Identiv, Inc. Q2 FY2022 Earnings Call

Good afternoon. Welcome to Identiv’s Presentation of its Second Quarter 2022 Earnings Call. My name is Matthew and I will be your operator this afternoon. Joining us for today’s presentation are the Company’s CEO, Steve Humphreys; and CFO, Justin Scarpulla. Following management’s remarks, we will open the call for questions. Before we begin, please note that during this call, management will be making references to non-GAAP measures or guidance, including adjusted EBITDA and free cash flow. In addition, during the call, management will be making forward-looking statements. Any statements that refer to expectations, projections, or other characteristics of future events, including future financial results, future business and market conditions, and future plans and prospects, 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 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. In the second quarter, Identiv continued to make progress securing our leading position in the expanding RFID-enabled Internet of Things sector. We had two primary goals in Q2, growth in RFID of over 40%, validating our long range plan, and gross margins holding at the 37% or above range we guided for the year. We beat both goals. RFID growth was 41%, and non-GAAP gross margins expanded to 38%, showing margin expansion even while driving RFID growth. Two other key goals in Q2 were growth in our Premises business and expanding EBITDA. Our Premises business grew 19%, another quarter of growth that is three times the industry’s growth rate, bringing our half-year growth rate to 21%. We think this level of growth is sustainable throughout this year and next. EBITDA of $1.4 million was above our projections. As we go into choppy economic times, growth has to happen with strong, positive EBITDA. So we can self-fund our growth regardless of the macroeconomic environment. And we demonstrated this in Q2. Now we see a clear path to continue and to expand these growth and profitability ranges. Our core markets, medical devices in RFID, and security and Premises are both reliably stable and grow even in recessions. We’ve shown their strength in inflationary times with our ability to raise prices to hold and expand gross margins. As a debt-free company, we’re also not exposed to interest rate rises. These all give us confidence that our long-term strategy is paying off in growth and EBITDA results, and that the nature of our business and balance sheet leave us in a good position to execute our strategy regardless of macroeconomic issues. In Q2, we maintained discipline in our business execution to drive these strategic priorities. That led us to decide not to pay premiums for components for our legacy business. As a result, we didn’t ship almost $2 million in legacy smart card readers and access hardware, choosing not to pay expedite fees and inflated component prices. These would have compressed gross margins in non-strategic categories. Now we overperformed in RFID to offset most of this and delivered above plan gross margin dollars as a result, which drove our above plan EBITDA results. We’ll continue this discipline prioritizing strategic growth in RFID and Premises and gross margin strength over shipments of legacy products if they create margin pressure. Another characteristic we’re driving into our business model is recurring revenues. As a result of this effort, deferred revenues on our balance sheet are up 37% versus last quarter. Over $1 million of bookings in Q2 were recurring, meaning they weren’t recognized as revenues in Q2, even though they were booked orders. These will be recognized as recurring revenue over the next 12 months. So putting this together, this is the momentum we need to drive sustained 40% plus RFID growth with steady margins that’s the core of our strategy. In fact, we expect RFID growth in the current quarter to be over 50%. Also, as we go into uncertain economic times, we’re well-positioned to keep growing with our expanding EBITDA, strong balance sheet with no debt, and our focus on recession-resistant medical device solutions in RFID and Federal Government Security Solutions in Premises. From a market perspective, we’re enabling the IoT where we continue to differentiate our business model and technology. This goes beyond our foundational strength in identification and tracking. RFID-based IoT devices require complex, highly integrated designs. We are the industry leaders in deep technology specialty RFID applications, powering use cases with multi-technologies and flexible designs for our IoT partners. Our new BLE RFID device with Williot is a prototypical example. We also have the IoT software stack in place with companies like Blue Bite, Tapwell, and collectID. We’re an enabler for all those platforms. Without our design and encoding capabilities, they wouldn’t be able to deliver the product engagement and experience that their customers demand. So we’re creating solutions that are driving the future of the IoT. Our high-margin specialty applications continued to expand with 38 different NRE projects underway in Q2. We will go into more details in our forward discussion later, but we really expanded our NRE activities. And as a result, our reputation as the leader for advanced RFID applications. Now a couple of NRE projects with major volume potential that we launched in Q2 were for a major athletic footwear company, another for a golf ball project, a third that uses accelerometers to track shock and vibration, and five different projects that are medical device related. So with this progress in Q2, RFID is positioned to grow even faster with upside volumes from specific projects that can transform our business and NRE initiatives that are creating even more transformational use cases. As I mentioned, our Premises business is growing at more than three times the industry’s growth rate. In physical and converged security, we’ve always been strong in the federal market. Our drive to expand our commercial Premises business has made progress now representing over half our Premises sales. Sales to the federal government also continue to grow as well as airports, schools, and other public sector markets that are security-sensitive. With this broad market, product, and services strength established, we expect to continue to grow at a multiple of the industry’s rate as the seasonally strong federal cycle in the third calendar quarter drives growth in our federal, state, and local education markets. This gives us high confidence in our 20 to 25% growth expectations for Premises in 2022, and hitting well in this range in the first half clearly has us on track for the year. Overall, gross margins continue to strengthen as we focused on them. In Q1, you might remember our non-GAAP gross margins rebounded over 300 basis points. And in Q2, gross margins expanded another 97 basis points. Our systems implemented in Q1 are working. We’re staying committed to our prioritization of gross margins, even over legacy growth, as long as we’re supporting all the growth opportunities in RFID and Premises. The continuing progress on gross margins is important, of course, for the strength of our business model, and also because it validates that higher margin specialty RFID devices are the fastest growing segment. We can drive growth as well as margin expansion. Overall, revenues grew to $27.9 million, up 16% versus Q2 of 2021. This was without the almost $2 million of legacy products we didn’t ship and excluding the deferred revenue component of another $1 million. Consistent with this, our forward indicators grew with total backlog of $34.2 million, up 23% year-over-year. In addition to these growth metrics, our business model progressed. While increasing gross margins, we tightly controlled operating expenses resulting in EBITDA ahead of plan. Behind the financial and operational aspects of our second-quarter results, we continued our track record of 100% customer retention in RFID. Our other growth drivers made strong progress across existing customer launches and expansions, new design wins, and technology launches. As expected in Q2, growth was driven by our wide base of existing customers. This shows the sustainable growth in our core RFID business, which is the basis for our projections. On top of this core predictable growth are transformational projects, which are of major scale but whose full-scale production timing is less predictable. Each made progress. Our auto-injector category built more momentum. We have two new designs in progress as separate NREs, one for a faster track near-term product. Our chip allocation and commitment from the suppliers for this project has been confirmed for the ramp. To be clear, these are for a basic capability device with a price point in the $0.35 range. We’re also expanding our activities in this category. We’re now in discussions with the largest provider of auto-injectors worldwide and a third smaller, but very proactive auto-injector company. Last, but possibly most strategically important, we’ve now completed and signed the intellectual property and development agreement with our anchored customer for the technology we jointly developed for our high-end auto-injector project. This agreement includes NRE in both 2022 and 2023. Both of our cannabis initiatives also made progress. The retail pilot we’ve been tracking is launching in August rather than July, but it’s broader, covering almost 100 dispensaries, each deploying about 500 units. On the design side, we now have three designs in place, two for the U.S. market and one for Canada. As described last quarter, we still expect around 2.5 million units in the second half of 2022 across the U.S. and Canada. Progress in Q2 also included an LOI for 80 to 100 million units for 2023. Now the market potential is much more, but getting tangible projections this early in the cycle is a key step. As described before, the dual frequency design and services, including conversion and encoding support strong margins. The cannabis program in Canada also is progressing, with about 2000 of our test units delivered and in testing – production programming tuning and converting, which includes a hologram, and the finished product is going well. We can go into more details in the Q&A, but this billion plus unit program is moving as we expected. Turning to our RFID-enabled prescriptions. We continue to win awards and get industry recognition for our accessibility solution. Replenishment volumes at CVS are continuing and four other pharmacy chains are in various stages of pilots and deployments, giving the solution more visibility and putting more pressure on other pharmacies to adopt our solution. Our largest mobile device customer ramped the new design we mentioned last quarter. We’re now shipping this design in multimillion unit quarterly volumes and expect to continue into Q3 as they build for fall launches and the holiday season. Most of their prior designs are continuing, resulting in more total demand than we had projected. So our RFID business is on track with our transformational projects moving forward and volume outlooks getting clearer as the programs progress. Demand is growing fastest for our specialty RFID devices, strengthening margins and unit prices. Design wins are growing with our expanded technical sales and engineering team, and our marketing investments are driving more opportunities that our expanded sales team is converting. Our production capacity continues to expand to meet this higher demand, and our systems are in place to manage customer life cycles as more and more customers and projects come into our revenue streams. In Premises, we continue to take market share aggressively, growing as I mentioned at a rapid rate and winning in the commercial market, just as security is getting more focus and budget allocation than ever. Our Premises growth was also well balanced across software services, products, and recurring revenues. So before getting into the next quarter and our outlook for 2022 and beyond, I’ll turn the call over to Justin to review the financial highlights for the second quarter. Justin, over to you.

Thanks Steve. As Steve mentioned, our financial results reflect our continued strength exiting the second quarter of 2022 with the delivery of sequential and year-over-year growth in revenue, sequential increases in GAAP and non-GAAP gross margin, and a positive non-GAAP adjusted EBITDA. Both non-GAAP gross margin and adjusted EBITDA were above consensus estimates. In addition, total future backlog increased 23% year-over-year. We believe these results demonstrate our continued commitment to protecting our margin and maintaining tight control over our operating expenses, reflecting strong operating leverage. To close the second quarter of 2022 at $27.9 million in revenue, up 16% compared to the second quarter of 2021 and up 11% compared to the first quarter of 2022. Our revenue in the second quarter of 2022 was slightly below consensus estimates, primarily due to supply chain issues in our legacy smart card reader business. The trailing 12 months revenue was $110.5 million, up 15% versus a comparable prior year period. The sequential and year-over-year change in revenue was across both our Premises and Identity segments. Second quarter 2022 GAAP gross profit margin was 37%, an increase compared to 36% in the first quarter of 2022 and comparable to 37% in the second quarter 2021. For the second quarter of 2022, non-GAAP adjusted gross profit margin was 38%, which was above consensus estimates and an increase compared to 37% in the first quarter of 2022 and comparable to 38% in the second quarter of 2021. Non-GAAP adjusted gross profit margin changes resulted primarily from our product mix, as well as our continued focus on tracking and prioritization of higher margin products. We remain committed to a long-term non-GAAP adjusted gross margin target of 40% to 45%. In the second quarter of 2022, our GAAP and non-GAAP adjusted operating expenses, including research and development, sales and marketing and general and administrative costs were $10.5 million and $9.2 million respectively, compared to $10.0 million and $9.0 million in the first quarter of 2022 and $9.1 million and $8 million in the second quarter of 2021. Our non-GAAP adjusted EBITDA was $1.4 million or 5% of EBITDA margin in Q2 2022, as compared to $0.2 million in Q1 2022. This was above consensus estimate and we are continuing to deliver leverage in our operating model. We also remain committed to a long-term non-GAAP adjusted EBITDA margin of 15% to 20%. Our Q2 GAAP net loss was $0.3 million or a loss of $0.02 per share, which was in line with consensus estimates. This compared to a loss of $1 million or a loss of $0.06 per share in Q1 2022, and net income of $2.5 million or income of $0.09 per share in Q2 2021, which did include a $2.9 million one-time gain on the extinguishment of our debt. We have provided the appendix today, a full reconciliation of GAAP to non-GAAP information, which is also included in our earning release. Our next slide further analyzes trends by segment, beginning with Identity. Revenue from our Identity products totaled $16.9 million or 61% of our total revenue in Q2 2022. This was a 16% increase from Q1 2022 and a 14% increase from Q2 2021. The sequential and year-over-year increase in Identity revenue was primarily driven by higher sales of RFID transponder products, which were driven by current customer expansion, new customer wins, and our ability to deliver product versus competitor constrained supply chains. The increase in our RFID products was partially offset by a decrease in our legacy smart card reader revenues due to increasing component costs, which we elected not to purchase as we were unable to pass this increase onto select customers. Our Q2 2022 Identity segment non-GAAP adjusted gross margin increased to 25% compared to 23% in Q1 2022, and was comparable to Q2 2021. The essential increase in margins was due to a greater proportion of higher margin specialty RFID products sold in Q2 versus Q1. We continue to actively monitor our component cost increases to pass these through to our customers. This combined with our ability to track and focus on higher margin customers should allow us to sustain and expand this margin going forward. Quarter-to-quarter margins can fluctuate, but we expect long-term margins to trend upwards from current levels as we expand and deepen our existing customer and technology partnerships. We believe our focus on more complex devices and strategic NRE relationships with our customers will only further strengthen our margin profile. We remain committed to a long-term gross margin target of 35% to 40% in our Identity business. Now, turning to the Premises segment. This segment accounted for $10.9 million or 39% of our total revenue in Q2, represented an increase of 4% from $10.5 million in Q1 2022, and a 19% increase compared to Q2 2021. The sequential and year-over-year increases in Premises segment revenue were primarily in our commercial business as well as our video product offerings, which have been a key focus area for us to expand on our market share and offer a total platform solution. Non-GAAP adjusted gross margin for Premises in the second quarter of 2022 was 58% compared to 57% in Q1 2022, and 59% in Q2 2021. The sequential and year-over-year changes were primarily due to product mix. We remain committed to a long-term gross margin target of 55% to 60% in our Premises business. Moving now to our operating expense management. Our non-GAAP operating expenses in the second quarter of 2022 adjusted to exclude restructuring and severance costs and certain non-cash charges consisting of stock-based compensation and depreciation and amortization was 33% of revenue compared to 36% in Q1 2022, and 33% in Q2 2021. This resulted in a return to positive non-GAAP adjusted EBITDA for two consecutive quarters in 2022. In summary, we continue to demonstrate a strong gross margin profile and operating leverage in our business while successfully reinvesting for growth within our current cost structure. Now turning to the balance sheet, we exited Q2 2022 with $25.9 million in cash and cash equivalents, and restricted cash. We spent $1.8 million in strategic inventory purchases and $1.1 million in capital expenditures. We remain debt-free, and we have maintained our strong working capital position. 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 in the appendix of this earnings release. As we move to the third quarter, our total backlog for all future shipments was $34.2 million exiting Q2 2022, up 23% versus Q2 2021. This provides visibility into the current business momentum we anticipate continuing through 2022. Momentum exiting the second quarter of 2022 combined with this strong backlog gives management confidence that the business is on the right track to meet the company’s growth expectations in our key strategic RFID and Premises businesses for 2022 and 2023. With our continued focus on gross margin, in the event that current supply chain and macroeconomic issues would result in margin compression, we may elect to forego revenues in our legacy businesses as long as our strategic growth targets are maintained. As a result, we are expanding our full-year 2022 guidance range today with expected revenue between $125 million and $135 million. We are also reaffirming our guidance for 30% to 35% year-over-year revenue growth in fiscal 2023. Normal seasonality is expected to continue. And with that, I will conclude the financial discussion and pass the call back to Steve.

Thanks Justin. As you can hear from Justin’s comments, our growth in RFID and Premises, continued gross margin expansion, and EBITDA strength show our business model continuing to strengthen, trending towards our long-term operating model of growth, gross margins, and EBITDA margin. Now, every business is exposed to macroeconomic forces this year, but because of our technology position and the market segments driving our growth, we think results in our strategic businesses will continue to be strong. This means our business path is all about execution. Regarding macro forces, let me address them quickly so then we can get back to execution for the rest of this discussion. In terms of macro forces, one of the top concerns people have is recession risk. Our RFID focus on medical devices and healthcare, and our Premises focus on federal, state, and local government security are both categories that are strong even during economic downturns. Regarding inflation and increasing interest rates, we’ve proven we can raise prices when our costs increase. We’re debt-free and capital-light, so interest rates aren’t a major factor. Geopolitical risks are also on everyone’s minds, but again, we have a strong position. If anything, in times of geopolitical risk investments in security increase, and certainly government security budgets grow, which we’re seeing. Now, regarding supply chains, nobody’s immune to some supply pressures these days. We’ve shown that we can manage supplies and costs so that our RFID and Premises businesses grow fast with strong margins. And we have the demand strength to keep our strategic businesses on track. If we need to, we’ll maximize margins in our growth categories over our legacy business lines. We know supply chains are always a source of risk, so we’re managing them closely. For at least the next couple of quarters there’s going to be supply churn, but so far we’ve managed it and made real lifetime trade-offs to support strategic growth and strong gross margins. Longer term we’re even assessing near-shore and on-shore supply chain options to keep us in a strong supply chain position. We already manufacture in Canada and California, so we’re positioned to expand near-shore activities if needed. Hopefully that addresses some of the macroeconomic topics on everyone’s minds. We can certainly go into more detail in the Q&A, but now let’s turn back to execution. With our expanded world-class sales team, with the industry’s best engineers to support NRE projects and other design wins, with deep relationships and technical expertise, engaged with a half dozen transformational programs, and with our ongoing production capacity expansion, all the pieces are in place to drive the vision and targets we’ve set. RFID showed the 40% plus growth we expected, and Premises grew in our target range of three times the industry growth rate. So how do our metrics look going forward? And how are we positioned to build our strategic leadership as an IoT company? I updated the status of our transformational projects in my opening comments, and we can go into more detail in Q&A if there’s more interest. I’ll focus here on the wider base of NRE project design wins. Design wins are the clearest indicators of our business strength going forward. Leading in design wins drives more wins as customers gravitate towards companies that have proven they can deliver. That brings more scale, more experience in IT, more reputational leadership, and a stronger moat around our lead in the market. In Q2, we had 38 active NRE projects, more than ever in our history. This is up from the two dozen reported in Q1. We also finished a dozen in Q2, up from a half dozen completed that we reported in Q1. With this growth in NRE projects, this is one area we added people in Q2, both in engineering and project management. We never want our NRE capacity to be a bottleneck. It drives future volumes, so it’s one of the few areas we expect to keep adding people to support NRE project demand. Now, in addition to the athletic shoe and golf ball projects I mentioned earlier, we have NRE projects ongoing for an NFC solution provider for sensor-enabled applications, including humidity, temperature, shock, and vibration, and other sensing. I also mentioned we have five new projects in medical devices, and four more in the cannabis and luxury wine and spirits categories. The more we can talk about, but each quarter, we’re trying to give a sense of the range of applications and categories with clearly major unit volumes like these. NRE projects are clear indicators of both industry leadership and future revenues, since most NRE engagements lead to shipping projects and then long-term customer relationships that are the foundation of our growth and, of course, of our competitive moat. So these projects show that our growth drivers are in high-margin, high-ASP devices for IoT applications. From a vertical perspective, our focus continues to be medical devices, specialty retail, and industrial applications, which have higher margins and, of course, higher switching costs. Turning to our other strategic lever, our technology partnerships are expanding our growth opportunities. As I mentioned in my opening comments in Q2, we expanded the capabilities of our Bluetooth RFID device with Wiliot. We’ve now implemented a full IoT pixel-enabled cold chain solution. This integrates traceability, authentication, temperature, humidity, and capacitive sensing along with geolocation and timestamping, all in one solution. The target markets for this technology are medical devices, healthcare and pharma, and food supply chains, all of which are sensitive to quality and cost, as well as being recession-resistant categories. Now, there were other technology partnership activities across the software stacking in Silicon, and we can go into those in more detail in Q&A if there’s interest. The third leg of our execution is our growing profile as the industry thought leader. Now, we made a lot of progress here in Q2. In addition to awards, social media presence, podcasts, and speaking engagements, we’re also expanding our leadership role in the NFC forum, which we will announce more about later this month. We’re also honored to welcome Manfred Rietzler as a senior advisor to Identiv. Some of you know Mr. Rietzler is the Founder of Smartrac. He was also their CEO and subsequently CTO over an eight-year period and on their board until their sale to Avery-Dennison. He’s made it clear to us and others in the industry that he sees our opportunity to be the leader in the category of advanced RFID. In announcing his role, Mr. Rietzler commented that he thinks we’ve established a true leadership position in the industry with an exceptionally talented team and innovations in the RFID-enabled industrial and IoT markets. This sort of endorsement from one of the most respected people in the industry is really powerful as potential customers assess working with us on advanced solutions and as partners and even employees assess becoming part of our team. It even has an effect on chip allocation decisions by some of the big chip providers. And this, of course, all helps our business momentum. Now another key project for future growth is making sure we have the capacity and cost competitiveness to stay ahead of fast-growing customer demand. We’re well along planning a second production site to leverage the expertise we have in Singapore, but with lower costs and an ability to expand production volumes. We’re likely to move ahead with an expansion in Batam in Indonesia. This is just an hour ferry ride from Singapore, but there’s room to build the capacity we need, skilled people to lead and operate the facility and a cost base that’s very competitive with any location while easily leveraging the world-class expertise we’ve built in Singapore. With this facility, we’re positioned to scale well beyond half a billion units annually, very cost-competitively to support the expanded margins and to support some of the transformational projects as they scale up. In addition to RFID capacity expansion, we’re continually working with component suppliers to keep our partners and our own operations running at full capacity. So that’s the execution picture for the RFID business. We’re confident that our execution is best-in-class across our design wins, partnerships, industry leadership, capacity scaling, team expansion, and supply chain. This gives us confidence in our plans for growth in our strategic categories, gross margins, and operating margins through 2022 and 2023. Turning to Premises, we covered most of the growth drivers in the opening comments. With our strength demonstrated in Q2 in both commercial and federal markets as the seasonal buying cycles in government hit in Q3, we’re seeing budgets for security continue to grow, in particular for highly secured end-to-end platforms, where we’re the clear leader. With all these growth drivers and with the 21% growth we delivered in the first half of 2022, we’re confident of 20% to 25% growth in Premises. To wrap up, RFID is growing over 40% and Premises is growing over 20%. Our industry position and execution support these trends continuing in 2022 and 2023. In Q2, our RFID business grew at our expected long-term rate without the transformational projects kicking in. We’ll keep updating tangible progress milestones to confirm the solid position we have in each opportunity, as well as confirming and refining the scale of each. The macroeconomic environment is tough, but we’re positioned well. In particular, we continue to work hard to stay ahead of supply chain shortages. Our priority is to ensure we drive our RFID and Premises growth while also sustaining gross margins. If supply chain issues require too much premium being paid on normal COGS, such that margins would be pressured, we’re Raising prices aggressively. Wherever we aren’t able to raise prices, we’ll forgo revenues to support margins, as long as our strategic growth is kept up at all times. As a result of this commitment and knowing supply chain and macroeconomics can have an effect on any business, we’re expanding our guidance range for 2022 to be $125 million to $135 million. Now we have plenty of chances to exceed this range, but as long as we’re supporting our RFID and Premises growth rates to meet our target model, we might forgo some legacy revenues. It’s only responsible to make sure we’re meeting expectations. Our strategic growth gets total focus, and our margins continue to be strong as we keep driving our transformational projects so they can drive growth well above our 40% baseline RFID growth. We expect the second half of 2022 to build on the trends in Q2. RFID growth accelerated, gross margins expanded beyond our target for the year. RFID-driven NRE projects reached record numbers and revenue strengths in RFID offset legacy revenues where cost increases would have pressured margins. The progress on RFID and Premises growth, gross margins, strategic initiatives, and our increasingly high profile industry position are all encouraging for growth and profitability of our strategic businesses. So with that, we’ll open the discussion for questions. And once again, we’re joined for the Q&A by Dr. Manfred Mueller, our COO and GM of Identity, and Amir Khoshniyati, Vice President and General Manager of our Transponder business. So I’ll now ask the operator to open the line for questions.

Your first question is from Jaeson Schmidt from Lake Street. Your line is live.

Hey, guys. Thanks for taking my questions. Just want to start with the 2022 guidance, just so I can fully understand maybe the slight downshift that’s entirely due to you guys just baking in the potential to walk away from some low margin legacy business in the future, or does that also bake any RFID projects maybe being pushed to the right, given the macro?

Very good clarification, Jaeson, thank you. No, it is totally the former and none of the lot of the RFID business has a lot of momentum and strength behind it. And that led us to even include the comment that in the current quarter, we’re looking for over 50% growth in RFID and that is certainly the trend that we’re on. It’s sequentially increasing its growth rate as we look at it. But we know how important gross margins are in the blended gross margins and want to have the flexibility to do what we did in the current quarter, which is protect aggregate gross margins while making sure we’re creating zero headwinds. In fact, we’re putting everything behind investment in our growth businesses.

Okay. That makes sense. And it’s really helpful. And then just looking at the auto-injector market, I mean, Steve, based on your commentary, it sounds like you’re seeing some really nice momentum there. The comments regarding discussions with some additional customers, including the largest auto-injector, are those in data trials or are those just initial discussions?

So Amir’s right here across the table from me. So I’ll let him answer that, and also that’ll make sure that I don’t step across any lines on customers because he’s the one talking to them.

Sure. Still in the confidential phase, but this is another enterprise-level customer that’s committed to NREs to us. So they’re binding NREs, we’re in design phase right now. And we anticipate hopefully to get something over the next two quarters that’s actually tangible volume.

Okay. And last one from me. And I’ll jump back into the queue, you mentioned four other pharmacy chains in pilots and deployments. How many of those pharmacies do you think could actually be in full on deployments by the end of this year or early next?

Full on deployment as in all of their pharmacies equipped and rolling, there might be one of them by then. They’re all pretty measured in their rollouts. But in terms of by early next year, I expect that they’ll all be fully commercialized in that timeframe.

Okay. Got it. Thanks a lot, guys.

Thanks Jaeson.

Thank you. Your next question is coming from Anthony Stoss from Craig-Hallum. Your line is live.

Hi guys. Nice execution in a really tough market. Steve, on the 38 NRE projects you have ongoing, do you expect all of them will be commercialized at some point by the end of 2023? Any hints at potential volume when you lump them all together? And then do you – in terms of component supply issues, do you see that they’re starting to get better? Then I have a couple follow-ups for Justin.

Sure. And I’ll talk about NREs and I’ll let Amir add to it as well. So typically somewhere around two-thirds of our NREs turn into commercial business. There are some that just turn out to be experiments and that’s fine. They often come back around, but the vast majority of them definitely do turn into business and we expect that to do. That said, it’s sometimes non-linear. Sometimes you start out with a project, do an NRE and then the product direction changes and you end up doing another one or some variation on it. That ultimately becomes the business you choose. And that’s actually the main reason that it’s less than 100%. Yeah, the customers themselves did engage in NRE, the vast majority of them convert into business over time. There’s always the time phasing there because sometimes in the medical device sector, it can be a year and a half from NRE to production. I’ve mentioned in the past that for our mobile customer who we love very much, it was over two years between our first designs with them and getting it to ramp up. So that’s how I’d characterize that profile. Then to characterize volumes, the numbers get rather extreme because athletic shoes, of course, see billions sold a year. Just in the True Athletic use category and similar with some of the medical devices, you quickly get into several hundred million uses, but I’d say there are two to three new use cases that could certainly well be in the over 100 million units space among that cohort of new NREs. Some of the NREs in that 38 are ones that have been underway in auto-injectors and others, but there are a few that we aren’t going to add to the list and be tracking every day, but we have them as part of our business model that can be driving substantial volumes. But let me let Amir comment further on that.

Yeah. Just to add, a lot of these NREs are turning from reference selling opportunities. What may have taken us a longer cycle on the first design now is becoming much simpler in the second and third paths. We’re also getting a lot of assurance from these customers that are coming forward on the NREs because they’re coming forward with multiple NREs. One of them may be for an application, and another one may couple with a feasibility study behind it. When that usually happens, they know exactly what they want and they want our expertise to craft around it. Then hopefully it goes to the standard sales cycle so the right project can ramp up. All the right signs are here, and definitely they are growing quarter-over-quarter, which is the right trajectory for us.

Does that answer what you were trying to get to, Tony?

Yeah, I think so. And I guess either for Amir or you, Steve, when you look at this tranche of potential new customers and the ASPs, it sounds like ASPs are moving up. But if you looked at a year ago at a similar tranche of NREs, what was the average ASP at that time versus what you’re at now? If you don’t know, maybe just a percentage guess would be helpful trying to figure out or get a better sense of how much ASPs are going up?

So, yeah, two dimensions to that is on the pure ASP side. Partly because of the focus that we have on it and the rigor that Amir’s put into his team and everything else has probably, nearly doubled. It’s certainly 50% higher, and it’s some from 1500% on that. Even the auto-injector we mentioned at $0.35, a good proportion of NREs a year ago could have been in the $0.20 range. The other thing I’d add is really the volume. We haven’t really been talking about NREs and tracking them as a pipeline into the last few quarters. And as I mentioned last quarter, it was a couple of dozen. Now it’s more. The truth is we never want to be gated by NREs, but we probably could have done 20% more coming in the hopper. So we’re adding people as quick as we can on that. The growth aspect of it is both in the number of opportunities, and a lot of them, as Amir mentioned, are references now; people are just coming to us. It’s the nature of the opportunity, as people are getting more comfortable and sometimes with second-generation designs, that you get a lot more value-add, a lot more complexity, and therefore higher prices. You want to add to that, Amir?

Yeah. The only addition is really that price points are going up because the innovation is going up. With innovation, what we were doing last year was more around validation, just simple authentication. Now we’re doing that coupled with capacity sensing and many other add-on capabilities around tampering. As we add more value, we could justify a higher price point, and the customers are willing to pay for it.

Super helpful, guys. And then Justin, really strong gross margins, 38% guys were the second half relatively flat from Q2 of now. Q2 came in higher than what you were anticipating. What do you see for Q3? You think gross margins are roughly flat, or can they keep growing a little bit each quarter?

Yeah, we try not to go too granular into quarter-by-quarter analysis. I think we had put out we’re trying to shoot for 37% for the year, and I think that’s a big target for us. As I mentioned with Identity taking a bigger and bigger piece and knowing that Identity is in the 25% range, that mix might keep us right around 37%, which would be a target for us.

Okay, perfect.

It’s not that any margins are going down in our eyes. It’s more just the mix and taking a little bit bigger piece of the pie.

Got it. Thank you.

Thank you. Your next question is coming from Mike Latimore from Northland Capital.

Great, thanks. Yeah. Great execution and EBITDA levels here. So Steve, did you say that the 41% growth in RFID did not include any transformational deal revenue?

Effectively, yes. I mean, some people count the mobile customer in those transformational deals, but of course that’s really part of our base for the last year and a half. But for that, it didn’t include anything meaningful. I mean, we previously disclosed 50,000 units that we sent for the cannabis pilot and some 10s, and 20s, and 30,000 units in that category. But in terms of a multi-million unit ramp up, which is when I would characterize one of those actually ramping, the answer is no. That growth, and to be fair, the growth I characterized for the current quarter is really Amir and his team driving the business and the real embrace of some of these higher-end advanced RFID devices.

And then, you expanded the guidance range for the year on the legacy product category. I guess, as you look at the second half of the year and the kind of sales plan, what percent of the planning would legacy comprise at this point?

Well, Justin will remind me because he has it in preparation for these conversations. We don’t break them out. They’re in the Identity business segment. But we don’t break out the pieces there. But you can see that it can happen, when you pull a couple million out. It can have an effect at our scale in terms of, I mean, if we had included those, but at substantially below gross margins that we wanted, it would’ve had an effect as well. So, we’re just trying to manage to make sure that we’re supporting the core RFID and Premises growth. There’s nothing diluting the margin or growth message on that. And if the legacy business can contribute to basically funding growth and the rest of the business, that’s primarily what it’s there for.

Got it. And then also just last quarter, you gave a number on backlog plus committed contracts as a percent of, I think it was RFID goals. Have those rough percentages changed much?

No, they have if anything they’ve progressed because I don’t remember the exact number off the top of my head. But for the fourth quarter, it was lighter coverage, and of course, as we move our bookings, that gets higher coverage there. So it’s moved along sequentially.

Okay, great. Thanks very much.

Thanks, Mike.

Thank you. Your next question is coming from Craig Ellis from B. Riley Securities. Your line is live.

Yes. Thanks for taking the questions team, and congratulations on the margin execution in the quarter. So Steve, I’ll just start by saying I like what you’re doing with security card and really trying to prioritize strategic growth at the right margin structure at the overall business. The question for you and Justin is really twofold off of that one. Just from what you’re seeing in the supply chain, as you look out here in early August, can you give us any sense for the degree to which you may be expecting a similar impact, in the third calendar quarter and the fourth calendar quarter? It would seem that would something similar would fit real well with where the midpoint of the new guidance is. I wanted to check on that as well for supply chain questions.

We are optimistic, but we have to plan for the worst, frankly. It may already be behind us. I believe it’ll be behind us, certainly by the end of this year. But supply chains are very strange right now. Some places are – some categories of advice for loosening up, others are just $2 devices that are costing you $50 if you want to get them and build today. We’re just not going to do that. So, we are assuming that the world is not going to get a lot better, even though we see some signs that might get a lot better. But I think it’s really important. We’ve got such good growth going on in RFID and in Premises that we just don’t want to create pressure on supporting that growth and driving it. Because there are other areas that have A, they’re supposed to be cash negative for the business, and B, I do think the supply chain issues will sort out and that will come back in as opportunity. But if it’s not in this quarter, next quarter, we don’t want to be pressured on the growth businesses to manage our way through that.

It does with one clarification. I think there were a couple references in the prepared remarks and in Q&A thus far about the security smart card business within Identity, but are there potentially other businesses that would be more opportunistic about that have a potential supply chain impact? Or is it just that one business that’s really in quite?

Yes, it is really the security cards and smart card readers.

Okay, great. Second question, if I could for Amir. Amir, I think over the last couple quarters, one of the things that I believe we’ve heard from you is an interest and a prioritization in sales-related hiring. With comments today around a priority of lightweight capability around NREs, does that mean you’re really trying to press ahead on two levers with incremental talent additions, or if you really swap one for the other, a different picture it’ll – will you help there please.

So right now, we’re still commercially facing 100%. So revenue is the top priority. Top margin business is the top priority, but as we’re scaling, we are trying to find the good balance to support the number of projects that are coming in because of this year demand that currently is inbound. Now, outside of that, we’re hiring very strategically. What I keep giving as an analogy is they’re Navy SEALs are not soldiers. So, all of our salespeople are technical enough that they basically cover two or three competencies in one. They’re usually salespeople that have come up in the factory. They understood the production runs, went into inside sales and now they’re in the field organization. So as a result of it, they can carry the solution selling the criteria much further than a green salesperson would coming into the organization.

Okay. And the hiring that’s being done is that inside of the prior OpEx outlook for the business? Or are you nudging that up just because of the magnitude of the opportunity that’s in play with potential demand, 20% above where you are based on Steve’s comments?

No, it’s all within budget. Justin is right on top of me on that.

Yes, and then finally Steve, interesting opportunity to expand capacity. Can you provide us some color on the timing for that and what the capital cost would be and when the outlays would occur?

Yes, and actually we’ve got Manfred Mueller on the phone as well from Germany who has been driving that initiative. We’re moving it very fast. Actually, so Manfred, do you want to comment on the timeline and process for Batam, and then Justin can comment on this.

Hey, nice to meet you. So timing-wise, we have boiled down the respective locations in Batam to only two. We will be basically assigning a contract within the next week or two. In addition to that, knowing that some of the machine lead times along, we have already started communications with the factory again. So we will be adding two additional pieces of equipment. We are starting to hire the people in order to basically train them in Singapore and then get them ready for the Batam facility. It is supposed to be up and running by the first quarter of 2023.

Got it. And then lastly, one of the things that we’ve seen in the broader industry team is that as capacities needed in the current environment, customer deposits have been one way to sometimes partially or meaningfully fund capacity. Is that something that the team is considering? And if so to what extent?

We’ll certainly have those conversations with our broad base of customers. That usually is not the way we go for it, but the other aspect of it is you’re talking about a couple million dollars in aggregate that, as Manfred said, we expect to be fully up and running in the first quarter, which means we’ll be starting pilot runs and early runs before the end of this year. We think we can cash flow it reasonably well and have the capital outlay being pretty well balanced. Justin, do you want to add anything to that?

Sure. I mean, we’re taking a look at another mobile, which we all know is roughly in the $900,000 range, and we are looking at a DDA type machine, which is an upgrade from there. It’s about $2.5 million. So as Steve mentioned, our CapEx is somewhere in the range of $3.5 million to $4 million over the next, let’s say, 18 months. And we have the working capital and the cash today to fund that.

Excellent. Thanks team.

Thanks Craig.

Thank you. Your next question is coming from Brian Ruttenbur from Imperial Capital. Your line is live.

Yes. Thank you very much. A couple of questions here. In terms of cash generation, you just answered the CapEx question, but do you anticipate in 2022 generating positive cash flow for balance?

I don’t see a big cash drain. I don’t think we’re going to be generating cash only because of the outlays. Even when I talked about those two machines, there’s a 30% plus deposit that goes in for 60 days, and we have a pretty early payment stream on those as well within 2022. So because of the nature of the CapEx and the timing on the cash flows, I don’t see us being cash-generative in the next six months, but I don’t see it going down significantly.

Okay. So cash remains around the same. And does that change in 2023? I know that you can’t give us guidance for 2023, other than you’re looking for X amount of growth, but will the cash situation change significantly in that year, 12 months, 18 months from now?

I don’t see it changing significantly. If it, I think that we’ll be able to, we continue to invest in CapEx. Even if you look at this quarter, that’s the easiest way to describe it. Let’s say we went down about $2.5 million, but if you look at my cash flow statement, our cash flow statement, $1.8 million were just strategic inventory purchases. We’re really trying to get out in front of those. A million of it was cash CapEx. If you just combine those two, you’ll see that we’re running really neutral on cash flow from operations and we don’t have any debt to serve. We hope that trends continue. If there is a decrease in cash, I’m talking about would be for either strategic inventory purchases or additional CapEx.

Okay. And then one other housekeeping question I have is RFID units. Did you state the number of units shipped in the period?

We did not.

Can you?

We’ll follow up with you on that one, because I don’t have it in front of me.

Yes. Okay. That’s it then. Thank you very much. Great quarter.

Thank you.

Thanks.

Thank you. That concludes our Q&A session. I’ll now hand the conference back to Steve Humphreys for closing remarks. Please go ahead.

All right, thanks. And again, thanks to all of you for joining us this evening. It’s very important to keep our investors updated on our business progress. So we’re going to be redoubling our efforts on that. The main message will be conveying is that we’re executing on our plan. The market segments are growing very strongly despite any of the macroeconomic forces around us, and we really think that’s going to continue. To keep you updated more specifically on our progress, we’ve got several events coming up among investor events; we’ll be at the Needham Conference, actually just next Monday, which is virtual, we’ll be at Canaccord in Boston in person on August 10th, Lake Street BIG conference in New York in the middle of September, and the Craig-Hallum Conference also in New York on November 17th and Imperial Capital in New York on December 13th. You can see a couple right off the bat and then monthly phased out. We’ll certainly do some investor outreach and events along the way. We’ll keep you posted and as always, if you have any other questions or follow-ups, please reach out to our IR Team and we’ll be happy to keep you posted on all the progress in the business. So again, thank you all for joining us and have a good evening.

Thank you, ladies and gentlemen, this concludes today’s event. You may disconnect at this time and have a wonderful day. Thank you for your participation.