INSIDE Secure announces full year 2015 results along with Company repositioning and restructuring

Aix-en-Provence, France, February 25, 2016 – INSIDE Secure (Euronext Paris: INSD), a leader in embedded security solutions for mobile and connected devices, is today reporting its consolidated results ^[3]for the financial year 2015 and announcing its new strategic plan and a reorganization plan of its worldwide activities.

2015 Financial Results – Key Figures

Commenting on these results, Amedeo D’Angelo, President and Chief Executive Officer of INSIDE Secure, stated:

“Since taking the leadership of INSIDE Secure in October of 2015, my team and I have conducted an in-depth strategic review of our business lines within the current competitive environment. It is clear to us that our company’s key strengths and advantages lie in our core software and intellectual property security and technologies, which addresses the rapidly growing mobile payment & banking and Internet of Things, as well as developing and marketing our differentiated embedded security technologies. We will aggressively move to extend our leadership in these markets.

“We have also determined that we do not have the sufficient scale or financial capacity today to successfully sustain our semiconductor business. Consequently, we are taking the difficult decision to discontinue these efforts. We have entered into exclusive negotiations with a potential acquirer for the semiconductor business to ensure continuity for our customers. In addition, we will further streamline our operations as needed to better align with the size of the business.

“Our goal is to focus all of our energy where we can expand our market leadership, support our customers and return quickly to profitable growth. With our deep expertise and strong capabilities, I am confident we will succeed.”

Details on the Company’s strategic repositioning

1. Secure Transactions division: Exit from the semiconductor business

Exclusive negotiations commenced with a view to selling the semiconductor business

INSIDE Secure has entered into exclusive negotiations with a potential acquirer with a view to selling its semiconductor business. The scope of the transaction would include products, technology, customer agreements, certain patents and, more generally, the assets related to the development and sale of secure microcontroller-based integrated circuits, as well as a complete team (R&D, sales, marketing, support). This scope largely comprises the semiconductor activities of INSIDE Secure centered around the Internet of Things, anti-counterfeiting and brand protection, EMV payment card and secure access.

At the same time, INSIDE Secure is working with one of its strategic customers on the transfer under license of a line of semiconductor products developed specifically for this customer, together with the associated resources.

These projects follow on from the outsourcing agreement entered into in June 2015 with Presto Engineering covering the engineering of the integrated circuits and the supply chain management activities.

In combination, they should provide INSIDE Secure’s customers with an ongoing solution both for their development projects and for the sourcing of existing products.

Restructuring plan ^[4] for the residual semiconductor activities and, more broadly, the Company’s worldwide organization

In parallel to the sale of the semiconductor business to a third party, the Company plans to launch a restructuring. The aim is to tailor the Company’s resources to fit its future size and to pave the way for it to reach and then move beyond its operational breakeven point. The plan also aims to reduce and adapt selling, general & administrative costs, refocus the research and development activities and improve its sales and, more generally, its operational efficiency.

This restructuring could potentially lead to a reduction in INSIDE Secure’s workforce in France and the other countries where it operates (around 15% of its current global staff). This plan will be implemented in accordance with the laws and regulations of all the relevant territories, and will, in France, be subject to an information and consultation procedure for the Works Council.

The Company aims to achieve its target organization by the beginning of the third quarter of 2016.

The Company estimates the reorganization is likely to lead to a restructuring expense of around $4 million in 2016. INSIDE Secure is targeting a reduction in its operating costs of around $4.6 million on an annualized basis upon completion of this reorganization.

2. Mobile Security division: completion of repositioning of the Company in software security and embedded security technology licensing

INSIDE Secure’s exit from the semiconductor activity would help to concentrate all its efforts on its core software security business serving the expanding payment and mobile banking markets, as well as embedded security technologies.

This business would then have a leaner cost base as a result of the envisaged restructuring plan, and it would be able to call on two well-known and expanding strategic offerings:

• The software and application protection product lines, providing software solutions securing all banking transactions and mobile payments, as well as for any secure exchange between fixed and connected devices, a technology that lies at the heart of the Internet of Things.
• DRM (Digital Right Management) solutions enabling secure content access and protecting rights anywhere, at anytime, and from any device and allowing broadcasters, content owners, mobile operators to provide a variety of purchasing and consumption models for premium multimedia content to consumers. Secure communication solutions (VPN or Virtual Private Network) helping enterprises and governments secure access to critical information for employees from anywhere, addressing demand for mobility such as bring-your-own-device through certified cryptography, authentication and secure protocols.
• An intellectual property offering (IP blocks or components) that customers can integrate directly in the design of their semiconductor platforms. For example, an IP component can be added to the core of application processors and SoC (Systems-on-Chip) chips, introducing an optimum level of security for smartphones and connected objects.

In addition, the NFC patent licensing program managed by France Brevets will be handled at corporate level rather than being handed over to the Mobile Security division because of the specifics of this program and the fact that it is not strategic for the embedded security market,

1. 3. Launch of a project of two successive capital increases

To increase its financial flexibility and its financial strength, support the development of its software and technology licensing activities and better serve its customers, the Company has announced its decision to launch soon two successive capital increases for a total amount of approximatively 7 million euros (issue premium included).

The Company will launch first a capital increase with preferential subscription rights granted to existing shareholders for an amount of approximatively 5 million euros (issue premium included). This capital increase should be carried out in the next few weeks, subject to market conditions and the visa of the Autorité des marchés financiers on the prospectus relating to this operation. This issue will have the backing of Jolt Capital, a fund investing in medium-sized technology companies in Europe, which has undertaken to subscribe for 75% of the shares to ensure the success of the issue.

The Company will also propose by 30 June 2016, a capital increase without preferential subscription rights for the benefit of Jolt Capital for an amount of approximately 2 million euros (issue premium included) at the price of 0.75 euro per share to a vote at the Extraordinary Shareholder’s Meeting. Bpifrance, shareholder of the Company, has committed to vote in favour of this transaction.

Fourth-quarter and full-year 2015 financial highlights

Fourth-quarter and full-year 2015 revenue

Revenue by operating segment:

Revenue by category:

Consolidated revenue in the fourth quarter of 2015 amounted to $15.8 million, representing a decline on both the third quarter of 2015 and the fourth quarter of 2014. The Company did not achieve the expected increase in the second half of the year, despite the surge in revenue from the application protection software product line.

Adjusted operating income

Adjusted gross profit amounted to $32.8 million (46.8% of revenue) in 2015, down from $74.4 million in 2014 (59.3% of revenue), which included non-recurring high-margin revenues in relation with NFC technology and patent license to Intel and NFC patent license under the partnership with France Brevets.

The Company’s adjusted operating expenses amounted to $53.8 million in 2015, down 19% on the previous year. In the second half of 2015, adjusted operating expenses totalled $26.6 million, representing a small decline compared to the first half of 2015 and a steep fall in comparison to the second half of the 2014.

The decrease in operating expenses in 2015 compared with 2014 reflected the shift in INSIDE Secure’s business model towards higher value-added security activities, including the impact of:

• The June 2014 licensing agreement with Intel, under which an R&D team was transferred to Intel from the second half of 2014 onwards, and
• The outsourcing of the engineering and supply chain management activities to Presto Engineering on June 30, 2015, including the transfer of a team of about 40 people.

The decrease in operating expense was also due to the appreciation in the US dollar against the euro ^[5], which, as anticipated, had a positive impact on adjusted operating expenses in 2015, for $4.2 million.

As a result of a lower revenue and despite a significant decrease in operating expenses, INSIDE Secure recorded an adjusted operating loss of $21.0 million for 2015 (vs. income of $8.1 million in 2014).

EBITDA

In 2015, EBITDA showed a loss $17.6 million (compared with income of $12.9 million in 2014) as a result of the adjusted operating loss, while the depreciation expense was $1.4 million lower in 2015 than in 2014.

Financial items

Net financial income was - $1.0 million in 2015 (against -1.7 million dollars in 2014) consisting mainly of the impact of the evolution of the EUR / USD exchange rates and interest expense on asset-backed financing (R&D tax credit).

Consolidated net income

The group’s share of the consolidated net loss (IFRS) was $44.6 million in 2015, representing a significant deterioration on the loss of $5.0 million recorded in 2014. In addition to the adjusted operating loss of $21.0 million, the consolidated net loss can be explained by:

• The still significant burden of (non-cash) amortization expense related to intangible assets arising from the Company’s acquisitions in past years (SMS in 2010, ESS in 2012, and Metaforic in 2014), which amounted to $11.3 million in 2015 ^[6] (compared with $13.7 million in 2014);
• A non-recurring, non-cash impact of $2.7 million for the impairment of long-term assets, net of the reversal of accrued liabilities, related to the semiconductor business; and
• The recognition of a $7.0 million charge in connection with the implementation of the partnership agreement for the outsourcing of INSIDE Secure’s engineering and semiconductor supply chain activities to Presto Engineering Inc. on June 30, 2015, and with the anticipated outlook for the semiconductor activity.

Business segment analysis

Mobile Security

The division’s revenue amounted to $27.0 million in 2015. This reflected a disappointing performance by the embedded security solutions product line (largely owing to lower-than-expected royalty payments from certain customers, also lower than in the previous year) and the lack of any revenue from France Brevets’ licensing program for INSIDE Secure’s NFC patents.

The software protection and HCE mobile payment product line continued to experience strong momentum. In particular, INSIDE Secure executed a multi-million dollar software protection licensing agreement with one of the three largest banks in the U.S. to enhance the security of mobile applications provided by the bank to its employees and customers. Revenue from this deal was recognized in the third quarter of 2015. This contract joins the licensing agreements sealed with a major U.S. retailer and, in the second quarter, with one of the leading US healthcare insurance providers, demonstrating the potential of INSIDE Secure’s security offering in the field of mobile applications for the financial and retail industries in particular. Accordingly, this product line generated revenue amounting to several million US dollars in 2015.

The division’s adjusted gross margin amounted to 86.9% of revenue in 2015, reflecting the favourable product mix consisting almost solely of licenses, royalties and maintenance revenue.

The Mobile Security division recorded an adjusted operating loss of $8.5 million in 2015 (vs. operating income of $11.5 million in 2014) as a result of:

• Lower revenue in 2015 (revenue recognized under the licensing deal with Intel and licenses to NFC patents in 2014), and
• An expense related to the development and marketing of INSIDE Secure’s embedded secure element, which did not generate any significant business volumes in 2015. Company anticipates to significantly reduce the 2016 corresponding expenses in the context of the reorganization plan described above.

The division recorded a $7.7 million loss at EBITDA level in 2015 (vs. EBITDA of $12.4 million in positive territory in 2014).

Save the embedded secure element related operating expense, the Mobile Security division remained significantly profitable in 2015, both in terms of adjusted operating income and EBITDA.

Secure Transactions

The Secure Transactions division’s revenue totalled $42.4 million in 2015, down 35% on the previous year. As stated in previous quarters, sales of INSIDE Secure’s chips and modules for the US market as it transitions to the EMV standard remained disappointing, confirming the issues the Company faces in generating a satisfying market share in this business. The secure access (excluding 2014 revenue from a one-time, non-recurring order of chips together with a licensing agreement from a longstanding customer) and secure modules product lines recorded revenue growth in 2015.

The division’s adjusted gross margin deteriorated again in 2015, slipping from 31.6% in 2014 to 20.5% in 2015, largely as a result of provisions for excess inventories.

The adjusted operating loss widened in 2015 ($10.7 million, up from $5.3 million in 2014) owing to the decline in revenue, despite the reduction in operating expenses. EBITDA in 2015 showed a loss of $8.9 million (compared with a loss of $1.5 million in 2014).

Cash

At December 31, 2015, the Company’s consolidated available cash stood at $16.4 million, down from $36.3 million at December 31, 2014 and $23.8 million at June 30, 2015.

Net cash ^[7] stood at $12.5 million at December 31, 2015, compared with $25.3 million at December 31, 2014 and $22.5 million at June 30, 2015.

Cash generated by operating activities

INSIDE Secure used significantly less cash in the second half of 2015, compared with the first half. In the second half of 2015, cash used by operating activities (including financing for the research tax credit) amounted to $7.0 million, down from $11.8 million used in the first half of 2015 owing mainly to a reduction in the working capital requirement (down $3.1 million in the second half after a $4.9 million rise in the first half). The working capital requirement was cut primarily through inventory reductions ($7.9 million at December 31, 2015, compared with $11.9 million at June 30, 2015 and $9.9 million at December 31, 2014).

Over 2015 as a whole, cash used by operating activities (including financing for the research tax credit) amounted to $18.8 million, compared with $13.6 million in 2014.

Investments

Capital expenditure was very modest in the second half of 2015 and it remained low on a full year basis ($1.1 million).

Financing

At December 31, 2015, consolidated shareholders' equity amounted to $ 48.8 million. The Company did not carry out any financing transactions in the second half of 2015.

In April 2015, INSIDE Secure set up an equity line with Kepler Cheuvreux, pursuant to which Kepler Cheuvreux has undertaken to subscribe for new shares over a period of two years up to a maximum allocation of 3,400,000 shares, provided that the conditions laid down by the parties are satisfied. In April and May 2015, 400,000 new shares were issued under this agreement (for a total of 870 thousand dollars, share premium included). No further shares were issued under this equity line in the second half of 2015. INSIDE Secure retains the option of issuing an additional 3,000,000 by April 2017. However, the program was put on hold in the context of the rights issue plan described above, so as, among other reasons, to limit maximum dilution.

Outlook for 2016

2016 will be a transition year due to the implementation of the strategic transformation initiatives announced today. Through these actions, INSIDE Secure intends to focus exclusively on its activities related to software security and embedded security technology licensing and aims to generate profitable growth over time.

Conference call

In the context of this press release, the company will hold a conference call at 1.30pm (Paris time) on February 25, 2016. Access to the call will be by dial-in on one of the following numbers: +33 (0)1 70 77 09 47 (France), +44 20 33 67 94 62 (UK) or +1 866 907 5925 (USA). The presentation will be available online at www.insidesecure.com. An audio webcast of the presentation and the Q&A session will be available on the INSIDE Secure website approximately three hours after the end of the presentation and will remain posted there for one year.

About INSIDE Secure

INSIDE Secure (Euronext Paris FR0010291245 – INSD) provides comprehensive embedded security solutions. World-leading companies rely on INSIDE Secure’s mobile security and secure transaction offerings to protect critical assets including connected devices, content, services, identity and transactions. Unmatched security expertise combined with a comprehensive range of IP, semiconductors, software and associated services gives INSIDE Secure customers a single source for advanced solutions and superior investment protection. For more information, visit www.insidesecure.com