Identiv Inc (INVE) 2003 Q2 法說會逐字稿

Ladies and gentlemen thank you for standing by. Welcome to the SCM Microsystems second quarter earnings conference call. During the conference, participants will be in listen only mode. Later we will conduct a question & answer session. At that time if you have a question you need to press the one followed by four on your telephone. As a remainder this conference is recorded Tuesday, July 29th, 2003. I would now like to turn the conference over to Darby Dye, investor relations. Please go ahead.

Hello, everyone, and thank you for joining us today as we discuss the results of SCM's second quarter of 2003. Speaking on today's call are Steve Moore, Chief Financial Officer, who'll provide financial analysis of SCM's recent quarter and forward looking financial guidance. And Robert Schneider Schneider, chief executive officer, who will provide an overview of SCM's market environment and business strategy.

As we begin today's call, let me remind you that during the course of this conference call management will make certain forward-looking statements regarding future events or the future financial performance of the company. We caution you that such statements involve risks and that actual events or results may differ materially. We refer you to the company's 10K and recent SEC filings which explain several important factors which could cause actual results to differ from those contained in any projections or forward-looking statements. Any forward-looking statements made on this call are based on information that is currently available and which is likely to change over time. Although our projections will likely change, we do not plan to update them.

SCM will provide our analysts and investors with information and forward looking guidance in our quarterly financial news releases and conference calls. We will not provide any further guidance during the quarter unless done through a news release, conference call or SEC filing in accordance with regulations fair disclosure. Please also note on today's call we will provide you with several financial metrics determined on a non-GAAP or pro forma basis. These items, together with the corresponding GAAP numbers and a reconciliation to GAAP where practical able are contained in today's earnings press release which we have posted on our website at SCMmicro.com and filed with the SEC on form 8-K. I would like to introduce Steve Moore.

As most of you know I joined SCM on June 30, the day we announced the planned sale of our Dazzle consumer digital video business to pin Cal.[inaudible]. I've actually been working for SCM or these transactions for the last couple of months. So I am very pleased to report that we announced yesterday the pin Cal transaction has now closed and the close of the transaction with Zio is now imminent.

While there is still work to be done to make these transactions successful, this will require a decreasing amount of effort over time. I am personally very pleased to have joined SCM at this exciting juncture and look forward to shifting my efforts and attentions to the financial management of the business. Now let's look at the results of our second quarter. Because of the sale of our dazzle consumer business, SCM is now operating as a security company and our financial results in the second quarter and going forward include financial performance for the company's continuing security business only. Financial results for the disposed Digital Media and Video business are being treated as discontinued operations. Revenues for our continuing security business were $19.3 million in Q2.

This is a decrease of 18% from revenues of $23.07 million for the security business in the second quarter of 2002 and represents a sequential increase of 3% from revenues of $18.7 million in Q1 of 2003. Revenues from our continuing security business primarily consists of sales of conditional access modules which provide removable security for the digital TV market and smart card readers used to provide secure access to PCs in computer networks. In addition there is a small revenue contribution from sales of ASICs technology and other products used for accessing digital content. Looking at revenue split by geography, Europe represented 52%, the U.S. 27% and Asia Pacific 15% of total Q2 revenues.

Revenue levels in the second quarter reflect a small increase in sales to our established base of customers in the digital TV market, which are primarily in Europe, offset by a small decrease in sales of our smart card readers to the U.S. government as projects related to the department of defense's common access card program wind down.

As SCM management has expressed in the past, our security business is affected by the state of the overall economy as well as by the pace of technology acceptance in the emerging markets in which we participate. We, therefore, expect the sales of our conditional access modules for securing digital TV broadcast will continue to be under pressure for the next several quarters.

We also expect the sales of our smart card readers will be under pressure as economic concerns continue to hold back I.T. budgets and as technology and market transitions continue. That being said, we remain excited about the long term prospects for growth in the digital TV and PC network security markets and SCM's growth potential as a leading provider of Secure Digital access products. Robert Schneider will provide more detail about the trends and opportunities of our markets in a moment.

Gross margins for the continuing security business in Q2 were 35% below our target growth margin for the quarter of 40%. Gross margin was impacted by a write-down of approximately $800,000 for inventory related to a European digital TV customer. Excluding this write-down gross margin for the quarter would have been 39%. Underlying operating expenses for the continuing security business came in at $8.6 million, up about 6% from the under lying expense level of 8.1 million in the first quarter hence resulting in a pro forma loss of 1.8 million in the second quarter.

Including amortization of tangibles and charges related to the restructuring of the ongoing security business, which totaled approximately $2.1 million, operating expenses as reported in accordance with GAAP were $11 million and our operating loss was $4.2 million. On June 30, we announced that we had restructured our business to better align our operations to support our security customers. The main thrust of this restructuring was to organize our management and operations along functional lines. Supply chain management and manufacturing activities, which were formerly split between Security and Digital Media and Video products are now dedicated to our continuing Security business.

Likewise, our R & D resources have been consolidated to more cost effectively support both current customers and new product development for next generation conditional access modules and smart card readers. Sales and marketing formerly managed by three different groups is now unified under one organization with worldwide scope and responsibility. The restructuring of our business was not intended to be primarily a cost-cutting exercise.

We believe that we have the appropriate level of expenses currently to run our business. However, we will continue to evaluate ways to lower our base line expenses on an ongoing basis in order to increase efficiencies in our operation. Amortizations of tangible, $281,000 in Q2.

We expect quarterly amortization expenses remain around this level going forward. Restructuring and infrequent charges, SCM recorded charges of $2.1 million in the second quarter related to the restructuring of our security business. We expect to record additional restructuring charges over the remainder of the year as we incur costs from facility closures, contract cancellations and severance payments, which will take place over the next six months.

Loss from investments was $457,000 and related to write downs of investments in scripto-vision and smart disk. Q2 interests and others stood at a loss of $435,000 resulting from a loss on foreign exchange offset by interest expense and other expense. We recorded a tax provision of $115,000 in the second quarter as well.

SCM's net loss from continuing operations for the second quarter of 2003, as reported in accordance with GAAP, was $5.2 million, or 34 cents per share. This compares with an as reported net income of $672,000, or 4 cents per share in the year-ago quarter. On a pro forma basis, net loss from continuing operations for the second quarter was $1.8 million, or 15 cents per share, excluding amortization of intangibles and charges related to the restructuring of our security business. This compares with pro forma net income of $2.4 million or 9 cents per share for the second quarter of 2002. With the disposition of consumer -- of the consumer Digital Media and Video business we now have two line items on our income statement related to that disposition -- loss from discontinued operations represents the entire P&L for the Digital Media and Video business condensed into one line.

For Q2 2003, the result is a loss of $5.1 million. Loss on sale of discontinued operations represents the write-down of the assets of the Digital Media and Video business. That is the book value of the Digital Media and VIDEO business less the estimated proceeds from selling those assets. The loss on sale of discontinued operations was recorded at $5.9 million. Now looking at guidance. For the third quarter of 2003, we expect revenues to be in the range of $15 million to $20 million.

This reflects continued near-term pressure on sales of our conditional access modules to the digital TV market as well as increasing sales of our smart card reader products due to economic issues and transitions in the industry. We expect gross margins to be in the range of 35% to 39%. Within this range of revenue and gross margin performance, we expect to record an operating loss from our continuing security operations in the third quarter.

Consistent with our guidance on June 30, 2003, SCM expects to record charges related to discontinued operations and the restructuring of our continued security operation of between $35 million to $45 million in fiscal 2003. And as I have discussed on this call, approximately $13 million of this amount has been recorded in Q2.

To wrap up, I'd like to turn to the balance sheet. Cash and investments were $48.6 million at the end of Q2 as compared with $55.9 million at the end of Q1. During Q2, the company used approximately $1.8 million in cash in the stock buyback program with the remainder funding the losses for discontinued and continuing operations. Net accounts receivables totaled $13.2 million at the end of Q2 compared with $19.6 million at the end of Q1.

Both quarters' numbers include receivables related to the discontinued operations because receivables for the Digital Media and Video business were not sold as part of either transaction. Digital Media and Video receivables have been reserved for collectability and the P&L of those have been reflected in the loss of discontinued operations for Q2. The balance sheet also includes assets of discontinued operations held for sale, which represents the estimated net realizeability value of the assets being sold to Pinnacle and Zio. Inventorial (ph) levels were at $8.4 million which represents the fair value of inventory for security products only as the inventory for discontinued Digital Media and Video division are classified as assets held for sale.

With that, I'd like to turn now the call over to Robert Schneider. Thank you.

Thank you, Steve. And thank you all for joining us today. I'm very pleased to welcome Steve Moore to the executive team. Steve has more than 25 years experience in finance and accounting. And for the past several weeks has done an outstanding job of driving the sale of our consumer Digital Media and Video business. I congratulate him on bringing this transaction to a close. There is no doubt that his experience and his leadership will be a valuable asset to SCM.

The sale of our Digital Media and Video business was a significant accomplishment in Q2. The final separation of this consumer business allows SCM to focus our business around our core security markets which are digital TV security and secure PC and net ready access. The reason we chose to focus on the security market is simple. SCM has tremendous strengths in terms of technology, experience and market persons in secure access and opportunities in these very early marketing areas are significant who have been involved with these markets from the very beginning as contributors to the development of USB open standards for digital TV, both of which are now being used in different parts in the world, including Europe, Asia and in the U.S. And on the PC network security side, we have been involved in the development of the multiple protocols and standards for smart cards and smart card readers in collaboration with Microsoft and Intel.

Today I'd like to give you an update on SCM's marketing opportunities and share with you the reasons why we remain very positive about the future of these markets and confident of SCM's ability to achieve growth, profitability over the long term. First, the digital TV market. As I've discussed with you before, SCM's opportunity on digital TV has historically been in Europe where the transition from analog to digital TV broadcasting has created opportunities for operators to sell more content and services. This has also created more risk that pay TV content and services will be accessed illegally and operators will lose revenues. SCM's hold on this market [inaudible] resolutions that protect encrypted content until an authorized subscriber unlocks it.[inaudible]

So far over 6 million removable security modules through operators throughout Europe, and are the unchallenged market Leader in this technology. To date, our digital TV security modules have been selling to smaller operators, who do not have a large enough subscriber base to justify the cost of deploying [inaudible]. This remains largely favorable component of our business. We have also had some initial success with larger digital TV companies and, in fact, are very close to announcing that another major European [inaudible] access supplier has selected SCM to provide removable security modules based on the security software. However, the pace of adoption of removable security modules by larger operators has been slow.

Looking outside Europe, other areas of the world are beginning to move toward the adoption of the removal of security technology. In U.S. a major breakthrough occurred in December of last year when a national television Cable association and a group of leading consumer electronic companies agreed to adopt the U.S. open Cable standard for removable security as a way to open the market for new digital television sets. In order to be able to broadcast signals from different operators located in different parts of the country to new TVs, must use a Cable card. That's a new term for formerly call the P.O.D. module, which we have been specializing and developing. This module will contain the broadcast encryption and allows open Cable standard for interpretability and removable security.

SCM has submitted a Cable cart module using the NDS, conditional access system to cable labs for certification and testing. NDS is the worlds largest conditional access software provider. And we expect to receive certification of this module within the next few weeks. With a certified module, we'll be able to offer a qualified [inaudible] detection solution to the US digital TV cable market as it prepares to manufacture the first integrated digital TV sets with removable security. In addition in the U.S. operated Cable vison, the fifth largest U.S. Cable operator has already committed to utilizing Cable card modules in their subscription area. And several of the major consumer [inaudible] companies are working to develop Cable card and enable individual TVs in time for retail sales for Christmas season this year. On our [inaudible] call we announced we released a new hardware and software tool for testing and certification of U.S. open Cable compliance, center boxes and digital TV sets, a product called HPNX(ph).

We are the sole supplier of the technology and recorded first sales of this product during second quarter. Leading consumer companies, including Toshiba, sharp, Hitachi, Samsung, LG, Pioneer, Panasonic, Motorola have purchased the first copies of HPNX products. We've sold multiple copies to Sony, Thompson and Mitsubishi, who are using it to build the speed up development of Cable cart compliant equipment.HPNX is the same use by cable labs for certification testing of open Cable boxes,individual TV sets and to Cable cards themselves. Clearly consumer electronics companies believe in and are driving the development of security modules in the U.S. digital TV market. As I indicated last quarter, opportunities in the digital TV market are also opening up in Asia.

The Korean government has mandated the use of removable security modules -- actually, the it's the same version as the U.S. It's part of the country's conversion to digital television technology and expects to roll out digital Cable TV to between 5 and 8 million Korean households over the next five years. SCM has been working with various partners in Korea, including several to prepare for the launch of the digital Cable using common interface security. Overall, the Korean program has been moving smoothly and the industry plans to bring it in [inaudible] in the second half of 2003 with the first commercial deployments taking place in 2004. Over the next five to eight years, we believe the switch from analog to digital technology, as well as the industry's cost-heavy business model will force a more rapid transition to a more open standards paced delivery model which will provide significant worldwide opportunity for SCM. Our product and technology portfolio, our proven experience in deploying removable modules and our relationship with the security companies, the conditional access providers, the consumer electronic companies and other major players in the company positions SCM to be the leading provider of removable security technology as this market develops and expands.

Turning now to our second market opportunity, secure PC network access based on smart cards. There are a number of trends occurring in this market which I would like to talk about. Some of them are very positive for SCM. Others present a near-term challenge. The first trend concerns the pace of U.S. government's smart Card initiatives, which, to date, have produced the largest hold out of smart applications and readers in the world. As those of you who follow SCM are aware, SCM has been a significant supplier of smart card readers to the U.S. government. It's part of the common access card project. And in this program, the U.S. department of defense has issued more than 4 million smart cards to military personnel for secure network access and E-government applications.

This program is now in the final implimtation phase and decreasing numbers of readers are expected to be deployed. The U.S. government is now in the process of evaluating smart cards from many other security programs which it plans to implement over the next few years. Among these are the transportation work I.D. program or T.W.I.D. And 57 million railway, seaport workers will be issued identification tokens to provide [inaudible] Also has access to sensitive areas and data. Testing programs using smart cards for the T.W.I.D. initiative is on the way and scm is actively engaged in these pilots.

Based on our partnerships with government suppliers and our success with our common acess card program, SCM expects to be a major provider of readers to any US homeland security program that utilizes smart cards. A second client that is creating new opportunities for SCM, in addition to implementing systems to provide secure PC networks, U.S. government in the United States is implementing physical access systems based on smart cards. That is, secure access to buildings, for example. Delivered by U.S. homeland Security initiatives , physical access system will secure access to government buildings and be adapted to various security levels.

To accommodate these requirements, scm is Currently developing secure readers that can read both contact and contactless smart cards as well [inaudible]. We expect to have our first physical access products ready by the fourth quarter of this year. Of course the government is not the only sector in placing smart cards. For some time now SCM has been working with companies such as Hewlett-Packard, Sun and Microsoft to produce smart cards for the enterprise. These companies are incorporating support for smart cards in their products. They are also implementing smart card based employee batching systems for the internal secure needs as well.

These internal programs are expected to remain in pilot phase until budget constraints lighten or security issues increase. For SCM, the expansion of I.T. budgets will signal a significant opportunity to capitalize on the relationships that are already in place. The third client impacting both government and enterprise smart card security programs is the integration of smart card interface technology onto the PC. Over time, this will eliminate the need for external peripheral smart card readers. SCM expects to continue to be able to participate in this new smart card based security programs, providing peripheral readers to let PCs within a given program. In addition we are responding to the changing needs of this market by developing silicon and [inaudible] base interface solutions for keyboards and desktops which allows us to [inaudible] in embedded systems. To date, we are working with leading people, manufacturers in the world to embed our chip and software, to implement a smart card reader.

The fourth trend I'd like to talk about is the potential for other potentials for smart card to be used for security, both for network identification and personal I.D. There is an increasing interest in the use of identification tokens, such as secure flash media cards to authorize access to networks and to store data. SCM is prepared to address the requirement for secure media readers if it develops. When we disposed of the consumer Digital Media and Video business we made, the decision to retain our core [inaudible] like any type of flash cards. We can also now offer secure access device based on any media and not just smart cards. We believe that we can leverage our interest in technology to take advantage of changing market requirements for secure access to networks and data. In addition to these plans that affect the use of smart cards for government and enterprise security applications, movement continues in the financial sector as well.

The most significant development recently was the decision by Asian governments to adopt the set of standard known as you will pay MasterCard visa or UMV for smart card based Internet, widely regarded as a strategy. SCM has secured [inaudible] for our entire range of smart card readers. We also complied with the European Finn rate. That's for financial transactions involving smart cards. In addition we've achieved certification to the set of standards known as common criteria, which grants compliance with international requirements for digital signature. We are well positioned to address the specific and special identified requirements for our readers which are critical to mainstream financial applications. So across the government enterprise and financial sectors SCM is extremely well positioned to capitalize on increasing demand for secure access technology.

Our product and technology, our experience and market share, leadership and our strong partnerships across the smart Card industry prepare us to win smart card reader and even secure media reader business as these market opportunities develop. With the separation of our consumer Digital Media and Video business, SCM can now focus solely on the opportunities in the security market which I've just discussed in order to maximize our efficiency as a security organization. We have both restructured our business, formerly all sales, development and management positions were making -- were driven from a divisional perspective. Under the new structure, the sources such as R&D, sales and all other persons are being [inaudible] on a better level on a worldwide basis.

In particular we've taken engineering resources in India that formerly supported Digital Media and Video projects and reassigned them to support security projects. This has expanded the R&d capability for security business and allowed us to leverage strong engineering capabilities at very competitive costs. In addition, we have shifted work forces to Asia and built up our sales and development team to expanding opportunities in this geographic market, including EMV financial applications and the conversion to digital television. In summary, SCM has achieved a major milestone by selling our consumer Digital Media and Video business.

We're now fully focused on the security market with opportunities for digital TV, [inaudible] and secure acess to networks-- we benefit from a strong technology base and market presence with a strong cash position and no debt. While the economy and technology adoption rates are slowing market development currently, we believe that the opportunities for security applications will grow rapidly in the future. And as a leading enabler of these applications, SCM will surely benefit. Now I would like to turn the call over to the operator for questions and answer.

Thank you.Ladies and gentlemen, if you would like to ask a question, please press the one followed by the four on your telephone. You will hear a phone prompt to acknowledge your request. If your question has been answered and you wish to withdraw your request, you may press the one followed by the three. If you are using the speakerphone, please pick up the handset before issuing your request. One moment, please, for the first question. Adrian Hopkinson with West LB Panmur. Please go ahead with your question.

Good afternoon, gentlemen. Thank you for that very expansive run-through. Could I just ask one financial question and one general question about the TV modules in the United States market? As far as the financial question is concerned, you referred, I think, to the restructuring charges this year as being $35 million to $45 million in total, of which $13 million were taken in the second quarter. Can you give us an idea of what the remaining cash costs could be expected in the second half? How do you see the cash position for the company coming out at the year end? And as far as TV modules is concerned, could you give us a little bit more color as to whether in the U.S. market, you envision yourself being a software and IP vendor or whether you see yourself selling or most of your revenues deriving from actual modules?

Okay. I'll take the second question first and then pass on to Steve Moore on the financial restructuring cost side. The modules for the U.S. digital TV market, as I explained, are starting to take off. Christmas season will be the first time they are being deployed. As you know, the U.S. market is still under a very dominant grip from OTI model in significant lender. And of course those companies have their own security technology and have their own modules, basically, so far. The free -- available market today is the dessert conditional access system from NDS. NDS, in fact, is the world's largest conditional access software supplier. And we are working together with NDS for CableVision. We do not know in how far we would have a chance to get into licensing agreements with Motorola or the others at the moment.

Okay, sir. Effectively, therefore, if you're talking about one Cable company in the U.S. out of, say, 15, does this mean that the accessible market for your modules can be regarded as around maybe 5% or 10% of the market? Or do you see yourself also selling into the -- into a larger freer market through the digital TV market in general?

That's not true. I mean, we're pretty sure what is already available is about what you said, about 5%. In the other markets and areas, it's at the moment a closed market. And we have no indication how we would anchor this. But we are very happy to enter this market with a module with at least for one Cable operator. And in 2004 we'll see how further we can go. We are definitely the leader worldwide. I mean, nobody else has supplied this 6 million units. For example, Motorola [inaudible] have supplied nothing so far. So we have a tremendous advantage, of course, in technology, in costs. And eventually we might have a business opportunity to go in the big markets as well.

I mean, I imagine that you must have economies of scale in producing the modules which Motorola and Scientific-Atlanta, for example, would not at present have.

Correct. So we hope that there might be a good chance.

Can one ask whether you are in conversation with these companies about helping them with the supply of modules?

We are in conversation with all of them, because, actually, they're buying from us the development tools and we have a very good working relationship since we are representing the standard, if you want. But that's -- we cannot indicate anything further beyond that.

Okay. Thank you.

Okay. I'll pass you on to Steve Moore.

Okay. Thanks.

concerning your question about cash. The $34 million to $35 million that we described, being the total possible loss, was on an accrual basis, not related to cash. The cash that we do expect to receive for the sale of assets will almost entirely be received in the fourth quarter. So we would expect the company to use cash in the third quarter and then generate cash in the fourth quarter. The overall net impact of both the restructuring and the discontinuance of the DMC division we expect to be either cash neutral or slightly cash positive.

That is taking the second half overall?

That's taking the second half overall. Well, the second half and the effect that occurred in the second quarter. So over the three quarters.

So, at the moment, I think it says the cash position is $48 million. At the year end, it would be lower only to the extent of operating losses, if they were to occur?

Exactly. Yes.

It wouldn't be lower through the disposal program?

We don't believe so.

Okay. Thanks very much, Steve.

Certainly.

Ladies and gentlemen if you would like to ask a question, please press the one, followed by the four on your telephone. Gentlemen, I show no further questions at this time. Please continue with your presentation or any closing remarks.

Okay. So, in summary, SCM is now focused on the security market, where our technology and market strengths will enable us to take advantage of emerging markets and opportunities over the long term. Thank you for joining us today.

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.