Identiv, Inc. Q3 FY2020 Earnings Call

Good afternoon. Welcome to Identiv's Presentation of its Third Quarter 2020 Earnings Call. My name is Karen, and I will be the operator this afternoon. Joining us for today's presentation are the company's CEO, Steve Humphreys; and CFO, Sandra Wallach. Following management 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 and free cash flow. 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 obligations to update these forward-looking statements, which speak as of today. I will now turn the call over to CEO, Steve Humphreys, for his comments. Sir, please proceed.

Thanks, operator, and thank you all for joining us today. In our preliminary results, we said we expected to beat the aggressive growth projections we outlined on our second quarter call, including 80% growth in RFID for the full year, 20% sequential growth in physical security from Q2 to Q3, and federal sales up 80% sequentially. With our finalized financial results, we're confirming that we beat each of those expectations. This shows both strong industry trends driving our business and our leadership within the industry. Overall, revenues grew 30% sequentially to $24.9 million, showing strength across the business. We projected our premises business, which is about two-thirds federal, to grow 20% sequentially. We actually grew 26% sequentially in premises. Our RFID business grew more than 50% sequentially and over 100% year-over-year, and is on track for 80% full year growth. Our federal revenues grew nearly 90% sequentially. This has us lined up for a strong fourth quarter and a second half of the year that will be more than 30% higher than our first half. We're seeing business momentum continue, backlog building, and the pipeline for 2021 becoming stronger. But before we talk too much about the future, let's review the operational and financial results for the third quarter. Our key focus areas of RFID and our federal business were particularly strong. Within our identity business, which is predominantly RFID, revenue increased sequentially by 33% to $15.4 million, and year-over-year identity in total grew 53% from $10.1 million in Q3 2019 to $15.4 million in Q3 2020. The growth was mainly driven by RFID, where we ramped up production volumes for several customers. In particular, a major customer whose production started in Q2 came through in Q3 even stronger than we expected. As a result, our RFID business more than doubled the volume we produced a year ago. Even with our ramp up, there were nearly a million dollars in shipments we didn't fulfill. We balanced customer requirements to make sure the most critical deliveries were recovered. The business implication is that the industry launches we expected are well underway. The mass market adoption of RFID integrated products is happening. Our major customers are incorporating RFID devices in their healthcare products, mobility, consumer products, appliances, libraries, pharmaceuticals, and app-enabling the physical world. The point is that each of these is a hundred million or billion-plus unit application. It's a huge market that's just beginning to grow. The overall trends clearly show in our third quarter results, as well as in the ongoing backlog strength; we went into the fourth quarter with backlog for shipments up 68% over last year. We will talk about the implications going forward of all these trends later on the call. Also with identity in the third quarter, our identity readers grew strongly, up 38% over last year's third quarter. We all expected the work-from-home trend to plateau after the initial lockdowns in the spring, but this really shows that demand is continuing. The third quarter is always strong for smart card readers because of the February year-end. The growth comes from a normally strong prior year period because the federal government, especially the DMV, are adopting policies supporting work from home and mobile work for the long term. We do expect these trends to sustain. We'll talk more about that as we look at 2020. Turning to our Premises business in Q3, it showed the strength of our full product range, as well as our federal government focus. As I mentioned before, premises grew 26% sequentially. The federal business, where our Velocity security platform was the strongest vertical, grew 90% sequentially. We also saw activity in banking, retail, utilities, and others. For example, in financial services, we quoted our first large 3VR Prime managed video services order, which has now closed. The leading banks are adopting our platform across almost a hundred branches. The six-year, $650,000 agreement provides video surveillance, analytics, and case management on a subscription basis, spending tens of thousands of dollars in capital expense for our customer and assuring a predictable revenue stream of over $100,000 annually for a full range of services. That said, we've had continuing strong business progress. Within our industry, some small dealers and small businesses are under pressure as our competitors, who focus their efforts on federal, state, and local government customers, represent more than two-thirds of the business for our physical access platforms. We're seeing strong performance in premises. Our quick pivot to recurring revenues with lower cost of entry has put us in a strong position overall. These include our Velocity Cirrus products, Mobile SID, 3VR Prime, our Freedom Cloud, and Freedom Mobile, which we just launched this week. All of these are recurring revenue products, launched in the last 12 months. The broad adoption of RFID and our major customers' core products is what really gives us reason to believe this growth is a long-term trend that we're just starting to see take off. It's building backlog for the fourth quarter and for 2021. Overall, the third quarter was highlighted by 30% sequential revenue growth, over 100% year-over-year RFID growth, a 90% sequential growth in federal sales, 38% year-over-year identity reader growth, and Q4 backlog up 68% for last year. Certainly, there are challenges in the economic environment we're all in, but the strong secular growth we're experiencing in RFID and in federal, along with work-from-home going into a second wave of demand and the products we've launched in the third quarter to take advantage of the return to work needs build the base for a strong fourth quarter and 2021. Let me turn it over to Sandra to go through the third quarter financial results. Afterwards, I'll go into more metrics and the industry-wide trends that are really accelerating our business into the fourth quarter and into 2021.

As Steve mentioned, our results show the continued delivery of what we committed to with a solid trajectory for 2021. Please note that these results are all within the preliminary results announced October 29th prior to market open. The first metric is revenue growth. Even with the continued impact of COVID-19, we closed out the third quarter of 2020 with $24.9 million in total revenue, up 30% compared to the second quarter of 2020, and up 8% compared to the third quarter of 2019. Our recurring revenue accounted for 6% of our third quarter revenue, and 8% of our total revenue in the first nine months of 2020. This part of our business remained steady at 8% of our total trailing 12-month revenue. For the third quarter of 2020, our GAAP and non-GAAP adjusted gross profit margins were 40% and 41%, respectively. For the trailing 12-month period, our non-GAAP adjusted gross profit margin was 42%. For the third quarter 2020, our non-GAAP adjusted EBITDA margin was positive 11% with a positive 4% for the trailing 12-month period. Our GAAP net income for the third quarter 2020 was $0.4 million, compared with a loss of $2.7 million in Q2 2020 and net income of $1.1 million in Q3 2019. With the dividends on the Series B preferred, our GAAP net income attributable to stockholders was $0.1 million, or net income of $0.01 per share compared with a loss of $0.17 per share in Q2 2020 and positive $0.05 per share in Q3 of 2019. We have provided in the appendix a full reconciliation of GAAP to non-GAAP information, which is also included in our earnings release. On our next slide, further analyzing trends by segment, our Premises segment, which includes sales of physical access control and video products and services, accounted for $9.4 million or 38% of our total revenue in Q3, representing an increase in dollars of 26% from Q2 2020 and a decrease of 27% from Q3 2019. Revenue from our identity products, which includes sales of access credentials, smart card readers, RFID transponders, and mobile security products totaled $15.4 million or 62% of our total revenue in Q3 2020, an increase in dollars of 33% from Q2 2020, and an increase of 53% from Q3 2019. Our non-GAAP gross profit was 41% in the third quarter of 2020. This compares with 42% in Q2 2020 and 47% in Q3 2019, driven by both the mix of products across segments and within segments. Our Premises segment margins are 55%, relatively flat compared to Q2 2020 and Q3 2019 at 55% and 56% respectively. Our Identity segment margins are 30%, relatively flat compared to Q2 2020 at 31% and lower than Q3 2019 at 33% due to a higher proportion of lower margin transponder sales. Now moving to our operating expense management, our GAAP operating expenses for the third quarter were $8.9 million, which was down from $10 million in Q2 2020 and down year-over-year from $9.3 million in Q3 2019. The sequential decrease was primarily due to the non-recurring $1.2 million restructuring cost in Q2 2020. Our non-GAAP operating expenses as a percentage of revenue decreased to 30% in the third quarter of 2020, compared with 40% in the second quarter of 2020, and 34% in the third quarter of 2019. Our non-GAAP operating expenses totaled $7.5 million in the third quarter of 2020. This compares to $7.6 million in Q2 2020 and $7.9 million in Q3 of 2019. Bringing all the pieces back together, our non-GAAP adjusted EBITDA was $2.8 million in the third quarter of 2020, a sequential increase of $2.3 million over Q2 2020. Turning to the balance sheet, we'll be comparing our position at September 2020 to the position one quarter ago of June 2020 and the prior year quarter ended September 2019. We exited the third quarter with cash at $12.3 million and a net decrease of $0.8 million from Q2 2020 and a $1.2 million increase from Q3 2019. Net cash activity for the quarter was driven by $2.2 million of cash provided by our net income excluding non-cash items, $3.6 million of cash used for working capital and CapEx, driven primarily by late Q3 billings that were not collectible within the quarter, and by an increase in working capital to support our Singapore growth. Under financing in foreign currency, we had a $0.6 million net cash provided, driven by a $0.9 million increase in net borrowings under a revolver, and a $0.5 million reduction through scheduled payments on the term loan facility. We believe that we have adequate capital available to fund our business growth and return to positive non-GAAP free cash flow exiting Q4 2020, as well as retiring the term and note debt on schedule in Q1 2021. In our 10-Q filings, we will be providing a full reconciliation of the year-to-date cash flows. For completeness, we have included the full balance sheet per the earnings release in the appendix. Even with the global disruption continuing, today we are confirming our guidance for the consolidated results of the company for the full year 2020 with revenue between $86 million and $88 million within our original guidance entering this year. We achieved GAAP EPS profitability in Q3 2020 ahead of expectations and continue to see the benefits of our actions to optimize costs carry forward. In addition, we believe we will be non-GAAP free cash flow positive as committed during Q4 2020 and beyond. Today, we're providing guidance for the full year 2021, building on the strong base of growth that we have delivered. Our full year 2021 guidance is for revenue between $96 million and $102 million, which reflects growth year-over-year from the midpoint of our 2020 guidance, exceeding the market growth by a factor of two. We expect our normal seasonality to continue with our lowest quarter in Q1 2021, and building up quarter-over-quarter through the end of 2021. We will be issuing a full set of guidance at our Q4 and full year 2020 earnings release targeted for March 2021. With that, I will conclude the financial discussion and pass it back to Steve.

Thanks, Sandra. As I said earlier, our RFID growth is predictable for two reasons. It's heavily backlog driven. And it's driven by major companies who have incorporated RFID devices into their products. Planning for global products is a yearlong process. So even now we're getting visibility into plans throughout 2021. First, backlog going into the fourth quarter; our total backlog stood at $10.5 million, up 68% from last year and our RFID backlog for shipment in the fourth quarter is up 125% over last year. We've now received orders for about 95% of our expected shipments for the quarter in RFID. This means that most additional orders either contribute to upside within the quarter or drive more backlog for 2021. This is a key driver of our growth for 2021 and we expect the RFID portion of our business to grow well over 50% in the first half of 2021 versus the first half of 2020, with full year growth in the mid-20% range for 2021. The core driver of our RFID business is the mass market adoption of RFID integrated products. Our customers are leaders in their own industries, incorporating RFID devices into their products, each with volumes of tens or hundreds of millions of units. This is a huge market that's just beginning to grow. In the third quarter, two strong use cases were launched in the market, one by CVS and the other by Apple. Now we don't generally disclose customers, so these are just industry examples to be clear. But both are great examples of the RFID market accelerating. They're both basic uses that establish platforms to then drive multiple products from already significant first launches. The first, some of you saw in the demo session we had a couple of weeks back, CVS’ Spoken Rx for visually impaired people. You tap your phone to the RFID tag on the prescription bottle, and it reads out medication with dosage and all the other information for people who can't read the label. About 13% of prescriptions go to people with some visual impairment. There are about 4.5 billion prescriptions annually. In the U.S. alone, that's over 1.5 billion RFID tags every year just for the visually impaired sector. Now that's the current use case and the first use case, so let's extrapolate. With the platform deployed, every CVS Pharmacy is now set up to program and put RFID tags on every prescription. When you have your prescription bottle, you tap each time you take it, and you'll know if you've taken it in the morning or evening or whatever the prescription regimen. It’ll auto refill as you get low. There are all kinds of capabilities you can do there. You could even opt in, and your doctor could get information about how consistently you're taking your meds. Because anyone who studies this area knows that the biggest issue with prescription pharmaceuticals is people complying with taking their meds. There's a number of things that companies like CVS are thinking about now that they've made that additional investment, and they can really expand into other categories. So ultimately, we think the opportunity is for all 4.5 billion prescriptions in the U.S. annually. The U.S. is about a quarter of the world's prescriptions. So again, you can see the potential. The investments are really done, and, of course, the reader and the app technology is already in everybody's pockets in their phones. Now related to the mobile space in phones, the biggest event was Apple's launch of full NFC support in iOS 14 and the iPhone 12, especially with the new ecosystem of products around MagSafe. Apple has made it very easy and secure to connect peripherals to the iPhone. Through NFC, they connect them into core iPhone features. Just as a couple of examples, the first Apple branded cases; if you buy an orange case, you pop it on your phone, and the screen turns orange. It goes through an animation, indicating a successful connection. You know it's an Apple verified phone; it seems trivial. But it shows that the peripherals are communicating securely with the phone, launching processes inside the phone and controlled securely by Apple through a secure NFC channel. This enables a whole world of new peripherals to connect to the phone seamlessly but securely. With over 200 million iPhones shipped a year, connecting multiple MagSafe enabled devices each, again, you can see the market in the 2 billion units plus range annually. Now, of course, we see Apple and CVS moving forward, and competition from Samsung, Walgreens, Amazon pharmacy, and others. The scale of the markets we're targeting and the volumes that are already happening show RFID gaining traction right now. We've been the trusted co-developer and supplier for some of the most advanced applications and the most demanding companies. This is where the growth is, and it's where our competitive advantage is strongest. How are we going to keep our advantage? We're expanding our technical capabilities. And for 2021, we're launching services to help companies put RFID into their products, unique in our ability to go from concept to optimized design, to early production, scaling production, and then immediately starting back into the next generation of devices. This is the cycle that customers need. We're also innovating with new products, answering needs we know from our own customers. An example is a new product we've launched, which we think is the industry's lowest carbon footprint RFID tag, our eco tag. Instead of being an etched antenna on a plastic substrate, we’ve developed a unique laser cutting process, and it’s on recyclable paper substrate; we even use recycled aluminum for the antenna. There's no etching chemicals, no lost metal, no plastic layers, and no chemical runoff. Why do we do all this? The biggest users of high-end RFID are consumer-facing companies, and sustainability matters to them. Companies like Amazon and Apple have a public commitment to being carbon neutral, and RFID tags are consumer-visible devices. Our eco tag shows their eco commitment and eliminates what otherwise would be a negative on their carbon footprint. Our customers told us this is what they want. It's tricky technology, but we developed it. Fundamentally, this is exactly why we're going to maintain our lead in the fast-growing RFID market. Now let's look at premises, which has some similarly exciting opportunities. Remember, the core technology in our RFID tag is shared with our access cards, dual readers, identity readers, and other parts of our physical and data security solutions. One growth driver really supports the other. With the premises industry overall growing about 6%, we grew 26% sequentially and expect the premises to grow about 25% year-over-year this quarter. For 2021, we expect growth in the mid-teens, more than double the industry rates. The fundamental drivers are recurring revenue growth, a shift to IT-driven buyers, and federal grants. Why would we be growing faster than the market with these dynamics? Just like with RFID, we're both the trusted provider and we've got some of the most advanced technology and broadest product range. As customers move to software-defined platforms, they need to migrate their entire platform across readers, credentials, controllers, access video, and audio, all integrated with their active directory or other sensitive data repositories. We're the only company that delivers all of this, and we think total solutions and IP-centric recurring revenue platforms will be the fastest growth sector in physical security, with our strategic position in providing access video and audio management being key for anyone trying to win. A great example of this is our Freedom Cloud platform that we just launched this week. It's the lightest weight implementation in the industry, totally web and mobile-based, and especially on the hardware side, our Freedom Bridges are extremely compact and cost-effective IoT devices. A bridge that can control two doors is the size of a pack of playing cards. This is what customers are looking for; hardly noticeable, really intuitive to deploy and manage, and a platform that the IT department is totally comfortable owning and managing. The software is browser-based, and the hardware is managed just like a network switch. We’ve described the growth in each segment, putting it together; in the fourth quarter, we're expecting overall revenues to grow in the 25% to 30% year-over-year range. Looking at the business drivers for next year, we have RFID use cases that can be hundreds of millions of units over time, giving us clear line of sight into 2021. The strong federal government demand for our physical security, identity readers, and mobility apps, along with our complete range of recurring revenue products, is now in place. With all these growth drivers, we could see faster growth in any given quarter. To maintain our predictability, we’ve given a strong base growth outlook and will update as we get further into the market's takeoff. 2020 has been a challenging year, but we're in markets that are taking off. We've strengthened our leadership even as they accelerate. The result is we're looking forward to a strong finish to the year and an exciting 2021. With that, let me open the discussion to questions.

Thank you. Ladies and gentlemen, we will now take questions. We'll take our first question from Jaeson Schmidt with Lake Street Capital Markets. Please go ahead.

Hey, guys, thanks for taking my questions, Steve. Appreciate all the color and sort of why you're feeling so confident in 2021. But curious if you could talk about sort of the backlog coverage to 2021, and some of this confidence is really just driven by some sizable orders already in hand, or if it's just general confidence, especially on the RFID side that you are just seeing, going to see this big general adoption?

Yeah, thanks for the question, Jaeson. Yes, backlog has been growing nicely. I think we earlier indicated that at that time, it was up. It just doubled from what it had been just a couple of months earlier. I mentioned that we've already got over 95% of our Q4 shipments already covered in backlog. All the orders coming in are 2021 orders. We actually have orders that extend throughout all of 2021. We’ve got good visibility, both front-ended. As I said, we expect the first half of the year to be 50% growth over the prior year. Obviously, we wouldn't be saying that with clear numbers if we didn't have a fair amount of visibility in it, and that's really driven by our backlog.

Okay, that's helpful. In your prepared remarks, you noted about $1 million in business not being able to shift in Q3. Could you just comment on what sort of constraints you're seeing there, and if those constraints have eased now in Q4?

Yeah, also, thanks for picking up on that one. Yes, as I mentioned in the second quarter call, we've been expanding our capacity rapidly. When you look at doubling your capacity, and we talked about in Q4, we've got a backlog that’s up 125% over where you were a year ago. We're building out space and putting in more equipment. Some of the devices that we're producing are particularly complicated and high-end, which is great for us because it's more differentiated. But they take more machine capacity because there are multiple processes and passes, versus some of their more straightforward products. Those more complicated products often go to the more sensitive and high-end customers. So we always want to favor those. We did have some that we couldn't ship; we're catching up this quarter. We’ll have the capacity built out by the end of this quarter. Again, we talked about building capacity you're talking about $100,000 and $150,000 in facilities build-out and a few hundred thousand dollars in equipment. It’s not major capital absorption, but we have been catching up through the third quarter and we'll be in good shape going into 2021.

Okay. And just the last one and I'll jump back in a queue. Obviously, the school and education market could be a little challenging with budgetary pressures and whatnot. But just curious if you could comment on what your expectations in that market are going forward?

It is choppy as you say, but it's also highly motivated for security. We put out a white paper on remote schooling cybersecurity, for example, with our FIDO keys that we just launched. One of the dirty secrets that a lot of people haven't focused on is, we've taken all the kids in our country and put them online to go to school. If anyone thinks that we've secured their data pipes for their learning, they're being a little optimistic. There are opportunities to cyber-secure more of the distance learning environment. As we go back to school, physical security is as important as ever, especially as physical security infrastructure is now being integrated with health and safety infrastructure. There are opportunities there. We're seeing interest from schools. But schools are facing financial challenges, so some are moving ahead fast while others are hunkering down. I don't know on a month-by-month basis how it's going to emerge, but I actually think schools and universities will be a very good segment for us, both on the cybersecurity side and on the health and safety physical security side over the course of the next year.

Great. Thanks a lot. Great quarter there.

Thanks.

Steve, I couldn't tell; did you give some guidance on what you thought premises would grow in the fourth quarter? I couldn't tell if you said that or not.

For the fourth quarter, I am reviewing the information, but we anticipate a year-over-year growth of about 25%.

All right. So that's like up sequentially. And is that driven by non-government, or is that government driving that sequential pattern then?

Yeah. Good question. It's across the board. It's driven by both government and non-government growth. Underneath the numbers, it's probably more commercial than government in terms of increases sequentially.

Okay. Very good.

We’ve seen a rebound in activity in premises. You can only defer these things so long. Now a lot of the installers and users are getting back out there. They’re getting back in line. There are also customers needing things like video systems where Microsoft stopped supporting Windows 7, or something similar; they have to do something. So there’s a built-in migration and growth pattern that we’re starting to see come back.

Yes. Okay, got it. And then on the identity, just seems like a ton of opportunity there. I guess how would you see that revenue stream being in terms of customer base over the next year? Is it going to be very diverse, or is it going to be a couple of big customers really driving the growth?

Are you asking primarily about RFID and Identity?

Yes.

Yeah. Actually, I think it's going to be quite diverse. Certainly, when some of these global corporations launch, their numbers are big, but there are several of them that are either already launching or in pilots and building in preparation for 2021. You might have noticed we didn't disclose any 10% concentration customers, so there are certainly some significant players but a range of them. The interesting thing is a variety of applications that are not just in one vertical; there are several different use cases gaining momentum.

Yeah. Okay. And then you have a number of cloud offerings now, I'm sure you're going to be promoting that even more aggressively next year. I mean, what would be, you know, when you book a cloud deal it doesn't always show up within the quarter or year obviously, but like what would be sort of a good amount of cloud booking for next year if you're successful? Is it a $1 million, is it $5 million? Like what would be a successful cloud bookings year?

I think we're just learning what the profile looks like. But I think that that six-year, $650,000 VA bank installation we did is on the high end, but it characterizes how those things work. If you mean how much would be recognized within the year, probably a couple of few million dollars incremental to the 6% to 8% we're already at. But that would represent, of course, 5 to 6 times that much in terms of booked business.

Yeah, I guess that's more what I was referring to. Okay, great. Yeah. Good. Thanks a lot.

Thanks.

At this time, this concludes our company's question and answer session. If your question was not taken, you may contact Identiv's investor relations team. I would now like to turn the call back over to Mr. Humphreys for his closing remarks.

All right. Operator, just want to confirm you don't have any other questions in there, that's right.

No further questions in the queue at this time.

Terrific. All right. Thank you very much. Well thank you all for joining us. I really appreciate it. Also please join us at some of the virtual investor events coming up this quarter that we've got Imperial Capital, the first week in December, and Northland the week after that. I look forward to continuing to update you on the business and until then best wishes. Be well and be safe and have a good evening. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. We thank you again for your participation. You may disconnect your lines at this time. Have a great day.