Neonode Inc (NEON) 2005 Q4 法說會逐字稿

Good morning; my name is Felicia and I'll be your conference facilitator today. At this time, I'd like to welcome everyone to the SBE fourth 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 session. (OPERATOR INSTRUCTIONS).

At this time, I would like to the call over to Dave Brunton, Chief Financial Officer. Thank you. Mr. Brunton, you may begin your conference.

Good morning. This is Dave Brunton. I'd like to welcome you to SBE's fourth quarter and fiscal 2005 investor call. I am with Dan Grey, our President and Chief Executive Officer and we are going to address SBE's financial results and activities over the past quarter and fiscal year and then elaborate on our product roadmap and talk about the Company's future direction.

At the end of our call we will open the floor for your questions. If you would like a copy of our full earnings release, please contact Judy at 925-355-7602 and she would be very happy to send you one.

As a reminder our financial statements are prepared in accordance with generally accepted accounting principles and this conference call may contain forward-looking statements that are subject to risks and uncertainties including, among others, those described in our 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 this call.

To start, Dan will provide some opening remarks. Dan.

Thanks, Dave. First I would like to wish everybody a happy holiday season and a prosperous new year. During this call I'd like to mention highlights of the recent past including a summary of where we are today, mentioning highlights and takeaways from the quarter, as well as our goals. Then Dave is going to discuss the financial results in detail. Following that, I will provide more detail on the quarter from a product and a market perspective.

Last year, SBE was faced with tough issues, realizing the end of an ongoing business relationship with Hewlett-Packard, spanning 14 years in which the Company sold roughly $55 million worth of products and seeing the future growth of the opportunities increasing in technology surrounding Internet protocol, including iSCSI, IP storage software and VoIP hardware. Posed with either shrinking our operations amid (ph) reduced revenue levels or bolstering engineering sales and marketing for new products SBE with the shareholders and our Board of Directors decided to invest in new product technology.

So we believe that the short-term investments and resulting losses will result in healthier returns for shareholders in the long-term. We acquired PyX Technologies in late July of this year and have just completed the first full quarter postmerger. Concurrent with the acquisition of PyX, we raised approximately $5.1 million to a pipe providing sufficient cash for the increasing engineering, research and development, sales and marketing expenses as we broadened our iSCSI product features, sales channels, and increased our brand recognition throughout the market.

Last quarter, we announced that SBE's core product plan included new products including voice video and data, digital signal processing -- or DSP modules, leveraging on existing SBE WAN and LAN IL products. The importance of this VoIP product line can't be emphasized enough for the embedded products and will provide us with higher revenues, higher profit margins, and longer lifecycles as compared with many of the other commodity products we have today. These two technologies are arguably the hottest technologies around today.

Key activities in takeaway. Since the acquisition of PyX, SBE has made several announcements including business arrangements with LSI Logic or packaging our iSCSI software in their iMegaRAID SATA Adapters. Design wins with ONStor and other storage OEMs, selecting our iSCSI target solution for their NAS Gateway Systems as well as engaging with four prominent -- excuse me three prominent manufacturer sales rep organizations to promote our product to OEMs in the storage marketplace.

As a result of expanding the sales channel, we announced design wins with YMI for their rack-mount pro series of SATA and SAS storage servers as well as open source storage for integration into their next-generation SATA systems. Although little of our past quarter's topline revenues can be attributed to iSCSI sales we see adoption activity increasing in the form of design wins, design wins being a predecessor to increasing licensed revenue.

Goal achievements. We had several key goals for the last quarter and achieved most of them. SBE moved into a slightly larger facility close by and completed the integration of PyX employees. Our sales team was broadened to discover and support new opportunities and our Company deployed a customer relations (technical difficulty) for managing customer activities providing the framework for higher levels of internal communication.

Not the least of our goals was increasing topline revenues for storage products. I thought we'd see more traction in iSCSI sales; however, delays with LSI's rollout and sales channel implementation resulted in initial softness. I'll go more into the iSCSI detail later.

Now Dave will present the financial details.

I'm going to start with a review of our results for our fourth quarter and year ended October 31, 2005. As Dan said this has been a year of transition for the Company. We have talked about our strategies and specific activities we are pursuing to support these strategies during the last couple of conference calls. Before I get to the numbers, I want to recap some recent highlights.

As Dan said in July we acquired PyX Technology; and when we acquired PyX we took a very important step in determining the future direction of the Company. As we reported last quarter we issued 2.6 million shares of our common stock to the shareholders of PyX. We also assumed their stock option plan that had approximately 2.1 million stock options outstanding.

To provide working capital, as Dan previously said we raised approximately $5 million by issuing 2.1 million shares of our common stock and warrants the purchase of an additional one million shares of our common stock to investors in a private placement offering. Although 95% of the shares issued to the PyX shareholders are locked up until July of next year we did register all the shares issued in both the acquisition and the pipe for resale with the SEC.

How did the PyX acquisition and the issuance of stock affect our financial position? Let me try and summarize for you. With the acquisition of PyX, we increased our investment in product development and to this end we hired some outstanding engineers. We also invested in sales and marketing initiatives in both the iSCSI stores software and VoIP product lines. And we hired two sales professionals.

These planned activities increased our overall operating expenses. We recorded approximately $12 million of intellectual property in 2.5 million deferred compensation associated with the PyX acquisition. We began amortizing these to expense in our fourth quarter just ended. The total non-cash amortization expense for these two items is approximately $1.2 million. After the acquisition and private placement, we now have approximately 9.8 million shares of our common stock outstanding.

Overall we ended fiscal 2005 as expected. Our revenue, net loss and cash position are in line with our expectations and our total number of shares of common stock outstanding is as planned. At this point we are well on our way to our IP Everywhere strategy.

With that said let me move to some of the financial details. For the year we reported revenues of 8.1 million compared to 11.1 million in 2004. All of our revenue for 2005 was generated from the sale of our embedded hardware products. The year-over-year reduction can be attributed to the end of life of the HP program. In 2005 we sold $1 million to HP compared to 4.9 million in 2004. We have been reporting the HP end of life and its effect on our topline review and gross margins for some time now; so I expect you are all familiar with this event.

We did see a slight uptick in our sales of our HighWire product, that covered a portion of the HP reduction.

We ended the fourth quarter with 1.8 million in sales compared to 2.2 million in the same period of 2004. The fourth quarter of 2004 did include $800,000 in sales to HP. This was our first full quarter after the PyX acquisition and it went pretty much as expected. We had minimal software license sales, all of which were deferred for the rules for software accounting review accounting that we discussed last quarter. As of year end we now have 138,000 of deferred revenue related to prior sales of software licenses and software consulting services that will be recognized in future periods.

So the end result is that we feel we are pretty much at our baseline revenue levels and have successfully repositioned the Company to take advantage of the markets for both IP storage and VoIP communications. We expect both of these product lines to make up an increasingly greater proportion of our future revenues. Our gross profit margin for the year was 33% compared to 40% in fiscal 2004. The profit margin for the fourth quarter was a negative 12% compared to a negative 15% for the fourth quarter of fiscal 2004.

It is important to note that the margins for both periods were negatively affected by the $1 million of non-cash expense related to the amortization of intellectual property assets. In 2005, we amortized the PyX intellectual property in the fourth quarter and in 2004 included the amortization of and write-down of the Antares intellectual property.

In addition, fiscal 2004 also includes non-cash inventory write-downs totaling $500,000. Without the intellectual property amortization and inventory write-down, our gross profit margins for fiscal 2005 and 2004 would have been 45% and 55%, respectively. We are scheduled to amortize the PyX intellectual property to our cost of goods sold expense over the next 11 quarters at the rate of about $1 million a quarter.

Because of this non-cash amortization expense, we expect a negative gross profit margin until such time that we can begin to recognize revenue from our iSCSI software license sales. We do expect to have sufficient vendor-specific objective evidence -- related to the pricing of our software that is required by the accounting rules -- to begin to recognize software revenue in the third quarter of fiscal 2006.

Our cash base gross profit margin from embedded hardware products is in the mid 40% range and is in the high 90% rates for our iSCSI software products. During the year, our total operating expenses increased to 6.9 million from 6.1 million in the previous year. The increase was planned and is related to new employees hired when we acquired PyX, increasing spending on the iSCSI software and VoIP product development, and strategic sales and marketing initiatives.

Fiscal 2005 operating expense also includes 175,000 of non-cash deferred compensation amortization expense, related to the assumption of the outstanding stock option plan in the PyX acquisition. The deferred compensation expense will be amortized to general and administrative expense over the next 13 quarters at the rate of $175,000 a quarter. Because of these factors, we expect our annual operating expense to increase to approximately $9.1 million for 2006.

As required, we adopted SFAS 123-R related to the expensing of stock options at the beginning of our fiscal 2006. We will be expensing all unvested stock options outstanding as of November 1st, 2005, along with all future option grants. The annual non-cash expense for 2006 related to the existing stock options as of November 1,2005 will be approximately $520,000. And any new stock options issued in the future will increase this expense.

Our bottom-line net loss for the year fell within the expected range at $4.2 million or $0.66 per share compared with a net loss of 1.7 million or $0.33 per share for the prior year.

We ended fiscal 2005 with cash of 3.6 million, no debt and working capital of 5.2 million compared to cash of 1.9 million and working capital of 3.9 million at the end of 2004.

Also as of October 31, 2005, we have 9.9 million shares of common stock outstanding along with 4.2 million issued stock options of which 1.4 million are vested. These options have exercise prices ranging from $0.90 to $18 per share. In addition, we have issued an outstanding warrant to purchase 1.2 million shares of our common stock at prices ranging from $1.50 to $3.50 per share.

That concludes my comments and I will turn the call back to Dan.

I will start by covering the storage products. The PyX iSCSI software is a robust and fault-tolerant package that provides Linux-based servers with the compact capability of being an iSCSI target or an iSCSI initiator. In the real world users can implement iSCSIs for storage solutions ranging from direct attach storage to replacements of fiber channel storage area networks or SANS.

Due to the scalability of our iSCSIs from one gigabit to 10 gigabit per second, we are demonstrating high-performance and reliability using off-the-shelf networks, off-the-shelf switches, and standard management infrastructure. Applications running above our iSCSI software include disk backup, disaster recovery, mirroring and storage volume management.

Our iSCSI software products take on three forms. First, iSCSI target and initiative -- excuse me, iSCSI target and initiator binary software running on Linux platforms in conjunction with LSI Logic, iMegaRAID, status two rate controller. Second, for iSCSI target and initiator binary software running on Linux platforms without the VLSI controller and, thirdly, iSCSI target and initiator source code software for custom operating systems.

Our target customers include storage OEMs who provide disk and servers solutions for their customers' needs. Leaders in this tells include Network Appliance, EMC and Hewlett-Packard. Although SBE is strategically approaching opportunities with these market leaders and others, we see active traction starting with mid-sized storage companies who offer alternative products and services to storage end users.

As I mentioned earlier, we recently announced design wins with YMI and NOSS (ph), and being selected for the next generation systems. We expect several more design wins very soon and have roughly 20 evaluations going on now. Some accounts are being supported through LSI and others directly. As iSCSI increases its deployment worldwide, SBE Solution will be picked up by Tier 1 OEMs and serious compound revenue growth will then occur.

Exactly when this will happen is a question on everybody's mind. Historic markers continue to show growth as most of you have seen by following the market. The total size for the iSCSI market in 2005 is roughly $200 million and analysts expect more than double that number in 2006; and it is expected to grow to 2.7 billion by 2008.

So market reports indicate increased shipments along with our recent design wins, successes, and ongoing evaluations show us that the iSCSI market is indeed taking off. Our strategy is to cover 2 tier storage -- is to cover the 2 tier storage OEMs who is going to capture approximately 10% of the market and strategically focus on several tier 1 OEMs who have the greatest potential revenue impact to SBE. We are engaged with several key advisers, industry experts who are giving us both products and marketing guidance, as well as engaging us with strategic perspective customers.

LSI Logic is a major strategic partner of SBE in the rollout of our iSCSI. LSI is a market leader selling SATA wave controllers to OEMs worldwide. Last quarter, we thought that LSI's prospective customer list would dominate our sales and support activities. However, concurrent to their announcement of the iMegaRAID product line LSI introduced their next generation rate controller based on serial attached storage or SATs. Due to the timing of that rollout I believe SBE somewhat competes with the new SATs opportunities and the direct LSI sales will be less than expected in the future.

The biggest delight in the past quarter was the enthusiasm of several larger manufacturers' reps who signed agreements with us and introduced us into accounts needing the PyX iSCSI software transport. We signed three of them at this point in time -- PSI Solutions in the Northwest, Centaur Sales in Southern California and Fourfront in Northern California. Due to their involvement, our number of opportunities in the sales funnel has risen dramatically. In the near future Nelson Aball (ph), who manages our sales as well as Chris Short, who drives business development will engage with manufacturers' reps in Texas and East Coast to fill up our coverage there.

Regarding sales in Europe and in Asia, SBE is working with several OEMs and sales organizations now with the goal of rolling out our IP storage solution within six to eight months.

Last week, we recently announced the stored blade product in the embedded communications industry and this product was called the Fast (ph) iBlade. This is the first of many products that combine the PyX iSCSI transport on a standard telecom processor. The particular product features a single or dual SATs (ph) daughterboard mounted on a processor allowing for the network processors within the embedded system to have iSCSI access to either eight or 16 SATs disk drives. This product is fairly unique in the telecom space and it will take one to two years to hit production revenues. But it is a move in the right direction following the industry trends and it leverages multiple products within SBE.

That covers the storage products. I would like now to discuss the embedded business units. Our embedded products consist 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, T3, Gigabit Ethernet, local area network modules and intelligent compact PCI processor platforms, allowing modular application-specific solutions.

SBE's embedded sales were flat from third quarter to fourth quarter and for our year the core products accounted for, roughly, 72% of the revenues split evenly between WAN adapters and the compact PCi platforms. The remainder of that is the legacy.

We expect our core platform revenue to increase over time at the same time legacy products decrease. As I have mentioned in earlier communications our plans reflect modest growth in the embedded products and cash (ph) into operations in the business segment as we ramp up the development and marketing of new VoIP products.

Due to the design and development lead time VoIP sales will start to have a significant impact to our revenue in 2007. Last quarter, SBE announced two DSP products that are used by OEMs in area class media gateways. These gateways are typically located in central office areas or service provider racks and they typically will convert analog voice channels into fast Internet protocol packets. These hot applications are used in VoIP and video format transcoding.

We are currently engaged with a handful of OEMs interested in deploying our products in next generation systems and hope to announce several design ends within the next quarter. During the past quarter the VoIP has slipped a little bit in its schedule -- roughly three months. However we are committed to -- with the resources -- bringing in to complete the effort by the end of March. As we have said in the past, forecasted revenue during 2006 for SBE's DSP products will be modest as production volumes will begin really in 2007.

To summarize, SBE continues to execute against its plan to make an impact with IP technologies -- ISCSI storage as well as VoIP. At this point I would like to open the floor for any questions you have for Dave or myself.

+++ q-and-a.

(OPERATOR INSTRUCTIONS) David Mithra (ph) from Meadowbrook Capital.

Evan Greenburg from Meadowbrook Capital. I just wanted to know the ramp up with LSI. Do you have a schedule of them yet in terms of -- have you gotten -- I'm sure you've gotten some pilot orders. But do you have any schedule with them in terms of when you think they can ramp up their order process for you?

Our relationship with LSI Logic is sales and marketing and we are enabling them with the software packages they bundle along with their controller and they go in to the seals (ph) and they basically sell that combine package to their opportunities. So we support them as engineering opportunities come up and that type of thing. They do not give us a forecast for business at all but what we do is we react to opportunities that they bring us into.

So, therefore, we really don't have a solid forecast. We don't have a list of what we will call -- well, we do have a list of target customers but it's not as concrete as having forecasts from each one of them.

That gives you an inability to forecast revenues and forecast revenues internally I guess as well as externally. Forget about us. I'm thinking about you. What do you do internally to react to LSI? Because LSI can suddenly hit you with a huge order flow that you can't handle.

The beauty about our software product is that it doesn't take much of an operation to increase capacity. The beauty is, you basically duplicate software. Now the real question, I think that you are asking is, when is IP storage going to become a forecastable technology. I think everybody in this industry is asking the same question.

Over the last quarter we have been spending a lot of effort, to try to understand who the leaders are in this industry and what their forecast is. As a result of that effort, we believe that the primary leaders in this technology are bringing out the technology, they're supporting the technology, and we don't believe that they are seeing a forecast or can forecast data that is significant to all of us that are involved in this market.

We believe we are on the front end of a hockey stick. We believe traction is occurring, but we think it is that a slow rate. But I don't think anyone is I guess being too vocal about forecasted revenues until they really happen.

Thanks a lot.

Thanks, Evan. Sorry that the answer is so vague and when we get more traction data we are going to be happy to pass it along to you.

I was just wondering, I know you have 20 potential installations. That's exciting. But you just want to see how scalable it is and how much LSI is going to do. And I guess that if they haven't given you that indication there's nothing you can do.

I think the biggest thing we are looking from LSI is traction with some large OEMs. Because knowing that they are the market leader presents us with unique opportunities to support business in that area. So we are already engaged with some very large customers. However, the design and cycle is based on the customer need. What they see in a market and a business plan, and we go from there.

Paul Packer of Globis (ph) Capital.

Could you elaborate a drop here about LSI's product. How similar is that to you guys?

LSI's product in the combined IMegaRAID. Paul, the iMegaRAID package that LSI offers is a combination of their Megaraid SATA 2 controller which is a piece of hardware that goes into a PC and our standard binary iSCSI package that handles targets and initiators. So what they're doing is, taking a standard product -- SATA product -- that is being used by many large OEMs in the storage industry, putting our software with it and making it very easy for existing customers to transition to this new IP storage.

So part of their business plan is to hit up existing OEMs; secondarily to grow the SATA marketplace. They plan on using this bundle approach new OEMs as IP storage takes off.

(inaudible) Yes, I think a follow-on to that would be LSI introduced a new the technology called Storage Area -- SAS -- what does SAS stand for? I just drew a blank. Serial Attach Storage. Sorry about that. Serial Attach Storage is faster technology and it also drives a signal to the disk drive a little bit longer. So therefore it is the storage OEM in this industry, it's a very hot technology and probably a technology that many of them will end up using. It is also higher priced.

So the current product support include the SASA, the existing serial products. We do support SAS, but LSI Logic is just releasing their SAS product that does not have the iSCSI. So here is part of our dilemma, is that LSI who is being asked for their SAS adapters from OEMs does not have iSCSI support for that particular product. Therefore, we are engaged with the sales channel, manufacturer sales reps and distributors supporting a variety of different adapters in the marketplace and SBE through the PyX study software can handle not only the SATA that other SAS type of controllers, including the LSI products.

So what we are seeing is a bigger opportunity in the long run to have an effect not only with LSI customers but OEMs in general as they approach different controller speeds and controller types.

Now LSI at one point was dedicating its significant staff to your product. Am I correct?

Yes.

Is that still happening?

Still happening. They still have a product marketing group. They have engineers that are testing and doing QA and we continue to support them as they roll it out to a variety of different prospects. They have not cut back their commitment to roll this product out.

The important thing that needs to happen here is, as Dan said in his prepared remarks, that on the LSI deal is that they rolled out the SATA, the iMegaRAID card. They also were rolling out the SAS card at the same time which is the newer technology. We made and they made a decision and we had meetings on it that for the SAS products we would meet in the channel.

So in that situation we, their reps or our reps, and as they sell LSI SAS card and if someone wants iSCSI, our iSCSI interoperates with their SAS card. We've already -- they've given us the card and we tested it and everything works great. So we still are pursuing the opportunities with whether it is a SAT or a SAS card. The difference is the SATA card is an LSI product on their product SKU listing including the iSCSI. On the SAS card, the reps are selling the LSI SAS card as a product and our iSCSI as a product.

So they are 2 separate products that we're (MULTIPLE SPEAKERS)

You have any idea what their demand has been so far?

I don't know. I do know that from a customer compact perspective approximately 50% of the customers that are being contacted are wanting to do evaluations which is a pretty good hit rate. We'll see what falls out of that as the actual purchases. But we are pretty encouraged by it at this point.

So if I could just summarize kind of what Dave said, instead of seeing so much iMegaRAID SATA business, we are seeing combinations of iMegaRAID SATA business and SAS business. And we are seeing combinations of LSI as well as direct sales through the channel for these products. The big picture, when you are looking at all the prospective OEMs that we are talking to, the number is still pretty huge. Now we need to execute and close the sales.

Taylor Lumpkin of Anderson and Strudwick.

Let's say the LSI deal gets delayed by a year. Are you going have to raise capital again between now and, say, '07?

You know, if everything gets delayed by a year I would say the answer is approaching yes. Right now we don't see that happening. It is not delayed. Actually it is out there. We are in the midst, and as Dan said, there's approximately 20 customers that are evaluating. It is a combination of three ware (ph) cards, LSI SATA, LSI SAS cards so there's a bunch of rate adapter cards that are being evaluated in our software works with all of them. So there is, I guess the answer right now is we don't think that is going to happen.

Right. These guys could evaluate for six months or 12 months.

They could. I don't, we don't -- we now have six customers since we signed up -- since we acquired PyX we've -- we have signed on -- they had one customer when we bought them. We've gotten five design wins in the last couple of months and it doesn't seem to be the long design cycle that we see with telcom at this point. Now a couple of those are source code deals that they are developing new products but the newer ones that we got -- the YMI and the OSS -- they are actually shipping product and this is a feature that is going in and it's going to be, we think, a fairly short design cycle. So I don't expect it is going to be a long (indiscernible) period.

What about the competitive fund? Are you seeing anything from Adaptec at all?

I'm not personally seeing Adaptec out there. From a competitive standpoint, frankly, the leader on this thing is Falcon Store and they have a Windows-based system and they have a variety of software applications right above their iSCSI transport. So that is combining apples to oranges. The Falcon Store's market is the market leader in iSCSI transport as well as applications. We don't see Adaptec, there are a variety of others that are out there that we compete with.

So I would say that, as the market gets bigger, certainly we will have more competition. Our goal is to get enough dominance on the OEM iSCSI transport side to where we dominate at least that segment.

There are no further questions at this time.

Thank you very much, everybody, we will talk to you next quarter.

Have happy holidays.

Thank you for participating in today's SBE conference call. This call will be available for replay beginning at 11:30 AM Eastern Standard Time today through 11:59 PM Eastern Standard Time on Saturday, December 17, 2005. The conference ID for the replay is 299-0705. (REPEATS) The number to dial for the replay is 1-800-642-1687 or 706-645-9291.

Thank you and you may disconnect at this time.