Exhibit 99.1
NEOWARE
Q1 Fiscal Year 2006 Earnings Conference Call
November 2, 2005
OPERATOR:
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Good day and welcome to the Neoware Q1 conference call. [INSTRUCTIONS] Now I
would like to turn the program over to Chairman and CEO of Neoware, Mr. Michael
Kantrowitz. You may begin, sir.
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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Thank you, Adam, and welcome everybody, to Neoware's Q1 conference call for the
quarter ended September 30th, 2005. At this point you should have seen our press
release, which was distributed over the wire and is posted on our Website at
neoware.com.
With me today is Keith Schneck, Neoware's Chief Financial Officer. For today's
call, I'll start with the highlights of the quarter, I'll turn the call over to
Keith and he will go into the numbers in some detail and provide you with some
insight into our guidance. Keith will then turn the call over to me and I'll
update you on our strategy for the coming year, and at the end, we'll take your
questions for about 30 minutes.
Before we begin, let me turn it over to Keith for the Safe Harbor statement.
Keith.
KEITH SCHNECK - NEOWARE SYSTEM - CFO, PRINCIPAL ACCOUNTING OFFICER, EVP AND
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SEC.:
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Thanks Mike. The following topics to be discussed today will contain
forward-looking statements; the expansion of our distribution channels; our
entry into the Asian market; the closing of the Maxspeed acquisition;
amortization and restructuring costs associated to the Maxspeed transaction; our
continued strong growth, organically and through acquisitions to enhance our
portfolio of software solutions and increase our geographic reach; our ability
to customize products and fully support customers in the Americas, throughout
Europe and in India; projected growth in revenues in fiscal 2006; gross margins;
operating expenses; and effective income tax rates for the 2006 fiscal year; the
anticipated non-cash impact of stock-based compensation during the 2006 fiscal
year under FAS 123R; expected large sales from a major retail customer; the
anticipated performance of our Neoware e900 thin client and our high margin
software products; anticipated increased customer recognition of the benefits of
thin client computing; and our anticipated investments to capitalize on
significant growth opportunities.
These forward statements involve risks and uncertainties. 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, 2005, filed with the Securities and Exchange Commission.
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Back to you, Mike.
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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Thanks, Keith. So, at this point you should have all seen the results and it was
another record quarter for Neoware, in fact, an all-time record for the Company.
We delivered record revenues of 26.5 million, which is a 63% increase from the
first quarter of last year, and in fact, a 15% sequential increase from what is
typically our strongest quarter of the year.
We saw especially strong performance from our new Neoware e900 thin client,
which is designed for harsh environments, like retail distribution centers,
transportation companies and manufacturing environments.
It's important to point out that this isn't just one quarter of success. We
embarked on a growth plan and believe that our growth plan is working. We've now
delivered six record quarters in a row, with significant year-over-year revenue
growth and even higher profit growth.
We've done this by expanding our business with enterprise customers, gaining
more traction with our partners IBM and Lenovo, investing in new geographies and
adding new partnerships, including our new relationship with ClearCube and our
new distribution partners in the UK and South Africa.
We believe that the results are in our numbers. We're growing our revenues and
we're growing profits at a faster rate. For more details on the quarter, I'll
turn the call back over to Keith. Keith.
KEITH SCHNECK - NEOWARE SYSTEM - CFO, PRINCIPAL ACCOUNTING OFFICER, EVP AND
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SEC.:
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Thanks Mike and thank you all for joining us on our conference call today. I'd
like to review the highlights of our first quarter financial performance.
FIRST THE INCOME STATEMENT.
Revenues increased 63% to $26.5 million from $16.3 million in the prior year
first quarter and a 15% sequential increase from our seasonally strong June
quarter. This represents the highest quarterly revenue in our history. Revenue
growth for the quarter was driven by strong sales in several key accounts
including a major auto parts retailer, a global retailer that included large
initial sales of our new Neoware e900 product as well as other products, and a
number of other large enterprises via our IBM/Lenovo relationships. These two
accounts plus the larger number of accounts represented by IBM and Lenovo
comprised about 46% of our quarter revenue - indicating our continued focus and
success in attracting large enterprise customers.
Gross profit was $10.7 mill or 40.4% of revenue, compared to $7.1 mill, or 43.5%
of revenue, in the prior year first quarter. Excluding $273,000 for amortization
of acquisition-related intangible assets and $19,000 of stock based compensation
in the September 2005 quarter as compared to $101,000 of amortization expense in
the prior year first quarter, non-GAAP gross profit was 41.3% of revenue in the
September 2005 quarter, compared to 44.1% of revenue in the prior year quarter.
Cost of sales reflects very strong initial sales of the Neoware e900 thin client
which carries higher average selling prices and lower percentage gross margins
than other Neoware products. Percentage gross margin on other revenue was
consistent with recent prior periods.
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Operating expenses were $8.1 mill, or 30.4% of revenue, compared to $5.1 mill,
or 31.4% of revenue, in the prior year first quarter. Operating expenses in the
September 2005 quarter include $315,000 for amortization of acquisition-related
intangibles and $701,000 of stock based compensation as a result of the adoption
of SFAS No. 123R on July 1, 2005, compared to operating expenses in the prior
year quarter that included $170,000 for amortization of acquisition-related
intangible assets. Excluding these expenses, non-GAAP operating expenses were
$7.1 mill, or 26.6% of revenue, in the September 2005 quarter, compared to $5.0
million, or 30.4% of revenue, in the prior year first quarter.
GAAP net income for the quarter was $1.8 mill, or $.11 per diluted share,
compared to $1.4 mill, or $.09 per diluted share, in the prior year first
quarter.
Non-GAAP net income for the quarter was $2.8 mill, or $.17 per fully diluted
share, compared to $1.6 mill, or $.10 per fully diluted share, in the year ago
quarter. This represents an 80% increase in Non GAAP net income on a 63% revenue
increase. Non-GAAP net income excludes amortization of acquisition-related
intangible assets and stock based compensation and applies a pro forma tax rate
of 33% and 34% in the first quarter of fiscal 2006 and 2005, respectively.
NOW FOR SOME COMMENTS ON THE NUMBERS:
We have been articulating our growth strategy consistently for the past 2 years
- - our focus has been on building a scalable infrastructure to capitalize on the
growing demand for thin clients and related software. Our expanded investments
in people, technology, and acquisitions have given us an unparallelled
capability to be a global company and to deliver customized solutions locally -
whether in France, the UK, Germany, Austria, India, the US and soon in China
once the Maxspeed acquisition is completed.
The fact that we were able to deliver revenue growth in the first quarter of 63%
over the prior year quarter was significant. Our GAAP gross profit margin for
core products in the quarter was comparable to other periods, and 40.3%
including the Neoware e900. It is important to note that non-GAAP gross profit
dollars (excluding amortization and stock option expense) increased 52% from a
year ago compared to 51% on a GAAP basis. But even more significantly, our
non-GAAP net income (excluding amortization and option expense and using a
proforma tax rate) increased 80% from a year ago. Comparable increases on a GAAP
basis were 52% for gross profit dollars and 33% for net income This highlights
the leverage opportunity in our business model. We continue to think investors
should focus on our operating margins, excluding amortization of
acquisition-related expenses and stock option expense, as a measure of our
business.
Moving to the GAAP Operating Expenses compared to a year ago-
We increased sales and marketing expenses in the quarter as we expanded staff in
France, Germany, the UK and the US. We have also stepped up our marketing
activities to increase our outreach to our target customer base and to promote
the advantages of thin client computing.
We increased research and development expenses in the quarter as a result of
increased staff in the US, Europe and India, as well as expanded product
development efforts for new products like Neoware Image Manger and the Neoware
e900 thin client.
G&A expense in the September 05 quarter increased from a year ago given the
increased complexity of our business including fees related to audit and
Sarbanes Oxley compliance and incentive plan provisions driven by our strong
operating results, but declined from the prior quarter.
GAAP operating expenses also increased due to $701,000 of stock based
compensation broken out as $250,000 in Sales and Marketing, $105,000 in R&D and
$346,000 in G&A for the Sept 2005 quarter. Amortization charged to sales and
marketing expense also increased and was $315,000 in the Sept 2005 quarter and
$170,000 in the Sept 2004 quarter.
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Total operating expenses excluding amortization of acquisition expenses and
stock option expenses were lower as a percentage of revenues than in any quarter
in the last year.
Our Non GAAP effective tax rate for the September 2005 quarter excluding stock
option expense was about 34% consistent with prior year. Our GAAP effective tax
rate was 36% for the September 2005 quarter.
We have provided non-GAAP measures that exclude stock option expense and
amortization of acquisition intangibles in order to present information about
the Company's financial performance, as we believe it provides a more comparable
view of the Company's core business and trends relating to its results of
operations including its cash requirements for ongoing operating activities.
A reconciliation of the differences between the GAAP and the non-GAAP measures
is attached as a schedule to the press release that appears on our web site.
MOVING TO THE BALANCE SHEET AND CASH FLOW
Cash and short term investments were $44 million at September 30, 2005, compared
to $43.1 mill at June 2005. Cash requirements subsequent to Sept 30, 2005
include $3,350 million paid in October for the TeleVideo transaction, about $2.1
million of additional consideration for the acquisition of Visara based on
achievement of earn out targets due to be paid this November and future cash
requirement for the acquisition of Maxspeed which I will discuss separately.
We do continue to generate cash from operations and operate with no debt.
Receivables were $17.6 mill at quarter end and days sales outstanding (DSO's)
were 60 days at September 30, 2005 in line with our targets.
Inventory was $3.6 mill at Sept 30, 2005 compared to $3.1 million at June 30,
2005. The increase in inventory during the quarter relates to product staged for
a large order that subsequently shipped in October.
Goodwill increased by $2 million during the quarter as a result of the
additional purchase price due on the earn-out on Visara which will be paid in
November.
NOW FOR GUIDANCE FOR FISCAL 2006
As those of you who follow us know, we try to provide annual guidance at the
beginning of a fiscal year, and tend not to provide specific quarterly guidance.
In our September 1, 2005 call we gave guidance of 30% revenue growth for the
upcoming fiscal year - or approximately $103 million in revenue for the year
ended June 30, 2006.
Today we reported a very strong quarter with meaningful contribution to our
revenues and profits from the new Neoware e900, and we see more possibilities
for strong contributions from this product in future periods.
In the December quarter we expect continued sales of the Neoware e900, as well
as several large transactions from other major enterprise customers. We also
expect to begin to see initial contributions from our new distribution
relationships with Getech in the UK and ITWise in South Africa, both of which
changed their focus from other thin client providers to us.
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We announced the acquisition of Maxspeed, and because we normally provide only
annual guidance and haven't yet closed this acquisition, we wouldn't normally
update our guidance at this time.
However, some analysts have updated their revenue estimates, and now there is a
$110 million revenue consensus, which reflects approximately 40% revenue growth
from last year.
Based on our planned closing of the Maxspeed transaction by Dec 31, 2005,
expectations of continued sales of our new products, and contributions from our
new international relationships, we are now comfortable increasing our revenue
guidance to 40% growth from 30% growth for the year - or approximately $110
million of revenue for the year ending June 30, 2006. As always, our results in
any individual quarter may vary - up or down - based upon the timing of
individual transactions.
Stock based compensation expense related to stock options, which is a non-cash
charge, is expected to be approximately $700,000 per quarter. Such amounts may
change as a result of additional grants, forfeitures, modifications in
assumptions and other factors.
Amortization of acquisition related intangibles for completed transactions will
be about $275,000 charged to Cost of Sales and $395,000 charged to sales and
marketing expense.
We don't expect the Maxspeed transaction to be dilutive over the remainder of
the fiscal year.
We expect the vast majority of the restructuring costs associated with the
Maxspeed transaction will be deal costs, not period costs in the December
quarter.
Gross margins for the year are still expected to be in the range of 40 to 45
percent for the year, and may vary from this range by 1 to 2 points in any given
quarter due to individual orders. This quarter, gross margin excluding the e900
was consistent with other recent quarters.
Non-GAAP Operating expenses (excluding the impact of stock option expense and
amortization of intangibles are expected to be below 30% of revenues or
potentially lower with leverage (for example Non-GAAP operating expense
excluding stock option expense and amortization of acquisition intangibles was
27% of revenues this quarter due to higher revenues. Our GAAP operating expense
was 30% of revenues for the Sept 2005 quarter.
Our Non-GAAP effective tax rate (excluding the effect of exercise of stock
options) is expected to be approximately 33% for the year. Our GAAP effective
tax rate for the first quarter was 36%.
Our cash balance is projected to be about $28 million as of Jan 1, 2006 assuming
the Maxspeed transaction closes by Dec 31. We continue to operate with no debt.
Our fully diluted share count presently is 16,464,000 and may go up to about 17
million based on the stock price and the impact of this on the treasury stock
method of calculating share count.
REGARDING THE MAXSPEED TRANSACTION
We signed a definitive agreement for to acquire Maxspeed Corporation last week.
Maxspeed is a thin client provider focusing on customized solutions for
enterprise customers. They engineer their products in China, and sell in the US
and in Asia. Acquiring Maxspeed enables us to enter the Asian market with full
engineering to provide customization services for local markets - a proven model
enabling Neoware to win new accounts.
After reflecting Maxspeed's $9 million of cash and a hold back of $1.4 million
to fund restructuring costs, we will use a net of approximately $13.6 million of
Neoware's cash to fund this transaction.
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In addition, unlike in our other transactions where we primarily acquired assets
and not a full company, Maxspeed is required to bring $3.7 million of net
working capital excluding cash as of closing. Both the cash and net working
capital minimums provide for dollar for dollar downward adjustments in the
purchase price if the minimums are not met.
Naturally, the numbers related to amortization and restructuring are preliminary
and are subject to change upon completion of the transaction and finalization of
the purchase price allocation.
IN SUMMARY,
It has been a very busy quarter for us at Neoware, and one in which we delivered
excellent results. Many good things are happening and we are confident that our
business is poised for continued growth.
That brings my prepared remarks to an end. After the balance of Mike's
presentation we'll open the call and I'll be happy to answer any questions you
may have.
Back to you, Mike.
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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Okay, thanks, Keith. Now as Keith pointed out, we're delivering excellent
results with our report for this quarter. Our business is growing and we're
confident in our future opportunity. In fact, as Keith pointed out, we're
increasing our revenue guidance to $110 million for our fiscal year ended June
30th, 2006 and as we've shown in the past, our objective is that increases in
revenue translate to increases in earnings.
Our pipeline of large enterprise transactions continues to grow, both as a
result of our IBM and Lenovo relationships, as well as through other channels.
This year we embarked on a significant expansion in our global reach. Once we
complete the Maxspeed transaction, we'll have the ability to support, customize
and engineer our products in the United States, the UK, France, Austria, India
and China. We see a real opportunity to increase our business with IBM, Lenovo
and other significant partners in Europe and in Asia.
As we pointed out in the last call, although our sales to IBM and Lenovo have
grown significantly and are an important part of our business, so far we've had
success with them primarily in the United States. Now that we have local
engineering and support centers in major global markets, we have a much better
opportunity to engage with large partners in international markets.
Just this week we announced new enhanced distribution relationships with two
important partners in the UK and in South Africa, Getech and IT Wise. These two
distributors sell thin clients and related solutions to resellers, systems
integrators and VARs. Between the two of them, we believe that they generated
millions of dollars of sales of our competitors' thin clients in the last year.
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As a result of our new partnerships with them, they will now both focus on
Neoware thin clients and we see a significant opportunity to partner with them
to engage and support customers and to grow our revenues.
In October, we announced a partnership with ClearCube to work together to grow
the PC Blade market. ClearCube is a leader in that market, having invented the
concept of the PC Blade, where the electronics of a personal computer sit in a
managed rack, offering a user all of the functionality of a dedicated PC via a
thin client.
We see PC Blades as one more solution available to Neoware thin client users and
we believe that we have an opportunity to expand our efforts into new markets as
a result of this partnership.
It's interesting to note that just like our new distributors in the UK and South
Africa, ClearCube previously used thin clients from another vendor. We believe
that this is another example of Neoware's opportunity and ability to gain market
share.
Now let's talk about market share for a bit. I'd like to point out that over the
last five years, Neoware's share of the thin client segment of the PC market has
grown significantly, from about 5% to well over 20% of the market according to
IDC. We've grown faster over this time period than other industry participants.
In fact, while our share has grown by more than 15%, IDC maintains that our
primary competitor's share declined by nearly the same percentage.
IDC projects strong growth for the thin client segment of the PC industry, with
greater than 20% revenue growth projected from 2005 to 2009. We have
historically been able to outgrow the overall market and we have plans in place
to continue to do so.
Given Neoware's financial strength, global reach, strong partnerships,
commitment to the thin client business, as well as our knowledgeable people, we
believe that we are coming to be recognized as the stable, reliable alternative
in our market, which is positively impacting our business.
Now turning to the Company's financial strength, as Keith pointed out, Neoware
has a strong balance sheet and we have no debt. We generate cash and we have a
proven, successful acquisition strategy.
Looking forward, we would consider additional acquisitions to continue to expand
our geographic reach or to further enhance our ownership of key software
intellectual property.
Our introduction of Neoware Image Manager this quarter is an example of the
latter strategy. By introducing Neoware Image Manager, which is based on
technology that we acquired via the Qualystem acquisition, we now have new
software that can virtualize an operating system, enabling hundreds or thousands
of users to use just one operating system image, lowering cost and improving
manageability for thin client or PC users. We see a significant opportunity for
this software in the 90% of server based computing environments that continue to
use PCs instead of thin clients.
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As Keith pointed out, we've increased our investments in sales and marketing and
in R&D and today we're spending more than twice as much on R&D than we were a
year ago. We have exciting new products that are already driving growth and we
have additional new products in the pipeline.
We've pointed out the Neoware e900, which is a new product that was just
introduced this quarter and already is generating significant revenues for us.
With average selling prices of over $3,000 a unit, the Neoware e900 represents a
significant opportunity and as we pointed out, sales began very quickly after
the product's introduction.
Today, Neoware is a much stronger company than it was one year ago. We have
development centers throughout the globe. We have strong partnerships with
industry leaders, including IBM, Lenovo and ClearCube.
We have new distribution partners that represent a real opportunity for us to
gain market share. We have proprietary intellectual property. We have an
experienced team, both at the management level and throughout the Company. And
we plan on deploying these resources to satisfy our customers so that we can
deliver consistent increases in revenue and in profits in coming periods.
So in summary, we're pleased to deliver another record quarter, both in revenues
and in earnings. We achieved our goal of delivering significant revenue growth,
in fact, our revenue growth was 63% in this period, and we grew our profits even
faster.
We believe that thin clients are gaining share in the PC marketplace and that
we're well positioned competitively in our market. We're bullish about our
prospects and believe that we have a superior growth opportunity in front of us.
So that brings my prepared remarks to an end. At this point, Adam, we'd like to
open up the floor for questions for approximately 30 minutes. And I want to
apologize in advance, if we don't get to you. Adam, let's open up the phones.
OPERATOR:
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[INSTRUCTIONS] Jill Mastoloni.
JILL MASTOLONI ANALYST
Congratulations, it was a great quarter. Are you guys giving December guidance
at all or the forward quarter at this time?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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No, we don't give quarterly guidance. We give annual guidance and then we update
it if events happen that cause us to update it. So, the beginning of the fiscal
year we gave revenue guidance of 30% growth, which would have meant 103 million
in revenue for the fiscal year. And now we've upped that to say we believe that
we'll be able to deliver higher revenue growth of 40% for the fiscal year. But
we've never as a Company given quarterly guidance.
JILL MASTOLONI ANALYST
Oh, I thought last quarter you put it in the press release for the forward
quarter.
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MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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Yes, maybe I want to reconsider the word "never." I think we have done it and we
did it about two years ago as well, if there are any significant events in a
particular quarter where they might vary quite significantly. But typically we
don't. We give annual guidance only.
JILL MASTOLONI ANALYST
Okay, great. And the guidance that you're giving for this year that includes the
Maxspeed acquisition, is that correct?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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Typically when we do these acquisitions, they independently don't generate
significant revenues on their own. And that's the case with all of our
acquisitions typically, we don't expect them to generate significant revenues.
We typically make significant changes in product lines.
So with Maxspeed, like with our other acquisitions, the purpose of the
acquisition is to expand our ability to penetrate the Asian markets, to have
development centers in Asia. We do believe that that's going to drive revenue
growth, but it's just as much by engaging with our partners Lenovo and IBM, by
being able to better support large global rollouts of thin clients with major
global enterprises. So it's as much about generating and using those resources
to generate organic growth.
JILL MASTOLONI ANALYST
Okay. And have you disclosed the percentage of revenue from IBM this quarter?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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Actually, that'll be in the Q and we'll file the Q next Tuesday. I don't happen
to have that right in front of me. It's probably down a little bit as a
percentage of revenues, just because the major global retailer that we deployed
Neoware e900 to happened not to go through IBM. So that was a big percentage.
But in terms of overall revenues, it was probably among the top in terms of the
total dollar amount of revenue contribution. It's probably among the top-three
quarters in total revenue.
JILL MASTOLONI ANALYST
Okay. And did you get revenue from Lenovo as well, this quarter?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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Yes, our transactions, whether it's IBM or Lenovo, it's IBM customers that we're
selling to. So yes, we did generate revenue from IBM. We generated revenue from
Lenovo. But in both events, whether it's IBM or Lenovo, it's really IBM
customers that we're selling to. So while they're different customers and we
have to report on them differently, because obviously, they represent different
credit, different actual customers, in both cases its examples of selling to IBM
customers.
JILL MASTOLONI ANALYST
Okay. And the last question is, could you describe sort of how the quarter is
tracking so far and how much visibility you have into the December quarter? I
know it's December quarter for IBM and typically it's a very strong quarter for
you. How much visibility do you have into - well, you're not giving guidance I
guess.
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MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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Well, we try never to give quarterly guidance. I wouldn't take our not giving
guidance for the December quarter as any indication of what the December quarter
might look like. That's not our purpose, so don't view the fact that we're not
giving guidance for the December quarter as any indication.
Typically we have good visibility for quarters, because typically more than 80%
of our revenue comes from existing customers. We enter a quarter very often
knowing where as much as 75 to 80% of our revenue is going to come from for the
quarter.
We have several large transactions, as Keith pointed out. We actually had some
orders that, at the end of last quarter, he pointed out, that we had excess
inventory, because we had some large orders that subsequently shipped in this
particular quarter. Keith pointed out that we're going to have continued sales
of the Neoware e900 in this quarter. He pointed out several other large
transactions that we're doing with other customers.
So there's a lot of activity in this quarter. And again, don't take our
indication that we're not giving guidance on a quarterly basis for this quarter
as any indication of the quarter results.
JILL MASTOLONI ANALYST
Great, no problem. Thanks a lot, guys and congratulations. Great quarter.
OPERATOR:
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Brian Hertzog.
BRIAN HERTZOG - THOMAS WEISEL PARTNERS - ANALYST
It's actually Brian, calling for Kevin Hunt. First question is a little bit of
clarification on the IBM contribution. I believe last quarter it was 21%. And
then I may have mistaken, but maybe earlier on in the conference call you said
that 46% was from IBM/Lenovo in this quarter. Is that apples-to-apples
comparison?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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No, actually, Brian, that percentage was IBM and Lenovo combined, as well as two
other enterprise customers who happened not to go through IBM. So for IBM and
Lenovo, I happen not to remember exactly what the percentage was. In terms of
dollar amounts, it was, again, one of the top three or four quarters
historically throughout our relationship with those companies. So it was very
good. But, because of the large sales that we have at the global retailer for
the Neoware e900, it'll drop as a percentage, but not significantly as a dollar
amount. That's just an anomaly, because we happen to have very large sales
Neoware e900 that didn't go through the IBM or Lenovo channels.
BRIAN HERTZOG - THOMAS WEISEL PARTNERS - ANALYST
Okay. And then on the inventory that shipped out, I guess in October, that was
still on the balance sheet at the end of September, could you characterize that
as more e900 products? And if you could talk a little bit more about the
contribution of e900 this quarter versus next quarter and what that can mean to
the gross margin levels?
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MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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Okay, that particular inventory that was on the balance sheet wasn't Neoware
e900. That was product that shipped to a large telecommunications company in
Europe and it just so happened that everything wasn't complete by the end of the
quarter. So that was a large transaction that just moved into this quarter,
which is obviously good for this quarter. So, no, not Neoware e900.In this
particular quarter we're going to have continued sales of Neoware e900, but
they'll be smaller as a percentage of our total sales. And as we pointed out
last quarter, our gross margin on product, excluding Neoware e900 was consistent
with prior quarters, there was no change in its gross margin. So if Neoware e900
is a lower percentage of our total sales, we would expect that to mean in that
particular period that our gross margins might tick up a little bit.
BRIAN HERTZOG - THOMAS WEISEL PARTNERS - ANALYST
Excellent. And then, the large telco deal, I believe that was 17,000 units
total. How far along are we on that deal or how much do we have left going
forward?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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The bulk of that is left to go forward. That's just an initial - we have had
just initial deliveries on that contract, which is 17,000 over one year, with an
optional renewal for another 17,000 in the second year. So, that's going to
continue throughout the year and the bulk of it, by far, is yet to come.
BRIAN HERTZOG - THOMAS WEISEL PARTNERS - ANALYST
Okay. And then, one last question. On the Maxspeed acquisition, what did they
have in revenue prior to the acquisition and I guess, without giving specific
guidance, what kind of a contribution could we look forward to in fiscal '06?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
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We actually have to file their historic revenues within 71 days after we close
the transaction. The reason we don't emphasize their historic revenues is
because they're not relevant to future periods. Typically, when we do one of
these acquisitions, we make changes in product lines, we make changes that
result in reductions in their revenue, so we don't like to encourage investors
to take a look at those historical revenues and think that they're going to be
reflective of future periods. We typically are not acquiring these companies for
their revenue streams.
The purpose of the acquisitions that we've done, like the Maxspeed acquisition,
have been to expand our global reach, so that we can better support major global
enterprises. The purpose of the acquisitions is absolutely to drive revenue
growth, but it's not necessarily the historic revenue from those companies that
we're driving for.
Very often the historic revenues from these companies are lower gross margin
that ours. Our primary purpose in acquiring businesses internationally has been
to better support major global enterprises, for example, like the customer that
we're shipping millions of dollars of Neoware e900s to, who has operations all
around the globe.
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So, there were revenues from Maxspeed, just as there were from many of our other
transactions, but we don't encourage people to look at those and assume that
they're going to be reflective of future revenue contributions. It's about
growing our organic revenues by having global support and engineering that we
think is going to drive growth in both revenues and profits.
BRIAN HERTZOG - THOMAS WEISEL PARTNERS - ANALYST
Okay, understood. And then one follow-up on that. Can you characterize some of
the investment also that's going to be required for the Maxspeed to expand some
of the distribution channels and to build the infrastructure and what not,
CapEx, OpEx, what have you?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ----------------------------------------------------------------
Well, we don't expect significant CapEx. Again, we have an outsourced supply
chain model and we don't have to make significant capital expenditures in order
to grow our business. So CapEx is not really an important part of our business.
In terms of operating expenses, we think that we're going to be able to continue
to generate operating expenses that are in the range of 30% of revenues or
driving even lower as we drive revenue growth. This particular quarter, when you
look at our non-GAAP operating expenses, it was 26.6%, when you exclude
amortization of intangibles and stock option expense.
So moving forward, as we drive revenue growth, we think that we're going to be
able, as we add people as a result of either acquisitions or as a result of
hiring, as you've seen us do in the past, we're able to generate more revenue
than expenses and that translates into bottom line growth.
OPERATOR:
- ---------
Orin Hirschman.
ORIN HIRSCHMAN ANALYST
Congratulations on the results, once again. There was a brief mention that the
Maxspeed acquisition would be dilutive.
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ----------------------------------------------------------------
No, actually, it was the opposite. We said the Maxspeed acquisition we expect
not to be dilutive.
ORIN HIRSCHMAN ANALYST
Okay, I apologize then.
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ---------------------------------------------------------------
Well, no, I'm glad you brought that up.
ORIN HIRSCHMAN ANALYST
Thank you. Also, you mentioned some of the gains that you've been making in
market share. Does anybody have real data, independent data that gives the
magnitude? Obviously, we can get the feeling from your revenue growth that
you've been making big strides, but is there actually numbers that you can point
to from any recent studies?
15
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ----------------------------------------------------------------
Well, there is IDC and IDC reports growth of the overall thin client segment of
the PC marketplace and then they also track that by vendor. So IDC does report
that. And as we point out, over the last four years, we've grown our market
share from 5% to well over 20% and we believe we've been the fastest market
share gainer in the thin client business and the business itself is projected to
grow robustly, is the word that IDC uses.
ORIN HIRSCHMAN ANALYST
And over the last few quarters, clearly, from your results and from IDC is
saying there's been a tremendous acceleration in the market for thin clients,
because there's finally real adoption from larger customers.
Is there anything more that has to happen here to create more of a snowball
effect or the snowball is set in motion already? Are there other things going
on? Is virtualization important? Anything else that you can point to that needs
to happen to get things to go even faster or it's happening, it's just a matter
of some of the bigger companies going from pilots to getting bigger.
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ----------------------------------------------------------------
Well, I think you're seeing both of those things. We are seeing and experiencing
larger deployments of thin clients, larger contributions from enterprise
customers, the sizes of transactions that we had in this particular quarter
really were unprecedented. And looking forward, we see other transactions of
similar and frankly, even larger sizes in some cases, in individual periods.
So, we're seeing major global enterprises moving forward with large-scale thin
client deployments. If we look at the customer that we have in France, the major
telecommunications company, a 34,000-seat deployment, on top of 20,000 seats
that they already have, and they switched to us, again, from a competitor.
That's a 54,000 seat thin client deployment when that finally completes. We
believe that's the largest deployment to date in thin clients. So we're seeing
large enterprises deploy.
The other thing that we're seeing is more technology companies supporting this
infrastructure. An example of that is IBM with their virtualized hosted client
initiative. IBM came out in partnership with VMware and Citrix with a set of
technologies that would enable customers to use their Blade center servers and
their IBM X series servers in order to deploy PC level quality over LANs to thin
clients.
So, we're seeing more attention from technology companies, as well as more
demand from enterprises. I mean, you can even see Microsoft's support recently,
an introduction just this week of the Microsoft Live, the Windows Live and
Office Live technologies as technologies that can be deployed on thinner
devices.
OPERATOR:
- ---------
{INSTRUCTIONS] Dick Feldman.
16
DICK FELDMAN - MONARCH CAPITAL - ANALYST
Once again, great quarter. I wonder if you could address the outlook for Image
Manager and how do you fully capitalize on the potential for that product? Does
it require a different type of marketing?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ----------------------------------------------------------------
That's a good question. When we are looking at acquisitions of software
technologies or complimentary technologies, our strategy is to acquire
technologies or to develop them internally, that can be sold through the same
channels, to the same customers, as part of the same sale and extending our
opportunities with our existing channels and customers. So we're not interested
in developing or acquiring technologies that require us to set up different
sales forces.
Neoware Image Manager is a perfect example of this. It is technology that is
directly applicable in thin clients. It can be deployed with traditional Neoware
thin clients and it just drives the cost of a thin client down by eliminating
one of the most costly components in a thin client, which is flash memory. So,
it has a directly applicable benefit to our existing products.
Now in addition, it allows us to provide the kind of security and manageability
benefits of thin clients for the personal computers that our customers already
use. And our target market for that product is the 85 to 90% of seats that are
attached to Citrix and server-based computing environments that are personal
computers. Only about 10 to 15% of the seats attached to Citrix servers are thin
clients. The bulk of them are personal computers.
So, it's an example and what we're doing strategically is looking to develop and
acquire software technologies that can be sold to the same customers. It's
actually the same people making the decisions for that kind of product that make
the decisions for our thin clients.
So, what we're doing is obviously, we're benefiting from the fact that there's a
lot of attention being paid by enterprises to new technologies, including
virtualization, including on-demand software. Neoware Image Manager is an
example of both. It virtualizes a Microsoft operating system and enables it to
be streamed from a server to clients on demand. So it's technology that's
actually getting a lot of attention these days.
DICK FELDMAN - MONARCH CAPITAL - ANALYST
When did you start selling this?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ----------------------------------------------------------------
Just in the quarter that we just reported. So, it was brand new in the quarter.
We only introduced it in July and started rolling it out during the quarter. And
we expect meaningful contributions from that product in coming periods. But you
know, it's a brand new product, brand new software product.
We wouldn't want to encourage people to think that it ramps from zero to
millions of dollars of sales in just a single quarter. Although, we've seen new
technologies that do that, like the Neoware e900. That was also introduced and
shipped just in this last quarter and we did generate millions of dollars of
sales with that product.
17
DICK FELDMAN - MONARCH CAPITAL - ANALYST
But this would have software kind of margins, as compared to the e900, which had
lower than average margins?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ---------------------------------------------------------------
Yes, but we want to point out, although the Neoware e900 has lower than average
percentage gross margins, it's only on a percentage basis. It also has $3,000
average selling prices. We make more money per unit of Neoware e900 that is sold
than any other product. And you can see the results in our results this quarter.
The Neoware e900 contributed positively to the top line and the bottom line of
the Company.
But you're right. Neoware Image Manager does have higher percentage gross
margins. But it also has dramatically lower selling prices. It's a product that
can be sold for as little as $89 a seat. So, even if that's 100% gross margin,
you'll make $89 a seat for that is sold and a lot more on an e900. So I would
encourage people not to look at percentage gross margins on our products, but
instead to look at increases in our operating income.
OPERATOR:
- ---------
Jack Pitts.
JACK PITTS ANALYST
Just looking at the sequential growth in the operating profit, I guess it
doesn't exactly match the growth in revenues. And kind of looking at the margin
being a little bit lower than it was a couple of years ago, in its peak in 2002,
I'm just kind of wondering, over the next year, kind of what happens to
operating profit as the revenue grows?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ----------------------------------------------------------------
Well, one important thing when you're looking at sequential from Q4 to Q1, is in
Q1 we reported stock option expense, which was $700,000 in the quarter. So, you
can't just look at the expenses, because the accounting treatment changed from
Q4 to Q1. So actually, our operating profit increased on a comparable basis from
Q4 to Q1. It didn't decrease. So you have 700,000 in stock option expense, which
like every other public company with a June 30 year end, we started reporting in
this quarter.
So I think we've been clear. Our strategy is to grow our revenues and to grow
our profits at a faster rate. We did that in this quarter and we intend to do
that in coming quarters.
JACK PITTS ANALYST
Thanks. And also the e900 product, since it does go for over $3,000, how does
that fit into the model of kind of the thin client being not as expensive as a
PC on the desktop?
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ----------------------------------------------------------------
That's a good question. Cost is only one of the driving elements behind thin
client deployments. Some of the other driving elements behind thin client
deployments are improved security, because thin clients can be made to be
virtually immune from standard PC viruses; improved manageability, because thin
clients can be centrally managed using Neoware software; improved reliability,
because thin clients have no hard drive, no floppy, no CD-ROM, no fan. And it's
those three things that are really driving deployments of the Neoware e900. It's
used in harsh environments, so the fact that there are no moving parts, no fans,
no hard drives, makes it a benefit. So, it isn't just cost.
18
And that's one of the things that I think people misunderstand about our
marketplace. We don't think that price is the primary driving element in our
marketplace. Cost savings versus personal computers up front is one driving
element, but it's more importantly, total cost of ownership over time, improved
security, improved manageability and improved reliability of the whole IT
infrastructure that makes a difference.
JACK PITTS ANALYST
Thanks. And then one more, if you don't mind. The Mangrove and ThinTune
acquisitions, I realize you don't like to kind of break those out, because they
get integrated pretty quickly, but at the same time, you do have to kind of make
acquisitions on some sort of metric like price to sales or price to earnings or
as you talked about on previous questions, whether the acquisitions are dilutive
or not--
MIKE KANTROWITZ - NEOWARE SYSTEM - CHAIRMAN, CEO AND PRESIDENT.
- ----------------------------------------------------------------
Well, we absolutely look at the profitability and the expected cash return from
our acquisitions, but what we look at is what can we do with these companies as
a part of Neoware? And how can we deploy these resources in order to grow our
overall sales? That's how we value acquisitions.
And so, for example, Mangrove, if you look at the Mangrove acquisition, the
entire development team that was at Mangrove is now working on our next version
of Neoware Linux, which is an important new product introduction for us. And so
that development team has been completely integrated into the overall Neoware
engineering organization.
But if you look at the history of the Company, we've made acquisitions, we've
done it accretively, we've done it profitably and we've generated cash to pay
back the acquisition prices. And that's our intent.
At that point, I'm going to have to cut it off for additional questions.
I want to thank everybody for participating with us on our Q1 conference call.
Again, we're pleased to have delivered excellent results for the quarter. We're
confident in our future. We believe that we have an excellent opportunity and a
growing market. We believe that we're gaining market share. And we hope to
deliver excellent results for you in the future.
So, once again, thank you for joining us.
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