KVH Needham Growth Conference 2003 presentation, January 8, 2003
Pierre Maccagno, Needham
… KVH presentation. It is a company we like very much, especially since the announcement of the low-profile satellite antenna, and that drove the stock quite a bit last Monday. So I have the pleasure of introducing Martin Kits Van Heyningen, the CEO of the company, who will be giving the presentation. And afterwards we have a breakout session in the Campo room. Thanks.
[Martin Kits Van Heyningen] Thanks Pierre,
You know, the one problem with the Needham conference is that it’s so early in the year; whatever we say here ends up being like our New Year’s resolutions. And as part of preparing for this year’s conference, I went back and looked at what we said here last year, and we talk about growing the business 30-40%, doubling our military business, introducing some new products, and developing technology and getting back to profitability. I’m pretty pleased to say that we actually did all those things. That despite the economy, we’ve been able to grow and prosper, and do pretty much what we said we were going to do.
So, I’m going to start with a little bit of an overview, high-level. KVH is an established company. We have two different technologies that we are focused on, fiber optics and mobile satellite antennas. We’ve been able to grow the business, actually in excess of our targets for last year, we grew about 45% overall. At the same time we reached breakeven about mid-year, and we have improving profitability. I think the company has demonstrated an ability to act successfully over the last year. That’s really evidenced by the fact that we are able to be the market leader in two different areas, one is the Defense market for tactical navigation systems, and the second is the mobile satellite area, for mobile satellite communications.
Now within both of those markets we are pursuing some very large opportunities, these are multi-billion dollar opportunities, so the company has significant growth potential in both sectors. And perhaps the most exciting thing that Pierre just alluded to, is that we have just announced that tomorrow at CES we will be introducing a revolutionary new product, which is a satellite antenna for cars and automotive products.
So the company addresses two markets, the Defense and Communications market, and within each of those markets we have two different technologies. We have the fiber optic and digital sensor technology including the digital compasses, and mobile satellite antennas for the communications market.
Given all that’s going on in the world, I thought I’d start with our Defense market. It represents about 30% of our business today on an annual basis. What we do is we provide our tactical navigation systems for vehicles within this market. As you know, the military’s role is evolving and changing quite a bit. It is now much more focused on rapid deployment, on high speed precision maneuvers, and a much greater use of Special Forces, a much more tactical type of military operation. And that’s exactly what our products do, these are tactical navigation devices that provide precision navigation, heading and pointing, essentially situational awareness for the troops. It is based on our digital compass technology, as well as our fiber optic gyros – a very cost effective solution for military NAV systems.
But perhaps the most important aspect of our product, is that it is completely self-contained, and it is jam-proof. Many of you have probably heard that the Iraqis have been buying these Russian made GPS jammers, so that they are able to now jam the GPS signals for a radius of 100 miles or more, with a device that costs about $100. This is a major concern to the military of course, and that’s one of the big benefits of our product, that it cannot be jammed. The market itself is fairly large for military vehicles. For what we consider to be our target market there are about 450,000 vehicles, and that includes Hum-vees and Light Armored vehicles, and we are actually a leading supplier in that market, as we’ve pioneered that whole concept of putting NAV systems on vehicles, which we did during Desert Storm, we were the first company to build NAV systems for Light Armored Vehicles.
As a result of that, we still are the market leader. We’ve installed about 8,000 systems so far, that’s roughly $80 million worth of product, so the penetration rates are still very low, and we are at the early stage of the adoption curve with this technology. Just recently we’ve gotten some major contract awards, which are fairly significant. In September, we were awarded the contract for our Special Forces vehicles, all their Hum-vees and light trucks are going to be equipped with our equipment, our NAV system.
As you know the U.S. military around the world is highly regarded, and people look to see what the U.S. military is buying, and within the military the Special Forces has by far the most prestigious group, so it’s a very important win for us, and we are very proud to be on those vehicles as they head over to the Middle East. Also, just yesterday we announced a couple of other contracts, the UK army – again this was an urgent operational requirement – we have to deliver all this equipment very quickly for those vehicles that are going overseas, and we also got contracts from the Marine Corps and the government of Saudi Arabia. A lot of business is happening right now in this area for KVH.
The technology that we are using here in our NAV systems is based on our Fiber Optic Gyros, but we also use these gyros for other applications and we sell the gyros separately, as a stand-alone sensor. Now these fiber optic gyros actually measure rotation rate very precisely. They are accurate enough that, if you put them on your desk, you’ll measure the rotation rate of the Earth, so they are very, very accurate. And they are used as a replacement for mechanical gyros, and they are also now much more accurate than the Micro Machine technology, or the MEMS technology.
And the reason that’s important is that the applications for fiber-optic gyros in what’s called IMUs or Inertial Measurement Units, is expanding. – drones, unmanned aircraft, and of course in missiles, and now Smart Bombs. All of these things require guidance. During Desert Storm 10 years ago, 90% of the bombs that were dropped were unguided, free-fall dumb bombs. This time around, it’s estimated that 80%-90% of the weapons will be smart – will be guided weapons, and those require three gyros per device.
Not too long ago, they would take a 2,000 pound bomb, and if you got it anywhere within a city block, you would wipe out the entire block. Now they want to be much more strategic, with a far higher level of precision, and that precision gets translated into a greater accuracy requirement for the sensing device. Now something that we are working on, just in the last year we got a $1 million development contract from L-3 Communications to integrate our fiber-optic gyros into one of these very high precision devices. It’s a very large market, it’s a growing market, and we estimate that it’s probably about a $2.7 billion addressable market just for our fiber-optic gyro technology.
Overall, if you look at our Defense business, the addressable market then, between the vehicles and the fiber-optic gyros, smart munitions type applications is about a $7 billion addressable market. In terms of overall trends, obviously Defense budgets are going up, but even within that, you may have heard Rumsfeld say yesterday that more money again is being allocated to Special Forces so the types of fast response groups, that use our equipment are getting more and more money as well, so that’s a good trend that helps our type of products.
And of course the focus on smart weapons and precision, that trend is important from a technology point of view, because if you think about the problem of strategically taking out one particular building where the bad guys are, in order to do that you need to very accurately designate where these targets are. That translates into better accuracy requirements for the vehicle, so that you know YOUR position, so that when you point to a target with your laser, you are accurately able to designate. So it’s driving demand for tactical navigation, as well as for the guidance system that’s in the munitions.
So, overall the military channel has been relatively good to us in the last year, our business has more than doubled. The military channel is a profitable channel for us, but it also provides good balance for the company, in that we have part of our business that’s not dependent on the current economic conditions. We’ve got some good backlog going into 2003, and we see significant upside in this part of our business, although we certainly don’t expect 100% growth like we had last year.
Now the technology that underlies these products, our fiber-optic technology is not just a military technology. There are a lot of applications here. We have a very unique technology base. We’ve got over 80 patents now that have been issued and that are pending. We have a state of the art fiber-optic facility where we make our own fiber. We make all the components that go into these optical systems. There are a lot of exciting new opportunities. Just last year we signed a contract with the ABB group to develop an optical Current Sensor which is based on our fiber-optic gyro technology, but uses a different kind of sensing coil, and a different type of fiber, and it measures electrical current in high voltage power lines. Today this is about a $500 million market a year, for high voltage current sensing, so we see that as a very exciting opportunity.
On the technology side we are also developing some interesting products based on the optical fiber itself. We have a project we call PhotonicFiber where we’re putting electro-optic polymers actually inside the fiber to make the fiber an active fiber to make optical components. Originally this was targeted towards something called the telecom market, which we haven’t been able to find recently, so instead we’ve redirected a lot of that effort in the sensing market. Just recently we got a contract from the Department of Defense to build a high-speed optical modulator in the fiber for a defense application. Also this technology can be used as a phase shifter for a photonic phased-array antenna. Of course antennas are very important to KVH, because that’s where a large portion of a business comes from today.
So the second part of our business, we’ve covered Defense now and I’ll move on to Communications, our Mobile Satellite business. On the satellite side, KVH really has an enabling technology. What we do is we allow mobile customers to receive the same type of services while they’re mobile, that they can get at home. The same broadband Internet, the same digital satellite quality television. Our antennas accurately track the satellites despite the motion of the vessel or the vehicle, giving it full video and broadband capability.
That’s actually a pretty challenging problem because you need to be pointed at the satellite to within 1 degree at all times, whether you are a boat rolling and pitching in 12 foot seas, or on an RV driving down the highway and making sharp turns. In order to do that you need a number of different technologies. It’s a software/hardware problem, you have fiber-optic gyros, robotics, antennas, antenna technology including phased-array antenna technology, and RF technology. So it’s a very difficult problem, and you have to integrate that with the satellite itself and the satellite services to make sure you are decoding the correct M-PEG II data streams from the correct satellite. So it’s a surprisingly difficult problem, that we’ve been able to solve. One of the advantages, I think it gives us some significant barriers to entry, and it has dramatically limited the competition in most of the markets that we are in.
On the demand side, we’ve seen a very, very strong demand for satellite television in the markets we are in now. The television screens are already on board just about every boat over 40 feet, and just about every motor home and RV, so the TV screens are there, and once the screens were there we saw a very rapid adoption of our technology. People wanted something to watch on those screens once they had the TVs onboard. Satellite TV as a product category in these mobile markets is now a leading after-market product, and at the OEM level, really every RV manufacturer and every boat builder is now offering some type of satellite television. So it’s becoming much more of a mainstream product.
We’re also seeing emerging demand for satellite high speed Internet. Those same customers that now have our product, we’ve introduced a product called TracNet, which will provide high speed Internet service. And this uses the same satellite antenna, the television antenna that our TracVision product uses. It’s an integrated server, router, and it has a 802.11 Wi-Fi connection to the laptop, so if you think about it, this is like having a roving 300 foot Wi-Fi hotspot that just travels around you wherever you go. So if you stop for lunch and you go into a restaurant, if you’re within 300 feet of your vehicle you can have a broadband connection.
Now we’re doing this though an exclusive partnership with DirecPC. We are the only mobile service provider for this capability, and today we are providing this for both the land market, the RV market, as well as the Marine market. And this is an important step for KVH because this is the first time that we are an actual service provider in addition to selling the hardware, so we have a recurring revenue stream from the airtime, from the minutes and from the connectivity as well as from selling the hardware.
Now, in the markets we’re in we’ve managed to become a dominant player in the satellite markets. We have accelerating growth in these markets, we’re estimating our 2002 revenues in the satellite segment will be up about 45% year over year. We’ve got about a 75% market share in both the RV market and the Marine market, so we’ve seen very solid growth there, and that’s really come from two areas, one is a very solid distribution channel in the after market, so we’re selling to retail and distributors and dealers, and we also are now for the first time, starting in June of last year, Fleetwood was our first major RV OEM. We’re now selling directly to the vehicle manufacturers. We are now selling to eight of the top ten OEMs, who are selling our satellite TV systems and our Internet systems, directly at the factory as standard equipment or optional equipment.
So we’ve done a good job in the markets that we are in. We’ve shown our ability to enter new markets, and to execute and grow the business, and now we’re expanding into a major new market, which is the automotive market. Back seat video systems are THE fastest growing automotive accessory. This is a tremendous new market for KVH. Obviously there are a lot more cars on the road than there are boats. In the U.S. there are 200 million registered vehicles, and roughly 16 or 17 million new cars built every year. Last year over a million automotive back seat video systems were installed, so this is now no longer a niche market or a specialty product, this is becoming a mainstream product. Not just for SUVs or minivans, but for the automotive market in general, you’re seeing it installed in a wide variety of cars.
This year, all 2003 minivans and SUVs will be offering video, either as standard equipment or as a factory option. Last year, actually 16% of the minivans sold, were sold with the back seat video systems, a very, very rapid adoption. We’re now seeing some very significant numbers, and in some classes of vehicles, those penetration rates are even higher, 31% of Ford Expeditions, 96% of Nissan Quests, 30% of Ford Windstars, so those are real, serious numbers. In fact J.D. Powers and Associates expects this to continue. Their research has shown that 49% of full size SUV owners want video in their next vehicle.
So, if we look at what we think the early adopters are going to be for this technology, is really the minivan market and the SUV market. And within that segment, if you forget the installed base and just look at new construction, you’re still talking about 5 million vehicles a year in that category, and for us, a 1% share of that sub-segment of new vehicles represents a $100 million a year opportunity.
So the main thing that we are doing here is banking on the fact that consumers prefer live programming. Now today, those TV screens, the only thing you can watch on them are pre-recorded media, which is videotapes or DVDs. Research has shown that people, in their cars, even if they have an MP-3 player and a CD player, 70% of the time they listen to the radio. And that’s just because consumers prefer live content, they like the feeling of having real-time information and real-time entertainment.
So, why is it then that people don’t have the capability to have satellite television? And the answer is simply that it hasn’t been done before, that it could not be done technologically. So we’ve spent the last two years applying our in-motion satellite technology and our antenna expertise to the problem of trying to make an antenna that’s attractive enough – you can see it on the top of this small Toyota SUV here, and low cost enough to be affordable for this market.
And that’s the product that we will be introducing tomorrow, it’s the product we’re calling the TracVision A5, “A” for Automotive antenna system, and this really a revolutionary product, it’s a hybrid phased array, a patent pending design. It’s a little difficult to see in the picture here, but there’s hundreds of elements here that are all linked together, tiny sensing cells that are connected via wave guides, the antenna is only about 1 inch thick itself, and it has an electro-magnetic lens that steers the beam.
So the benefit is that the antenna is very flat, and the innovation is that it works in motion and that it is relatively low cost. In terms of what it gives you it provides 300 channels of digital quality satellite television, and you get the 50 music channels that DirecTV and DISH network offer for free as well, so it comes with the television programming.
The product is designed to be very easy to install, it clips onto a roof rack, plugs directly into an existing video system, and we’ve architected it so that it is compatible with our high speed Internet product. We have a growth path here to introduce our TracNet type services to the automotive market using the same antenna. That will be a follow-on product.
So our strategy here really is similar to what we did when we entered the RV market, which was only 2 or 3 years ago, and that is, as I mentioned we are introducing it on Thursday at the Consumer Electronics Show in Las Vegas. The product will be delivered towards the end of the second quarter, and really we have the same introduction strategy that we have used effectively in other markets. The initial distribution will be through after market dealers and distributors.
We have already established a dedicated distribution channel for this product, and at the same time we will be pursuing the vehicle manufacturers in parallel. And that is something, you know, we can’t really push that rope, and we don’t expect to be selling to the vehicle manufacturers as the first customer. As the demand comes from their customers and we’ve proven the demand in the market, then we expect to get the OEMs.
One point I’d also like to make here is that what we won’t be doing is building any infrastructure. This product, unlike satellite radio, does not require building satellites, buying spectrum, launching satellites, or setting up a broadcast center. So all of that infrastructure already exists. We’re simply piggybacking off of all the satellite networks that are already in place and cover all of the United States today.
[audience question on pricing]. The pricing will be somewhere between $2,000 and $2,500, MSRP.
In terms of the infrastructure for what we’ve got in place, we see a lot of growth opportunities for the company, and what we’ve done over the last year is put a very experienced management team in place. We’ve made some key additions. We’ve added a new CFO in the last six months, so we’ve got a very strong management team, we’ve got a proven manufacturing capability, and we’ve been able to double our unit volumes very successfully and grow the business. We’ve got state of the art management systems in place, so we really feel that we have laid the groundwork to grow the business.
A couple of quick financial highlights, we did pre-release our top line and EPS estimates yesterday for Q4. It was a record for us, record quarterly revenue of roughly $13 million, that’s up 48% from a year ago. EPS was positive, it was in line with Needham analyst estimates, to around three cents, and that compares to a loss of about 11 cents a year ago.
For the full year, revenues were up about 45%. As I mentioned, we returned to profitability at mid-year and we have continued, and that’s really important that we have been able to do that, despite the fact that we are spending, for the last couple of years, about 20% on R&D, so before these new products have even come to market, we are above breakeven now, so this is an incremental revenue opportunity.
I think it is also a good validation for our distribution strategy, and the diverse market approach where we have a balance of consumer and defense business.
So to summarize the company, we’ve just finished a breakout year, solid revenue growth despite what happened in the economy, 45% increase, we returned to profitability, we made VERY SIGNIFICANT technological breakthroughs and technology developments.
In our core business we’ve got a couple of good market trends that are helping us, one is the increase in defense spending, the second is the growth in the RV market itself, the vehicle sales for RVs are increasing. So we think right now KVH represents a unique opportunity because the base business is growing, we’ve got improving profitability, we’re launching a breakthrough product, so I think we’ve got some significant upside potential, not just for 2003, but for the years beyond that as well.
Thank you very much.
Brief Q&A before moving to breakout room.
Q. Does this $2,000 to $2,500 include programming?
A. No. The programming is sold separately. We’ll do the activations as we do now, so it will be provided by us through the TV provider, so we’ll handle the actual activation for the consumer.
Q. Then the $2,500 includes the receiver as well?
A. In terms of the installed product you can either use one of our receivers … One second I’ll get that – [audio cut off] |
