Neonode Inc (NEON) 2005 Q3 法說會逐字稿

At this time I would like to welcome everyone to the SBE third-quarter 2005 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. (OPERATOR INSTRUCTIONS). At this time I'd like to turn the call over to Mr. Dan Grey, President and CEO. Thank you. Mr. Grey, you may begin your conference.

This is Dan Grey. I'd like to welcome you to SBE's third-quarter fiscal 2005 investor conference call. I'm with Dave Brunton, our Chief Financial Officer, and we're going to address SBE's financial results and activities over the past quarter and elaborate on our products roadmap to clarify the Company's future direction. At the end of our call we'll open the floor for your questions. To start with I'd like Dave to cover the financials.

Good morning, this is Dave Brunton and thank you for joining us today for SBE's third-quarter conference call. If you'd like a copy of our full quarterly results press release please contact Judy at 925-355-7602 and she would be happy to send you one.

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, 2004 and subsequent filings filed with the Securities and Exchange Commission. Actual results may differ materially from those described during the call.

I'd like to review our results for the three and nine months ended July 31, 2005. We executed on some significant milestones during the past quarter including completing the acquisition of PyX Technologies and finalizing the private placement that raised over $5.1 million that we will use for working capital. Later in the call Dan will talk more about our product strategy and the future direction of the Company. Now to the results for the quarter.

Nets sales for the third quarter 2005 were $1.7 million compared to $2.9 million in the third quarter of 2004 and our net sales for the nine months were $6.2 million compared to $8.8 million in the same period last year. Last year, as you probably remember, we were still shipping significant volumes of communication controllers to Hewlett-Packard for use in the cellular base station system since end of life. In the third quarter last year we shipped a total of $1.6 million of product to HP compared to no shipments to HP in the third quarter just ended. And we shipped $4.2 million of controller products to HP in the nine months ended 2004 compared to only $1 million this year.

Without the HP shipments our net sales for the third quarter last year would have been $1.3 million and would have been $4.6 million for the nine-month period last year. We have seen an increase in shipments of our non HP products this year compared to last year and as a result have been able to fill some of the hole but not all left by the HP end of life shipments.

Two important things happened when HP end of lifed their products. The first was the obvious decrease in our top-line revenue. And the second has been a decrease in our overall gross margins. The gross margin of the HP business was in the mid 70% range compared to lower gross margins for our other products. In addition, as I reported last quarter, we have seen a slowdown in the sale of our Antares productline and, after reviewing the sales trends of these products, felt it prudent to write down certain slow-moving and obsolete Antares inventory. We did this during the quarter just ended.

The heavier concentration of lower margin products in our sales mix combined with the inventory write-off resulted in a 38% gross margin for the third quarter of 2005 compared to 53% for the same quarter in 2004 and a 46% gross margin for the nine-month period just ended compared to 54% for the same period last year. We do project our gross margins to be in the high 40% range for the next few quarters. We also expect improvements in our gross margin when we start getting increased customer acceptance for our new iSCSI storage software that we acquired in the PyX transaction as well as increased shipments of our new Voice-over-IP blades.

As you may already know, software is a very high gross margin product and over the course of the coming quarters we expect our iSCSI software to be a significant contributor to our product mix and to see resulted increases in our overall gross margin. You also need to be aware of the impact on top-line revenue that the accounting rules related to software revenue recognition creates. Because of the complex accounting rules in this area we may be prohibited from recognizing financial statement revenue related to software license sales for up to one year after the sale.

In the future, after we establish a pricing history for the various elements of our software, for example, licensing fees compared to maintenance fees, we will be able to record a portion of each sale as current revenue and a portion as deferred revenue that will be amortized over a future period. We will still collect the cash related to software sales when the license is sold, so this will not be a cash flow issue. The reason I bring this up is to let you know that even though we have signed several contracts to sell our iSCSI software and expect to sell software licenses over the coming months, we may be prohibited from recognizing revenue on these sales for financial statement purposes until mid to late next year.

Our total operating expenses in the third quarter of 2004 -- of 2005 were 1.6 million compared to 1.5 million in the same period last year. For the nine months our operating expenses were 4.6 million compared to 4.3 million last year. This slight increase in operating expenses is primarily due to increases in the staffing levels of our engineering groups and the initiation of some product marketing programs. We have already begun the process of hiring additional software engineers, sales and marketing personnel, particularly in the storage groups, to take advantage of the newly emerging market for our iSCSI products. As a result of the staffing increase and the marketing initiatives there will be an increase in our overall operating expenses.

The failure to completely replace the end of life HP business has resulted in net losses for the past two quarters. For the quarter just ended we reported a loss of $945,000 or $0.17 per share basic and diluted compared to net income of 79,000 or $0.03 per share basic and two diluted for the third quarter of 2004. For the nine months we had a loss of 1.7 million or $0.32 per share basic diluted compared to net income of $660,000 or $0.13 per share basic and $0.11 diluted for the same period last year.

Now I want to move to the discussion of the acquisition of PyX and the results of the financing. I'd like to provide some detail on the components of the stock, stock options and warrants that were issued in the transactions along with some of the major items that we recorded on our balance sheet. We closed the PyX acquisition on July 26th and issued 2.6 million shares of our common stock to the stockholders of PyX. We also assumed their stock option plan that had 2.1 million stock options outstanding with an exercise price of $2.17 per share.

Now 95% of the shares of stock issued in the acquisition are locked up for one year and the options have a four-year vesting schedule with the first vestings occurring on February 28, 2006. So the majority of these shares will not be available to the marketplace until next year at the earliest. In recording the PyX acquisition we booked a $12.2 million intangible asset related to the intellectual property associated with the iSCSI software and 2.5 million of deferred compensation related to the assumption of the stock options.

We will amortize both of these items to expense over the coming 14 quarters beginning with our fourth fiscal quarter 2005. The annual non-cash amortization expense over the next couple years will be approximately $4.7 million per year. In the pipe financing that just closed we raised $5.2 million netting $5 million after offering expenses and we issued 2.1 million shares of common stock and warrants to purchase an additional 1 million shares. The warrants were issued at $3.33 a share.

As a result of both transactions we now have 9.9 million shares outstanding compared to 5.2 million prior to the transactions. We also have warrants to purchase 1.2 million shares at prices ranging from $1.50 to $3.50 per share and 4.4 million employee stock options outstanding, and of these 1.4 million are vested with prices ranging from $0.90 to $17.50 per share. After all is said and done our current fully diluted, if you count everything that's outstanding, is now 15.5 million shares of common stock which includes the stock, the warrants and the options compared to 7.7 million stock warrants and options outstanding prior to the transactions.

I know that liquidity is generally an issue was small cap companies, so I want to walk you through where we are in regards to cash. During the nine months just ended the Company's operations used approximately 1.3 million in cash, during the same period we also used approximately 254,000 in cash to purchase software and engineering equipment. Of the 254,000, 173 was used to make payments to an outside company that's providing engineering services for our first two Voice-over-IP products.

Concurrent with the acquisition of PyX we also reorganized the Company into two operating business units -- the storage unit and the embedded unit. As part of this reorganization we staffed the embedded unit to be cash flow breakeven and expect to use the majority of the proceeds from the recent financing to further develop and sell the PyX iSCSI products.

With the proceeds from the private placement, our common stock and cash from our embedded business, all of our projections indicate that we have sufficient liquidity to fund our business plan. We ended the third quarter of fiscal 2005 with cash at $5 million, no debt and working capital of $7 million compared to cash of 1.8 million and working capital of 3.9 million at October 31, 2004. This concludes my comments and now I'm going to turn the call back to Dan. Dan?

Thanks, Dave. First let me share my appreciation for SBE's Board of Directors and shareholders who have confidently voted in favor of the acquisition of PyX Technologies and the private placement financing. We've worked on this business for over six months and can now devote our full time and resources to executing the plans to become the dominant suppliers for IP storage and Voice-over-IP OEM products. SBE has reorganized the Company, managing P&L for storage and embedded business units separately, operating cash neutral on the embedded side.

In future investor calls we're going to describe the activity on the products in such a way that you can identify the business unit and the functionality of the product. Our management will focus its energy on incremental success for each business unit with an urgency that produces both short-term revenue as well as long-term OEM relationships. These are important to us. We'll continue to report new customers' acceptance of our products in terms of design wins. Design wins indicate traction in the marketplace reflected by an endorsement from our customers making a commitment for at least $400,000 in future annual and recurring sales of SBE products. I'll start with the embedded business unit.

The embedded productline consists of core products, new products and legacy products. Our core products provide the foundation of our sales revenues including wide area network controllers like T1/E1 and T3 Gigabit Ethernet network modules as well as intelligent compact PCI platforms that produce modular application-specific solutions.

SBE's net sales were flat from second quarter to third quarter, core products amounted to 85% of third-quarter revenues split evenly between the WAN adapter sales and compact PCI platforms. This segment of our business is growing. We're going to continue to support many past design wins in the communications marketplace that are showing a recovery from the 2001 telecom recession. These businesses, however, are ordering slowly, and slower than we expected. For example, last week we received a nice purchase order from a company that selected SBE back in -- excuse me, 2003, and they're just getting around to production. It shows how slow the market traction is taking place in this segment. We expect our core products revenue to increase at the same time legacy products revenue will decrease.

As I mentioned earlier, our plans reflect modest growth and cash neutral operations in the embedded business segment as we ramp up the development and marketing of new Voice-over-IP products. Due to the design and development lead-time, Voice-over-IP products will start to have a significant impact to our revenues in 2007. Last quarter SBE completed a development and marketing agreement with Texas Instruments with SBE using their DSP chips as well as their Telogy Voice-over-IP software.

We received our first purchase order for these products from the very large Voice-over-IP OEM supplier for early access to development units that provide them a head start in writing software as well as integrating into their systems. We've received very positive customer feedback over our DSP designs and believe that our modularity, high port density and low cost per port will allow SBE to have an impact in this market.

Also, TI has displayed a willingness to introduce their customers to SBE in order to satisfy Tier 1 and Tier 2 requirements for standards-based PTMC modules bearing their hardware and their software components. SBE will exhibit at the VON tradeshow in Boston next month and announce the first of the family of voice, video and data solutions and are very optimistic about the leads coming in from that tradeshow.

The Voice-over-IP products that SBE will soon announce are used in carrier class media gateways located in central office or service provider racks. These products convert traditional analog voice channels into fast Internet protocol IP packets. Unlike the nonage (ph) or Skype end-user Voice-over-IP solutions that are point to point, SBE's customers will purchase 10 to 20 blades per rack providing the capability to service metropolitan areas and connect either to the Internet or the public switched telephone network or the PSTN. So that's really our niche.

The financial results of our third quarter reflect the reason why we've strengthened our position with the IP solutions; our growth in T1, E1 and T3 traditional telephony interfaces won't get much larger as voice communications over the Internet will increasingly dominate. This is not to say that T1, E1 and T3 business is disappearing, just that building an aggressive growth plan on just these products is unlikely. The bottom line is traditional T1, E1 and T3 business is sustaining while next generation systems require IP based solutions.

Now I'd like to discuss the storage business unit. The storage business unit consists of the company formally known as PyX Technologies as well as other SBE employees now focused on the development, productization and deployment of iSCSI solutions. Moving forward the iSCSI products sold by SBE will bear the PyX brand. Like the embedded business unit, the iSCSI products are sold to OEMs, system integrators or VARs. Since we don't sell solutions to end-users directly it takes six to 12 months to realize significant iSCSI license royalties. However, due to the increasing adoption that we're seeing on iSCSI in storage area networks, we believe that orders of magnitude growth is possible in 2006 and beyond.

I'd like to explain the three classifications of PyX iSCSI products for you. First, iSCSI comes in target and initiator binary software versions running on Linux operating systems in conjunction with a SATA RAID Controller. Second, the iSCSI target and initiator software running on Linux operating systems without the RAID controller. And thirdly, the iSCSI target and initiator software running on Linux, non-Linux or custom operating systems. Those are the three types of classes of products we support for iSCSI.

During the Linux World Trade Show several weeks ago, LSI Logic announced the availability of a product named iMegaRAID, a combination of LSI's MegaRAID SATA2 disk controller and PyX iSCSI target software. As the worldwide leader in RAID adapter sales, LSI is positioned to have a key role in the proliferation and use of cost effective, scalable enterprise San solutions. We target 10 to 12 large design wins through LSI next year; where applicable SBE will refer all opportunities for iSCSI RAID solutions to LSI Logic and its sales channels.

Interest in iSCSI is increasing. In addition to completing the agreement with LSI last month, PyX announced an OEM deal with ONStor, a manufacturer of network attached storage or NAS gateways. The iSCSI software will be featured in ONStor's Bobcat NAS gateway and provide IT managers who use it with the capability of consolidating storage for multiple Linux, Windows and UNIX servers into a single manageable environment. We're also pleased to announce that during the last week of July, SBE secured a design win with a startup storage OEM for both iSCSI target software as well as our TCP/IP upload engine for next generation SAN gateways. An OEM agreement has been executed between both parties, and development is now underway.

Unfortunately, due to a nondisclosure agreement that we have with this company, SBE cannot reveal the name of this OEM until their products begin shipping, we believe, during the first calendar quarter of 2006. SBE's business in the storage area has a primary goal to sell software to operate on all Linux hardware platforms. In order to continue developing very competitive software, SBE in the future will offer additional products to the iSCSI family that provide features for virtual storage management, as well as increased performance.

That covers my overview of storage and embedded units. Now I'd like to share with you my vision of the Internet's future, starting by quoting Ken Couch's -- Ken Couch from Nortel; "We're heading into a truly converged network where services nimbly follow you around and are seamless. As for the future, we believe that access media, whether it is DSL, wireless, PSTN, will become almost transparent to the user because they are all equally the same in bandwidth, offering services on an equally playing field."

In other words, in the near future we are going to have the ability to travel between our offices, homes, airports, cities and countries, and phone, access voicemail, coordinate conference calls, browse the Web, download movies and MP3 files, access terabytes of database applications, remotely backup stored data and many other things as if we never left the office. So to tie SBE's strategy together I'd like to say that it's no coincidence that SBE now delivers IP storage and IP communications products.

IP networking solutions address the expansion of the virtual workforce on a global scale, providing business agility by breaking down distance barriers as well as enabling new ways to share information. Companies like Cisco and D-Link are perfect examples of networking communications manufactures who now support iSCSI storage products. SBE will provide fault tolerant iSCSI storage area network products to enterprise storage OEMs, server OEMs and embedded computing platforms. Also we'll supply at the same time a variety of communications hardware that interface with or to the storage, the server and the embedded platform.

SBE is at a very exciting point in the Company's growth. We have an unwavering commitment to growing and expanding our business with innovative IP technologies and I look forward to sharing with you more success in the coming quarters as we continue to gain traction in the iSCSI and Voice-over-IP markets. I hope that this commentary has been helpful to you and we'd like to open the floor for questions for Dave and myself.

(OPERATOR INSTRUCTIONS). Jim Gentrup, Meadowbrook Capital.

Good morning, gentlemen. How are you?

Pretty good.

I just had a couple quick questions I think here. Can you on the storage side -- can you give us an idea of the mix between software and hardware revenues once you get -- reach more of a steady-state?

Thanks for that question. What we have done in the reorganization is organize the storage group that we now call it into IP storage products only. So that includes the iSCSI software and the TCP/IP offload engine only. All prior storage products that we had, specifically the Antares storage products are now part of our legacy group. So we will continue to track our storage revenues. However, our main focus is on IP storage or Internet storage activities.

So when we discuss the storage products group we will talk about the TCP/IP offload engine. We anticipate sales for that particular product to continue especially as iSCSI and IP storage applications increase. We believe that the market is just getting traction and taking off and we expect good growth over the next 12 to 24 months.

Jim, this is Dave. Specifically the mix of the -- I expect to see the vast majority of the revenue on the storage side to come from software licenses and not the hardware products at this point. I hope that helps you.

Yes, but then that means that that particular part of your business, even though your cash balances may go up, we won't probably see the recognition until late next year then?

Yes, that's why I mentioned that is that because of the accounting rules related to software it's probably going to be third quarter or so and we may get a big hit during that quarter as we bring in the deferred revenue associated with the licenses. But as most software companies recognize, you start building up a big deferred revenue, right, associated especially with the maintenance side of the portion of the fees that come in. And so that has to be amortized over the period.

So the hardware that's sold in the storage side will be recognized immediately like we do with all of our hardware. The software will be deferred and so we will see a deferral buildup associated with the software side.

And is the maintenance that's attached to this, the software licenses, is it going to be a standard 15% type thing or can you (multiple speakers)?

Well, yes, it's probably going to be somewhere between -- I'll say 10% and 20% is going to be the maintenance side. And that's the problem that we have right now, in most startups in software -- which I have to consider us in that base is that part of the business -- my accountants tell me take about a year to develop specific pricing because they require -- the accounting rules actually require a company to have a pricing committee and to have a particular history related to that Company or us, on that element -- the price of each element. You can't use a standard average or anything. But I expect it's going to be somewhere in 10% to 20%. Because we bundle the price. We don't price separately for maintenance and license, it's just one -- to the OEM it's whatever one price.

And then just changing the direction here a little bit. The LSI deal -- is it a fair question just to ask? I guess we're looking for a little more of a quantifiable number from you guys if you may. You probably knew that question was going to come.

Yes.

What kind of volume do you expect to see from -- how can you help us I guess in this area? Can you talk about the average license deal, the size of the average license deal through LSI logic? How can you help us with the numbers there?

Jim, we really can't forecast a number right now. LSI has their number and they're keeping it fairly confidential. We know that we have a model based on design wins. And we have a target number of design wins that we need to see in the next year. We're focusing on that and really don't want to set an expectation with the investing community at this time.

This is an enterprise sized type of deal isn't it, or not?

Yes. LSI has a goal of going after the big guys. They don't want Tier 2 and Tier 3 OEM storage guys. Although if you look at the way the market is broken down, LSI logic has 85% market share of that SATA marketplace. So they are certainly in a position for, you could say worldwide success. That said, clearly LSI wants to go after the big OEMs and that's where their focus is. We're going to support LSI as they roll the thing out, and we'll support it from a sales and a technical standpoint assuring that the OEMs they bring to the party get the best support from us and success rolling their products out into the marketplace.

Would you have the same answer then regarding the ONStor deal with the Bobcat and the other OEM that you couldn't name? Would that be the same answer there you're not sure about or is that the same type of a target?

We're going to be very careful about projecting anticipated revenues. Clearly we expect a significant impact due to the impact in revenues from this acquisition. But let me point out that there is a huge difference between the LSI package and the business that we have what LSI which primarily focuses on what we'll call standard products as they roll out into the iSCSI marketplace compared to other deals. ONStor happens to be a deal where they had a proprietary operating system, and so we enabled them through a source code license to take our product, change it and they're rolling the product out paying us royalties as they succeed.

So it's a little different model where LSI happens to be a sales and marketing arrangement and we're going to support them worldwide as they roll the product out, have opportunities and that type of thing. From our standpoint we see a huge amount of our effort, roughly 85% of our bandwidth supporting LSI and the activities that are ongoing there. On the other hand, ONStor and other companies that come to us for custom packages will pretty much by the package and run on their own. I hope that answers the question that you had.

I think it's -- close enough for now. What I wanted then to switch the last part of my question here is the, could you help us a little bit more again with the end user profile? I guess I'm looking for what's the benefit of switching to the IP storage -- besides some of the obvious things? Can you tell us a little bit more about why a customer is going to switch or improve and what the demand is going to be there?

Yes. If you look at the market I think that the largest end-user base is being driven by IT managers or managers of businesses that set up both Intranet and Internet services for their companies and support storage in one form or another. Now, the bigger the business grows the more storage you have and the more needs for storage that are required. IT managers can store modest amounts of data on a network attached storage, that is that if you have small numbers of people you might set up a server specific to the needs of that small company. But the larger the organization grows the more that IT manager wants to segment the data into a separate and specific storage network and that's called a SAN.

So the IT manager today has been using fiber channel predominately to support the SAN. Fiber channel happens to be proprietary, it's expensive and it's also very tough to manage; it's hard to get SAEs and IT managers that understand it. Those have been the three biggest problems with fiber channel. The IT manager now with network storage, meaning you can use your existing Ethernet network to store data, can start replacing direct attached storage or disk drives to a workstation; they can replace the NAS or a small disk drive and small companies, and on a larger scale compete with fiber channel.

So we see really three different topologies, if you will, of how the IT manager and the end user will use IP storage. iSCSI in the early days was kind of thought of as the poor man's disk storage system. It's turning out though with the fault tolerance that iSCSI is now capable of as well as the performance, it's truly an alternative to any kind of storage that you can find. Right now fiber channel dominates in the SAN. We're going to find applications as time rolls on for iSCSI replacing fiber channel. So that's kind of what we see, Jim, in that area.

Thank you very much. I guess then as shareholders that we should -- just confirming what you said earlier, I think that the communication business is going to be cash flow positive, I believe you said?

That's correct.

Or cash flow breakeven I should say.

Breakeven or positive. We're just budgeting so it doesn't take away from the pipe funds and that we're focused on basically organic growth in that segment.

And in the storage then we probably are going to see losses in the storage area until you can start recognizing the revenues and until some of the -- when these deals start wrapping up?

That's correct.

Okay, guys, thank you very much for the update.

Thanks, Jim.

(OPERATOR INSTRUCTIONS). At this time there are no further questions.

Thanks for joining us, everybody. We'll see you next quarter.

Thank you for participating in today's SBE third-quarter 2005 results conference call. This call will be available for replay beginning at 1:30 PM Eastern standard time today through 11:59 PM Eastern standard time on Saturday, August 27, 2005. The conference ID number for the replay is 865-4963; again, the conference ID number for the replay is 865-4963. The dial number for the replay is 1-800-642-1687 or 706-645-9291. Thank you. And you may disconnect at this time.