Aware Inc (AWRE) 2010 Q2 法說會逐字稿

Good day, everyone, and welcome to the Aware Inc. second-quarter 2010 conference call. Today's call is being recorded. At this time I would like to turn the call over to Mr. Rick Moberg, CFO. Please go ahead, sir.

Thank you, operator. Good afternoon and welcome to Aware's second- quarter 2010 earnings conference call. I'm Rick Moberg, the Company's CFO, and I'm with Edmund Reiter, our President and CEO. Thank you for joining us today.

First, I will review the financial results for the quarter, then Ed will talk about the business, and then we will take questions.

Before we begin, 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 markets constitute forward-looking statements for the purposes of the private 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 Annual Report on Form 10-K for the year ended December 31, 2009. This Form 10-K is on file with the SEC. A recording of this call will be available on our website at Aware.com after the call is completed. Now I will discuss financial results for the quarter.

Before I begin, I would like to remind everyone that we sold certain technology assets to Lantiq in the fourth quarter of 2009. As part of that transaction, we transferred 41 employees to Lantiq. Financial results for Q2 last year include revenue and expenses associated with the assets sold in the transfer of employees. Financial results for Q2 this year no longer include such revenue and expenses.

With that in mind, revenue in the second quarter was $5 million, which is 14% decrease from $5.8 million in the second quarter of 2009. The net loss for the quarter was $148,000 or $0.01 per share. This compares to a net loss of $1.6 million or $0.08 per share in the second quarter of last year.

We also report net income and EPS on a non-GAAP basis. Our non-GAAP results exclude stock-based compensation expenses. These expenses were $203,000 this quarter. Excluding these charges, non-GAAP net income was $55,000 or $0.00 per share. A reconciliation of GAAP to non-GAAP results has been included in today's earnings release.

Now turning to revenue, product revenue for the quarter was $3.9 million compared to $3.9 million in the second quarter of 2009. Flat product revenue reflects a $400,000 increase in biometrics software revenue that was offset by lower DSL test and diagnostics hardware and software revenue.

Contract revenue was $346,000 for the quarter. This compares to $1.4 million in the second quarter of 2009. The $1.1 million decrease is due to two reasons. Number one, the sale of assets to Lantiq in Q4 reduced contract revenue by $900,000 because we no longer derive contract revenue from Infineon and/or Lantiq. And number two, we had $200,000 less contract revenue from biometrics professional services contract due to the completion of a larger project in the first half of 2009.

Royalty revenue was $714,000 for the quarter compared to $470,000 in the second quarter of 2009. The quarterly increase in royalties was due to higher ADSL chipset sales reported to us by our two principal licensees.

Now turning to spending and margins, second-quarter spending was $5.5 million versus $7.4 million in the second quarter of 2009. The $1.9 million spending decrease was primarily due to lower engineering spending as a result of our asset sale and employ transfer to Lantiq in Q4 of last year. Our gross margins on product sales were 79% this quarter compared to 73% in the second quarter of 2009. Higher margins this quarter were primarily due to a higher proportion of software revenue and product sales.

We also recorded $325,000 of other income this quarter. This amount represents proceeds from a legal settlement with a former customer. Interest income for the quarter was significantly lower than the corresponding period in 2009. The decrease was primarily due to much lower money market interest rates.

Now turning to our June 30 balance sheet, cash was $39.1 million at quarter end, which is up $100,000 from last quarter. Receivables were $4.5 million, which equates to DSOs of 81 days. Inventory was $3.1 million compared to $1.1 million last quarter. We had no debt, and there were 19.9 million shares outstanding at June 30.

And finally, at the end of the second quarter, we had 81 full-time employees, 48 of whom were engineers.

This completes the financial commentary. Now I would like to turn the call over to Ed.

Thank you, Rick. In the second quarter, we made substantial progress toward our long-term goal of migrating our OEM business model to one where we sell on both an OEM and on a direct basis to end-users. This progress is evidenced by some recent transactions in our biometrics and DSL test businesses.

In our biometrics business, we signed a deal with the United States Department of Defense agency in late June to which Aware is responsible for the design, development and testing of a biometric handheld application. This effort, which we expect will span several years, involved a direct contractual relationship with the US government and should expose us to additional opportunities for business.

In our DSL test business, we have signed deals with two service providers covering the license of our LDP software product for use in lowering the cost of provisioning, maintaining and troubleshooting their DSL networks. These LDP deals represent important steps in the development of our test business as they expose us directly to end-user requirements and position us to meet those requirements. Although due to timing and engineering development activities, these deals have not affected our revenue line yet. They are solid indicators of progress on our strategic plans.

From a financial perspective, we did not achieve our immediate goal of breakeven or better performance. While we were somewhat disappointed by the quarter's financial results, we had some accomplishments in the quarter that were both positive for the quarter and position us well going forward.

First, in our biometrics business, we had follow on software sales to an OEM that is involved with deploying the FBI's next generation IAFIS system and to a large DOD agency that is deploying a biometric credentialing application. I should clarify that this DOD agency is different from the one that I mentioned a moment ago for whom we are developing a handheld biometric application. These deals continue to demonstrate that our products are well-regarded and capable of winning in highly competitive sales situations.

In our DSL test business, we continued to see strong demand for aggressively priced handheld test products and are seeking to leverage our early success in this portion of the market by investing in follow-on products. This demand for our OEM hardware products, coupled with the LDP software deals mentioned previously, illustrate our unique approach to the market where we saw hardware products on an OEM basis and software products on a direct basis. We believe this approach positions us well to compete over the long term.

Now turning to the test business, in the OEM hardware side of our test business, we saw increased interest in lower-priced handheld test equipment focused around VDSL test solutions and support of VDSL deployment and IPTV services. We believe this portion of the handheld test market will support higher volumes than the mid and higher price segments of the market and are positioning ourselves to provide an attractive value proposition for vendors of such equipment.

Our value proposition, originally based on the widest possible interoperability footprint and embedded DSL test functionality, is expanding to focus on reducing the costs incurred by our OEM customer base in developing equipment based on our hardware products. We are driving this cost reduction effort by identifying and eliminating design and integration costs so that our customers can quickly and cost-effectively design equipment based on our hardware products. By reducing such costs, we seek to expand our customer base and allow our customers to focus on differentiating their end-user products. Our initial product development activities in this area have been well received, and we hope to ship product targeted at this segment of the market before the end of 2010.

We anticipate expanding our value proposition further to include additional test functionality targeted at the end home networking segment of this market. Based on feedback from our OEM and direct customer bases, it is clear that test solutions that quickly and cost-effectively identify the location and nature of a problem whether inside or outside the home can bring substantial cost savings to operators of DSL networks. Doing so at price points that are consistent with the lower cost, high volume segments of the market will strengthen our position in the DSL handheld test market.

The underlying drivers of the handheld DSL test market continue to be VDSL network buildouts and IPTV services. These trends continue to show strength and are driving market requirements and overall demand.

On the software side of our test business, we see an increased level of confidence in the market for software-based test solutions. These solutions utilize line diagnostic data, commonly known as single-ended line test or SELT and dual-ended line test or DELT that is available on most of the current DSL/DSLAM infrastructure. By increased level of confidence, I mean that service providers are more willing to commit to critical test architecture decision that include DSLAM-based SELT and DELT measurements. This confidence reacquires proving the accuracy of software-based test solutions in the lab and field and identifying business cases which support its deployment.

Based on point topics market data, we estimate that over 90% of the DSL infrastructure worldwide now provides usable line diagnostic data. The penetration of testable DSL infrastructure is encouraging as our Line Diagnostics Platform utilizes exactly this infrastructure to lower the cost of provisioning, maintaining and troubleshooting DSL networks. The availability of testable DSL infrastructure, coupled with positive trends in IPTV and VDSL2, are driving demand for products such as our Line Diagnostics Platform.

The business cases supporting SELT- and DELT-based product purchases involve standard service assurance and network reliability metrics. Rapid and accurate identification of [loop] impairments leading to improved technician dispatch efficiencies directly drives cost savings. Proactive identification and repair of line problems prior to customer support calls is another direct driver of cost savings.

Our Line Diagnostics Platform software is focused squarely on utilizing already deployed DSLAM assets to save service providers money during deployment and operation of their DSL networks.

Successfully demonstrating an attractive return on investment to service providers requires an in-depth understanding of their existing processes and the savings LDP can deliver. We successfully demonstrated such an ROI in the two LDP deals mentioned previously. Aware's depth in DSL technology, coupled with our understanding of DSL test requirements derived from our participation in this market over the last years, makes us a strong supplier candidate for software-based test solutions. We will continue to refine our products based on these deployments over the coming months, and we will work to leverage these initial successes as rapidly as possible. We were also pleased to announced last week that our LDP product received Frost & Sullivan's Product Differentiation Excellence of the Year Award for the DSL test and measurement market.

I will now discuss the biometrics business. As mentioned in my initial remarks, in our biometrics business, we successfully competed for follow-on work involved in the design, development and testing of a complete handheld biometrics application. We had previously won business from this program, and the current deal illustrates our ability to win additional business from an important US federal government biometric program. Our performance on the previous program contributed to the confidence necessary to win follow-on work, and we are pleased with this development in our business.

The program is expected to last 18 to 24 months, and we are focused on executing and potentially expanding this relationship. We now have the skill sets and infrastructure necessary to compete for certain biometric programs directly or to partner with system integrators while playing a larger role in delivering more value than we did in the past.

We are pursuing similar opportunities in non-US federal government markets by partnering with system integrators and VARs worldwide. While these opportunities generally have long sales cycles, we have been active in marketing our capabilities as a more complete application and solutions provider for some time. Our ability to quickly and cost-effectively translate customer needs involving complicated biometrics-related image processing and standard compliant interoperability requirements makes us a strong candidate to supply products for biometric programs both in the US and overseas. Our intention is to continue to pursue such programs so that we can build revenue backlog and provide follow-on business opportunities.

We recently announced a Personal Identity Verification or PIV with system integrator, ICF International subsidiary Jacob & Sundstrom to a non-DOD federal agency. The US federal government PIV program is part of an overall activity to increase security in US federal government agencies by utilizing a biometrically secure credential. The program involved our Universal Registration Client application or URC, our biometric services platform or BioSP, and software customization services. Our URC product manages the front end of the enrollment process by supporting the collection of fingerprints, facial images, biographic data, identity documents and digital signatures. BioSP supports the overall enrollment workflow and interfaces with legacy systems to deliver background checks and PIV card personalization.

Of specific importance to this customer was our ability to manage lifecycle costs effectively by eliminating dependencies on obsolete hardware. This was accomplished using image processing technology we developed specifically for the purpose of managing hardware obsolescence. By providing a value proposition ranging from detailed image processing technology, easy to integrate products and software customization services, our customer was able to quickly stand up a high-performance system. Our system integrator partner, Jacob & Sundstrom, has deep experience in PIV system design and stand up, and we are pleased to be a supplier to them on this program.

We continued to invest in our patent portfolio during the quarter. We are focused on high quality standard space patents in the digital communications and signal processing areas, as well as in areas related to our product strategy in the DSL test and biometrics and imaging areas. We continued to pursue strategies and opportunities to leverage this valuable set of intellectual property assets into shareholder value.

Overall we are making good progress toward migrating our business model to one in which a portion of our sales are targeted at end-users or at least substantially deeper in this channel than we had traditionally operated. At the same time, we continued to maintain focus on our OEM customer base and component model as this represents the majority of our current revenue and is crucial to us going forward. Ultimately we would like to be in a position to segment the markets we operate in so that we can run an OEM component model in some segments and a more direct sales product model in other segments. This strategy will support our long-term goals of growth and profitability. The end markets in which we operate are big enough to support a far larger business than we have, and our goal is to execute on our strategy to achieve growth.

This concludes our prepared remarks, and I will now turn the call over to the operator to take any questions you may have.

(Operator Instructions). Stanley Cohen, Atrium Advisers.

Was the small increase in contract revenue due to the start of this handheld project for the US Defense agency or whatever it is?

It was due to a bridge or kind of a precursor to it.

Okay. So the quarter did not benefit materially from it?

No.

And also you did not -- maybe -- did you make any mention of the contract you announced a few weeks ago with the European Police Department or law-enforcement agency?

I did not talk about it in the prepared remarks, no. I can give you a little bit of color on it now if you would like.

Sure. And was this quarter affected by sort of order of magnitude going forward?

Yes, I would not say it had a big impact in this quarter. The real benefit of it or the real importance of it was that it involved our BioSP product acting as an intermediary between large-scale fingerprint identification systems, basically facilitating the interoperability between one large federal system and one part of a region of Europe with the US and with other police agencies in Europe that are more Europe-wide. I'm not at liberty to talk in too much detail about it.

It is a very important win for us. It is a tough customer. I think the real benefit is we are hoping for similar kinds of follow-on work and follow-on business from other people with a similar need.

But isn't this also material -- in what timeframe?

We did not talk and we cannot talk about the specific impact on the quarter. Its major benefit to us and I guess biggest importance to us is demonstrating our performance in this particular segment of the market in terms of delivering interoperability between large-scale ID systems.

And the two LDP contracts in Europe, is it a coincidence, or was it done with the same carrier?

Two separate customers. (multiple speakers)

I mean equipment manufacturer, I'm sorry?

There are two separate service providers to whom we signed LDP deals with. And a coincidence, maybe given that we have been working on it for a while, but they are two separate pretty much unrelated deals.

I misspoke. I meant were they done with the same equipment manufacturer results -- (multiple speakers)?

No, it would not account for it. These are deals directly between us and the telco without going through an equipment manufacturer.

Okay. And can you give us something like how many more of those you have in the hopper you are working on so we can get a feel for --?

I mean I can certainly communicate to you that our goal is to -- we are marketing to many other people, and the goal and strategy of the business is to build that segment of our customer base. So we have been working on that for a while, and we've got a couple of wins here and that is great. We are really excited by it, and our goal is to get a lot more.

(Operator Instructions). [John Philips], private investor.

It sounds like there's a lot of good things in the pipeline. I just wanted to get a sense for the importance that we are likely to see -- the contract that you want to design, develop and test a biometric handheld device, I guess at this stage in that project, this will manifest as contract revenue? Is that correct?

Yes, it would begin as contract revenue. In the event that those activities came to a successful fruition and the product made it into volume deployment, it would migrate from contract revenue to product revenue.

Okay. And is there any sort of sense at this point for the magnitude of the revenue, and will it begin in Q3 or at some later time?

I would expect that it would begin in Q3 on the contract line. And then, as I said, if the product successfully gets into the market and we will do everything we can to see that it does, it will migrate from contract revenue to product revenue. And we, at this point, cannot talk about the size of it, but it will start showing up on the contract line in the third quarter.

And on the biometrics program with both the BioSP and the URC, as that was deployed with the -- in the US --

In the PIV.

-- GSA customer, was this a similar product that was also deployed in the European law-enforcement, or was it --?

Okay. That is an interesting question. There is one, the European situation involved the BioSP product, and the reference PIV win with Jacob & Sundstrom involved the URC plus the BioSP product.

And so the BioSP product is common to both situations. In some sense it shows the flexibility of the product. In one case it is operating as an interoperability bridge between systems. And in the other case, it is managing a biometric secure credentialing application. So that product is in common but in very different usage modes.

It also, and I guess this is a question, the BioSP also is a way to table or platform other Aware biometric products, is that correct?

You could think of it like that. The BioSP you can think of as an application server or a subsystem that sits back in the network and can contain as, you can think of it as processing blades, various Aware products that we can sell as libraries or -- yes, we can't sell as libraries or components. But what BioSP can do is we use the same underlying technology, but they reside in BioSP as we would call them processing blades or blocks and essentially perform a very similar if not identical capability but from a centralized location.

Is there any sense that you can give us on the size of this market? And I guess there's a couple of questions I would have. Number one, what is a typical value per unit to Aware if you can say that? And how many units -- you did reference in one of your PR pieces that there are 200 applications of the BioSP in US state police -- in the US state police system. So there is a number, 200 sort of units is what I would interpret that is. Is there anyway you can say what is a typical value to Aware, maybe not the precise for those specific, but a typical average value to Aware on a per unit basis?

I mean it is a tough one to answer. It is a perfectly valid question, but let me try to give you a general idea of the difference -- of the relative pricing between a BioSP type of sale and a license of a bundle of components onto a client. The license of a bundle of components onto a client is generally in the hundreds of dollars, and the sale of BioSP is in the tens of thousands of dollars. You can drive it a little bit outside that range and maybe license a single component on a client in super high volume and maybe get a little bit lower than that, not much. And you could also fully load a BioSP with many processing blades on a very powerful server and get above the 10s range into maybe 100. But generally it is tens of thousands for one and hundreds of dollars on the other.

That is helpful. So, in the case of that deployment with the state police system, we are looking at --

I'm not --

200 deployments of a $10,000 plus product?

I'm not sure exactly what you are referencing there. So I would hesitate -- like, I do not want to respond until I have that in front of me. But those -- that is generally what the difference between your server class BioSP type pricing and the components on a client are.

Then would you say there are tens of thousands of deployment opportunities for BioSP, or could you -- in terms of how big is that market for Aware?

Yes, it is a good question. I would not answer it at the moment without really framing it I think a little bit more precisely than you have. Tens of thousands sounds a little bit high to me right now. Because if you look at the type of environments I have mentioned, the PIV installations, the interoperability stuff, those are somewhat smaller than that. But our basic product strategy for BioSP was to build a flexible product that, for example, could work in either as an interoperability bridge in a criminal justice kind of background or as a product to manage the enrollment and issuance of biometrically secure credentials. And basically by having that flexibility, it exposes us to larger and larger market opportunities.

Is there any sort of maintenance or annual revenue component to any of these deployments?

Our standard software model is to sell software licenses, essentially perpetual right to use licenses plus software maintenance. So it is a pretty -- the software maintenance represents a recurring element, and it is by and large purchased by the customer base. Occasionally there will be somebody who prefers to go with that for whatever reason. But it is part and parcel of a standard software model, and it is an important part of our business.

(Operator Instructions). It appears we have no further questions in our queue at this time. I will turn the call back over to Edmund Reiter for any closing or additional remarks.

Thank you, operator. Please visit our website, www.aware.com, for a list of upcoming tradeshows we will be attending in the third quarter. Thank you very much for attending today, and we look forward to speaking with you on our Q3 call. Thank you.

Thank you for participating in the Aware conference call. You may now disconnect.