Aware Inc (AWRE) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the first quarter Aware Inc. earnings conference call. My name is Sue and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS)

I would like now to turn the presentation over to your host for today's call, Mr. Rick Moberg, CEO. Please proceed.

Thank you, operator. I'm actually the CFO. Good afternoon and welcome to Aware's first quarter 2008 earnings conference call. I'm Rick Moberg and I'm joined by Michael Tzannes our CEO. Thank you for joining us today. First, I'll review financial results for the quarter, then Michael will talk about the business and then we'll take some questions. A recording of this call will be available on our website at www.aware.com after the call is completed. Before we get going, I'd like to point out that various remarks we may make about future expectations, plans and prospects for the Company, and the DSL and biometric markets, 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 "Factors That May Affect Future Results" in our annual report on form 10-K for the year ended December 31st, 2007, which is on file with the SEC.

Now I'm going to discuss financial results for the quarter. Revenue for the first quarter increased 1% to $5.9 million from $5.8 million in the first quarter 2007. Our GAAP net loss for the first quarter of 2008 was $1.3 million or $0.05 per diluted share. In the first quarter of 2007, our GAAP net loss was $98,000 or $0.00 per diluted share. We also report net income and earnings per share on a non-GAAP basis. Our non-GAAP results exclude stock-based compensation expenses. We use non-GAAP information internally to evaluate our operating performance. We believe these non-GAAP measures are useful to investors as they provide additional insight into our underlying operating results. However, non-GAAP measures are not stated in accordance with GAAP, should not be considered in isolation from GAAP, and are not a substitute for GAAP results. A reconciliation of GAAP to non-GAAP results has been included in our earnings release today.

Our Q1 GAAP results included $325,000 of stock-based compensation charges under the provisions of FAS 123R. Our non-GAAP net loss this quarter excluding stock-based compensation was $957,000 or $0.04 per diluted share. Turning to revenue, product revenue was $3.9 million this quarter, which compared to $5.2 million last quarter and $3.5 million in the first quarter of 2007. The sequential decline was primarily due to lower sales of DSL test and diagnostic software, which was partially offset by increased sales of biometric software. The year-over-year increase in product revenue was the result of increased sales of biometrics and DSL test and diagnostic software. Contract revenue, which includes license and engineering service fees, was $1.5 million for the quarter compared to $1.1 million last quarter and $1.8 million in the first quarter of 2007. The sequential increase in contract revenue was the result of increased revenue from biometrics technology contracts. The year-over-year decrease in contract revenue was the result of lower revenue from DSL contracts, which was partially offset by increased revenue from biometrics contracts.

Royalty revenue was $431,000 for the quarter, compared to $518,000 last quarter and $501,000 in the first quarter of 2007. The decrease in royalties compared to both periods reflects decreased chip set sales reported to us by our customers. First quarter spending was $7.5 million, compared to $7.1 million last quarter and $6.4 million in the first quarter of 2007. The sequential spending increase was primarily due to spending on consultants to assist us with biometrics customer projects. This spending was included in cost of contract revenue. Higher spending this quarter compared to last year's first quarter was primarily due to three reasons, one, higher hardware cost of goods sold, consulting expenses for biometric products and compensation increases. Our reported gross -- product gross margins were 79% this quarter. This is slightly lower than last quarter and the quarter a year-ago. Hardware margins were in the 35 to 45% range. We had interest income for the quarter of $383,000, which is lower than last quarter and the year-ago quarter. The decrease is due to a decline in money market interest rates.

Cash and short-term investments were $40.3 million at the end of March. In January, we liquidated our auction rate securities and invested the proceeds into a money market fund. In April, we liquidated the remainder of our investment portfolio and invested the cash into a money market fund. Both of these actions were intended to lower the risk profile of our cash and investments. Receivables were $5 million at the end of the quarter, which equates to DSOs of 78 days. Inventory was $1.5 million at quarter end. This inventory level reflects the growth in our test and diagnostics hardware business and long lead time requirements. We have $588,000 of deferred revenue, a slight increase from last quarter. Deferred revenue primarily relates to contracts and maintenance agreements. We have no debt.

During the first quarter we did not repurchase any shares of common stock under our stock repurchase program. As of March 31st, there were 23.9 million shares outstanding. At the end of the first quarter, we had 125 full-time employees, 91 of whom were engineers. And this completes the financial commentary section. Now I'll turn the call to Michael.

Thank you, Rick. I'm going to start with our DSL test business today. Our test and diagnostics products are benefiting from a vibrant market for test solutions as DSL providers roll out IPTV and triple play services over their networks. Our product line is built around an integrated test and diagnostics chip that we've developed. The hardware platform that uses this chip is compatible with all ADSL, ADSL2+, VDSL1 and VDSL2 service offerings. Our DSL test and diagnostic products operate uniquely well, since they provide central office and customer premise equipment functionality in a single platform. Our margins on this product benefit from the leverage we get by integrating at the silicon level, as well as by combining DSL software module sales along with hardware sales.

Up until this quarter, hardware sales were primarily to OEM manufacturers of automated test heads. Our largest customers were Spirent and Tollgrade. This quarter, significant revenues came from the handheld market, where we believe we have a strong position going forward. One of our customer's is selling handhelds into Deutsche Telekom and is also pursuing opportunities in other European countries as well as in the U.S. Another notable event this quarter was that JDS Uniphase, one of the test market leaders, announced their product based upon our platform. We're actively pursuing test infrastructure opportunities in United States, Europe, Asia and North America in general. The business model for our hardware and software modules is to sell to an OEM channel.

Our line diagnostics platform is another core offering in our test and diagnostics product line. LDP, as we call it, is a server-based product that supports prequalification and maintenance without the need for dedicated hardware. It utilizes information available from DSLAMs and other hardware devices in the network and provides DSL line analysis and diagnostics information. We sell this product to DSLAM manufacturers such as Occam as well as directly to phone companies. This product is particularly well positioned for independent telcos that are deploying video services. We are actively involved in expanding the DSLAM compatibility footprint to suppliers such as Zhone, Calex and others. We expect to be announcing deployments of LDP over the coming months. The business model for this product is to target license fees based upon the number of lines that are being tested. We also sell Dr. DSL software to Alcatel. Overall test and diagnostics was on track with our internal plans and was about 30% of overall revenues.

Turning now to biometrics. Our biometrics product line continues to deliver solid results. Revenues were a record this quarter at over $3 million and exceeded internal plans. Our core products are software solutions for client platforms in enrollment and related biometric applications. Our exposure is especially strong in applications that involve biometrically enabled credentials and border control using biometrics. This exposure has become increasingly broad, as biometric ID's become more pervasive and as multi biometrics become more widely used. Our strongest market to date has been the government market and the number of programs using the types of biometrics we know well are generally on the rise. Examples of market segments where our biometrics products have a strong value proposition include border control and credentialing, which include programs such as U.S. visit, registered traveler, transportation workers identification credentials and HSPD12 credentialing deployments.

We also have developed a presence in the emerging market for compact handheld biometric units. We sell software, library and subsystem products through over 100 OEMs and system integrators. During the quarter, Q1, we received a large order from a government agency for a PIV - that's Personal Identity Verification - middleware and client side system. We also recently expanded our offering in this area to include professional services. These are contracts with select customers. Our goal is to bring our biometrics technology and systems expertise into situations where we can add -- where we can deliver additional value to the development of an overall biometric system. Our longer term goal is to deliver software products for these systems. This quarter we began to see significant revenues from this activity. Service revenue is a new and potentially significant revenue source for us. The general opportunities for biometrics continue to expand, in our view. New opportunities will also emerge as biometrically enabled IDs go from issuance to wide use, as the Department of Defense more widely uses biometrics and as commercial enterprise solutions gain more momentum. We've been working with several Fortune 500 companies to help integrate biometrics into identity management systems.

Turning now to DSL licensing. As a result of our recent review of the market status of our licensees, the financial performance of this business and non-DSL market opportunities, we're providing the following update on this business. In terms of the market status of our licensees, during the quarter, Q1, one of our DSL customers, who was never formally announced, sold certain DSL assets and exited the DSL market. Another one of our licensing customers, PMC Sierra, has we believe suspended marketing their DSL products. Our other licensees, Infineon, Ikanos and Thomson, all continued their ongoing market activities. Infineon and Ikanos contributed to our royalty line in the quarter and we're optimistic that Thomson will also soon see market success and generate royalties for Aware. We continue to actively support these customers as they work to expand their product offerings and market share.

The financial performance of the licensing business has not been satisfactory to us. And we believe a prudent course of action is to allocate a portion of R&D assets to programs which can provide the basis for a more diversified, better performing licensing business. Given the status of our DSL product line, we believe we can accomplish such a diversification plan while maintaining our world class DSL StratiPHY product line. This allows us to take advantage of new opportunities in the DSL market, realize our maximum returns from our existing DSL product lines, while gaining exposure to new communications markets and customers. We'll be entering the home networking arena and marketing products to support the emerging G.hn standard. We recently joined the HomeGrid Forum as a founding member. The home networking market looks promising and is complementary to the broadband and DSL market that we're very familiar with. It's based upon multi-carrier communications technology and we're one of the few centers of excellence in the world for this technology. We believe this market will have a large and diverse number of participants, giving us multiple opportunities to generate business.

Timing on entering this market appears very good. IPTV and in particular HD to the home needs to be delivered around the home. G.hn will enable that to occur over any wireline medium in the home either coax, power line or telephone wire. We are developing technology for 10-gigabit per second ethernet over copper wires. This has application in enterprise networks and data centers and delivers that extremely high data rate over 100 meters of copper wire. We also have licensing opportunities and discussion involving our patent portfolio which covers communications, DSL and signal processing technologies. Our objective in these discussions, which have been going on for some time, is to enter deals that allow us to generate revenues from our patents while staying away from legal battles that we believe would be distracting to our business and unpredictable.

So in summary, we are pleased with the progress in our biometrics products and have expanded the business model to include professional services for select customers. We sell software libraries and middleware solutions through a large number of OEM's and system integrators. Our test and diagnostics products are capitalizing on a transition by DSL service providers to IPTV and triple play offerings. We sell hardware modules and a soft test head solution through a healthy OEM channel of test head, handheld and DSLAM suppliers. Our DSL licensing business has not been satisfactory and we've accelerated our entry into new areas where we believe we can rapidly deliver high-value silicon solutions. Turning now to guidance. We're lowering guidance for the year to $28 million to $32 million and a GAAP EPS of between break even and $0.05. With that operator, please open up the call for questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Mike Easson. Please proceed.

Hi guys.

Hi Mike.

So in the bigger picture, could you potentially describe the macro environment for DSL as compares to potentially cable and fiber to the home or fiber to the X and the trends you're seeing there. And obviously, it's potentially affected the royalty business and could that affect the DSL test business in the future?

Okay, the DSL end market continues to look healthy. I think if you go out, maybe four or five years now, some of the forecasts that I've seen -- I don't have any personal experience with this, but just relaying what I've read -- some of what I've seen is that competition, in particular from fiber, may start eating into sort of the growth portion of DSL out past 2011. But from what I understand and from my limited anecdotal information, DSL subscribers continue to grow and the transition to ADSL2+ and VDSL2, in particular VDSL2, continues to look like it's going to be the way that most phone companies go, especially in Europe and in parts of Asia. So I think the end market looks fine. The market share that we have in the market hasn't -- hasn't met our level of satisfaction and we look at what's occurred in the recent past with several of our customers deciding to get out of the market. We look at the state of the product line where we have a very mature, a very high end piece of silicon in StratiPHY that easily licensable, and we can maintain the ability to offer that product, but we can diversify and reallocate some R&D and pursue some of these other areas that aren't entirely new to us. We've actually been looking into these, but we certainly are accelerating the move into those areas based on some of this data.

So I think the overall DSL market's fine. I think our customer base hasn't gained the market share that makes us happy, so we look to expand into new areas. We do continue to see opportunities. There are still customers or prospective customers who are considering licensing and certainly there's opportunity for the existing licensees to improve their market share. And on the test side, the market is, because the market at large is healthy, the test market is very healthy. That's being driven by really IPTV deployments and triple play and the kind of services where phone companies need to do a better job of monitoring the quality. And so we're seeing a lot of interest in those products, both through test head guys, through handheld guys as I mentioned and through some of the DSLAM relationships we have. So in that case, the fact that we have a solution that can be compatible with any chip and any box, whether it's a CO from a customer's solution or a competitor's solution on the silicon side or any CPE, really expands the size of the market opportunity we can address.

Okay, thanks. You also discussed the -- what seems like a very promising transition to home networking, which an exciting market and getting a lot of interest lately. When do you estimate that could become material? And how do you see the market shaping up in home networking?

There are elements of it that are already being served by certain folks. There are companies in the HomePlug, which is the power line stuff -- and I know you're very familiar with this stuff, Mike. But -- so Intellon's in that market and Entropic is addressing the coax LAN market. And what we've focused on through G.hn is that sort of superset technology that we believe has an opportunity to really serve the -- the issue with the existing solutions is they don't solve all problems, they only solve certain point problems and the opportunity that G.hn has and the opportunity that HomeGrid, which is the forum we joined along with some other prominent folks, is to really promote, develop, standardize a solution that will address any wire in the home for the hardest application which is really HD video throughout the home. So we think we bring some pretty unique technology expertise there. The standard is too far away to be able to predict right now. It's certainly not going to happen this year. I suppose it's possible for next year, we'll probably be able to have a better gauge on that later this year.

But we intend to be there with products as that standard evolves and the size of that market is very attractive. The number of participants in the market are much larger, both in size and scope, than in the DSL markets, so it's got some diversification appeal. When you're talking about home networking, every device in the home that wants to be networked has to have this technology. So the size of the market is many times the broadband subscriber market. So, we do see it as a good opportunity. We think it's a good fit. We think now is a really good time to be entering it, because it is -- there are some problems that haven't been solved there. And we think we bring a pretty unique perspective to it. And we've gotten in with a group of companies in HomeGrid that we think are leaders in the industry and are -- we're all on the same page to try and get something into the market that's both technologically solid and in a timely way.

Okay, sounds encouraging. And one last question if I could. You mentioned on your last call you anticipated adding up to 15 new employees in '08. Given that head count was flat quarter-to-quarter, is that still the plan or do you see that changing?

Yes, that's probably not accurate any longer. So we haven't added -- we're a little behind that. I think we're down actually so far this year a little bit. And at this point, adding head count that would be specialized in DSL wouldn't make as much sense, given the focus on reallocating some of that R&D. We do continue to look at adding the right folks in the biometrics and the test and diagnostics side, so I'd say it's probably more in the five to 10 range for the year now.

Great, thanks guys. I'll turn it over.

All right. Thanks Mike.

And your next question comes from Bob Lee from Sidoti & Company. Please proceed.

Hi, good afternoon. Thank you for taking my questions here. Just wanted to follow-up on the last couple of questions about the transition away from the DSL business. Are you going to be attacking this new market as a licensing type company, as you've done with DSL licensing, or are you going to look at it as a product and licensing as well?

We're initially entering it with licensing in mind, because it's something we know we can do quickly and there's an opportunity for it, because there isn't such a company in that market. And it looks to us to be conducive to that type of -- to that type of player and we have some experience with that in communications and IP for communications. Over time, if you look at what we've done in DSL, the test market is -- we have a silicon device that we developed that's the heart of that and then we have hardware products that we develop around that silicon device that we -- that we sell. And there certainly could be a test market in home networking, as well, that we might be able to participate in. So I think, pretty much any product opportunity is probably fair game. It's too early for us --

Yes, he pressed that once (inaudible)

Hello?

Hello? I'm sorry I heard some comments there.

Okay. So I was going to say, pretty much any product opportunity -- I wouldn't imagine us ever getting into services or anything like that in these -- in any of these areas. But hardware products, software products, potentially but to start we see a licensing opportunity that we know how to deliver the technology for, we have the technology assets to do it, we have the R&D capability, we have expertise that's unique. So that's the initial foray for sure.

Okay, this I guess -- that kind of is a good segue into the next question is what do you think is the competitive landscape? How do you think your products will specifically be able -- I guess is better than what's out there right now?

Well there isn't anything out there right now that solves the problem of high speed that is reliable enough for HD video over any wire in the home. (technical difficulty) Can you hear me, Bob?

Yes, yes.

We're getting a strange noise. Okay, good. So there's a solution for power line that is emerging and there's a solution for cable, which is really specific to the -- to a home that has cable infrastructure in it, and there's a solution for telephone wires that's specific to a telephone wire infrastructure. So the idea of G.hn is to have a solution that actually leverages all of that infrastructure in your house. And if you have telephone wire and power line and coax, improve the likelihood of getting data around reliably and a particular video around the home reliably by leveraging all of those things. So there isn't anything in the market today that does this. There are folks in the market that have, what I referred to earlier as point solutions, either a home plug, which is the electrical wire, or the MoCo, which is the cable wire or HomePNA, which is the phone wire. But there isn't anyone who's got the solution we're talking about delivering, which is what G.hn is trying to deliver, which is a solution that can work on any wire.

I think we can bring -- and that technology is still in design, so that technology's being designed at the standards bodies very much like VDSL2 was designed or ADSL2+ or any number of other communications technologies. So we're bringing a lot of the expertise that we have in communications technology and we've been looking to come up with a solution that is better than things that are currently out there. The main target, sort of from a big picture viewpoint that the standards -- both HomeGrid, which isn't a standards body but is a marketing forum and G.hn, which is a standards body, are looking at is really high data rates, so a gigabit per second ultimately throughout the home, so that you have very, very high speeds. The current solutions are in the, at best, hundreds of megabits per second.

Okay. If I may, I'd like to ask two questions concerning DSL -- related to the DSL licensing business.

Of course.

I guess the -- one interesting report that came out today that isolated DSL was from Juniper talking about a 12% market take from DSL by WiMAX in the next, I think it was five years. Is that something that should concern you in terms of -- I think the last questioner mentioned cable and fiber to the premise, but mobile WiMAX seems to have some properties that compete very nicely against DSL, do you think that that's a concern?

I think WiMAX has certain -- poses a competitive threat, but I think it's limited. I think it's limited in a couple ways. It -- from what I've seen and I haven't seen the report you just referred to, but from what I've understood from the research I've looked at or been talked about to -- talked to about, is that in particular in some of the far east countries like India and China, there may be -- India in particular, I think it was, there were some opportunities for WiMAX where there isn't the infrastructure for DSL, so I think -- or fiber or cable. So in those cases, I think it's -- I don't really see that as competitive. I sort of see it as complementary to what DSL wouldn't have been able to serve anyway. I think the other challenge that WiMAX has, being a significant competitive threat on the high end at least, on the IPTV and HDN, is I'm not sure it's to deliver that type of reliable data for HD to a large population. And if you're looking at VDSL or fiber solutions being able to do that, I just don't think WiMAX will be able to compete. But I do think that WiMAX and fiber-to-the-home, for that matter, have sort of improved their general outlook in the last year or two versus what people thought they were going to be able to do prior to that. But I think that the impact they're having is really more in the four and five years down the road.

Okay, and then lastly is, if you -- I mean, you had mentioned that DSL subscriber base continues to grow and with the licensing revenue kind of stagnant for the last three quarters or so, are you -- would you say that you probably hitched the horse in terms of licensing revenue on the wrong players here or is it the -- or is it something else?

Well, well certainly the two folks who exited the market turned out to be a bad event for us, because we did -- when we get into one of these development activities, there's a tremendous amount of work that goes into it, and there's some revenue, but the real opportunity there is royalties. And these folks aren't going to be generating royalties if they're not in the market. So they, they didn't prove to be what we had hoped and the existing customers, the market share that they've -- that they've captured hasn't been satisfactory. They've I think got good products. I know our technology's good technology, but it's certainly not -- the market share that the current customer base that's in the market has isn't good enough for us from a business perspective. I think there's been a lot of consolidation in this industry. There still are some folks who are actively discussing with us, licensing, but there aren't nearly as many as there were, certainly three or four years ago, but I suppose it could change. There could be a change in that outlook, because I do think IPTV over DSL is going to be a pretty widely deployed service. And if that becomes a requirement at the silicon level for someone who's strategically involved in broadband solutions for homes, then I think they'd know where to come to get a quick foot in the door in that market.

Okay, thank you very much. And good luck on the new initiatives there.

Thank you, Bob, thanks very much.

Your next question comes from the line of Paul Berger from PI Associates. Please proceed.

Good afternoon. Rick did I hear you say right, that you got out of all the auction backed securities?

We did.

Congratulations, how did you do it without -- or did you take a hit?

No, we did not take a hit. We in late December, came to the conclusion that it was just too risky to be in those securities and it wasn't worth it and we began liquidating the portfolio in late December and it continued through the third week of January and we managed to get out before it all crashed down the first weeks of February. So it was a little bit of good luck and making the right decision.

Good, congratulations. Because you're one of the few people that did that. Also, the reduction in guidance, can that pretty much all be attributable to DSL?

Yes. We've got -- yes, mostly. We had, we had certain customers that, as I mentioned, are no longer pursuing their developments, so development revenue, contract revenue from them is no longer to be expected and royalties from them aren't going to happen. And the other product lines are doing very well. So it is a consequence of the financial position in DSL. Yes.

Okay and one final question. Can you go over a little your thought process of why you haven't bought back any stock and how does that buy back look going forward?

Paul, I think in the past, what we've said is that if we haven't bought back shares, it was for one of three reasons. Either we didn't like the valuation or we were in a quiet period or we were in possession of inside information that precluded us from selling. And I can tell you that the reason that we didn't buy back any during Q1 had nothing to do with valuation. It had something to do with the other two. Where the stock price is now, we think that it's undervalued and would buy back the shares. However, we have certain limitations and those limitations are real and we need to pay attention to them. This is something we pay a lot of attention to, we've got this buy back plan in place, it's real, and if we can take advantage of -- excuse me, if we can buy back shares without any limitations on us, we intend to.

Okay, so there's something other than what you haven't stated so far that's working, I assume.

There was in the past for sure.

Right, but I mean going forward, now that the conference call is out, are they all gone or is there still stuff going on?

We're in a quiet period for a few more days and past that the -- as Rick just said, the reason we wouldn't buy shares, if we didn't, would be either because we have got some sort of material inside information or we don't like the valuation and we just said the valuation at this level does appear attractive to us.

Okay, I won't push it any further.

Thank you.

Good luck.

Thanks very much.

Thank you ladies and gentlemen, I would like to turn the call to Michael Tzannes for closing remarks. Please proceed.

Thank you very much, everyone, for listening in today. And we look forward to talking to you again next quarter. Bye-bye.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.