Aware Inc (AWRE) 2010 Q3 法說會逐字稿

Good day, everyone, and welcome to the Aware, Inc., Third Quarter 2010 Conference Call. Today's call is being recorded. As 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 Third 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'll review financial results for the quarter, then Ed will talk about the business, and then we'll take any questions. Before we begin, 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 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, 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 complete.

Now, I'll discuss financial results for the quarter. Before I begin, I'd 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 the first nine months of 2009 include revenue and expenses associated with the assets sold and the employees transferred. Financial results for this year no longer include such revenue and expenses.

So with that in mind, revenue of $6.2 million this quarter was approximately the same as revenue in the third quarter of 2009. Net income for the quarter was $76,000, or $0.00 per share. This compares to a net loss of $1.1 million, or $0.06 per share, in the third quarter of last year.

Revenue for the nine months ended September 30, 2010, was $16.7 million, which is a 1% increase from $16.6 million in the same period last year. We had a net loss for the nine months ended September 30 of $50,000, or $0.00 per share. This compares to a net loss of $4.9 million, or $0.23 per share, in the same period 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 $621,000 this quarter. Excluding these charges, non-GAAP net income was $697,000, or $0.03 per share.

For the nine-month period in 2010, non-GAAP net income, excluding $1.2 million of stock-based compensation charges, was $1.1 million, or $0.06 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 $5 million, compared to $4.7 million in the third quarter of 2009. The revenue increase reflects an increase in test and diagnostics hardware and software revenue that was partially offset by lower biometric software revenue.

Contract revenue this quarter was $489,000. This compares to $1 million in the third quarter of 2009. The $0.5 million decrease was primarily due to lower contract revenue as a result of selling our DSL licensing assets to Lantiq in the fourth quarter of last year.

Royalty revenue was $637,000 for the quarter compared to $553,000 in the third quarter of 2009. The increase in royalties was due to higher ADSL chipset sales reported to us by our two principal licensees.

For the nine-month period, the 1% increase in revenue, the $16.7 million, was primarily due to two reasons. Product revenue was $2.3 million higher as a result of increased sales of biometrics and test and diagnostics products. However, this increase was mostly offset by a $2.2 million decrease in contract revenue. Again, this decrease was the result of the DSL asset sale.

Now turning to spending and margins. Third quarter spending was $6.2 million, versus $7.4 million in the third quarter of 2009. The $1.2 million decrease was primarily due to lower engineering spending as a result of the Q4 asset sale.

Our gross margin on product sales were 75% this quarter compared to 82% in the third quarter of 2009. Lower margins this quarter were primarily due to a higher proportion of hardware revenue in product sales.

We also recorded $100,000 of other income this quarter. This amount represents proceeds from a legal settlement with a former customer.

Interest income for the quarter was slightly lower than the corresponding period of 2009. The decrease was primarily due to lower money market interest rates.

And now, turning to the September 30 balance sheet. Cash was $39 million at quarter end, which is down $88,000 from last quarter. Receivables were $5.2 million, which equates to DSOs of 76 days. Inventory was $1.5 million, compared to $1.3 million last quarter. We had no debt and there were 20 million shares outstanding at the end of the quarter.

Also, at the end of the third quarter we had 84 full-time employees, 51 of whom were engineers.

This completes the financial commentary section of the call, and now it'd like to turn it over to Ed.

Thank you, Rick. Our break-even performance in the third quarter included several positive developments which indicate good progress on our overall execution of the Company's strategy. In addition, compared to the year-ago period, out GAAP net income improved from a loss of $4.9 million for the first nine months of 2009 to a loss of $50,000 for the first nine months of 2010.

Though our performance was short of our goal of consistent quarterly profitability, it's clearly a positive trend. Now for several of the positive developments in the quarter I referred to.

First, we successfully deployed our LDP product into a European teleco in the quarter and received final acceptance by the customer. This is an important milestone for the test group as it demonstrates our ability to successfully sell and stand up a software-based DSL test system. This teleco intends to use Aware's LDP product to improve the overall profitability of its DSL network by reducing trouble tickets and optimizing the repair process for those DSL lines which require technician repair.

In the biometrics and imaging group, we competed for and won business with a Tier-1 consulting company for a European biometrics border control program in which we will perform software customization services as well as sell run time licenses covering a suite of our biometric products.

We also submitted proposals directly to end-user government agencies for projects which also involve software customization work and run time licenses.

We are encouraged by these developments and continue our focus on a business model which includes OEM sales while, in parallel, pursuing a more direct selling model. I believe our ability to develop high-IP content technology platforms and the flexibility to bring these to market through either an OEM or more direct selling model positions us well for the longer terms.

I'll now review the test business for the quarter. We had strong OEM sales of hardware products to vendors of DSL test equipment in the quarter. Our value proposition in this market is based on our DSL interoperability footprint and our ability to deliver CO and RT modem emulation across the ADSL, ADSL2-plus, and VDSL2 installed infrastructure.

In addition, the value-add test and diagnostic software we include in these hardware products further differentiates these products and enhances our overall value to our customer base.

In the software side of the business, the successful deployment of our LDP software, coupled with ongoing trials and sales opportunities, are a positive sign of our progress in growing this portion of our business. Demand for products such as LDP appear strong as service providers increasingly focus on reducing the operating costs of their DSL and IPTV infrastructures. Both of these developments are positive for our test business.

On the hardware front, our year-to-date unit volumes were up significantly. In addition, our investment in the higher-volume, lower-price segment of the DSL handheld test market we discussed in last quarter's call has yet to materially impact our revenue line. This investment, which includes a focus on the in-home network, is designed around delivering high-functionality, low-cost OEM solutions for vendors in this space.

The home networking focus is driven by the increased acknowledgement in the marketplace that while a multitude of home networking technologies may be installed largely by the subscriber, problems with service quality generate call volumes to help desks regardless of their source.

Our strategy of leveraging our access to core DSL silicon technology as a foundation to address and support additional features and functionality such as home networking allows us to grow the functionality of our products with limited incremental cost of goods sold. Our customers appreciate the reduced costs in designing end-user products based on our hardware and the growing functionality footprint we provide.

On the software front, we are actively working on deploying our LDP in a second teleco and are involved in a number of trialing activities.

From an integration perspective, our product is proving to be cost-effective at accessing required elements for our customers' broadband OSS such as provisioning, inventory, and customer care systems. This allows service providers to minimize their costs associated with the integration of a new software component such as LDP in their network and it makes it more likely for technology trials to migrate onto deployment, as integration do not appear to be an impediment.

Our initial successes on the LDP front have positioned us to learn firsthand from service providers their detailed needs and requirements, both currently and in the future. This flow of information from the service provider to us is a major benefit of adopting a more direct selling model.

Over the next few quarters, goals for the test business include migrating our hardware product to a new generation of DSL chip sets. This migration should improve gross margins and better support our product development activities in the home networking and other areas. We are focused on executing in this transition while maintaining sales volumes and customer focus.

On the software side of the business, our goals are to migrate trials and related sales activity into committed customers and successfully execute LDP deployments.

Now turning to our biometrics and imaging business. At the Biometric Consortium Conference in September, we demonstrated our Forensic Workbench and BioSP Report Manager products. The Forensic Workbench product, a software application which creates standard compliant biometric transactions from a variety of electronic and paper-based inputs, is representative of our end-user application capabilities.

This product combines a broad suite of our component-level products with a customized end-user application interface and is a good example of progress in our strategy to selectively move up the value chain by leveraging our component-level offerings. The product fits the unique requirements of a US federal agency who requires the creation of standards-based electronic biometric transactions from a wide variety of electronic and paper-based inputs.

We also demonstrated our BioSP Report Manager, which provides a centralized view of biometric quality and throughput metrics, enabling the monitoring of the health of a biometric network. The Report Manager measures the quality of biometric face and fingerprint images and can flag decreases in image quality which would reduce the performance of a back-end biometric matcher. We believe that this product can help improve the matchability performance of biometric systems by rapidly identifying adverse quality trends and providing appropriate alerts.

Biometric sales for the quarter included a BioSP installation in which our product will be used to translate biometric transaction formats between local, state, and federal biometric systems. In this case, each of these systems uses a variant of what is known as the EFTS format. And BioSP automates this translation process and stores the transactions for later use.

We announced a similar BioSP deal in Europe last July, in which the product was being used to translate formats between various federal fingerprint identification systems. In both of these deployments, BioSP is used to ensure interoperability between systems in addition to storage and management of biometric enrollment clients. We are hoping to see improved demand for similar BioSP usage models.

We also continue to sell into the FBI's next-generation IAFIS program and are pleased to be associated with this activity. Participation in such programs helps keep us on top of market requirements, strengthen the interoperability portion of our value proposition, and better position us for upgrade business in the state and local markets.

I'd now like to comment on the L1 and Cogent transactions, and what I believe their impact will be on our business. As many of you know, both L1 and Cogent, who are large players in the biometric market, recently announced their sale to [Sagem] and MMM, respectively. From our perspective, we think this is a positive development for our business. We think that a substantial portion of the market likes to work with their long-time or familiar system integrator or consulting vendors, and that increased size and vertical integration is not necessarily an asset in these situations.

Aware enables such traditional integrators and consulting companies with a flexible package of biometric expertise and products, allowing them to address large biometric programs without requiring in-house biometric expertise. Especially since the addition of our products and services capabilities, we believe we have a strong value proposition as a biometric partnering specialist for these system integrators and consulting companies.

In the medical imaging area, we continue to work with lead customers on JPEG 2000 and JPEG-based compression and image-streaming projects. We believe that growth in medical image volume and the industry-wide focus on medical records and interoperability represent an attractive opportunity for us.

Goals for our biometric and imaging business include strengthening our product and services business by executing on projects in hand; and transitioning our pipeline and sales opportunities to contracts.

We would have liked to be further along in our products and services strategy than we currently are. However, the Tier-1 European consulting customer I referred to in the beginning of the call, the DOD hand-held biometric program we are actively working, and opportunities we had bid but are waiting to hear on illustrate we are focused and making measurable progress in this area.

Now for a comment on the spin-off. On September 24, we announced our plans to pursue a spin-off of our patent licensing operations. The rationale for beginning this process, as described more fully in the September 24 press release, is to allow this spun-off entity to focus more fully on patent licensing-related activities.

The proposed transaction is expected to be structured as a tax-free distribution to Aware stockholders and is contingent on several items, including, but not limited, to receipt of a favorable ruling from the Internal Revenue Service, a determination by Aware's Board of Directors that the spin-off is in the best interests of Aware, and completion of a review process by the SEC.

We expect to file documents with the SEC within the next month which will more fully describe the transaction. The transaction, if all goes according to plan, could be completed within the first quarter of 2011.

Shareholders should have received a proxy statement by now regarding the special shareholders' meeting on November 1 in connection with the proposed equity exchange program. All information regarding the proxy statement can be found in our SEC filings, which are available on the Investment Relations page of our website at www.aware.com. And as all always, we encourage all shareholders to participate in the vote.

Over the last several years, we have taken a number of significant steps to improve shareholder value. We have reduced our outstanding share count, restructured the Company via the sale of our licensing business, and improved the performance of our operating businesses significantly over the last nine months. We believe these steps in improvement, as well as our anticipated patent spin-off, are building a solid foundation for the Company going forward.

We recognize we have more work to do and are optimistic we are on course toward achieving everyone's goal of increasing shareholder value.

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

Thank you. (OPERATOR INSTRUCTIONS) At this time, we have no questions. (OPERATOR INSTRUCTIONS) [Lee Alfor], [Hammock] Investors.

Good afternoon.

Good afternoon, Lee.

Could you go over a little more why you're going to split the Company? I'm having a hard time understanding how you justify having two companies when you can't have one profitable one.

Okay. The details of the spin-off transaction, if we go forward with it, will be found in an SEC filing known as a Form 10. And that Form 10, we expect right now, would be available some time in November. And until we file that document, our rationale on the details of it, we won't discuss. But that document will be fully disclosed with respect with our thinking on the matter and the details of the transaction.

Will you have a chance to talk to your shareholders before you actually do the transaction?

The document itself will describe in detail what the transaction's about. So that document will be available to all shareholders, for sure.

All right, but will you have a public call before that vote is taken?

The spin-off transaction itself is not subject to a shareholder vote. The spin-off transaction itself is subject to a Board of Director vote.

Can we not voice something? You won't share why you're doing it, publicly, at this point. It doesn't make sense.

Well, we discussed in our press release that the basic purpose, at 50,000 feet, is to take our patent licensing operation and put it into a separate entity so it can more fully exploit the value of our patents -- the thinking being that that's better for our shareholders.

How do you justify that -- having a whole new public company, overhead and everything else associated with it -- when at this point, you can't do it when it's in house?

Well, there are reasons why separating our patent licensing operations from what we call our operating businesses which involve products make a lot of sense. And it's because the two of them have different business models and the patent licensing operations can be pursued, we think, more effectively outside of a company in which you are running a product business.

If you're doing that, why don't you join with a company like, say, Acacia, who does that as opposed to starting something up from scratch?

Okay. The details of how we would structure this would be available on this Form 10. The rationale at 50,000 feet is the one I've just provided to you. And when we look at this right now, it looks like an attractive opportunity for us. There are other companies who do very well with patent licensing operations and we think that given our portfolio and the way the market is right now, that it makes serious sense to look at this.

I mean, I just don't understand how you guys think you can do that without asking the shareholders. Or talking to-- and willing to talk to the shareholders.

Well, we're willing to talk to the shareholders. And if what you're asking--

Will you have a conference call after those documents are out?

We may have a conference call after the documents are out. We certainly could.

Can you have a definite commitment that you will?

I'll seriously consider your input on it. We'll have to look at the documents and what our shareholders are looking for. We'd be happy to discuss it with people.

Yes, but doing it one on one, you're trying to force it through. I mean, it doesn't make any sense.

When you look at a patent licensing operation and you look at a product business, there's a great deal of-- it makes a great deal of sense to look at separating the two. When you say that we can't make money as a company right now, why would we consider doing this? Well, we're very close to making money right now. I mean, we've made a little money in--

After 10 years?

We've made money this quarter; we've had a much better nine months in 2010 than we had in 2009. And when we look at the assets of the Company, this looks like a very prudent idea to pursue and that's why we're pursuing it.

But there is no patent company that has made money well before five years if they've been in business, at least.

I don't know where your data's coming for that, but the patents that Aware has had--

Do you want to go over the millions of companies that are doing it? That's where the data's coming from.

Aware's patent portfolio isn't starting up; Aware's patent portfolio has been developed for many, many years. So when we look at this, it looks like something that makes a good deal of sense to us. And as we said in our press release, and what I've said today, we've got a number of different issues we need to get through. If we get through them and we file our Form 10, there will be a lot of information in the Form 10 about this -- details about this -- and then we'll be happy to talk to investors about it.

Well, I'm holding you to your word that you'll have a public call on this. Thank you.

Okay. You're welcome.

(OPERATOR INSTRUCTIONS) It appears we have no further questions at this time.

Okay. Thank you, Operator. Please visit our website, www.aware.com, for a list of upcoming trade shows we'll be attending in the fourth quarter. Rick Moberg and I will be attending the annual AeA Classic Financial Conference at the Manchester Grand Hyatt in San Diego on Tuesday, November 9. We look forward to seeing any of you who may be attending this event.

Thank you very much for attending today and we look forward to speaking with you in our Q4 call. Thank you.

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation.