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Wave Systems (NASDAQ:WAVX)

Q3 2012 Earnings Call

November 9, 2012 4:30 p.m. ET

Executives

Jerry Feeney – CFO

Steven Sprague – President and CEO

Analysts

Kevin Casey - Casey Capital

Kevin Gusinow – First Place Financial

Ronald Meier – REM Financial

Operator

Ladies and gentlemen, welcome to the Wave Systems third quarter conference call. [Operator instructions.] I would now like to turn the conference over to Jerry Feeney, chief financial officer. Please go ahead.

Jerry Feeney

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 o’clock this afternoon, we released our financial results for the third 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 third quarter ended September 30, 2012, Wave’s net revenues were $6.97 million, compared to the third quarter of 2011 net revenues of $9.534 million, and the second quarter of 2012 net revenues of $7.761 million.

The year ago third quarter of 2011 included an additional $2 million of recognized revenue from two large enterprise customer licenses that were recorded ratably during 2011 and were fully recognized by the end of 2011.

Additionally, the third quarter of 2012 reflected approximately $1.6 million less in OEM bundling revenue, due to a lower volume of shipped units during the quarter, coupled with lower average royalty rates per unit, which started back in November of 2011. These decreases in revenues were partially offset by a net increase of approximately $1.3 million from Safend, which was acquired a year ago, toward the end of September 2011.

Total billing for the third quarter of 2012 were $6.1 million, which included $1.3 million from Safend, compared to the third quarter of 2011 billings of $6.4 million. Primarily attributable to the late September 2011 addition of Safend operations and expenses, Wave’s total operating expenses increased to $13.044 million in the third quarter of 2012, up from $11.379 million in the third quarter of 2011.

Due to a curtailment of expenses in 2012, Wave’s $13 million of total operating expenses in the third quarter are approximately $1.2 million less than the expenses in the second quarter of 2012, and approximately $2.2 million less than the expenses in Wave’s first quarter of 2012.

The net loss for the third quarter was $6.108 million, or $0.06 per share, compared to last year’s third quarter net loss of $1.846 million, or $0.02 per share, and a $400,000 improvement when compared to this year’s second quarter net loss of $6.521 million, or $0.07 per share.

The weighted average number of basic shares outstanding for the third quarters of 2012 and 2011 were approximately 97.987 million shares and 83.681 million respectively.

To highlight the company’s operational performance on a cash flow basis, Wave reports EBITDAS, which is a non-GAAP measure defined as earnings before interest, taxes, depreciation, amortization, and stock-based noncash compensation expense. In the third quarter of 2012, Wave had negative EBITDAS of $4.189 million, compared with negative EBITDAS of $311,000 for the third quarter of 2011.

At September 30, 2012, Wave’s total current assets were $6.5 million which included $2.2 million of cash. Wave’s total current liabilities were $12.6 million, which included $4.5 million of short term deferred revenue.

During the third quarter, Wave had issued approximately 4 million shares of common stock through it’s at the market, or ATM, structure, at a weighted average price of $0.93 per share, raising net proceeds of approximately $3.6 million after deducting 3% offering [unintelligible] of approximately $111,000.

Also during the third quarter, Wave completed the sale of 2.6 million shares of Class A common stock at $0.6425 per share, yielding net proceeds of approximately $1.5 million. The purchasers also received warrants to purchase up to 1.3 million shares of Class A common stock at $0.58 per share, which expire in August of 2017.

And subsequent to the end of the third quarter, in October of 2012, Wave raised approximately an additional $3.1 million in net proceeds from the sale of 3.3 million shares of Class A common stock at $1.0025 per share. Purchasers also received warrants to purchase up to 1.7 million shares of Class A common stock at $0.94 per share, which expire in October 2017. Both of these private placements were pursuant to Wave’s effective shelf registration statement.

With that, Steven will highlight some of the key developments for the third quarter of 2012.

Steven Sprague

Thank you, Jerry, and thank you everybody for joining the call today. I’d like to start by apologizing for having a call on Friday. We had a conflict with a customer meeting that was yesterday, and so we moved it to Friday. We do not try to do that as a practice, and we will try and maintain a midweek call in the future.

With that, let me start by just saying that the trusted computing market in general has been a challenge this year, both in our forecasting, obviously, and in execution of the larger enterprise transactions that have been there. The overall business environment has been very challenging in that manner. However, the interest in the technology of trusted computing, the adoption of TPMs, the adoption of self-encrypting drives, continues to grow very strongly in the marketplace.

It’s certainly very frustrating for management, I’m sure it’s frustrating for shareholders as well, to see this disconnect between an enormous enthusiasm for the concept and the technology and the gap that’s been in execution.

As we look across the marketplace at those who both compete with us and who are in the trusted computing space, I would say we are similar if not actually ahead of some of the other players in the market in our ability to close business. But having said that, it’s still been a very tough environment over the course of the last three quarters.

I believe that’s substantially improving, and we’re seeing that. I think that one of the key events that’s taken place happened October 26 with Microsoft’s launch of Windows 8, which has really brought very solid support to the trusted computing space.

Actually if you look at both our website, and I know anybody who follows us on social media, we’ve been trying to connect folks to any of the articles that have been published around both Windows 8 and the security aspects of Windows 8. And there’s really been very strong press coverage.

A lot of it’s been quite positive, especially in the security aspects of the technology. And Wave has been very broadly referenced within those articles. So we’re pleased to be able to help support the launch, and support the technology in the marketplace, and so far it continues to be a very successful launch of the capabilities of trusted computing as part of the operating system.

And the focus is still really in these three core pillar areas of secure boot, modern access control, where we really are making passwords go away, and pervasive encryption, or the self-encrypting drives and software encryption that are possible within the PC platform.

So that’s been a very positive effect. It’s brought us interesting opportunities in the marketplace just even in the course of the last couple weeks. And I think some of the capabilities as people explore them and understand them and use them for the first time, it really is incredible to make some of your passwords go away permanently.

And I think that’s one of the real objectives. It’s something we’ve talked about for a long time, and it is now possible in your Windows 7 and Windows 8 machines to no longer require things like a VPN password for your corporation. It’s really an obsolete technology at this point. Your machine just connects. It actually forms and works almost like your mobile phone does. You turn it on, and all the services that you belong to, that your corporation provides, are consistently provided to your machine. And we have very strong interest in these capabilities.

I think the other piece that’s important is that the Microsoft launch has really helped invigorate the channel partners over the course of the last six to eight weeks. They see a story that’s not only told by Wave, but is also told by Microsoft in the marketplace. They’re putting more resource to it. They’re interested in it. They’re bringing us more contacts. And we think that we’ll see better channel support going forward from this point. So we’re pleased to see how the channel is reacting to the launch of Windows 8, and the security aspects that are part of it.

We are also seeing an expansion of the number of self-encrypting drives that are available. Now also drives in what’s called the mSATA form factor, which is the form factor that fits in ultrabooks and tablets, so that you can have a self-encrypting drive in your tablet and it makes your tablet safe to lose. So you don’t have to have your tablet auto-wiped if you accidentally forget it somewhere. You can just lock it. And it really provides a very effective capability.

We’re also seeing an increased number of drives that are either going through a certification process or already have completed a certification process, making it easier to sell this technology into the government sectors.

And I’ll finish on sort of a trusted computing market growth. I think one of the most significant events in the course of this quarter was the publishing of Army’s technical authority around their configuration for end-user devices, where they’re mandating self-encrypting drives on all mobile and tablet platforms. You’re not allowed to have a non-self-encrypting drive in your notebooks. And there’s TPM on all those platforms. The TPM is turned on, and there’s some specific guidance on how trusted platform modules and self-encrypting drives should be used in those platforms.

That’s a direct benefit for us. We supply management software that is then supplied to the government, and we also, I believe, have the only enterprise management software for self-encrypting drives and TPMs for BIOS integrity that has been through the certificate of the [net worthiness] process, and we continue to expand that process with the new versions of our software as it ships.

So I think that puts us in an interesting position and certainly there are lots of other people watching what one of the largest, or the largest, IT group in the world does. It’s always great to have them supporting the technologies.

So the enterprise market, we’re making progress. Revenue this quarter is already ahead of where it was last quarter. I think we’ll see a good finish to the end of the year. It’s an interesting question to explore why the challenges were in 2012 what they’ve been.

I think certainly we underestimated the interruption in momentum that was caused by the lack of availability of drives. And the drives are available today, but I think we still see some of the momentum effects of that as the marketplace sort of reattaches to the concept that the drives are broadly available and should be used.

I think the other place we see it certainly is that the budgets that are out there within corporations have been either distracted into mobile, or have been certainly lightened up due to the economic conditions. And that just doesn’t help the situation. And so it doesn’t make it an easy environment to sell into.

And I’m sure there are things that Wave could have done substantially better to improve its market conditions, but it’s an interesting combination of all of the above.

I think that one of the things that we’re trying to do is provide a very strong diversity of product and capability going forward. We began an effort really in January to fully support the trusted computing launch on Windows 8. We have those products available in the marketplace today around support for no passwords to log you onto your PC, no passwords to log you onto the VPN, a complete elimination of passwords required for access to your wireless.

So you now really can have a PC that you have a PIN number or a biometric that logs you into the PC and that PC provides storage of the credentials that automatically log you onto the network. I will just say that I finally got Microsoft direct access with TPM support with Wave software deployed on my PC a week ago, and it really changes the environment.

My computer is persistently connected to the company. I have access to all my fileshares. I have access to the ability to share files with other machines. I have secure network access anywhere. I walk into any facility anywhere in the world. I don’t have to worry about somebody sniffing my web traffic, and I don’t have to worry about logging into the wrong kind of a hotspot, because my PC is persistently secure when it’s connected to the enterprise.

And so that, combined with my self-encrypting drive, and the other pieces that I have of Wave software in the box, really provide a very interesting experience in the marketplace to make this easier. And so I think that whole collection of capabilities, direct access, secure wifi, secure domain log on, really the elimination of passwords in those arenas, and the reduction of reliance on the employees.

We have a number of very large customers who are interested in it. We’re piloting a customer next week that’s in the couple hundred thousand seat range potential. We’ve been engaged in conversations that are also in the multiple tens of thousands, if not into hundreds of thousands, of seats range.

And we’ve had really good conversation with both U.S. and one of the international governments about standardizing on TPM as a protection mechanism for access to all of their wifi networks. That you could walk into any government building anywhere, and as long as you had the government key, you’ll get access to the wifi. And it will be secure. And that’s a very deployable technology that we have all the tools and capabilities to make that operate out of the box today. And that would be true for any major corporation.

And so there are opportunities in both the self-encrypting drive business and the TPM management business that represent our core enterprise software and we continue to have very strong pursuit of that, good customer interest. And I certainly hope that the execution of closing with those customers gets substantially better.

We have closed a number of very large brands, but to smaller volume buys that we believe will continue to have repeat buys as we go forward. And I think it provides a much better foundation for us in enterprise revenue going forward. But we’d like to see some of these as the larger transactions we can promote and support as well.

And I would also say that in the government space, there is a momentum that’s coming together toward a broader transaction. The U.S. Army mandate is something we expect to have other services pick up and follow in a similar manner. We certainly hope for that.

And I think now that the technology is specified in all the endpoints, putting it fully into use requires the next piece of the puzzle, which is how do they buy the software on a larger scale basis. And we have a number of conversations that are going on, both at the service level and at the full Defense Department level to have access to this technology across the entire enterprise.

And so this isn’t a new process for us. We’ve been at this for three or four years in this conversation, but there is, I think, a really good momentum at this point in time to actually get a transaction done. And we’re working toward that.

So we’re certainly hoping to see progress on that. I think we’ll see progress after they’re sure they have budget, because of the current fiscal cliff thing. It’s definitely holding a damper on all the government spending, while they’re not sure whether they’re going to have sequestration or they’ll actually have budget.

And so certainly we expect politically that’s going to get solved in the next… We certainly hope. Let’s put it that way. I don’t think I have any crystal ball on that subject. But it certainly sounds like everybody’s intending to try and solve that as opposed to drive us off the cliff. And that would be certainly a very positive action for us because then you’ll free up budget that people are mentally already trying to spend in our direction.

To talk a little bit about the OEM business, the OEM business is a very important piece of our puzzle, as Jerry mentioned in the numbers. We certainly saw softness in Q3. OEM volumes in the PC industry were off, and reasonably off.

And certainly we believe that’s a lead up to the Windows 8 launch. General expectations from all our OEM partners are that volume picks up at the end of this year. And they’re seeing that now. We’ll see that as we see the numbers reflect back to us. I don’t think we’ve seen our October results yet, and frankly those would be too early.

The number of different models of PCs that have TPM in them is growing substantially now. So all of Microsoft’s Surface tablets that you see, even the Surface RT tablets, have a TPM 2.0 in them. And all of what you see from HP and Dell and Lenovo have TPM in both their tablet models and PC models. So Windows 8 is dramatically increasing the availability of the technology, which is a very good thing for us. And we still are in a position to provide some of the core infrastructure to enable and facilitate those machines.

I would also say in the OEM space we have just begun work on the 2013 deliverables for Dell. So we continue to have strong sight forward in our Dell relationship through 2013. And we’re pleased to continue to supply them with the infrastructure they have in the box. And so that process is ongoing.

It was interesting times over the course of the last few months because of Apple’s acquisition of AuthenTec, which was one of the major manufacturers in the OEM business of biometric sensors. And actually I think that’s going to turn out to have been a very good transaction for us, because we have very strong support for what was AuthenTec’s competitor, a company called Validity.

And we have strong OEM support for the Validity sensor. And I think it will help us to bring additional business. Or at least we see that opportunity forming in front of us today. So I think we could see actually interesting expansion, because AuthenTec was taken off the market by Apple.

And so overall, OEM continues well. We continue to supply Samsung’s PC group. We expect to see product out of them very soon, and shipping with our software in the box. We’ve delivered the capabilities to them. And so we’ve been very pleased with how that relationship is working. And that really leads us into the next step with them, which is working on how do we support their mobile non-PC-based platforms.

On the mobile side, just to touch on mobile briefly, we were at the ARM Tech conference out in California last week, demonstrating TPM on an Android device. We had very positive feedback. It was a really good, small tradeshow event. There was very strong interest in TPM on the mobile platform, and how it extends into both the tablets and then ultimately PCs.

And we had good, continuing dialog with players both in the chip side of that business, as well as in the manufacturers of devices. And we have good interaction with a number of very strong influencers in that arena.

So the context of an ARM-powered smartphone having trusted platform module capability as a generic capability to any smartphone manufacturer continues to make really good progress. It feels as though the timeline will be really solid progress in the first half of 2013, that there will be significant devices that are available supporting TPM in volume that could be very useful to the growth of what we supply in the business. The same server infrastructure and management infrastructure that we manage, the laptops and desktops with, will be able to manage your mobile device.

And as the line blurs between what a Windows tablet is and what an Android tablet is, that will become very, very important. If you look at what we can do today on a Windows tablet in assuring that the machine is always monitored, it’s always connected, there are no passwords on it, the network has a forensic mode capability that I can do file shares to that machine, the capability of automated backup of certain components, some really interesting capabilities that already exist on a Windows tablet, with the tools that we already have in the marketplace today.

It’s just most of them have only been out there for, realistically, a couple of weeks. And in most cases, the Intel-based tablets, or Intel-powered tablets, really what the enterprise is going to benefit from, are not available until after the first of the year.

As part of our mobile strategy, we invested in, a year ago, the construction of Scrambls. And so some highlights on what’s going on with Scrambls today. Over half a million messages have been encrypted and delivered so far. We continue to expand support across platforms for the technology. And we have very strong interest from an enterprise capability.

We’ve recently added the encryption capability for files, and we’ve been testing that and showing that to a number of organizations. This means that you can scramble any file, attach it to an email, send it to Dropbox, put it under SkyDrive, it doesn’t really matter, and those files are protected. We’ve been piloting that technology for a little while. There is very good level of interest.

We also have a capability now to fully support an enterprise centralized management of Scrambls, and how they manage their groups, how we can check on which users are using it, how much they’re using it. Full audit trail on the consumption of a file. Binding it to other group models, like your Active Directory groups, or other lists that a corporate might maintain with other services.

And so a really strong capability to support distribution of files on an auditable and secure basis over cloud computing. And the corporate interest is strong. And we’ll see how that ultimately adopts our business model there. It’s a subscription based model, on a monthly fee basis. I think it’s $1-2 a month. We do have capacity capabilities as well, so if somebody uses it a lot we could charge them more based on how many megabytes or gigabytes they actually scramble. Although we never actually see the data that’s in the file.

We think this provides a really strong capability to enhance the environment. I’ll give you a simple example to put scale to it. All of a sudden, instead of your doctor mailing you, in the post office mail, your results from your blood test, you could scramble that file, attach it to a Gmail account, and send it, and not worry that that healthcare data has been unencrypted when it traveled through Google or however it got to your phone or your PC. T

hey can be encrypted from the point of creation, all the way through to the point of consumption, and therefore meet the high tech rules and HIPAA compliance rules for assuring the integrity of data that’s delivered. And so I think there are really interesting roles for Scrambls in the commercial marketplace and the business is beginning on that front.

Finally, one other project that I think would be worthwhile mentioning, we’re successful in being a partner on the Criterion team for an NSTIC grant. So, NSTIC is the National Strategy for Trusts, Identities, and Cyberspace. And what we’re doing is bringing to that project strong device identity.

And so a good way to think of this is many people in financial services or electronic bank accounts or whatever have had a tool that does some kind of fingerprinting of your PC. And this, in essence, will replace that capability with using your trusted platform module to have a strong device identity. So instead of hoping it’s the same PC, we can mathematically prove that it’s the same PC.

And there’s very strong interest for this in the financial services arena. And so what we’re doing with Criterion and a number of other very significant players in the identity space is pulling these pieces together so there’s a turnkey solution in the marketplace. It’s being supported by U.S. government both on a promotional and funding basis to help point to the fact that we can move to a much more secure ecommerce environment.

Criterion has a couple of partners that are identified that are already doing tens of millions of transactions with hundreds of thousands if not millions of end users. And this is really providing the infrastructure into that environment. So if you have a PC that has a TPM on it, we’ll be able to use it to secure your everyday relationship with services that are out there.

And I do believe that financial services will be one of the early adopter spaces here. There are a couple of very interesting customers that have already been identified. And the whole team is working to expand that.

So we’re excited about that. I think it really shows the power of these technologies in real use. The timing is good, because we’re starting to see more devices through the Windows 8 program with TPMs in them. And Wave really has a very unique offering in the marketplace for this. So we generate good revenue off of it. We have the right revenue model with the OEM partners. And these are the things that will propel the company forward over the course of the next year.

We’re seeing expansion in the enterprise business. We know it’s been tough sledding. I think we’ve taken appropriate steps to try and pull down the expenses within the organization to make sure that we have the right balance.

We certainly got ahead of ourselves last year. We really felt that after the transactions that we did for a few hundred thousand seats in 2011, that the marketplace was ready for expansion. And we underestimated the impact of, I think, a number of different factors that have made that harder in this calendar year.

Having said that, the enthusiasm for putting encryption and making your machine safe to lose, and leveraging the trusted computing technology as a standard. There are new drives being launched by many of the manufacturers as we speak, in anticipation of next year. Nobody’s dropping the technology or the capabilities.

This is a continually expanding capability, and Wave continues to have the leading solution in the marketplace to offer and really the leading market share in dollars generated off of managing self-encrypting drives and TPMs in the marketplace today.

So we continue to be in a strong position, but it has been a challenging environment. Some days it whipsaws you back and forth a little bit. Yesterday we were discussing a multimillion unit wireless deployment, and it’s like, okay great, guys, but what we’d really like to see is the first order and the execution of that.

And so we’re really pressing hard on delivering that from an order basis. I think we have the right team in place to accomplish. We’ve made some changes, and the company’s pretty well situated right now for the future.

So that’s where we are. With that, I will stop my general comments here and open it up to questions. We will try and keep it to a single question for each person, and if you want to ask multiple questions in a row, please then just dial back in. And I look forward to your questions.

Question-and-Answer Session

Operator

[Operator instructions.] Our first question is from the line of Larry Gordon, private investor. Please go ahead.

Larry Gordon

I have a two part question. I am assuming that we still have over 200 employees in the company. And if we’re not making sales, why are we keeping all of these people, to keep the expenses up so high? Why aren’t we reducing our employees if we’re not getting the sales in?

Steven Sprague

The company’s just around a couple hundred employees. We have been reducing our headcount. Actually relatively substantially. We’ve done it quarter in and quarter out. I think the challenge has been that we don’t sit here without opportunity sitting in front of us. It’s been converting that opportunity to ground. And in some cases, it’s been a little interesting how some of these opportunities have slid to the right.

So in order to deliver the capabilities that we have in the market to support our OEMs and their launch with Windows 8, to support the capabilities that we have to offer within the marketplace, we’ve maintained that capacity. Having said that, we’ve also taken steps to reduce it, because you can’t do everything.

So it’s been a balancing act. The trusted computing market is launching in scale as we speak. There’s no question about it. And Wave has a leadership position in that space. What we’re trying to do is be in the right balancing act. We should have seen broader engagement in the SED market in the course of this year. And so there’s no question we got out in front of ourselves.

But, at the end of the day, you have to make a decision at some point if you want to completely walk away from certain places in the market, because you have an obligation to a certain level of quality and capability, etc. that you have to bring to market.

Larry Gordon

As a follow up to that, in order to pay the employees, I noticed that we’re still using ATM. We’re selling stock with warrants. And when is this ever going to stop? When are we ever going to have enough revenues where we don’t have to go to the ATM or we don’t have to sell stock? I thought that would be behind us this year, and apparently it’s still going on. I noticed there was 175,000 shares traded after the close today. I don’t know if that was our ATM or where that came from, but I’d sure like to know when you think we’re going to be able to support ourselves without having to go to the market all the time.

Steven Sprague

I think we’re very close to the end of the process. I think that between the reductions that we’ve done, the increase in enterprise revenues that we believe are underway, that we’ve seen much better engagement in sales already this quarter.

We certainly believe there’s the potential to get to cash flow breakeven this quarter, although we have the capacity and capability to support getting into early part of next year. There is enough business sitting in the pipeline to easily support the operations. We have to close that business to ground. And some of these opportunities are substantial in scale, that then address the problem in its entirety.

Obviously we’ve run the company in a position where you were basically cash flow neutral for two or three years prior to this, and as the scale of enterprise business grow, we certainly expected that growth to continue into 2012. And we’ve seen a definite softness in the large enterprise space in the closing of self-encrypting drives.

Part of it has been availability, part of it has been momentum, part of it has been Windows 8 technology transformation. No, we don’t want to do anything until those new platforms ship. There are a myriad of reasons for it. But at the end of the day there’s no excuse. We estimated that the business that with did last year would expand into this year.

This is an emerging technology. It’s an emerging business. The drive industry is putting more weight behind it. The OEMs are putting more weight behind it. And Wave’s still capturing the same market share, but the market shrank. And that’s a hard thing to predict in an emerging market space, where everybody was saying this on the positive side.

In some ways, you’d almost like to be able to say, oh, look, we lost all the business and XYZ Co. got it all, because then you could say that we’re doing something completely wrong. This has been very frustrating in the context, because all the normal indicators should indicate that this grew into this market space.

I think there are a lot of different reasons for it. I think we can talk about them all day long, but at the end of the day the real question is we have to put the numbers on the table. And the team is very focused on executing the transactions, being as lean as possible. You can see it in the reduction in our expenses already. You’ll continue to see that until we reach a point where the company is cash contributing again.

And we have no interest in selling another share of stock either. We would prefer not to. And we’re trying to be as efficient as possible in those transactions, and it’s never great, but we’ve done okay in the pricing of our transactions and the stock in the market situation we’ve been in.

Operator

Our next question is from the line of Kevin Casey with Casey Capital. Please go ahead.

Kevin Casey - Casey Capital

Mine’s kind of a follow up question to the previous question. Can you just outline kind of past profitability, what we need from OEM, what do we need from enterprise, how likely we are to get there? You know, I figure some of these OEMs should be kicking in now, but they’re not. So can you talk about that too?

Steven Sprague

Our OEM business, as we’ve said in the past, we expect to be relatively steady state from a revenue perspective. OEM is off this year by $3.5-4 million during the course of the year from where we were a year ago. Part of that is pricing, part of that is volume.

We’ve brought on a new OEM in the form of Samsung. They haven’t shipped the first revenue generating unit. We’ve generated revenue from Samsung, but we haven’t shipped the first license software yet. We expect that the end of the year.

We’d like to see greater volume in both Acer and Asus. They are typically consumer business model as opposed to an enterprise model. Their enterprise share has shrank over the last year. However, what changes now is that trusted computing shows up across a much broader market space, and so we’re in discussions with them as to how that changes, because how do they support these capabilities across their consumer platforms as well.

And like I said, it’s an interesting environment. I think it’s a little hard right now. We’re just in the earliest stages. Over the course of this quarter, I think we’ll understand the impact of the change in the biometric sensor business. We generate significant revenue from surfacing the software for the biometric sensors. And certainly that market change is a change that should benefit us, not detract from our business. In many ways, it already has.

So from an enterprise space, the pipeline that sits in front of us grows and has grown almost every quarter we’re in. This is the real dichotomy of this business right now, which is that the challenge is, how are we going to execute enough transactions to pay the rent, and then the rest of the day I’m in a discussion with somebody who wants to roll it out on a million seat installation. And it’s like, okay, somewhere between zero and your million seats, why don’t you start the ordering process?

And we have put a lot of pressure in that environment to move that forward. The technologies are there. Windows 8 launch helps us hugely in this space, because it’s provided clear cover for anybody who makes the decision to leverage these technologies, that they’ll be here for the next decade.

And so we believe the enterprise business will continue to get easier. But it’s been a mixture of small, medium account business and then these large transactions that have been prepaid. What’s happened during the course of this year is many of the large transactions are, while we’re doing business with companies that have more than 100,000 seats, they’ve only decided to roll it out regionally as opposed to a wholesale, across-the-board rollout, where they pay us up front.

And so in some cases we have similar customers, but it hasn’t generated the kind of transactional revenue for us where we’re prepaid, we’re being paid as the technology’s being rolled out. Now, there’s good news and bad news. The bad news is that the cash flow isn’t that up front. The good news is that the probability they continue order units next quarter is pretty good. And so it’s providing us a slightly more solid base for us in the enterprise revenue and every quarter I think that solid base continues to grow.

Operator

Our next question is from the line of Kevin Gusinow with First Place Financial. Please go ahead.

Kevin Gusinow – First Place Financial

I had a question on Scrambls. One, I think at the last conference call you guys were really excited about a potential closing at the end of August. I was wondering, has Scrambls generated any income as to date? And second part would be what is the outlook as to do we have a timeframe as to how long we’re going to give this project? I know it’s costing $100,000 a month for a company that’s decreasing in revenue every quarter. Do we have an outlook for that investment?

Steven Sprague

I can be very clear on it. The revenue so far generated by Scrambls is, call it, less than $100,000. It’s in nickels and dimes. But it has caused revenue to come into the company. Having said that, the business model that we think is very effective in the space is in the enterprise offering. The consumer offering today is free, so you want to go sign up for it, you can go to scrambls.com and sign up. And you can begin to use it today and there certainly are quite a few people out there using it, and finding it an interesting technology.

We believe two things that really help drive the launch of this business. Number one is the addition of files, which makes it possible for us to support any kind of file distribution. So you want to put all your PowerPoints and your business plans into a Dropbox, you can do that. And all I need to know is the email address of the people that you want in your group. You add that email address to the group, and now I have secure file sharing, and you really didn’t have to do anything else. And it provides a very effective, very easy to manage tool. In order for a corporation to actually deploy that capability inside their corporation takes about 15 minutes.

We are just launching. We actually would have launched it already, except a bunch of the team members associated with this got run over by Hurricane Sandy, which put about a 10-day delay on our project. But you’ll see in the very near future the capability launched in the market. We have pilots that are running today. We have quite a few very interested enterprise customers. So I think we’ll see, let’s say starting at the beginning of the year, the first subscriber revenue that comes off of Scrambls.

It’s always hard to know if, with something that’s out there that’s a new concept in apps and cloud services, etc., this is a cloud service everybody could leverage. You can encrypt a file in your mail, and any type of attachment, put it up on any of the social sites that are out there, and it supports your text-based messages in social media.

We have good conversations that are going on also at a government level on a couple of different projects. And so we’re trying to provide a pricing model that’s $1-2 per user per month. So think of this as a $12-25 per year type service. That’s then an ongoing relationship with those customers.

And we think it’s a very viral service in its basis, because if I encrypt the file and I send it to you, you have to have a Scrambls account in order to decrypt the file. Now, of course that Scrambls account is free, but then if you want to use it within your enterprise, it also becomes something that’s a paid-for service.

So this is a service that should grow to have a revenue structure that looks similar to a company like Yammer that got bought by Microsoft or you could argue Dropbox is a similar model, where it’s a charge per user on a subscription basis, based on the capacity and use of the service. So I think we have an effective economic model. Certainly a proven economic model in the enterprise space.

And this is a value-added service on top of almost every one of the existing social media services that are out there. There are a couple of other people that are competing in the marketplace now, so they’re interesting to watch. They’re behind us in implementation. We were first to launch in this arena, and I think we have excellent service that’s up front. And we’re integrating it with our trusted computing story and going forward.

I think long term, the subscriber management capabilities of Scrambls for the distribution and assured distribution of information offers a tremendous economic model in this business. And actually, you could make the argument that all of trusted computing has been designed and built to support the conceptual services that look like Scrambls going forward, whether built by Wave or built by others.

The idea of secured information sharing on platforms that are known platforms with known capabilities, we will show you by the beginning of the year the ability to only descramble content on platforms that have self-encrypting drives, as an example. And so those become very important tools for the enterprise going forward.

So I think we’re very comfortable with the economic model. I think we’ve done enough test and validation with the customer base out there. I have some very large brand name customers that are in piloting today. And we’re quite enthusiastic about the service.

Operator

[Operator instructions.] Our next question is from the line of Ronald Meier with REM Financial. Please go ahead.

Ronald Meier - REM Financial

I’m a bit unclear about the Wave-Microsoft relationship. Could you give us your perspective on what Wave can expect from Microsoft in return for our cooperation with them and providing our technical support and helping them develop and implement their trusted computing security system for Windows 8 and PCs and mobile devices?

As an example, there are roughly 700 million copies of Windows 7 out there. Is Microsoft signaling to Wave their willingness to refer Windows 7 and 8 customers to Wave for their TPM management and WEM for their remote out of station needs? In other words, the question is are you experiencing significant increases in customer leads coming from Microsoft customers?

Steven Sprague

I would say not yet, but I have a couple of projects I’m working on today already, referred by Microsoft, to support Windows 7 platforms in the marketplace today. They were not opportunities that Wave was working on or knew about before. They were brought to me through that channel.

So Microsoft does not write a check to Wave. Let’s be very clear. We support them as one of their partners in the marketplace, in support of Windows 8 platforms. We have a good operational working relationship with Microsoft. And we’re pleased to support their platform very broadly.

The opportunity for us directly with Microsoft is with all the Microsoft channel partners and realistically also with our existing OEM channel partners who fundamentally are selling Microsoft powered machines. I mean, the vast majority, when you look inside Dell and HP and Lenovo, they are selling Microsoft-powered machines.

And so that channel has undergone education and is undergoing education now with Windows launch. And to be fair, most of the people that are in those groups, they wait until the new platform launches, because they don’t want them selling you Windows 8 laptops when they’re not available yet. So getting training October 1 would be a bad plan. And you can see the softening in PC sales that happened in Q3 anyway.

So we’re underway in that process. Like I said, we have a couple of direct opportunities we’re working on now. I have one of them that I hope would confirm to a transaction before the first of the year, which would be great.

And I would say the other piece of the puzzle is that our task is to understand and leverage the full suite of capabilities of security, so that we are the system matter experts in that space. And so to the extent that people want to turn on the trusted computing within their Windows platforms, the best thing you can do is call Wave. And that’s true for both Windows 8 and Windows 7.

And so we have the infrastructure to support that, deploy it. We’re supporting those platforms today, and we have the experience and capability to do it. So we’ll see how it continues to develop.

This role has been a well-defined role for other companies in the past in supporting new Windows launches. And I think we’re well-positioned, we’re unique in the space, and we have the right mixture of technologies. We don’t compete with Microsoft. We leverage their technology.

I think there are some things that could be a little bit better done in how Microsoft compensates its channel to drive this business more heavily across the whole Microsoft sales organization. And we’re actually providing feedback to them around that. And I would say they’re receptive to that conversation as well.

So, you know, it’s our job. Our job is to be the evangelist and deployment experts in trusted computing, and we continue to do that. It’s been, what, almost two weeks since launch? And there’s been significant progress already. It really changes the tenor of the conversation a lot. Whether it’s been in our OEM trainings that we’ve done, and those are ongoing.

So I think we see a really cool market. I have a Windows Surface tablet. It runs all of my Office applications. And it will seamlessly connect into my enterprise network the same way my laptop does. And that’s cool. And in some ways, what Wave is enabling is really almost a mobile device management model for laptops and tablets off of these combined technologies that is completely unique in the marketplace.

Operator

Our next question is from the line of Dave Abbot, private investor. Please go ahead.

Dave Abbott

My question is related to the government mandating the SSDs and the SEDs. My question is basically a three-part question. Number one, when do we predict that we’re going to see revenue and scale from them mandating SEDs? And give us an idea like, say, the first half of 2013, what type of revenue we could see from them mandating this? And also, do you still feel at this time that the system integrators are going to still be turning on their TPMs before the government is, as you’ve said in the past?

Steven Sprague

Actually I would tell you right now the government is moving faster than the integrators. So that race continues to be on. I think there is a real movement underway to actually produce an enterprise-wide license for the Defense Department for turning on the TPMs and enabling them. And we’re participating in that process, we’re pressing that process forward. It’s extremely hard to guess when that’s actually going to come to ground.

I think once they make a decision, and then it takes them three months to write a contract, I’ll be much more comfortable in saying it’s going to take them three months to write a contract. I don’t know if it takes three months or one month, but the decision to procure a global enterprise-wide license, either at the Army or Air Force level, or at the Defense Department level, is in process. There’s discussions actively going on about it. And we’ll see how that moves toward actually consummation of an agreement or not. And obviously we’re pushing pretty hard on that. And so if that happens, then they’ll get way in front of the systems integrators.

So what’s the impact of first revenue? So U.S. Army CHESS program, which is their commodity hardware program, has now adopted the new technical authority. It’s part of what they call CB16, which is their consolidated by 16. It’s up on their web page, the CHESS website. And our understanding is those are machines that get ordered before the first of the year.

So we should see an impact of whatever the volume of computers are that are ordered before the first of the year, which typically are in the tens of thousands. Should happen in December. And obviously I don’t have any greater foresight than anybody else does in what the volumes are. They range over time.

Have they been waiting for new platforms or do they not have any money now because the fiscal cliff? There are lots of variables that flow into this as to what that volume may or may not be and certainly hard for us to estimate. But it should be in the tens of thousands of machines.

As Wave has a direct economic benefit, as the machines are ordered in our existing relationships with the OEM partners that we have, and this really sets the stage then for the broader enterprise wide buy of the software that’s there and then ongoing maintenance of that software. And I think that’s an important piece as well, because that will become a recurring revenue stream off that entire installed base on an annual basis.

So what’s the scope? Wave generates in the $30-50 range per device on enterprise-wide management of a device. And there are almost 10 million machines in the Defense Department. So say half of them are interested in trusted computing capabilities. It’s still a 5 million unit installed base. Army, by itself, is almost a million devices.

So there should be good scale in this event. And we should see significant return on it. It’s taken a long time to get to this point. I think we’re well-positioned in the execution of it. And we need to see the next couple pieces drop to the ground. We will see significant revenue that comes out of the consolidated by, just in the volume of machines with self-encrypting drives, and we benefit from that. So that, for us, generates multiple dollars per drive, and per machine.

Operator

Our next question is from the line of George [Pantalakos], private investor. Please go ahead.

George [Pantalakos]

There’s been a lot of talk on the internet lately about the possibility of going back on a three for one split, a reverse split. Could you touch on that particular possibility? Is that something that could happen again I should say?

Steven Sprague

The rules are well published out there. Wave is not in dollar compliance. If the company would trade above a dollar for 10 days, we would be in dollar compliance. We got very close to that a couple of times in the third quarter. I think we have interesting news flow that could generate that, and if we’re successful in holding the share price above a dollar for 10 days, it would put us back in NASDAQ compliance.

If you don’t achieve that dollar compliance, then there are a variety of different things you can do of which obviously changing the share count is one of them, to put the company back in compliance. No specific decisions have been made on that.

So the company always has the capability to do that if it’s approved by the shareholders. So the shareholders have to decide it’s the right thing to do. If that’s what you decided to do, it’s certainly not our intention today in any way, shape, or form. But we have a finite period of time to maintain dollar compliance.

Operator

Our next question is from the line of Ray [Knopp], private investor. Please go ahead.

Ray [Knopp]

I had a quick question regarding the consumer devices. Do you see there being a push in the industry to incorporate TPM into mobile devices? Because I’m just personally thinking about several killer apps like banking. And in what shape or form would you be willing to actually exploit that and market that business model?

Steven Sprague

So mobile for us is a very important market. We’ve had a small team focused on it all year. We have a relationship with Samsung to provide trusted computing infrastructure to Samsung Corporation. We continue to invest in that, and that certainly would provide them with capability into their mobile devices.

We have an existing relationship with ARM. We’re part of the ARM trust zone partners program to put TPM into all ARM designs. ARM doesn’t make chips. They make the designs that are in all of your smartphones. And I think will have some much greater clarity hopefully before the end of the year as to kind of the scale of smartphones in calendar 2013 that could have trusted platform module capability in the smartphone.

Microsoft has decided to include TPM capability across all of their devices. My consumer Surface tablet, that I got two weeks ago, has a TPM 2.0 in it. And so I really think the interesting question here comes down to a very simple question, which is how wed are we all to our passwords? Because the tools that exist today for you to not have any passwords, you log into your device, and your device logs you into the stuff you want to get access to.

So far, I am a complete and total believer in this concept that the consumer wishes to get rid of their passwords. Everybody you talk to at a cocktail party or sitting next to on an airplane, or anybody you run into on the street, you say, “I’m here to make all your passwords go away.” That’s what the Wave investors are investing in, is the elimination of the passwords. We should have a party at the science museum when we finally put up the little display that explains to the children that there used to be these things called passwords. Because we can make them go away.

Now, the challenge is, we’re at 600 million PCs. And your IT department in whatever company you work for, or whatever company you had a previous relationship with, hasn’t seen fit yet to decide to get rid of the passwords. They just think it’s a brilliant idea to have passwords on everything.

And yet every time you give them a device, or every time we give the consumer a device like an iPad, which has a lot less passwords, people go, “Ooh, I like that. That’s really cool. That’s a really excellent device. It has a much better interface.” Well, of course it has a better interface, because every two seconds there isn’t a little box coming up, saying “We’ve forgotten who you are. We don’t understand that we’re your personal computing device. So would you type a password in to remind us who the heck you are?”

My laptop being a perfect example. It has a button on it that connects me to my Verizon broadband program. I have an unlimited Verizon broadband license, just like you have on your iPad. I have to push the button on my laptop. On your iPad, it just connects to the stupid internet.

This is amazing rocket science, to get rid of the button that says “Push to connect.” Because I’ve got to check whether the human, when you open a browser, would actually like to be connected to the internet.

And so we should all find that both a little bit humorous, a little bit depressing. And so yes, there is a truly enormous opportunity in the keying of devices and the management of groups of people who have keyed devices to have access to different services and content on the internet.

Now, here’s the trick. I think that in mobile, having learned a few lessons in this PC space, one of the key things is what are the key applications, the top applications, to eliminate passwords and [hold keys] in the device? And I believe there are at least a couple.

One of them is banking. The problem with banking is if I want to do secure banking, first I have to ship lots of phones, then you have to call Citibank and Bank of America and Wells Fargo and get them to agree to support this installed base of devices so we could have secure banking and not have the liability that malware, bad guys, phishing attacks, etc., steal all our passwords. And as none of them are actually interested in the customer service model, they’re very slow to adopt.

The second application would be payment. So great, I put a wallet in a phone, then the challenge with the wallet in the phone is I’ve got to get all the commerce sites to take the wallet. Because unless Amazon will take the wallet that’s built around the trusted platform module on the phone - again you have the same problem. You’ve got to ship millions of devices. Now you could have a wallet capability in the phone that’s based on hardware security in the handset. But it doesn’t really do anything for you day one unless you have all the merchants signed up.

And that’s why Wave has invested in Scrambls, because we think the third category is communications. And the really cool thing with communications is if I put a TPM in a phone, and I give it a key so I don’t have to have a password again, and you and I wish to exchange secure information, a file, a tweet, a post on Facebook, it only takes two of us to tango. And if the two of us want to have a secure communication over social media, leverage Dropbox to send each other a file, then the two of us together can provision this infrastructure, turn it on, and have no more passwords for what we do. And it only takes two of us to communicate.

And we think that communications is a much more viral adoption of the security and identity capability than payment or access control for things like banking or healthcare, etc. If you key all the devices with the purposes of communication, now I have tens of millions of people who are keyed and you call a bank, and you say, “Hey, I’d like all my keyed customers to have an account at your bank,” that’s a much different conversation, because the technology is enabled, empowered, and in use.

And so that’s the current tactical strategy. Scrambls is an enormously important component of this. And all of a sudden, there’s this really weird thing which is Windows devices have gone mobile. You can buy a Windows-powered tablet. And so we’ve blurred the lines, where you have laptops, which are sort of mobile. People can’t decide whether they’re mobile or not. And then you have tablets. Those are definitely mobile. And this bridges into phones, which Microsoft’s phone also has a TPM in it. And so now you have a common hardware architecture across all those devices.

And so what we need to see are adoption by players like ARM, Samsung, others, to move this into the rest of the ecosystem, so we have one common technology across all the devices. And Wave’s job is two things. We key the device, we run the servers to do that, and we want to run the cloud management service to manage the groups of devices. And you’re seeing the beginnings of that come together. You can certainly go play with it today, without the hardware required on Scrambls, where we’re doing groups of people instead of groups of devices. But it works the same way.

And so I think we have an effective strategy to go after this. This is going to be one of the largest markets in tech ever formed. Because this is how you establish the foundation for the new economic model on the internet. So it’s not an ad-supported model only. It also supports premium access, either to content or to services, or to sites, etc., based on having the right relationship, and not having to give users passwords that they can propagate, like Netflix. Netflix has a huge security problem, because everybody is sharing their Netflix password with everybody else. DirecTV, on the other hand, has no security problem, because their box secures the video.

And this is moving toward that model, where everybody can have their own box. Everybody. Three kids in a garage producing content and services, or two people having communications, or the largest media companies in the world. And we think this really provides a tremendous foundation, but it’s been an enormous heavy lift.

And the enterprise business should have grown stronger in the course of the last nine months, but the market opportunity for Wave has actually grown tremendously over the course of this year. You just can’t measure it today, because the only measurement that we all should really pay attention to is revenue, and the revenue’s been really tough in 2012. But the overall market condition has grown tremendously.

So Wave has a strong presence in mobile. I think we have a strong execution plan. We have a strong vision for how it should execute, and I think we’re very unique in the marketplace on this. So I know that’s a long-winded answer to the question, but I think it really puts in frame what we’re trying to do, or at least hopefully it does.

Operator

Our next question is from the line of Ron [McDermond] with Davis Enterprises. Please go ahead.

Ron [McDermond] - Davis Enterprises

Question in regard to the two WEM pilots we had running, one within the government and one with an aerospace company. Can you give us any update on that? I’ve heard a little bit about the government pilot, but I don’t think I’ve heard anything about the aerospace company.

Steven Sprague

In both of them we’re working to move them to the next stage, which is actual enterprise deployment. I would say they’re probably first quarter timeframe as opposed to fourth quarter timeframe. And one is definitely ahead of the other one. So the government side is actually moving more quickly.

And part of that is also trying to figure out what the broader enterprise look and buy looks like. All these things link together. The same server infrastructure that we deploy for BIOS integrity would give you secure global wireless. And so it provides a very strong capability in the market.

So we have a number of others who have started BIOS integrity projects. We’ve had some interesting outreach into the Middle East who, of course, lost a huge chunk of their machines in the oil industry out there, to a BIOS attack. So the technology worked out very well. It performed as expected. The pilots were successful. We got very good reviews from the customer. So now it’s the next stage, to go close the enterprise business on it.

Operator

And the last question is from the line of Kevin Casey with Casey Capital. Please go ahead.

Kevin Casey

I just want to go back to some of the number questions. Have you guys mentioned a potential revenue quarterly for Samsung?

Steven Sprague

No, we haven’t. The challenge with an OEM today is we’ve learned to believe their volumes once they start shipping them, because they tell us all sorts of stuff, and then it’s interesting to see what they actually ship it on. So we’re quite hesitant to articulate volumes until they’re actually in place and have shipped for a couple of weeks.

Kevin Casey

And then I’m looking at the $4 million negative EBITDA, trying to close that gap, and it seems like there’s a couple of OEM customers that can ramp up. And then I’m trying to figure out how much more we need to sell on the enterprise to shrink that gap.

Steven Sprague

So from a revenue projection perspective, we’re actually getting pretty close. Both bringing the expenses down has made the gap much closer and we see the revenue growth that’s there. So we’re making good progress in Q4 toward getting it all the way down to zero. I hope to get it all the way there.

And like I said, we certainly have pipeline that gets it there. It’s interesting to note that the OEM business we think is changing because of change with AuthenTec with the biometric sensors, and that may actually result in greater revenue projections for us in OEM in 2013 than we had two months ago.

And so we’re enthusiastic about that, but it’s early on in the process, but also they can’t take forever to make a decision, because the tools will not be available to them after sometime in the middle of springtime, because the software is no longer available from the previous supplier.

So we think there’s an interesting opportunity there that could help bridge the gap. So I think from my view, there are a number of different projects that are underway that help dramatically address the gap and drive us, ultimately, to a profitable company. This is the goal. This can’t continue on at this scale of pace. The market space we’re pursuing is much, much too large for it not to have a more substantial engagement.

And we just can’t have 100,000-seat customers that are going, “Wow, this is the coolest. This is the most important thing we should do,” and then you’re like, “Okay, great. Where’s your order?” And, “Oh, we’ve got to think about how we’re actually doing it, because this is really important. This is going to affect our whole business. We have to have a plan.” And it’s like, “Okay.”

So I think as it begins to unlock in a larger scale, then it will drive more solidly in the revenue development on its side. So it will grow in OEM, but OEM has a moment in time space for growth, but OEM is not the place to look for growth. The growth will come from a combination of cloud services models of Wave Cloud and Scrambls, and come from the enterprise growth over the course of the next 12 months. And there will be clearly enterprise growth over the next 12 months.

I think if that’s our last question, I’ll just wrap up and say that I know this has been a long and frustrating road. It’s been a long and frustrating road for lots of folks involved with Wave. I will say that at the end of the day, the trusted computing market is really growing in scale. We have the right tools. We have the right technology. We’re in the right position in the marketplace. I think we have the right team addressing it. We’re trying to make the correct changes to be as efficient as possible.

And also, these challenging times are forcing us to really think through how we best package our strategy and our technology and our execution of that. And so today you have a team that has a lot of experience, that’s really mentally working hard, to make sure that we have the right package solution in the marketplace.

And hopefully, the result of that is you’ll get a much stronger execution as the market engages than otherwise. Some people can have an easy market, and then it’s hard to think through where you should be. I think we are doing a good job right now of strategically understanding where we’re supposed to be. That doesn’t replace revenue, but I think it does increase value in the organization as we package that plan, the partners to execute it, and our execution in the marketplace.

So I thank you for your support, and your interest, and thanks for hanging with us on a Friday evening. And as I said before, we’ll try and make sure it’s done as a midweek call in the future. Again, thank you very much and have a good night.

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