Exhibit 99.1
On January 26, 2004, Neoware Systems, Inc. held a webcast conference call to
review its 2004 second fiscal quarter results and discuss management's
expectations and current views of the industry. The following represents a
textual representation of the content of the conference call, and while efforts
are made to provide an accurate transcription, there may be errors, omissions or
inaccuracies in this transcript. A recording of the conference call is available
on our website at www.neoware.com.
MANAGEMENT DISCUSSION SECTION
Operator
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Good day ladies and gentlemen and welcome to Neoware Q2 Earnings Conference
Call. At this time all participants are in a listen-only mode. Later we will
conduct a question-and-answer session and instructions will follow at that
time. If anyone should require assistance during the conference, please press
"*" then "0" on your touchtone telephone. As a reminder this conference call
is being recorded. I would now like to introduce your host for today's
conference Mr. Michael Kantrowitz, Chairman and CEO of Neoware.
Michael Kantrowitz, Chairman, President and CEO
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Thank you Molina and welcome everybody to Neoware's Q2 conference call for
the quarter ended December 31, 2003. At this time you should have all seen
our press release, which went out at 4 o'clock today. It is posted on our
website and if you need one sent to you, please feel free to call 1800
Neoware and ask for that. With me on the call today is Keith Schneck,
Neoware's Executive Vice President and Chief Financial Officer. And let me
tell you our agenda for the day. And let me tell you our agenda for the day.
We will start by me giving you an update on recent events and highlights for
the quarter. I will then turn the call over to Keith who will go over our
numbers for the quarter and the first 6 months in detail and provide some
insight into our business model and some key metrics. Keith will then turn
the call over to me. I will talk a bit about our strategy and our plans for
the future, and then we will take questions for approximately 30 minutes at
the conclusion of the call. Before we begin, let me turn it over to Keith for
the Safe Harbor statement. Keith.
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Keith Schneck, Executive Vice President and CFO
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Thanks Mike. The following topics today will be discussed and it will contain
forward-looking statements - our relationship with IBM, our TeemTalk product
line, our focus on increasing software revenues, our financial results, the
thin-client appliance market, our expectation for the growth of our business
organically and through acquisitions, our flexibility in our future
operations, customer recognition of the benefits of our products and services
driving our results, and the cost saving benefits of our products to our
customers. Additional information concerning factors that could cause actual
results to differ materially from these forward-looking statements are
contained in our Form 10-K for our fiscal year ended June 30, 2003 and Form
10-Q for the quarter ended September 30, 2003, which was filed with the
Securities and Exchange Commission. Mike.
Michael Kantrowitz, Chairman, President and CEO
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Thanks, Keith. Let's start going over the results for the quarter. While we
didn't meet all of our expectations for this quarter, you can see from the
release in the numbers that we released today that we did report some
positive results. First on the revenue line, revenue of $15.3 million is the
second highest that this company has ever delivered. In fact this is only the
third time that the Company has ever exceeded $15 million and that's the last
three quarters in a row, as a matter of fact. Once again, gross margin
significantly exceeded our estimates of 45-48%; gross margin came in at 50%
for the quarter - the result of our efficient supply chain and our increased
software sales. Earnings per share were $0.09 on 1.5 million more shares than
last year and this included $316,000 of amortization of intangibles from
acquisitions. As planned, operating expenses were up by $1.9 million from
last year as we invested in sales, marketing, R&D, and infrastructure as part
of our growth plan. And, I think, very impressively on the balance sheet, for
the first time the Company has reported more than $50 million in cash. The
Company, the balance sheet, the cash position - they are in the strongest
position that they have ever been at Neoware with over $50 million in cash
and no debt.
Obviously we have the resources to move forward and to grow this business.
And we're confident that we are in the right place at the right time. And we
believe our products offer real tangible benefits for our customers. We
improve customer security, we allow customers to save money, and, in general,
we let them do more with less, with fewer staff and with lower budgets. These
are important benefits that we provide given today's IT spending environment.
And in fact our industry is beginning to see - is beginning to get more
attention as these benefits become more widely known. We've seen increasing
attention with major articles talking about the benefits of thin-client
computing. In the mainstream press, as a matter of fact, yesterday there was
an article in the New York Times talking about this; a few weeks ago a cover
article in Computer World talking about the benefits of thin-client computing
with some wonderful examples of Neoware customers in it; and recently a major
piece in CIO magazine as well. The result is that thin-client computing is
becoming more widespread and more widely known everyday. So as a result of
that, obviously we are quite positive about the future opportunity for the
Company both because of the resources that we bring, the groundwork that
we've laid, the benefits that we bring to our customers, and the opportunity
that we see in our market. Let me turn the call over to Keith to give you
some more details on the quarter.
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Keith Schneck, Executive Vice President and CFO
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Thanks Mike. I'd like to review the highlights of our second quarter
financial performance. First on the income statement, revenues for the second
quarter ended December were $15.3 million, up 4% from the $14.7 million
reported in the prior year December quarter and up sequentially from the $15
million in our recent September quarter. As Mike pointed out, this is only
the third quarter in the Company's history that we've delivered more than $15
million in revenue. Our customer base continues to remain strong with a mix
of existing and new customers including Accor Hospitality, Raymour and
Flanagan Furniture, ADT, Allied Holdings, Art Van Furniture, Badcock
Furniture, The California Department of Motor Vehicles, City of Montreal,
DaimlerChrysler, Haverty's Furniture, L.L. Bean, Los Angeles Municipal
Transit Authority, Provident Bank, Raytheon, and Wal-Mart to name a few. Once
again we signed up hundreds of new customers in the quarter and more than 85%
of our business came from existing customers showing that the customers value
the products and services that our people provide.
Operating income for the quarter was $2.1 million or 14% of revenue compared
to $2.9 million or 19% of revenue in the prior year December quarter. This is
a result of our planned increase in operating expenses, which I will talk
about in a minute. Net income for the quarter was $1.4 million or $0.09 per
share fully diluted compared to $1.9 million or $0.13 per share in the prior
year. Fully diluted shares increased by 10% over the prior year due to the
1.5 million shares issued in the private placement in July 2003. Gross profit
margins were 50%, up significantly from the 45% reported a year ago and well
above our guidance of 45-48%. We have reported results well above our
guidance in the past several quarters driven by improvements in our product
costs, leverage of our supply chain model, and a product mix that includes an
increasing component of software revenues. However we are holding guidance at
45-48% for gross profit margins.
Our operating expenses are up 50% from last year's second quarter or about
$1,850,000 and up 8% from the recent September 2003 quarter as planned. About
25% of the increase from last year is a result of personnel we hired and
operating costs including amortization of purchase price related to our
TeemTalk acquisition. Additional cost increases in sales and marketing are
due to people additions and marketing expenses for items such as trade shows,
direct mail, collateral materials and other activities incurred as a result
of implementing our growth plans both domestic, U.S., and Europe. In the G&A
area, our operating costs have increased for salary and benefits due to staff
additions such as our Chief Operating Officer, Eric Rubino and myself; both
of which were not there a year ago, additional costs to support expanded
efforts in complying with new Federal and SEC regulations like the
Sarbanes-Oxley internal control documentation and audit fees associated with
that. We also increased D&O insurance, which has more than doubled in the
past year. One other factor impacting our operating costs, although not as
significant, is the price fluctuation in both the pound and the euro. Both
are up over 11% since June 30. The change in the December quarter on
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operating expenses was approximately $100,000. Since we invoice most of our
international customers in U.S. dollars, the price fluctuations impact our
expenses only.
Moving to the balance sheet and cash flow statement - cash and marketable
securities increased to $50.8 million at December 31 from $45.7 million at
September 30, primarily as a result of positive cash flow from operations.
Cash flow from operations for the quarter greatly improved as we focused on
collection of receivables, now down to 54 days sales outstanding compared to
63 as of June 30. A reduction in inventories, now about $740,000 or about
half of where they were as of September 30. And better management of our
payables. These are especially good results as our targets for DSO are 60-65
days and our target for inventory is higher than what we deliver.
Now looking forward, as we indicated in our release in early January IDC
continues to project robust growth in our market for coming years. In
addition there are signs that point to industry growth in the coming year
such as others in our industry projected IT spending will grow at a healthy
rate in 2004 and there is expected to be a significant upgrade cycle related
to the Y2K systems replacements. Of course in developing our guidance we also
consider our own internal data including past history, customer pipelines,
roll out schedules, and the continued addition of new customers, which
continue to be in the hundreds per quarter. However, we do believe we are
best served by giving relatively conservative guidance and as a result we are
providing guidance assuming that the market in the coming year is similar to
the market this past year. Our projections did not assume a significant
increase in IT spending nor do they assume that thin-clients capture a
significantly larger portion of the expected PC upgrade cycle. With this in
mind we are guiding revenue projections for the remainder of the fiscal 2004
year to be similar to revenues reported in the past six months plus or minus
$1 million per quarter.
We are forecasting revenue growth of at least 17% in our fiscal 2005 that
starts in July of this coming year. This revenue growth is also about
equivalent to our calendar 2003 over calendar 2002 revenue growth. Our gross
profit margin guidance continues to be in the 45-48% range, dependent on
product mix and relative percentage of software revenues. Operating expenses
will go up slightly as we invest more heavily in marketing and realign our
sales resources to stimulate growth while maintaining other costs in line.
Share count is expected to remain constant and our effective tax rate should
not exceed 36%. Mike will detail more of the operational activities
associated with our plans. So to summarize guidance in an example, if we are
at the same revenue levels as the past quarter, which is around the mid point
of our guidance margins of 48% and operating expenses at the same quarterly
level, this translates to $0.07 earnings per share. At the top end of the
revenue range plus $1 million it's about $0.09 per share. Overall we continue
to believe we have a strong business model, a strong financial position, and
leverage and a handle on what we need to do in our business. That brings my
prepared remarks to an end and after Mike's presentation we'll open the call
to answer any questions that you have. Back to you Mike.
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Michael Kantrowitz, Chairman, President and CEO
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Thanks Keith. Let me first comment on a phrase that we put into our press
release in the beginning of January which I had gotten some questions on.
We talked about market dynamics that were impacting the growth of the company
and let me talk about what we meant by that. Basically the most important
change that I think we faced and the most important challenge I think we
faced in 2003 is that our core market didn't achieve the growth that was
expected of it in 2003, according to IDC and we got their numbers in
late December for the period, the nine months period ended September 30th.
For that nine month period according to IBC the thin-client market was
relatively flat compared to the prior year and it was projected to grow in
the 20-30% range. So, that was something that we faced and that was what we
were talking about when we talked about market dynamics impacting the
company's growth. In retrospect as we look at this and we look at our market
and we look at the dynamics of the market it's really not surprising that
this happened in 2003 as we look back on it. Let me tell you why I think that
is, first of all the IT spending climate was terrible in 2003. Virtually all
areas of IT spending were flat or just up slightly or even down in many cases
just because of IT spending. So I think that potentially impacted our overall
market but I think there were specific dynamics in our own market that
affected it even more.
In 2003 our primary competitor went private in Taiwan, which we believe is
one of the first going private transactions ever in that country. Now we
believe that this likely consumed significant management time and that as a
result it's possible that our competitor wasn't necessarily doing all they
could to expand the thin-client market. Neoware, the number two player in our
business has actually never had a strategy of trying to grow the thin-client
market. Our strategy all along has been to utilize our market, our marketing
expenses and our efforts to gain market share, but to save marketing dollars,
by finding customers already familiar with thin-clients, avoiding the
expenses of evangelizing thin-client computing, and as a 15% market share
player in our business that is not an inappropriate strategy to take given
that other people are evangelizing the market.
The number three player in our market is Hewlett Packard, and in 2003 they
underwent a complete product change. In the beginning of the year they were
selling Wyse thin-clients to their customers, to their customer base and at
the end of the year they had ceased as far as we understand, ceased acquiring
those products and changed their product line to one that they designed
themselves and so looking back on it, it makes a lot of sense that they
wouldn't do a lot of evangelizing early on in the year to promote a product
that they would end up competing with. And their own product line only was
introduced in volume in Q4 of 2003. So again it's understandable why they
wouldn't evangelizing in the marketplace. So we had market dynamic in 2003
with the top three players in our industry with approximately 75% of all the
thin-clients sold possibly not of evangelizing in the marketplace as much as
they should have. In retrospect given that dynamic it is not surprising that
the market was relatively flat.
Now going into 2004 we see a very different environment than what we saw in
2003. We see positive signs that this will change. First of all there is a
lot of talk about increases in IT spending, increases in IT budgets, and
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overall those types of increases we believe can have a positive impact on the
thin client market. Most important in our overall - in our market we see HP
evangelizing thin client computing and very importantly doing it in a way
that's designed to grow the market. They are evangelizing thin clients
combined with blade PCs as alternatives to traditional desktop PCs. In fact
their other executives have been quoted as using this strategy to compete
with Dell in the Corporate PC market. This is not a market that we've
traditionally gone after and this has not been one of our traditional core
markets and if HP is successful in doing this it has the opportunity to
really move thin client computing into new and broader markets. And if they
do it and a great example of a major industry player promoting a technology
in an effort to grow a market, and realistically it's much easier for a major
industry player like HP to get a CIO to consider using thin client technology
than it is for a company like Neoware. We believe that if HP does this, and
we are seeing of it, that this evangelizing will have a positive effect on
our overall market.
Now we also, given our new position in the market, we also intend to
evangelize more in coming periods. We are increasing our marketing spending
and we are realigning our marketing spending and our sales resources to
better communicate the benefits of our products to our target customers.
While we are keeping most areas of spending constant at this point because we
have invested quite a bit in increasing our operating expenses and we feel
confident about our reach and about our infrastructure, we do intend to spend
more money reaching out to customers to explain the benefits of thin-client
computing and the benefits of Neoware. We are not going to go into much
detail on this on a public forum like this, but we do intend to more
aggressively promote both thin-client computing and to Neoware as the best
way to get the benefits of thin-client computing.
Another thing that we think is a positive opportunity for us and one we
intend to pursue, Keith talkes about the PC replacement cycle. There were
tens of million of older PC that were purchased as part of Y2K upgrades in
the late 90s and companies have not replaced these PCs to a great extent as
they look for ways to reduce their IT expenditures and these PCs are now
4 going on 5 years old. And as companies increase their IT budgets, if
that happens, we believe we look to replace these outdated personal computers
and that these personal computers in fact are ripe for replacement. We
intend to market our products, as PC alternatives in our target markets in
order to increase our share and to get our share of this expected upgrade
cycle that many in our industry expect to happen in 2004 and 2005. And if you
look closely at our operating expense lines, you will see that we've
increased our spending in R&D fairly significantly up more than 50%
year-over-year and we are developing innovative new products that will help
us to capitalize on the PC replacement cycle and to drive growth in our
overall market.
Let me comment on our alliance with IBM, which is continuing to go strong.
IBM is a very significant customer for us this quarter, as they are and in
fact this quarter we generated more new customers with IBM then we have in
any periods since our alliance started, and we saw a new high in the number
of individual transactions with IBM in this quarter. We processed more
individual transactions with IBM than we have in any other quarters since we
entered into our alliance with IBM in the beginning of 2002. For those you
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who follow us, you know that we don't split out IBM revenues because we can't
do so accurately. Some of our IBM business goes through distribution,
especially in Europe and so we can't do it accurately, we don't actually
split out the amount of revenue, but again IBM was a strong contributor to
the company this quarter. We are generating significant revenue as a result
of this alliance and we are very pleased with the results. We are seeing
adoption of our products in our core target markets, in addition to the
opportunities we see outside of our core markets, for example, with Hewlett
Packard evangelizing into the main stream corporate PC market.
In our target markets, we are seeing adoption by major customers, many of
whom are replacing green-screen terminals, and this is the low hanging fruit
that we have been referring too. We are now seeing this happen. Some examples
include Autozone which was a new customer for us in the prior quarter. They
are the number one auto parts retailer nation-wide. They are replacing
thousands of green-screens with modern thin-client appliances in order to
provide better service to their customers. Ikea, the well known home
furnishings chain has thousands of Neoware thin-clients already deployed
around the world, again, replacing green-screens. They purchased these
devices through IBM. Other examples of customers like this include AirCanada,
Royal Jordanian Airways, again both of these IBM customers.
Keith talked about software products and their contribution to our gross
margins. Software products sales are growing. They were higher again in this
quarter then in prior quarters but they are still relatively small and much
less, they are less than 5% of revenue in Q2, but software is contributing to
our excellent gross margins and we believe that we have an opportunity to
grow our software business fairly significantly. We have three primary
software products, TeemTalk which is our host access product that lets PCs
and servers and thin-clients get on-demand access to legacy applications
running on mainframes and UNIX machines. We have software upgrades and remote
management for out thin-client products, which we can provide for Neoware
thin-clients, as well as, thin-clients from other manufacturers, including
IBM thin-clients, and we have ThinPC, which is an innovative software product
that converts PC's into managed secure thin-clients without requiring
customers to replace hardware.
So as we continue to emphasize these software products and promote them
through the same channels to the same customers as part of and extending the
same sales, we see significant upside opportunity as these software sales
grow. Acquisitions, the last acquisition that we did for those of you that
have been following us, was concluded in July of this year and we acquired
the TeemTalk product line. TeemTalk, as I mentioned is our host access
product line. This is the most popular host access software used in the
thin-client marketplace and that lets thin-clients and other devices connect
into legacy systems. This gives us a new revenue stream and it's a great
example of what we are looking for in potential acquisitions. We are looking
for complementary technologies that can be sold to our customer base by our
sales force, by our channels in order to leverage our relationships and
basically gain stronger relationships and become more relevant to our
customers by providing them a more comprehensive set of solutions. And that's
an example, one example of the kind of technology that we might be looking
for in acquisitions. We're interested in large markets and again TeemTalk is
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a good example of that, the TeemTalk, the market for host access software is
nearly $1 billion market and it's a significant market and it gives us a new
product line with which to enter that market. And for acquisitions as we
pointed out, we have a very strong balance sheet. We are generating cash, we
now have near - more than $50 million in cash; we have no debt; we generated
5 million - nearly $5 million in cash this quarter alone. And our business
just isn't capital intensive. We don't have to finance in order to grow our
sales. So we have the resources to continue to investigate acquisitions and
to bring complementary products and technology to our customers, through the
same channels and as part of and extending the same sales.
So in summary, while we didn't meet our initial expectations for this
quarter, we believe that we did deliver positive results in many areas. And
most importantly we see very positive signs for the future. We are a leader
in a robust market and we are gaining market share in our core business. We
are investing in our business in order to drive future growth. We have the
strongest balance sheet and the most cash that we've ever had in the company.
So clearly we have the capital to invest in our business, as well as, to
acquire additional businesses and technologies.
So in summary, we are confident about the company's opportunity. We are
confident about our products and the benefits that they bring to our
customers and we believe that this is a company with a very bright future.
With that I would like to open up the call for questions. We are going to
take questions now for just about 30 minutes maximum. So let me apologize in
advance, if we don't get to you. And let's open up the call for questions.
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QUESTION AND ANSWER SECTION
Operator: Ladies and gentlemen, if you have a question at this time, please
press the "1" key on your touchtone telephone. If your question has been
answered or you wish to remove yourself from the queue, please press the "#"
key. One moment please for our first question.
Our first question comes from Kevin Hunt from Thomas Weisel Partners.
(Q - Kevin Hunt): Hi. Thank you. Couple of questions. First, can you update us -
give a little update there on TeemTalk? But could you maybe give us on the
quarter and what that might have contributed? And then also you know whether the
other guys like Wyse and HP are still using that product and kind of what the
outlook for that is? So that's the first kind of general question. And the
second one was, just in terms of pricing environment, maybe more roughly where
your ASP was in a quarter? And then, what are your kind of expectation, you
know, along with the evangelizing in the market, is pricing I mean any kind of a
weapon that you use in the future to maybe spur some higher volumes of sales?
(A): Okay. I will be happy to. All right, so first TeemTalk, and what it
contributed in the quarter. We don't split out TeemTalk separately just because
the revenues are so small at this point. They are not going to just you know go
up, the individual transactions could have them go up or go down in any
individual quarter given the revenue levels. I think once we get closer to
having software combined being about 10% of the Company's revenue, we will split
it out. In this particular quarter, TeemTalk sales did go up slightly from the
prior quarter. But again you know, that's not always going to happen to just,
you know, every single quarter that it is always going to go up given the
revenue levels where they are today. You asked specifically are other thin
client vendors using TeemTalk, yes. So the thin-client vendors continue to use
TeemTalk in their products and we would like them to continue to use it. And our
objective is we have set aside a separate part of our organization to support
those customers that are not at all involved in the thin-client business, in
order to provide them with the security that they want and rightfully should
have, and so we want to continue to enhance and to develop this for use by other
client vendors and they are continuing to use it. So, I think that was your
first question Kevin.
(Q - Kevin Hunt): Yeah.
(A): The second was about pricing environment and ASPs. We don't - we generally
don't give out the actual ASP in any quarter. As a matter of fact we never give
out the actual ASP and the reason we don't, is because there is such variance in
our product line from products that can sell close to $200 to products that can
sell for over $700, and the ASP on a quarterly basis will vary more because a
customer buys the $700 product instead of the $200 product in volume than
because of actual price changes in the individual product lines themselves.
There hasn't been dramatic change in ASPs in this quarter or in prior quarters.
The pricing environment has been relatively stable. Looking forward you asked,
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what are our expectations and do we view the opportunity to use pricing as a
weapon. I think, you know, to be honest I think Neoware is very well positioned.
We believe that we have very low cost supply chain. A very innovative way to get
our products to market and we believe that that is an opportunity for us and one
in which we can do quite well. I don't think that there is much of an
opportunity to use pricing as a weapon versus our competition but we do see the
opportunity to develop products at new price points specifically to target the
PC market. So for example, historically we've always been about half the price
of a PC - our average selling price, both given the technology, the opportunity,
I mean there are opportunities for us to drop that so that thin-clients could be
significantly less than half the cost of a PC - and that's something that we
might do in the future in order to grow thin-clients' share of the overall PC
market.
(Q - Kevin Hunt): Okay, thanks.
(A - Michael Kantrowitz): Okay.
Operator: Our next question comes from Brad Mook.
(Q - Bradley Mook): Thank you. Just a follow-up on that - the products that you
have developed to target the PC market and potentially dropped the price below
the 50% threshold compared to PCs, could those products in turn affect the gross
margin?
(A - Michael Kantrowitz): They could - they could affect the gross margin in a
positive effect as well. I mean one of the products that we have that's doing
that, that's designed to do that is our ThinPC product, which is a pure software
product and it generates higher gross margins than the thin-client products. So
that would be a positive impact. If we took a combination of software and
hardware, a traditional thin-client, historically our lowest end thin-client
products have been among our highest gross margin products. So if we reduced our
gross margin on some of those products, our lower end products actually - they
still would be very strong gross margin contributors. So, in general the lower
end products that we have - lower average selling prices are either much higher
software content or all software, and so they historically have the higher gross
margins.
(Q - Bradley Mook): Okay. And I know as far as stimulating demand you said you
didn't want to get into a lot detail about the sales realignment marketing
initiatives and the steps that you might take in a public forum. But I am
curious why would you look to spend more dollars there, and push that up when
you see the landscape changing this year, the IT spending environment improves,
HP is out there now evangelizing thin-client - presumably Wyse, having moved
past its privatization, it would be doing some more of evangelizing. And it
would seem that you are getting a tailwind now and you wouldn't necessarily get
a lot of bang for your buck if you start spending you are still small not a lot
of influence.
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(A - Michael Kantrowitz): The good news is and we are really clear about where
we are going to evangelize - we are going to evangelize in our core markets and
there are really innumerable markets, you know, we're talking about retail and
healthcare and transportation and hospitality, state, local and federal
government - you know these types of markets. It's not terribly expensive to do
some evangelizing in those markets, and we're doing that also as part of a
branding campaign, so that people when they consider thin-client computing they
consider Neoware. And so we're not talking about ads on the super bowl and going
after the general purpose market or trying to get these things into people's
homes and in their living rooms, so it's - you know we are not doing that at
all; we are evangelizing in our core markets. So we are not talking, you know,
and we wanted to make it clear we are talking about modest increases in
marketing expenses. And so we're not - I think you are right, Brad; the biggest
opportunity for this market to grow is when a major player like HP evangelizes
it that's what forces CIOs to sit up and take notice of it. And I think that's
going to be very helpful to Neoware. But we think some modest increases in
outreach, in our core target markets, where we believe thin-client computing is
going to be the predominant architecture; we think most of those customers
should be using thin-clients anyway.
(Q - Bradley Mook): Okay. And then finally just - your organization has gone
through some evolution over the past year or so, you've has acquisitions,
personnel changes and additions, the relationship with IBM has developed. How
comfortable are you now operationally, that you have things tightened up and
that the organization is being optimized?
(A - Michael Kantrowitz): I think we are in very good shape, as you know we have
significantly expanded our - management team with Keith, who has now been on
Board, it's going on a year, with Eric Rubino, who has been on Board for over a
year - both significant additions to the top management team. Both companies
that have run much larger organizations - Eric came to us from SAP where he was
Chief Operating Officer of a multi-billion dollar company. So, not only have we
brought in individuals at that level but we have also expanded the operations of
the Company really throughout and tightened up the internal systems and the
controls of the Company. And I feel very good about where the Company is and its
ability to grow and to absorb that growth.
(Q - Bradley Mook): Does that play at all into a change in your visibility
levels or your ability to manage the pipeline or it is that just a factor of the
market?
(A - Michael Kantrowitz): You know I think as you add new channel partners the
way that you manage your pipeline varies. So for example we've been on a
learning curve with IBM as to how should we manage our pipeline with IBM and
what does the pipeline through IBM mean and how does that compare to our other
channel partners, or our customers directly. So I think, as we've gotten more
visibility, you know, and more time under our belt in dealing with IBM we have a
better handle on it today. Can we learn more there? I think so and we will
continue to do so. But I think that we have a pretty good understanding of our
pipeline; and again, because we do such a large percentage of our business with
existing customers. You know, while it's not infalliable it
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is a little easier than some other companies. You know, but as we saw this
quarter it's not infalliable. We can always learn something new and when we
stumble we do learn something from it.
(Q - Bradley Mook): Okay, thanks.
(A): Okay.
Operator: Again if you have a question, please press "1" key on your touchtone
telephone. Our next question comes from James Mcilree from Unterberg Towbin.
(Q - James McIlree): Thank you. You've mentioned in the press release and then a
couple of times in your verbal comments about increasing marketing expenses
moderately. Can you quantify for us in some way what moderately means? Is
it either as a percent of sales or as it relates to the December quarter
sales and marketing levels?
(A): It's you know, when we say moderately you know, we mean you know, something
that would be less than what would add up to a penny per share. So a penny per
share for us - if you tax affect it, before the tax effect is about $250,000 on
operating expenses. So we are looking at something less than that on a quarterly
basis. You know, you are talking about increasing marketing expenses by maybe a
$1 million a year, may be in that range and again we don't have all of our
programs in place. You are probably not going to be able to see that immediately
in the coming quarter and in fact in the December quarter if you take a look at
our sales and marketing expenses they were up so some of that money was already
being spent in that quarter as well. So, you know, when you look at the December
quarter and you look at the total operating expenses, you might expect total
operating expenses to go up over the next four quarters. In and around a couple
of hundred thousand dollar range.
(A): Okay. Jim, just as a result of marketing, these kind of marketing expenses
I'm talking about.
(Q - James McIlree): Right. That's helpful. Keith, just to jump in, in addition
keeping the other expenses really at a tight level.
(A - Keith Schneck): Right.
(Q - James McIlree): Right. I'm with you. Okay, great and then once you hit that
level, I'm assuming then that the marketing expenses would grow at a rate less
than sales and so you - the leverage in the model would come after you have done
this realignment of the marketing?
(A - Keith Schneck): Well, marketing expenses as a percentage of sales, Jim, are
not that high. So, you wouldn't get much leverage out of reducing your marketing
expenses as a percentage of sales. Our marketing expenses as a percentage of
sales total and again it, depending upon what we are spending on individual
programs in any one quarter, but they are only in the 3-5% range.
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(Q - James McIlree): The pure marketing portion?
(A - Keith Schneck): The pure marketing portion, total. So where you would see
the leverage would come more from sales as opposed to marketing.
(Q - James McIlree): Okay.
(A - Keith Schneck): You can sell more without increasing your headcount as well
as overall G&A.
(Q - James McIlree): Right, okay. You also said that the software revenues
declined Q to Q as well as it sounded like year-over-year, but gross margins
were down versus the prior quarter. Was that just a mix issue for the
non-software sales?
(A - Keith Schneck): While in the prior quarter, you know, we told people 53%,
this is way above our guidance and our guidance is the 45-48% range and we are
keeping that guidance moving forward. So, you know, 53% that's not something we
would want anybody to get too attached to, because that is not our operating
plan. I mean, our operating plan truly is 45-48%.
(Q - James McIlree): Okay, great. Thank you.
(A - Keith Schneck): Okay.
Operator: Again, if you have a question, please press the "1" key on your
touchtone telephone. There are no further questions in the queue, sir.
(A - Keith Schneck): Okay, very good. You want to check again to see if there
any more. If you have any additional questions what do you press.
Operator: The "1" key.
(A - Keith Schneck): Okay.
Operator: Again ladies and gentlemen if you have a question please press the "1"
key on your touchtone telephone. The next question comes from Richard Baldry
from Roth Capital Partners.
(Q - Richard Baldry): Can you talk a little bit about what third parties like
Wyse and HP can do to stimulate the market. I would have thought that efforts
existing inside of your closer partners like IBM and Citrix might be more
important and then if you're adding several hundred new customers a quarter the
process of them moving from beta type first orders which still seems to be the
pattern given less than 15% of revenues came from new customers in the quarter
indicating the still small bite sizes to start, you know, that those two things
in concert would have some implications for growth aside from what, call it
disinterested parties would have to do, so maybe you can talk a little about
what do you think something is missing in those two factors to stimulate the
demand on an "as is" basis?
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(A - Keith Schneck): Okay, well the first, our partners Citrix and IBM, we have
very active marketing programs with them and we are constantly doing new ones so
we did some new marketing programs with them in this last quarter, we will do
more new marketing program with them in coming quarters so we do quite a bit of
an evangelizing in connection with them. Realize though, we have to drive those
efforts ourselves, right. Why is IBM doing it? Thin-clients are a very small
part of the reason of why IBM would evangelize this solution. We estimate if IBM
sells a million dollars worth of our thin-clients in the same solution and as
part of the same sale, they typically could sell up to about $10 million worth
of their own stuff. So they are really evangelizing their servers, they are
evangelizing their services, their integration services, they are evangelizing
the software that goes as part of that solution and then it's our job really to
stimulate the demand and to evangelize the thin-client portion of it. We really
don't rely on them for that. You know, they do it, they absolutely do, but we
consider that to be gravy. It's not something that we expect. And we partner
very heavily with Citrix. Citrix helps us to promote thin-client computing but
realize Citrix you know while thin-client, it's great for them and they
absolutely do promote it, they are kind of agnostic about what's at the other
end. They sell a server-based solution. Their software would let you use a
personal computer or use our software to lock a personal computer or use a
thin-client with our software, they really don't care about what's at the other
end of the wire, so they are a perfect partner for us to go out and evangelize
with, but our job is to evangelize what's at the other end of the wire. So again
there - we don't really rely on them to grow the thin-client market because they
don't have enough incentive on their own to do it, but they're a wonderful
partner to do it with and we do a lot of that. So again, I think in those two
cases, Rich, we take it as our responsibility but leveraging their resources in
order to evangelize our overall market as opposed to expecting them to do it,
does that makes sense?
(Q - Richard Baldry): Okay, then from a sales resource perspective, when you use
the word realignment on a year-over-year basis that the spending in that segment
is up on a magnitude roughly of 50% and top line revenues up say 4. So are you
talking about actual headcount transitions where, you know existing people in
the pipeline are - that are simply not told that they are going to be asked to
move aside and has the six-month flat revenue period has something to do with
new people coming in with a solutions based approach that are building new
pipelines or is it something not that simple?
(A): Well that's an element of it. What we are doing when we talk about
realigning our sales resources is not so much changing people. I think we've got
a great team. It's changing where they are focused and what they are doing. When
we talk about evangelizing for example, we have compared to a year ago now we've
just recently split our team into an enterprise sales organization and a smaller
and medium-sized business sales organization and a separate channel sales
organization. And so we have teams of people that are focused on specific
enterprise accounts now. And their job is to - they have targeted accounts in
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particular verticals and you know when we talk about increased marketing, we are
doing specific marketing allied with specific sales campaigns aimed at specific
customers. And that's what we talk about, when we talk about evangelizing. To a
great extent it's a combination of marketing and selling campaigns. We don't
want to go into too much detail because I am sure my competitors listen to my
calls. But that's what we are talking about when we talk about realignment of
sales resources is changing what people are doing to focus more on the specific
opportunities where we have seen great results and where we expect to continue
to see great results.
(Q - Richard Baldry): All right. Then maybe from a different perspective looking
at the top line as not achieving objectives in the quarter and again
with an eye on the magnitude of increased spending that's gone on at that 50%
level. Do you think that the current is slightly higher revenue rate aside from
any marketing increase? Is that sales headcount - is that capable of driving a
similar 50% topline upside to get back into sort of a more full quota bearing
load or is that not reasonable to expect?
(A): It's absolutely reasonable to expect that the sales headcount can deliver
significantly more revenue without increases in expenses. We'd have some minor
increases around the edges but we have, as you point out, invested quite heavily
in increasing our headcount in sales and other areas of the company, on purpose,
in order to deliver growth and we can increase revenues from this point fairly
significantly without significantly increasing those operating expenses. So,
there's a lot of leverage there.
(Q - Richard Baldry): Thanks.
(A): Yup.
(A): Okay, are there any other questions.
Operator: Our next question comes from Kevin Hunt from Thomas Weisel Partners.
(Q - Kevin Hunt): Hi. Thank you. I just had a follow-up question, can you make a
comment on the component pricing environment. My suspicion is that's what really
allows you to get to the 53% margin and I am wondering what you kind of - what
you kind of saw this quarter on that front and maybe what the expectations are
going forward, you know, positive or negative influence there could be on the
gross margin?
(A): Okay. In components pricing you know we use fairly industry standard
commodity components by design where we use hardware where it is not just a pure
software solution. Typically, we use industry standard microprocessor, standard
memory, standard flash memory, and the gross margin benefit that we have seen to
a great extent has come from improvements in our supply chain. And that's in
these commodity components. We haven't seen any dramatic, sustainable changes.
I mean, there are some areas that where costs have gone up, flat panel monitors
widely publicized that those have gone up, and so, we do have a thin-client that
has a built-in flat panel screen and costs have gone up on that. But again,
that's such a tiny percentage of our overall business; it's really very small. I
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don't think that it has had any impact on our overall gross margins. I think
that more - we've designed our business model around gross margins that are in
the high 40% range and we've exceeded that. I think that moving forward we would
instead try to utilize some of that gross margin, if we could, to drive more
top-line growth. For example, we talked earlier about developing and designing
new products that would allow us to take a larger share of the overall PC
market. So instead of the thin-client market being 1% of the PC market, we could
try to focus on growing it into 2% or 3% of the PC market - that's a huge
upside. And I'd much rather have a business that's focused on doing that, that's
delivering 45% to 48% gross margins than a business that's trying to stay at 1%
of the overall PC market with 50% to 53% gross margins. So to directly answer
your question, I don't think we've seen any significant changes as a result of
component costs in the past. And that's not - I don't think a very significant
reason or any really big part of the reason why the gross margin this quarter
was 50 instead of 53 - 53 - it was just really way above what we expected.
(Q - Kevin Hunt): Okay, thanks.
(A): Okay. Okay at that point I think I'm going to end it here. We said we'd
allocate about 30 minutes, which we've done. So, I want to thank everybody for
attending our call. We are happy you could join us, and we look forward to
discussing our progress again with you in coming quarters. So once again, thank
you.
Operator: Ladies and gentlemen, thank you for your participation in today's
conference.
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