Identiv Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2023

There are 7 speakers on the call.

Operator

Good afternoon. Welcome to Identiv's presentation of its Q3 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.

Operator

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 ks and quarterly report on Form 10 Q.

Operator

Identiv assumes no obligation to update these forward looking statements, which speak as of today. I will now turn the call over to CEO, Stephen Humphries for his comments. Sir, please proceed.

Speaker 1

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 $13,600,000 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 $3,000,000 below what we had planned.

Speaker 1

We'll talk about this in more detail later, but I wanted to address it early. We had 3 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 1 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.

Speaker 1

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 SCRI. This is a category we're truly leading is happening, but it's still early stage. This is a high margin business opportunity in the RFID segment.

Speaker 1

We now have over 50 customers in the $20,000 revenue range We'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 $20,000,000 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.

Speaker 1

Additionally, our most important vertical for SCRI Healthcare now accounts for more than half of our NFC based This reflects our drive over the past 2 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 push outs 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 IdentityReader product line. We expect Identity Regier margins to return to historical levels in the current quarter.

Speaker 1

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 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. Premises' 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.

Speaker 1

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 2 short term headwinds. 1st is the continuing government budget confusion happening right during fiscal year end, which usually is the strongest buying period for federal customers. 2nd was a ransomware attack that hit 1 of our largest federal integrators.

Speaker 1

This resulted in them being unable to issue new orders during the critical last weeks of the quarter, which have now resumed. Without these headwinds, our Premises growth would have been more than 1,000,000 and 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.

Speaker 1

And very importantly, we launched Vision AI, our video intelligence solution that's now a standard feature in all of our video offerings. I will 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.

Speaker 1

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 PropTech 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.

Speaker 1

And finally, the convergence of cyber and physical security. So in summary, Premises is growing at double the markets 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.

Speaker 1

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 54,000,000 units in Q3, up 18% year over year and made strategic progress, especially in SCRI applications in healthcare, our most important vertical. We shipped 500,000 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.

Speaker 1

We do over a dozen product changeovers Each production line over the course of the quarter, which is needed for production of early stage products. That's 100 changeovers across our 8 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 needed to meet these It's extra work, but we're confident that it will 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.

Speaker 1

We are 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 is 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 another production related metric, in Q3, we delivered 11,000,000 units of WILIET 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 1,500,000 units we could have shipped otherwise.

Speaker 1

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.

Speaker 1

We made the progress in healthcare that I described earlier and we 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 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.

Speaker 1

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 2 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.

Speaker 1

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 Q3 financial results in more detail. Justin?

Speaker 2

Thanks, Steve. As Steve mentioned, despite a revenue shortfall in RFID, in Q3 2023, we were able to deliver record revenue for our fiscal Q3, while also expanding sequential and year over year gross margins and EBITDA to their highest levels in 8 quarters. We also continued to maintain a strong working capital position. We believe these results, paired with our focus on driving disciplined 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 position the company to continue its growth momentum in the Q4 of 2023. 3rd quarter 2023 revenue was $31,800,000 lower than our expectations as previously noted.

Speaker 2

This represents a 3% increase versus the comparable prior year period and an 8% increase versus Q2 2023. 3rd quarter 2023 GAAP and non GAAP 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 IdentityReader 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 Q3 of 2023, our GAAP and non GAAP adjusted operating expenses, including research and development, Sales and marketing and general and administrative costs were $11,600,000 $10,300,000 respectively, a decrease from Q2 2023 marking the 2nd 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.

Speaker 2

Our Q3 GAAP net loss attributable to common shareholders was $300,000 or $0.01 per share, compared to GAAP net income of $200,000 in Q3 2022 and a GAAP net loss of $1,500,000 in Q2 2023. Non GAAP adjusted EBITDA was $2,200,000 in Q3 2023, an increase of $100,000 versus the comparable prior year period and $1,500,000 versus Q2 2023 as we are able to increase revenue and expand our GAAP and non GAAP adjusted gross margins while maintaining our operating expense profile. This was consistent with our continued strategic investments in R and 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.

Speaker 2

Beginning with Identity, Revenue from our identity products totaled $18,300,000 or 57 percent of our total revenue in Q3 2023 compared to $17,700,000 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 GAAP and non GAAP adjusted gross margins were 21% 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 increased production at our Thailand facility, which has lower manufacturing costs than our Singapore operations.

Speaker 2

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 $13,600,000 or 43 percent of our total revenue in Q3 2023 compared to $11,800,000 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.

Speaker 2

GAAP and non GAAP adjusted gross margins for Premises in the Q3 of 2023 were 60% 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 Q3 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.

Speaker 2

Now turning to the balance sheet. We exited Q3 2023 with $20,900,000 in cash and cash equivalents and restricted cash, a decrease of $1,300,000 from Q2 20 20 In Q3, the decrease in cash was a result of $300,000 in cash used in operating activities, $600,000 in investing activities, primarily related to capital expenditures and $200,000 from financing activities. Our working capital exiting Q3 was $49,800,000 an increase of $600,000 from Q2 2023. Notably, inventory decreased $1,700,000 in Q3 as we work through our strategic inventory balances. As a result, we expect to continue rebalancing our working capital and anticipate repaying our revolver balance in 2024.

Speaker 2

In our 10 Q 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 push outs 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 $31,800,000 this implies a Q4 below the $31,000,000 range.

Speaker 2

Factoring in a conservative view of lower margin RFID customer demand leads us to an expected Q4 revenue range of $29,000,000 to $31,000,000 This concludes the financial discussion, and I'll now pass the call back to Steve.

Speaker 1

Thanks, Justin. As we go into the end of 2023 and into 2024, we expect the shortfall that we had in Q3 in our lower margin RFID products will be behind us, although we're watching very carefully the customer segments that pushed out demand. Despite these concerns, we expect our high margin use cases in FCRI will continue to grow and expand to new customers. In Premises, we expect to continue the growth, margin strength and recurring revenue expansion. As a result, we expect to keep our balance sheet and working Capital strong as we build our competitive value in both of our businesses.

Speaker 1

Let me start by addressing the Identity business, particularly focusing on the RFID segment. In RFID applications for IoT, we build value 3 ways. 1st, by supporting NRE projects and subsequent pilots for technically complex applications, which sustain higher margins and give us an edge for full scale production orders for our SCRI applications. 2nd, by solidifying our reputation as a and our R and D lab expansion that can support the entire range of customer profiles and third, by expanding our lower cost production footprint in Thailand, giving us the scale and flexibility to be the best provider to the growing demand for RFID IoT solutions, while simultaneously lowering our production costs, enhancing our cost competitiveness and supporting gross margin expansion. Now let me now address our Premises business.

Speaker 1

In Physical Security, We accomplished our leadership goals in 5 ways. 1st, by offering a tightly integrated end to end physical security solution that goes from identity provisioning to all facets of access control through to integrated video surveillance, all enhanced with analytics based intelligence throughout, with a single pane of glass interface for control supervision. We do this with our complete suite of Velocity, Primus, TouchSecure, TS credentials and Utrust products, differentiating ourselves from other vendors who specialize in only 1 or 2 aspects of a complete physical security solution. 2nd, by growing our leading position in federal physical security product sales with solutions that protect and modernize federal government systems, including FICAM compliant solutions and FedRAMP solutions for the fast expanding move to cloud based services. 3rd, by bringing high security and our trusted brand to the SMB market leveraging our market leading expertise in enterprise scale high security into our new Primus Cloud EG2 controller and encryption bridge offerings.

Speaker 1

Thus making a complete high security solution available to millions of smaller businesses in a reasonable price performance formula. 4th, expanding our presence in the enterprise market with our complete solution approach, but importantly focusing on sales of our Cirrus cloud offering to our existing enterprise install base and new logo sales potential. With a particularly large enterprise install base, the potential here is truly meaningful. And 5th, consistent with all 4 of the objectives above, we're working to drive a higher mix of high margin recurring revenue carrying 80% plus margins across the business. To continue to drive this growth, we're committed to keeping a strong balance sheet with healthy working capital to fund our strategic growth We continue to tightly manage our expenses reflected in the sequential reduction in expenses, but still prioritizing investments in key growth initiatives.

Speaker 1

Now to discuss the specific drivers in each of our business segments in more detail, let's start with the Identity business, particularly focusing on the RFID segment. SCRI offerings notably in healthcare and medical devices are the most strategically important market for RFID IoT solutions, Whereas our competitors' business models are fundamentally focused on low margin commodity products, our emphasis on delivering solutions that meet the challenging technical requirements of our SCRI customers positions us to generate stronger gross margins. Now it bears repeating that healthcare projects move slowly. There's progress quarter over quarter, but large scale ramps are difficult to forecast. Many are in evaluation with our existing customer pilots and we have more inquiries for high quality healthcare NRE projects than we can reasonably support.

Speaker 1

The NRE and pilot pipeline is healthy, and we've been devoting more resources to the best near term production rollout revenue generating opportunities. We continue to support 5 different auto injector projects across 4 different companies with various ASPs ranging to over $1 depending on the complexity of the solution. This remains an exceptional category of opportunity. Sales of our Spoken RX prescription pill bottle solution remained steady. We continue to see a big opportunity with the ever expanding prescription medication market, but near term issues with the pharmacy channel have created a modest challenge.

Speaker 1

In Smart Packaging, we're seeing more traction with our life of garment applications that can be embedded in apparel and accessories. In Q3, several European football clubs have launched Collect ID enabled merchandise for the current 2023 to 2024 season. We've also partnered with E. ON, a global leader in product digitization for the new Coachtopia sub brand from Coach. Our solution supports the sustainable circular business model objective of Coachtopia, and we see sustainability applications to be a long term growth driver for IoT.

Speaker 1

On the chip supply side, we remain in a good position. NXP continues to be a strong partner. A healthcare focused marketing event we co hosted with NXP in mid September was well received and in recent joint business planning sessions, they've communicated that we are expanding our position as the most technically capable and most responsive for high end specialty applications of NFC based RFID devices. NXP remains our key technology and channel partner, but we're also continuing to diversify our revenue by chip type, including STMicro, Assign, TI and others. Finally, we continue to expand our low cost production capacity in Thailand.

Speaker 1

Our initial CapEx in Thailand is essentially complete, and we have more equipment on order for delivery through 2024 to continue scaling capacity. We expect the advantages of producing IoT devices in Thailand, lower production costs for rent and labor, Shorter supply chains and an advantageous tax status to improve cost competitiveness and further drive margin expansion.

Speaker 3

So let

Speaker 1

me now continue with the Premises business, specific growth drivers in physical security. In the Premises business, security In both commercial and government organizations, this is one of the few noncontroversial, non partisan areas of investment. This is in part because the functionality Investments in upgraded security infrastructure can have a very rapid and strong ROI. We benefit from a broad base recession resistant customers particularly focused on higher security across federal and local government, education across K-twelve and higher ed, hospitals, airports, banks, utilities and more. The value proposition of our tightly integrated end to end system has clearly resonated with commercial customers.

Speaker 1

End users appreciate our complete solution, but integrators are an even more effective leverage point. It's significantly more profitable for integrators Implement systems from fewer partners. It reduces their training costs, consolidates purchase order complexity, allows for faster and more efficient installations and makes ongoing system maintenance easier and more profitable. Now some of our competitors have recently created opportunities for us by either actively reducing their integrated channel or even circumventing them and going directly to end users. This might look attractive in the near term, but ultimately harms scalability and growth leverage Ultimately, profitability.

Speaker 1

Especially with the migration to a more recurring revenue focused solution model, we believe a strong channel base is critical to success. Competitors undermining their channel and integrators search for progressive and profitable solutions to deploy has created a meaningful market share opportunity for us in the channel. In addition to these opportunities in the commercial market, our federal business is strong with great potential for expansion. We focused on maximizing share of wallet with federal customers, reflected by our continued strong growth in federal billings of 16% year over year in Q3. As we mentioned, Were it not for the turmoil in Congress at the end of September, our federal sales could have been even higher.

Speaker 1

As we also mentioned earlier, video software sales more than doubled year over year. Video is included in any complete security solution these days and our Velocity vision was designed to encompass all of the components of a full range enterprise class video system, including an analytics offering with Vision AI as a standard feature. This also supports our integrator strategy I just mentioned and gives customers truly best of breed across identity, access and video. Adding high performance video analytics gives us both a high security foundation and leading edge AI technology for our most progressive customers. Another growth driver is Primus, our new SMB market product suite.

Speaker 1

We can leverage our enterprise level technology expertise used in some of the most highly secure locations in the world and offer that high level security at a cost effective price point for millions of small and medium sized organizations. We demoed our Primus products at the recent GSX show and had great feedback from both integrators and prospective end users. Complementary to Primus is the EG2 Edge Controller, a resilient smart controller that allows door access management from anywhere. This solution can also be used for customers with many locations for a cost effective option to have uniform access control across distributed organizations. With Primus Cloud, we're piloting pricing models that we believe will accelerate ease of adoption for the channel enhancing recurring revenue growth.

Speaker 1

This is made possible by the high margins we have in our Edge Gateway and Encryption Bridge devices. An additional trend the physical security industry is embracing is the convergence of identity management for logical as well as physical security. A Gartner study in 2022 found that 41% of enterprises participating in Gartner's Physical Security Emerging Trends survey plan to converge parts of their cyber and physical security operations by 2025 and this is up from just 10% in 2020. Identiv is especially well positioned to lead this emerging market demand. Our identity readers, which are in our identity segment, provide logical access as well as being used as enrollment For example, we believe we provide the vast majority of identity readers for DoD personnel to log into their networks and laptops, which as a reference use case shows our reputation and technical capabilities.

Speaker 1

We've extended this technical depth into sensitive use cases such as payment terminals, gaming machines, Fido keys and secure tokens used by 1 of the largest German defense manufacturers in their military products. As a secure identity and data access requirements converge with physical security, We believe Identiv's technical expertise and product range is another advantage that none of our mainstream competitors can match. We're well positioned and even ahead of this trend. Now let me summarize thoughts on the business as a whole. As you can hear from our comments, We're very positive about the value creation and industry leadership progress we think we're making in both of our businesses.

Speaker 1

We have the metrics to show it and industry participants and customers are acknowledging it. From a business planning perspective, we're expanding our next generation products, We're moving to higher margin recurring revenue based business models and we're expanding our channel, but at the same time putting more focus on our best integrators, all of this while investing carefully only in high ROI initiatives. We've got a recession resistant set of markets for our medical and other high value RFID solutions with the potential for significant growth. In the physical security, it is by its nature a solid performer through different economic cycles, but it's uniquely positioned for extraordinary growth given the growth drivers we've outlined. We have challenges we can manage, while we continue to focus on growing our business.

Speaker 1

Some of our RFID business can fluctuate with economic cycles, especially lower margin and cyclical categories like libraries, consumer products and logistics and warehousing Our customers only deferred revenues, but these lower margin and cyclical categories need to be watched closely. Additionally, product for one of our largest customers are shipped to Israel before going on routes to end users. We have to be realistic that shipments could be disrupted in that part of the world, affecting our business, but again with potentially little impact on EBITDA. We currently have alternative demand to offset most of these risks, but we're watching them closely. The situation we will not allow is to over order or over produce in a way that slows down the strengthening of our balance sheet, margins or working capital.

Speaker 1

As we mentioned, we're now moving to quarterly revenue guidance. So for Q4, we're anticipating revenues in the $29,000,000 to $31,000,000 range with continued strong contribution for our Premises Physical Security business. With more granular communication of near term business performance and expected completion of our strategic business alignment early next year, We believe we'll be well positioned to build the business value we've been working towards as we head into 2024. With that,

Operator

The floor is now open for questions. And the first question today is coming from Jaeson Schmidt from Lake Street. Jaeson, your line is live. Please go ahead.

Speaker 4

Hey guys, thanks for taking my questions. Just a clarification on your commentary regarding normal seasonality. Looking into Q1, Historically, the Identity business was is down sequentially. But just considering some of the Push outs you've seen, could you actually be flat to up or do you still expect that normal seasonal pattern?

Speaker 1

I think we'd still expect the normal seasonal pattern, Jason, maybe it'll be moderated a little bit as you're saying. In fact, I would expect it would be moderated a little bit because we have some things that should push into it. So that should give us a little bit of strength. But as you can hear from We're trying to be cautious about customers that might be Just not reliable. It's very frustrating when some things happen.

Speaker 1

But fundamentally, I think you're right. They're A little bit less down than normal is certainly something we're expecting unless something changes.

Speaker 4

Okay, that's helpful. And then just as a follow-up, when you look at that RFID pipeline, understanding sort of the Customers pushing things to their right. Have you seen any significant cancellations though?

Speaker 1

We haven't. They have all been push outs. But again, I'm just very cautious because There were some push outs that were late in the quarter and the biggest challenge is when you get a push out late in the quarter because we have to produce, We don't have a lot of flexibility to pivot on there. So, but so far everything has just been a, oh, we're going to be taking it next quarter and we're managing our inventories. That's the storyline, but the impact We can't tolerate, but that is what we're being told so far.

Speaker 1

If we hear something different, our intention is to share whatever we're hearing.

Speaker 4

Okay, understood. Thanks a lot guys.

Speaker 1

Thanks, Jason.

Operator

Thank you. Your next question is coming from Anthony Stoss of Craig Hallum. Anthony, your line is live. Please go ahead.

Speaker 5

Thanks, guys. Good afternoon. Just to confirm, all of your supply constraints have now been fixed? Or is it just A factor of less revenue or do you think truly if you had unlimited demand, you'd be able to get a limited supply?

Speaker 1

Yes. I think the supply side is in very good shape, both from each vendor and also the diversification that we've got on vendors. We've got if anything, we've got some positive PPVs and freight and other things that are contributing a little bit to gross margin and OpEx being better. So it has turned the corner from that respect.

Speaker 5

Got it. And then on your Q4 guide, just curious, it seems like Justin may have mentioned OpEx flat sequentially. Curious on kind of gross margins for Q4 and what you expect both OpEx perhaps and gross margins for 2024 as a whole?

Speaker 2

Yes, I think that we'll continue to see what we saw in Q3. I think we talked a little bit about OpEx is relatively flat and margin. There's a little bit of a mix in there. We do expect a little bit of a bounce back on the Identity side, slightly lower margin. There might be a Little pushed on pressure on margins in Q4, but pretty consistent to Q3, which as you can see, we're above expectations.

Speaker 5

And then just your thoughts, Justin, on OpEx going forward into 2024, you're going to try to keep them at These similar levels all throughout 2024?

Speaker 2

We're hesitant to give 2024 guidance as you said, but if I were to directionally Comment on it. Yes, I think it would be consistent with 2023.

Speaker 5

Got it. If I could throw another one for Steven, healthcare definitely becoming a great category for you guys. I think it's Definitely the right place to be. Of the pilots that you have in healthcare, I'm guessing it's a small number, but how many of those or percentage or ballpark, just Any more color would require FDA approval before they would move forward?

Speaker 1

Very few. Our FDA approval focus in fact It was just that one which we highlighted from the beginning when we knew we'd have to go through approval. That typically Yes, we're on the device side of things. And so if you're just doing a peripheral aspect of the technology on the device, I don't know all the details of the FDA structure, but apparently there's umbrellas in which they can slide it in and carry it under their FDA approval for the overall device. That just wasn't the case for the auto injector, partly because of the volumes and I think the medication that they're thinking about for it that they were being very careful that it was FDA approved top to bottom, But typically, not nearly as much.

Speaker 1

In fact, we've got Amir Khosniadi on the line. Amir, you want to add a little bit more color to that in terms of you're seeing directly from the customers related to FDA approvals or not?

Speaker 3

Yes, very much aligns the points that were made. If it's not hindering how the product works, it doesn't strive a requirement to hit the FDA mark. The auto injectors that we're working on and where we made progress, that one had to do with the label adjusting a position because RFID tag Right behind that label. That's the reason that one was submitted to FDA. But in summary, the majority of them are Not going that confinancy route.

Speaker 3

So that's to our advantage from a time cycle.

Speaker 5

Got it. Thanks. And since you're in the line, Amir, I'm just curious, are you getting any pushback With the slowing economy on ASP or any pricing pressure from your prospective customers?

Speaker 3

No pressures, as Steve mentioned, because of the health Our focus is pretty recession proof. The only challenge we have is this is a slow moving segment, just getting The approvals through these organizations and specifically when the product does get spec and it goes to from an NRE to a Small pilot run to a controlled run, these processes typically move pretty slow because they don't want the product to become a bottleneck in the supply chain. And once we get through that phase, the ramps typically pick up exponentially, but that's our challenge working in healthcare. It's having the patience to really work through their approval cycles.

Speaker 5

Got it. Thanks for all the color guys. Best of luck.

Speaker 1

Thanks Tony.

Operator

Thank you. And our next question is coming from Craig Ellis from B. Riley Securities. Craig, your line is live. Please go ahead.

Speaker 6

Yes. Thanks for taking the question and team nice job on the Adjusted EBITDA in the quarter, nice to see it moving up. Steve, I also like the change in the guidance period from annual to quarterly. I think that makes a lot of sense in a macro that is this volatile. But I wanted to make sure I understood What was really changing as we go from where we were, which is annual guidance, was shattered up to $127,000,000 and now Calendar 'twenty three, which is 117, it looks like from the comments about 60% of that is the low margin RFID IoT push outs in another 15 was some of the one offs that you had in premises in the quarter that you detailed.

Speaker 6

Is that right? And then what would make up the other, call it, 25% of the variance?

Speaker 1

Yes, I think you've got it structured right. And the other part, which is Q4 variance per se, because you characterize some of the Q3 and the Q4 there, is some conservatism. I mentioned that one of our biggest customers in Israel And we ship we transship through Israel, everything gets tested there and then sent on to a big customer in the U. S. We just have to be realistic that things could happen there and we're already seeing some things that are creating friction in the system.

Speaker 1

And then similarly, Yes, I mentioned library and consumer goods. And until we see demand as well as Payment reliability and everything else that goes with a healthy customer relationship, we're just trying to be careful that not only will we have the demand, but it'll be Healthy demand, proper margins, proper payment terms and no compromises on the balance sheet.

Speaker 6

Got it. That's helpful. And then next question is related to gross margins. It's actually a 2 parter. I'd love to see the premise to 60%, the up 200 basis points.

Speaker 6

Is there anything structural there or were those more one time Period benefits in the quarter and then on the identity side, I would have expected with the low margin push out for gross margin to be flat or better, but it was down. So why would it be down if we were mixing out some lower margins to see a push up?

Speaker 2

Sure. I can take that one. On the Premises side, it was largely mix. Our readers and controllers and access control carry a higher margin. We had a strong Q3 driving the margin up there.

Speaker 2

So I think that is a good number. It wasn't as much of a one timer as it is. Structurally, what we're able to sell in a product mix factor within premises in Q3 that benefited us There and then on the identity side, it was largely attributed to our smart card readers and we had a pretty big dividend in the margin Profile there on the smart card readers.

Speaker 6

Got it. Okay. And then lastly, if I could just Pitch 1 to Amir. Amir, as we go from really focusing on NREs within RFID, IoT and really focusing on the next step in the process before we get to volume production. What does it mean for your team operationally?

Speaker 6

And what does it mean for the way that you feel like you can roll up the business To Steve and what does it mean for the ability to either accelerate either growth or provide more predictable growth? Thank you.

Speaker 3

Yes. Two pronged answer to that. So the first is the pipeline and the way that we're getting Intake to create NRE opportunities, that is staying in place. We're actually putting a lot more investment from a marketing perspective to make sure the webinar is there. We're Creating awareness around the SCRI type applications we have, so the demand continues in a steady stream.

Speaker 3

But what we're doing with the notation we made with 50 plus customers in the smaller revenue range that are starting to ramp, We're really tasking the sales team to go much deeper into these accounts to try to find cross selling opportunities within divisions, Not only homegrown, but then also to get involved and try to grow those accounts and ramp them much quicker. So this includes Added services with field application engineering, getting to know exactly how their supply chain works and then really providing consulting level guidance to get the projects to a faster ramp. So it's NRE and then at the same time, it's getting more hands on and much deeper with the customers.

Operator

Thank you. And there are no further questions in queue at this time. I would now like to turn the floor back to Steve Humphreys for closing comments.

Speaker 1

All right. Thanks, operator, and thank you all for joining us tonight. From this discussion, you can certainly see the strategic opportunities as well as some of the challenges we have in the key parts of our business. Near term results are certainly what matter the most in public markets. And so we're really determined to make sure that investors have very fast and clear insights at all times.

Speaker 1

And this is what drove our move to quarterly guidance. We also have 3 investor events over the next 5 weeks with Lake Street and Craig Hallum this month and with Imperial Capital in December. And as always, we're available to discuss our business status and outlook with investors. So in the meantime, we're completely focused on building our strategic position in both of our core businesses, driving our Premises and IoT businesses forward aggressively, as well as pursuing our strategic review to maximize the value opportunities for our investors. So thank you all again for joining and have a good evening.

Operator

Thank you. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

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Earnings Conference Call
Identiv Q3 2023
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