Identiv, Inc. (INVE) Q2 2013 Earnings Report, Transcript and Summary

Welcome to the Q2 2013 Identive Group Earnings Conference Call. My name is Dawn, and I will be the operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Darby Dye. Darby Dye, you may begin.

Thank you. Hello, everyone, and thank you for joining us today. We appreciate your patience. We've had a few technical difficulties this morning, so I'm glad that you're here with us and ready to start the call with us. The purpose of today's conference call is to supplement the information provided in our press release issued earlier today, announcing the company's financial results for the second quarter ended June 30, 2013. Speaking on today's call are Ayman Ashour, Chairman and CEO; and David Wear, CFO. On today's call, Ayman will review our vision and quarterly business highlights, and David will follow with a review of our non-GAAP financial results and then Ayman will close with our view of the future. Before we begin, I'd like to remind you that various remarks we make on this call, including those about our projected future financial results, economic and market trends and our competitive position, constitute forward-looking statements. These forward-looking statements and all other statements made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. The forward-looking statements we make today speak as of today, and we do not undertake any obligation to update any such statements to reflect events or circumstances occurring after today. Please refer to today's press release, our annual report on Form 10-K for the year ended December 31, 2012, and our subsequent SEC filings for a description of factors that could cause forward-looking statements to differ materially from actual results. During this conference call, we will also be making reference to non-GAAP results or projections including non-GAAP gross margin, operating expenses, adjusted EBITDA and earnings per share. Identive uses these non-GAAP measures internally and believes that they provide a meaningful way for investors to evaluate and compare our operating performance from period to period. We've cautioned investors to consider these measures in addition to, not as a substitute for nor superior to, Identive's consolidated financial results as presented in accordance with GAAP. Each of the non-GAAP measures that we discuss excludes various items. And a complete reconciliation between GAAP and non-GAAP financial measures is included in today's press release, which is available in the Investor Relations section of Identive's website. As a reminder, today's call is also available as a webcast with slides, which can be accessed from the Presentations, Reports and Webcasts page within the Investor Relations section of our website at www.identive-group.com. If you are viewing the webcast, you may enlarge the slides of this presentation by clicking on the magnifying lens in the bottom right-hand corner of your screen. It is my pleasure to turn the call over to Ayman Ashour.

Thank you, Darby, and thanks to all of you for joining us today. I'm going to begin today's call with a quick reminder of Identive's vision to be the premier supplier of Secure ID solutions. Our offerings protect and securely utilize the digital identities that enable dozens of everyday applications where a digital credential is needed, be it physical access to payment or logging on to computers. We leverage significant engineering expertise in IP to deliver end-to-end solutions for multiple high-growth end markets. To drive growth, we're building a robust foundation of IP and expertise in RFID, NFC and Smart Card technology, which are the building blocks of Secure ID. Combining these engineering prowess with our relationships with key clients and understanding of their needs, we are establishing sustainable differentiation. Today, we hold key positions in key established Secure ID markets, including physical and cyber security, as well as in emerging areas such as NFC and SaaS-based ID systems. We are leveraging our advantages to exploit pivotal trends in the market towards smarter ID credentials that enable multiple secure applications and which work in many different form factors, be it a contact or contactless smart cards, tokens or key fobs or embedded in mobile phones or in the cloud. To exploit these trends, we have been investing in emergent markets with hypergrowth potential including NFC, cashless payment and identity as a service or identity -- or SaaS-based identity management. During the second quarter, we continued to increase the stickiness of our offerings by moving closer to end users. In addition, we believe our investments are coming to fruition and our results demonstrate just that today. We have also announced the capital raised that will contribute new funds to further our execution. During the quarter, we delivered growth in key areas we have been investing in for the last few years. This enabled us to achieve stable revenues of $23.6 million. While our Access Control & Security business has been severely impacted by the U.S. Federal Government sequester, our non-U.S. government business has actually grown substantially. For Q2, it grew 17% sequentially and 13% year-on-year. Looking at our 2 revenue segments, ID Products grew 35% year-over-year, reflecting a large number of NFC transponders to enable machine-to-machine, electronic games and mobile phone-based applications, driving the significant increase in transponder sales overall. In the coming weeks, you will be able to see the use of NFC -- of our NFC in games compatible with Xbox, PlayStations, et cetera. In fact, during the second quarter, we shipped 46 million units, that's 46 million transponders, bringing the year-to-date shipments on par with the full year of 2012. This activity was enabled by our increased transponder capacity, which we've been investing in over the last few years. The growth on our transponder business is important as it demonstrates the success of our strategy to establish Identive as an early technology leader in NFC and contactless applications such as payment, electronic games and mobile access that are starting to emerge. The full utilization of our manufacturing helped us to continue to improve our gross margin for transponders, which, while normally carry lower margins than the rest of our business, also attract much lower OpEx. In our Identity Management Solutions segment, revenues were down 26%, primarily due to the lower sales of access control systems. The U.S. Federal Government sequester has continued to impact negatively our Access Control & Security business. We have stated, "We believe this setback is fundamentally temporary because of the nature of the multiyear programs and projects we do with the U.S. government." We cannot predict the exact timing of recovery of sales nor can we estimate when the Access Control & Security business will return to its normal sales level, but we can tell you, our long-term strong relationships with our U.S. government customers and federal mandates of government security programs give us confidence that this will occur. Notably, the higher volume and better margins we achieved in our transponder product group in Q2 helped us partially offset the mix or the adverse mix from the lower access control sales in the quarter. Access control care is our highest margin. Another key area of investment for us in the last few years has been cloud solutions and SaaS. Here again, we are gaining traction with our idOnDemand solution. This quarter, we recorded some meaningful revenues. In addition, we won 2 major contracts. The first we won back in April is a $2 million long-term agreement with a global Fortune-100 technology company, which will use idOnDemand to issue a manage credentials that allow its employees to access securely their corporate networks, entrusting us, Identive cloud solutions, to issue and manage secure credentials on our own secure servers. The same cycle has been a long one, but we are now there. The second win for us came at the very last day of the quarter to manage issuance of secure credentials for a major health care provider. This is a critical win for us, years in the making, and as we speak, we are issuing credentials for this major customer. Our positive momentum continued as represented by our backlog. We closed the quarter with a record $27 million backlog. This breaks down into $19 million with scheduled deliveries over the next 12 months, plus an additional $8 million with longer-term delivery. We believe this record backlog is particularly impressive in light of the pressure on our Access Control business and the weakness of our largest single customer, the U.S. government. I would like now to turn the call over to David Wear, our CFO, to take you through our financial results for Q2, then I will wrap up with some strategy comments and our outlook for Q3 and the full year. David?

Thank you, Ayman. As noted by Darby, today, we will present our non-GAAP figures for which we will provide a reconciliation in the earnings press release in the appendix of this presentation. During the second quarter of 2013, total revenues were $23.6 million, up sequentially from $21.1 million, and relatively unchanged from $23.9 million in last year's second quarter. Revenue from the Identity Management segment was $10.6 million, down 26% compared with $14.2 million. Revenues from the ID product segments were $13 million, up 35% compared with $9.7 million. As Ayman highlighted, our performance by segments diverged greatly. I'll provide some more color on the year-over-year variances. First, in our ID product segments, Transponders revenues reached $7.2 million, an increase of 81% year-over-year and reflecting several large NFC product orders for mobility and M2M applications. ID Infrastructure revenues were $5.8 million, remaining stable, with improved revenue in North America, offsetting the slight reduction in the Asia-Pacific region. On to Identity Management, cloud-based identity management recorded its first meaningful revenue as $0.6 million. Access Control & Security revenue was $4.4 million, which decreased 41%, largely reflecting the U.S. government federal budget sequester, the impact of which we do believe is temporary. Integrated ID solutions revenue was $5.5 million, lower by 16% due to the timing of contract awards for our mobility solutions operations in the Netherlands and low demand from health care providers in the U.S. Looking at the operating highlights, non-GAAP gross profit margin was 41%, declining 4 percentage points year-over-year, primarily due to lower access control sales, but it remains unchanged from the previous quarter. As Ayman touched on, our overall revenue year-on-year remained similar and the higher revenues and improvement in our transponder gross margin assisted in partially offsetting the impact of lower sales in our higher margin Access Control & Security business. Non-GAAP operating expenses in Q2 were $10.8 million compared with $11.9 million in the year-ago quarter. The 9% improvement reflects our 2012 restructuring, as well as ongoing initiatives to improve operational efficiencies. Year-on-year, we've reduced our operating expenses by approximately $1 million, of which $0.6 million are people-related savings. Quarter-on-quarter, research and development expenses increased approximately 8%, as we continued to invest in new product development and associated patent expense. Sales and marketing expenses were stable, while G&A expenses fell approximately 11%. Non-GAAP net loss was a loss of $2.5 million, or $0.04 per share, compared with a non-GAAP net loss of $1.1 million, or $0.02 per share, in Q2 2012. The non-GAAP net loss is reported on a consistent basis and reflects the removal of impairment charges, but does not reflect the portion of these charges attributable to noncontrolling interests. For this to be adjusted, it would result in a favorable variance year-on-year. More details of this are included in the earnings release. Adjusted EBITDA loss improved $0.1 million to negative $1 million, compared to the loss of $1.1 million 1 year ago. As commented above, the low gross margin of $1 million was offset by lower OpEx of $1.1 million. Moving to the balance sheet. Cash and cash equivalents were $3.7 million at the end of June compared with $5.5 million at March 31. In addition to the supporting $1 million adjusted EBITDA loss, principal uses of cash in Q2 included service of financial and related-party liabilities and associated interest of $1.4 million, plus the buildup of inventories to support customer orders of $1.4 million. Net proceeds from the capital raised during the quarter amounted to $2.5 million. Today, the company announced it has confirmed subscriptions in connection with a private placement of this equity securities. The anticipated gross proceeds are approximately $7 million, and Ayman will discuss the use of these proceeds in a moment. At quarter end, working capital, which we define as inventory plus accounts receivables less accounts payable, increased is $0.9 million from March 31. The $0.7 million improvement arising from a reduction in accounts receivable was offset by an inventory build of $1.4 million, as inventory increased in anticipation of strong demand for new products in the ID Infrastructure business in the third quarter. Accounts payable were largely unchanged, reducing by $0.4 million in the quarter. Software development expense capitalized in the quarter amounted to $0.2 million. Accrued expenses decreased by $1.2 million, reflecting reductions and short-term debt and adjustment to pension liabilities. With that, I will turn the call back to Ayman.

Thank you, David. I would now like to give you a close look at our business as we enter the second half of the year and discuss product and market momentum. First, a look at the backlog and the outlook. Overall, we have strong momentum across much of our business. As I noted, we entered the third quarter with a record $27 million order book. In addition, next quarter, we expect -- or this quarter, rather, we expect to experience at least a modest benefit from the favorable seasonality through additions associated with the U.S. Federal Government year-end spending. We continue to focus on reducing OpEx. We remain optimistic about our near-term prospects. However, we must temper our outlook with the risk related to the impact of the U.S. Federal Government sequester on our access control sales. Keeping this in mind, for the third quarter, we are expecting revenue between $23 million and $25 million, and adjusted EBITDA of negative $0.5 million to positive $0.5 million. For the full year 2013, we're tightening the range of revenue to between $98 million and $105 million and broadening the range of EBITDA between a negative $1 million and a positive $1 million. We are estimating the U.S. government business will wind up being between $15 million to $18 million, compared to $20 million last year -- $22 million last year. Entering the year, we expected the business with the U.S. government to be $7 million to $10 million higher, or $22 million to $25 million this year. So we're sort of dealing with a shortfall of $7 million to $10 million against our expectations. Looking ahead, we're particularly excited about delivering the next-generation applications for emerging secure ID opportunities, such as converged access cashless payment, NFC, mobility and identity as a service. With regards to transponders and NFC, we continue to be bullish on transponders. Our impressive backlog includes NFC orders for machine-to-machine and payment sticker applications, as well as NFC-equipped games. This will hit the shelves in the coming weeks, and we hope the consumer excitement will further boost this already strong demand. We drove the expansion of mobile network operator relationships using Tagtrail cloud-based content management platform and NFC tags to our marketing campaigns in the U.S. and Europe. We are seeing more of this going on as we speak. We launched Tagtrail mobile app for the iPhone, which allows campaign owners to include iPhone users on their Tagtrail marketing programs. iPhone users can use -- can scan Tagtrail QR codes to download marketing content that they can save and revisit and get the same exciting use of Tagtrail, which is very different than other QR code scanners on the market today. With the ID Infrastructure area, we're expecting strong U.S. cyber security sales to continue as the U.S. government nears its physical [ph] end. And I'd like to remind you that this particular area of our business was not impacted by the sequester. And typically, the year end drives favorable seasonality for us here. On the mobility and bring-your-own device trends, the iAuthenticate is continuing to do well during the quarter. We had additional shipments of readers to distributors and end-users for this particular product. Meanwhile, our cloud-based identity management, or idOnDemand, continues to gain traction. I talked earlier about 2 new contracts in the second quarter. These wins are now the culmination of months of customer education pilots, trials and the customers feeling comfortable with our whole process and the security of our servers, et cetera. The conversion cycle has indeed been very long. Our wins this quarter represent a new phase of acceptance of idOnDemand and a clear inflection point for this business. We're building a strong base of long-term customer contracts that will result in recurring revenue from monthly and annual licenses beyond the initial system set up and the initial credential issuance. Additionally, in this area, we were awarded a patent for secure mobile authentication technology that enables NFC smartphones to generate one-time password to provide 2-factor authentication when accessing a secure corporate cloud in a corporate side or a banking application. This is a major opportunity for Identive as the trend towards mobility is also highlighting the need for more secure methods for authenticating users on their mobile phones. Our patented one-time password technology provide a really elegant and a simple solution for this need. For those of you who actually use a one-time password generator, this basically means that you don't need to carry a separate reader, you can simply use your NFC phone for it. Regarding our Access Control & Security, I'm very pleased to report we saw some good recovery in July. While uncertainty persists, we're even more optimistic about August, which is shaping up to be our best month this year. We are still cautious, but getting more optimistic as the U.S. government agencies start getting the hang of working under the sequester regime, which initially created a little bit of dislocation and a mild form of chaos for the last few months. Regarding our Integrated ID Solutions, we won a major contract to provide cashless payment systems for Germany's Olympic Stadium in Berlin. This raises the number of stadiums where we operate our justpay payment system to 7 stadiums in Germany. This will be our first system to combine both open-loop and closed-loop payment capabilities. Our contract in Berlin is one where we operate the system and hold an 8-year contract with revenue sharing. In other parts of our ID business, our ID solutions business, the orders that were delayed in the first 2 quarters, particularly in Holland, are now moving forward and we're beginning to see new growth from Cashless Betalen with Rabobank in Holland. Finally, I want to conclude with just some remarks on investment rationale. We are disappointed with the ongoing impact of the U.S. Federal Government budget issues. We are pleased our growth initiatives have delivered stability. You can imagine with the U.S. government business this year, it could've been a very different picture, because the growth we have been working on for the last few years is finally happening and happening big-time as you can see in the backlog. We are confident in our growth plan and excited about our opportunities. We are investing to be the secure -- leading Secure ID with smart mobile secured solutions for electronic credentials, targeting multiple opportunities with significant growth potential, leveraging market-leading end-to-end products and solutions, driven by our engineering expertise and strong and expanding IP portfolio. We are an attractive, highly diversified global customer base across multiple geographies and verticals. And with the recent -- or the pipe announced today, improving our financial stability. The pipe we announced today, we intent to use the capital to fund working capital growth. As you can see our expectation for the full year carries significant additional revenues for the second half of the year, so we'll need to fund the working capital for that, as well as sustainable cost-reduction initiatives to ensure financial independence and cash-flow-positive operations as we continue investment in our growth. Looking ahead, you can evaluate our progress by measuring how our investment and products address our high-growth market opportunities, add new and expand existing customer relationships and generate more revenues. With that, I'll go back to the operator -- turn it back to the operator for Q&A. Operator?

[Operator Instructions] We have Bryan Prohm online from Cowen and Company.

Ayman, first off, so it looks like there's another pretty tough quarter of access control and security sales. I mean, obviously, that's largely U.S. Federal Government sequester-related. You sound confident that the business is going to rebound, but then in your comments on the call, you're sort of less clear when that might happen. Has that come down to a fiscal year transition and you'd see that in Q4 and start to rebound then?

I think we're -- I acknowledge that we're probably giving you a little bit of a contradiction here, because we're guiding relatively low and saying that July has been good and August is shaping up better. And we're seeing a lot more requests for quotes and activity and the U.S. Federal Government customer is getting the hang of sequester and learning how to work under it and beginning to ask us for more bids. So we are -- but we've had the feeling, in June, we've had the feeling that we will have a fantastic June, then with the access control, ended up being weaker. So we are getting more and more cautiously optimistic and perhaps had I -- been another week from now and we're having this call, I'll be much more upbeat. It is just really the uncertainty of it that continues to be uncertain. But the kind of programs that we're on, be it customers like the IRS or the Department of Justice, different agencies and Department of Energy, DoD, et cetera, Department of Safety [ph], these are all long-term customers and in many cases, you are working on a sort of 8- or 10-year sort of refresh cycle and so it is -- and some of these programs are 20%, 30% of the way. So we're very confident and in our discussions, we're not aware of any single program we're on that's been shelved or put on hold. So they are all there. It's just a matter of both time and getting budget allocation. I don't know if I'm over-answering, Bryan, but I just wanted to try to give you a bit of color about it.

No, that's fine. That's -- because when it comes back, it comes back. I guess my -- I should segue into my next question, because more significantly for the company, the backlog -- you referenced the strongest backlog in the company's history. The order book looks like it's up about $12 million since the beginning of the year. Can you walk you through some of the details of that? I mean, obviously, if it's not access control and security sales, it's coming from things like tags and transponders. Can you walk me through some of the details of that?

Sure, sure. The -- I'll talk about the larger number, the $27 million. David sort of takes things that are not scheduled within the next 12 months and sort of treat them separately, so David can talk to that afterwards. But basically, we announced a while back a large retail application for payment solutions in Central Europe, actually in Western and Central Europe, covering multiple countries with some 350 stores with an element of recurring revenue. That, alone, was about $4.5 million or so, of which about $1 million is this year. We also announced early in Q2, the contract with a major technology company for idOnDemand that's about $2 million. And we've announced in June a major transport win with a 3-year contract where basically, in our business, transponder quite often is a razor blade business, because you're selling a consumable where people are using electronic tickets or using amusement park passes and the like. We've announced a new contract for 3 years with a major -- for a major metro application and that, I think, is about $3.5 million. And then our work in the electronic games we supplied, that has really been a large portion of our transponder business and, I think, the backlog in this area at any one point is probably stabilizing at about $2 million, $2.5 million, because we're continuing to be booked solid through probably half of Q4 right now in this area.

You're going to run at full capacity?

We're running flat out. Absolutely flat out, and sort of like breaking records pretty much every -- I guess [ph] every month, every week in terms of productivity and productivity improvement. And that's really one of the exciting things for us on the transponders side. David, I don't know if I left anything out that you'd like to add.

Yes. I think the only other area -- the cloud solution side where we -- Ayman alluded to another major contract and that we're actually operating on. But we -- again, we only take into the backlog the revenue that we can see, and the delta between the $19 million and the $27 million is part of it. I think most of the growth that you see in terms of the backlog is on the transponders side, but in terms of the delta between, what we've talked about, that of $19 million and $27 million, that's actually across 3 different business units. It's partly, as Ayman alluded to, the transponders side in the metro, partly the ID Solutions business and then the cloud business. So it's a very positive trend and one that we're hoping continues.

Great. A couple of quick questions then on the outlook, David. So with most of your restructuring now completed, is the Q2 OpEx run rate something that you feel the business can maintain over the medium-term even if some of the new growth drivers emerge and fuel the top line?

I think so .I mean, it's something that we're not complacent about. We want to make sure that we're investing appropriately, so we're looking to manage the OpEx we have to ensure that we don't strangle the growth opportunities while being cautious in areas that we're not really seeing as much traction. So it is something that we are conscious of. We're also looking at how we can continue to be more efficient in OpEx, and again, use it to invest elsewhere and continue to drive top line assets.

Great. And do you have projected cash flow number for the coming quarter?

I would suggest that, typically, it would be around the value of the debt service, not dissimilar to what we had in the previous quarter. And obviously, we have the investment that closed today. But in terms of the operating cash flow, the cash flow from operation, I would expect that to be relatively neutral in this quarter. And therefore, really the cash relates more to debt services and negated to the degree that we do look at means of raising funds for the equity line, et cetera.

Understood. All right, last question for you, Ayman. NFC is roughly a quarter of transponder shipments, I believe, if I read the release correct. Is that number -- where does that number get 6 months from now or 1 year from now? Is it 33%, 40%, 50% with some of the new markets that you're selling into?

That number has been steadily growing and it sort has been growing every week. And our expectations is that it will continue to grow. And frankly, in some cases, we're looking at other traditional RFID applications that might be less differentiated and moving from freeing up capacity from these areas for NFC. So our expectation is that it continues to grow and become a more and more meaningful part of the company as a whole.

Our next question comes from Chris Basta [ph].

Just had a question on the guidance. I hate to jump ahead to Q4, but if you look for the guidance you gave for the year, even at the low end of the $98 million for the fiscal year, you're at the highest quarterly revenue rate for Q4. I'm just trying to figure out, is that assuming a big recovery in the government business? Or is that still being driven -- are you being cautious there and that's still being driven by the growth in the new product lines?

I think we're -- as I sort of mentioned in the comments on the government business, our expectations for the government business for the full year is somewhere between $15 million and $18 million. And we've had expectations last quarter -- we entered the year with expectations between $22 million and $25 million. Last quarter, the expectation, I think, were $18 million to $20 million and we've downgraded that again. So we're still having a degree of optimism in looking at the U.S. government business, but we're not betting on any big recovery. We're betting on recovery from Q2 levels because if you look at the first or second slide on the deck, you will see that the U.S. Federal Government business for Q2 2013 is the lowest we have -- I think we've had since the sort of Identive, sort of, journey started 3 years ago. So it's been much weaker than we've ever had. So that's been unusually weak. And as I said, July is already better than it has been, August is shaping up better, and we do expect a little bit of recovery in September. In terms of the calculation that you have done of taking the full year guidance minus sort of the guidance for Q3 plus the actual of Q1 and Q2, that means that Q4 would be quite substantial. That is not unusual for us, for our business is normally second half year loaded. So we've -- what we've really -- we can see anywhere between the first half being 38%, second half being 62% to being 45%, 55%. So it is not at all unusual and if you'll see in the prior years, that has been pretty typical for us.

Yes. No, I understand. I guess you're above the $30 million threshold, though, which would be a first, and that would be good to see. So thank you for the color on that.

Absolutely. And I mean, perhaps one of the things that we should mention is sort of like we look at our breakeven point with our -- when Access Control & Security is reasonably strong, which is our highest margin business, we look at Access Control -- our breakeven point being about $23 million a quarter. When it is a bit weaker, then it is $24 million to $25 million. So once we get above that critical factor, the leverage is considerable. And one of the things that we're doing with the pipe funds that we've raised is further opportunities for OpEx reduction, which obviously takes cash to achieve. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.