Identiv, Inc.
Q3 2018 Earnings Call Transcript

Published: 10 Nov 2018

[Operator:]

Good afternoon. Welcome to Identiv’s Q3 2018 Earnings Call. My name is Steve, and I will be your operator this afternoon. Following – joining us for today’s presentation are the company’s CEO, Steve Humphreys; and CFO, Sandra Wallach. Following management’s remarks, we will open the call for questions. Before we begin, please note that during this call, management may be making references to non-GAAP measures or projections, including adjusted EBITDA. In addition, during the call, management will be making forward-looking statements. Any statement that refers to expectations, projections or other characteristics of future events, including financial projections and future market conditions, is a forward-looking statement. Actual results may differ materially from those expressed in these forward-looking statements. For more information, please refer to the risk factors discussed in documents filed from time to time with the SEC, including the company’s latest annual report on Form 10-K. Identiv assumes no obligation to update these forward-looking statements, which speaks as of today. I will now turn the call over to CEO, Steve Humphreys, for his comments. Sir, please proceed.

[Steve Humphreys:]

Thanks, operator, and thank you all for joining us. In the third quarter, we took more major steps towards our vision of delivering a platform to make the physical world as secure and convenient as the digital world, and we also made substantial progress, building a strong business to deliver that vision profitably. We also executed a subsequent event, the merger with Thursby Software Systems, that’s a further big step in both the vision and building our businesses’ strength, which we’ll talk about in a lot more detail later today. But first a few highlights from our third quarter. We continue to have strong revenue growth and to take market share. We grew 30% year-over-year, and year-to-date, we grew 30% as well. Now this is really the most important data point because growth can always hit in a single quarter or there can be a comparable quarter that’s more or less favorable but to have 30% growth throughout the year compared to nine months of last year, which shows the sustainability of our strategy, our execution and of our markets. And once again, more than half of our growth came organically also during both the quarter and year-to-date. So all of this shows that our strategy is really working. We’re clearly growing faster than our competition, faster than the market and building our strategic position. Now in addition to the sustained growth, the growth has been broad-based across our business. Our Premises segment grew 58% year-over-year. Now certainly, our 3VR acquisition contributed and we’re very happy with the progress we’re making there, but just as important, our physical security products drove well over half of this growth organically. In fact, we had record physical access panel sales and access reader sales. And as an aside, we did this while also having some quality and delivery problems from one of our vendors, HID. Their problems held back over $300,000 of physical security orders we had ready to go. Now fortunately, our business is so strong and diverse, we absorbed it without affecting our overall business and we’ve now cleared all that backlog in the current quarter. In addition to the strength in physical security, our Identity business grew 12% year-over-year, bouncing back to double-digit growth. And we expect this segment to accelerate with the addition of Thursby, which brings more of the mobile software and security value-add that we wanted to add in this segment. Again, I’ll talk about that in a bit more detail later. Our Credentials segment also grew 12% year-over-year. So you can see we’ve got growth coming across the board and sustainably. Now this strength on the top line has been complemented by our continued operating discipline. One of the most important indicators of the healthy nature of the growth we’re driving is that gross margin is up on a GAAP and non-GAAP basis over three percentage points versus third quarter last year. Operating expenses continue to be well under control, even decreasing sequentially as expected. So as a result, our positive adjusted EBITDA of $1.7 million reflects over two years of consistent positive EBITDA now. So looking at the business progress in a bit more detail. As I mentioned, Premises has been particularly strong, especially our Hirsch Velocity and Cisco ICPAM access control products. Just as important though, our TS Readers are among the most advanced in the market, another platform that we’re adding a range of sensors and RF capabilities into, creating that always on, always aware platform that we envision for the physical world. Our TS Readers within the segment grew 30% sequentially and over 90% year-over-year. Now this is a great indicator for the product but also for our overall strategy. Now of course, our readers are particularly well-suited for federal government FICAM installations and the continuing progress that FICAM helped, but the TS Readers growth clearly showed strength in commercial as well as federal. Now in addition to this product progress, our services business, Identiv Global Services, is kicking in. We’re taking more of the total solution revenue associated with selling our platform, driving software and services revenues up 15% sequentially. And some of these contracts will continue to add revenues recognized in Q4 and carrying throughout 2019. On the federal government side, these IGS contracts are growing. FICAM and FICAM-ready continue to be growth drivers. We’re expanding our presence with marketing activities, such as the picture on the right, which is from the Government Matters news program, and we’re also hosting an open house next month for our new office in Arlington just outside DC. This office has a full lab, training, meeting and demo center, and it’s across all of our product lines that we have demo setup for, showing them individually and integrated, including 3VR video, Hirsch and ICPAM access controls, TS Readers, our smart card readers, soon our Thursby product line and, of course, our RFID products. And since I just mentioned 3VR in my federal government comment, it’s worth focusing there for a moment. Here, we’re getting leverage across the board. I had mentioned before in a prior call the shopping mall example. These malls are now expanding and going into later pilot phases in production. But what’s more important is with 3VR, we’re seeing the leverage we hope to see in any inorganic combination. There now are several dozen video opportunities being tracked through our core regional sales teams, and these are in addition to the business that 3VR brought in at the time in the merger. So you’re really seeing leverage out of the organic and inorganic strength that we have in the video space in particular. Turning to Identity and Credentials. I mentioned earlier the 12% year-over-year growth, but there was also a 20% sequential growth. This was driven by a strong fiscal year and government quarter reader chipset sales and e-voting project in Asia, reader modules for payment applications and more. And really, this shows the diversity of applications of our Identity technology, which really continues to deliver as one of our core strengths. In Credentials, we saw healthy growth in both revenues and gross margins. As many of you know, this a great segment with explosive growth potential, but the challenge is always delivering value-added solutions with stronger gross margins. So the segment increase of four margin percentage points is one of the best indicators we hope we can have in this segment. We’re also positioned for stronger growth in Credentials as our new UHF capacity and technology capabilities come online, which is happening as we speak in this quarter, as we’ve discussed before. And last but not least, on November 1, we completed our merger with Thursby Software Systems. Now I’ll go into the implications of this very positive combination for our Identity segment as well as for our business and strategy overall in just a minute. But first, I’d like to turn the call over to Sandra to review our full financials. And after that, we will discuss Thursby and our outlook for the balance of the year and into 2019. Sandra?

[Sandra Wallach:]

Thank you, Steve, for providing the context for our financial results for the third quarter of financial year 2018. Our revenue in the third quarter was $20 million, a 30% increase compared with $15.4 million in the third quarter of 2017, and a 1% sequential decrease compared with $20.3 million in the second quarter of 2018. Our Premises segment generated 47% of our total revenue or $9.4 million in the third quarter 2018, up 6% sequentially from the second quarter 2018 and up 58% from the comparable quarter of 2017. These increases were primarily driven by higher physical access control solution product sales, higher sales through our channel partners, software licensing sales, as well as the sales of video, technology and analytics hardware and software products and related support services following the 3VR acquisition. Revenue from our Identity products, primarily smart card readers, reader modules and chipsets, was $3.8 million in the third quarter and drove 19% of our total revenue. This represents a sequential increase of 21% from the second quarter of 2018, as the result of higher smart card reader sales in the Asia-Pacific region, partially offset by lower smart card reader sales in the EMEA region. Comparatively, Identity revenue increased by 12% from the third quarter of 2017, reflecting higher sales of smart card readers in the Americas region, partially offset by lower smart card reader sales in EMEA. Approximately 34% of our third quarter revenue or $6.8 million was derived from our sales in our Credentials segment, which comprises both access control credentials and transponder products. This revenue represents a sequential decrease of 18% from Q2 of 2018, primarily due to lower access card products and RFID and NFC transponder product sales across all regions. Comparatively, Credentials revenue increased 12% from the third quarter of 2017. This change was primarily due to higher access card product and RFID and NFC transponder sales in the Americas and EMEA regions, partially offset by lower transponder sales in the Asia-Pacific region. Now turning to our gross margin. Our GAAP gross profit margin was 42% in the third quarter of 2018, compared with 40% in the second quarter of 2018, and 38% in third quarter 2017. Our segment GAAP gross profit margins continue to be strong and stable, with Premises at 57% for Q3, and 56% year-to-date; Identity at 35% for Q3 and 35% year-to-date; and Credentials at 26% with 25% year-to-date. On a non-GAAP basis, excluding certain noncash items, our gross profit margin was 44% in the third quarter of 2018, compared with 42% in the second quarter of 2018, and 40% in the comparable quarter 2017. The sequential and comparative increases in both GAAP and non-GAAP margins are primarily a result of product and channel mix with a higher proportion of our current quarter sales represented by our Premises segment. On the next page, we now take a look at our full income statement per the earnings release. Our GAAP net loss for the third quarter was $0.3 million, compared with a loss of $2.7 million in the second quarter 2018, and a loss of $1 million in the third quarter of 2017. Sequential decrease in net loss is primarily a result of a $1.4 million loss on extinguishment of debt recorded in the second quarter that did not recur. And in fact, we’re pleased to note that our GAAP results this quarter adjusted for transaction-related cost and restructuring would have our Q3 net income on the slightly positive side, signaling significant progress towards achieving our goals of net income positive. On the next page, we provided a full reconciliation of GAAP to non-GAAP information, which is also included in our earnings release. A few noteworthy items include interest expense, which was approximately $0.3 million for Q3 compared with $0.5 million for Q2 of 2018, and $0.6 million in Q3 of 2017. Noncash stock-based compensation was approximately $0.7 million in the third quarter compared with $0.6 million in the second, and $0.7 million for the third quarter of 2017. Now moving on to our operating expenses, which is the next graphic in the webcast. For the third quarter of 2018, per our earnings release, our total GAAP operating expenses were $8.6 million compared with $9.2 million in the second quarter. The decrease was due both to the seasonal reduction from Q2 to Q3 with the trade show expenses always higher in Q2 as well as the continued efforts to rationalize and integrate the cost structures of 3VR and Identiv with reductions in all categories across the board. Comparatively, our total GAAP operating expenses increased $2.4 million from $6.2 million primarily due to the additional headcount and other related costs associated with the acquisition of 3VR, including acquisition-related transaction cost and restructuring charges. Our non-GAAP operating expenses, adjusted to exclude restructuring and severance costs and certain noncash charges normally excluded from our non-GAAP results, such as stock-based compensation, depreciation and amortization and loss on extinguishment of debt as well as other non-GAAP items consisting of acquisition-related transaction costs in the third quarter, were $7.2 million as compared with $7.8 million in the prior quarter and $5.2 million in the third quarter 2017. On a non-GAAP basis, our R&D expenses for the second and third quarter of 2018 were $1.6 million compared with $1.4 million in the third quarter of 2017, representing 8% and 9% of total revenue, respectively. Sales and marketing expenses were $3.4 million in the third quarter of 2018, compared with $3.8 million in the second quarter and $3 million in the third quarter of 2017. This sequential decrease was primarily driven to the decrease in trade show-related expenses and lower external services cost. In addition, our non-GAAP G&A expenses for the third quarter of 2018 were $2.1 million compared with $2.4 million in the second quarter and $1.9 million in the third quarter of 2017. This sequential decrease was primarily due to lower outside fees incurred in the third quarter of 2018. Bringing all the pieces back together, given our strong growth profile and ongoing cost controls and aggressive integration of 3VR, our non-GAAP adjusted EBITDA gain was approximately $1.7 million in the third quarter of 2018, compared to $0.7 million in the second quarter of 2018, and $0.9 million in the comparable quarter of 2017. We believe that our business model is positioned to continue to generate positive and profitable growth. Now if I could turn to the balance sheet. I’ll be comparing September 2018, to our position one quarter ago at the end of June. Cash at the end of September was $14.2 million compared with $17.9 million at the end of June. The $3.7 million net decrease in cash for the quarter primarily consisted of a source of $1.3 million cash driven by our net loss excluding noncash items, a $1.8 million use of cash from changes in operating expenses and liabilities, a $0.4 million net cash usage from capital expenses, a net cash usage from financing activities in the third quarter totaling $2.6 million, which comprised primarily of a $2.4 million net repayment of debt, and a $0.2 million tax payment related to RSU releases. As a note, at the end of the quarter, we had an additional $2.4 million available on our bank line, but we left it undrawn as we are looking to minimize interest payments in future. And lastly, there was a small $0.2 million negative impact of foreign currency fluctuation on our cash flows. With respect to our accounts receivable, our balance increased $0.1 million from $14.1 million to our – with our days sales outstanding decreasing from 55 days at the end of the second quarter, which is corrected from the previously reported 67 days, to 54 days at the end of the third quarter. Inventories net of reserves decreased from $12.8 million at June to $12 million at September 2018. Our adjusted inventory turns at September 2018, increased to 4.5 compared with 4.1 at June 2018. Accounts payable at September 2018 was $5.6 million, a decrease of $1.6 million from June, due to a decrease in our current payables and payables aged in the 1 to 180-day range based on the focus that we have in investing in the health of our supply chain relationships as we look to continue to grow. Financial liabilities of $13.2 million in September 2018, reflects our current East West Bank financial liabilities plus the $2 million note related to the 3VR acquisition. Our liabilities or other liabilities decreased in the third quarter by $0.2 million. This category includes the current to noncurrent portion of payment obligation, deferred revenue, accrued compensation and other accrued expenses. This change was primarily driven by a $0.4 million decrease in deferred revenue, a $0.3 million decrease in long-term payment obligation, reflecting the continuing quarterly payments made, partially offset by a $0.5 million increase in accrued compensation and other accrued expenses and liabilities. For completeness, we have included the full reconciliation of non-GAAP adjusted results to GAAP and the full balance sheet per the earnings release in the appendix. In the context of our target business model, where we measure ourselves with you quarterly to assess our progress, we’ve delivered what we can set out to do

[Steve Humphreys:]

All right. Thanks, Sandra. In my opening comments and in Sandra’s financial review, we covered most of our core businesses’ strengths and recent events. And I think you can see the progress we’re making in our strategy, our execution and the development of our business. Now I’d like to look forward, where we think we’re hitting our inflection point and we’re positioned to deliver as profitable, growing and strategically positioned. To do this, I’ll focus on two things

[Operator:]

Thank you. [Operator Instructions] The first question is from Mike Latimore with Northland Capital Markets.

[Unidentified Analyst:]

Hi Guys. This is Von [ph] on for Mike Latimore. I have two questions. One is like, how much of the growth in Credentials is typically from new customers going live versus current customers expansion – expanding? And I have a follow-up.

[Steve Humphreys:]

Okay. So I’ll repeat it because you were a little bit weak there. The question was how much of the growth in Credentials is typically coming from new customers versus current consumers expanding. And we have our COO, Manfred Mueller, who runs up part of the business that can give a from-the-street answer.

[Manfred Mueller:]

So the Credentials part, which is a combination of both access cards as well as transponders. So on the access card segment, I would say 80% is based on current ones, which are expanding; and 20% is new ones. On the transponder side, in terms of the new business that we are adding, we’re constantly expanding the pipeline. And I believe we have talked about this in prior quarters as well. I would say a solid 25% to 30% number in terms of new customers being added over – every quarter is probably a good assessment. Certainly, new customers don’t contribute immediately in terms of high revenue, but it’s just going to be giving us more breadth in terms of, like, pipeline and giving us the right base for future growth.

[Unidentified Analyst:]

And my second question is, what are the top three, four applications showing most growth for Credentials?

[Steve Humphreys:]

So the question, I think, was the top three or four applications for the – driving the most growth for Credentials. Again, I’ll turn it over to Manfred.

[Manfred Mueller:]

All right. So I can comment on that. I would say there is a couple of major trends out there. One, certainly, is anything related to NFC applications, which are adopted throughout multiple verticals out there. So most of our top growth projects right now and also most of the – some of the most attractive ones out there are related to various verticals, like in the apparel industry, in the toy industry. There is sports companies out there. We have companies in the pharmaceutical and in the health area out there that are adding NFC RFID technology to any of their products out there. And it’s either a combination – it’s basically a combination of both consumer experience so that there’s an enhanced use case out there or its brand authenticity in that area. So the lion’s share of all these, let’s say, new application basically fall into that camp. And you might remember about one year, 1.5 years ago, when Apple finally had adopted NFC technology to their iPhone, it was basically the first boost. And then there’s a new one very recently because the new iPhones have, like, the RFID polling, always on, which means it makes them an even more attractive, let’s say, end point device out there. So that will be triggering some more demand going forward. And another area out there – and that’s also one of the areas where we are really expanding out there in terms of, like, growth. And that’s also related to some of the extended production capacity that we just have added in our Singapore plan is related to UHF, and most of the use cases in that area and the implications are in very classic asset tracking and inventory management areas.

[Unidentified Analyst:]

Okay, thanks.

[Operator:]

The next question is from Jack Vander Aarde with Maxim Group. Please go ahead.

[Jack Vander Aarde:]

Hi Guys. So I was just curious to know in terms of the FY 2018 guidance, I see that the revenue range has tightened to $76 million to $78 million. And then I just had a question about the EBITDA range tightening. The prior guide reference was to a $4 million to $5 million EBITDA. I recall it was $4 million to $6 million. Was that restated at one point?

[Sandra Wallach:]

No, the guidance that we came into the year and shared was $4 million to $6 million, and we’ve tightened it now to $4.5 million to $5 million.

[Jack Vander Aarde:]

Okay. And then, I guess, I missed the GM breakup by segment? Could you just quickly provide that again?

[Sandra Wallach:]

Absolutely. So Premises, on a GAAP to gross margin basis was 57% for the quarter, 56% year-to-date. Identity was 35% for Q3 and 35% year-to-date. And Credentials was 26% for the quarter and 25% year-to-date.

[Jack Vander Aarde:]

Got it. That’s helpful. Thank you. And then with the FY 2019 initial outlook, I think you said mid- to high teens is the initial outlook, with at least 50% of the growth driven by organic. Can you talk about how you think of Thursby contributing to that mid-to high teen growth?

[Sandra Wallach:]

Yes. So right now, we are projecting that Thursby is going to add $5 million, $5.5 million of top line to our guidance for next year and that we’ll sit on top of our organic growth.

[Jack Vander Aarde:]

Okay, great. Thank you guys and great quarter and that’s all for me.

[Steve Humphreys:]

Thanks Jack.

[Operator:]

The next question is from Jaeson Schmidt with Lake Street Capital Markets. Please proceed.

[Jaeson Schmidt:]

Hi guys, thanks for taking my question. I apologize if I missed it, but could you comment on if you’re seeing anything out of the ordinary from a pricing standpoint across any of the three segments?

[Steve Humphreys:]

Yes, a good question. We don’t talk a lot about pricing because we’re fortunate to not have substantial pricing pressure anywhere in our business model, and you can see with the expanding gross margins that we’re not having prices driven down. And in fact, we’re driving down COGS. So Premises, in particular, has always been resistant on a price perspective. So we really see very little price pressure there; Identity as well, smart card readers and the solutions there, very little. Sometimes, on the Credentials side and, in particular, on the transporter as well as access cards, on a deal-by-deal basis, it can be competitive and price-competitive, I mean. But our positioning, especially in that category, is very much around higher-end, value-added applications. And that’s where some of the larger corporates turn to us and that, therefore, gives us something of an umbrella related to price. So I’d want to give you some color and I didn’t want to be so glib, but price really has not been creating pressure by average unit prices on a year-over-year basis.

[Jaeson Schmidt:]

No, that’s very helpful. And then looking at the Premises segment, I don’t know – you mentioned seeing strength from both commercial and federal in the TS Readers. Do you expect both of those markets to continue to show momentum? Or was this commercial strength more of a – I don’t want to say one-time phenomenon but kind of more of a near-term event.

[Steve Humphreys:]

Yes, a really good question. We actually think it is a secular event. It’s an ongoing event for three reasons, both kind of near, medium term and vision-wise. Near and medium term, we’ve got some very nice – speaking of price positioning, price competitive positioning on our products, we’ve got some OEM solutions whereby we’re taking our technology and putting it in readers of even some Silicon Valley start-ups and others that are in the physical security space. And we’re then leveraging their volumes as they grow. And then thirdly, as I mentioned, TS Readers, the readers at the door, are really a strategic initiative for us. We see that as the fundamental sensor to this situationally aware physical environment, where we’re going to be putting more and more in there, certainly first the RFID. You should have audio, you should have video, you probably should have infrared, and you probably should have Bluetooth and WiFi radios all in there. And we’ll be adding more and more value into our readers. And so – but we’re doing it carefully. The market can only absorb it at certain rates, but that’s the category that we really expect to be, long term, strategically growing for us. And I think we’re starting to see that just now.

[Jaeson Schmidt:]

Okay. And the last one from me and I’ll jump back into queue. Can you remind us how we should think about your quarterly breakeven revenue run rate and with the Thursby acquisition if that changes anything?

[Steve Humphreys:]

You mean about the seasonality?

[Jaeson Schmidt:]

More so just with the Thursby contribution, if that changes the breakeven revenue run rate.

[Steve Humphreys:]

Oh, fair point on the breakeven revenue run rate. I don’t – Sandra and I are looking at each other across the table. I don’t think it changes dramatically the breakeven revenue run rate. It is true Thursby gross margins are in that 70% plus that you would expect with the software business. But from the numbers, as Sandra indicated, it’s starting out of the small portion of the business. So it’s not going to fundamentally change it, but it definitely strengthens the business. And there’s an indication of our intention of driving more software content and higher gross margin content, but that’s going to be over the next several quarters and couple of years.

[Jaeson Schmidt:]

Okay, thanks for your guidance.

[Steve Humphreys:]

Thank you Jaeson.

[Operator:]

[Operator Instructions] The next question is from William Gibson with Roth Capital Partners. Please proceed.

[William Gibson:]

Hi Steve. You’ve already owned Thursby for a week and you talked about wanting to buy capabilities that you can leverage, but what’s the environment like out there in being able to do that on an accretive basis? I would think pricing is a real problem.

[Steve Humphreys:]

You have a very good question. And I think that’s why you see our transactions involve a substantial portion of equity because I think they see the opportunity in our business together. And I’ve talked about Thursby being relatively small at this point, but you can hear all the leverage points. So I think the ability to drive our overall value that they can participate in is an opportunity that we have that someone like a Cisco or a major, Fortune 100 acquirer can’t offer, you better get it in your upfront consideration or you’re pretty much done. So that’s certainly part of where we commence the value. And then the rest is along things like culture alignment. We have been working with Thursby, for example, for seven-plus years. And the companies that we tend to bring in on an inorganic basis are accretive partly because of the relationships we’ve already got and the strategic complementarity.

[William Gibson:]

Thanks Steve.

[Steve Humphreys:]

Thanks William.

[Operator:]

[Operator Instructions] At this time, this concludes the company’s question-and-answer session. If your question was not taken, you may contact Identiv’s Investor Relations team at [e-mail]. I’d now like to turn the call back over to Mr. Humphreys for his closing remarks.

[Steve Humphreys:]

All right. Thanks, operator, and thank you all for joining us. As you all know, we’re very active in the investor and with our commercial community. And we welcome you to join us at any of our events. Next week, for example, we’ll be at the Roth Tech Day in New York. Also, on the business side, the Thursby team, next week, will be at TechNet Asia-Pacific, which is sponsored by the Armed Forces Communications and Electronics Association in Honolulu. Also, on the business side, on December 6, we’ll be hosting an opening celebration for our expanded Washington D.C. office. And then back on the investor side, we’ll be at the Imperial Capital Conference in New York on December 12. So thank you very much for joining us for this discussion today, and we look forward to seeing you at any of these events and we hope you all have a very good evening.

[Operator:]

Thank you for joining us today. You may now disconnect.