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Edited Transcript of INVE earnings conference call or presentation 10-Aug-17 9:00pm GMT

Thomson Reuters StreetEvents

Q2 2017 Identiv Inc Earnings Call

SANTA ANA Aug 14, 2017 (Thomson StreetEvents) -- Edited Transcript of Identiv Inc earnings conference call or presentation Thursday, August 10, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Sandra Wallach

Identiv, Inc. - CFO and Secretary

* Steven Humphreys

Identiv, Inc. - CEO & Director

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Conference Call Participants

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* Michael James Latimore

Northland Capital Markets, Research Division - MD and Senior Research Analyst

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Presentation

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Operator [1]

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Welcome to the Q2 2017 Identiv Earnings Call. My name is Ali, and I will be your operator for today's call. (Operator Instructions) Please note this conference is being recorded.

On the call with me today are Steven Humphreys, CEO of Identiv; and Sandra Wallach, CFO. In a moment, you will hear remarks from both of them, and then we will take questions from the sell-side analysts.

Before we begin, please note that, during this call, we'll be making references to non-GAAP measures or projections, including non-GAAP gross margins, operating expenses and adjusted EBITDA. A complete reconciliation between each of these non-GAAP measures and the most directly comparable financial measures can be found in today's press release, which is available on identiv.com.

In addition, during our call today, we will be making forward-looking statements. Any statement that refers to expectations, projections or other characteristics of future events, including financial projections and future market conditions, is a forward-looking statement. Actual results may differ materially from those expressed in these forward-looking statements. For more information, please refer to the risk factors discussed in documents filed from time to time with the SEC, including the annual report on Form 10-K for fiscal year 2016. Identiv assumes no obligation to update these forward-looking statements, which speak as of today.

I will now turn the call over to Steven Humphreys for his comments. Steven?

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Steven Humphreys, Identiv, Inc. - CEO & Director [2]

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All right. Thanks, Ali, and thank you all for joining us.

As we highlighted in our earnings announcement this afternoon, we continue to see organic year-over-year growth across all 3 of our business segments as well as strong 11% sequential growth in the business overall. And we've previously talked about the importance of balanced growth in all of our segments to provide stability, especially for a small public company. Last quarter was the first quarter in several years when we had growth in all of our 3 core segments, and that trend has now continued into this quarter, led by 39% year-over-year growth in our Identity reader segment; 2% in Credentials overall, but solid 10% growth in our RFID products, which are in the Credentials segment; and 5% in our Physical Access segment.

And you might recall last quarter, our growth was led by our RFID business at 40% year-over-year growth. And now looking ahead, with the current quarter being the fiscal year-end of the federal government's budget year, we expect physical access products to be one of the fastest-growing segments for us for this quarter. So as you can see, having growth in every segment continuously, with varying segments leading with the strongest growth in different periods, gives us great balance.

Now conversely, it does expose us to margin shifts as different parts of the business drive growth in different periods. We expect this variability to continue, and we have to keep our expense controls tight and manage gross margins extremely carefully to deliver consistent predictable results. We didn't manage this as well as we would have liked in the second quarter. And at our scale, a few transactions can change outcomes, so we always need to have more than enough safety factor to offset them all. The timing of a few events created pressure even as we were delivering the strong growth I've mentioned. So we've taken steps to keep us in an even safer financial position. Ultimately, building our business to greater scale will be the best way to sustain enough resilience in the overall business model to balance varying seasonality and growth rates in our segments. And even at our current scale, we've continued to closely manage our operational expenditures and, therefore, delivered positive adjusted EBITDA for the fourth consecutive quarter, which we certainly expect to sustain for the foreseeable future.

Now later we'll give more detailed insights into our path to scale but, as a snapshot, we already see that, in addition to the third quarter's federal government growth driver, the business levels building into the fourth quarter show it to be shaping up to be one of the most balanced we've had in years, with solid growth across all segments.

As I mentioned earlier, this quarter, we've had strong growth in our Identity segment, growing at 49% over the comparable quarter last year. Credentials' growth was 2%, which includes our access card products but, more importantly, it was anchored by RFID growth of over 10%, which brings our first half transponder year-over-year growth to 24%.

Our Physical Access segment grew at 5%, reflecting a very strong year prior comparable but, more significantly, it reflects our highest quarter yet through the Cisco channel. Our revenues through Cisco channels and partners grew a couple of hundred percent in fact, albeit from a small base since it was just beginning a year ago. Nevertheless, it's now over 10% of our physical security revenues, and we expect it to continue to expand as a contributor to our year-over-year growth.

Our overall physical access systems and reader sales remained strong, positioning us to once again realize accelerated Hirsch growth from the federal government's annual fiscal year-end purchase cycle, which is the current quarter.

So turning now to specific growth drivers within our segments. In physical access, we had a range of product launches and events in the first quarter, including bringing HIRSCH Mx panel support into the Cisco-related ICPAM platform. As a result, in the second quarter, we saw demand for these products through the Cisco channel driving rapidly growing volumes of our MX-4 and MX-8 controllers.

As I mentioned, for the first time the Cisco channel in aggregate represented more than 10% of our physical access sales. This was partly due to the Mx volumes, but also included wins in key segments such as a multisite educational deployment, reflecting the accelerating adoption of physical security among educational institutions nationwide and the long-standing strength of Cisco in the education market.

Regarding our HIRSCH Velocity offering, we had challenging comparables due to a very strong Q2 last year. And as I mentioned, we're already seeing the seasonal strength we expect as we enter the fiscal federal year-end, made even stronger by our core Hirsch strength in the federal government but also the advantages we've discussed before in our FICAM solutions.

Now beyond products and market spaces, one of the most significant sales milestones in our physical access business is that we were fortunate to bring on Ed MacBeth, a world-class sales leader whose impact was felt at the end of the last quarter and is accelerating into the current quarter.

Ed brings a background that includes EMC, Oracle, Symantec, TiVo. And in fact, he was with Identiv's predecessor company, SCM Microsystems, during our highest growth period, back when we broke through the $100 million revenue level for the first time. Particularly with our federal government opportunities, Ed's driven yet disciplined approach to complex system sales will make our sales and marketing outreach in this area more efficient, more scalable and ultimately reaching higher penetration than we've ever had in this key segment.

Now let's turn back to our Identity segment. As you know, this segment is primarily our smart card reader products, encompassing desktop readers, modules, components and tokens. And in fact, our smart card reader products specifically grew even faster than Identity overall, growing at a 41% year-over-year clip. This growth includes a smart card reader deployment for an overseas government, where our readers are used to authenticate military personnel, and other applications including payments, U.S. government authentication, mobile e-mail and other smart card-enabled applications. We have a long track record of successful support of highly demanding solutions such as credit card payments, government security and health care.

In addition, we've seen continued high demand for our reader components in the quarter, where we delivered chipsets to long-standing OEM customers who incorporate our smart card technology into their products. I could go on at length, but as I mentioned earlier, the clearest indicator of our strong position here is the demand growth. And this has even exceeded our bandwidth to deliver everything being requested of us. This only strengthens our business model, however, since we're able to add very cost-effective technical talent in our engineering center in Chennai, India. The result is faster growth and deeper market penetration with virtually no change in our operating base.

Now on the Credentials side, the design-in strategy that drives our transponder solutions is demonstrated by the project conversion we've seen also in this quarter. We've identified brand authenticity and customer experience as drivers of this business in the past. And now we're seeing our category-leading customers going from early volumes into mass production. For example, we're now shipping to several contract manufacturers in Central America for one of our customers. And as we track these volumes, we get visibility into the product's success and the business prospects overall.

We're certainly encouraged by what we're seeing so far, and this is only one example of RFID customers who are at this stage going into production with solutions we've developed with them in prior quarters. Now what's really underpinning the success we're having in RFID and transponders is our focus on customers that have innovative, value-delivering solutions for their industry that we can tailor to them and then scale up. This is the stage we're entering with several of our leading RFID customers in our current quarter and going into the third and fourth quarter. So when you add up all these details within our segments, the results is growth that's leveraging the overall strength of our business model. While driving growth, we've held stable operating expense levels resulting in consistently positive adjusted EBITDA for the fourth consecutive quarter, even with below-average gross margins.

And we expect margins to move back up into our target range as the mix moves towards a higher contribution from physical access in the second half of the year. This will also drive a higher EBITDA percentage relative to sales.

And we continue to be confident that we can leverage our business model and expand our growth rates. This was also supported by the equity offering we completed during the quarter, resulting in a healthy cash position of $18 million at the end of the quarter. This provides strength to our balance sheet and confidence in the company industry-wide.

Looking back 12 months, the company came from an operating loss position and a debt overhang out of 2016. This position is completely changed now with the debt refinancing in Q1 and the solidifying of the balance sheet in Q2. We believe the current balance sheet and operating strength provide a strong base to continue organic execution and growth as well as the flexibility to execute inorganic and other opportunities.

So putting this all together, for the first time in a couple of years, there are no nonoperating, legal, financial or any other distractions in the business, so our entire focus is on driving this growth to maximize the market opportunity we've got in front of us, which will be the focus of the rest of the business discussion today, following the financials.

So with that, I'll turn it over to Sandra for our financial results and some analysis. Sandra?

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Sandra Wallach, Identiv, Inc. - CFO and Secretary [3]

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Thank you, Steve, for providing the context for our financial results for the second quarter of financial year 2017.

Revenue in the second quarter was $14.8 million, an 11% sequential increase compared with $13.4 million in quarter 1 of 2017 and a 10% increase compared with $13.5 million in the comparable quarter of 2016. In fact, if we remove the All Other segment, which are discontinued businesses today, our current quarter is also an 11% sequential growth over the comparable quarter of 2016. Our Physical Access Control segment generated $5.8 million of revenue in the second quarter of 2017, up 9% sequentially from the $5.4 million in the first quarter and up 5% from the $5.5 million recorded in the comparable quarter of 2016. The increase sequentially and comparably is the result of higher sales of physical access control solutions attributable to higher demand from our federal government customers and higher sales through our channel partners.

Revenue from our Identity products, primarily smart card readers, reader modules and chipsets, was $4.1 million in the second quarter. This represents a sequential increase of 31% from the $3.1 million of revenue in the first quarter of 2017, reflecting higher sales, primarily in the Europe and the Middle East and APAC markets, and an increase of 39% over the $2.9 million recorded in quarter 2 of 2016.

Approximately 33% of our second quarter revenue or $5 million was derived from sales in our Credentials segment, which comprises both access control credentials and our broader Internet of Things transponder products. This revenue performance in the second quarter of 2017 of $5.0 million was comparable to the results achieved in both the first quarter of 2017 and the second quarter of 2016 at $4.9 million.

As previously anticipated and disclosed, we have virtually no revenue in our All Other segment in the second quarter of 2017. This change is primarily due to the phasing out of our digital media product lines and the discontinuation of our CHIPDRIVE product line.

Now focusing on gross margins. Our GAAP gross profit margin was 38% in the second quarter of 2017, 43% in the first quarter and 39% in the second quarter of 2016. On a non-GAAP basis, excluding certain noncash items, our non-GAAP gross profit margin was 40% in the second quarter of 2017, 45% in the first quarter of 2017 and 42% in the comparable second quarter of 2016. The sequential quarter-over-quarter decrease in both GAAP and non-GAAP margins was attributable to product mix with channel partners within our PACS segment and lower margins on a large order of readers for an international government project in our Identity segment.

Moving now to our operating expenses, which is the next graphic on the webcast presentation. GAAP operating expenses totaled $6.9 million in the second quarter of 2017 compared to $6.6 million in the first quarter of 2017 and $7.9 million in the comparable quarter of 2016.

Adjusted on a consistent basis to exclude restructuring and severance and certain noncash charges normally excluded from our non-GAAP results such as stock-based compensation and depreciation and amortization, our non-GAAP operating expenses in the second quarter of 2017 were $5.8 million as compared with $5.7 million in the prior quarter and $6.8 million in the second quarter of 2016.

The comparative decrease is primarily due to the positive impact of the restructuring activities undertaken in the first quarter of 2016 and the continuing cost focus across the business to keep our operating expenses sub-$6 million. Our R&D expenses of $1.3 million in the first and second quarter of 2017 represent 10% and 9% of total revenue, respectively. These results were comparable to $1.3 million or 10% of revenues incurred in the second quarter of 2016. Sales and marketing expenses remained consistent at $2.9 million in the first and second quarter of 2017. Again, these results are comparable to expenses incurred in the second quarter of 2016. G&A expenses in the second quarter of 2017 were $1.6 million compared to $1.4 million in the first quarter and $2.6 million in the second quarter of 2016, with the decrease from the comparable quarter reflecting the reduction of noncore legal expenses in addition to the benefits of the restructuring completed in quarter 1 of 2016.

We now look at our total full income statement for the earnings release. Our GAAP net loss for the second quarter was $1.9 million compared to a loss of $0.7 million in the first quarter of 2017 and a loss of $3.0 million in the second quarter of 2016.

On a non-GAAP adjusted EBITDA basis, our second quarter EBITDA gain was approximately $0.2 million in the second quarter compared to a $0.3 million gain for Q1 of 2017 and a $1.2 million non-GAAP adjusted EBITDA loss in the second quarter of 2016. The results this quarter represent the fourth quarter in a row of positive non-GAAP adjusted EBITDA as we exit Q2 with our seasonally lowest quarters historically behind us.

We have 1 significant item to disclose. On August 7, we received final notification that our insurance provider agreed to reimburse us for certain legal fees incurred in connection with the matters related to the class and derivative litigation and related investigations. We now expect to recognize a credit to operating expenses of $0.4 million in our third quarter of 2017.

On the next page, we've provided a full reconciliation of GAAP to non-GAAP information, which is also included in our earnings release. There are a few items worth noting at this point. Interest expense was approximately $0.7 million in the first quarter and second quarter of 2017 and $0.5 million in the second quarter of 2016. Noncash stock-based compensation was $0.7 million in the second quarter of 2017, $0.6 million in the first quarter of 2017 compared to $0.4 million in the second quarter of 2016. There were no restructuring charges recorded in the first or second quarter of 2017, and we do not expect to incur further charges in connection with the implementation of the quarter 1 restructuring plan from 2016.

Now if I could turn to the balance sheet, I'll be comparing our position at June 2017 to our position at March 2017. Cash at June 2017 was $18 million compared to $7.9 million at March 2017. The $10.1 million net increase in the quarter is comprised of a decrease of $0.1 million net loss, excluding noncash items; a reduction of $1.8 million net change in operating assets and liabilities; offset by a net increase of $2.3 million from financing activities, which contains the $2.6 million of proceeds from the common stock sale, less $0.3 million of changes in existing debt from the prior quarters.

The last page is the full balance sheet. As per the table in the earnings release, we define working capital simply as accounts receivable plus inventory less accounts payable. This was $14.7 million at June 2017 as compared to $13.9 million in March of '17. The net increase was driven by an increase in accounts receivable of $1.8 million, offset by an increase in accounts payable of $1.0 million. With respect to accounts receivable, our average days sales outstanding increased to 55 days in the second quarter from 49 days at the end of the first quarter, driven by higher quarterly volume build in the last month of the quarter. Inventories net of reserves remained consistent at $12.5 million at June 2017 compared to $12.6 million at March 2017. Our adjusted inventory turnover was approximately 4 for the second quarter compared to 3.5 for the first quarter of 2017.

Accounts payable increased by $1.1 million from $7.4 million at March 2017 due to an increase of approximately $1 million in the 1-to-180-day payables.

A couple of other noteworthy items in the balance sheet. Accrued expenses and liabilities are comprised of employee compensation, legal and professional fees and other items amounting to a total of $4.8 million as of June 2017 and $5.8 million as of March 2017. The decrease of $1 million was primarily driven by reductions of $0.6 million in accrued professional fees and $0.3 million in accrued compensation. In addition, our long-term payment obligation decreased from $3.8 million at March of 2017 to $3.5 million at June of 2017, reflecting the continuing quarterly payments made and partially offset by the accretion of interest. Our long-term financial liabilities decreased from $7.6 million at March 2017 to $7 million at June 2017 as a result of more of our long-term debt reclassified to current.

On the next page, if we put the second quarter performance in the context of our guidance and our midterm target business model, based on our combined Q1 and Q2 results, we believe that we are on the right trajectory, and we are confirming the previously announced guidance for the fiscal year 2017 of revenue between $64 million and $68 million and positive non-GAAP adjusted EBITDA between $4 million and $7 million.

With that, I will conclude the financial discussion and pass it back to Steve.

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Steven Humphreys, Identiv, Inc. - CEO & Director [4]

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All right. Thank you, Sandra.

In my opening comments, I mentioned 2 growth drivers for the quarters ahead. These are the current quarter's federal government business and the fourth quarter's balanced business momentum, which includes our backlog but especially our current customer demand rates. Successful shipments of our customer's own products drive increased demand in the subsequent periods, which is looking strong across all of our segments. So I'd like to discuss these 2 drivers, some product progress, some insights into our accelerated sales drive and some insights into our inorganic growth plans.

Now as many of you know, the fiscal year-end for the federal government is always a growth driver for Identiv. This year it seems to be more so than usual for 3 reasons: number one is our FICAM solution, encompassing our Hirsch systems as well as our TS and ScramblePad readers. This serves a serious need of nearly all government agencies. By providing a phased adoption path, agencies can both deploy at their own pace and acquire as budget's available in a "usable today but FICAM-compliant tomorrow" platform. Additionally, even when there are competitive incumbent systems, since it's less expensive to put in an entirely new Hirsch system than to upgrade in place a competitive system, it's a safe purchase for any government agency at any time. This makes it an ideal end-of-year purchase. So our greatest challenge is simply getting that message out to all the agencies in the government because when it's understood by federal buyers, it results in a high conversion rate.

Now related to this last comment, Ed MacBeth, who I mentioned earlier, has launched an accelerated sales process in both the centrally located headquarters of the federal agencies in Washington, D.C. and also a nationwide and worldwide outreach effort to reach the literally thousands of facilities and departments that purchase and deploy locally.

These include, for example, the 1,400 Veterans Administration hospitals nationwide, which we're targeting in each of our regions. Military bases also deploy locally, so much of our European sales team is actually focusing on U.S. military bases and other U.S. government facilities in Europe. Other departments and agencies operate this way, and we're optimizing to penetrate locally as well as nationally. Ed's team has also developed more aggressive, directly competitive attacks, quite frankly. For example, some of you might be aware of a renewed drive to buy American by the federal government. It turns out some of the newer entrants into the government market, such as Gallagher and Paxton, are foreign companies. New Zealand and U.K.-based, respectively, in the case of these 2. Now even one of our larger competitors, Software House from Tyco, owned now by Johnson Controls, is an Irish company. Identiv is a pure Delaware corp based in California, nowhere else, and we aren't shy in pointing this out. Thirdly, uncertainty in the federal budget process, which is certainly the situation in Washington right now, actually drives a stronger incentive to deploy existing budget. In an uncertain environment, having utilized your existing budget is one of the most clear indicators of need for budgetary continuation. So we are seeing stronger year-end demand due to the uncertain environment in Washington. Now in commercial markets, this might motivate a conservative approach, but the rationale in the federal market is somewhat different.

Now the second growth driver I mentioned earlier is the balanced demand we're seeing shaping up for the fourth quarter. This is where our different growth segments really pay off. With the broad and deep RFID partnerships we've established, we are seeing production ramps that are already running solidly into the fourth quarter. Similarly, with the OtterBox and other smart-card reader projects, we've got visibility into demand specifically for that period as well. Then lastly, with both our sales acceleration and product launches, we have visibility into a physical security sales pipeline that can deliver sequential growth in Physical Access in the fourth quarter over the third quarter, also for the first time in several years.

Now everything we're talking about today so far is very tactical and a line of sight to revenues. I'd just like to highlight 1 topic that's longer-term and potentially game changing, which is the iPhone 10th Anniversary Edition and its accompanying iOS 11, coming out either in September or October. Now the relevance for us is that Apple's use of NFC for the first time is extending beyond the closed use case for Apple Pay. Now they're likely to only enable limited RFID reading, but even this will change the entire NFC-enabled market. This is the 1 topic today that's not an immediate revenue driver for us, but it will likely happen before our Q3 earnings discussion, so we wanted to address it. You'd expect us to be very close to this. We are, and we think we'll be positioned to benefit as the industry realizes what Apple is doing and as it ripples through the end of this year and especially going into 2018.

So turning back to our smart card readers, which were the initial product line of Identiv's original company, by the way, we experienced wider and deeper demand than we've seen in years. Both from a competitive perspective and a project perspective, we're taking more share faster. As a result, as I mentioned earlier, we've actually been adding technical resources very carefully in our lower-cost engineering center in Chennai, India, because demand has actually exceeded our capabilities to quickly fulfill the solutions requested by our customers. The 41% year-over-year smart card reader growth in the second quarter actually reflects a resource-constrained situation. We're now catching up. And to be clear, we haven't lost any business as a result, but we need to continue to be very responsive to undercapacity in engineering to avoid opportunities for competitors to make inroads into this market in which we have clear leadership.

Now while we're driving growth, we also have to continue to drive the entire business platform. We know that any of our segments can experience rapid growth acceleration, as happened with RFID in the first quarter, smart card readers in the second quarter and that we anticipate in physical access for the third quarter.

We need to operate with enough business model headroom to throw top line revenues growth to the bottom line regardless of which segment it comes from. And related to this, one of our challenges is our scale. As Sandra mentioned, due to the timing of 1 subsequent event we disclosed in our earnings release, we have about a $400,000 contribution that fell a few days outside the quarter. We need to quickly get beyond the scale in which our results can be affected by a few events. We're doing this primarily through organic growth, tight expense control and margin tracking because those are the things we can control directly. However, an additional path to growth and profitable scale is through our inorganic strategy, so I'd like to focus on that for just a minute.

With our solid operating organization, we're well positioned to add accretive, directly related acquisitions. We actually had hoped we'd have 1 completed by now, but we've set a rigorous bar for the profiles we'll evaluate and execute. They have to be directly aligned with our markets, clearly accretive, the right scale and at a good price. Although we'd like to have a completed transaction by now, our discipline related to these criteria hasn't gotten one through to completion so far. We have active discussions with prospects that fit all of these criteria, but we will always remain disciplined, so having something closed within a specific period is impossible to commit to. However, there's definitely a range of candidates we're actively working, and we're well positioned as a consolidation leader. So in some periods, there will be none, but in some there may be 1 or even more than 1. This strategy is core to our drive to achieve scale though, so not having closed an inorganic growth transaction means we're not moving as fast, frankly, as we expect of ourselves.

The last growth factor is the one that's most core to us, which is people. I've mentioned our physical access sales leader, Ed MacBeth. You'll hear much more about his initiatives over time. But as you've already heard, he's hit the ground very fast. I'd also like to comment on our RFID and smart card reader sales teams while we're on the subject. While they're not new, we have the industry's best sales teams in both of these areas, and you're seeing it reflected in the numbers. In transponders, nothing short of the best could be landing the wide and deep relationships with the leading global companies embedding our RFID products deep within their products and solutions. You can also see this clearly in our gross margins in the segment, which can run more than 50% higher than the industry average. Similarly, our smart card readers sales team is also the best in the world. And in fact, we are looking to strengthen our European sales team with an addition in the next quarter that we're confident will lead our European sales back to the leadership in that truly key market for smart card readers.

Now in prior quarterly updates, we've spent a lot of the time updating products, technologies and vision. All those efforts, of course, continue, but we thought to focus on sales, customers and inorganic growth would be appropriate as we continue to deliver sustained EBITDA-positive, predictable growth.

We know we need to build to greater scale, and we're certain we're on that path and on a stronger and faster path overall than we've been on years. Nonetheless, we're going to remain disciplined and methodical, building for the long run and always through steps that build rather than dilute. This sometimes can take more time than just getting something done to fit into a period, but we're certain that it will keep driving us quickly towards our vision for our business' potential and to creating much greater shareholder value. We'll encounter challenges with margin shifts, personnel changes, demand spikes and others, but we'll adjust rapidly and build an even stronger business every time.

Most importantly, we have established growth engines across all of our businesses, which now have been demonstrated in each of the last few quarters. There's no mystery about where our growth is coming from and how close in it's happening. Similarly, we've shown leverage from our operating base, delivering positive EBITDA in our seasonally toughest half of the year, positioning to accelerate into the second half and throwing most of that progress to the bottom line, moving from our midterm business model towards our long-term goals.

So on the last slide here, as we always do, we reaffirm our commitment to keep you updated as we move forward. In fact, we have the busiest investor communication calendar we've had for a few years, including the Gateway Conference in San Francisco and the Rodman & Renshaw and Imperial Capital conferences in New York. We'll keep our investor communications bounded to ensure our primary focus remains building the business. But we'll keep any interested investors informed of Identiv's growth and the exciting opportunities we've got in the marketplace.

Thanks for your attention. And now we'd like to open the discussion for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Mike Latimore.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [2]

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Just on the federal government strength, I guess, can you talk just -- you gave very good detail, but I guess, is most of the strength coming from current customers that are upgrading? Or are some of these new agencies you've won starting to pick up steam in this quarter? I guess, maybe could you talk a little bit about sort of current versus new customer demand?

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Steven Humphreys, Identiv, Inc. - CEO & Director [3]

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Sure. In terms of numbers, of course, current customers are always going to be the bigger number because it's so easy for an agency CIO to -- knowing us, knowing our products, to make year-end buys. So that's very straightforward, and we've got a number of activities going on in that front. But what we're finding is, especially out in the regions, over half of federal government purchasing occurs outside of Washington, D.C., getting to people we haven't been touching before out at the VA hospitals, out on the bases, other things, and demonstrating how we can get them along the FICAM path with infrastructure that they can already deploy and works with their systems, but then is FICAM-ready and really would make them look like heroes, that's an area where we're seeing a lot of activity. It won't be as big numbers but it will drive a lot of growth. Even in Europe, we had a big open house just a few weeks ago, and we had a bunch of army bases there, some other government facilities and customers we had not been close enough to engage with saying this is a great use of our funds right now. So it's a bit of both.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [4]

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Great, great. And I believe you won a couple new agencies in -- earlier this year. Have they started to purchase product yet?

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Steven Humphreys, Identiv, Inc. - CEO & Director [5]

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A couple of them have. One of them is still doing their [PSG] analysis, their infrastructure analysis. And then there's a couple of others that are coming even as we speak. So the expansion across the federal government is working pretty well.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [6]

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Great. And then on -- as it relates to Cisco, it sounds like it was a strong quarter. I guess, how was the momentum there? How does -- what does the pipeline look like? And then maybe a little more color on is it international versus domestic? Yes, just a little more color on Cisco would be good.

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Steven Humphreys, Identiv, Inc. - CEO & Director [7]

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Yes. The international versus domestic is a good one. It's a remarkably global pipeline that they've got. And it is starting to appear more in verticals. I mentioned education. There's a lot going on in the -- what they call SLED, the state and local education vertical for them. And they also spill over into some federal government agencies as well, so we are seeing across-the-board adoption. It's always exciting working with a company as large as Cisco. Sometimes we get lost in the noise, but we're so small that even a little extra noise pickup from them is substantial for our numbers. So it's feeling very positive.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [8]

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Great. And then you talked about kind of a balanced demand for the fourth quarter, but did you say that you thought there is a chance that the PACS revenue segment might be up in the fourth quarter versus the third? Or did I mishear that?

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Steven Humphreys, Identiv, Inc. - CEO & Director [9]

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No. You're right. And that would be the first time in a while. So we're going to watch it carefully. But as I said, with the broadening visibility for the Hirsch FICAM solution, we think that will be purchases that go even outside of the fiscal year-end with new accounts, in particular. And then Cisco is not as seasonally driven as Hirsch without the government concentration. So if you put those both together, we definitely have a shot at it.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [10]

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Great. And then just last on, you mentioned the Apple iOS. I guess, if that benefits your Credentials business, is that more of a 2018 revenue lift? Or would you have some benefit in the fourth quarter, potentially?

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Steven Humphreys, Identiv, Inc. - CEO & Director [11]

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No. That would be 2018 in terms of anything specific. And it drives our RFID business. Now where it can go into '18 and beyond is our early-adopter users of RFID technology have some of these very nascent applications. As the iOS platform becomes a user of NFC-based applications, it really just opens up the whole marketplace. And we've got some interesting developer's kits and other things we're putting out there to have us be kind of the referenced supplier in this space as Apple moves into it. And like I say, I was hesitant even putting that into the conversation because today has been so tactical, and that really is an '18 and beyond thing. Where it might show up earlier is if customers for transponders also believe that Apple's going to go in this direction, and therefore, they might start projects earlier and a little bit more aggressively.

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Operator [12]

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[Operator's Instructions) And it looks like we have [Tom Kutch] on with a question.

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Unidentified Participant, [13]

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Nice to see the growth and your excitement as far as the visibility going forward. I've got a couple of questions. One, I was wondering on a clarification. So at the beginning of the year when you put out the guidance and you put out the $64 million to $68 million of revenues, which is a nice increase, I don't recall any kind of breakdown between organic and inorganic, and my assumption was that was all organic. Now you're talking about some inorganic growth, potentially, although you haven't done a deal yet. But can you just clarify that number? Is that an organic growth number?

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Steven Humphreys, Identiv, Inc. - CEO & Director [14]

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Yes, fair question. That's an organic growth number, yes. And I didn't mean to confuse anybody with that.

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Unidentified Participant, [15]

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Okay, great. And then, so the second thing is your growth, while you've had growth in the first half of the year, it's obviously lower than on a pro rata basis, kind of that year-end number. I recognize you're talking about some -- or expecting some nice lift here in the second half. But -- so you would be talking about, I mean, real numbers here of something like $36 million to $40 million in the back half of the year to make those numbers. And I guess, you've got -- I'm just trying to understand the visibility into those numbers at this point. I mean, is that pretty visible? I mean, you don't talk about bookings and things, but are you guys pretty comfortable that you're going to land on that number, in that range?

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Steven Humphreys, Identiv, Inc. - CEO & Director [16]

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Yes, that's why I tried to go into a fair bit of detail in terms of the federal government; buying motivation in terms of the projects and programs we've got going on at the local and European, even for federal government level; the fact that we're seeing production volumes for our transponder customers that give us insight into what their reorders are going to be as they go into the holiday season. So I tried to build that up as well as we could, but you're right, we don't go putting backlog numbers and other things out there.

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Unidentified Participant, [17]

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Right. Okay, great. And then another one, if I may. Regarding margin, if I remember correctly, it sounds like you had a really strong business in the -- on the readers side. Correct me if I'm wrong, but going from memory that, that might be the lower end of your margin spectrum. You're also talking about continued strength into the back half of the year in that area. But I guess where I'm really going with this is, so that range of revenues is not -- from the low end to the top end for the entire year is not really that big. It's a $4 million difference. When you get to EBITDA, you've got a, what, $4 million to $7 million, that's $3 million range. So I guess your range on the EBITDA side, I don't know if you can talk a little bit more about your expectations on margins, but is that really going to be dependent on kind of the mix of the credential versus say the access control business? I mean, I'm sorry, not credentials, but the readers versus the access control?

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Steven Humphreys, Identiv, Inc. - CEO & Director [18]

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You mean is hitting EBITDA going to be dependent on mix?

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Unidentified Participant, [19]

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Yes, I mean, how dependent on mix and kind of your visibility in that at this point.

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Steven Humphreys, Identiv, Inc. - CEO & Director [20]

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Yes. So it is, it -- I mean mix, of course, affects aggregate EBITDA, although the EBITDA is fairly solid in all of our segments. But I've tried to give some insight into -- third quarter is always skewed towards physical access systems, which is our highest gross-margin segment. And fourth quarter, as I answered Mike's question a little earlier, we still expect to have a good mix of physical access, even though in the fourth quarter we often see some more transponder and smart card reader business. So does that get at what you're asking?

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Unidentified Participant, [21]

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It does, I guess. I'm just going to try one last one. As we go into next year, over the next few years, can you comment at all on what you see as far as -- you got these 3 verticals. Any one that will take over more than another as far as, again, influencing your margin as you grow your business going forward? Also when you look at inorganic growth, are you focused on 1 area over the other? I'm just -- 6 months ago or maybe a year ago now, you had a slide in 1 presentation that had kind of your -- I think you called it a midterm target range as far as trying to get your EBITDA up to, I think, it was a 10% kind of number. And I'm just -- now that we're 6 or 9 months beyond that, how are you kind of triangulating that going forward?

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Steven Humphreys, Identiv, Inc. - CEO & Director [22]

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Yes. Well, I think as you saw even the last half of last year and under most modeling scenarios you could look at this year, even if you were flat, you'd have something in the range of that model for the second half of this year and going out of the year. So we're certainly comfortable with those models. Back to your earlier question of is there any particular segment. From an organic growth perspective, I think they'll all be growing at healthy clips. I don't think there's going to be a substantial mix shift. From an inorganic perspective, we are certainly more heavily leaning towards higher gross-margin acquisitions in all the areas. Physical access is where you'll find more higher-scale acquisitions just because it is a bigger industry overall. So from a mix perspective, you'd probably expect to see more mix shifting of top line towards the physical access business.

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Operator [23]

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And we have Mike Latimore back on with a question.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [24]

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Yes, so Steve, you talked about some accelerated sales efforts. What does that mean generally for just kind of sales and marketing spend, let's say?

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Steven Humphreys, Identiv, Inc. - CEO & Director [25]

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Good question. Yes, well hopefully, you know us long enough that, that means no increase in spend. It means we have 3 -- really 4 categories of customer-facing activity. We have our sales engineers, we have our direct salespeople, we have our inside sales and we have our professional services group, which is paid for, basically. So you'll see us doing more in professional sales -- professional services because when we add a person, we actually get 1.5 to 2x their all-in cost in revenues. And you'll see us shifting more towards highly leveraged inside sales lead gen that makes our sales guys more productive, our sales guys and gals. But not an aggregate increase -- not a dollar increase and certainly not a percentage increase.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [26]

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Okay, great. And then on the just channels and partner front. Did you add any new channel partners in the quarter or sort of developed additional partnerships that sort of can help with the channel? And then how does that look for the second half of the year?

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Steven Humphreys, Identiv, Inc. - CEO & Director [27]

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Yes, from a channel perspective, yes, although we don't call them out. We haven't -- to be clear, we haven't added a Northrop Grumman-scale system integrator or a Cisco-scale partner. But we've added a number of regional dealers and superregional dealers as our channel builds out.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [28]

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And then on the government strength that you're seeing, does that flow through to the Identity segment as well? Or do you see it more on the access?

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Steven Humphreys, Identiv, Inc. - CEO & Director [29]

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Mike, you cut out, I'm not sure your...

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [30]

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Sorry, is this better?

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Steven Humphreys, Identiv, Inc. - CEO & Director [31]

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Oh, yes, yes. I heard you say then on the gov, and then lost you.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [32]

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Okay, great. Yes, the strength in the government you're seeing, does that also flow through to the Identity segment some?

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Steven Humphreys, Identiv, Inc. - CEO & Director [33]

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Yes, good point. Because the smart card readers, a portion of that volume, especially the desktop readers for smart card readers, are driven by network login for the DOD as well as our OtterBox project when that comes online. That will be for mobile e-mail access also for DOD and government security applications.

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Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [34]

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Got it. And just last one on the physical access security, you mentioned FICAM a few times. I guess, just can you compare the FICAM initiatives that you're seeing in the second half? Or is there a pick-up in FICAM activity? Or is it more really tied to just kind of more kind of second half government spending?

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Steven Humphreys, Identiv, Inc. - CEO & Director [35]

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No. There's a pick-up in FICAM activity, actually. Partly -- you might remember, we went on the approved product list in -- it was either January or the first week in February this year. And so the message is just really bedding in now that we've repeated it a couple of times and people are coming to seminars, and so it is picking up.

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Operator [36]

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And we have no further questions at this time.

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Steven Humphreys, Identiv, Inc. - CEO & Director [37]

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All right. Well, thank you, and thank you all for joining us today. We look forward to keeping you updated on our progress as the business goes forward, particularly at any of our investor conferences and our third quarter earnings call when that comes around. But thank you again for your time and have a good afternoon or evening.

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Operator [38]

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Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.