Aware Inc (AWRE) 2002 Q2 法說會逐字稿

Good day everyone and welcome to this Aware, Inc. second quarter 2002 earnings conference call. Today's call is being recorded. At this time I would like to turn the call over to Mr. Richard Moberg, chief financial officer, for opening remarks. Please go ahead, sir.

Welcome to Aware's second quarter conference call. I'm Richard Moberg, the company CFO. And with me is Michael Tzannes, Aware CEO. Thank you for joining us today. The agenda for the call will be as follows. I'll review financial results for the quarter. Next Michael will talk about the big picture, and finally we'll take questions. A recording of this call will be available on our website at Aware.COM after the call is completed. First I'd like to point out that various remarks that we may make about future expectations, planning and prospects for the company in the DSL market constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those discussed in the section titled risk factors in our quarterly report on form 10-Q for the quarter ended March 31st, 2002, which is on file with the SEC. Now turning to results for the quarter. Q2 results were in line with the guidance we provided in April. Second quarter revenue was four million dollars which resulted in a loss of nine cents per share. Last year in Q2 revenue was four million dollars and we broke even. Royalty revenue was $759,000 this quarter which compares to 476,000 last quarter and 1.1 million in last year's second quarter. Contract revenue was 2.2 million this quarter which compares to 2.1 million last quarter and 2.2 million a year ago. The sequential increase came from business with existing customers. Product revenue was 1.1 million this quarter which compares to 1 million last quarter and $687,000 a year ago. The increase over last year is mostly due to compression software sales and sales of ADSL development systems and specialized ADSL modules. For the quarter we had three ten-percent semiconductor customers, Analog Devices, Infineon, and Intel. These three customers accounted for 65 percent of our revenue this quarter . Q2 spending was 6.4 million which compares to 6.4 million last quarter and 5.7 in last year's second quarter. The Q2 spending increase over last year is mostly due to spending on engineering. Our balance sheet remains strong. Cash investments were 52 million dollars at the end of June. Receivables were 2.6 million at the end of the quarter which translates into DSOs of 59 days. As usual our inventory levels were minimal. We had 163 full-time employees at the end of the quarter which is down from 165 at the end of 2001. 126 of these employees were engineers. There were 22.7 million shares outstanding at the end of the quarter. Turning to guidance. Our financial guidance is as follows. We estimate that the third quarter revenue will be roughly flat with a range of 3.7 to 4.3 million. We estimate the third quarter EPS will be a loss of between nine and 12 cents. Now I'd like to turn the call back over to Michael.

Thanks very much, Rick. I was going to start today by reviewing our business by giving some more detail by digging in into each of the revenue categories that Rick just reported numbers on. Starting with royalties and then talking about contract, and then talking about product revenues. On the royalty side we saw an increase in royalties from under $500,000 last quarter to over $750,000 this quarter, primarily because of an improvement in Analog Devices chipset sales in the ADSL market. Analog Devices has built and continues to expand on a very strong presence in the international market, especially in Asia, in the Asia Pacific region, which happens to be the most rapidly growing part of the ADSL market. I'll get into that in a little more detail later. And ADI is unequivocally one of the strong leaders in ADSL. Most recently they announced a very important design win in Taiwan and have had other successes as well. On the contract revenue side we had a contract revenue increase, a slight increase this quarter. And most of that business came from our three largest customers, Infineon, Analog Devices, and Intel. I'll talk a little bit about each of those. Infineon has now entered the market with a highly integrated central office, ADSL plus voice solution, announced this quarter a very important design win for digital loop carrier equipment at Alcatel. This is of very tremendous importance going forward, we think, given the very large untapped digital loop carrier market in the United States. We've always been very confident that Infineon solution was a strong solution for digital carriers. And they have one business at what is arguably the most important ADSL digital carrier account in the world. Analog Devices also contributed to the contract revenue line. And this is based on developments that we're involved on with them in new leading edge solutions for both central office and customer premises markets. These chipsets represent highly integrated multiport central office solutions and full feature customer premise equipment solutions that embody all annexes of the standards including annex C for Japan and a number of value added features. Intel also contributed significantly to our contract line this quarter once again. And we continue to believe that that relationship holds great promise for the future. ADSL appears at this point now more than ever before to be an important strategic initiative at Intel based on a number of public statements that they have made. And we think that the presence that Intel could have in the CPE market could really change the nature of that market, and we expect to continue to benefit from the collaboration that we have with them. Turning now to the product revenue line. This is made up of sales of ADSL development systems and modules as well as compression software that had a slightly better quarter than last quarter. Most of this is due to strong software business that is characterized by a very healthy base of repeat customers as well as new customers. And most of the business there is in the electronic identification software market. Now I'd like to turn to a review of the ADSL market. And I'm going to talk a little bit about deployments and then some of the standards activities that we're seeing taking place. On the deployment side we're continuing to see a very healthy growth of ADSL lines around the world. And there are new countries entering the fray with ADSL as well as countries who have already been deploying continuing to deploy. Some of the notable events this quarter were the United States, Europe, and Asia have continued to grow subscriber numbers pretty much as they earlier projected. Quarter over quarter from last year, i.e., Q2 of 01, to Q2 of 02, there were about 200 more subscribers added this quarter as compared to last quarter. So last quarter our estimates show about 3.6 million new subscribers. In Q2 we're seeing about 3.9 million new subscribers, and this is despite a very bad economic environment and despite numerous slowdowns in many parts of the telecommunications industry. In particular looking in a little more detail in some of the areas. The United States remained roughly flat with about 530,000 new additions this quarter. Europe had about a million last quarter and added about 1.15 or so this quarter. And then Asia grew from about 1.7 million new adds last quarter to just under two million new adds this quarter. We've been forecasting that this year, the year of 2002, we'd se about 16 to 20 million new ADSL lines and we still think that remains accurate. From a cumulative viewpoint there were about 17 and a half million total ADSL lines as of the end of 01 and that number has now increased to about 25 million lines around the world. The next thing I'd like to talk about is on the level of activity at standards body that we're around DSL. The ITU has effectively completed the approval process for the new ADSL two or business set of standards. This standard improves the rate-reached characteristics of ADSL. It improves the diagnostic capability that ADSL has and it embodies a number of features that are essentially solutions to challenges that the ADSL industries encountered in the first three years of worldwide deployment. We've actually written some articles about this, and there is a white paper on our website that I would direct you all to to get some more detail on this new standard. In addition to this the ITU is working on standards for what is known as ADSL plus which is a higher speed, higher bandwidth version of ADSL two. Bonding of multiple pairs, so taking multiple telephone lines, using them at the same time to get greater rate and reach; single-ended line testing to enable easier provisioning of service; and extended reach to allow ADSL to reach further than it can today. These are all new standards activity taken place at the ITU. The IEEE group is working for standards in ethernet in the first mile, or EFM as they call it, with a focus on very high speed DSL at short distances as well as long-reach ethernet over copper wire. And ANCI T1 E1 has initiated an activity on what they call MDSL which is a ten megabit symmetric DSL solution for the outlook. I think it's fair to say that this level of activity at standards we haven't seen, and we've been in this industry a long time, for at lease two years. And we really think it signals that there is a strong interest in improvements around ADSL. The combination of a steadily growing ADSL deployment numbers and increased standard activity, as I just outlined, to us indicates that the ADSL market is a very healthy market. Given the health of the market we think that the current slum will be exited and we will see better days. And we think that here at Aware we also will see better days as that market improves. And here are some of the reasons why we believe that. First of all, we are one of the strongest incumbents in the market and our position has continued to improve over the last few quarters. Second of all, we've improved and expanded on our technology so we're in a better position today than we were in the past vis-a-vis the rest of the market. And third, our business model which allows us to weather a storm like the one we're in now better than most companies. And I'll expand in just a moment on some of these. Our technology has improved because we've invested over the last few years in new IP packages, in intellectual property packages that make it easier for chip companies to integrate ADSL into their chipset solutions. These packages include ace DSL two, the new standard I just spoke of, as well as legacy DSL. They also include a number of enhancements that we've developed including our Dr. DSL diagnostics technology, higher speed DSL technologies, longer reach DSL technologies, and voice enabled DSL, which is our channelized voice over DSL technology. We're pretty confident that we have the best set of up-to-date feature-rich solutions for the ADSL chipset market. Now commenting on the wire business model that's important for our success. As an IP business with a very strong balance sheet, we can weather the storm that we're in right now for a pretty long time. As an IP company our biggest assets are our people and our technology. We don't have to worry about managing inventories or making large capital expenditures to sustain or grow our business. This has allowed us to focus on our business and improving our presence in our industry and improving our technology. And we believe it will continue to allow us to do that. It's for these reasons that we're confident that Aware will be successful in ADSL in the long run. The vision for this company is to be the leading supplier of communications IP for the semiconductor market. We're confident the chipset industry will re-emerge strong one day and that intellectual property suppliers will be part of the fabric of that industry. We've seen this work. Our track report and success in ADSL we think speaks for itself. Towards that vision, in addition to ADSL we're developing other technologies, higher speeds of DSL, SHDSL, wireless LAN, and power line technologies. Our focus today is on returning the company back to being a profitable business. The current challenge is managing our way through a very difficult environment. In the near team we'll improve our business as our largest customers increase sales on chipset and when new chipset companies commence design starts based upon our technology. It's difficult to predict exactly when that's going to happen and how rapidly it's going to happen. But in the meantime our focus is on executing with existing customers and on executing on developing technology packages that improve our offerings for our customers. 00:14:27 Now I'd like to open up the call to questions.

Thank you, sir. Today's question and answer session will be conducted electronically. If you would like to signal to ask a question, please press the star key followed by the digit one on your touch-tone phone. Once again, that is star one to signal for a question. We'll pause for just a moment to give everyone a chance to signal. Our first question comes from Anton wallman with Needham and Company.

Michael, can you hear me.

Yes, we can hear you.

All right. By the way, congratulations on scheduling the conference call so it doesn't actually conflict with another call for the first time in memory.

We'll take that congratulations.

All right. A couple of things. On the CPE side. Where do you think that the industry stands in terms of going from, you know, two or three chip solutions to a single combined network processor, slash, physical layer device. I mean [inaudible] announcement the other day said they had shipped a half a million of these units, and connection has some products that have been shipping. And if you were to listen to Henry nickel at Broadcom, he already has a hundred percent market share in the DSL market. So it's something that has already started moving here. Where do you think we stand.

I think that's a natural - I think that's right. I think that is what's happening. I don't know about the specific numbers that companies are quoting, and I won't comment on that. But I think the idea that integrating ADSL with other capabilities, and network processors are certainly a leading candidate for that other networking functionality, makes plenty of sense. It reduces the cost of the board that needs to be built because fewer chips, it's easier to build something. It integrates function in digital silicon which generally allows you to take advantage of reductions in silicon fabrication costs. So I think the combination network processor plus ADSL makes plenty of sense. It's something that is not at all a surprise to us. Analog Devices, one of our customers, has a very strong solution in this area as well as some of the guys you mentioned. I also think, though, on the customer premise side, that other types of functionality make sense to be integrated with ADSL. And another leading candidate there in our opinion is wireless LAN capability. In general what we have been investing a lot of engineering development effort and money into is developing an intellectual property package that allows companies who have some piece of relevant networking technology to add ADSL to that piece relatively easily in a system on a chip kind of architecture. And that means that companies who are network software companies that want to add DSL can come to us to do that. That means that companies who are video compression companies or security chip companies or wireless LAN or other home networking companies can do that. And we think it opens up the market for our technology to a reasonably large number of semiconductor companies. Most of those companies today are reticent to really invest in large amounts given the state of the industry. But we don't think that will last forever. So the way that we have positioned Aware is to have a very strong technology that is packaged in a very easy to use chip solution for semiconductor companies. And I hope that answers your question.

Yeah. So you're saying that the integration effort with the network processor has started. You're not so sure how far it is. But there will be others.

Right. And I think the way we see that is one of the instances of ADSL becoming part of system chip solutions and our other instances.

And you said that ADI is there in this regard.

They have a product called pathfinder that they announced, at least at Supercon, if cannot prior.

And that is shipping now? Are there customers in existence for products like that that are taking volume, or is that something -

I would have to look at exactly what the press release says. I don't want to state things that aren't publicly announced.

Do you see a bifurcation in the market between chip companies that are focused more on the central office versus CPE and vice versa, companies such as Intel and connection maybe on one side of the aisle? And would there be any companies that focus on the other side of the aisle, or is that not the case.

No, that is the case. The central office is a multiport integration of analog and digital, integration of voice. And I don't mean voice or IP but really plain old voice because that's where, especially in the digital carrier side of things, you need to be able to integrate those capabilities, regular pots and ADSL. So the way, sort of the road map for chipsets on the one side and on the other side are quite different. You're not going to see the integration of networking capability necessarily on the central office side and you're not as much going to see multiport solutions required on the customer premise side although there may be some instances where that happens.

So if somebody needs a multiport to DSL at home, they are going to have other problems to worry about.

That's probably true. We haven't seen nearly the interest or the entrance of new guys on the central office side as we have on the CPE side.

That seems to be the case. Can you think of any example of a company that would be focused squarely on the CO side. I can't think of one.

Well, Infineon is certainly a leading candidate there with a strong offering. I think ADI will continue to focus there. I think TI will continue to be focused there. But those are not new guys.

All right. So that would be the one example that would only be doing the C O, then. All right. On ADSL two and ADSL plus, could you just sort of define. There was ADSL two plus as well as, there was ADSL plus two. And then somewhere between Alzheimer's and somewhere else it gets a little confusing. If you could just once and for all straighten out the difference between ADSL two and ADSL plus and ADSL two plus.

Okay. ADSL two is the formal name of what used to be called [BITS], which is the new version of ITU standards for full rate and light. So there are new standards. The numbers are 992.3 and 992.4. And they represent a bunch of improvements. I'm not going to go into that. That's not what you asked me. But they are called the ADSL two standards. ADSL two plus is an enhanced bandwidth, an expanded bandwidth, an expanded data rate version of ADSL. Instead of being a one megahertz bandwidth and up to 12 or 13 megabits per second, it is a two megahertz and up to 26 megabit per second flavor of ADSL. It is not yet standardized although it's in the process of getting through the approvals at the ITU. And think our expectation is sometime next year it guess approve. And it will be based on ADSL two. So this higher speed version of ADSL, which is a two megahertz bandwidth - and you're familiar with VDSL. You remember VDSL was typically ten megahertz. This is a two megahertz version of ADSL. It's really going to be ADSL two plus because it's going to be based on the ADSL two standards which are the latest and greatest ITU standards. So those are the two new things, the ADSL two standards and then the ADSL two plus which is a higher bandwidth and speed version of ADSL two.

Okay. But there is no ADSL plus without the two.

You will probably find some people refer to the ADSL two plus as ADSL plus just because it's a higher bandwidth, higher speed. But it is going to be based on ADSL two.

Okay. They are the same thing. Plus to it, we're talking about the same thing.

Correct. ADSL two.

Final question a little bit broader in nature. If you could just comment on the overall industry landscape when it comes to the chip supply in the market and the number of players. I mean, is it your opinion that we are going to see fewer or more players shipping in volume, you know, six to 18 months from now as opposed to today. We've got new entrants, Broadcom, Intel, plenty of existing players. What's your take on the requirements to stay in the market and do you think that there are too many large diversified players in the market, or where do you think those constraints are.

Well, I think there's a difference on what's going to happen on the CO and on the CPE side. I think on the central office side you will not see new players and you will see a market share battle between the current incumbents with Infineon sort of being new, I guess, to the market. They are not new to us because we have expected this for a long time. And with their presence now at some point in the future in the digital carrier market in the US we think they are going to hopefully ramp quickly on the CO port side. I think on the central office side you'll see Analog Devices, Texas instruments, Broadcom potentially, Infineon, globe span, and [centillion]. And I don't think I'm forgetting anybody.

ST microbe perhaps.

Not so much on the central office side in my opinion, but perhaps. On the CPE side, it's really a great question. And I don't know the answer. I can tell you that our bet and our belief is that you will see sometime in the time frame you gave, six to 18 months, I think it's a reasonable window, a diversified new set of entrants into the ADSL market. Who are not, however, entering the market with just an ADSL solution. They are entering it with an integration of ADSL with other capability, whether it's a network processor or a wireless or other home networking capability or video capability or something else.

Sort of stuff that Broadcom has talked about in public for some time.

Sure. They would be one example of that. But we think there could be a number of other companies that could enter that market. So if that's going to happen it's going happen on the CPE side. We think it is going to happen because we think the opportunity for lots of companies to enter the ADSL market through licensing technology from us, and that you won't see quite as much consolidation on the CPE side as you will on the central office side.

Okay. One more question. Pricing. Any thoughts on incremental development on the pricing front on the chipset side.

Yeah. It's been very bad in the past year as you know. Prices have come down a lot. I think the only way that it doesn't continue to decline is with a combination of the improved functionality and at the integration level, similar to what we were talking about with integrating ADSL with other things. And then with new standards coming out, new requirements inside ADSL that allow companies to differentiate themselves from others and hopefully maintain a price profile that's reasonable going forward.

All right. Thank you.

Thank you.

Just a reminder. Star one to ask a question. Next to Alvin [cressler] with FDR.

Good afternoon, gentlemen. I wanted to take a look at your revenue guidance in the third quarter versus as you extrapolate that in the fourth quarter of the year, versus the unit forecast or estimate for the year. The two matching up would imply one of a couple different scenarios. Either there continues to be an inventory overhang, there will be a unit miss, or pricing continues to be a real problem, or there's some share loss. Can you expand on the matching up of the revenue and the unit forecast or outlooks.

Well, I guess we didn't give any forecast beyond the third quarter. We only gave third quarter forecast. And I think there is some uncertainty and difficult to predict exactly what the status of channel inventory is. And when we talk about new lines, how many of those new lines are being served by either existing equipment and existing chipsets or new equipment and new chipsets. Over time you're going to certainly see new equipment and new chipsets serving a market that's constantly growing. But there's still potentially inventory problems and channel issues that, you know, it's very, very difficult for us certainly to know what they are. So trying to reconcile or trying to compare a subscriber growth at this point with specific revenues at Aware continues to be very difficult.

Okay. And then really the other question I would have is that given the current revenue run rate and kind of the outlook and expectations, where are you targeting your break even at this point, what kind of margin structure are you looking for that break even on an operating basis to occur.

Was that a when or a what question, Alvin?

That's more of a what question. And I think we'll extrapolate based on looking at the overall subscriber forecast the when. But just kind of what is the structure you'd be looking at.

I guess the best way to answer that is to look at the royalty revenues, the contract revenue, and the product revenue separately. And product revenue grow is a little bit. But it's not through product revenue that we expect to get back to break even. It's through a combination of improvements in royalty revenue which are based on customers of ours selling a lot more chips than they are today, and then contract revenue which is based upon new chipset designs starting based on our technology. I think our expense run rate this quarter was 6.5 or so million dollars. So you have to get to a point where you can add up those three buckets. And the primary increases are going to come in the royalty and the contract lines.

In terms of absolute dollars, we're spending about six and a half million dollars a quarter and we've got about couple hundred thousand dollars of interest income. So revenue needs to get to the 6.3 level in order to achieve break-even. Some of the percentages in the financial model are highly dependent upon revenue levels. And a number of those areas of spending, like GA and S and M, in actual dollars remain pretty constant. So it's hard to use percentages in the financial model. I think looking at it in terms of absolute dollars is a better way to do it. We need to get to around 6.3 million dollars to break even.

And the way we do that on the royalty line is going to be primarily Analog Devices and Infineon in the near term, adding royalty to the royalty line through sales of chipsets. And on the contract line we have an existing customer base that contributes to the contract line every year, and we need to add new customers to that list. And those are going to be people who are like some of the new intellectual property packages we've developed.

Okay. Thank you very much.

Thank you.

Just a reminder. It was star one for questions.

Do we have anymore questions, Josh?

We have no more questions at this time. Do you have any additional or closing remarks.

Just thank you all for attending, and we'll look forward to speaking with you again next quarter. Good-bye.

This does conclude today's conference call. You may now disconnect.