Identiv Inc (INVE) 2004 Q1 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 first quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star then the number two on your telephone keypad. Thank you. Ms. Dye, you may begin your conference.

Thank you. Hello everyone and thank you for joining us today, as we discuss the results of SCM's first quarter of 2004. Speaking on today's call will be Steve Moore, Chief Financial Officer, who will provide financial analysis on 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 risks and uncertainties and that actual events or results may differ materially. We refer you to the company's 10-K for fiscal 2003, filed March 12, 2004 and other 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 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 that. 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 filings in accordance with Regulation Fair Disclosure. Please also note that on today's call, we may provide you with financial metrics determined on our non-GAAP or pro forma basis. These items together with corresponding GAAP numbers and a reconciliation to GAAP were 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 Moore.

Hello everyone and thank you for joining us today. The first quarter of 2004 proved to be much as we had expected, and SCM executed within the plan, in terms of financial results and cash preservation. As the year progresses, we believe we can gain traction in terms of revenue generation and bring the company to profitability. Revenues from continuing operations in the first quarter were $13.2m, within management guidance of $12m to $15m for the quarter. Year-over-year revenues were down approximately 29% from the $18.7m recorded in the first quarter of 2003, but were sequentially up 5% from revenues of $12.6m in Q4 of 2003.

Looking at revenues by product line, sales of our digital television security modules were $5.9m in Q1, which represented 44% of total revenues. These security modules are used in conjunction with open platform set-top boxes to protect the 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 network, totaled $4.3m in Q1, which represents 33% of revenues. And sales of Flash Media Interface products were $3m in the quarter or 23% of revenues.

A geographic split of revenues in the first quarter included 50% of sales from Europe, 25% from the United States, and 21% from the Asia-Pacific region. Revenue levels in the first quarter reflects continued softness in sales of our digital TV security modules in Europe, due primarily to grey market competitions coming into the market over the last several months. These grey market modules use unauthorized emulated conditional access software to decrypt broadcast content and in addition are delivered in a preloaded form factor, which does not require the user to subscribe to broadcast service.

We expect the sale of our digital TV modules will continue to be under pressure from these market dynamics in the near-to-medium fixed term. In Q2, we began shipping a new preloaded module platform to address this competitive issue -- excuse me, in Q1, we began shipping the preloaded module platform to address this competitive issue and to enable an affordable, legitimate option for customers, which include preloaded modules; however initial technical difficulties have limited our success with this product in the quarter. In our PC security product line, in Q1 we saw a shift in the composition of our smart card reader sales away from the US where government projects continue be the main driver of business and toward Europe, where we have seen an increase in the number of banking, financials, and PKI applications for smart card. During Q1, SCM was successful in winning contracts for new pilot projects focused on banking and PKI application. In the US, we continue to focus on the emerging market for physical access control based on smart card, which we believe will be driven by federal government project and where we expect to participate beginning in the second half of the year. Robert will give you more detail of these market trends in the US and Europe in a few moments. Focusing now on gross margins, in Q1 gross margin for a continuing security business was 41% in the middle of the range of guidance for the quarter of 40% to 42%. This resulted primarily from strong margins in our PC Security and Flash Media Interface product lines offset by lower margins for Digital TV products. Digital TV product margins were adversely impacted in the first quarter by the inventory provision of $400,000, our product line gross margins for Digital TV products were 26%, gross margins for our PC Security products were 46%, and gross margins for our Flash Media Interface products were 63%. As reported in the GAAP, operating expense in the first quarter were $9.3m, which included amortization of intangibles of approximately $300,000 as well as cost associated with the legal settlements of approximately $91,000. Excluding amortization and other charges, underlying operating expenses for the continuing security business were $8.9m. Operating loss for the quarter in accordance with GAAP was $3.9m. Interest and other incomes stood at a gain of $399,000 resulting from the interest income, from cash investments, as well as the gain on foreign exchange. Loss from continuing operations for the first quarter of $3.6m or $0.23 per diluted share as reported in accordance with GAAP. This compares with an as reported income from continuing operations of $105,000 or $0.01 per share in the first quarter of 2003. I'd now like to talk about management's outlook for the near term and provide some specific guidance for the second quarter of 2004. We expect revenues to be in the range of $13m to $15m, and gross margins to be in the range of 40% to 42%. These estimates reflect continuing pressure on sales of our security modules, the Digital TV market, as well as an uncertainty as to the deployment base of anticipated digital security projects in the US and Europe. Within that range of revenue and gross margins performance, we expect to record an operating loss from our continuing security operations in the second quarter. To wrap up, I'd like to turn to the balance sheet. Cash and adjustment increased to $56.2m at the end of Q1 as compared to $55m at the end of Q4. This increase is primarily due to cash provided through the return of the holding taxes and Europe of $4.9m that had previously been paid in 2003 offset by cash used in other operating activities. Net accounts receivables dropped to $8.4m at the end of Q1 compared to $10.4m at the end of Q4, it's driven by a higher rate of collection during the quarter. And inventory levels were at $12.4m at the end of Q1, up from $9.1m at the end of Q4. With that I'd like to turn the call over to Robert.

Thank you Steve. As expected, our sales remained soft in the first quarter reflecting the nature transitions we're seeing in our Digital TV and PC Security markets. For several months now, we've remained focus on the

to expand our customer base by developing a lines of new products and market initiatives. During the first quarter, we achieved some very positive initial steps against the strategy. First we have achieved a world-wide

and signed a cable operator BSI as our first Digital TV customer in Korea. BSI is the first Korean operator to begin high volume deployment of security modules called CableCARD modules in Korea. Those are removable modules for the good Digital Television broadcast. Our initial contract with BSI for more than 50,000 units over the next 18 months. We believe we will be able to increase this contract to include additional volumes of units during the second half of the year at BSI and deployment of modules. We are already in discussions with other operators in Korea. We supply them with CableCARD modules. Unlike other partner suppliers we had announced, products and our developments, we can provide immediate delivery of modules to the Korean operators. Further, we have partnered with three of the world's leading conditional access security providers, NVS,

, to provide security modules that are certified to the open cable standards in Korea, which is certification for our modules with all three conditional access systems during Q1 and we are the only supplier currently able to ship certified modules to Korea This a significant opportunity, but the Korean government is bit planning to deploy digital cable television between 6m and 9m households over the next several years. Our strategy and

to be includes finding new broadband base operators as they look to convert to a customer base digital technologies, hereto we achieved successes in Q1. We assigned two new regional operators, one in the UK and one in Turkey to provide to the movable security modules for digital broadcast. Together, these operators serve over 1m subscribers. We will be announcing the details of these new customers in the next few weeks. We are hopeful that these new opportunities in Korea and Europe will help to offset the decreases we have experienced in our traditional European module business. As we have discussed previously, gray market competition in the form of unlicensed modules has happened to change dynamics of this business, resulted in the loss of market share of a flat yen, however, if those modules are unlicensed technologist on the security companies, we expect that we will take, we will fight this together with the conditional access system provider. In August of 2003 we announced to breakthrough products for mobile broadcast reception on the PCs. The CeBIT show in March, we then announced our mobile terrestrial digital receiver in a PC Card form factor, and it will be available for volume shipment in May. We also announced the distribution agreement with the distribution partners of

for Europe. This receiver PC Card module enables subscribers to receive digital terrestrial broadcast TV programs and use wireless data services including Internet access on their Laptop or PDAs. It is a very exciting technology to focus worldwide with such a product and we have received the deal of positive coverage in this new product in the European trade fair.

Turning now to smart card reader business. We have achieved some positive development that relate directly to emerging market opportunities. First, we've shipped the first 10,000 units of mobile smart card readers for smart pen, which we produced in November of 2003. Smart pen enables authentication of the user for banking transactions online. We also announced another new mobile smart authentication product called my EMV for secured credit card transaction via the Internet, which is complied with MasterCard specification. Both Smart pen and my EMV utilize the smart cards to channelize a one-time password and are independent from the PC being used for transactions. European banks are actively looking for ways to increase security for their customers for online banking and throughout Europe, Canada and Brazil, and other countries where EMV's payment cards are being mandated, EMV and for common systems between Europay, MasterCard, and Visa. For those payments can't be mandated, credit cards companies are looking for ways to protect users' entrance against fraud and identity tests. In both cases, mobile authentication devices are promising and affordable low cost technology. SCM is rapidly developing products and new product capacities in emerging markets. We expect high volume deployment of these new mobile authentication technologies in 2005. In Germany, there is an increasing interest from the Federal Government and from banks in using smart cards on a large-scale basis to deliver services using digital signatures. Since 2001, digital signatures have been legally binding in Germany and the Key, and I'll start on the smart card. During Q1 of this year, we signed an agreement with T-Systems, a division of Deutsche Telekom. We supplied smart card readers to facilitate consumer authentication within the PKI framework of Germany. Today we've shipped approximately about 10,000 readers. This is an initial holdout of key systems for the German market. The solution makes it possible to generate electronics, signatures in compliance with the German signature law and to verify their origin and integrity of signed documents. During the quarter, we also signed a contract with Giesecke & Devrient, preferred vendor for all smart card readers. G&D is the third largest smart card supplier in the world and is the number one for banking applications. Finally at the March, computer ship CBIT in Hanover we launched two new products in our

lines for small business markets, both smart card office and

. Both products include a smart card reader, a smart card, and an application to improve productivity for the small office and home office markets. The key application here is the transport management, transport

stored on the smart card. We are initially marketing this product in Germany and plan to expand it throughout Europe and the rest of the world by end of the year. While financial and banking applications are the main drivers for smart card security programs in Europe, in the US the main driver continues to be the US government. For SCM, the government is a great opportunity, since it has been historically the key supplier for smart card reader technology and now the shift to physical access

. At the recent card technology show in Washington DC in April, we introduced our physical access control terminals for PAC, a product which has been under development for over a year now. Targeted at the US government, this smart card reader combines SCM's years of experience in smart card interface technology with new physical access features to safeguard entries into federal buildings and other facilities. We expect that physical access based on smart cards will play an important growth opportunity for SCM in the US. The US government's goal is to combine the logical PC network access and the physical access into buildings in one common access smart card. We are going to participate in pilot program for physical access control terminals using contactless smart cards and expect to shift working samples and photographs by the end of this quarter. In addition to executing against our new customers and into this new product in Q1, as you have seen from Steve's presentation, we have also increased our cash reserve to $56m for tightening of balance sheet and we have no long-term bank debt. While the near term outlook remains challenging, we remain very optimistic about long-term opportunities for growth in the secure access markets and about SCM's ability to capitalize on those opportunities that provide revenue and earnings growth. Now I would like to turn the call over to the operator for questions and answers.

At this time I would like to remind everyone. If you would like to ask a question, please press star, then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. The first question comes from Adrian

of DC

.

Yes, hello. Good afternoon. Just a couple of questions. Basically I would be interested to know, or let's say I was a little bit astonished about operating expenses being higher than the level in Q4. Could you give me sort of reasons for this development and also how you feel how this is going on in the next couple of quarters?

The growth in expenses was primarily in R&D and in marketing expenses. But we also did have in Q1 additional couple of compelling expenses in G&A. We did not expect to be adding significantly to expenses quarter-to-quarter through the year. The only other factor is that it was in the growth that frankly we can't predict was, we have a very large amount of expenses in euros. And we did experience the growth in the exchange aspect of our euro-based expenses.

Okay. When it comes to restructuring cost, I mean, they were pretty low in my opinion, I remember that you said last time, that we are going to expect further restructuring cost, but on a much lower level. So, my question is how will you - what is your projection for the future? Do we see similar low amounts of restructuring in the next

quarters or will there be none?

For the most part, we are through with expenses related to restructuring, the restructuring that was announced last year and for the discontinued operations expenses. We will have some continuing cost and cash cost for the restructuring. For example, costs related to facilities that we're no longer using and remain idle that have not yet been sub-leased, those who will have a cash expense, but those have been accrued for, within the discontinued operations. There are some small liabilities that are still outstanding that has not been taken care of, but for the most part that is behind us.

Okay.

In both cases.

Okay. Just two questions on the Digital TV segment. First of all, just to get an impression, would you agree that product sold in the first quarter in this segment was slightly below 150,000?

I don't think we ever talked in terms of - I don't know that we give a unit basis, clearly you can see from the breakout that we gave that our Digital Television units are down from the first half of 2003. I think that you will find that the number of units for the total revenues are similar to our first quarter shipment.

Okay. And last question from our side is coming back to the order of 150,000

for Korea. We could read in the announcement that the time span is 18 months for this order. Can you give us an impression on how this will be split up into the different quarters? I mean, will we expect ramp up of units already in the current quarter or will the most part of this order be due in the fourth quarter or just to get sort of impression?

Yes, a good one. It was started in Q2, and we have definitive schedules from the customer. And as it stands right now, we will be able to ship in Q2 and the customer will accept, will want the product in Q2, but we have to caution in initial ramps up there is always some possibilities of change.

Right.

But the good thing is, it is starting in Q2. And it's starting in Q2 with some considerable volume.

Okay.

Just to add to that, we do expect it to ramp as well. The volume that we are seeing in Q2 will be a relatively small to the entire order, but still of a quantity as represented that is significant, but we expect it to grow in Q3 and Q4. And as we said, this

hopefully that will not be the only catalog, there will be others following. With the beginning of big concession in Korea and as if probably happening soon in another countries in the world, although Germany will change in cable for some

and those transitions will take a couple of years, they will start slowly, mostly this year and next year. So, we expect a continuous ramp overall on marginal deployment for digital cable.

Okay. Just another follow-up question. We saw that - you said the margin in the Flash Media interface segment was 63%. Is that correct?

It's correct.

Okay. So this is significantly higher than the average of last year, where this from one time effect or should we expect this pretty high margin to continue of growth in next couple of quarters?

My first answer would be, Steve can go with more details. We have - now in the separation sale of the retail type of business, we have basically eliminated any low margin business. This Flash Card core leader technology, which we have kept, these is to base

camera technology companies OEM business.

And we have a leading market position there and a good and quality and service. So that's the reason their margin is higher, however the revenues overall is not that big.

I guess, I might add that there is some mix there as well within that -- we also -- the other element that we sell within that product line with the ASICs too that are used by OEMs for the digital media reading. Our mix has improved for the reader products for kiosk from the ASICs. We expect that mix to remain favorable going forward.

Okay. Okay, thank you. Brilliant.

Your next question comes from Thomas Becker of HSBC.

You're right. Thank you for taking my questions. First of all, probably you can clarify to your talking about operating expenses. What percent of your operating expenses is in euro?

About half, a little more than half, but about half.

Okay. Next question is, probably you can remind me, what's your current number of employees?

Well, the total including contractors and temporaries is about 360. That would include a fairly high number in India, so it may not be on an apples-to-apples if you are thinking here on Europe.

Okay, thank you. And probably just one question to Robert, you are talking about grave market competition in Europe. Can you probably clarify how you want it to target this competition, because it seems to be that is heating in the last months and that is really, let's say they are already depressing your market share?

Yes, good question. It's -- we have started to take some actions in Q3 of last year and was happy to have successful decisions to our favor in court. In Germany, when we started to go against them, the non-licensed module distribution, which is mostly for

applications, we have received ten injunctions like port. That's a basic sensible initiative. We will be continuing to do this, we are now inviting the security cumulative condition of access companies, because they have been not as successful as we've been and so we hope that they will join in the fight against the illegal access and then of course we might expand this activity into France, UK or other countries, but then we would do it alone. We would like to have the industries joining us. And we have some strong signs that they would be joining us in fighting the hacker scenario.

Yes. It seems to be a thing without hands. First of all the magic cards, then this joker card and the

things are changing, but --?

Now, if you are in a security business and that's true for any security company you have. This is part of your job to fight the illegal companies who I would like to supplement and it's ongoing -- I think, overall all those things will be about a 20% of the market which is illegal, I mean, that's kind of the average today even without modules. So if you look at the digital TV and pay-TV scenario, it's estimated that dependent upon different countries but between 20% and 30% of the access is unauthorized.

Okay.

Hence there's a real need for better security.

Okay. Probably one last question regarding the gross margins, you talked about the Flash, good Flash gross margins, flash media reader. What about the smart card reader side and the digital TV reader side, can we expect that we will see, I'd say gross margins on that level for the next quarter going forward?

We would expect the digital TV to be higher than we had this quarter, because we included in the -- well, two things hit us, but the major chunk was taking an inventory provision net of about $400,000, which is played into that. Additionally, we -- the mix within our various CAMs, our various conditional access modules have different margins depending on customer and depending on the kind of conditional access software that's been loaded. So our mix is also a little bit unfavorable relative to other quarters. So, we certainly would not expect it to be in the 20s, we would expect it to be higher.

Okay, fine. On the smart card reader business?

I'm not going to give -- again, our overall guidance is to remain in the 40% to 42%, but I would have to say that we are seeing within Europe and the United States ASP pressure, but we are also improving our cost to work. We are not expecting our margins to deteriorate in any big way in smart card readers.

Okay, thank you very much.

Your next question comes from Adrian Hopkinson of WestLB.

Good afternoon. Just a general question. Is this coming across or -- can you hear me?

Yes, we can hear you.

Just a general question first on the Digital TV and the laptop. I couldn't quite understand the marketing channels you plan to use for that?

Yes, good question. Because the company is wholly not well known. We have developed this technology, which is a set-top box, a little too convergent technology between a set-top box and a PC, in a PC platform factor. We have had couple of distribution companies to try to get the right to sell it and we've decided to cooperate with one which is actually a part of the Catherine Group, I'm not sure that a consumer company and in fact, they are the worldwide leading provider of antenna, and since you need a specific antenna for this product, a tiny small antenna for the laptop, we decided to go with them and actually they have developed the antenna and they will sell the product in one retail pack, and

is really a subsidiary of the Catherine Group.

Okay. Do you imagine the product that are having a fairly rapid take off or is it -- are we talking about really selling through in large groups to metro or are we talking about selling to business users, how do you think it's taking off?

No, it seems to be an end-user, it is an end-user product. Therefore, we need a retail distribution channel which we have within OEM basically to us, which is serving that market and the end-user benefit is that wherever there is digital terrestrial broadcast and it's starting in some areas in Germany and in Scandinavia, you could tap the full Digital TV content on your PC screen by plugging in this little tiny PC card. And so this is really an end-user, a simple end-user application, which at the moment has no security features. That seems there is no pay TV over free-to-air. The expectation is that they are difficult to judge, definitely by end of this year in Germany alone, there will be -- I think it's fairly

than the industrial areas in the northern pat of Germany. So about one-third of the German population will be available, will be receiving digital terrestrial signals. So the potential market is assembly of this, plus who had a notebook PC. Potentially, you talk about of millions, realistically it's in the tens of thousands, what we expect in the next couple of quarters.

Okay, and the consumer will buy it in the media market or factoring or somewhere like that?

Yes, I'll give it by in special retail shops and maybe eventually in the later stage at the mass-market shops.

Thanks very much. Can I just follow-up with two financial questions? The inventories jumped a quite bit in the first quarter, is this caused by new products, or I just want to know about the general explanations there? And on the PC security side, obviously, you are making very good progress in Europe. Could you give us a rough split in that business area between the US and Europe currently?

Okay. For inventory, inventories grew because we ordered one lead-time component frankly to a higher revenue level demand forecast in the fourth quarter and they were delivered in the first quarter. The good news there is just everything that we did order is for current products and the product -- the components will be used. So we do expect to draw down our inventory levels over the next several quarters. Within the split of revenues, the PC securities.

At this point larger within Europe than it is within United States. Again sort of emphasizing what I said in the prepared remarks, the United States PC security market is primarily a government market and we are currently in bidding stages and in pilot stages on projects there. But, there are no current mass government projects going on in the United States. Whereas the market in Europe for Smartcard oriented security is broader based with a variety of customers mostly revolving around the banking industry. And we see that not kicking off but increasing at a good pace and we are participating in that growth very nicely. It currently as I said is larger than what we are seeing in United States, but we could see that turn around rapidly if the government deployments take off again later in this year.

Yes.

Robert, any comments to that?

I mean it does look as if the 35% of sales in the United States is a bit lower than what you would normally have. And I wondered whether may be in the Digital TV area, you might expect now some developments as we draw close to the 2005 deadline?

Yes, Adrian certainly as Steve said, we are very sure about the government secure access business, and we are

and there is the next wave coming, and it's starting with a pile

this year. In the Digital TV side, there is the agreement that Consumer Electronics Association has reached with the US OpenCable is that all at the ITTV level, at the integrated digital TV set level, which really start to take off in volume by Christmas season in the US this year. That will be a module technology deployed. The problem of course we are faced in the US is that companies like Motorola have their security systems and they make their own modules, kind of a fully integrated technology company. So, and the thing is they have some almost monopoly in the US for security in cable. There is not much left to independent companies. So, in other words, the FCC decision of the US as it is of now is starting to mandate deployment of modules. But it's not starting to mandate the change of security systems in the US in the head end equipment. So, we will see a small business for us for whatever is non-Motorola GI Type business in 2005. But it will not be a substantial contributor to our Digital TV business in 2005. We believe much more that the government secure access and authentication business will be a key contributor from the US for filing in end of this year.

Okay, great. Thank you very much. Thank you.

At this time, there are no further questions.

In summary, we believe that SCM is uniquely positioned to capitalize on long-term of

in the markets for security access and we are financially strong enough to hold our core as these markets develop. Thank you for joining us today.

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