a target price.
An investment in Kasten Chase may be particularly suited for investors with above-average risk tolerance, who are seeking a potential for capital appreciation and who have diversified investment portfolios. |
