Aware Inc (AWRE) 2006 Q1 法說會逐字稿

Good day, everyone, and welcome to the Aware, Inc. first quarter 2006 earnings release conference call.

Today's call is being recorded.

At this time, I would like to turn the call over to Mr. Rob Weiskopf, CFO, for opening remarks.

Please go ahead.

Thank you.

Welcome to Aware's first quarter 2006 earnings conference call.

I'm Rob Weiskopf, the Company's CFO. With me is Michael Tzannes, Aware's 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 business; 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 we make about future expectations, plans, and prospects for the Company in the DSL and biometrics markets constitutes forward-looking statements for 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 "Factors that may effect future results" in our annual report on Form 10-K for the year ended December 31, 2005, which is on file with the SEC.

Turning now to financial results.

First quarter 2006 revenue was 6.1 million, compared with 4.2 million for the same period last year. The Company reports its net income and basic and diluted net income per share in accordance with U.S. Generally Accepted Accounting Principles, GAAP, and additionally, on a non-GAAP basis. Non-GAAP net income, where applicable, excludes the effect of stock-based compensation expense. The Company uses the non-GAAP information internally to evaluate its operating performance and believes these non-GAAP measures are useful to investors as they provide additional insight into the unlying operating results. However, non-GAAP measures are not stated in accordance with, should not be considered in isolation from, and are not a substitute for GAAP measures. A reconciliation of GAAP to non-GAAP results has been provided in financial tables included in today's earnings release.

GAAP net income was 0.5 million, or $0.02 per share, which includes 0.5 million of stock-based compensation charges, as this was the Company's first quarter subject to the provisions of FAS 123(R). This compared to a GAAP net loss of 0.3 million, or $0.01 loss per share, for the year-ago period. GAAP results prior to 2006 do not include a charge for stock-based compensation.

Non-GAAP net income for the first quarter of 2006, excluding the effect of stock-based compensation, was 1.0 million, or $0.04 per share.

Product revenue was 1.7 million this quarter, which compares to 1.3 million last quarter, and 1 million a year ago. Product revenue this quarter consisted of software sales for biometrics and medical imaging, as well as hardware sales for ADSL test and diagnostics. Product revenue increased this quarter versus last quarter, and last year's first quarter, due to higher software sales. Contract revenue was 3.7 million this quarter, which compares to 1.7 million last quarter, and 2.2 million a year ago. Contract revenue was up this quarter versus last quarter, and last year's comparable quarter, primarily due to fees recognized in the transfer of certain technology licenses as a result of the acquisition of a customer's business.

Royalty revenue was 0.7 million this quarter, down slightly from last quarter, and down 0.4 million from last year's first quarter. The decrease in royalties was primarily due to lower sales of ADSL chips by our customers.

For the quarter, Analog Devices and Infineon were top customers.

Q1 spending was 6.0 million, including 0.5 million of stock-based compensation charges, which compares to 5.2 million last quarter, and 4.8 million in last year's first quarter. The sequential increase in spending was predominantly due to higher compensation and fringe benefit costs. Higher spending in this quarter compared to last year's Q1 was primarily due to higher compensation and fringe benefit costs, including salary increases and additional head count.

Interest income was 394,000 for the quarter, at a 4.1% analyzed interest rate.

Our balance sheet is in excellent shape.

Cash and short-term investments were 38.7 million at the end of March. Receivables were 3.3 million at quarter-end, which translates into DSOs of 48 days. Our inventory levels were minimal, and we have no debt.

On March 31, we had 113 full-time employees, 84 of these employees were engineers.

And finally, regarding capital stock, there were approximately 23.4 million shares outstanding at quarter-end.

This completes my financial commentary, and now, I'd like to turn the call over to Michael.

Thank you.

I'm going to start today with a discussion in the DSL licensing portion of our business.

The highlight this quarter is DSL licensing was the win by Infineon at Deutsche Telekom. As we understand it, these slams will be supplied by Semens and ECI, both exclusively using Infineon chipsets, and modems, the supplier, in this case, was not identified, will also use Infineon chipsets. This deployment required a difficult to implement, 17A profile, which supports 50-megabyte per second speeds. This requirement was one that Infineon could meet and did so, and there were also strict interoperability requirements that Infineon had to meet, which they also did. We understand that the first roll-out of this service is to 10 cities and will take place during 2006.

IP TV broadcast of German soccer games will be made available to subscribers of this service. We understand that Infineon has already shipped hundreds of thousands of chipsets during the first part of 2006, so we expect to start recognizing royalties in our second quarter from this deployment. We expect Infineon will ship millions of chipsets over time to support the Deutsch Telekom deployments, but we don't know the exact timing.

Deutsche Telekom's decision to invest 3 billion Euros to upgrade an infrastructure using fiber and DSL Is part of a larger global trend. Fiber and VDSL2 can deliver 50 to over 100-megabyte per second speeds and fuel the distribution of value-added service and triple-play to consumers. We expect that VDSL2 and, in particular, the 50-megabyte per second and above versions of VDSL2, will become synonymous with IP TV and HDTV services. Infonetics Research has published numbers forecasting that DSL ports, including central office and customer premise, will reach 95 million in 2007 -- sorry -- 240 million in 2008, and over 300 million in 2009, with more than half of those 2009 chipsets being VDSL chipsets.

In addition to Infineon, Thompson Microelectronics has licensed our StratiPHY3 for VDSL2. We see Thompson Microelectronics as a player with significant potential in the DSL industry since their sister modem division is one of the largest market share holders in the DSL industry.

In addition to Thompson and Infineon, we have a third, unannounced StratiPHY3 VDSL2 customer. We expect this customer to be very aggressive in the DSL industry, especially in the Asia-Pacific region, and we're working very closely with them to rapidly bring both central office and customer premise, VDSL2 products to the market.

We also know that one of our so far unannounced StratiPHY2+ customers will be announcing their ADSL2+ product around the time of the Globalcomm Trade Show in Chicago next month. This customer is a blue-chip semi-conductor customer, and their product is already being selectively demonstrated and marketed.

The sale and transition of the Analog Devices ADSL business to Ikanos took place during this quarter. This has been seamless from our perspective, with most of the engineering team we with work at Analog Devices moving to Ikanos. [SayGem] continues to be the primary customer for these ADSL2+ products, and we and we continue to be optimistic about the future from a revenue-stream, as well as a market share growth perspective.

Ikanos is now an aware StratiPHY2+ licensee, with all the rights and obligations that Analog Devices previously had. This means that Ikanos has the right to manufacture and sell ADSL2+, as well as Legacy ADSL products that ADI has license to, and then, Ikanos assumes the obligations to pay Aware support and royalties.

These products give Ikanos today an important presence and strong growth potential in the European ADSL2+ market.

We're well-poised to capitalize on the growing DSL market. Infineon and Ikanos both have strong positions in the growing ADSL2+ markets. Thompson and Atmel have products that to-date, have not been successful, but their efforts continue. A new blue-chip licensee has an ADSL2+ product ready for release.

On the VDSL2 side Infineon has established a clear leadership position, and Thompson Microelectronics will be entering the market later this year, as well, a third customer.

Turning now to new product developments -- we'll be introducing a new analog front-end product in the near future. This will support VDSL2 band-widths and data-rates. This product, when combined with our StratiPHY3 chip technology, will constitute a complete DSL solution, from network interface to the telephone wire, and will support all modes of all ADSL and VDSL standards.

We're also developing a new digital silicon level for bonded ADSL2, as well as for multi-port central-office solutions for VDSL2. These levers are highly intra-operable, field and market-proven StratiPHY2+ and StratiPHY3 technologies. Our central-office multi-port solution supports all flavors of DSL and is targeted to the growing VDSL2 Annex B market, where we expect the density requirements to continue to increase.

Turning now to our test and diagnostics product line -- in this area, we had another solid quarter in terms of relationship and product development. We'll be announcing and showcasing at trade shows, a number of our new products over the next few months.

In test and diagnostics, our strategy is to align ourselves with OEM suppliers of automated test head and hand-held testers. We have developed products for each of these markets and are heavily involved in various test infrastructure deployments or upgrades that are being considered. We also in active discussions with new customers. There are currently opportunities at U.S. [Arbos], as well as International PTTs, where we believe our customers are well-positioned to win business.

Turning now to the biometrics side of our company -- I'm going to dedicate some time today to describe the strategy, customer base, and growth goals that we have for this software set of products.

Our biometric strategy is to gain broad-based expose to the biometrics market through a software component-based OEM model. This means that we deliver key functionality required by our customers biometric application in an easy to integrate package of software components, also known as a software tool kit. Our pricing model consists of low up-front software development kit fees in order to encourage customers to design in our products and then, run timed license fees when our customers sell through their applications, which include our products.

Our products are built around the implementation of biometric industry standards. Our focus on high performance and made easy to integrate into our customers' own software applications. The combination of zero risks, standard compliance, and the resulting high-reliability intra-operability, coupled with high performance run time, an image quality in an easy-to-integrate package, presents a compelling value proposition to our customers. We encourage our customers add their own unique value around our biometric products, which allow them to focus their engineering resources on differentiating their products, while using Aware's products to address the must-have market place requirements of standard compliance, intra-operability, and image quality.

Our target customer base includes vendors of clients-side biometrics systems, including both hardware and software companies, as well as system integrators who develop client or middle-ware portions of the biometric system itself. We achieve broad software-based market exposure as a consequence of the number of selling opportunities that exist, given our business model.

In contrast with an AFIS system -- an AFIS stands for -- Automatic Fingerprint Identification System -- which are in-practice winner-take-all opportunities, in which a single AFIS vendor is selected for a major government program, we've found there are a large number of selling opportunities at the client-end of these systems and that these opportunities tend to grow in number over time.

For example, while the original IAFIS program's AFIS component was awarded to PRC Lockheed Martin in the mid-1990s, client-side biometric applications, for instance, criminal justice booking stations, and middle-ware, for example, local storage and storing forward systems, involved hundreds of software and hardware OEMs and system integrators at the State and local level, which continue to deploy today. Each of these State and local systems represented a opportunity for Aware due to the requirement of intra-operability with the standards-based IAFIS system.

Today, we see a trend away from the original proprietary closed-end-to-end AFIS model of the early to mid-90s, towards an open-standard, or, generally, open standards, which require intra-operability involving many companies whose products must work together seamlessly. This general trend is consistent with our fundamental value proposition, and we believe it is positive for our overall business.

Emerging biometric opportunities in border control and security credentials are following this trend and represent an even more attractive opportunity for our OEM software model. In these systems, which are also standards-based, the processes of enrollment, personalization manufacturer, and reading create three distinct market segments, for which our products are well-positioned. As these market segments require companies with differing technical expertise or experience, and often, a local presence, our target customer-base increases accordingly.

As a result, across existing and emerging biometric markets, we have a diverse customer base of OEMs and system integrators who use our products to target the non-matching portions of those systems.

The goal for our biometric software products is to maintain growth at a rate consistent with, or greater than, the biometrics market as a whole. This market, according to the International Biometrics Group, is growing at a compounded annual rate of 40%, and is expected to continue to do so for at least several years. We believe our increasingly broad product line and customer base, coupled with our strategy, will provide us the path to achieve these goals.

In 2005, most of the product revenue we reported was from biometric software sales. We started 2006 with a solid quarter of biometric software sales, and we believe we can achieve our growth goal in 2006.

Turning now to more general guidance--.

Our business has entered 2006 on a strong note, and we believe it will continue through the year.

During the first quarter, our licensing activities generated healthy revenues. In Q3 of 2005, you'll recall, we had a strong quarter in biometrics products sales. Our goal is for our licensing products in DSL, our biometrics software products, and our test and diagnostics hardware and software products to all achieve healthy revenue levels on a quarterly basis. I outlined today our product and sales activities that are solid indications that we're on the right track.

For the second quarter of 2006, we expect revenues to be in the 5 to $7 million range. We expect we'll be in the 5.5 to $5.8 million range, not including stock-based compensation for expenses. Some of this spending is for increased head count in R&D and sales and marketing. Our goal is to show a profit again in the second quarter, but it's most important that we continue executing on product development and customer acquisition activities to secure long-term success and profitability.

So, to summarize, the Infineon win at Deutsche Telekom establishes clear leadership position in VSDL2. We expect that two new VDSL2 customers, one of which is Thompson Microelectrics, will enter the market in the second-half of this year. ADSL2+ market share, through Ikanos and Infineon, is poised to grow.

A new blue-chip ADSL2+ licensee will be releasing a product in late-May or early-June.

New products developments are underway to expand the value of our DSL licensing offerings, and the strategy to grow market share in the DSL market is on-track.

In test and diagnostics, our hardware and software product lines have been broadened through product developments, and biometrics had a solid quarter with notable contributions from our JPEG and JPIP products as well.

With that, I'd like to open the call up for questions.

Thank you.

[OPERATOR INSTRUCTIONS]

And we'll go to Lilly Wu, PTRA Capital.

Yes, hi.

I want to get some more background on the Deutsche Telekom contract [inaudible]. You mentioned that revenue recognition for you will start in the second quarter. How is that likely to look? Is it going to be a very lumpy deployment as far as your revenue goes, similar, to say, last year where you had a big spike up in the third quarter, or is that something that will gradually ramp-up as they deploy both customer premise equipment and central office?

We'd expected it to ramp-up. Now, how -- exactly how smooth that's going to be is hard to know, but what we know is that the first-phase of this deployment involves some ten cities.

This isn't quite as well documented, so some of what I'm saying is rumor and things we've heard through the industry-grapevine, but the intention is to deploy to about 3 million homes during 2006, and then, to expand to many more than that over the next years.

The way it appears to be taking place now is consistent with deployments we've seen in other parts of the world. The first heavy deployments are on the central office side, so you see a lot of volume on central office chips to populate the various nodes that are being fed by fiber, and then, VDSL2 is being out of those nodes, and then, the customer premise equipment will follow as subscribers sign-on to the service.

So, we think we'll see a steady ramp through the year, and hopefully, past 2006, into subsequent years, and hopefully, in other deployments in other parts of the world as well.

Okay.

Are you, at this point then, when subscribers will be able to start signing up for this service?

I'm not aware of exactly when people will be able to sign-on. I think there are some lines already in service. I think it's a limited number, and I'm sure -- actually, Deutsche Telekom has been very public about a lot of their intentions. So, I believe you can find that -- I don't know, offhand, what exactly the date is.

Okay.

On the biometric side, is the revenue, at this point, primarily generated from -- what's the breakdown, Mike, between the SDK fees and long-time license fees? Are you seeing a significant portion of the current revenue from licenses?

It's almost all one-time licenses. The SDK fees are really the entry point.

Okay.

They are already in active deployment and sale?

Yes. Correct.

Okay.

And just--.

The description I provided was more of a business model approach, as opposed to a fact -- a statement of where we are today. Now, there are some products that are new, which will follow that first SDK, and then, run-time license, but we have a number of mature biometrics products, especially in the fingerprint enrollment station station for law enforcement applications that are in -- many years into run-time licensing.

Okay.

So, the SDK fees, frankly, are just to make sure the client is serious?

Right.

So that people [inaudible] nominal customer support efforts is, that's not the key revenue focus?

Correct. Right.

Okay.

Alright. I guess that's it for now.

Thanks.

Thanks.

[OPERATOR INSTRUCTIONS]

We'll go to Ted Moreau with Cardinal Group.

Hi, Mike.

Hi, Ted.

Sounds like things are coming together here?

I think so.

Isn't it about time?

Yes. Yes.

Well, then, CapEx adjustments and financial adjustments, but now IP TV seems to be the buzz word, but--.

My question is really a very general, generic one -- maybe it's a stupid one, I don't know but -- tell me, do you need to be involved in a fiber to the node buildout, where there's some part of the copper network as part of that infrastructure, as opposed to the fiber to the prim, where there really isn't a copper connection in some green fields. You don't have really a fiber-product, per se -- am I right in that, or--?

That's correct.

And really, what we're seeing, in terms of the major trends around the world, with the one expectation being Verizon's FIOS initiative, which I'll come back to in a second, but most of the trend in Europe certainly, in the other parts of the United States, so that AT&T and Bell South, which -- I guess they're all becoming one, but -- Ex SBC Bell South -- it's much of a fiber to the node, so fiber, to some point, and then, copper the rest of the way using -- several years ago, the plan was to use ADSL2+, and now, increasingly, it appears the plan is to use VDSL2 because it's such a future-proof technology.

Right. Well, fiber to the node is the preferred distribution mechanism even outside of the United States?

Certainly outside the--. You see what Germany is doing, and you look into the Far East, and that's a fact.

Do they have mostly copper, and -- I mean, in the Far East, or is it wireless actually?

Well, you look at the VDSL deployments in Korea and Japan. They were one of the first adopters of ADSL, and then, they were rapid transitioned to next-general ADSL+ and ++ and some of the -- very specific that to region of the world -- flavors of technology, and they've been a rapid adopter of the VDSL.

So, you were going to comment on Verizon--.

I was going to say, I have begun to hear -- and you have heard some of this stuff as well -- that Verizon is looking at complementing, I guess, their -- their FIOS. They also have a pretty active regular DSL deployment as, I think, pretty much everybody knows. They offer one of the most competitive, from a pricing perspective, DSL offerings for residential customers, but I've also heard that they're considering and starting to look into fiber to the building and then, VDSL-type technology inside the building that also complements the service offerings.

Well, the general consensus -- this is just what I hear; this isn't documented, but -- first of all, Verizon's stock has been under more pressure than the other stocks, and the general view is that the analysts don't believe the economics of the fiber-in-the-prim build, and because of that, there may be more pressure to go fiber-to-the-node.

Verizon will probably dispute that, but I think it looks like they're going to probably start to succumb a little bit and do a combination. It would be faster, first of all, and fairly cheaper except for in the [inaudible] field, and maybe--.

The rest of the world is certainly moving in that direction.

Yes. So, That would be good too.

That would be great.

Do your suppliers have a relationship with Verizon?

We reach through chip companies to very broad number of equipment -- large number of equipment and, on the central office and the deslam side and the customer side.

So, inside the U.S., Addtrans is a customer of Infineon. A number of modem companies are customers of various chipset suppliers that we sell technology to.

So, yes, I think there's plenty of exposure to those kinds of opportunities.

So, if Verizon would migrate somewhat to the fiber-to-the-node, clearly, that would be incremental benefit to you on top of all these other things that are--?

If they move quickly to VDSL2, which would make sense, since it's the latest and greatest technology, we have a clear leadership spot there with Infineon and some new customers entering the market later this year, and I think we'd be really well-positioned to see some business there.

Yes.

Great.

We'll see what happens.

Yes, indeed.

Thanks, Mike.

Thank you, Ted.

We'll go next to Tom Herzfeld, Pacific Asset Partners.

The contract revenues grew sequentially about $1 million, and I think Rob said it was mainly due to fees in acquisitions of a customer's business.

Right.

I assume that means the Ikanos analog thing? First of all, is that is right?

Yes. That's correct.

Okay.

So, was that all -- basically, all of that $1 million sequential increase?

We haven't given any specific numbers on that because it's sort of a sensitive -- just like we don't like to give specific numbers on any of our licensing deals. It's how we price our technology. We try to keep as close to the vest as possible.

The backdrop there was, as is now, very publicly known, Ikanos acquired a division of Analog Devices that included products that were licensed from Aware by Analog Devices. In order for Analog Devices to sell the division, it required that we transfer certain technology licenses to Ikanos, which we were paid to do.

From our perspective, it was very much like signing up a new licensee. In this case, the new licensee was Ikanos, and effectively, ADI was replaced by Ikanos, and, as with any new licensee, there are fees associated with getting access to Aware's technology. So, it was a little different way of acquiring a new customer since it was through the sale of a division of an existing customer, but it looked, in form, very similar to the typical acquisition of a licensing customer.

Okay.

And I assume that none of this had anything to do with StratiPHY3?

That's correct. Analog Devices had licensed StratiPHY2+, but not 3, no.

My question is -- is Ikanos, in your -- is Ikanos, clearly, not a potential customer for StratiPHY3?

No, I wouldn't say that they're not a potential customer. I think everyone's a potential customer for StratiPHY3 -- in each case, for different reasons.

Ikanos is a StratiPHY2+ licensee and through that relationship, they have, currently, a very strong presence in the European market, primarily in France with, I think, tremendous growth opportunity, and I think they are very optimistic about it.

I would -- obviously, they have VDSL technology. If you're familiar with the company, they talk very positively about it. So, I don't think it would be their first choice to come to Aware to license technology, but I can't -- I suppose I can't speak for them, but I'd be surprised if they said that under no circumstances would they ever license [inaudible] to Aware.

But you have said, I think, both Broadcom and Ikanos do not have all the technologies -- difficult for me -- but all nodes of the technology?

Right.

Is that still true?

What we've said is that StratiPHY3, which is our product, as well as the Infineon products, which are now seeing a lot of success in the market, do support all modes of operation required in VDSL2. One of those modes, which is known as the 17A profile, is a 17-megahertz, 50-megabyte in one direction, and, I think, roughly 10 in the other direction, performance requirement, that Deutsche Telekom imposed as a must-have in their selection process.

Infineon was able to meet that. I can't really talk about who -- what other folks did because a lot of that information is not -- first of all, it's not public, and second of all, it's not right for me to talk about it. But I can say that our solutions and our customer solutions will support all those modes, and in particular, the 17-megahertz and a 30-megahertz mode, which will run over 100-megabytes per second, which, in some applications, is going to be very attractive.

I would expect, given the fact that there's a standard, that people will get all these modes working if they don't already have them working, but I also think that Infineon is clearly in the lead right now, and they think they're in the lead right now.

Good.

My last question -- different subject -- regulation -- I read somewhere in the journal that some of the same regulatory issues that have existed in the United States, exist in Germany, regarding Deutsche Telekom's requirement to allow others to use their pipe. What's -- maybe I shouldn't be asking you this; it's unfair -- what's the status there?

I'm probably in the same boat as you.

I've read those things as well. I'm keenly interested in, obviously, if there's any problems. I haven't been -- I can't give you a conclusion, given what I've seen to say it is or isn't a problem.

I do know that the deployments are commencing, so it's, hopefully, if it is a problem, it's a short-term problem.

Okay. Okay.

Thanks you.

Alright, Tom.

This does conclude our Q&A session.

I'd like to turn the conference over to Michael Tzannes for any additional or closing comments.

Alright. Thank you, all, very much.

A couple of things -- we're again going to invite stakeholders to submit questions, as we put in our press release, via email to investorquestions@aware.com, and we'll post questions and answers next week on our website.

We have the Globalcomm, which used to be Supercomm, now called Globalcomm Trade Show, coming up in the first week of June in Chicago. We've got a booth there, and we're going to be demonstrating a number of exciting things. If any of you are there, please stop by.

We also have our shareholders meeting -- annual shareholders meeting -- coming up on May 24.

Thank you very much. We look forward to talking to you again next quarter.