Identiv, Inc.

Good afternoon. Welcome to Identiv's presentation of its third quarter fiscal 2023 earnings call. My name is Tom, and I will be your operator this afternoon. Joining us for today's presentation are the company's CEO, Stephen Humphries, 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 may be making references to non-GAAP financial measures or guidance, including non-GAAP adjusted EBITDA, non-GAAP gross margin, and non-GAAP operating expenses. 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 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 and quarterly report on Form 10-Q. IDENTIF assumes no obligation to update these forward-looking statements, which speak as of today. I will now turn the call over to CEO Stephen Humphreys for his comments. Sir, please proceed.

Thanks, Operator, and thank you all for joining us. In Q3, we continued to focus on high margin revenue growth in our strategic business lines to strengthen our balance sheet and our business growth. Our premises business grew 15% year over year to a record $13.6 million, and our video software revenues more than doubled year over year. This brought our software services and recurring revenues to a record over 20% of our total premises business. However, in the identity business, mostly within the lower margin products of our RFID segment, we had a major revenue shortfall, coming in about $3 million below what we had planned. We'll talk about this in more detail later, but I wanted to address it early. We had three customers in particular push out orders in the library, packaging, and warehousing and logistics categories that delayed shipments which we expect to recover by the end of Q1. We also had a design change in a logistics application that affected Q3 revenue. One action we're taking immediately from a planning and communication perspective, we're moving to quarterly revenue guidance. This way we can factor in every upside and downside and give clear projections as quickly and completely as possible to our investors and analysts tracking our business. Now let me first address the RFID segment of our identity business. I want to be clear about one fact. Our RFID strategy is intact and making progress. The revenue miss is very frustrating, but it does not harm our core business progress in high-value, specialty, complex, RF-enabled IoT solutions, or SCRIs. This is a category we're truly leading, is happening, but is still early stage. This is a high margin business opportunity in the RFID segment. We now have over 50 customers in the $20,000 revenue range who've deployed new, innovative SCRI products at the pilot stage, many coming from non-recurring engineering engagements with us. Some of these applications can scale to $20 million annually or higher based on the market sizes for their end products. Now, many of you are familiar with the NRE terminology we focused on for tracking early stage opportunities. We'll continue to update on NRE stage opportunities, but our business update focus going forward will be more targeted to pilot stage opportunities, which is the next stage past NRE. At the pilot stage, projects are typically poised to move into production scale based on the application success in their end market pilot. Additionally, our most important vertical for SCRI healthcare now accounts for more than half of our NFC-based revenues. This reflects our drive over the past two years to emphasize large potential high margin healthcare applications. Even at their current early stage volumes, some of these healthcare applications carry gross margins in the 40% range, suggesting even more margin opportunity over time. Because the demand pushouts in Q3 were in the lower margin part of our RFID business and our higher margin projects are growing well, Despite the revenue shortfall, we had our highest gross margins and highest adjusted EBITDA since Q3 2021. In the identity segment overall, margins declined primarily due to a year-over-year decline in gross margins in our identity reader product line. We expect identity reader margins to return to historical levels in the current quarter. Fundamentally, we clearly need more pipeline in our RFID segment. particularly in SCRI applications, to offset surprises like this. It's a big impact. We've taken action on people and processes to keep it from happening. We're tracking demand carefully to avoid another revenue miss versus established expectations to make sure we're not seeing a more fundamental demand slowdown in some markets, particularly the categories that pushed out demand in the lower margin RFID applications in Q3. Let me now talk about our premises business in the physical security sector. Premise's overall revenue grew at more than double the industry's growth rate, while video and total software, services, and recurring revenues grew at an even faster rate. Commercial customer expansion, with 14% revenue growth, is on track with exciting potential based on many new product offerings and positive market dynamics. For federal customers, normally Q3 is strong, and this quarter was no exception, with federal revenues growing 16% year over year. Federal growth was strong despite two short-term headwinds. First is the continuing government budget confusion happening right during fiscal year end, which usually is the strongest buying period for federal customers. Second was a ransomware attack that hit one of our largest federal integrators. This resulted in them being unable to issue new orders during their critical last weeks of the quarter, which have now resumed. Without these headwinds, our premises growth would have been more than a million and a half dollars stronger. In-premises, among several exciting new products, we went into full launch of our cloud-first, small-to-medium business product, Primus, along with a totally new edge controller, our EG2, and our Primus mobile app. This is a big industry statement, creating the standard for a high-security cloud offering in the SMB space. Additionally, we've released Enterphone 10.3, along with Enterphone Mobile, creating materially more sales potential. And very importantly, we launched Vision AI, our video intelligence solution that's now a standard feature in all of our video offerings. Now, we'll elaborate further on the significant implications for these releases, but one notable metric of our progress is our high margin software services and recurring revenues, which increased over 16% sequentially from Q2 to Q3. There's still a portion of revenues that are perpetual license revenues, which we expect to convert to subscriptions. This is a relatively near-term recurring revenue growth opportunity because it's grounded in our own customer base. Now, the premises business is taking advantage of several favorable trends in the physical security sector, for which Identiv is exceptionally well-positioned. To call out a few of these, physical security infrastructure is being used for other value-generating objectives within the enterprise, driving strong and rapid ROI for investments. The big CRE prop tech trend, where identity, access control, and video technologies are critical to new business paradigms for how office space will be used and managed. Next generation cloud-based technology, with recurring revenue models being deployed in physical security solutions, driving substantial customer upgrades and significant new market penetration. Now, the physical security industry is late to this party, but the acceleration of this trend will be dramatic in the next several years. AI technologies deployed across physical security solutions dramatically enhancing efficacy and lowering total cost of operation. And finally, the convergence of cyber and physical security. So in summary, premises is growing at double the market's rate, growth is well balanced across commercial and federal, video software doubled year over year, and software services and recurring revenues grew to over 20% of premises revenue. These metrics position us as one of the strongest performers in the physical security industry. Now let me go into the dynamics in our RFID business in more detail before I turn the call over to Justin. In the identity segment, our RFID-enabled IoT business shipped 54 million units in Q3, up 18% year-over-year, and made strategic progress, especially in SCRI applications in healthcare, our most important vertical. We shipped a half a million units of prototype samples for an auto-injector project, which now has received FDA approval. As I mentioned earlier, healthcare now accounts for more than half of our NFC-based revenues. This progress in SCRI products is also reflected in our production dynamics. We do over a dozen product changeovers on each production line over the course of the quarter, which is needed for production of early-stage products. That's 100 changeovers across our eight primary process production lines that we did in Q3. None of our competitors can deliver as fast, flexibly, and with high quality, despite the technical complexity and short runs they need to meet these demands. It's extra work, but we're confident that it'll pay off. As a result, we believe we're serving the majority of the industry's early adopters for SCRI, both at the design stage and in pilot production. Our competitors are focused on running hundreds of millions of commodity tags on a single production line nonstop. We're optimized for high-end devices eventually built into products and experiences as customers move beyond tags stuck onto them and thrown away. We're the clear leaders both in engineering and in the flexible production these customers need. This is why we have Germany, Singapore, and Thailand doing engineering and prototypes, flexible production, and volume production. It's an exciting new category with a very large TAM defined by the potential number of units of RFID-enabled products in each of our customers' use cases. Now, in another production-related metric, in Q3, we delivered 11 million units of Williott IoT pixels, down from the quarter prior level, partly because of a cost reduction process change we made. We had to revert to our prior process, and the delay did affect about 1.5 million units we could have shipped otherwise. Now, as we continue to focus on healthcare applications and specialty devices like these, demand can fluctuate quarter to quarter in early-stage applications that haven't yet stabilized. However, it does not affect our strategy or market leadership in SCRI. Since we stayed disciplined and kept our high-value focus, we fell short on revenues. But our overall company working capital strengthened, receivables are healthy, overall gross margins expanded, and our strategy is progressing. For example, as I mentioned, we're managing about 50 pilot projects, which is growing as we discussed earlier. We made the progress in healthcare that I described earlier, and we've got a larger range of potentially large-scale SCRI use cases than ever. As a result, we're more excited about the prospects for this business segment than at any time in its history, given all the potential we can see for new dimensions of growth and profitability. So in summary, our premises business made the industry-beating growth I mentioned, and our leadership in the RFID sector focused on SCRI applications also built a wider and stronger base. From an investor perspective, it's important to know that the company's business model is strong enough to manage near-term revenue shortfalls and keep driving our core business objectives as our strategic business units build stronger competitive positions in Q3. We're also committed to strategically acting so that we optimize our value creation potential across both of our larger strategic business units. Our board-led strategic alternatives review process was a major focus and activity in Q3 and will continue to be in Q4. I can't comment in detail, but as we've said before, we have two great growth businesses with excellent value creation opportunities. We're exploring very interesting prospects for each business unit and the business as a whole. Each business unit has different capital needs, and both need aggressive management execution focus, but they're materially different businesses. We're working this thorough strategic review process, led by our board, at the same time we put intensive efforts into managing these businesses. Now, timelines can never be totally predicted, but my personal assessment is it will be successful with a meaningful strategic action sometime in the beginning of 2024. We have exciting businesses with huge potential. We're going to make sure we optimize this opportunity for our shareholders. So with that, I'll pass the call over to Justin to review our third quarter financial results in more detail. Justin?

Thanks, Steve. As Steve mentioned, despite a revenue shortfall in RFID, in Q3 2023, We were able to deliver record revenue for a fiscal third quarter while also expanding sequential and year-over-year gross margins and EBITDA to their highest levels in eight quarters. We also continued to maintain a strong working capital position. We believe these results paired with our focus on driving discipline growth in both our identity and premises businesses, including our new cutting edge premises products, our focus on SCRI and build out of our Thailand facility positioned the company to continue its growth momentum in the fourth quarter of 2023. Third quarter 2023 revenue was $31.8 million, lower than our expectations as previously noted. This represents a 3% increase versus the comparable prior year period and an 8% increase versus Q2 2023. Third quarter 2023 gap and non-gap adjusted gross margin was 37% and 39%. both above consensus estimates as we're able to expand margins in our premises segment, offset in part by a decline in margins in our identity segment related to product mix, particularly in the identity reader product line. GAAP and non-GAAP adjusted gross margin reflect our continued focus on maintaining our margin profile in 2023 while continuing to increase our investments in technology and manufacturing processes and equipment. We remain committed to a long-term non-GAAP adjusted gross margin target of 40% to 45%. In the third quarter of 2023, our GAAP and non-GAAP adjusted operating expenses, including research and development, sales and marketing, and general and administrative costs, were $11.6 million and $10.3 million, respectively, a decrease from Q2 2023, marking the second consecutive quarter we were able to expand our operating leverage by delivering expanded revenues in excess of our operating expenses. We expect this trend to continue in Q4 2023. Our Q3 gap net loss attributable to common shareholders was $0.3 million, or one cent per share, compared to gap net income of $0.2 million in Q3 2022 and a gap net loss of $1.5 million in Q2 2023. Non-gap adjusted EBITDA was $2.2 million in Q3 2023, an increase of $0.1 million versus the comparable prior year period, and $1.5 million versus Q2 2023, as we were able to increase revenue and expand our gap and non-gap adjusted gross margins while maintaining our operating expense profile. This was consistent with our continued strategic investments in R&D, evidenced by our new product launches in the premises business and in capital equipment for our Thailand facility in our identity business. In the appendix of today's presentation, we have provided a full reconciliation of GAAP to non-GAAP financial information, which is also included in our earnings release. Our next slide further analyzes trends by segment. Beginning with identity, revenue from our identity products totaled 18.3 million, or 57% of our total revenue in Q3 2023, compared to $17.7 million, or 60% of our total revenue in Q2 2023 and 62% of our total revenue in Q3 2022. This reflects an increase in RFID and legacy smart card reader sales, offset in part by a decrease in our access card sales. Our Q3 identity segment gap and non-gap adjusted gross margins were 21% and 23%. respectively, a decrease of 2% and 1%, respectively, as compared to Q3 2022. The decrease in gross margins is primarily due to product mix and our legacy smart card readers. 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 and increase production at our Thailand facility, which has lower manufacturing costs than our Singapore operations. 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 $13.6 million, or 43% of our total revenue in Q3 2023 compared to $11.8 million in Q3 2022, an increase of 15%. The year-over-year increase in premises segment revenue was across both federal and commercial businesses, including many of the verticals Steve mentioned earlier. We saw increases in both our access control and video product lines and software services and recurring revenues. We continue to execute our go-to-market strategy by offering a comprehensive end-to-end security platform solution. GAAP and non-GAAP adjusted gross margins for premises in the third quarter of 2023 were 60% and 61% respectively, an increase of 2% compared to Q3 2022 and demonstrate our ability to expand our margin profile. We have achieved and 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 third quarter of 2023, adjusted to exclude restructuring and severance costs and certain non-cash charges consisting of stock-based compensation and depreciation and amortization was 32% of revenue, compared to 31% in Q3 2022 and 36% in Q2 2023. As noted previously, we expect quarterly operating expenses to remain at their current levels. Now turning to the balance sheet. we exited Q3 2023 with $20.9 million in cash and cash equivalents and restricted cash, a decrease of $1.3 million from Q2 2023. In Q3, the decrease in cash was a result of $0.3 million in cash used in operating activities, $0.6 million in investing activities primarily related to capital expenditures, and $0.2 million from financing activities. Our working capital exiting Q3 was $49.8 million, an increase of $0.6 million from Q2 2023. Notably, inventory decreased $1.7 million in Q3 as we worked through our strategic inventory balances. As a result, we expect to continue rebalancing our working capital and anticipate repaying our revolver balance in 2024. In our 10Q filing, 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 today's earnings release. As Steve mentioned, considering our recent quarterly variations as a result of demand pushouts in some of our lower margin RFID categories, along with the persistent macroeconomic uncertainty, we have decided to move to quarterly revenue guidance. Consistent with our normal revenue seasonality, Q3 is our strongest quarter for the fiscal year, and there is a dip in revenues from Q3 to Q4. Given our Q3 revenue level of $31.8 million, this implies a Q4 below the $31 million range. Factoring in a conservative view of lower margin RFID customer demand leads us to an expected Q4 revenue range of $29 to $31 million. This concludes the financial discussion, and I'll now pass the call back to Steve.