Aware Inc (AWRE) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to the Aware, Inc. Second Quarter 2008 Earnings Release Conference Call. Today's call is being recorded.

At this time I would like to turn the call over to Mr. Rick Moberg, Chief Financial Officer, for opening remarks. Please go ahead, Sir.

Thank you, Operator. Good afternoon and welcome to Aware's second quarter 2008 earnings conference call. I'm Rick Moberg, the Company's CFO, and I am with Michael Tzannes, our CEO. Thank you for joining us today.

First, I will review financial results for the quarter. Then Michael will talk about the business. And then 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 would like to point out that various remarks we may make about future expectations, plans and prospects for the Company in the DSL and biometrics markets constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Our 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. This Form 10-K is on file with the SEC.

Now I will discuss financial results for the quarter. Revenue for the quarter decreased 4% to $6.2 million from $6.4 million in the second quarter of 2007. For the six months ended June 30, 2008, revenue decreased 2% to $12 million compared to $12.2 million for the first six months of 2007.

On a GAAP basis, our net loss was $1.3 million or $0.05 per diluted share for the quarter. This compares to a net loss of $1 million or $0.04 per diluted share in the second quarter of last year. For the first six months of 2008, our GAAP loss was $2.5 million or $0.11 per share. During the same period last year our net loss was $1.1 million or $0.05 per share.

We also report net income and EPS on a non-GAAP basis. Our non-GAAP results exclude stock-based compensation expenses. These expenses were $393,000 this quarter and $718,000 for the first six months of 2008. Excluding these charges, our non-GAAP net loss was $864,000 or $0.04 per diluted share for this quarter and $1.8 million or $0.08 per share for the first six months of 2008.

A reconciliation of GAAP to non-GAAP results has been included in today's earnings release.

Product revenue was $3.9 million for the quarter compared to $3.9 million last quarter and $3.8 million in the second quarter of 2007. The flatness of product revenue both sequentially and year-over-year was the result of increased sales of biometric software, which were offset by lower sales of DSL test and diagnostic hardware and software.

Contract revenue which includes license and engineering service fees was $1.8 million for the quarter compared to $1.5 million last quarter and $1.6 million in the second quarter of 2007. The increase in contract revenue, both sequentially and year-over-year, was the result of increased revenue from Biometrics' Professional Services. This revenue increase was partially offset by lower revenue from DSL licensing contracts.

Royalty revenue was $443,000 for the quarter compared to $431,000 last quarter and $1.1 million in the second quarter of 2007.

Sequentially, royalties were flat. The year-over-year decrease in royalties was primarily the result of lower ADSL chip set sales reported to us by our customers.

Second quarter spending was $7.7 million compared to $7.5 million last quarter and $7.9 million in the second quarter of 2007. The sequential spending increase of $200,000 was primarily due to higher cost of contract revenue, related to Biometrics Professional Services and higher Biometrics sales-related expenses.

Our hardware margins are generally in the 35% to 45% percent range. This quarter they were below this range, primarily because of a charge to cost of goods sold. We revalued our inventory to reflect lower costs that we negotiated with our component vendors and contract manufacturer. Excluding this charge, hardware margins would have been in our range.

Interest income for the quarter was $315,000 which was lower than last quarter and the year ago quarter. The decrease is primarily due to lower money market interest rates over the last six months and our decision to shift our cash into safer investments, given current credit market positions.

At June 30, cash was $37.9 million. Receivables were $5.7 million which equates to DSOs of 85 days and inventory was $2.1 million. This inventory level reflects the growth in our Test and Diagnostic Hardware business and long leadtime requirements.

Also as of June 30, we had no debt and there were 23.8 million shares outstanding. During the second quarter we repurchased 217,000 shares of our stock at an average price of $3.60 a share. We intend to repurchase more shares in Q3, subject to the provisions and limitations of SEC rule 10B-18.

At the end of the second quarter we had 120 full-time employees, 88 of whom were engineers.

This completes the (technical difficulty).

This business has been slower to develop than we would like but our level of confidence is very high that we will succeed in many of these opportunities of units (technical difficulty) and would involve multiple hundreds of dollars per unit in hardware sales and potentially multiple hundreds of dollars per unit in software sales to Aware.

These opportunities are being driven by the need for phone companies to monitor their ADSL2+ and VDSL2 networks. Our UDMT hardware modules and Dr. DSL software enable them to do so cost-effectively in a compact form factor.

A crucial part of our value proposition comes from our ability to integrate our know-how in DSL technology via a custom silicon device that is at the heart of our offerings. Also in testing diagnostics we continue to seek market penetration for our Line Diagnostics platform, a software platform.

We are receiving positive feedback from our sales activities from OEMs such as [Occam] as well as from service providers. LBP is a server-based solution that enables a phone company to use existing ADSL2+ and VDSL2, DSLAM, or test infrastructure to provide provisioning and maintenance of DSL services.

It is currently being marketed to North American as well as several international service providers.

The business model in Test and Diagnostics is a mix of hardware and software. Margins in the hardware module business improve as more Dr. DSL software is incorporated. The LBP is sold as software on a per line serve basis.

Revenues so far this year were below this same period last year and we have not hit profitability. We believe this is a consequence of revenue timing and will improve as some of the many testing diagnostics opportunities we are pursuing materialize.

Our position in this industry is strong with an expanding product line and strong customer interest for our handheld, test [head] and LBP software products. We believe that this business has tremendous promise going forward as phone companies deploy a combination of hardware- and software-based solutions to provision, diagnose problems and maintain their networks.

Our DSL licensing business continues to be challenging. We expected to see improvements in market share for StratiPHY-based products this year. However, a number of our customers chose to exit the market.

Earlier this month, [Thomson] announced that they will be discontinuing their DSL chip business and hence would not be selling the licensed products that we developed with them. Our relationship with licensee Ikanos is healthy but limited to ADSL opportunities; and Ikanos is focused on the DSL for their growth.

This means that Infineon is currently where our long-term growth prospects lie. And while we expect that they will significantly improve their position in the market, our overall outlook for the DSL licensing business is inadequate to support a DSL-only licensing strategy.

Having said that, Aware is one of the very few sources of DSL technology in the world and DSL will continue to be widely used for the delivery of residential broadband services. These are important facts that we consider as we chart our path forward.

Over the last 10 years, we've built a world-class communications and silicon design team which most recently delivered the first commercial VDSL2-compliant chipset on time, within budget and with a full compliance to an exceptionally complex and challenging communications standard. Based on this and past accomplishments in the DSL market, we are certain that we hold a tremendous asset in the digital communications silicon marketplace.

Our goal is now simple -- to select strategies that maximize the value of our silicon licensing assets. We have concluded that we must involve -- that that must involve a change to our strategy based on solely being a provider of DSL intellectual property.

As we have discussed previously, we see technology overlap benefits, natural barriers to entry, commonality among customers and other attractive characteristics in the home networking market. We are also evaluating other strategies which leverage our assets.

Our overarching goal for this business, however, is profitability and shareholder value over a reasonable time horizon. We are closely monitoring our opportunities, the marketplace, the competitive landscape and our internal progress to ensure that this goal is met.

As I have mentioned previously we are pursuing several opportunities that involve transactions with our patents. We view these as an especially valuable asset.

Turning now to guidance, we are lowering our guidance to a range of $24 million to $28 million. The primary factor that will allow us to reach the high end of this range will be our ability to sign new licensing deals.

At this point we would like to open up the call to your questions. Operator, please open up the call to questions. Thank you.

(Operator Instructions). Mr. Stanley Cohen.

You mentioned about the charge, the cost of goods sold to reflect the -- I guess the lower-cost of your chips going forward. Could you tell us what the absolute amount of that charge was? And also what will the positive impact be going forward, versus your previous natural rate of cost of goods sold on the product?

Yes. It was a fairly small charge. It was like $75,000. And you are right. It puts us in a position to enjoy better product gross margins going forward, because we lowered our standards to these new negotiated costs we have for our components and the assembly cost we have with our contract manufacturer.

So it means I can't quantify it, because it depends on how much hardware we sell. But it does mean that our margins should improve because our standard costs are now lower.

Okay, I mean, but what would the rate be, of margin improvement on -- ?

I still think we will be in the 35 to 45% product or hardware margin range. I just think that we will probably move up anywhere from 2% to 4% -- percentage points.

And, Michael, you mentioned closing a large [border] control deal in the quarter. Was all that revenue recognized in the quarter or is there any --?

Yes. A majority of it. There's am element of maintenance associated with that which reaches out into future periods. But the majority of that was a license to a number of seats that took place in the quarter that was delivered in the quarter.

That was delivered in the quarter.

Yes.

And the contract revenue in the quarter, is that maintainable going forward? Or was that a onetime thing that (multiple speakers) --?

Well, there are two elements to contract review now. There's the -- I think you are asking about the biometric (multiple speakers).

The [1.1 million] biometrics. Is that a maintainable level?

We think it is for the foreseeable future. This is a new element of sort of a strategy for us as I mentioned. The goal in this area is to take on projects where we develop a software application for a particular deployment. We use our own software products in that application to the extent we can so that once the application development process or the service aspect of this is done, there's an opportunity for us to sell products as whatever application that's developed is actually deployed.

So it has multiple pieces to it. One is, we think we can get a piece of services revenue on an ongoing basis and, for the next several quarters, that's certainly what we expect. And also we expect these Professional Services contracts to lead to software sales.

Is it possible for the contract rev -- the services business to grow or --?

It has over the last couple of quarters. You know, it was sub $500,000 in Q4 of last year. It was sub $1 million last quarter and it's over $1 million this quarter.

We are not expecting it to grow significantly at this point beyond that level. But over time, it might.

And have you seen the [fruits] of those people actually selling software again or that's just (multiple speakers) --?

Not yet. This is still -- the development is still going on.

Finally on the DSL licensing side, can you comment what the prospects are --?

Stanley? Hello.

It will be just a moment, Sir.

Okay. Thank you. As long as somebody is still there.

You're welcome. Mr. Cohen, go ahead and finish your question. I apologize.

Okay. Can you hear me now?

I can hear you, yes. Thanks.

Regarding the DSL licensing area [and] Infineon, can you speak to what you think the prospects are over there? There have been some stories in the press this quarter about them getting some pretty large potential design wins for VDSL2.

I mean, I understand that you are a little bit gun shy given what's happened up until now. But these opportunities seem rather large. It's (multiple speakers).

Yes. That is an excellent point. So, yes, Infineon has been very aggressively marketing, especially in the VDSL2 area. Earlier this quarter or I guess now in Q2, during Q2, they announced a new CPE solution which is really leading edge. It uses a number of technological innovations that we've been involved in that improve IPTV service deployment. Things like better coding and better noise immunity, things like that.

So from a technology perspective and from a product development perspective, they continue to very aggressively invest and be committed to the market. And we continue to be very aggressive in supporting them and they are a very important customer to us.

One of their customers has been talking about a significant opportunity that happens to be in the United States at large RBOCs here in the US involving the deployment of remote cabinets for VDSL2.

And that could indeed be significant. It looks like it's a real opportunity. It looks like this customer of Infineon's is in good shape to roll out some pretty significant volumes and that would absolutely have an impact on our DSL licensing business, a positive impact.

Okay. Thank you very much.

[Mike Eason].

Congratulations on a very solid result of the Biometrics business this quarter. If I could focus on the second leg of the stool, the DSL test business. You threw out some interesting numbers there talking about the test (inaudible) opportunity, measured in the thousands or tens of thousands of units with what sounded like mid to highly triple digit revenue per unit to quantities (multiple speakers) opportunity there.

Would you walk through some of the sequence of events that would have to happen to start to realize some of that revenue in terms of what do your customers need to do? [And] some of the large carriers to get to that stage?

Yes. So those types of opportunities seem to be the general size we are seeing, both on the handheld side as well as on the test side.

So in the handheld area you know we've, since the beginning of this year and part of last year, [Kirth] who I believe you have seen their device, has been deploying into a large European deployment. That activity between Kirth and the carrier probably began in the early part of '07. They began deploying in the latter part of '07 and into this year.

That is kind of the time frame that we are seeing for a lot of days. There is usually a trial lab sort of a validation or evaluation period and then often something in the field. And we have been involved in an increasing number of these. If we were to look at what we were doing last year versus, say, this year, a lot of our customers are involved in these opportunities. One of our customers is poised we believe to deploy handhelds into another European country at a pretty large volume in the near term, very near term.

And so I think the general time frame is probably something like six to nine months between a phone company deciding they want to deploy and going through the various processes they need to go through, of trials, etc. Many of these are already underway. The activity I've mentioned in Europe, there are other activities in Europe. There's a number of activities in the US.

Some of the US phone companies have taken longer than that to pull the trigger on actually deploying product. There is an opportunity in Canada that's moving along quite well. There is an opportunity in the Far East that's moving along reasonably.

So we are expecting in later this year and in '09 to start to see some real benefit from these. And the timing is always tricky. You are very familiar with the telecom, especially the carrier world. So it is very tricky to predict these, but there's nothing in what is going on that tells us that these aren't on their way to happening. There's always a question as to how quickly they will happen.

On the test head side, the largest opportunity is a big US RBOC who has been committed to deploying test infrastructure for a long time. One of our largest customers has been pursuing that opportunity. It has been a very long time coming. It has been something that they've been pursuing for multiple years now.

It still appears to be a likely event. They still appear to the in very good shape. In fact, I think they've -- generally feel like they have improved the likelihood of success there.

That could be one of these tens of thousands of units type size opportunities, if it really materializes.

Thanks. If I could turn to the licensing side of the business, the third part of the equation as it were. Maybe I can combine two questions here.

The continued investment in the VDSL2 IP licensed portfolio and could I potentially correlate that with what looks like a decline in a headcount over the quarter? Are you continuing to invest actively in things like, I guess, bonded DSL, some of the higher layer features that are included in your IP portfolio?

We do continue to support what Infineon is doing and to the extent that Ikanos is -- although they are primarily focused on ADSL2+ so that's more supportive of their product in the field as opposed to developing new products with them, but we do continue to develop new products with Infineon.

So there's some element of our engineering team that's still focused on VDSL2 developments because we do have a large important customer there. But as I mentioned in the call in the prepared remarks earlier, the idea of being a sort of -- of having a DSL-only licensing strategy has become very clear to us that's not liable.

We are aggressively pursuing technology developments and being very active at various standards bodies around home networking. You know about the HomeGrid group that we joined where we think we have got a real opportunity to participate as an IP supplier. We have many years of experience doing this. A lot of the people that we are talking to about licensing this technology to are very familiar with us.

So there's a lot of benefits in terms of the overlap between what we know how do very well, uniquely I would argue, and some of the requirements in home networking.

On the market side, we look back the home networking market as something that has some nice distinctions that make it different from the DSL market. It is a market that is not controlled by phone companies. It is a market that is very likely to have a much larger and more diverse group of companies that want to participate because there's plenty of belief -- and I tend to think this is probably accurate -- that some sort of home networking will end up not only in high-end electronic devices, but also in low-end devices and appliances and other places.

So there's a pretty diverse group of semiconductor suppliers who would be interested in this technology. And the size of the market is significantly larger than DSL because you have multiple devices in each home.

So for all of these reasons it's -- you know, it's nice that there is an overlap technologically and that it's a market we can get into from an engineering perspective. But the marketing aspects of it or the characteristics of it for the market perspective are also very attractive.

So one of the activities on the engineering side is to diversify away from being just VDSL2 development shop.

Great. Thanks very much, Michael. I'll leave it there.

(Operator Instructions). Stanley Cohen with Atrium Advisers.

One other thing. Can you give us an update on any progress in the patent licensing portfolio?

We've got a number of discussions going on there. It's a set of assets that we value very highly. It's a core technology asset of the Company. There are a number of, we think, opportunities to monetize those assets in a way that's both beneficial in terms of how they would generate shareholder value.

And also, one of the constraints we have been putting on this and I know I've talked about this, but I will mentioned it again is we are not really keen on going and starting a legal fight that would put the other businesses that we have in any sort of jeopardy because of a legal -- some sort of legal counterattack to Aware.

But we do think there are ways for us to monetize these assets and there are a number of discussions going on. And that's really what one of the elements of what I am talking about when I talk about getting to the higher end of our guidance range. Because if we are able to complete some of these deals, and I am optimistic that we will be able to, they would have a positive effect on revenues in the near term.

Thank you.

Thank you.

That concludes today's Q&A session. I would like to turn the conference over now to Mr. Michael Tzannes.

Thank you very much. Thank you, everyone. Just a quick note of an upcoming conference we will be attending. We will be at the AEA Conference in early November in San Diego, I believe it is this year. We will be posting a press release about that later on.

Thanks very much for attending and we will talk to you again next quarter.

That concludes today's conference. We thank you for your participation and hope you have a wonderful day.