Wave Systems Q2 2007 Earnings Call Transcript

| About: Wave Systems (WAVX)
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Wave Systems Corp. (NASDAQ:WAVX) Q2 2007 Earnings Call August 8, 2007 4:30 PM ET



Steven Sprague - President, CEO

Gerry Feeney – CFO


Rob Goldman - Dutton Associates

Timothy Collins - Security Research Associates

Robert Taylor - Private Investor


Welcome to the Wave Systems' second quarter 2007 results conference call. (Operator Instructions) I'd now like to turn the conference over to Gerry Feeney, Chief Financial Officer. Please go ahead, sir.

Gerry Feeney

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 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 four o'clock this afternoon, we released our financial results for the second quarter. 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 quarter ended June 30, 2007, Wave's net revenue rose 155% to $1.41 million compared to the second quarter of 2006 net revenues of $910,000. During the quarter, licensing revenues more than doubled, primarily due to the increased shipments of Wave software by our leading OEM partner. Services revenues were lower in comparison to last year's recognition of a large, one-time $300,000 government services contract which was recognized over the first and second quarters of 2006.

Gross profit rose to $1.228 million or 87% of net revenues in the current quarter versus gross profit of $555,000 or 61% of net revenues in the second quarter of 2006. The increase in gross profit is a function of the increase in higher-margin licensing revenues.

The net loss for the quarter was $4.841 million or $0.11 per share, compared to a net loss of $4.539 million or $0.13 per share for the second quarter of 2006. The weighted average number of basic shares outstanding in the second quarters of 2007 and 2006 were 44.931 million shares and 35.416 million shares, respectively. At the end of the second quarter of 2007, Wave had cash and equivalents of $12.5 million with no long-term debt.

With that, Steven will now highlight some of the key developments for the period.


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Steven Sprague

Thank you, Gerry and thank you, everybody for joining our call today. I'd like to start by telling you to just describe the four major areas I'm going to talk about today. The first is we've begun shipping Seagate drives and our software with Dell, and we're very pleased to see that enter the market a couple of weeks ago. I want to talk some more about our demonstrations with Microsoft and Juniper around the Network Access Control solutions. We will spend a little bit of time talking about the broader support for our software within the enterprise deployments at Dell, and finish up with some further comments around where we are on the government side.

So having said that and just giving you a little framework for the conversation today, let me start by talking about the availability now of the Full Disc Encrypting hard drives. This is something that we've been working towards really for the last three years, much more strongly of course over the course of the last year. We're very pleased that Dell has chosen to offer the Seagate drives and our software. This really shows the progress from the announcement in our 8-K back in November that we had signed a licensing agreement with Dell for our software for the Trusted Drive Manager. We believe this is really going to provide a very strong differentiator for a data at rest solution; data at rest being that, if you happen to lose a laptop or whether it's lost or stolen, you really don't have to worry that the data on that laptop can be compromised. So we offer a really excellent solution, both something that's very easy to manage and has very strong performance, and really has fantastic auditing capabilities. It's that auditing component I think that will ultimately be very important for Wave.

We provide a centralized server that administers these drives. It's called our Embassy Remote Administration Server. It happens to be the same server that we built to support the management of trusted platform modules. But one of the key aspects of this is that when an ERAS server is put in administrative control of a remote drive, it's impossible for a local administrator to turn off the encrypting capability of the drive without going through the server. As a result, we have a very strong centralized audit log that a machine has a drive in it, the drive is either in encryption mode or not in encryption mode. But it really helps any organization that buys this solution in proving that they are in compliance with the current 29 different state regulations around data protection and a number of the international regulations as well.

I will make an attempt to give you a little bit of an update on where we are. I put the caveat to this that this represents about now a week's worth of data. We believe that over 1,000 machines have actually been ordered with Seagate drives and we see very strong interest from the customer so I think a lot of these orders represents initial sample quantities where they can actually put their hands on the first production machines. We have also received orders for ERAS server, so we are excited to see that in the very early stage of this, our customers understand that they need to buy both the server and the client-side product.

What's helped us to achieve this is that, over the course of the last quarter, we've been providing valuation kits which had been prereleased drives, typically running on a Dell Latitude 620 platform. We provided basically two Latitudes, one as a client machine with a drive in it that we built, and one with our server software fully functioning on the machine as well. This pair of machines we provide on a 30-day trial basis so that a customer can fully evaluate the solution, both client-side functionality, how do I turn it on; how do I turn it off? What happens if I delete the drive, and full remote administrative control from the server. We've gotten very positive feedback on these evaluation kits. We've shipped just under a couple of dozen customers have had an evaluation. Many of them have had the evaluation, evaluated the product and sent the kit back to us so that we can send it back out to others, because we see recycling these machines through multiple customers. We've had a great conversion ratio.

Now that the product is available to buy, we've seen customers that either purchase some initial volume of units or have told us that they intend to purchase an initial volume of units. They have been about 80% of the customers who actually tried the evaluation kits. So we're very pleased to see that. You know, I'd love to see that number continue. Obviously, I think that as we see more use of this product in the field, different people have different requirements, but it is a very strong offering in the data security area.

Obviously, one of the challenges in this solution is that anyone who wants to take advantage of the new hardware-based Full Disc Encryption has to go buy a new machine or have to go buy drives and retrofit those drives into existing machines. We've been consistently surprised at the number of customers who have asked us where they could buy drives so that they could retrofit existing machines. It continues to surprise us, the number of customers who ask for that.

Part of the reason is that this solution will offer the enterprise a much higher performance over the life span of the machine. It's not only the performance day-to-day of my machine actually operating, but for example, if you turn on the encryption in a Seagate Momentous 5400 RPM drive, then it's instantly encrypting all of the data because in essence, think of it as almost installing the lock. So the drive is always encrypting; you are just telling it if you have a key or not. A good example would be like a hotel room safe. You come into the hotel room; it's got a safe; but until you put a code in, it's really not locked. This functions in a very similar conceptual manner to that.

So as a result, it takes fractions of seconds for the drive to go from an encrypting mode to a non-encrypting mode. So all the software-based full disc encrypting solutions require that you spend the better part of an hour or two encrypting the entire drive so that the drive is encrypted, and then it takes the same amount of time to decrypt the entire drive if you want to remove the encryption. So, I think we're very pleased with the early response by the market. Certainly, we're in the thick of it right now in seeing the first levels of support. The marketing is really just beginning to broaden the awareness of these capabilities across the entire organization. We certainly look forward to working with Dell, their sales force, their support teams around the world, to communicate the tremendous capability this drive brings to their products.

So let me switch topics a little bit and talk about the demonstration we did back in May. I think this will be another very significant sector in the market for Wave in relationship to network access control. In May, at the Interop show, we demonstrated the role of the Trusted platform module in connection with both Microsoft and Juniper's network access control strategies. What this in essence does is there are really two key roles for the Trusted platform module in any network access control solution. One is for the TPM to provide the role of strong machine identity. This would be true not only for Microsoft and Juniper but also for Cisco solutions, where the TPM can store a unique key and before any machine is connected to the network, the network switch will verify that key is present and it's an authorized key before that machine is connected. This is how ultimately you can make the statement that only XYZ Corp.'s machines are on XYZ Corp.'s network, and really can provide a tremendous deterrent to someone stealing user IDs and passwords or other access credentials, gaining access to a corporation.

The second is to use the Trusted platform module to sign and what the industry calls measure the health certificates of the network access control solution. So in the case of a machine connecting to the network, what the Trusted platform module does is it collects any measurement data that's done before the machine connects; it signs it, and it prepares what looks like a health report and submits that health report with a request for connection. If the health report is satisfactory, then the network switch will provide an IP address and the machine will be connected. So this is a great way to ensure that every corporate PC is in compliance with corporate IT policies around anti-virus, certain applications, certain types of software needs, either needing to be or not be installed on specific platforms.

The reason this is important for Wave is that we see these technologies packaged in Windows 2008 server. As the Windows 2008 server rolls out across the market over the course of the next few years, this will be one of the huge driving reasons to turn all enterprise TPMs on. So if you look out a number of years, this is one of the applications that will drive the multiple hundreds of millions of endpoints on the network to end up with their Trusted platform modules turned on. By no means the only application, but demonstrating the capabilities, having Wave's products as part of the solutions being offered, we're in a very unique position today to have built our Embassy Endpoint Enforcer software in a position where we are demonstrating with the market-leading NAC solutions how the TPM properly integrates according to the Trusted Computing Group standards.

So I think it's a place where we will continue to make strong investment. I don't think we will see first revenue generated from the network access control area for a couple of more quarters, but I think in understanding the traction of this technology in the market, it's important to see the core large application vendors building the tools to support the adoption of TPM not in a narrow slice, but across the board.

To that extent, I think another major event that happened in this quarter is that all of the new 2008 PCs that are being shipped by Dell now have an updated version of our Embassy Trust Suite version 2.0. We've included both enhancements to our base features and really an improvement in the quality of the software across the board in both the experience of how easy it is to set up and use, the capabilities as to how it integrates with existing network technologies that are out there, and the use of the technology for strong authentication.

One of the key aspects of course is its ability to support Microsoft's new Vista operating system, which was critical for us. This represented a very large investment for Wave over the course of the last 12 months in building support for this next generation of software shipped. It provides a key pillar in holding up our long-term relationship with Dell, ensuring that we can continue to be their software provider of choice.

So, we're pleased to see that they continue to select our software and move it forward across new products. I think that part of this that's very important for investors to understand is that accompanying this is a new generation of marketing campaign to the sales force, the application engineers, ultimately the customers where last year, Trusted platform modules were very lightly mentioned within the overall context of the security offerings. I think we've seen a real expansion of that through and across Dell in the launch of the new 2008 platform. So we're very pleased to have helped provide that differentiation and support the efforts to offer one of the most secure platforms in the market today.

I think we're seeing the results of that. Well over a third of our new customer contacts are interested in the application of the Trusted platform module for strong authentication in the enterprise, and so we're very pleased to see that. There are a number of organizations who would like to deploy both Trusted platform modules and the Seagate Full Disc Encrypting drive. It's a great combination of technologies. Obviously, there are some savings for them in choosing both technologies because you only need one server to manage both technologies.

In addition, we've found that there's a nice leverage in the sale, where some customers who have gone down the path to purchase an Embassy Remote Administration server for the purposes of managing a Trusted drive then also discover that not only can it manage their 50 new Full Disk Encrypting drives, but those 2,000 or 3,000 laptops and desktops they've bought over the last year that have a Trusted platform module. They now have an easier path to turning it on. So I think we will have good cross-selling across these two product lines that we're offering into the marketplace.

So we're very encouraged by it. I think there's really good energy within the sales force today. We're seeing very strong adoption of the technology and a real growth in the enterprise business.

Let me talk a little bit about the progress on the government side. There have been a couple of very recent developments, the most important of which has been a memorandum that came out of the Office of Secretary of Defense on July 3 that's been pretty broadly publicized, most can find it on the Web today, that articulates their need for data at rest solutions. It actually requires that all non-public information on laptops must be encrypted, and really outlines how that encryption is going to be bought. Part of the data at rest Tiger team was there to select the different software solutions.

As I mentioned at our annual meeting, we are not listed right now on the data at rest Tiger team, what they call blanket purchase agreement or really their list of technologies, primarily because the Seagate drive is a hardware device, not a software device, and it doesn't currently address all of the FIPS requirements or the secure classification requirements for that product. Seagate and the government have had, I think, very good conversations, and I think we are clear on a path as to how that product can be broadly made available across all government channels. I think we will see progress in that over the course of the next few months.

But Wave software, which is a management software for the Seagate drive, also doesn't necessarily belong on the blanket purchase agreement infrastructure because we are really a management tool, not an encryption tool. So, we believe the right way that this technology will be purchased broadly across the government is actually through the contracts that are already in existence for buying laptops and desktop machines and selecting a drive as an option. We're working very closely with the channels that we have into the government to ensure that those products, both Seagate's drive and our product, are available as an option for the customer to purchase across those commodity purchase agreements.

I thought it would be interesting just for everyone, I will read for you Subsection 4, which in that memo talks about Trusted platform modules. So this is actually a quote from that memo, Subsection 4.

“In anticipation of emerging encryption product capabilities, as well as requirements for device authentication, DoD components shall ensure all new computer assets -- servers, desktops, laptops and PDAs -- procured to support the DoD enterprise include a Trusted platform module version 1.2 or higher where such technology is available. Written justification must be provided to the responsible designated approving authority if assets are procured without TPM technology in cases where it is available.”

So it's a pretty clear statement that now the requirement that used to be at only the Army and Air Force level that all-new machines be purchased with Trusted platform modules, now there is a DoD-wide requirement or Defense Department-wide requirement that all new computer assets require a Trusted platform module. So we think this continues to further help our case.

How do we get TPMs everywhere? That was the first step. The second step is now to get the enterprise to turn on all those Trusted platform modules and join them to the Defense Department's active directory infrastructure. We've made really good progress on that front. We actually have a couple of very strong technical memorandums that have been generated internally that are providing some guidance. It is still unclear exactly when purchasing events will happen. I think there continue to be possibilities for stuff in the short-term, but in reality, I think is still a government project. The goal for us is very simple, which is to have an enterprise-wide license for the Wave products for the Defense Department so that they can take advantage of our servers and client software to fully utilize the capabilities of the Trusted platform modules that they buy. I think we're in a strong position; we're making good progress on that front. I'm not so sure I would hang my hat on revenue from it tomorrow morning. I think it's going to take a little bit of time still, but this is really good, solid progress from last quarter to this quarter and we hope to continue to advance that to next quarter.

I will make just a little caveat note here. One of the orders that we've received for both Trusted Drive Management software and the Embassy Remote Administration Server actually comes from one of the government agencies. It's actually on the federal side instead of the Defense Department side, but we're making progress on that side as well.

So, let me put a couple of notes in here on both WaveXpress and our eSign progress. WaveXpress has now launched its Vista capability. We've actually seen really nice growth of the subscribers under that. We're actually having to go upgrade some of our server capacity to support the growth of subscribers. We also are seeing some nice interest from some of the large content brands. We continue to work toward broadening the partnerships to support that program and finding some partners who will help us to carry both the marketing efforts and promotion of this more broadly into the market without it costing Wave too much.

The other piece is eSign. They continue to grow their revenue contribution. We've closed our Ellie Mae relationship. It is interesting noted on that front that was a very competitive bidding process for a digital signature solution and the Wave solution came out on top. We're very pleased to see that and we're very pleased to support their electronic signature business.

We also signed a revenue-sharing deal with Real-Time Solutions Group. They are integrating our eSign solution into their existing straight through, what they call straight-through processing engine. We are actually just in the process of deploying our first customer, who is a major insurance company. As that solution actually goes live, we will be able to talk about who the customer is. But again, nice, solid progress on the electronic signature side. Again, the reason eSign is important to us is that it brings us very strong identity services and signing services. Clearly, those will continue to expand as the number of people who get digital certificates and digital identities grows.

It was interesting to note. I believe it was announced today that Verizon bought Cybertrust. I think that's just showing that this is a space where the growth of how you hand out certificates and identities to customers is well appreciated to be an interesting area going forward. Trusted platform modules ultimately become the containers for all those identities. So what we do is we provide the software that provides that platform so that a Cybertrust identity, now what might be a Verizon identity, could be held and controlled securely in any one of our PCs. With the broad-based deployment that's underway, we continue to ship millions of copies of client software every quarter. We've shipped well in excess of 4 million copies in the last quarter of software bundled with our OEM partners. So we're putting our brand out there on a very broad basis. We think as the market begins to discover the use of these Trusted technologies, things like the Seagate drive, strong authentication with the tools that we ship with the Dell machines, eventually the use of the Network Access Control solutions, that they will turn on all of their Trusted platform modules.

So in many cases we see this as a winding up of the spring. Every day, we ship new units; we put more brand out into the market; we continue to invest in building the leading-edge technologies that support this Trusted platform module. I will not belittle the fact that the frustration is still there, that the market's awareness of this capability and what it could do to improve the overall cyber security for all of us is still not well enough understood. So we make efforts every day, both as Wave in our role in the marketing chair of the Trusted Computing Group and continue to broaden the education of the market on what can you do with a Trusted platform module? What's its benefit for you going forward? Why is it a cost-effective and easy-to-deploy security solution and really every corporation today should have a plan or strategy as to how not only to buy Trusted platform modules but how ultimately to turn them on.

So I think, with that background, we will see greater contribution of the enterprise business in the third quarter. I think we're very pleased with the fact that a new product has become available, and we can see the orders for it; we can see the enterprise software order for it right out of the box. I don't think there are one-off examples. I think there seems to be a pretty good queue of folks behind it. I would say the marketing energy is just at the beginning of the ramp in making folks aware that they can now buy the product, that it's easily available, easy to deploy, easy to turn on, and really offers the best-in-class solution for protecting your data on your machine.

So, with that, I will stop here. I think we're very pleased with our progress. I look forward to answering your questions. I promised everybody I would try and be shorter on my answers, so if everybody would please accommodate and let's try not to have too many questions in a row from the same person, I would appreciate that. With that, let's open it to questions and answers, please.

Question-and-Answer Session


Your first question comes from Rob Goldman - Dutton Associates.

Rob Goldman - Dutton Associates

I will just ask two questions right off the bat to make things go a little faster. I was wondering if you could perhaps give us a little bit more clarity on the pipeline in the enterprise market, perhaps number of seats or what you might perhaps call a hit list? I know that you had some nice progress on the evaluation kit side with respect to the Seagate relationship that you were mentioned earlier.

Also, just in the broader sense, would you say that you're better positioned now than you had been before to start to win some meaningful enterprise business now that these evaluation kits have been so widely accepted?

Steven Sprague

So, on the pipeline side, I'm a little hesitant because I think I've been a little bit burned in the past. The list of customers is a great Who's Who. The challenge is all of them have thousands of seats. If a company adopts this company-wide, then the ability to deploy 20,000, 30,000, 40,000 seats from a single enterprise even within the next year's timeframe is very practical. There are 30 to 40 of those kinds of enterprises that are actively engaged with us either sampling technology, getting quotes, et cetera.

Having said that, I think that what's helping our confidence level is that we have been able to provide an example system to them in the form of an evaluation kit. They've been able to evaluate it. In many of these cases, this is not a production product, right? We sent them an evaluation kit of something that Wave built. This is not where you went to Dell and bought a product and saw how it worked. So even in that backdrop, we've seen really positive enthusiasm for the capability that's been demonstrated.

I think we have a pretty solid sales process down now that hopefully is a much shorter cycle than it has been in the past. The past cycle has been months and months and months, because I think the Trusted platform module is a much bigger enterprise security decision as far as the overall framework and architecture for security in the enterprise, where the purchasing of a full disc encrypting drive solution is easier to get your arms around and your head around kind of in-the-box solution. Check mark the box, it comes with it, and I turn it on and life is pretty good.

I think there is still a little bit of an enterprise component and they need to deploy a server. They don't have to deploy it Day One in order to get an effective solution, but clearly to get ultimately a solution that will meet all of their requirements, they are going to need to deploy a server.

So, a little bit long-winded answer to your question but I think that that's what's giving us confidence that we will see much stronger engagement in the enterprise business over the course of the next even just a few weeks, as well as into the next quarter.

Rob Goldman - Dutton Associates

With respect to the demonstration with Juniper and Microsoft and with testing the network access market, there isn't going to be anything tangible from the revenue side, obviously, coming from this right around the corner; but what should we expect in terms of just perhaps product development or future demonstrations, say, for the rest of the year?

Steven Sprague

Well, I think we certainly hope to show folks how you can approach this on a two-step basis. One is just machine identity, which is actually something that most corporations could begin thinking about deploying today in anticipation of managing the health certificates on their machines, which is a much more complex policy conversation for any IT organization. So, certainly our efforts are in the path of educating folks that every enterprise should begin to think about the machine, the endpoint PC, as part of their overall security solution, not just the security problem, which is what it has been up until today. So I think you'll see more of that from us, just from the perspective of trade shows and events and other aspects.

Ultimately, we believe that network access control, or network access protection as Microsoft calls it, will be a big piece of the security portion of Microsoft's 2008 server campaign. So certainly we expect the awareness of that to continue to grow in the market.


Your next question comes from Timothy Collins - Security Research Associates.

Timothy Collins - Security Research Associates

Steven, congratulations to you and your team for winning the security for the Seagate drive. That's quite an expansion of product for you. I had two questions. One is that question I'm about to ask and then the other one is a P&L question. But in regard to Seagate, how is this going to provide synergy for the big picture? Obviously, it's going to help in revenue, but how will that drive adaptation of your whole enterprise upgrade cycle?

Steven Sprague

I think I tried to mention in my main body conversation, there really are two things. One is we've intentionally used the same server product to manage both TPMs and full disc encrypting drives, so our hope is that an enterprise that deploys our server to manage their drives will discover that, so maybe they go out and buy 100 new machines, but they might already have 1,000 machines that have TPMs. Now, from Wave's perspective, we sell a per-seat license, so we would get paid on the 100 machines for the Seagate drives, but the other 1,000 machines that are out there that have Trusted platform modules on them, if they want to use the remote administration server to manage those TPMs, they will have to pay us a per-seat license for that server to reach out and manage them. Obviously, if they want to do both on the same machine, they only pay one license fee.

So we think that bringing that capability in, if a corporation already has the server installed, the product is working, the administrators know how to turn it on and turn it off, all of the understanding of the product is there, and then they want to expand its use to a broader application, writing a check is certainly the easiest IT integration you can do if the product is already deployed and integrated. So, we think that will give us a really positive contribution into the broader picture, and that's where the synergy between these two products are in the short term.

Longer-term, there is great synergy between how the Trusted platform module and the drive interact together. Let me use an example. At Interop, we demonstrated that the Juniper server could detect and measure the presence of a Seagate drive, verify that it was properly installed and connected before that laptop would be allowed to connect to the data server that had a billion Social Security numbers on it. So that way, a corporation could ensure that the private information was only ever given to laptops that had an adequate security solution to protect them. So that's what was demonstrated; that's clearly where all the parts come together. It will take a little while before most corporations are ready to handle that from the deployment perspective.

Timothy Collins - Security Research Associates

On the P&L, I noticed that your SG&A and your R&D is up about 20% for the year, and that increase in expenditures, you weren't able to really meet it with increased revenue but your loss is up less than 10% on a quarter-to-quarter basis. With the additional 20% expenditures in R&D and SG&A, what are you getting for that? What kind of trend do you have there? Where do you think you're going with all of that?

Steven Sprague

The Trusted computing market is in its very early stages, and we see a number of opportunities that are extremely synergistic with where we are headed. If you were to look historically, think of it as investing in the Seagate business two years ago, it was clear that was eventually going to move through towards product and we wanted to be one of the leading providers.

We see expansion of just our core business from the perspective of TPMs, building support for more than one OEM, et cetera and continuing to support Seagate and Dell. The more entrenched we become within their existing products, the broader the requirements come back to us to enhance the product. So we like that because that's sort of deepening the roots of our core business into the soil and making it harder to displace us.

In addition, we see new lines of business around the Trusted computing space that are easy and inexpensive to invest in today that we think are huge potential contributors to the overall revenue going forward. They are in the areas of key management and subscriber management and different services that we've clearly articulated over the years as the third phase of our business plan, which is how do we move from an enterprise business, which we're not yet but clearly where our focus is today, to more of a services revenue generation business where you are collecting transactional revenues.

So I would say the vast majority of our new expectations are at least focused in the direction of where we think some of the services-based businesses around Trusted Computing are. So we are very focused on building on the future. I would say we have an equal weight to that as is weighed against how do I make my enterprise software business get bigger tomorrow?

There's a certain amount where our investment in growing the enterprise business makes sense, and there's also a certain point where we have to be a little bit patient and wait for the market awareness to grow broad enough that we're not just spinning our wheels trying to convince customers who don't know what a TPM is yet. We're getting way more help over the course of the last few months from big partners like Seagate, like Microsoft, like Juniper and Dell, certainly, in educating the customer. So it's not all carried on our nickel.

Timothy Collins - Security Research Associates

Is the headcount still around 100? Do you see that rising?

Steven Sprague

The headcount has been pretty consistent. It has probably risen a little bit from a year ago, not much. Certainly, we will see the headcount grow if the revenues dictate it. You know, there is no question there are things that we would do more aggressively if we can see the enterprise business more broadly engaging. If we do a couple of million dollars in enterprise business, you will see the headcount grow.

I think part of that is also just even on the salesforce side. If you look at the sales guys today, they are at or reaching capacity to manage the accounts they have in-hand today, and so that's something we are very focused on now. But we also need to know that they can convert; so it's not just talking to people but it's actually generating sales. Again, I think that we are seeing the traction for that. We are actually seeing orders coming in the door, which is great. As that overflow continues to grow, then it will give us more backbone on adding to the salesforce and feeling comfortable that a salesperson added is a net contributor to margin as opposed to somebody who is a drain on cash.


Your next question comes from Robert Taylor - Private Investor.

Robert Taylor - Private Investor

Actually, I stepped away for a couple of minutes, so hopefully this question wasn't already asked. The Seagate outlook is very encouraging but I wanted to revisit TPMs upgrades. About six to eight months, ago you identified in the neighborhood of 400,000 high-probability upgrade units which are still not upgraded, yet it seems that all of the hurdles have been covered. Key prospects who you've been speaking with have been educated about the TPMs; you've allowed a number of companies across industries to in effect test drive the product, to be assured that it works as promised. The number of TPMs in the market, there's no longer an issue with 50 million already out there and 100 million on the way in the next 12 months.

Then finally, you stated that a main reason if not the main reason for the $15 million stock offering in May was to ensure upgrade prospects were sitting on the fence, that Wave is financially viable and here to stay. Yet with all of that, and correct me if I'm wrong, maybe 1% of those 400,000 high-probability upgrades have actually converted, even though Internet security concerns are all over the news.

So my question is this: can you disclose what the problem seems to be why no major prospects have stepped up to the plate? In general, what's the feedback you are getting from prospects why they are not moving forward?

Steven Sprague

I will be as straightforward as I can on this. First off, let me say it's very frustrating, and I agree with the frustration and it's certainly a frustration I carry to the market on a daily basis. You know, here's a technology that's free, that everyone can leverage, that can really provide an advantage for their corporation, so what the heck are you doing? What our experience and feedback from the customer has been is there's no question there is continued education within the customer base of what is the capability of this? How do I turn it on? What does it do? I think we continue to run into the fact that the documentation that exists in a lot of the networking equipment, which is how TPMs would talk to the enterprise, is pretty poor. We've had to supplement documentation for a variety of network suppliers on how does a TPM actually work and get turned on and plug into a Cisco router or a Juniper Unified Access controller, or pick the product of choice.

So one is a technology hurdles is an education of all the different components so that they work together. The third and perhaps the hardest one is one of policy. The policy one is that they really haven't thought through the problem of what does it mean to have the PC as part of the security apparatus of the enterprise? That's where the most time has been spent, in saying so, how do I enroll it? Who should enroll it?

You know, today, in a lot of companies, you can walk in with a laptop. If you have your user ID and password, man, you can go to Wal-Mart, buy a computer and bring it to work, and plug it in and it works. Obviously, there are issues with that because that machine might have a gazillion different viruses on it. It's not an enterprise-managed machine, and yet it might still connect to the network. Now, lots of IT guys will say no, no, no; that would never happen on our network, but it's still works in a lot of PCs.

So we've found a very interesting dialogue around what are the policies that we should have to actually improve the security of the laptop and then use it as part of the authentication into the enterprise. We don't have prospects that are telling us we've looked at this; we've decided it is uninteresting, and stopped talking to us. It has just been a very long sales cycle.

Wave is a little opportunistic on this front from the perspective of, over the course of certainly last quarter, we've been very focused on the education around the Seagate drive because we've seen a much higher speed turn on the company saying yes, okay, I get this; tell me when it's available. I would like to order it. Why isn't it available yet? When is it going to be available? So we are very pleased to see the product finally being listed and something that the customer could buy. That was certainly a challenge for the month of June and the beginning of July.

So I think we are seeing a much broader engagement on both sides. There's no question that the existing enterprise clients we've had, and we're seeing new ones who are coming and saying, we would like to turn on our TPMs. We are seeing well more than a third of our new, it's 40% plus of our new contacts coming in. You know, people who call us up out of the blue want to figure out how to use their TPM, turn it on for strong authentication in the enterprise. It has been absolutely amazing to me that it has taken as long as it has to gain conversion in enough volume. I would say we're still not there on the TPM side. I don't think it's a product issue, a software issue. I think it is a new technology and it is not well understood.

Robert Taylor - Private Investor

Over the past ten years, there have been a number of blockbuster applications or partnerships that have been announced that have not resulted in any revenue to speak of for Wave. Will the Seagate relationship finally change the long drought for Wave? More specifically, based on you said it's out there, ready, you've had a week or two worth of data. Will the third quarter show a significant uptick in revenues for Wave based on what you're seeing? By significant, I'm talking like in the neighborhood of maybe a doubling or more of today's $1.4 million levels? Because it's been a long drought and things seem to be going good. Can you commit to saying we will see a significant uptick in the third quarter?

Steven Sprague

Like I said, I've tried to communicate with you about as much of the gory detail of actual factual data I have. I certainly have a nice list of customers who say they want to buy a FTE; let's see if we can go convert them.

It was great to see that as soon as the product was available, real orders flowed in the door. Realistically, I'm functioning with a couple of days' worth of data. So in some ways, the call is very opportune on the time that it is post the availability of the product, but it's also so close to it that it's hard to say, gee, have we just saturated the first instance of demand? Is there growth in demand afterwards? There has been minimal marketing. Frankly, most of the planet is not really aware unless you've gone to the Dell website and tried to buy a product; you can see it listed there.

So yes, I think we have good expectations that the enterprise business will start to have a significant contribution to Wave's revenues, which it hasn't to date. I mean, the contribution has been minimal. It's not that we haven't sold any product; it's just that the total dollar amounts haven't added up to anything.

I think that, you know, examples like the evaluation kits, if I can put one in somebody's hands, I have a very high probability of converting that customer to an actual customer who will buy everything going forward with a Trusted drive. So we're very enthusiastic about that. It will be interesting to see how many people just show up and order the product; order two or three, test it, see how it goes and then order everything that way.

We know that a number of large prospects have just been bid with Trusted drives as part of the solution that's being offered by our OEM partner, so we like that as well.

I guess I want to disagree a little bit with your initial statement, that there have been a lot of partnerships that haven't generated any revenue. I think Dell is certainly generating a little bit of revenue, and our Intel relationship is generating a little bit of revenue, and we've got four out of the five silicon vendors. We have a relationship with Microsoft that is helping us, both on the consumer side with what we're doing with WaveXpress and --

Robert Taylor - Private Investor

Some are breakeven when you say revenues.

Steven Sprague

Yes, and I appreciate that. I've been having this conversation for the past, now, number of months. This is truly the definition of an emerging market. I think we can all agree that Trusted computing is going to happen, and it's going to happen in a really big way. All of the historical context points to that. I think it's important to understand my philosophy, and I've tried, and I've reiterated this in the last couple of calls. My philosophy has been make sure that Wave has covered as many of the available targets as broadly as possible so that, as this thing launches, we are there.

You do that by really spreading your bets pretty broadly across the table, making sure you have the right partnerships, that your brand is as broadly deployed as possible, because once it starts to run, there's nothing we could do to catch up to it. I think there are a lot of signals in the market that the traction is getting stronger, that people are adopting that services-oriented architectures and services and software are the direction the industry is going. Trusted platform modules is a subscriber-management technology. There's just no question that it is the component that provides that.

So, I feel a little bit like in the early days of USB, I'm telling people that plug-and-play peripherals and multiple peripherals daisy-chained together is going to be really cool, it's going to be really big, it is going to change the world and how we work. You're going you know, I've got a parallel port. I plug it in it and my printer works great. What the heck do I need a USB port for? Right?

The conversation is no different. It's the same as the conversation around Ethernet or multimedia. TPM has the potential to have that scale. It has the deployment model; it has the go-to-market that's the same as those. Historically, the foundation of this deployment is tremendous. What Wave is trying to do is to leverage off those historic examples and say I know with certainty. I had this conversation with an analyst the other day. Put a dollar bet on the day that Microsoft and Intel made each of the technology standard and see how much you made in return: USB, Ethernet, multimedia, CD-ROMs, just to pick a few little ones. You know, obviously, I've got to throw infrared in; it's the one that didn't work. A dollar bet on infrared returned you nothing; you lost your dollar.

So, it's not a perfect record, but boy, it's a 95% of the technologies that they made and put on 1 billion machines killed whatever was there before and have become the dominant technology in the marketplace for the thing they've done, and have become multi-hundred billion dollar markets.

What Wave is trying to do is to look forward with that view and say where should we invest? Where should we point our resources and ensure that, while we're trying to grow the revenue of our business so that we can continue to fund that exercise going forward, we also don't get so focused on the bark on one tree that we can't see the five other trees that are interesting that are within an arm’s reach?


Mr. Sprague, it seems there are no further questions on the phone lines at the moment.

Steven Sprague

Well, if anybody else has any additional questions, please feel free to call me or send me an email. Email is probably the best. I will endeavor to answer most of them. I thank everybody for their attention today and their support, and I look forward to talking to you again in a quarter. Thank you very much.


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