Identiv Inc (INVE) 2010 Q2 法說會逐字稿

Good day, everyone, and thank you for joining us. And welcome to the second quarter 2010 Identive Group earnings conference call. My name is Josh, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions).

I'd now like to turn the presentation over to our host for today's call, the Director for Investor Relations, Ms. Darby Dye. You may proceed.

Thank you. Good day, everyone, and thank you for joining us. Speaking on today's call are Ayman Ashour, Chairman and CEO, and Melvin Denton-Thompson, CFO of Identive. The purpose of today's conference call is to supplement the information provided in our press release issued earlier today announcing the Company's financial results for the second quarter ended June 30, 2010.

Before we begin, I'd like to remind you that various remarks we make on this call, including those about our projected future financial results, economic and market trends, and our competitive position, constitute forward-looking statements. These forward-looking statements, and all other statements made on this call that are not historical facts, are subject to a number of risks and uncertainties that may cause actual results to differ materially. The forward-looking statements we make today speak as of today, and we do not undertake any obligation to update any such statements to reflect events or circumstances occurring after today. Please refer to today's press release, our annual report on Form 10-K for the year ended December 31, 2009, and subsequent SEC filings for a description of factors that could cause forward-looking statements to differ materially from actual results.

During this conference call, we will also be making reference to non-GAAP results or projections, including non-GAAP gross margin, overhead costs and adjusted EBITDA. These non-GAAP measures exclude all or some of the following, acquisition, transition and integration cost, equity-based compensation expense, overhead allocation, and amortization and depreciation. Identive uses these non-GAAP measures internally, and believes they provide a meaningful way for investors to evaluate our operating performance. But cautions investors to consider these measures in addition to, not as a substitute for nor superior to, Identive's consolidated financial results as presented in accordance with GAAP. A complete reconciliation between GAAP and non-GAAP financial measures is included in today's press release, which is available in the Investor Relations section of Identive's website.

I would now like to introduce Ayman Ashour.

Thank you, Darby. Good morning, and thank you, everyone, for joining us today. Q2 was a very good quarter for Identive on a number of fronts. Sales grew to $21.2 million, up 93% year-over-year, with 38% up compared with Q1. The growth was driven by the acquisitions, obviously, of Hirsch, Bluehill ID and RockWest when comparing to Q2 of 2009. But on top of retaining the acquired sales, we've generated organic growth of more than 10% when we compare the Q2 pro forma 2009 on a like-for-like basis including all the acquired businesses, and we'll go you through this in some more detail later on. In some parts of our business, project delays, and shortages of semiconductors especially, curtailed additional sales growth but overall we saw some signs of some improvement in the economic environment.

On the cost side, overheads also grew as a result of our acquisitions, but when you compare year on year, you see 93% growth in sales, but overhead grew at a rate of 40%, as we were able to offset substantially the additional expenses with our post-acquisition actions, which included facility consolidations, combining organizations in Germany and in India, and significant reductions in headcounts and other costs.

Most pleasing is the performance of our SCM business unit, actually showed significant improvement, and SCM was profitable on an adjusted EBITDA basis as a business unit within Identive. As a result of our higher sales and reduced overheads, we achieved profitability on an adjusted EBITDA line of nearly $700,000 in Q2. And of course, we are continuing to look for additional ways to reduce costs, and increase the bottom line.

During Q2, we also completed our acquisition of RockWest. RockWest contributed about $2.1 million in sales, and $17,000 in adjusted EBITDA in the first quarter as part of Identive which is Q2. RockWest was acquired on April 14. RockWest gives us stronger capabilities in the US state and local government market, which is following the US federal government in terms of investing in new and enhanced security and ID management systems.

During Q2, we also won a major award through our Multicard and SCM businesses to supply reader and software solutions under German electronic ID program. So we finished Q2 with a very strong order book across many parts of our business.

Before we go on to give you more details about Q2, I'd like to give you a quick overview of our progress in the three core elements of our strategy. And the slide, for those of you watching the slides on the webcast, the slide that you see on now is the same slide we've used in our last two webcasts, identical slide, which is really focusing on the three main things we're looking at, restructuring, organic growth and strategic acquisitions. In terms of restructuring, we started to see more of the benefit of our cost reduction effort that we implemented in Q1. We expect to see further incremental savings from these measures in the second half of the year.

Additionally, during Q2, we started implementation of a shared service structure across our operations in the US, combining things such as payroll, processing, healthcare benefits, bank accounts, and various other admin and finance functions. We expect these measures, along with the measures taken in Q1 and Q2, to result in additional savings in Q3 and Q4, and more fully in 2011. We expect our cost reduction programs will result in savings of approximately $6 million per year, of which $4.5 million would be realized this year.

Looking at the organic growth, which is the second part of the slide that you see, we are focusing on exploiting tremendous growth opportunities in our existing markets, and also in exploiting synergies between our businesses. We're beginning to see some good traction in this area. And as stated during the Q1 webcast, we added significant production capacity at TagStar to produce RFID inlays. We will be further improving this in Q3, and we have been working to strengthen our presence in Asia and Europe, and to expend more on the convergence area in terms of resources.

We are seeing some nice orders coming out of cooperative efforts between different business units, such as the German national ID or citizen ID order, which included both Multicard and SCM, and orders for e-payment applications including both TagStar and Multicard and other operations. We have now consolidated our semiconductor purchases across the group for readers and transponders in-house through our ACiG technology operation.

Finally, we continue to pursue acquisitions that enhance Identive's capabilities, and help us drive consolidation in our market. At any given time, we have a number of potential acquisitions that we're looking at in different stages of consideration.

I'd like now to share a little bit more with you, our overhead trend in the last couple of quarters. If we look at our overhead costs in the Q2 of 2009 on pro forma basis, on a like-for-like, so this is exactly what we have here netted out of any acquisition issues, so we're showing Q2 for Hirsch, for RockWest, for Bluehill and for SCM. So all the companies that now form Identive Group. So on a like-for-like basis, we see a cost reduction. The cost reduction measures that we have taken so far, resulting in 22% decrease in overheads when we compare Q2 2010 to last year.

We're beginning to see some leverage from our lower cost structure, so we had only small increase in overhead in Q2 compared to Q1, while at the same time we've added $6 million in sales. So we see we've gone from $15.3 million to $21.2 million, and the overhead stayed more or less flat. It's important to remember that during this time, we added $2 million in revenue from RockWest and the associated incremental overhead.

Let us now look at the business highlights of Q2. Hirsch had a particularly strong quarter with US government, with the US Department of Justice orders and sales of over $4 million for access control solutions. Hirsch continues to benefit from the build-up of momentum in the US government market over the last several months, as many agencies are working to enhance their security system, and to bring them into compliance with the tougher regulations brought upon by HSPD-12 and other Presidential directives. Our position in this important market area remains strong, and very encouraging.

Multicard, as I mentioned earlier, was awarded a EUR4.4 million order during Q2 for readers and application software to support Germany's new electronic ID card. This was a very creative application proposed by Multicard, and includes important city and regional clients. Our SCM business acted as the technology enabler, and the original architect and supplier for the card readers won the Multicard business, as well as business from other partners targeting different applications for the eID cards. And, as we announced, we expect the revenues under contract from the German ID project between Multicard and SCM to total about $12.5 million.

TagStar delivered its first payment [stickers] in Q2 to a US customer, and has a very strong order book for RFID inlays for the second half of the year. RockWest also performed well in Q2, and maintained its own business momentum despite a disruption of the acquisition and integration process. There was also good rebound in orders from Japan, and increased pace of inquiries from Japan for both contact lists and dual interface products.

Not everything was hunky-dory, and it is particularly pleasing for us that we are able to deliver a good quarter despite some problem areas. The IC or semiconductor shortages and allocation situation, and allocations we believe will continue well into Q1 of next year is making life difficult for some of our business. This has meant some sales slipping into future periods, and also it has meant additional inventories and general inefficiency as we try to manage the situation, and forecast now what we need in August, in December or January to place the orders now.

Sales performance in Multicard Germany and Switzerland was poor, and was disappointing in Q2. Multicard in Holland had very good growth, but the margins were lower, but this was mainly due to mix. Pricing pressures in Australia negatively affected our gross margin in that business.

Performance in our Arygon and ACiG business, especially in Brazil on the reader modules and component business, was weak in the quarter as well. So this is just a quick highlight in terms of the good and the bad that is going on.

The next point I would like to talk to is the segment change on the Frankfurt stock exchange. In line with our commitment to run the organization as a cost effective as possible, and also with our acquisition strategy, we have concluded that it's in our best interest to change segment to the entry standard market of the Frankfurt stock exchange. This process should normally take three to six months from the date of application, which we expect to be making in the coming days. We will retain both symbols we are trading currently under, so INV in Germany and INVE in the US, and trading on both the Frankfurt stock exchange and NASDAQ should be unaffected at all during the application and the transition process.

The background behind this is that we execute several transactions every year, and we align a lot of our compensation with the interest of the shareholders, and as a result, prime standards require us to issue new prospectives whenever we register new shares for most acquisitions, and annually as well. So moving to entry standard will save us hundreds of thousands of dollars in legal, banking and audit costs. Everybody knows the considerable costs that SEC and NASDAQ compliance requires. And while we are growing, we are still a small Company, and costs for added regulations, banking fees, audit consents, et cetera, are tough to take and tough to justify, especially when we're not really adding any additional disclosure.

We remain fully committed to our European investors, and to providing them with the highest level of disclosure and transparency. Under our continued principal listing with the NASDAQ global market, we will continue to be governed by a very high standard of regulatory oversight and disclosure that goes well beyond what prime standard requires. We are in the process of rolling out additional and enhanced information in the German language that will be posted on our website, and updated regularly.

Like the Investor Day we held in Orange County in March, we plan to hold another Investor Day in our offices in the Munich area in early October, so right after Oktoberfest.

To sum up my discussions on Q2, we had a focused and a successful quarter, with strong sales momentum and good reduction in our overheads, which are now starting to have positive impact on our results. In particular, we are seeing significant improvement below the adjusted EBITDA line, which Melvin will also be speaking to you about in a moment.

Looking out to the second half of the year and to 2011, we are cautiously optimistic about our ability to maintain the momentum we have been building. The economic climate is still not robust, and activity remains slow in certain markets and in certain countries. Delivering profitable results remains our absolute top priority, and we'll continue to look for ways to further adjust our costs while investing in our growth. We are raising our projections for 2010 and 2011 to reflect the addition of RockWest, and Melvin will give you the details of these new projections in a few moments.

We are excited about Identive's story, and we're working hard to make sure that our communication to investors is complete, helpful and responsive. Each quarter we look for ways to improve the transparency of our business performance, including providing more detailed comparable numbers, so people can strip out the effect of acquisitions, and look at and say, okay, so this is what it would have been had all these companies been together.

We have started also a blog on our website to answer investors' questions about our business, and for additional management postings. And we are planning, as I mentioned earlier, an October meeting for our investors in Germany. Obviously it's in Munich. It's open for all of our investors, Germany, Switzerland, elsewhere. We are launching an intensive effort to get the Identive story out to new, current and acquired company investors, and we welcome your participation and input.

Finally, we are very clear, and we recognize that we need to deliver more than one good quarter in order to demonstrate fully why we believe Identive has the right vision, the right technology, and the right mix of everything coming together to deliver and to become the number one Company in secure ID.

I would like to turn the call now over to Melvin Denton-Thompson, our CFO, who will give you a little bit more detail on our Q2 financial performance. Over to you, Melvin.

Thank you very much, Ayman. I'd like to start by comparing the Q2 2010 numbers with the Q2 2009 actuals. As Ayman said before, the Q2 2009 did not include Bluehill, RockWest, and only had two months of Hirsch. So the second quarter showed considerable improvement year on year, with both acquisition and organic growth.

Second quarter revenues were $21.1 million, compared to $11 million in the same period last year. The gross profit margin was 51% compared to 57% in 2009, and as you will see in a moment, this was the effect of some of the acquisitions made during the period. Overheads increased from $7.2 million to $10.1 million, which is as a percentage significantly lower than the percentage increase in sales. So the resulting EBITDA was positive $691,000, compared to negative $1 million in 2009.

I'd like to move on now to compare with the Q2 2009 pro forma numbers. This now includes the effect of the acquisitions of Bluehill, RockWest, and full period for Hirsch. So we have a growth in excess of 10%, with the revenues moving from $19.1 million to $21.1 million. The gross profit margin increased from 46% to the 51%. And overheads reduced substantially from $13 million to $10.1 million, as a result of the cost cutting that Ayman's already talked about, and some reductions in Hirsch R&D. Thus, the EBITDA moved from negative $4.1 million in 2009 pro forma to the positive $691,000 in the Q2 2010.

If we then compare Q2 2010 to the Q1 2010 actuals, we have, of course, included RockWest in the Q2 numbers, the acquisition was made in April. The revenues grew by 38%, and the overhead increased by less than 1%, corresponding to that substantial increase in revenue. The overheads will, of course, have reduced had we not added the RockWest overheads into that. Gross profit margin increased from 49% to 51%, driven particularly by good performance in Hirsch that Ayman talked about earlier. So the adjusted EBITDA progressed from a negative $2.4 million in the Q1 2010 to the positive $691,000 in Q2.

So to summarize, on the chart we have the Q1 to Q2 2010 sales increasing, revenue increasing from $15.3 million to $21.2 million, and the gross profit from $7.6 million to $10.8 million. On the right of the chart, you can see the chart on the webcast, the Q2 2009 pro formas to the Q2 2010 actuals show revenues increasing from $19.1 million to $21.2 million, with the gross profit increasing from $8.9 million to $10.8 million. And looking at the chart for the adjusted EBITDA, we have Q1 2010 to Q2 2010 negative $2.5 million moving to positive $0.7 million in Q2. And Q2 2009 pro forma loss of $4.1 million of adjusted EBITDA level, to positive $0.7 million.

If we now look at the reconciliation between the adjusted EBITDA number and the US GAAP numbers, the depreciation and amortization line is principally amortization of intangibles arising from the acquisitions. We don't have or need substantial fixed asset base. We do have, the factory where we do have some machines in the TagStar inlay manufacturer. This is mostly amortization of intangibles. We do have some ongoing acquisition reorganization costs resulting from the Bluehill acquisition, and we do have acquisition costs relating to the acquisition of RockWest during the period.

Foreign currency losses are non-cash, driven principally from revaluation of inter-company balances. These numbers change with the foreign exchange, and actually are positive in July. So we do have a substantial reduction in the losses, loss from continuing operation level. Q1 2010 was $6 million, down to Q2 2010 loss of $2 million.

Looking at the balance sheet, reduction in cash reflects the limited changes in the working capital, and the funding of the acquisition, transition and integration costs. The increase in goodwill and intangibles reflects the addition of RockWest. These increases have been somewhat offset by amortization of the intangibles, and some foreign exchange effects in both goodwill and intangibles.

I'd like to now just move on to the projections. As Ayman had said, what we have done is taken the projections that we had announced before, and integrated the numbers that we've discussed on RockWest. So essentially the numbers based on the change with the integration of RockWest means that revenues for 2010 are in the range of $83 million to $88 million. The revenues in 2011, $97 million to $107 million. And this gives us an adjusted EBITDA level in 2010 $0.9 million to $1.5 million, and in 2011 $5 million to $8.5 million adjusted EBITDA level. RockWest will be accretive this year, but the impact is limited by acquisition accounting effects, most of which will have worked their way through by the end of this year.

And with that, I think we open the call to questions.

Thank you, Melvin. Back to you, Darby.

(Operator Instructions). And our first question comes from the line of Ilya Grozovsky of Morgan Joseph. You may proceed.

Thanks. Nice quarter, guys. I had a question about the supply constraints. Can you talk a little bit about that in depth and how much did it cost you in the quarter, in other words, how much more could you have done in revenues and what exactly is happening to mitigate that? Thank you.

Thank you. The supply constraint seems to be affecting our side of the semiconductor industry, so most anything that has to do with smart cards or RFID is mostly affected by it. And basically a lot of other things as well as some of the microcontroller ICs that we're ordering are also affected by it. And what it means is that you need something and you can't get it and it's on allocation and you have to wait, et cetera. Because of our position in the semiconductor business being a redistributor and a value added retailer of some of these products, we are somewhat cushioned by that. The business that we lost for the quarter, or I shouldn't say lost because it will probably be deferred from Q2 to subsequent quarters, was primarily reader sales in the Asia Pacific region. I can't really quantify that right now. And the other big impact has been on inventory and planning, where we are holding higher inventories than what we would normally like to. And on the planning you're really having to take your production planning and rejig it to fit in, when can you get product. We're being told by our partners from the semiconductors area that we expect to see this work itself out end of this year, early next year but it remains a concern, for sure.

Okay. Thank you.

(Operator Instructions) And our next question comes from the line of Reik Read of Robert W. Baird. Reik, you may proceed.

Thanks, good morning. Could you guys just talk a little bit about, the internal growth, looks like 20%-plus, and just given the acquisitions, would you expect that to continue at that pace or are there some opportunities to accelerate that? And just maybe give us an overview of that as you continue to make acquisitions.

Good morning. I think our expectations on the pure organic part is somewhere between the 12% and the 15%. Some parts of our business are growing significantly faster than that and what you're seeing is when we talk about retaining all the acquired sales, it is technically correct but not really, because in a way sometimes we exit from unprofitable or less profitable sales and we end up generating more growth in other areas. We do believe that the industry we're in, that the potential for growth, despite the current economic situation, is in the 20%-plus range. But I think at this stage we are still trying to balance our overhead reduction with the sales growth. So I think we would rather stay modest and stay a bit more prudent and say we're going to be in the 10%, 12%, 15% range for this year and next year. Because when you're doing a lot of reengineering of a company and a lot of working out, a lot of cost, there's a balance between the two. And this is really the best I would be able to offer at this point in time.

Okay. And then maybe just a follow-up on that. As you exit from unprofitable sales and you do this reworking, would we see that primarily at the gross margin level or would there be some flattening out in the operating expenses, as well? Can you maybe give us a little color on how those costs are coming out or where those costs are coming out?

Definitely. It will be more on the operating expense line. So you will see, when you get a chance again to look at the webcast, you will see that the overhead as a percentage of sales is going down from the historic high of 2009 to Q1 to the full year and we're expecting that it will go substantially lower again next year. So we're looking at -- I think our projection's next year are somewhere in the order of $44 million to $46 million in overheads. And if you look at our overall overhead last year, just based on the various numbers we've shown in the previous two webcasts, I would say the pro forma for last year full year would have been over $50 million. And the revenues were, again, pro forma revenues would be in the range of $77 million or thereabout. So it is significant. It is really resulting in significant reduction in overhead. Some of our -- on the gross margin side, some of our markets where RFID and ID still proving itself the margins tend to be a little bit lower at first and then as you add improved capacity and you get volumes, et cetera, the margins end up improving quite a bit.

Okay. And then just shifting over to the UHF market, can you just talk about the constraints that are out there and your own internal capacity versus your ability to get silicon, and is that an area where you need to expand production? And maybe talk about the impact on cash flows throughout the rest of the year.

UHF is an area that we are not terribly active in. There are some. We see more and more opportunities but UHF is a very small part of our business and most of it tends to be on the integration side with Multicard where we are integrating UHF solutions. The UHF inlay activity for us is very, very limited. Most of our focus has been on the higher value RFID side which is HF and the more secure type technology.

But would you have an expectation for some of these -- I'm not really talking about the apparel stuff which is the lower end for you guys but maybe some of the higher end asset management applications that seem to be accelerating. Is that an opportunity or is that a market that you would like to see evolve a little bit more before you go after it a little harder?

I think you described it very well. There are some areas that we are interested in and we are working a little bit with it. And some of the integration work we've done in Australia in particular and in other markets with UHF has been very interesting. But in terms of really spending a huge amount of time and money on it, I think I fear it can be very seductive because it promises to solve a lot of problems but the ROI is not there yet for most applications. So the fact that the ROI is not there yet for most applications, it squeezes the margin opportunities even from the really good applications. So we tread very cautiously around UHF, but fully acknowledge that there's some really nice opportunities and we are looking at them for sure and doing some, more than looking.

Okay. Great. Thank you so much for the time.

And our next question comes from the line of Henning Cosman of WestLB. Henning, you may proceed.

Yes, good morning, gentlemen. Could you maybe briefly speak on the orders associated with the German EID program and how that has affected your 2010 guidance. I assume not to a very large extent since you expect the first sale to come in only in November but maybe could you update us then on the 2011 guidance and how that might change your 2011 projections, or whether we should rather calculate with the same kind of growth rates based on your new higher 2010 guidance, maybe some light on that one? Thank you.

Good morning. Thank you. I think the German ID project will have minimal impact in 2010. Some impact, but limited. And if you recall, I mentioned some weakness in our Multicard Germany and Switzerland business. With this order, hopefully that will take us back to where we'd expect it to be. We always assume a little bit of national ID business in Germany. This is going to be a little bit more. For 2011, the projections we've given actually do take into consideration the national ID project. And do please remember that the project is delivered over an 18-month period and there are different constraints and different steps in getting each stage. The one important effect that the order has for us this year is cash, because the order includes approximately one-third cash upfront, which is an important contribution to our cash, especially given that we're entering Q3 and Q4 which we are expecting to be a lot stronger and you need more working capital, obviously, for that.

So could you maybe just remind us of the full year '11 projections or just confirm that you haven't changed them whatsoever?

The 2011 we're projecting sales between $97 million and $107 million in 2011, and we're projecting also a profit between $5 million and $8.5 million on the adjusted EBITDA number. I also might add that unfortunately, because of the relative decline of the euro against the dollar, the order is a little bit smaller in dollar terms than it would have been.

Okay. Thank you.

And our next question comes from the line of Ilya Grozovsky of Morgan Joseph. You may proceed.

Thanks, guys. Just a follow-up. Can you break out the revenues by management versus products?

I'm sorry, by?

Products versus the management.

The ID management?

Yes, ID management.

The products and components business was -- I think you'll see that in the 10-Q when it's filed. Melvin, do you have that handy?

Just a ballpark.

I think it's a little bit more than 60/40 this quarter, approximately 63% or so is ID management and integration and 36%, 37% is products and components.

Great. Thank you.

And at this time, we are showing no further audio questions available. Ayman Ashour, you may proceed.

We have a question from the website about the -- can you tell me the question in German.

This is a question from our European shareholders. It is, When will we see a positive EBIT as opposed to EBITDA?

We don't have a huge amount of D in the DA because the D is mostly the depreciation and the big thing for us is the A for the amortization. So as we make new acquisitions there is -- we are, with the US GAAP accounting rules we are now required to allocate a lot more of the acquisition cost to intangibles and the intangibles are amortized over relatively short periods of time. Where in the past, a lot of these costs would normally have been goodwill and your amortization would not have been very high. So the amortization cost is likely to continue as long as we continue to acquire companies, but it is a non-cash. The reason we find the adjusted EBITDA number more meaningful, because it takes out something like the amortization which if you have a business like Hirsch business, you acquire, it's a fantastic business, or a Multicard business or a TagStar business, or even RockWest, you have amortization and you're being hit with that but it is a non-cash item. One of the reasons we went into -- we're looking at the segment change in Germany, because most of the acquisition costs go into the -- below the adjusted EBITDA line, is that we are very determined to get to a better picture on the below adjusted EBITDA line, all the way down to net profit. When do I expect it? Really largely depending on the acquisition activity, but I would say not too far from now.

Can I just follow up on that question on the segment, the ID management of 62.5%.

So 62.5% is ID management and the product is 37.5%. Thank you very much. We are pleased with the quarter and we hope we hope we'll be able to speak to you again at the end of a successful Q3. And we look forward to your feedback and your questions, either on our blog in English or German or directly through our Investor Relations team, Darby Dye and Fabien Nestmann or myself. With that I'll turn the call back over to the Operator and thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.