Neonode Inc (NEON) 2004 Q4 法說會逐字稿

Good morning. My name is Misty, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the SBE year end and fourth quarter 2004 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad.. If you would like to withdraw your question, press the pound key. Thank you. Mr. Heye, you may begin your conference.

Thank you. I appreciate your joining us this morning, and welcome to SBE's 2004 year-end conference call. For those of you who don't already know him, I'd like to take this opportunity to introduce the new SBE President and CEO, Dan Gray. Dan has been with SBE for the past three years as the Head of Sales and Marking, and will continue performing these jobs in addition to his new responsibilities. Later in the call, I will ask Dan to comment on his vision for the future of the business; and at this point in time, I have also with us Dave Brunton, our Chief Financial Officer. I will ask Dave to start the discussion by reviewing our financial results, and then I will discuss the significant events of the past year, and then turn the call over to Dan. So with that, here's Dave.

Good morning. This is Dave Brunton, and thank you for joining us for today's SBE financial year 2004 results conference call. If you would like to receive a fax or email copy of the full earnings press release, please feel free to contact Judy at 925-355-7602, and she would be very happy to send you a copy.

As a reminder, this conference call may contain forward-looking statements that are subject to risks and uncertainties, including among others, those described in the annual report on Form 10-K for the year ended October 31, 2003, and subsequent filings filed with the Securities and Exchange Commission. Actual results may differ materially from those described during the call. I'm going to start with a review of our results for the fourth quarter and year ended October 31, 2004. Overall, the year did not meet our expectations for either top line revenue growth or bottom line earnings.

Although our revenue for the year did grow by 48% over the prior year to $11 million, compared to $7.5 million in fiscal 2003, we slightly missed our financial plan of $13 million in revenue by 15%. For the year, HP continued to be the major contributor to our revenue stream. Total sales to HP were $5 million, which included both our VME and the PMCC 4 T1 adapter products, compared to $4.3 million for the prior year. As expected, HP has notified us that the shipments of slightly more than $1 million of VME products in the first quarter of fiscal 2005 would likely be their last significant order for these products.

In the future, they may purchase selected spares, but we do not expect any additional large orders. Our challenge, as we have discussed over the past couple of years, is to replace this source of revenue. We are encouraged by a 53% increase in shipment of adapter products, and a 71% increase in HighWire products in 2004 as compared to 2003. These increases came from multiple customers and do provide some verification that certain of our prior design wins are finally moving to production. These are the exact customers and design wins to which we have been looking to fill the void left by the long anticipated reduction in shipments to HP. We expect to see a continued steady increase in the level of shipments for both adapter and HighWire products to these and other customers over the coming year.

Our bottom line earnings for the year were a disappointment. After eight straight quarters of positive earnings, we had a net loss of $1.7 million, or 33 cents per diluted share for the year, compared to net income of $563,000 or 12 cents per diluted share for fiscal 2003. There were several major factors contributing to this downturn, not the least of which were some year-end non-cash write-offs to bring some of our assets down to realizable market value. Excluding these adjustments, the company would have had a profit of about $140,000 for the year. If you bear with me, I'll walk you through the most important of these adjustments.

In the fourth quarter, we re-evaluated the carrying value of the intellectual property asset recorded when we acquired an Antares Microsystems, and determined that market and other conditions in which Antares products compete have changed to the point that we had an impairment of that asset. We had been amortizing the intellectual property into cost of goods sold expense at the rate of $102,000 a quarter, and had a remaining balance of $713,000 at year end. We wrote off the total amount of $713,000 to cost of goods expense. Including the normal recurring quarterly amortization of the intellectual property, fiscal 2004 has $1.2 million of non-cash intellectual property amortization and impairment expense, including in cost of goods, compared to $102,000 of similar expense in 2003.

In addition, during the fourth quarter of 2004, we wrote down $547,000 of slow-moving and obsolete inventory. This write-down is included in our cost of goods for the fourth quarter of fiscal of 2004. And finally, our G&A expense for 2004 includes an accrual for a severance package related to Bill's retirement. This will be paid out over 12 months -- January through December of 2005. The total of these one-time non-cash expense adjustments, plus the normal recurring intellectual property amortization for fiscal 2004, is $1.9 million, compared to $102,000 in fiscal 2003.

Net sales for the fourth quarter of 2004 were $2.2 million compared to the same $2.2 million amount in the fourth quarter of 2003. For the quarter, we shipped $550,000 VME products to HP compared to 500,000 in the fourth quarter a year ago. As I said previously, we will make a final shipment to HP of $1 million of VME products in the first quarter of fiscal 2005. For the quarter, we reported a loss of $2.3 million, subject to the same non-cash adjustments as was previously discussed, compared to net income of $280,000 in the fourth quarter of 2003. The fourth quarter of fiscal 2003 did have a $235,000 reversal of a loan valuation allowance expense for a loan that was due in December of 2003. Excluding this -- that item, our net income for the fourth quarter of 2003 would have been $45,000.

Our gross profit margin for the year-end quarter suffered due to the intellectual property and inventory write-downs. The profit margin for the fourth quarter was actually a negative 15% compared to a gross profit margin in the fourth quarter of 2003 of 65%. Our gross profit margin for the year was 40% compared to 63% in 2003. Without the IP and inventory adjustments, our gross profit margin for 2004 would have been 55%. Our gross profit margin is dependent on product mix, raw material pricing and production, department utilization rates. Over the past two years, we've been able to sell a certain amount of VME products to HP that we wrote off in 2002, thereby increasing our overall gross profit margin.

In general, the older VME products tended to have a higher gross profit margin than adapter or storage products; and as we replace the VME products with these other products, we expect to see our average gross profit margins decrease to the low 50% range. Total operating expenses in the fourth quarter were $2 million, compared to $1.2 million in 2003. In the fourth quarter just ended, as previously discussed, we recorded approximately $259,000 in operating expenses related to a severance package. Without this adjustment, our operating expenses would have been $1.7 million compared to the prior year, where it was $1.4 million. We expect our quarterly operating expenses to range between $1.4 and $1.6 million for the next four quarters. This level of expense will allow us to continue to develop and marketing existing and new products.

Total operating expenses for the year ended 2000 -- October 31, 2004 -- were $6.1 million, compared to $4.2 million in 2003. For the year just ended, our operations generated $100,000 in cash compared to operations using $100,000 in cash in fiscal 2003. We ended the year with cash of $1.9 million, no debt, and working capital of $3.9 million compared to cash of $1.4 million, and working capital of $4.0 million in the prior year. As of year end, we had 5 million, 95,000 shares of common stock outstanding, and 1.8 million stock options issued and outstanding. Excuse me.

The stock options have an exercise price ranging from 90 cents to $19.85, and have an average exercise price of $3.48 per share. We do expect our working capital will be sufficient to fund the ongoing operations and growth of the company going forward. We do continue to have a working capital line of credit with the bank, if needed; however, our current plans and projections do not include any requirements to draw down on this available credit line.

This concludes my comments on the historical and quarterly information for fourth quarter and year ended October 31, 2004. At this point, I want to share with you some guidance information for the first quarter of fiscal 2005. Based on our current sales activity, backlog and forecast, we anticipate that revenue for the fiscal quarter ended January 31, 2005, will range between $2.8 million and $3.3 million, and projected earnings per share to be approximately 4 to 6 cents per diluted share. This guidance is based on the current backlog, forecast and expense levels, keeping in mind that visibility continues to be poor, and in this difficult business climate, forecasts change frequently. This guidance is our best estimate for the first quarter of fiscal 2005. That concludes my comments. I'll turn the call back to Bill. Bill?

Thank you, Dave. The strategy we've been pursuing at SBE has been straightforward. That is, to keep the telecom OEM business healthy while pursuing breakout products. These breakout products have included TOE, iSCSI and Security. Keeping telecom OEM healthy in fiscal 2004 has included multiple new products introduced, including a 672 channel T3 PMC card, a 24-port DUN [PHONETIC] card, and our first encryption card. We upgraded our HighWire processor platform card, and initiated design of the successor processor which will be available in 2005. In what will be a major impact to our telecom business, we also began design of a VoIP product.

That, combined with our new processor card, will provide our customers with a high density, flexible and cost competitive VoIP platform. In telecom OEM, we're seeing volume increases coming from earlier design wins. These will start filling a gap caused by the HP VME business falloff in the second quarter 2005. Shipping activity has picked up in several important areas for us: Gateway products for VoIP and broadband, telephone conferencing equipment, emergency 911 location equipment, credit card verification, and wireless in both Wi-Fi and commercial. We signed four new agreements to supply an -- IO PMC cards to suppliers of the newly-designed ATCA CPU cards, specifically for the telecom market.

Now to the breakout products. We are very pleased that the new A6 TOE chips performed exactly as planned, and produced TOE boards for us., which we sent out to BETA customers in October. The foreign factor of the TOE card is PCI, but we also have a PMC version following closely behind that. The card has two gigabit ethernet ports and utilizes a state machine processor, which results in very low power distribution. The two port capability provides the redundancy so critical to the iSCSI application, which I will now elaborate on.

As we've previously announced, SBE entered into a partnership with PyX Technologies to integrate and sell a fully-tested hardware/software that provides ERL 2 capability. ERL 2 is error recovery level two, which is required to transport files over IP lines, which is an absolute requirement for remote backup and storage applications. We believe, along with PyX, that this is the first working instance of ERL 2 in the industry. Heretofore, all iSCSI has been ERL 0 and ERL 1, which has limited the growth of this technology. There are strong demand drivers for iSCSI. Notably, security of business records, which requires remote storage, video over wireless, which requires a transport capability of error-free transmission.

ISCSI, with the ERL 2 feature, solves both of these problems. We are today offering our TOE iSCSI solution to suppliers of this type of equipment, who in turn will furnish equipment to service providers and resellers. As we put both TOE and iSCSI into BETA testing with prospects, we have made the products more user-friendly by simplifying insulation procedures and adapting to the nuances of multiple applications. As of today, we have product available for delivery and are continuing customer contact on a wider basis. Dan will discuss the next steps forward in his section, which follows mine.

So in summary, I believe we've set SBE on a course that maintains the health of the telecom OEM business, while providing the resources for execution on our breakout products. In closing my part of in conference call, I would like to express my appreciation to the SBE customers whom we have served for over many years, as well as express my thanks to those investors who have maintained confidence in SBE as we've moved along the path, which at times has been fitfully moving, of growing this company. I will be continuing my support of the company as a director beginning on July the 1st, 2005.

I have full confidence that as Dan takes over the reigns of the company on January the 1st, that he and the SBE team will deliver the results in fiscal 2005 that will fulfill the great potential of this company. And now, I will turn the call over to Dan.

Thank you, Bill. All of us here are suffering from colds today, so please excuse us. Well, I 'd like to share my thoughts about SBE's future revenue opportunities. I recently joined SBE back in 1989 and have seen several impact technologies change the revenue streams for us, including TOEKIN [PHONETIC] ring sales to SYSCO in 1993, and frame relay T1E1 sales to Motorola, which later turned into the business we know as of HP that started all the way back in 1996. So we are very excited about the new technologies.

We consider breakout offering revenue streams from Voice over IP, TOE, iSCSI and encryption. Bill has mentioned TOE and iSCSI, and we expect those revenue streams to have an impact in fiscal '05. We categorize our products into three basic groups for tracking core products, legacy products and new products. We are forecasting more growth for core products in '05 than we had in '04. That also increases our profit margins, leverages the mix of IO products that we currently have, and will continue that basis of revenue going forward. Last year, we developed a marketing partner program for ATCA, new technologies for OEMs in the teleco arena.

Several of these OEMs like DTI, Concurrent Technologies and GNP, have already signed agreements, and each one of those will reflect mobile design wins as business progresses moving forward. So we have a good grasp on the core business and how it's going to grow in the near future. Voice over IP is a product that we expect to announce in mid2005, and will be targeted at the carrier grade OEMs. These are telecos and service providers like Ericsson, Nokia, Motorola, Samsung, UTStarcom and others; and these are examples of our target customer base. But the Voice over IP structure will continue to grow over the next five to ten years, and we're confident that many of the people we're talking to today will be buying that product in the future.

I'd like to point out, though, that any significant Voice over IP impact to revenue will occur in 2006, as the design win cycle for this market place tends to be a little bit further out. SBE also has an encryption adapter. This encryption adapter is with or without gigabit ethernet ports, and it's aimed solely at the embedded security systems types of applications for government, military and commercial systems, as higher security standards are being set, like FIPS 14-2, SBE's in a great position to offer this product for SSL IP SEC [PHONETIC] and other wireless types of applications. But our new product focus going forward will include TOE and iSCSI. The PCP/IP off load product has been in a very thorough data test phase, and will soon offer the revenue stream that we've been looking for.

The problem is is that the value has not become apparent to many large OEMs and end users in the [INAUDIBLE], server IT communications area like database management, content delivery, web servers, video imaging -- I guess video streaming -- surveillance and teleco. These are all vertical markets that we are going after, have demonstrations ongoing, and expect to see some kind of results in the form of purchase orders in the near future. We also have brought out a PMC-based version of this TOE for multiple applications, and expect that to hit the embedded industry very shortly.

iSCSI, though is an IP storage application we believe is going to be very popular. Combined with PyX Technologies, it will provide a solution that will go into Linux target controllers, offering ERL 2 that Bill explained. Our product competes and it compliments Fibre Channel Networks in the SAN marketplace. It doesn't just compete with Fibre Channel, but we offer a homogeneous solution I think that's going to be very attractive. We have learned, though, through our BETA test program, that users demand storage flexibility options, along with service and support. So they expect all of these things. We are targeting OEMs and integrators, but the key thing we have learned is that most people don't want a board and a piece of software, They do expect a full package.

Our target customers include tier one companies like IBM, EMC, HP, LSI Sun Microsystems, Hitachi, Storage Tech -- and also includes smaller, what we'll call tier 2, focused companies, like Left Hand Networks, Equal Logic, Procom, and Innostore, as examples. SBE is currently being evaluated by several large companies, but due to non-disclosure agreements we currently have in place, I can't share the names or the specific activities. Recently, SBE PyX and Peak IP Solutions [PHONETIC] announced an agreement whereby Peak will supply full systems, including the SBE and PyX solution, along with system integration, storage options, support, and service to both OEMs, storage suppliers and end users alike.

We expect iSCSI to grow very rapidly through 2005, as users become comfortable with storing and backing up their data over the Internet. We believe that the iSCSI revenue will be significant, and that our TOE module, a requirement for many of the applications, as Bill explained, primarily the high-end systems complimenting and replacing Fibre Channel. The virtual storage capability extends across the LAN, across the WAN, into the SAN, and provides access to huge data banks, and it's possible to access this stuff through laptops, auto WiFi, over a wireless phone; and we believe in the future, PDAs will give access to all of this massive data in the near future. So iSCSI and our products are very well positioned to make all of this possible.

So that wraps up the core and the new product focus we have, and we feel confident about moving forward with these kind of strategies. I hope this has offered you a little glimpse of what I'm seeing in the future, and can open it up for questions.

At this time, I would like to remind everyone, if you would like to ask a question, please press star and then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Evan Greenberg with Meadow brook capital management.

Hey, guys, congratulations on releasing the TOE chip.

Thanks, Evan.

Yeah. I wanted to know -- you know, in reference to the TOE chip product, number one, do you expect -- the first quarter we look okay, but we've got the second half of the year and the second quarter of the falloff in HP business. Do you there will be enough revenue replacement [INAUDIBLE, AUDIO CUTTING OUT] to offset that between the IP and the other ventures, or do you have a -- do you have a -- an actual schedule from Hewlett-Packard as to how much product they are going to order and how that's going to be?

Well, I would say that the HP order has been in backlog now for quite sometime. I would say for a period of over six months -- so we know exactly what HP is going to take. But I think the key to filling in the hole that HP will leave is getting the new design wins of the past to start realizing production moving forward; and to that end, several of those design wins that we had over the last two years are starting to order more and more product. So it's -- it's not like turning the faucet on full blast at once. We've seen increasing orders from these past design wins, probably over the last year and a half, and I think that we're going to see significant improvements as both the market place picks up and our customers' products see success in the market.

Okay. Let's see, do you have any anticipation for revenue for the year for TOE, or is it just too early to tell?

Well, we would sure like to see a couple million dollars of this. We are not relying on the TOE or the iSCSI revenues for success, but we would like to see a couple of million dollars of revenue this year.

All right. Thanks a lot.

Thank you.

At this time, I would like to remind everyone, if you would like to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your next question comes from Scott Turkel with Turkel Investments.

Hi, good morning.

Good morning.

I have a couple of questions. If you look out 18 months or two years in this -- in the new market, what would you think your total addressable market opportunity would be?

From the --

From your new product?

From the SBE side on this, and addressing the TOE and iSCSI alone, 18 months out -- let's just take the year fiscal 2006 for us, it would be somewhere between $5 and 10 million in revenue, with upsides that could conceivably exceed that. And we base that upon our expectations that the iSCSI, in particular, will address very quickly the middle of the storage systems market. Today, we do not intend the -- the ERL 2 to address the lower end of the market, which is ERL 0 and ERL 1. We do expect it to address the remote storage, which requires the ERL 2, and we believe that starts in the middle of the storage systems market and not the low end. The low end of this market probably inquires storage systems, terabyte and the like in the 5-$10,000 range for the equipment that's sold to the business; whereas the middle of that market probably starts at $30,000 and runs through $100,000, including multiple terabyte storage systems. As a result of that, this middle of the market, we think, will have developed by the 2006 time frame to the point where we'll be shipping from an SBE point of view enough revenue to hit hose kinds of numbers. There are many -- as you're probably aware, the total storage market is probably in the $16 billion range. It's a huge market. We do not anticipate SBE participating in the very high level of these things where IBM, EMC and others participate, but that chance is not ruled out. At this point in time, we think the middle of the market is our space.

Okay. You guys shipped VME revenue in the fiscal year of about $5 or 6 million; is that correct?

The VME was about 3.4. The PMC was the remainder.

Was the remainder.

It was a total of $5 million, but it's -- that's a combination of VME and PMC.

Okay, and the VME is being discontinued this year after the first quarter with an order of $1 million?

Actually, both of those products, to HP for deployment in their cellular-based stations are being end of lifed.

End of lifed, okay.

It's going to affect both of those products, and we will continue and we'll see -- still see growth as a standard product for PMC T1E1.

Okay, so basically half of last year's revenue was from two product lines that are going to be discontinued to two customers -- to one customer.

That's right.

Okay. And the previous -- Evan asked a question about replacement revenue. If you guys were $100,000 cash growth positive for the year, and you're going to lose half the revenue stream after the first quarter, will you have enough in your ramp to keep your numbers at least year-over-year flat, and will you be able to generate $100,000 worth of positive cash flow again this year, as you replace half the revenue?

Yes, we expect to, Scott. One of the things that Dan had said is that we have -- we look to our top 5 to 10 customers that we have, excluding HP, filling that gap that HP is leaving behind, and those -- and we do -- we have seen, especially towards the latter part of the year, indications from them, and they've actually told us that they're going to be purchasing more and we've gotten more purchase orders right now from those customers selling into some Voice over IP systems and voice conferencing systems. And so we have -- some of those design wins that have sort of been languishing out there for the last couple of years are actually starting to go into production at this point in time, and we're starting to see some take away. We've talked about Nortel in the past. Nortel, we expect to generate probably a million and a half dollars worth of revenue for us next year out of an existing product line, and we have another one coming out that we're designed into that we've been waiting on for the last year to 16 months, and they're finally releasing it. And so we do expect other products to fill that gap.

Okay. The older products had a higher gross margin than the new product portfolio.

Yes.

To achieve the same type of operating margins on similar revenue, where -- where do you have to bring Op Ex down -- from 6.1 to where?

Well, I expect the actual operating expense will be running about $6 million -- about $1.5 a quarter. $1.4, to $1.6 million -- somewhere in that range -- per quarter next year, so that's about $6 million. I do expect to see the gross margins dropping a bit for next year.

Okay, so your operating income line will -- you know, the percentage of operating income will also drop as well?

Yes.

When do you believe that you can bring some stability back to that operating income line, and when will that margin itself begin trending upward?

I don't -- truly, I do not see in the future the gross margin line going above 55%. I think it's going to be in the low 50% ranges. I think that the days of the -- you know, 70, 80% VME products is gone at this point, unless some anomaly happens. So I -- I think you should, if you're modeling, use, you know, kind of a 51, 52% as a profit margin line.

And one last question, I'll let somebody else go. You took a write-off of $550,000 of obsolete inventory.

Mm-hmm.

On a 2.2 million quarterly revenue line, how do you get to $550,000 of obsolete inventory?

We had -- we had some inventory-related to Antares that was slow moving that we had built in anticipation of moving some of the stuff, and really from -- with that acquisition, which was primarily aimed at the Sun market place. Sun has moved into sort of a predatory pricing policy that's wiped out a lot of -- a big chunk of that market. And also, they are shipping their newer boxes with a lot of those after-market cards like Gigi and SCSI cards that used to be optional are now coming standard in their box. So we were sitting on some inventory. We actually -- I don't know, we'll see if we can sell it or not. It's still good product, but because the -- you know, the year-end audit process and everything slow moving inventory, we decided it was prudent to take the write-down at this point in time.

I think, you know, going into new product line, you're probably right about the timing. And will there be any more intellectual property right now?

No, that was -- 100% of it is off the books at this point.

Okay, so you threw in the whole kitchen sink this quarter, huh?

Right, right. Exactly.

Thank you very much.

Okay.

Scott, I'd like to address one question that you had earlier.

Sure, go ahead.

About gross profit margins. And let me comment that our focus and success in the HighWire product line, part of our core business, is growing. Last year, it was 77% growth as a product line. We expect to do better than that this year, because design win efforts that started in 2002 are finally hitting fruition. So relative to margin, we've got really two types of products. One, HighWire has margins today at MSRP around 70, 72% in volume, say above the 50s. Okay?

Mm-hmm.

And it's typically in the 60s. The other half of our product line is very commercial, very commodity-driven, and we're -- our margins suffer due to the price competitiveness of that business. So as we stress and grow the core business, the margins will increase, offsetting a lot of that other competitive stuff. So strategically, we are trying to grow that core business and keep the margins high.

Do you have enough -- do you have enough cash on your working capital in your balance sheet to grow the core business the way you want to expand the margins, or will you be requiring additional capital?

At this point, we think we have enough.

Great. Thank you very much.

Thank you.

Your next question comes from Taylor Tompkins with Anderson Strudwick.

Good morning, gentlemen.

Good morning, Taylor.

Congratulations on the TOE release; obviously, somebody else liked it too. It's been a long time coming. Seems like forever.

Yep.

I just want to say, Bill, good luck on your new endeavors and have fun in retirement.

Looking forward to it. Thank you.

That's all I had. Thanks.

Thank you, Taylor.

At this time, there are no further questions.

Okay. If there are no further questions, we appreciate your interest in SBE, and we look forward to -- that is, Dan and Dave look forward to talking to you next quarter. Thanks very much.

This concludes today's SBE year-end and fourth quarter 2004 results conference call. You may now disconnect.