Identiv Inc (INVE) 2003 Q4 法說會逐字稿

Good morning. My name is Kimberly and I will be your conference facilitator. At this time, I would like to welcome everyone to the SCM Microsystems' fourth-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over to Ms. Darby Dye of Investor Relations. Please go ahead.

Thank you. Hello everyone and thank you for joining us today as we discuss the results of SCM's fourth quarter and fiscal year 2003. Speaking on today's call are Steve Moore, Chief Financial Officer, who will provide financial analysis of SCM's recent quarter and forward-looking financial guidance, and Robert 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 risk and uncertainty and that actual events or results may differ materially. We refer you to the company's 10-K filed March 27, 2003, our 10-Q for the quarter ended September 30, 2003, and other recent SEC filings which explain important factors that could cause actual results to differ from those contained in any projections or forward-looking statements. Any forward-looking statement made on this call is 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 regulation fair disclosure. Please also note that 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 practicable are contained in today's earnings press release which we have posted on our web site at www.SCMmicro.com, and filed with the SEC on Form 8-K. Now I would like to introduce Steve Moore.

Hello everyone and again thank you for joining us today. I will start by giving you an overview of our current position vis-à-vis one of our most important undertakings of 2003, which was the sale and disposition of our retail digital media and video business. Then, I will review the numbers for Q4 and the year as a whole and give you some analysis on these results. I will discuss management's expectations for the next quarter, and as a reminder, our financial results in the fourth quarter and going forward include financial performance for the company's continuing security operations only.

Financial results for the disposed digital media and video business are being treated as discontinued operations. As those of you have been following SCM are aware, the company entered 2003 with the intention of divesting our consumer oriented digital media and video division and refocusing our business around our core competencies in Secure Digital access. In June, we announced the sale of the digital media and video division to two parties, Pinnacle Systems and Zio (ph) Corporation. As of December 31, we have successfully completed the divestiture fully exiting the low margin retail business.

We have realized approximately $25 million in gross proceeds from the transaction which included proceeds from the sale of Pinnacle stock and cash payments from both Pinnacle and Zio. The figure is substantially above the original base transaction value which was $21.5 million. Finally, we have nearly finished expensing the various charges related to the transaction which included the write-down of assets, fees for professional services and other items. The original estimate we communicated for the total write-down related to the divestiture was a range of $35 million to $45 million.

I am pleased to report that with the vast majority of the charges behind us, that our current estimate has turned out to be substantially less coming in under $30 million. Most importantly, this transaction was a critical -- strategic step for SCM and has been successfully implemented from both a financial and operational point of view. Post divestiture, SCM now has a primarily OEM business model which allows us to leverage our strong industry relationships and provide some protection for margins. We are focused on the digital security market where we see significant long-term opportunities in the areas of secure access solutions for digital television and PC network security.

In a few moments, Robert will discuss SCM's strategy related to these opportunities in more detail. Turning now to the numbers. As we announced in a preliminary release on February 3, revenues from continuing operations in our fourth quarter were $12.6 million, below the range of expectations we sat in our Q3 conference call which was $14 million to $17 million. This represents a decrease of 47 percent from revenues of $23.8 million recorded in the fourth quarter of 2002 and a sequential decrease of 21 percent from revenues of $15.9 million in Q3 of 2003. For the year as a whole, revenues were $66.5 million, down 26 percent from revenues of $90.1 million in fiscal 2002. As we have discussed over the last several quarters, weakness in the economy put pressure on our sales during 2003 both in terms of dampening demand for our customers' products and by limiting budgets for digital security programs.

We have worked to address these challenges by expanding our market opportunities and developing new products for existing markets. These are long-term solutions which we believe will begin to gain traction in mid 2004. Let's now look at revenues by product segment. Sales of digital TV conditional access modules were $5.4 million in Q4, which represented 43 percent of total revenues. These conditional access modules are used in conjunction with open platform set-top boxes to protect digital pay TV broadcast and enable legitimate subscribers to decrypt broadcast content. Sales of our smart card readers and related products used to provide secure access to PCs and computer networks totaled 4.2 million in Q4, which represented 33 percent of revenues, and sales of flash media interface products which are used to transfer digital images in devices such as photo kiosks and printers, were $2.9 million in the quarter or 24 percent of revenues.

Fourth-quarter sales levels reflect not only economic pressure on our markets but increasing competitive pressure in our Digital TV business as well. Several companies have begun selling conditional access modules with unlicensed security software in the retail market which directly competes with our licensed modules that are distributed through legitimate channels. We have been aggressively addressing this new competition by working with our customers to fast-track development of a new line of products that we believe will be very successful in recapturing market share lost in the last two quarters.

We shipped the first of these products late in the fourth quarter, but were not able to recognize revenue in the fourth quarter because of the performance issues that we now expect to correct over the next several weeks. Robert will provide more detail behind this in a few moments. The bottom line is that we're addressing the issue of growth in our business both tactically and strategically with both short-term and long-term objectives. With the near-term, we anticipate the market share loss may continue into the first quarter of 2004 but we also expect to recognize revenue from our new Digital TV products and to sell additional units of these products during the quarter.

While the near-term outlook remains challenging, we remain optimistic about long-term opportunities for growth in the secure access market and about SCM's ability to capitalize on those opportunities to fuel our own revenue and earnings growth. To wrap up the discussion about revenues I will give you the figures for the revenues split by geography. In the fourth quarter, Europe represented 55 percent, the U.S. 19 percent, and Asia-Pacific 26 percent of revenues. For the year as a whole, Europe contributed 58 percent, the U.S. 24 percent, and Asia-Pacific 18 percent of revenues. Gross margins for the continuing security business in Q4 was 42 percent at the high end of our targeted gross margin for the quarter of 39 percent to 42 percent.

This resulted primarily from a favorable mix of higher margin products sold in the quarter. By product line, gross margins for our Digital TV products was 37 percent, gross margin for our PC security products was 41 percent, and the gross margin for our flash media interface products was 53 percent in Q4. For the year as a whole, our gross margin was 40 percent, an improvement over gross margins of 37 percent for the previous year. Now, looking at operating expenses, as reported under GAAP, operating expenses in the fourth quarter were 11.3 million which included amortization of intangibles of $300,000 as well as restructuring cost of -- restructuring and onetime charges of $2.9 million.

Excluding amortization and restructuring costs, underlying operating expenses for the continuing security businesses was $8.1 million, operating loss for the quarter in accordance with GAAP was $6 million. To support ongoing product development and the strategic expansion of our business into additional geographic markets, we will continue to invest in research and development and sales and marketing at current levels. We will continue to control general and administrative costs although in a large part these are determined by our need to maintain a global presence and the cost of operating as a public company.

Continuing down the income statement, Q4 interest and other stood at a gain of $900,000 resulting from interest income and foreign exchange gains offset by other expenses. We also recorded a tax benefit of $200,000 in Q4. Net loss from continuing operations for the fourth quarter as reported in accordance with GAAP was $5 million or 33 cents per share. This compared with a net loss from continuing operations of $15.1 million or 97 cents per share in the fourth quarter of 2002. For the year as a whole, the net loss from continuing operations was $8.8 million, or 57 cents per share, which included amortization of $1.1 million and restructuring and infrequent charges of 4.7 million.

This compares with net loss for the previous year of $18.7 million or $1.20 per share. As a reminder net loss for the 2002 fiscal year included $800,000 in amortization of intangible assets and $6.6 million for impairment of goodwill and $8.5 million in restructuring and infrequent charges. Looking now at discontinued operations, with the disposition of the consumer digital media and video business, we 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 businesses condensed into one line. For Q4 2003, the result is a loss of $1 million.

Loss on sale of discontinued operations represents costs associated with severance, facility closures, and legal and professional costs associated with the transaction as well as 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 the selling of those assets. For Q4, the loss on the sale of discontinued operations was recorded at $3.3 million. For the year as a whole, loss from discontinued operations was $14.3 million and loss on sale of discontinued operations was $15.1 million.

I would like to talk about management's outlook for the near-term and provide some specific guidance on what we expect. For the first quarter of 2004, we expect revenues to be in the range of $12 million to $15 million. This reflects competitive pressures on sales of our conditional access modules in Europe -- European market, as well as a lack of visibility on the timing of new projects planned for smart card readers in the U.S. and Europe. We expect gross margins to be in the range of 40 to 42 percent, and within this range of revenue and gross margin performance we expect to record an operating loss from our continuing security operations in the first quarter.

To wrap up, I would like to turn to the balance sheet. As I have already mentioned, sales of Pinnacle Systems stock and cash payments from Pinnacle and Zio Corporation drove an increase in our cash and short-term investments in Q4 which ended the quarter at $55 million, a 40 percent increase from cash and short-term investments of $39.4 million at the end of Q3. Net accounts receivables totaled 10.4 million at the end of Q4 compared with 11.3 million at the end of Q3.

Both quarters' numbers include receivables related to the discontinued operations because receivables from the digital media and video business were not sold as part of the divestiture. Digital media and video receivables have been reserved for collectibility and the P&L effect of those reserves have been reflected in the loss from discontinued operations for 2003. Inventory levels were at 9.1 million, up 1.4 million from $7.7 million in Q3, due primarily to the lower than anticipated revenues in Q4. With that, I would like to now turn the call over to Robert.

Thank you, Steve. As you have heard from Steve, the economic and market environment remained very challenging for us in the fourth quarter as it has been through all of 2003. Last quarter, I shared with you the specific strategies and opportunities we are pursuing to transition SCM to a security company and to broaden our customer base. Today I would like to update you on where we are against those strategies and opportunities. Of course, our first significant step was to divest our retail digital media and video business in order to simplify our business model and focus on our core strengths in Secure Digital access.

This has been a difficult exercise which has consumed much of management's time over the last several months. It has also been very successful building up our cash position and supporting investments in our business in order to capitalize on our market opportunities. We believe that the opportunities across our markets are more than sufficient to support our growth. The first of our market opportunities is in Digital TV. In this market our current business comes primarily from small pay TV operators in Europe with whom SCM has been working for many years now. As Steve has discussed, this business was impacted by competitive issues in the last two quarters which we were aggressively addressing with new security modules, with at least new modules in the fourth quarter which carried two conditional access security systems and (indiscernible) companies involved.

We believe that these new products will allow us to regain lost market share. To expand our Digital TV business we are focused on penetrating new markets such as Korea and Germany. As we have discussed on previous calls, the Korean government has required that subscribers use the movable conditional access modules to secure broadcasts as part these country's conversion to digital television technology. As the company with the most experience with these modules in the world, SCM has been closely involved with preparation and testing of the end-user infrastructure for the new digital broadcasting system.

We have been working with long-term partners such as NDS, (indiscernible) and this partner such as Samsung. Today, we are in the final stages of contract negotiation with a Korean operator, the first of many whom we are targeting. Signing this operator will be a significant move (indiscernible) for our strategy to expand our business into Korea. The Korean government expects to deploy digital television to between five and eight million Korean households.

If deployment secure (indiscernible) we expect we will begin to see initial volume sales of security modules for Korea beginning in mid 2004 and sustained volumes in 2005. We're also targeting expansion of our Digital TV business with sales of our Digital TV products to the larger operators in Europe. During the third quarter, we announced a significant cooperation with Canal+ (ph) technology, licensed to a media (indiscernible) conditional access system for use with our security modules.

The Canal+ technology is the largest pay TV operator in Europe with over 13 million subscribers. During the fourth quarter, we shipped several thousand of modules to the touch operator, Canal Digital (ph) as part of Canal+ organization. The first of many such operators which we are targeting. Again, the opportunity here is significant as Canal+ Corp. (indiscernible) Canal+ has 10 million, more than 10 million analog subscribers that will be transitioning digital services over the next few years.

SCM is in the process of forging relationships with numerous operators and (indiscernible) to take advantage of this opportunity. In Germany, SCM has been invited to present our security module technology as the standard for removable decryption for digital cable broadcasts. This is very significant because it is the first time that public, private and pay TV operators have comes together and agreed to make removable security devices available as an option for broadcast decryption as digital cable television is rolled out in Germany over the next couple of years.

There are about 20 million cable television subscribers in Germany. In fact, Germany is one of the largest markets in the world for cable TV. They are still on analog and they will be converting to digital equipment over the next few years. If only a small percentage of these subscribers end up with the conditional access module, SCM could realize significant sales. We expect that there will be an announcement from the German cable television industry over the next few months that will provide status of course on the transition to digital broadcasting.

Our second major product segment, PC security, consisting of smart card readers and other solutions used to enable security applications for the government enterprise and financial markets. Growth in our current PC security revenue base will come both from new opportunities and from the ability to respond quickly to shifts in technology requirements in the current market environment. In all cases relationships are key. SCM has strong relationships with all of the prime end sub prime contractors working on smart card projects with the U.S. government.

We have trusted supply relationships with PC and other hardware manufacturers to leverage corporate security program rollouts and we have long-standing relationships with key European banks which are now striving to utilize smart cards -- smart cards to benefit their customers and enhance their own security programs. Specific opportunities for SCM over the next 12 to 14 months will primarily leverage current customers. First, the U.S. government has announced plans to implement new programs for both military and federal workers to utilize smart cards and smart card readers to identify and authenticate personnel.

That will continue to be used for logical access that is too log onto a PC or computer network. The U.S. government also announced plans, as already communicated, to implement highly secure access systems for physical entry points both for its transportation workers and for all federal buildings using smart cards. We estimate the market opportunity for physical access to be, over the next three to five years, to be over $40 million. Our strong relationships with government (indiscernible) and contractors give us confidence that we will be able to secure a significant portion of this opportunity after more than one year of product development.

During the first quarter, SCM shipped our first (indiscernible) readers for physical access and those products have been approved by some government agencies already. With the first pilots planned in the next few weeks it is possible that the U.S. government demand for these products could result in volume shipments as early as the middle of this year. Outside the U.S. government sector, we have made an agreement with a major German telecom operator for an initial order for smart card readers that bring secure public key infrastructure or called PKI capabilities to consumers.

Our customer will distribute Class II PINpad smart card readers as part of a retail package that will include a smart card and the software and a reader so that the consumers within Germany can secure their electronic transactions with digital signatures and personal authentication. This would allow for highly secure applications such as tax filings, general e-government applications including vehicle registration, and of course, also for any kind of secure contractual binding agreements and all of this from the home PC.

In summary, we have identified some opportunities for growth, conversion to Digital TV in Korea and Europe, expanding ourselves to large European digital TV operators providing physical access technology to the U.S. government and of course also in Europe we'll go beyond U.S. governments. Our readership and experience in secure access technology, our strong relationships with key industry partners across our target markets provide the fuel for this growth.

Given our size and our OEM business model, it is to be expected that we would continue to be exposed to fluctuations in our revenues on a quarterly basis until we can achieve great scale, however, our solid financial condition and our clear strategy to leverage growth opportunities give us the confidence that will be able to continue to operate our business and invest as required to support our long-term goals. I would like to turn the call over to the operator for questions and answers.

(OPERATOR INSTRUCTIONS). Adrian Hopkinson with West LB.

Good afternoon or good morning. Could I follow up possibly on the point about the digital media modules, the TV modules, and the unlicensed competition which came into the market? Could you give us a little bit more background about how this came about? Were these in fact black-market products? Were they -- or were they actually products which were legitimate but somehow at different prices to your product?

Very good question. In fact, all of those modules have been unlicensed. So, you could even put into the hacker scenario or black-market, as you call it. No official security company in the world has licensed those module manufacturers. So, there has been -- there is actually some undertaking about trying to make this illegal. In fact, we have been starting to fight this and we have started in Germany and in fact we have, during Q3 and Q4, won six court orders from German courts to stop shipments has had some impact, but of course we will have to continue this.

In other words that is nonlicensed business, but of course whenever there is security there will be hackers and this is a continuous fight but of course it is not the majority of the market. It is always the minority of the overall market scenario, and we have got some support of course from the security companies also to start fighting those illegal, so-called illegal use of those modules?

Do you have an estimate as to roughly what share of the market they may have achieved in the third and fourth quarters?

Since they kind of caught us by surprise, in 2003 I think it was about -- at the end about 30 percent of the total market.

I think it is certainly surprising that the hackers should have suddenly achieved such a large volume. I mean they have been very active in some geographies for a long time and it seems to me a bit strange that they should have become quite strong in Germany so suddenly.

Yes, and it is not only Germany. It, of course, goes all over Europe but we are only focused in Germany in taking some legal action successfully and we will hold (indiscernible) during the year in other countries in Europe.

So you redesigned some products which --.

Yes. Our response is basically two-fold. One is of course using whatever legal things we have from laws like (indiscernible) to try to stop those illegal access devices and the other thing is to be more (indiscernible) in terms of products. So as (indiscernible) mentioned before we have got finally agreement from two security companies to combine their security system in one module which gives a greater benefit to the consumer and should be a good defending strategy for our business.

Thank you very much.

At this time there are no further questions. Are there any closing remarks?

Yes. In summary we have had great success in focusing our business in other security scenarios. We have, especially with the cash position we were building up again in Q4, we have a very strong financial position which puts us in a unique position to capitalize on the long-term growth opportunities in the markets for Secure Digital access. Thank you for joining us today.

This concludes today's conference. You may now disconnect.