Jerry Feeney – CFO
Steven Sprague – President and CEO
Ronald Meier – REM Financial
Timothy Collins – Security Research Associates
Kevin Gusinow – First Place Financial
Robert Isler – Private Investor
Jeff Patterson – Private Investor
Dave Abish – Private Investor
Wave Systems Corporation (WAVX) Q2 2012 Earnings Call August 9, 2012 4:30 PM ET
Welcome to the Wave System Second Quarter Conference Call. During the presentation all participant lines will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions). I would now like to turn the conference over to Jerry Feeney, Wave’s Chief Financial Officer. Please go ahead sir.
Thank you and good afternoon everyone. During the course of this conference call, we may make forward-looking statements regarding future events or the future financial performance of the company. We caution you that these statements are only predictions, and that the actual events or results may differ materially.
Additionally, we refer you to the documents the company files from time to time with the Securities and Exchange Commission. These documents identify and describe important factors that can cause the actual results to differ materially from those contained in any forward-looking statements that we may make.
At 4:00 O'clock this afternoon, we released our financial results for the second quarter of 2012. These can be found on our website at Wave.com. Please refer to the company's press release for more details relating to the financial results.
For the second quarter ended June 30, 2012, Wave's net revenues were $7,761 million, compared to the second quarter 2011 net revenues of $8.094 million and the first quarter of 2012 net revenues of $6.982 million .
The year-ago second quarter of 2011 included $2.364 million of recognized revenue from two large enterprise customer licenses that was recorded ratably during 2011. As these licenses were fully recognized by the end of 2011, the second quarter of 2012 reflected only $369,000 of ongoing maintenance revenues from these two customers, accounting for $2 million less in revenue in the current quarter versus the year-ago second quarter of 2011.
The second and first quarters of 2012 net revenues also included $1.6 million and $1.1 million respectively from Safend. Safend is Wave's wholly-owned subsidiary which was acquired at the end of Q3 of 2011 and such as not included in any results from the year-ago period.
Total billing for the second quarter of 2012 were $6.9 million which included $1.4 million contribution from Safend. Compared to the second quarter of 2011 billings of $9.3 million which included $3.5 million in one order billing from BASF.
As a result of planned investments in the company's sales and marketing, and R&D efforts to support OEM partners and related sales opportunities, as well as increased headcount in sales, marketing and engineering support services resulting from the September 2011 addition of Safend operations and expenses, Wave's total operating expenses increased to $14.208 million in the second quarter of 2012. This is up from $10.153 million in the second quarter of 2011. Compared to Wave's first quarter of 2012 total operating expenses of $15.317 million, the second quarter of 2012 realized a decrease in expenses of approximately $1.1 million for the quarter.
The net loss for the second quarter was $6.521 million or $0.07 per share compared to last year's second quarter net loss of $1.828 or $0.02 per share and also a $1.8 million improvement when compared to this year's first quarter net loss of $8.313 million or $0.09 per share. The weighted average number of basic shares outstanding for the second quarters of 2012 and 2011 were approximately 92.483 million shares and 82.940 million shares respectively.
To highlight the company's operational performance on a cash flow basis, Wave reports EBITDAS which is a non-GAAP measured defined as earnings before interest, depreciation, amortization and stock based non-cash compensation expense. In the second quarter of 2012, we've had negative EBITDAS of $4.627 million compared with negative EBITDAS of $301,000 for the second quarter of 2011.
At June 30, 2012, Wave's total common assets were $6.9 million. Wave's total common liabilities were $13.9 million which included $5.1 million of short term deferred revenue. During the second quarter and to-date in Q3 of 2012, Wave had issued approximately 4.1 million shares of its common stock through its At-the-Market or ATM structure at a weighted average price of $0.97 per share. This raised net proceeds of approximately $3.8 million after deducting 3% offering costs of approximately $118,000.
Shares sale to date in Q3 of 2012 represented approximately $1 million of the $3.8 million in net proceeds. And as announced earlier today, Wave has agreed to raise an additional $1.66 million in what is to be considered an at market offering to the sale of Class A common stock pursuant to its effective shelf registration statement.
And with that, Steven will highlight some of the key developments for the second quarter of 2012.
Thank you Jerry and thank you everybody for joining the call this afternoon. I'd like to start by just a general overview of the state of trusted computing in the marketplace today and we'll get into the detailed operations in our enterprise sales and OEM activities. From a trusted computing in the marketplace perspective, I think this represents one of the most interesting, benefits and challenges for Wave. In reality, we have the major players in the market now actively supporting trusted computing both in their products and in their marketing momentum in the market customer. Companies like Microsoft, Intel, ARM, NIST, Samsung, Google and others are actively participating in driving the message of Trusted computing forward. In that context, it really is a fantastic growth in the market. The marketing efforts that Microsoft has done already around Windows 8 and we certainly see an expansion of that as the product actually becomes available has been very beneficial to us in the enterprise accounts and we really are seeing the overall market interest in trusted computing growing strongly. The bulk of that can be identified in the context of using trusted platform modules for device identity, BIOS integrity and really the ability to eliminate the reliance on users.
And I can't emphasize this enough. I think one of the real challenges in the world today and we certainly saw it in the course of this week with the phishing attempts that were successful with Amazon and Apple, is that it's time to move users off their reliance on userid and password and really the service provider's reliance on users remembering passwords. We can today and we've demonstrated this now and have a number of very strongly interested customers in it, the ability to support domain authentication of a user to your enterprise account and provide the user only a machine and a pin number. They will not have credentials that can be requested by an e-mail phished out of them over the phone because all they have is a pin number and a machine. You will have to steal the person's machine in order to steal their account. And I think that provides a really strong move forward.
Overall trusted computing is about moving the control into the device. Control of the data at rest, so that if you lose your laptop your data is safe. Control of authentication, so user logs into their machine, their machine logs them into the network. Integrity of the device and security of the device, and we are playing a very strong role in driving that market forward. We are providing the leading market solutions in this space and we have the leading expertise in this space.
And that's the good news, is the overall market in trusted computing is growing very substantially. And I think it can be seen every day through the evidence of the different partners we're able to sign, the relationships that we’ve been able to announce the product capabilities that we're able to show in the marketplace and the interest in having Wave present at a variety of different locations. The challenge has been converting that into the enterprise sales growth that we all expect in the marketplace. And I think this is clearly a case where we are a little bit out in front of ourselves. We chose at the end of last year to invest strongly in the growth of both in mobile and in the adoption of trusted computing knowing Windows 8 and what Microsoft was driving in to the marketplace. We from a product perspective have done an excellent job in producing the capabilities and technology. We have it on schedule. We have it available to market on time. In most cases, we're completing trials of new capabilities in the product today.
The challenge has been converting that into strong enterprise sales growth and realizing that growth in the actual sales numbers we present on a quarterly basis. The overall market growth is really actually quite good. It's actually bringing those sales to ground so we can show you the evidence from the perspective of actual revenues brought in the door. And so this last six to nine months has been a very strong investment period in really expansion of trusted computing and we are definitely a little bit out in front of ourselves on that front. We were expecting stronger growth in both Q1 and Q2 in the enterprise adoption. It's not that customers are telling us they're not interested, it's that it's taking them longer to make a decision in actual deployment than we expected. Deals we expected to close in Q1 are just closing now.
So overall Q2 growth was there. Q3 will be substantially stronger and Q4 is looking very good at this point. I believe that we will continue to make very strong progress towards cash flow neutral and get us out of the position of having to raise capital to support the investment in the marketplace. I believe those investments have been very well worth. The expansion in the product line and the ability to meet customer's expectations as to both what the product should do and the quality and capabilities of the product in the marketplace.
Today, a really good way to describe what Wave is capable of delivering is that we can provide the Windows 8 security promise on a Windows 7 platform. Now it’s not every feature because some of those are intrinsically embedded in the operating system. But for the services that are wrapped around the operating system, we're able to deliver that capability today. User log on to the network without having a password. Machines that are persistently connected with no VPN but a secure channel between the client and the enterprise. Full self-encrypting drive management both for the user and on a network basis for unlocking the self-encrypting drives and BIOS integrity assuring really the highest integrity of the BIOS that's possible in today's platforms setting the stage for future trusted execution.
So overall we are in an interesting posture on that. From an enterprise sales perspective, this is one of the great challenges I think for all of our sales people today is the balancing act between reporting on what their actual sales are or were yesterday and then the opportunity that they saw today and we have this on a consistent basis. Even just in the course of this week, we’ve had two well in excess of 100,000 feed accounts that have been added to our pipeline. I know we've talked extensively about pipeline in the past and pipeline is very important to us because it is a representation of future sales in the marketplace and interest from the customer. I believe that we are seeing a really substantial improvement in the customer interest and in the breadth of the customer's interest.
It's not just I need a self-encrypting drive solution but tell me how this integrates with TPM . Tell me how this integrates why my network. Tell me what you can offer me in cloud services. It’s an opportunity to move away from just that data protection story and finally into a full-blown trusted computing story in the marketplace, and you will see more from Wave on that over the coming quarters and years as trusted computing really becomes what it is the enterprise customers looking to achieve. It's really bringing the PC space in to a similar model of both management and operation that were starting to become familiar with, with a mobile device in that I can go anywhere and always be on the corporate network. I can use my device without having to type credentials into every service because my device secures the services that I log into.
There is still a lot of progress to be made. We, I think are solidly entrenched within the enterprise space and ultimately we need to see the major services in the market begin to adopt support for trusted computing as well and it’s very early days in that process.
One of the key markets that are helping to drive adoption for Wave has been self-encrypting drive sales. We're seeing an increase in the number of drives that are available on the marketplace that support the Opal standards and I think we're seeing very strong growth in the solid state drive area for Opal on all solid state drives. Actually one of the places that's consummated that into an actual requirement is we now see a requirement within US Army that mobile devices with solid-state drives must have Opal as part of the solid-state drive solution, and that's a very positive development in the marketplace and I think we'll see that requirement expand across DOD and across other both key enterprise and government markets in the world. The concept of having a solid state drive without having Opal really doesn't make any sense. It's much lower cost, it's much easier to manage, it's much easier to deploy, it really is a win in every column. Anyone who has a solid-state drive and then puts software encryption on it is taking about half if not more of the value of the drive out-of-the-box with the software encryptions they are putting on.
On a government front we've had actually very strong progress, in the US, Europe and actually in Asia as well. So the action is very strong. We're seeing smaller orders this quarter from a number of different entities if not all coming from one place. And these represent anything from a few hundred units to a few thousand units and we have interest and are quoting business that's in the hundred thousand unit range. Ultimately however it's about negotiating a strategy to put trusted computing across the entire government sector. Those conversations are under way with the right folks.
Decisions are being made to incorporate trusted computing as a standard requirement for all machines. I think it's something that really the last three or four years of investment and energy that's been put into government is finally showing motion. It is the beginning of the process; it's not an end to the process. It's the end of the last phase and the beginning of the next phase and it's clearly underway. How fast that ultimately happens will depend on the leadership within the government. This is something that could happen very quickly and it's something that could take a significant amount of time. As we have a major cyber security issue really on a worldwide basis at this point in time, the investment that should be made in turning these technologies on, to protect all of us from the challenges that are out there in the marketplace should be made relatively quickly. It's challenging for a company of our size to press that need and requirement across the entire space. we are doing I think a very good job of it today but again I think we're limited by the scale and scope of Wave as an organization and our ability to move the whole ball down the field and we need strong support from partners in order to accomplish that
The requirement for trusted computing, and I think this is also important within government, is not just any one component. It is a combination of self-encrypting drives, BIOS integrity, trusted platform modules and the engagement of industry standards as a mechanism to address cyber security going forward.
I think one of the huge challenges we face in that arena is that there's just a general lack of experience with the systems integrators in the space of hardware encryption that's built into devices. There is education that's going on. Some are more farther advanced than others, but I think it's one of the real challenges in the spaces. In some ways the systems integrators are quite happily supplying the legacy systems that they have been supplying and there's really a need to change how the market pursues both PCs and ultimately mobile devices going forward. Mobiles creating the activity to cause people to think about it substantially more, but really the action on the ground is in the PC space at this point.
From an OEM perspective, this was a great quarter for us with our signing of a new contract with Lenovo. That really expands our distribution relationship. We're very pleased that they're willing to make it public. We are working with their sales teams today to incorporate self-encrypting drives and TPM management software with their products into their customer bids. We have a number of active projects that are underway I think the Lenovo relationship will be one that actually provide us with strong growth over the second half of this year. We'll see how those accounts mature in the next couple months. We had a number of accounts leading into it and now that we have a formal arrangement in place, we're really now formally enabled to go work together to move accounts forward.
We have continued strength at Dell and HP. We will see first product out of Samsung, we believe in this quarter or beginning of next. And so we continue to have very strong support from our OEM channels. It’s interesting today that now with our relationships with Dell, HP and Lenovo, when we walk into accounts regardless of who they use on an OEM basis we're able to supply trusted computing solution. We have the leading solution available in the marketplace and those accounts are the ones who bring us some of the largest opportunities that we're working with. And we see new ones every week. I had two conversations in just the last two days with my sales team who met with new accounts, who are dealing with north of hundred thousand feet opportunities that are brand-new names that just came to the table. And so this is a continuous process , the pace of that is increasing, the pace of smaller deals is increasing so we're seeing more revenue per week in the transactions that are taking place and they are more continuous in process.
So overall the process is okay. the real challenges that we were expecting that process to move much faster than it has, and as a result it’s put us in an interesting challenge from an expenses and operations perspective, but I think we're managing that quite well and we're trying to balance the action between the opportunity that is presenting itself every day and the need to control expenses. You can see from Q1 to Q2 we substantially reduced expenses. We’re continuing that process, but at the same time we are really focused on maintaining support for our customers and our prospective customers in the marketplace.
We also have a continued interest in the expansion of the adoption of Opal for self-encrypting drive management. We continue to do testing qualification with new manufacturers and are continuing to add new manufacturers to list of devices that are out there. We are extremely interested in expanding not only to different form factors of storage, but ultimately to the smaller form factors that move into both tablets and then ultimately to the other devices.
And we have a broad suite of new capabilities we just launched in -- in our new version of enterprise management software and we really have I think a full suite of capability at this point in time for any enterprise customer whether they are single user environment or they are working in hospital floors or other manufacturing lines, we have really a complete solution for managing trusted computing today both self-encrypting drives and TPMs.
And in wrapping up, let me talk a little bit about our efforts in the cloud. Wave continues to make solid progress on self-encrypting drive management in the cloud. This addresses smaller customers. We continue to update the version of our Wave cloud service and I think are really approaching a point where any small business can now deploy self-encrypting drives, have them centrally managed and have the same compliance capabilities that a large enterprise benefits from. You'll continue to see us add functionality to our cloud services especially around TPM and authentication and we think the ability to key each and every device is important and we're continuing to make progress on that front.
On Scrambles , the service has been very effectively launched in second-quarter. We had very, very favorable PR around Scrambles. I know we’ve talked about that in previous calls and it continues in that process. I believe our experience in this space is giving us the advantage of having the right story in the marketplace around the balance between security, privacy, individual protection and control and the needs of all law enforcement or government to be able to look at content. The growth of user base is going well and continues to expand and very soon you will see the launch from us of our capabilities for enterprise management. We have a number of customers who are interested, who have been working with us on the functionality for enterprise management. I think we will have very compelling offering. I have running on my machine today the capability to encrypt the file with Scramble which is really a quite excellent capability and service.
So on a technology basis, the Scrambles service is solidly out there. There is really good interest in it, and I think we'll continue to see appropriate growth in that space. We have maintained our team in Scrambles but we are being very careful on the expansion of that team until we're able to show first revenue out of that. As I suggested before, we're hoping to see first revenue within Q3 on scrambles and I think we're on target to achieve that.
So we are working across a fairly broad front of capabilities. I think that all of them fit in the same conceptual picture. How do we make it possible to give you access to something that a user can't propagate? Put content on a cloud that the public cloud can't copy or reuse without permission. Provide a machine that if it's not in your control, it's useless to somebody else. This is all about centralizing control so that the enterprise can have a very broadly distributed network, take full advantage of the public services that are out there and strongly enable the user to have access but without complexity. And I think some of the services that we're showing now, certainly we were demonstrating the customers on a regular basis, many of which we showed back in February at the RSA tradeshow are amazingly compelling to the day to day use of your computer. The fact you can log on every morning and not have passwords, not have to worry about the fact that you got an e-mail that you answered incorrectly, and because you answered incorrectly now, somebody has stolen your account somewhere. The idea that your account could be tied to your device and so that phishing would require actually stealing your device, we think is a very compelling offering in this marketplace. We're all wrestling with what the customer service problems are associated with how we manage accounts.
So our investments in space have been extremely useful. They’ve helped us to expand the market opportunity for the company, they have helped us to maintain our leadership position in this marketplace and help us to maintain the margin contribution that we can achieve in the products that we have. The marketplace continues to be a struggle to get to any kind of consistent velocity, but I think the help from the major players in the market that are supporting trusted computing will really help drive the growth of revenue and the growth of this business forward, and I think we're doing the right downs today and not treating the medium term surely for the short-term benefit.
So it’s a challenge It’s no question we clearly hear the message that this company needs to stop investing in new technology and rely only on what we’ve built and show the sales strength that's there. We hear that message strongly and we are working towards that. At the same time we don't want to miss the opportunity that is represented by what has been the last ten to fifteen years of effort in really bringing trusted computing to the forefront where it is today and making it one of the key technologies to help address the cyber security concerns we have in the market.
So with that I will stop there and open it up for questions and let`s try and keep it to one question per person which I think gives more people an opportunity to ask questions and we'll rotate that. So just keep that in mind as we go through questions and I’ll try and keep my answers short and sweet.
(Operator Instructions). Our first question comes from the line of Ronald Meier with REM Financial. Please go ahead.
Ronald Meier – REM Financial
On past conference calls I asked you to discuss what you thought was a reasonable revenue projection for Wave in 2012 and of course that question was asked prior to you knowing the negative effects of Thailand floods and hard drive production issues and the recession in Europe , but acknowledging that was unknown at that time, you generally felt $50 to $60 million for 2012 was reasonably possible and in 2011, Wave produced 36 million which was 39% growth over 2010 and to get to 50 million in 2012 would require the same 39% growth rate over 2011 revenue and so far this year, Wave produced 7 million in quarter one and about 8 million in quarter two and to get to 50 million for 2012 that means Wave would need 35 million in total revenue for the two remaining quarters of 2012. And the question I have is how probable do you see Wave producing 50 million in 2012 which is 39% growth and with today’s expense number of around 14 million. How hard is it going to be for you to get to that breakeven cash flow 14 to 15 million in that quarter three?
So where we sit today, we have – inside the numbers that would be possible to make cash flow breakeven in quarter three. We're probably a little bit shy of it. We'd have to be very successful in closing all of our deals that are sitting on the table right now that we believe we can close. Having said that, in past experience, you wouldn’t rank me very high on the ability to achieve that, I probably wouldn’t rank me very high on the ability to achieve that either. There are a number of transactions that would get you well beyond that that out there, that are almost impossible to guess the timing of. Having said that we're sitting here at the beginning of the second week of August and they have to come to ground pretty quickly if they are going to make it within Q3, if we're going to have some of those exceptional transactions happen.
The Q4 numbers are looking excellent at this moment in time. That number of accounts that are out there, the scale and scope of the deals that are there are very strong The concept that the team has the capacity from where it sits today to fill the balance in the last two quarters is probably at the top end of their capability. And realistically you're going to see close to -- you're going to see significant growth closer to breakeven in Q3 and you should see substantially above it in Q4. With the caveat that there are definitely deals that are sitting in the pipeline, that would exceed those numbers. And that's the thing that's really hard for us to guess. We've guessed this in the past and we've been wrong.
I do not believe in trusted computing will be wrong forever or even for much longer. And I think that's the greatest risk we have is that right at moment where the market is turning the corner and every signal is pointing in the positive direction for trusted computing, the momentum and enthusiasm for what Wave is doing which is measured every single day, is certainly at the bottom of its curve, not at the top of its curve. And that represents a real challenge. It represents an internal challenge for the motivation of teams, the motivation of partners, et cetera. And it's just the nature of the beast. Trusted computing is in the process today of launching in scale and we are at the forefront of the ability to execute on that and to drive it forward and right where we're at that point, we are challenged from a resource perspective because it’s taking longer than we expected. We were expecting much more support of it in Q1 and we're seeing it now. And those six months is expensive.
Our next question comes from the line of John (inaudible). Please go ahead.
Yes, you had announced three things recently Lenovo, Samsung and NATO. And the things go well in calendar '13, what could the revenue for each of those three be independently?
So Lenovo is probably the easiest one, in that we're actively working against their distribution with PCs, they should be able to represent a significant amount of enterprise business for us. They are trading places with HP one and two as the largest PC manufacturers in the market and they are very solely focused on the delivery of the box. So we would expect Lenovo to be a very strong contributor in 2013. To guess the specific number is really hard. I mean the potential that's there is between 30 and 40 million units and we're averaging in the $30 to $50 range per unit. That number is too high. But I also have a hard time believing that it still remains in the 2 to 3% level. So I would certainly like to see in 2013 that we get to 10% of new machines that are turning on trusted computing which gets to a much more significant revenue contribution.
The Samsung business is brand-new. My experience with brand-new OEMs is they need to show us the numbers. Certainly Samsung is a huge manufacturer. What we're doing today is reflected against their PC business which is not their largest volume business, but that bleeds into their mobile business in 2013. How strongly they adopt trusted computing in 2013 and mobile business I don't think I can predict adequately today to articulate the revenue of what mobile is as we haven't shipped the first revenue in mobile. Does Wave want to be an enterprise management for trusted computing in mobile? Absolutely. And I think we have a leading position in it, but I think quantifying a hard fast number against it is complicated at this moment in time. Certainly it's not an insignificant volume business enterprise mobile and bring your own devices core to the future, and I think trusted computing will be core to enabling that. But I wanted cautious on the front of saying we have not yet sold a unit against it in revenue. We're just demonstrating the capabilities.
NATO on the other hand is ultimately going to follow US government in scale deployment. We're expecting US government scale deployment to happen in 2013. That should represent in $30 to $50 million worth of business and NATO is probably equivalent in size. The scale of opportunity and government adoption of trusted computing is there. Wave is in a prime position to accept and create a bunch of that business and I think we're extremely well positioned because it happened today.
We need a tiny bit of leadership out of the US defense department to make the next step but a lot of the foundation is laid. We have strong support from a number of the services. We have support from the headquarters at DOD for trusted computing across the platforms, I think Wave's technology is well-positioned and we have begun the conversations with overseas partners, NATO being one of them as well as couple of other direct government accounts.
Our next question comes from the line of Timothy Collins with Security Research Associates. Please go ahead.
Timothy Collins – Security Research Associates
I guess everyone knows that if you could book a major order of 5 million or above, then you’ve got a pipeline, I guess a substantial pipeline that's as good as you're working, that's what breaks you even for the quarter. And I think that's the noble effort that you're engaged in. But my question has to do with what you alluded to was your R&D versus your products in place that sell. And so your R&D for the first quarter – first couple of – for the first six is like -- $10 million, up about 3 or 4 million from last year. So where is that R&D taking you? I mean this is a huge investment, this is the future of the company and you've chosen to do it. Your orders prove that. Where is it taking you and how fast can that generate revenue? When can revenue come from that R&D?
So the R&D is invested in two fundamental technologies. One is around the implementation of TPM for BIOS integrity and its actual inclusion in our core product line which is really the basis of how you do device identity in the PC and set the stage for how you manage the security of Windows 8 going forward and you can do a lot of things with it on Windows 7 today. So it's the introduction of really strong uses of TPM for authentication. The best way to describe this is that what makes a PC the way you think of it as a PC into making it feel like a mobile device is this investment. Another way to say it is that the future network that's out there is a network that's based on identity not a network based on how you're connected. I'll say it one other way just because this is a really important concept and represents a huge change in the network. Today if you were to unplug the phone in your house and take it to Tim's house and plug it in, you'd have Tim's phone number. But if you take your mobile phone from your house and go to Tim's house, you'll still have your mobile number. And the turning on of trusted platform modules with what we've done over the course of the last now year and the deployment of it in the last six months, trusted platform module is part of device id and BIOS integrity and strong authentication is really core to making that happen and should unlock a multibillion dollar business in the space. And I know that's easy thing to say and a hard thing to deliver but this is not about how do we just get $2 million more with the revenue although that’s what we're very focused on a day-to-day basis.
The second piece of the puzzle is how does exactly that same set of capabilities exist within what we now all know as mobile devices, things not running the Windows operating system both on Android and on other devices including ultimately Apple, although that's the hardest ones to deal within this space. And so we are today pushing the industry forward as best we can on their inclusion of trusted computing, their adoption of the technology, the capabilities that are there and trying to show parallels that also should be a multibillion dollar business and Wave today is at the forefront of it. The problem with this is that we do it as a company; we've been doing it for a long time. It's been frustrating for people to watch the paint drying on the side of the building because this is not been a flash in the pan, this is actually big infrastructure. You have to ship all the devices before you can turn them on. Having said that, there are a range of conversations that are out there that in the future could be really interesting. conversations with how does your bank authenticate to a TPM, which would eliminate all your passwords for your home bank accounts. How do we strongly authenticate to you your top 20 club services so you have no passwords as well? And I think those things will still take time. It's part of what we're trying to deliver. we have to show the enterprise engagement as funding the business to do that and so we are extremely focused on how does enterprise play in it but in reality the R&D effort is unlocking how do we turn your PC into the primary mechanism for authentication and control and access to all the cloud services that you belong at. And we are at the forefront of doing that.
I think the pieces we show was Scrambles, I understand that our first endeavor in it has been very consumer-ish with entertainment of consumer, social media protection but fundamentally it's the central key server for how you do subscriber management for all the different devices that are out there, and I think we will show the strength in that as those pieces come together. So the investments have been very beneficial to us. They've really strengthened Wave's position in the marketplace. We weren't anticipating them being as expensive as they've been because that's been the market so far.
Our next question comes from the line of Kevin Gusinow with First Place Financial. Please go ahead.
Kevin Gusinow – First Place Financial
I've got a question regarding Scrambles; you mentioned that in this quarter you are hoping to close a deal to show that all our investment in Scrambles is going to be worth it. What kind of revenue is going to come through Scrambles? I know it's free right now for people to use and I know it's very -- loading people’s e-mails is very frustrating, and I just want to know what you're adding to it and what kind of revenue you're actually going to get from, let`s say, a big corporation and how we're getting a revenue from it. Are they going to pay one big fee to utilize it or are they going to pay on a license basis? How is that going to work?
So the business model for Scrambles is, today really based around the classic cloud services model, so it will be annual subscription or monthly subscription basis, tied into the existing corporate user management. So a lot of the work that has gone into Scrambles that from a consumer manually you have to do adding lists etcetera, that becomes fully automated within the corporate infrastructure against their existing internal group mechanisms they already have, as well as the ability to build your own groups as an individual employee. And we believe the corporation is not only interested in but will be required to have oversight over what people write and send outside of the corporation and I think we've confirmed that fairly quickly in the process.
And so therefore they're willing to pay an annual subscription fee to centrally manage all their employees’ accounts. And that should be in the tune of the $10 to $20 range per user per year. I think that's the right general scale and scope. It’s less expensive than you would pay for example for an enterprise to have a service like Yammer, and probably on par with a service like Dropbox. And certainly it's a capability that every single enterprise could benefit from yesterday. So we're going as quickly as we can. Today we do messages, we're already demonstrating files. The file stuff is extraordinarily cool. Now whether you e-mail or you post to any cloud service anywhere in the world, you can encrypt your files so that only you and your friends can read them and we think it should have a similar economic model or two on the existing cloud services that are out there, companies like Dropbox, Yammer others that have the capability to charge for a service that's in the cloud. And there's been no pushback from the enterprise on the pricing levels that we've been proposing at this point.
Our next question comes from the line of Robert Isler of Private Investor. Please go ahead.
Robert Isler – Private Investor
I was wondering can you give us more color and may be doing on, on an ongoing basis on the growth pattern for small and medium business accounts for Wave over the past six months and you can include large non-up front 8K accounts in the mix as well. What kind of growth have you experienced both in the number of accounts and revenues? What are you expectations in the next six months and then finally, when do you see these accounts growing to a point where they can fully cover quarterly expenses so that even without those large elusive opportunities, you're not so financially strapped?
So the growth has been pretty consistent. I am not so sure I can quote a number off the top of my head exactly, but today we're being sustained. I mean the growth you're seeing is coming from small and medium accounts. And the large accounts have been an interesting challenge in the process. In reality we've also seen a number of very large accounts diversify their purchasing, so instead of having one large central acquisition, they've purchased off a number of regions, and that's also contributing, but this just looks like a dozen medium-size businesses as opposed to one large account. Because you're not getting one contract; you're having to sell a dozen of them it's just easier because Company A, Division I will influence Company A, Division 2, not entirely but most of the time pretty well.
The challenge we've had from a resource perspective is just as we've been starting to ramp up the marketing so that as people realize they have trusted computing in their box, which is the number one challenge we have, we still run into customers who are like, Oh, I have a TPM in every box. Wow that's so cool. Maybe I should turn it on. The challenge is in educational process, and of course education is real expensive. I mean what should we have done, should have been spending $50,000 running full page ad in the Wall Street Journal the day after your Amazon password was lost because nobody had any security in their account. How mean now ridiculous is this. I don't know the answer at the end of the day but it strikes me that it be really cool if the main account password for most of your sites to do things like change passwords was tied to your home machine. So you can have a password log on to Amazon from anywhere in the world. You want to change your account? You've got to do it from your home machine. You want certain administrative capabilities? You’ve got to do it from your home machine. This would solve the problem. It's not like it would address the problem a little bit. It would solve the problem and in that I find a really interesting challenge, but the vast majority of the population doesn't know there are 600 million PCs out there. So what do I do? I pick up the phone and I send an e-mail off to people like LinkedIn and say hey, Amazon and Apple had a great time, would you guys like to turn on TPM? You're probably not getting any answer but it's worth the continuous try. This is I think one of the interesting challenges with being a publicly traded company because if we were a brand-new startup, your VC would be picking up the phone calling the guy going, oh my god you should turn this stuff on. And so we're doing a lot of the heavy lift in the small medium business to help accomplish that. There is no reason today that 100% of small medium businesses is not buying self-encrypting drive management with an Opal drive.
I ran into smart people, we ran into a division of US government the other day has thousands of self-encrypting drives and they were running software encryption on top of it, cutting their performance in half. That's just because nobody knows anything. And the education of that process is really intriguing. At first we had to find out they are buying. Then you got to convince them to stop buying the software slowing down their machine. You think it would be shooting fish in a barrel with a twelve gauge shotgun, but they've been thinking about it for two months while they clobber 50% of their performance in their machine spending more than it would have cost to have bought our management software for SED and they already have SEDs. And so this is part of the challenge is, it's not a lack of product, it's not a lack of sale, it's purely a lack of marketing and we're too small an organization to spend the millions of dollars that it takes. We have to wait for the larger partners in the marketplace to educate the marketplace, to trusted computings in the box, or we need really big customers who then get written up and talked about. The press is dramatically moving positively in our direction, it's just not loud enough yet.
Our next question comes from the line of Jeff Patterson (ph), a Private Investor. Please go ahead.
Jeff Patterson – Private Investor
I had a quick question. Could you elaborate a little bit on the relationship with Microsoft? Is that one of the big companies that you're planning on championing trusted computing for us?
Sure, so Wave does not have a contractual relationship with Microsoft. We certainly interact with them very strongly in the standards body arena. We make sure that our products are interoperable with theirs and we do a pretty good job of selling a lot of Microsoft product. If you were a customer today, one of the first things we'd be telling you about is a new capability from Microsoft, it's not that new, it’s a couple years old called Direct Access which completely eliminates any need for any third-party VPNs.
So we work with the Microsoft sales channel on opportunities like that and those are not on a formal basis today but an informal basis, so we have places in the world where it works much better than others, where we go hand-in-hand. Having said that, we interact with them very closely around the Windows 8 making sure our products are compatible, we work with them through the OEMs on both operating system compatibility and new feature capabilities. So I would say we have a pretty broad information exchange but there's not really a formal partner program that's designed to stick us into it today from Microsoft perspective. Having said that, we continue to be and are very strongly interested in supporting Microsoft's Windows 8 strategy and their mobile strategy in the marketplace. We work pretty closely with their teams around the world today, and I would say we have a strong and positive relationship today.
Jeff Patterson – Private Investor
So you don't see them as coming competition in the near future or could elaborate on that a little bit?
That’s a great follow-up to that . In reality we really do not see Microsoft as competition. Certainly there are bits and pieces of what we do that they will do the same pieces of and eventually as we've said for five or six years, there are pieces that we build that are part of the operating system for which it belongs as part of the operating system. So for example today, if you want to fully utilize the TPM, you have to have Wave's little client driver software that we supply on OEM basis, one of the components in every box from Wave or from one of our competitors on the OEM side. On Windows 8, they finally have put that functionality. Now it's not as full a functional piece but it does most of what you need to do. And so it will satisfy quite a few people that I have just this little component. How you put the keys in the TPM, how you centrally manage it, how you turn it on automatically? The enterprise management of it you still need to buy Wave's package for. The sum of the client component are getting built into Windows 8, which is fantastic because it's reinforcing the technology and strategy going forward. Long-term, I think there are some interesting aspects of it. Today I think the entire network architecture is going change to much more of an identity based network architecture. Is Microsoft going to build support for that into the marketplace? Absolutely, in windows 9 or 10 but it's not in Windows 8 and really the understanding by the marketplace to use it isn't there yet either. So we had quite a period of time. Today really our claim to fame is anybody wants to have the Windows 8 security story and run it across their whole enterprise I can deliver you 75 to 80% of that story today in product, production capable yesterday. And I think that's the key aspect of it.
So Windows 8 will continue to expand that, but Windows 8 for example is going to ship virtual smartcard support for domain logon. I can supply to Windows Vista, Windows 7 and manage it on Windows 8 and so from our perspective we really don't feel them as competition. They are a great strategic partner in launching trusted computing in the marketplace and I think they view what we do as positive contribution to the extent that they are aware of it. There are certainly groups that have no awareness of who we are at all.
Our next question comes from the line of Dave Abish, a Private Investor. Please go ahead.
Dave Abish – Private Investor
With the only mandating SSDs and the only budget ending on September 30th, do you see any kind of deployment of SSDs combined with ERAS and also, what is the overall scope of volume that the only mandating SSDs, what type of volumes do you think that is possible from the army?
So there one of my big question marks as to timing. But army represents a million seats which is $30 to $40 million worth of business for Wave in aggregate. They are in the process of moving Opal into standardization across their platforms for a variety of reasons all of them good. Today Wave has the only enterprise management product that’s been through a certificate of net worthiness to run on army networks to manage self-encrypting drives or TPM. So we're in the process of updating that certification to our newest version. So we are in a very strong position. Interesting question is will there be any dollars freed up in end of your money which is always throw the dice as it were between now and September 30th or is it in next year’s budget. Clearly one of the challenges is finding appropriate reapportionment of the budget to assure that only army machines are connected to army networks and that rogue machines and your kid’s laptop and Russian machines and Chinese machines and stuff you bought from Brazil isn't just running all of our stuff in the network. And so we think only known registered identified devices on US sensitive networks would be a good plan. And I think this is one of the key aspects moving forward. There is very, very strong interest in it. I think the architectural teams in government are supporting it. A little bit hard to figure out when the DOD wide buy happens.
What should the DOD do? The DOD should write us a $100 million check tomorrow. Now people might laugh at that, but it would be the cheapest thing that could be done by the US government to enhance national cyber security bar none, because somebody needs to make a statement that causes the rest of the trusted platform modules inside the entire ecosystem get turned on. And most likely they'll spend another $100 million chatting about it as opposed to actually implementing it because they spent a 100 million on R&D. And so it's time to take the R&D budget and double it and deploy it because spending another $100 million on R&D inside government around trusted computing which is what they spent in the last five years seems like not the best application of our tax dollars.
So trusted computing lends itself to being turned on in an organized manner. It's not a great panic to turn on. It's really expensive to turn on if you have to in a week, and so the best plan would be to turn it on across the board. So that’s what we advocate. And we pushed that position very strongly. I think we're starting to see motion in the right direction but first step will be both deployments in most likely army and Air Force that will provide the foundation with which they'll justify broader spends.
So it will take a broader period of time, it's not going to happen in a weekend. It should, but it's not going to. And we should continue to advocate for that. If congress is going to move on cyber security legislation which they're not, and doesn't appear to anytime in the future, then it’s left up to private industry and individual government departments to actually secure the network. And this is one of the key actions we can take to move away from a global posture of watching the threats go across the network which is what everybody's investing in today, is just watching stuff and actually move toward dose of prevention and Trusted computing goes a long ways toward the dose of prevention. So it’s a challenge. It’s a little tiny snapshot into our pressure into the US government and other governments in the world. We're pushing that activity forward. Should we invest in that? I think it’s the right thing to do. I think the government has the opportunity to demonstrate clear adoption of this and if they actually stepped off the platform and jumped in the pool, I think it's probably one of the fastest ways we get to broader adoption across all of enterprise of this technology as opposed to trying to convince 10 Fortune 50 companies to do it and then be willing to stand up and tell the world that it worked out for them because that's so far taking longer than we expected.
Our next question comes from the line of Ronald Meier with REM Financial. Please go ahead.
Ronald Meier – REM Financial
Steven, could you clarify or delineate what categories make us the so called pipeline. In other words what constitutes the sale prospect who have expressed interest versus a real customer who is actually purchasing product? What constitutes a small, a medium customer versus a larger customer and without giving away too much of information advantage to our competitors out there, can you give us some clarity as to the number of prospects and/or customers in those pipeline categories as an example? Maybe TPM related seat sales versus SED related seat sales or anything that makes sense to you?
Sure. I’ll do my best to answer it. The mixture is getting harder and harder, because I would say at this point in time, most of our major customers now are interested in both SED and TPM. It’s a question of which priority and they are starting to be much more mixed which is very healthy. I would say in the past it was 100%, let`s do SED first because we have a compliance issue there. They’re beginning to realize that perhaps TPM has got the greater value proposition for them which is a good thing for us because there are a lot more TPMs deployed.
So what makes a big customer versus a medium customer today? We have a threshold of a couple $100,000. So if you have couple $100,000 opportunity above you, you fall into the large customer play. They are probably what we would all consider medium-size enterprises that fall into that because they are buying all seats at the same time. But for us it's a good delineation at this moment in time. And probably we'll continue to march upwards in scale.
Number of customers, today we're working up in the neighborhood of north of $50 million in pipeline and there are a number of accounts that I wouldn't put in that yet that drive it, there's probably another $50 million that are just too hard to guess on a timing basis. I'll put you as DOD in that categorized. I just don't include them in pipeline. They are huge. They probably represent a doubling of my pipeline. They are just DOD and they'll get at the stage they get there. And it’s the right way to approach it. They are not going somewhere else right now. We seem to be in a very strong supply position. Maybe a little competition would actually make that marketplace move faster but right now we have the working and operational solutions and certified solutions for sale. So that's a good thing. Next step is to get them comfortable with a broader buy.
So would we like more accounts? Yes. Always having a broader pipeline of choice gives us more comfort in what the next quarters start to look like. And I think one of things that's working extremely well is the investments that we've all been paying for over the course of the last six months. A ton of that's been salespeople and those salespeople are dramatically increasing the list of opportunities. The good news is the list of opportunities increasing, the bad news is, it’s typically been nine to twelve month sales cycle. Most of those salespeople came on in fourth quarter last year. And I think that's one of the challenges we wrestle with. Hopefully I've answered your question adequately. It’s a challenging set of numbers to produce and you make the correct point that I want to be a little bit cautious with my accuracy because the moment I start naming any aspect of an counter or industry respective I see competition show up there the next day.
Our next question comes from the line of David (inaudible) with a Private Investor. Please go ahead.
There seems to be a lot of speculation with the Microsoft Wave relationship and in a earlier call you had talked about you're not really in a formal partnership and that's correct, correct?
That's correct. There is no revenue going either way between Wave and Microsoft today. They are not paying me for work and I am not paying them to sell my product.
Okay and you also mentioned that in order to market TPMs, SEDs and the products that you offer, it would take a large OEM or a larger company to assist you with that. With the release of Windows 8, do you feel as though Microsoft provides that platform for Wave to maybe reach a new level of enlightenment with other investors?
Oh I think it's happening today. The reality is that Microsoft is actively out there pressing security as part of Windows 8. It's one of the key aspects of Windows 8. That foundation is built off of trusted computing in both their mobile strategy and their PC strategy. So both Windows RT and Windows 8, and Wave is in a position to help support and fulfill against that. We work hand in hand with them at existing customer opportunities. We're doing joint sales into a couple of different accounts. But as I said before, we're doing it on an informal basis as opposed to a formal distribution basis. Many of the existing Microsoft value added reseller partners become really great targets for us because they want to know -- so here is what happens.
This is a typical day. Microsoft advance team shows up at a big Fortune 100 customer, tells them everything there is to know about all sorts of cool things that are in Windows 8. Secure boot, modern access control, E-drives, these are TPM based, Opal based, Trusted computing standards-based capabilities that are in Windows 8. Then the customer goes, that's really cool but I'm not buying Windows 8 the day it shows up. I might take another year. I just finished upgrading to Window 7. How can I have some of these capabilities and not wait for five years? And at that point Wave is able to walk in and provide a huge chunk of the functionality so that the customer can get ready and whatever infrastructure they deploy on Windows 7 with TPM directly operates on Windows 8 as it begins to show up. So I present a bridging strategy for the entire enterprise community to deploy the Windows 8 security model on Windows 7 platform. Now I can't build every feature. There is still enormous reasons as to why you should buy Windows 8 but I can deliver a lot of value on top of Windows 7 and create effectively lock in, into the Windows operating system so the customer doesn’t decide to get up in the morning and shift everything to running Citrix or Android or whatever they want to change their client platforms to. They remain stuck to Windows which is really what Microsoft’s long-term interest is.
So we're very synergistic with the Microsoft story. We are in no ways competitive today. We just aren't. And we provide a compelling mechanism for the enterprise to begin to adopt the trusted computing solutions that Windows 8 is promising. As soon as that product is available, people get their hands on it, in its full release version and begin to test it and conceive of it within the enterprise and the stories get written of the early adopting customers, I believe it will drive the adoption of the trusted computing in the market.
There are 600 million TPMs that are out there and if we continue to average to make between $30 and $50 per PC times 600 million, I think it’s a larger enough total available market that it justifies some of the investments we've made to make sure that we're at the front edge of the conversion to that market. I believe that, I continue to believe that. It is very clear we have not adequately communicated that because every time we show progress in that step, I seem to drive my market share price down a negative basis, and now it’s Lenovo, my price goes, and now it’s Samsung, my price goes down. I appreciate that there are extenuating circumstances in it but part of that is driven by the investment that's allowed those transactions to happen. So it is an interesting balancing act today.
Our next question comes from the line of Raymond (inaudible) a Private Investor. Please go ahead.
I'm worried that Wave seems financially, frankly precarious and I'm concerned about its survival. One way to get to stability and enlarge your marketing and public visibility is of course to partner up or merger or sell to a larger more stable company. Is going it alone really the way to go now?
I think on a short-term basis, the answer is yes. But long-term I think the problem will be the reverse, which I think the scale and scope of trusted computing and its importance in the marketplace will ultimately create a challenge for us. As a publicly traded company, you need 51% of the shares to trade hands then you get to own the company. And so there is enough public float in the company, if somebody wants to buy it, they can buy it tomorrow and they just have to make 51% of the shareholders smile.
So there is certainly no active pursuit today and an attempt to sell the company or merge it with something else. I actually think that our independence provides us with the maximum possible return right now for the investors, and I think that continues probably at least for another year. We're in a positioned today where we're aggregating our position of importance in the marketplace, and the market is growing. The fundamental problem we have today is not Wave's role. We have number one market share in trusted computing. The problem is the scope and scale of the trusted computing market, and the dot haven't been connected yet in the marketplace's head is just how important and how big trusted computing really is. And I believe that that signal has started. It's certainly growing in its importance. We see it. We're starting to see other voices tell other people how important it is and it's that crescendos, it will put a much more interesting valuation on the space. And so our objective is to make sure that as that valuation grows, Wave's along for the ride.
And it's no question interesting times today. How precarious we are on a day to day basis. Obviously we would be much happier if the company was cash flow positive, generating and you had cash sitting in the bank and you had no need to have access to capital markets. Having said that I think the company has as good a posture as any commonly traded stock can be as it relates to availability of the ability to both finance and support it etcetera.
So I think we've done a reasonably good job of keeping our balance sheet, really our cap table very clean and I think that's the key importance in how precarious the company is. Obviously at the end of the day if the marketplace determines we have no value, that's a little complicated for sure. But we have good strong recurring revenue streams. The company in theory can reduce its personnel tomorrow. We also reduced the scope and scale of the opportunity and it’s a balancing act today, that it’s a very real balancing act. I don't believe it’s artificially invented by management in our heads. We see real customers and real scale asking us to do real things for them. Now we need to get them to actually write us real checks, so they pay for the work that we're doing. And we've demonstrated we can do that in the past. We've demonstrated it more than once. We had a gap at the end of last year that we're still suffering from and with a $5 to $6 million transaction, it’s off the table. And if you put $5 or $6 million back into the picture, it wouldn’t be perfect yet in the first half of this year but its better spent (ph).
Our final question for today comes from the line of Dave Abish, a Private Investor.
Dave Abish – Private Investor
Steven, I know that over the past year that Wave has employed a lot of sales people in Europe and we've hired Joe Souren and it seems like there has been some activity there. But outside of the big oil company, we really haven't heard of any major deals closing. Could you tell us about any large deals going on in the European commission? Are we any closer in Europe to signing some of these big deals than we are back at home?
So we're making progress on both fronts. There is no question the economic slowdown in Europe has been more pronounced in Europe. I would say I have more activity on the enterprise front right now in North America than I have in Europe. Having said that, I have 25 or 30 really good sized accounts in Europe that represent second half of this year opportunity and quite a few of them are in scale, most of them are already buying product at some level. We have a very large country based carrier who has deployed a couple thousand units and is on its way to hopefully and across the company adoption of the technology. We have more interest in oil and gas arena. We have some very strong interest in healthcare and manufacturing and automotive. So it continues to grow. I see significant contribution by our European team in the second half of this year and they have been a significant contributor in the first half. So it's been good. They are mostly new hands and feet on the ground. As a result many of the accounts are less than six months old in their opportunity. There are quite a few that are older than that that we were working before we expanded the team. But I would say that the substantial growth from the pipeline has come off new accounts that they have gone on and dug up and they are hard at it. They are out there having four to five meetings a day. We have very, very strong expansion of the business and we probably add $1 million or $2 million worth of opportunity a week.
That does conclude the Q&A session for today. I'll now turn the call back to you to continue with your presentation or closing remarks.
Yes, thank you very much and thank you everybody for your time. As usual if you send me an e-mail, I'll do my best to answer it. It's been very busy last period of time, but I will endeavor to get to them and I appreciate everybody's support, your concern, your enthusiasm for what we're trying to do. It is an interesting time. The team, I can promise you, is very focused on the ball. They appreciate and understand the challenges that we have out there and at the same time I believe we're making many of the right investments in the marketplace. We are not being frivolous with our investor's dollars by any stretch of the imagination and we are really focused on both driving this ball down the field and showing the full value that can be realized by trusted computing marketplace.
It continues to expand in both scale and scope. We continue to maintain our leadership in the space. We just don't have enough of the trusted computing economy yet running at the strength we would like to make it an easier business to execute. Having said that, I believe that we actually can see light at the end of the tunnel pretty strongly here. I know that we've said this in the past and the company's been through ups and downs in this process. We are in a stronger position today than we have ever been in the marketplace. And it's certainly is a challenge. It's important to maintain the momentum and the enthusiasm and the support for what it is and we look forward to doing that. So thanks for your time, thanks for your interest and I look forward to talking to you all in the future.
Ladies and gentlemen that does conclude the conference call for today. We do thank you again for your participation and ask that you please disconnect your lines.
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