Aware Inc (AWRE) 2008 Q4 法說會逐字稿

Good day, everyone. Welcome to the Aware, Inc. fourth 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 fourth quarter 2008 earnings conference call. I'm Rick, the Company's CFO and I'm with Michael Tzannes, our CEO. Thank you for joining us today. First, I will review financial results for the quarter and then Michael will talk about the business and then we will 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 and the DSL and biometrics market 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 31, 2007. This Form 10-K is on file with the SEC.

Now, I will discuss financial results for the quarter. Revenue for the quarter increased 79% to $12.1 million from $6.8 million in the fourth quarter of 2007. For the year ended December 31, 2008 revenue increased 15% to $30.5 million compared to $26.4 million in 2007. On a GAAP basis, net income was $5 million or $0.21 per diluted share for the quarter. This compares to net income of $193,000 or $0.01 per diluted share in the fourth quarter of last year. For 2008, GAAP net income was $1.8 million or $0.07 per diluted share. In 2007, net income was $160,000 or a $0.01 per share.

We also report net income in EPS on a non-GAAP basis. Our non-GAAP results exclude stock-based compensation expenses. These expenses were $390,000 this quarter and $1.5 million for the year in 2008. Excluding these charges, non-GAAP net income was $5.4 million or $0.23 per diluted share for the quarter and $3.3 million or $0.14 per share for the year in 2008. A reconciliation of GAAP to non-GAAP results has been included in today's earnings release.

Product revenue was $2.2 million for the quarter compared to $3.9 million last quarter and $5.2 million in the fourth quarter of 2007. The sequential decrease in product revenue was due to lower sales of biometric software as well as DSL test and diagnostic hardware and software. The year-over-year decrease in product revenue was due to lower sales of DSL test and diagnostics hardware and software. Contract revenue which includes patent, license and engineering service fees was 9.3 million for the quarter compared to $2 million last quarter and $1.1 million in the fourth quarter of 2007. The sequential and year-over-year increases in contract revenue were primarily the result of an $8.5 million contract we closed in Q4 involving the sale of patents.

Royalty revenue was $527,000 for the quarter compared to $437,000 last quarter and $518,000 in the fourth quarter of 2007. Royalties were above $90,000 sequentially due to higher DSL chipset sales reported to us by our customers. On a year-over-year basis, royalties were flat.

Third quarter spending was $7.3 million versus $7.3 million last quarter and $7.1 million in the fourth quarter of 2007. These consistent levels of spending reflect no mayor changes in our cost structure during 2008. Our reported gross -- excuse me. Our reported product gross margins were 72% this quarter compared to 87% last quarter and 82% in the fourth quarter of 2007. The lower margin this quarter is primarily due to lower hardware margins and less software revenue in product sales.

Interest income for the quarter was $222,000, which was lower than last quarter in the year ago quarter. The decrease was primarily due to declining money market interest rates and our decision in Q1, 2008 to shift our cash into safer investments given credit market conditions. At December 31, our cash was $45.5 million which was up $7 million from $38.5 million at the end of 2007. Receivables were $2.2 million which equates to DSOs of 17 days and our inventory was $1.7 million which was down $100,000 from last quarter.

Also, as of December 31, we had no debt and there were 23.3 million shares outstanding. During the fourth quarter, we repurchased 29,000 shares of our stock at a total cost of $67,000. Since our stock repurchase program was initiated last year, we have repurchased a total of 721,000 shares at a cost of $2.4 million. We intend to continue to repurchase shares from time to time subject to applicable SEC rules. At the end of the fourth quarter, we had 122 full time employees, 86 of whom are engineers. This completes my financial commentary and now to Michael.

Thank you, Rick. Overall we are pleased with our 2008 results. Annual revenues were up again and we have been profitable for three years in a row. Looking more closely at our overall performance, it can be further characterized as follows.

Some areas of our business grew exceptionally well, while others did not meet our internal goals. Our biometrics business exceeded our internal goals in 2008. Our annual biometric sales were up nearly 60%. The operating metrics of this profitable product line are superb. Sales are driven by a broad array of software products sold to hundreds of OEMs, system integrators and end user agencies.

We also provide professional services. Aware has a long standing presence in enrollment applications and has emerged as a lead supplier for border control and secure credential applications. The combination of software products and professional services appears to be a powerful one.

In DSL test and diagnostics products, we have a large number of test head and hand held design wins including some with leading vendors such as JDS Uniphase, Spirent and others. We are also optimistic about the market potential for our Line Diagnostics Platform, a soft test solution that is in several lab and market trials, as well as in some small scale deployments. However, the slowing economy is having an effect on the telecommunications market and is expected to put pressure on telephone company CapEx budgets. Despite, this we are optimistic we will do well in the longer term as the next wave of test infrastructure for DSL rolls out.

Our stratified DSL silicon and intellectual property products continues to experience weak market demand because chip companies remain reluctant to enter the DSL market. While we haven't been able to sign any new licensees, royalty revenues from existing customers, Infineon and Ikanos, improved in each quarter in 2008.

We have been focusing on diversifying into new revenue opportunities, with transactions involving our patents and by expanding into new technology areas such as home networking. We executed a significant contract in December involving a portion of our DSL patent portfolio. This contract was $8.5 million of our sales in Q4. Monetization of our patent portfolio has been an ongoing area of interest, and we are encouraged by this contract that we believe validated that there is a market for high quality patents.

One of the elements of Aware's strategy has been to lead in innovation in our markets. We participate actively in relevant communications and imaging standards bodies and we patent our inventions to protect them. We have over 130 issued US and foreign patents that address a number of communications and signal processing applications. While predicting the size and timing of additional patent related revenue is difficult, we continue to expand this portfolio and to pursue additional monetization opportunities.

One area that we have identified as a new technology opportunity, is home networking. A new ITU standard called G.HN reached consent in December. We were actively involved in the standardization process. G.HN is focused on high speed network communications throughout a home, utilizing premises wiring. We believe the G.HN represents the future of home networking and that Aware is in a unique position to deliver high quality, innovative solutions to this opportunity.

While 2008 results overall were generally good, it is important to point out that starting in the fourth quarter, we experienced a slowdown in our business, that is a consequence of a challenging macro economic environment. Revenues trended down across each of our traditional product lines, with royalties being the only exception. Many of our customers have slowed their purchasing decisions, often because their customers are doing the same. We believe that this environment continues to exist today, and that it is likely to continue to have an impact on our business going forward, making it more difficult than usual for us to make predictions about our near term business.

We continue to see significant market interest in our products, but actual sales visibility is low. Because of this, we are unable to provide revenue guidance for the year. We do intend to revisit this topic in the future when our revenue visibility improves. Despite the current lack of visibility, we remain optimistic that we are well positioned for the future. The fundamentals of the biometrics market and hence, the long term outlook continue to appear strong. Basic driver,s such as continued investment and improved immigration and border control systems are in tact and deployments of these systems continue. While these initiatives are largely government driven, the resulting standardization, volume, and ultimately the cost effectiveness of these systems continues to provide the basis for broader scale use of biometrics within both the government and commercial sectors.

We also continue to believe that the DSL test market presents a significant opportunity for us. We expect that this will be driven largely by increased deployments of higher value entertainment quality services, such as IPTV, video and triple play by phone companies. According to the market research group, the worldwide IPTV subscriber base will grow from 11 million today to 89 million in 2012 mostly based on DSL subscribers.

As Rick pointed out, our cash position remains strong and improved in 2008. We believe it is important, especially in times like these to closely monitor expenses, and we are doing so across all areas of our business. Our long term goal is to build shareholder value, by leveraging a strong technology base into innovative products and service offerings. We remain optimistic that we're making progress toward that goal. At this point, we'd be happy to take your questions.

(Operator Instructions). We will take our first question from [John Patent] with Pacific Rock Capital.

Thank, guys. It is actually Chris Donnelly. I appreciate your taking my call and question and congratulations on a good quarter. I was hoping to see if you could maybe give us a little bit of sense on the patent portfolio side. If you can give us a monetary value of how big you think that could potentially be, and then maybe a time line over, how long you think it would take to continue to monetize that portfolio.

Okay. Well, that's a tough question, and it is -- it is a question we are also addressing internally. So I can tell you that we don't really have an answer, although it is a question that interests us very much.

I will give you just some of the parameters of what are the basis of our portfolio. We have a very broad portfolio, especially strong in DSL and in some imaging applications. But it also addresses other communications and signal processing applications. I presume you know the Company's been around for a while so a lot of these inventions date back many years and in many cases were pioneering inventions for certain types of technology. There isn't really a liquid market for patents and part of the reason that I talked about why we were encouraged by what happened in the fourth quarter is that we --we believe we validated at least for ourselves that there is a market for a high quality patent portfolio. And that leads us to believe that there is a good potential that we can generate additional revenues from this patent portfolio.

I can tell you that we don't intend to sale all or potentially even a majority of our patents because one of the primary reasons we built the portfolio was for defensive reasons to protect ourselves and generally that's, that's our -- that continues to be our primary goal when we go and file for patents. But it looks like this opportunity exists. There are companies who are interested in purchasing patents from other companies. We have been in touch with a number of them and we are going to continue to pursue these kinds of opportunities. We continue not to be interested in going off and litigating our patents ourselves just because of the -- for a number of reasons.

Would you say we are just scratching the surface in regards to monetizing this portfolio at this point?

You know, again it is hard to say because we don't really know how big the potential customer base is. And if we were -- if we had made our first sale of one of what we knew was a large number of companies I would feel more confident in giving you an answer, but given that this -- but given that this is not really a liquid market and valuation of patents is a very subjective and sort of artful exercise, it is tough for us to say. We think these patents are very relevant to the technologies we've written them for. What they're going to be valued at by third parties is still something we are, we are discovering.

Okay. But it is still safe to assume we are in the early stages of the monetization for you guys.

Yes, this is really the first time we have done anything like this. We had a patent related transaction we talked about I think two years ago, which was similar to this, but this is -- this is a lot more, yes, so yes.

How do you look at the time line toward monetization?

Tough to predict but something we are pursuing.

Okay. So --

I would be hesitant to -- I would be reluctant to say it is ever going to be a predictable revenue stream. It is likely to be -- sort of come in fits and starts just because of the nature of the types of contracts that are likely to get executed. But we are really just learning about it. We are at the very early stages.

But it is fair to say that there's an increasing focus on the part of management to monetize these patents and it seems like the demand is accelerating based upon your initial experience here.

We've been focused on it for some time. We are encouraged by the fact that we were able to close a deal that sort of validated our hunch and prove that we do, do have a strategy that could pay out here.

Okay. And can you just give us a sense, I mean I'm assuming it is a very high margin proposition for you guys?

Sure. Yes.

90% type of gross margins or better on that?

Yes.

Okay. Thank you. I will jump back in queue.

Thank you very much.

(Operator Instructions). Our next question will come from Tom [Curdo].

Could you just expand a little more if possible on the contract sale? Generally my question is, do you sale any crown jewels? And specifically, was it DSL related -- that's probably too broad, but was it DSL related patents?

It was DSL related patents, and one of the things that we've -- as I was saying to the earlier caller, the earlier question, we are very conscious to make sure that we have -- that we retain a very strong patent portfolio. So, whether something is crown jewel or not, if -- I am not sure how you qualify -- or quantify the term. But suffice to say that we retain what we believe are our crown jewels in the patents that we kept.

Okay. So can you say it is -- you sold nothing related to DSL test and diagnostics work that you have been doing?

How can I say that. Yes, I probably can't get into too many more details, but I can say that this transaction and in general, in the strategy we been pursuing to monetize the patents, our intention is to always retain our ability and whatever rights we need to continue to develop and sell our products, all of our product, any of our products.

Okay. That was my next last question. Let me see if I got this clearly. You sold your patents, but you -- are you saying you are reserving certain rights to use them?

I can't comment on any specific deals, but I can say that our strategy to monetize the patents involves us retaining the right to whatever -- retaining whatever rights we need from those patents to continue to practice our business. To continue to build and sell products.

Okay. That's great. I will hand it over to someone else.

All right. Thank you, Tom.

Our next question comes from Stanley Cohen with Atrium Advisors.

Hi.

Hi, Stanley.

Do you know of any design wins that your DSL chip customers have had that would account for the 20% sequential increase in revenue?

Well, we know that they have been very active so the -- I will talk about each of them. Infineon's continued to be very active, especially in the European arena, but they have expanded beyond that and I don't think they have publicly discussed any of the design wins that we might know about. So I probably can't. But they continue to very aggressively market both CO and CPE chipsets. As you know, they acquired a CPE business from TI and they're in the process of addressing that customer base, which is now largely transitioned to them because it has been over a year now since the acquisition took place. So without identifying any specific customers, it is safe to say that they have expanded their market share over the last year.

In Ikanos' case, I think they're a little bit more explicit about the area -- the area of their business that we are -- that relates to us, has to do with their ADSL chips and their primary customer there is Sagem. And to the extent that Sagem sells outside of France Telecom which has been the main customer for their modems, there would be an expansion of their market share as well. And I think it is safe to say that they're aggressively pursuing additional business outside of just France Telecom.

And back to Infineon, regardless of who the design win is with, is it the beginning of a large deployment or is it --

The market that has been largely as I think you know, it is really consolidated especially on the CO side, to really just maybe four people if you want to include Connex, who is very specific in their design for [Aucutel] for AT&T. So I don't -- I think -- I don't think we can point to any specific deployment and say this is the beginning of something or not. It seems to be a general improvement in their, in their position in the market.

Okay. And just back to the biometrics,sort of backing out what it was based on cost of goods sold. It looks like it was pretty weak. You've recently -- a few months back or whatever you hired someone to sell overseas, some of this to local governments. Have you seen the fruits of those labors? And what's going on there? I mean --

So the business was, as I pointed out in my remarks actually. Every part of our business, every sort of traditional product line was down in the fourth quarter except for royalties which were up. And I don't consider patent-related revenue a traditional product line just yet. I think the, the source of lower revenues in the quarter was really just general across a very broad array of customers. It wasn't any specific trend that we identify when we look at that -- at what happened there. And in fact, Q4 has typically been weaker than Q3.

So you can't read a whole lot off of that trend. But it did trend down without question. In answer to your -- we have expanded our sales, in answer to that question about sales, we have expanded our sales force and concentrated in certain areas. We haven't started to see any significant results from that yet. But we continue to be optimistic that it is going in the right direction.

But it wasn't due to any cancellation of programs or competitive loss of market share.

No, not that we know of. There may have been here and there things like that but no, nothing specific.

Finally, a more general question.

Yes.

In light of the economic environment that you're customers are also facing, have you noticed either anecdotal or any trend where a customer who had previously wanted to develop the technology in-house, be it for having it long term or not invented here attitude are now more apt to come to you to save money up front?

Yes. Well across --I think across the test, in the test market, there's, there's probably some evidence of that, and I don't know if it is a result of economic challenges at the various OEMs or product maturity on our side. But the design wins for our test and diagnostics, especially the hardware modules, were very strong this year. We have got into a number of very promising products at a number of OEMs including some of the lead folks in the industry. So that may have had some consequence there.

In the DSL IT side, unfortunately, there just isn't much interest in DSLIP. I don't think the question is being asked inside companies as to whether they want to pursue IP for DSL. If that question isn't asked whether you make it or buy it, doesn't get asked.

On the home networking side, we are aggressively marketing. We're involved in the HomeGrid, which is a marketing organization that we are one of the founders of. We are in touch with anyone who we can identify as a potential interested party in HomeGrid. We are active, very active at the ITU as I mentioned, and it is difficult to say today whether the economic environment is swaying that kind of decision because right now what appears to be happening more than anything with the economic environment is people are sitting on the sidelines, especially when it comes to a speculative new technology like G.HN . But it is -- we still see it as an opportunity. We think we are well positioned there to go after some -- delivering some high quality technology into the market. But I don't think the demand inside a lot of the companies we are talking to is mature enough to be able to decide whether a make versus buy is swinging our way or

Thank you very much.

Thank you, Stanley.

Next we have a follow up from John Patent.

Thanks, guys, just one last quick question on the sale of the patent. Will you guys be receiving any type of residual income based on sales to this customer on their -- on their future product sales?

Yes, we can't really comment on any specifics about the contract. Generally speaking, when we license or sell technology, our intention is to have that kind of structure. But I can't speak specifically about this particular deal.

Okay. Thank you. One last quick question as you look at operating expenses, where do you think I guess we are in terms of taking costs out of the business and continuing to try and [right size] and improve profitability?

Well, as I mentioned, it is something we are looking very closely at. Right now, on the biometrics side, it's a very profitable business. There's no interest really in taking anything out of it. We have managed to grow the business from a number -- a number in the high single digit millions to +50% that this year and we did that while maintaining the operating margin that we had targeted inside the Company. So that business is doing exactly what we wanted to do, grow reasonably rapidly while maintaining its business model.

The test business isn't making money, but we continue to think it is got a lot of promise. And the macro trends that we see in the DSL test market are, video becoming a very important offering by phone companies and we think we have a real edge when it comes to the types of technologies that are going be used for video, ADSL2+ and VDSL2. And right now the market is weak, the economic environment is tough, phone companies aren't spending a lot of money. But it doesn't look like they're steering away from DSL. In fact, I wouldn't be surprised to see more DSL get rolled out over time. This is just my opinion because DSL is a lot cheaper than all fiber or other alternatives. So if the economic crisis is going to continue in any way, I wouldn't be surprised to see phone companies decide to maybe stick with their DSL a little longer or invest more in their DSL as opposed to going to the fiber solutions.

On the licensing side as I mentioned, our DSL IP business hasn't been healthy for a while and our focus there is to try to refocus that, diversify that into other areas. So, our current plan is to build revenues.

Okay. Fair enough. Thank you.

Thank you.

(Operator Instructions). We do have a follow up from Tom Curdo.

Regarding growing revenues, will you be willing to predict whether your first quarter revenues could be up from a year ago, of course excluding another one of these one-time --

We are not -- we are not capable right now of predicting much, Tom. That's why I wasn't willing to do it. So --

Right. Well --

Thanks for the question.

My main question is in my view cash is king right now, and in fact I would prefer if you weren't buying any stock. But you're not cutting costs, as I understand it. So can you comment on what cash flow should be like in the first quarter?

Well, no. That is largely predicated upon what revenue will be and what our profitability will be. As Michael as mentioned, it is a bit of a challenge at the moment to forecast those numbers and due to the challenge involved we'd rather not do that right now.

Okay, Rick. Thank you.

Thank you, Tom.

At this time we have no further questions. I would like to turn the call back over to Mr. Moberg for any further comments..

Well, thank you for joining us today. We appreciate your participation and we will see you at the end of the first quarter. Bye now.

Once again that does conclude our conference call for today. We thank you for your participation. Have a great day.