Fluent, Inc.
Q2 2009 Earnings Call Transcript

Published: 5 Aug 2009

[Operator:]

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Cogent Systems Second Quarter 2009 Earnings Conference Call. (Operator's Instructions) This conference is being recorded today, Tuesday, August 4th, 2009. At this time I'd like to turn the call over to Jill Isenstadt, Investor Relations. Please go ahead, ma'am.

[Jill Isenstadt:]

Good afternoon, and thank you for joining us on today's conference call to discuss Cogent's second quarter 2009 results. This call is also being broadcast live over the web and can be accessed in the investor relations section of Cogent's website at www.cogentsystems.com for 15 days. With me on today's call are Ming Hsieh, President and Chief Executive Officer, and Paul Kim, Chief Financial Officer. After the market closed today, Cogent issued a press release discussing the results for its second quarter ended on June 30th, 2009. If you'd like a copy of the release, you can access it online at the company's website or you can call the Blue Shirt Group at 415-217-7722 and we will fax or email you a copy. This conference will include a discussion of non-GAAP financial measures as that term is defined in Regulation G. The most directly comparable GAAP financial measures and information reconciling these non-GAAP financial measures to the company's financial results prepared in accordance with GAAP are included in the earnings release which is posted on the company's website at www.cogentsystems.com We'd like to remind you that during the course of this conference call, Cogent's management may make forward looking statements including financial projections, statements as to the plans and objectives of management for future operations, and statements as to the company's future economic performance financial condition, or results of operation. The company believes that its estimates and expectations are reasonable and are based on reasonable assumptions. However, risks and uncertainties relating to future events could cause the actual results to differ or differ materially from the expectations. For a full discussion of the risks and uncertainties, please refer to today's press release and our recent SEC filings including without limitation, the company's annual report on Form 10-K for the year ended December 31st, 2008, and its quarterly report on Form 10-Q for the quarter ended March 31st, 2009. The company does not intend and assumes no obligation to update any forward looking statements. With that said I'd like to now turn the call over to Cogent's president and CEO, Ming Hsieh.

[Ming Hsieh:]

Thank you, Jill, and thank you, everyone, for being on the call. I'm pleased to announce that we had another solid quarter and are on track to meet our financial goals for the year. Second quarter revenue grew 22% year over year to $32 million. Our results were driven by (inaudible) orders from our largest customers, the DHS (ph), and also to the contributions from our broad range of the smaller customers including Italy, Ohio, Pennsylvania, Santa Cruz County. We achieved this as a result of recognizing revenue in the quarter from our partnerships with another (inaudible) or any of our contract wins announced earlier this year. Gross margin were at the high end of our target range and we posted a solid bottom line result with non-GAAP net income of $9.1 million, or $0.10 per diluted share. In the quarter we generated $24 million in cash and cumulatively we have generated $51 million in cash so far this year. While we cannot control the timing of our revenue recognition, the execution of our business model and the business of general cash remains strong. The strength of our existing customer basis has refreshed our results, providing both good visibility and solid incremental demands as we wait for the outstanding procurements to be awarded. The DHS was a gain — strong contributor to the quarter and we anticipate a number of opportunities that could drive demand from this important customer in 2009 and beyond. This includes the interoperability, unique identity, and mirroring the US with the fingerprint (inaudible) to DHS data centers. In June, DHS spending still was (inaudible) which includes the (inaudible) potential increases for the DHS US Visa program and is part of the funding initiative. The Department of Defense also continues to generate a significant demand for biometric technology and we are focused to position ourself to taking advantage of this large opportunities. We have made (inaudible) with this customer and they remain a prominent source for potential incremental revenue as they ramp up their spending in biometric solutions. Additionally we anticipate the procurement of other for products and services from above yields will take place in future. In UK we have begun to work with UK Post Office. It is worth noting that recent change making the (inaudible) a non (inaudible) for the UK citizens does not have any impact on the goal or our progress. We expect our enrollment patients to be enrolled in March 2010. With several key contracts still outstanding the world, we are confident in our competitive position and are encouraged by our robust pipeline. (Inaudible) the pipeline reflects a growing demand for the biometric solutions from Senator Schumer's recent announcement that work identity legislation to Mexico and India's identity card program. Where we may not win every opportunity, we remain focused on secure awards that are beneficial to the company and that will help us to strategically grow our business. Our secure technology and a strong track record build in the world's largest biometric database with key customers such as the DHS (inaudible) to win the future awards. We feel there are sufficient opportunities ahead to achieve our growth goal and are encouraged by the continued demand from the current customer. I'm pleased to announce today, a new contract win that further bills our (inaudible). We have signed a contract to replace Cuyahoga County, Ohio's regional law enforcement agent system, and also we have been awarded to build a large-scale statewide contract. To summarize, we are pleased to announce our second quarter results and indeed we are seeing a ramp in the second half of the year throughout our revenue targets. We'll keep striving to diversify our customer base and strategically grow our businesses to generate shareholders value. In addition, demands from our customers remains high and continues to provide important visibility in this environment. We are positioning ourselves to capitalize on the growth opportunities ahead of us with both new and existing customers as demand for the world class biometric solutions continue to grow. I will now please ask Paul to go over our Q2 results in more details, and also our financial outlook for 2009. Paul?

[Paul Kim:]

Thanks, Ming. I should mention that unless specifically noted otherwise we're discussing all numbers on a ProForma or non-GAAP basis. Second quarter GAAP results included $973,000 in non-cash charges related to (inaudible) 123R, regarding the expensing of stock-based compensation. Second quarter revenues were $31.8 million. Product revenue grew 4% from the first quarter and were up 23% on a year-over-year basis. Maintenance and service revenues decreased sequentially by1%. Revenue contribution during the quarter came from customers such as the DHS, Italy, Ohio, Pennsylvania, and Santa Cruz County. Gross margins were 64% in Q2, within our target range, and down from 69% last quarter due to product mix. Looking ahead we continue to expect annual gross margins to be in the range of 60%-65% for 2009. Operating expenses as a percentage of revenue are at 28% this quarter down from 30% in Q1. In actual dollars, operating expenses decreased to $8.9 million to $9.2 million in the first quarter. Excluding stock-based compensation we continue to project that 2009 operating expenses will be approximately $40 million. Operating margins excluding stock-based compensation was $973,000 or 37% in the second quarter. We recorded $2.7 million in interest income this quarter. Our tax rate was 38%. We anticipate the tax rate to be approximately 38%-39% for full year 2009. Excluding stock-based compensation, fully diluted non-GAAP earnings were $9.1 million or $0.10 per share based on a 90.6 million share count. Cash and investments increased by $24 million from the prior quarter to approximately $531 million or $5.86 per share as of June 30th, 2009. Accounts receivable decreased to $16 million to Q2 from $23.4 million in Q1. Inventories were $22.4 million at the end of Q2 compared to $22.9 million at the end of Q1. Fixed assets were at $37.6 million. Taxed assets were $39.9 million. The balances comparably comprised of deferred revenue and research and development credit. We believe it is more likely than not that these assets will be realized in the future to generation of taxable income. Accounts payable and accrued expenses were slightly down in Q2 at $33.2 million compared to Q1 at $33.9 million. Deferred revenue was up $4.3 million o $85.1 million compared to $80.8 million last quarter. This increase is related to various ongoing projects and reflects the growth of our backlog on some key contracts. As noted on our past earnings calls, deferred revenue as well as backlog can fluctuate. Our headcount increased to 408 in the second quarter from 383 in the first quarter. Now let me move onto our outlook for the remainder of the year. During this quarter, fluctuations in our maintenance renewal rebates caused us to fall out of being able to achieve vendor specific objective evidence or maintenance for our AFIS contracts. As a result, revenues which would have been previously recorded currently will get pushed out into the future. However, based on our backlog, entering the quarter, and strong orders from existing customers, we are reiterating our previous full year range revenue guidance of $130-$135 million and EPS guidance of $0.33-$0.40 per share even with this push out. At this time we expect to start recognizing revenues from the UK Post Office and most of our new contracts that Ming previously mentioned in 2010. As I said on the last call it is possible that we will recognize revenues from our new contract wins in 2009, but it is also possible that we will not be able to record revenues from these customers that all despite having to receive cash payment for products and services. In summary we are pleased with our solid second quarter financial results. We continue to generate cash and maintain good visibility based on backlog and current orders, even in this environment — a treatment to our business model. We remain focused on growing our business by winning new awards, advancing our technology, and driving incremental revenues from a broad base of existing customers. We would now be happy to answer any questions you may have. Operator, you may now open it up for questions.

[Operator:]

Thank you, sir. (Operator's Instructions) And our first question is from the line of Brian Gesuale. Please state your company name followed by your question.

[Brian Gesuale:]

Hey, guys. Brian Gesuale here from Raymond James, thanks for the color on the quarter. A couple questions for you guys, maybe first can you discuss where we're at with the buyback? Extending that, I think we're coming up in a few months on a decision point there and maybe just start with that one — stock buyback?

[Paul Kim:]

Sure, Brian. So our initial stock buyback program was announced at $100 million. Subsequent to that we expanded a program to $150 million. Up to date we purchased approximately $60 million worth of stock within that program You are correct, it is coming up for expiration in the next three to four months and we intend to leave that option open, but there's a great likelihood that we will reextend that buyback program or make it even larger.

[Brian Gesuale:]

Wonderful, thank you. Also not sure if I had hard Ming, from your comments, if Northrop Grumman revenue was recognized in the quarter, and if so or if not can you kind of give us a feel on the rest of the year on that.

[Ming Hsieh:]

Brian, for my comments we did not recognize any of the Northrop Grumman revenue, so Paul can give you the color for the rest.

[Paul Kim:]

Sure. Brian, we did not record any revenues associated with the Northrop Grumman agreement during this quarter. When we initially started out the year, we thought that the estimated range of revenues from the Northrop Grumman agreement would e anywhere from $5-$10 million. We do believe that we will start recording revenues associated with the Northrop Grumman revenues in the back half of this year. It could be in the third quarter, it could very well possible start in the fourth quarter. The amount that is required will be less than our original estimate of $5-$10 million, but having said that based on the orders that we've seen from our existing customers, as well as new wins that we've had in 2009, we feel comfortable with the back half estimates of revenues which is ranged from $130-$135 million. When we initially started off the year we had a target of $130 million for the balance of the year.

[Brian Gesuale:]

Okay, terrific. And then I'll just do one final followup and let someone else jump in. DHS it looks like that that number was about 60% of revenue, can you may be corral the number in and give us any other 10% customers, if there were any, in the quarter, please?

[Paul Kim:]

The amount of DHS revenues during the second quarter was a very high percentage. It was about the amount of revenue that we had from DHS in the previous quarter of 2009 at about 50%. We don't specifically list those 10% customers. We can say that we ha material contributions of revenues from Italy, Ohio, Pennsylvania, and Santa Cruz County, during the second quarter. When we look out at the back half of this year we believe that DHS will continue to be a material amount of revenues and we will have a customer concentration surrounding DHS, the second half of this year. Having said that, you will continue to see, and possibly in a more material way, contributions of revenues from our other customers.

[Brian Gesuale:]

Okay, terrific. Thanks so much, Paul.

[Operator:]

Thank you. Our next question I's from the line of Brian Ruttenbur. Please state your company name followed by your question.

[Brian Ruttenbur:]

Yeah, thank you very much, Brian Ruttenbur, Morgan Keegan. I guess you're getting rid of all the Brians at the beginning. The question I have was on accounting for the UK Post Office contract. Did you say that you expect that to start happening in the third quarter, is that what I heard?

[Paul Kim:]

Well, the actual activity and the deployment production of materials, a lot of that has already started and doing a preliminary assessment of the contracts and looking at when we might start recording revenues, we do not anticipate that that will happen in 2009. We believe that that will start happening in 2010.

[Brian Ruttenbur:]

Okay. So recognition of actual revenue should start first half of 2010?

[Paul Kim:]

That's a very good likelihood, yes.

[Brian Ruttenbur:]

Okay. And then can you get into the AFIS maintenance push out? You went over that kind of quickly. I was not aware of that, and what kind of standards did you not meet that caused the maintenance contract to get pushed up?

[Paul Kim:]

Sure. Well, for our AFIS contract, Bryan, we, on a quarterly basis, go through the actual maintenance renewal rebates that we've had that transpire during the course of that quarter, and under the accounting guidelines, the rates that we have for renewal has to fall within a very tight band for us to have it under specific objective evidence of maintenance, which we carve out separately from the contract when we record revenues on the product side. In looking at the rates that we've had during the course of a quarter, it wasn't in as tight of a band as our external auditors wanted it, as well as the guideline. So we fallout of any specific objective evidence for an AFIS contract. Now what that does is when we get signoffs, so when we get progress within the AFIS contracts, instead of reporting the product revenues up front upon sign off, we record revenues ratably over the entire maintenance term, sort of at the one, two, or sometimes even three years. But all that said, what that does to our revenue target for the year is it affectively pushes out the venues that we would have previously recorded in the realm of say $5-$10 million in the future, most of it being in 2010. But having said all of that, even with the push out, based on the orders, the contracts, and the heightened activity that we've had as a company since the beginning of the year, we are not changing our revenue guidance, meaning that we still feel very comfortable that we can achieve the top line revenue target of $130-$135 million. And I think that if you look at the activity of the company, we don't announce a backlog until the end of the year, that happens once a year. But you can clearly see from our ability to generate cash — in the first six months we generated approximately $51 million of cash which is well ahead of our initial plan for cash generation, as well as looking at some other visible data points like deferred revenues. They're at record levels for the company, so we feel pretty good about our business.

[Brian Ruttenbur:]

Okay. And then just as a followup to the AFIS situation, that revenue, that $5-$10 million that you don't recognize in '09 will be recognized in 2010, so instead of recognizing 5-10 each year you'd actually recognize 10-20 in 2010, is that how it would work?

[Paul Kim:]

It's not 10-20 — I mean whatever the push out was — I mean it depends on the entire value of the contract, but whatever that push out is going to be the amount that we record out in the future. We have to actually take a look at the maintenance term to see what — it may be all in 2010 or it may be some in 2011, but there's no multiplier effect. Whatever the push out is going to be, amount of revenues that we record out in the future.

[Brian Ruttenbur:]

Okay. And the last question, you mentioned two awards, can you talk about the revenue and the size of those awards?

[Ming Hsieh:]

Well, the revenue of what we expect the revenue will be following into 2009. The only thing that at present I can say is the (inaudible) of the contract awarded, the (inaudible) significant contract growth, large types of awards. It ranges well above the $15 million range. We could not make it that specific at that point.

[Paul Kim:]

I think what Ming went to say was 2010 rather than 2009.

[Ming Hsieh:]

Yeah, 2010.

[Brian Ruttenbur:]

Okay. So those two awards that you announced are potentially $15 million apiece in 2010?

[Ming Hsieh:]

No. There' s large jump. It's larger than $15 million.

[Brian Ruttenbur:]

Okay, but that wouldn't be revenue to 2010, that would be just in total, right?

[Paul Kim:]

That would be total revenue.

[Brian Ruttenbur:]

Okay. Thank you very much.

[Operator:]

Thank you. Our next question comes from the line of Daniel Meron, please state your company name followed by your question.

[Daniel Meron:]

Thank you. It's Dan Meron with RBC. Congrats on the good execution on your (inaudible) the cash generation. Paul, maybe you can give us a little bit more color (inaudible) what is the extent of the VSOE impact you have because of these changes?

[Paul Kim:]

The impact of VSOE for AFIS was approximately $5 to maybe even $10 million for this year, so that's the amount of revenues that we would have recorded if we didn't fall out of VSOE.

[Daniel Meron:]

(Inaudible) that should have been the back half of 2009?

[Paul Kim:]

Some of it would have even have been in the second quarter that we just reported.

[Daniel Meron:]

Gotcha. According to that the new guidance could have been (inaudible)?

[Paul Kim:]

Yeah. I mean if we were in VSOE our revenue target for the year would have been higher than what the current estimate is between $130-$135 million.

[Daniel Meron:]

But to clarify, you did expect to sort it out (inaudible) 2010?

[Paul Kim:]

Most of it moves into 2010. It's possible that some of it even moves into 2011, but most of it should be 2010.

[Daniel Meron:]

Okay. So basically you are doing the cash ahead of it, but the impact to the P&L is (inaudible) right now and in 2010 that should reverse itself?

[Paul Kim:]

Yeah.

[Daniel Meron:]

Okay. And then can you give us a little bit more color on what was the new project that you're working on back half and should be resolved by then, a little bit more of color on the progress there or the milestones and a little bit more color on the geography that you guys expect to have this (inaudible)?

[Ming Hsieh:]

There are two comments that I mentioned within the North American context and once we get a contract signed we will provide more details in terms of the contract value, but at the present time that is all we could say.

[Daniel Meron:]

Okay. And then just last one (inaudible), the progress of the international, what was the split of the US versus the rest of the world? Maybe (inaudible)?

[Paul Kim:]

For the second quarter we had approximately three quarters of our revenues come from the United States, and I would say the remaining 25%, the rest of the world. I don't have the actual percentage, but the majority of the revenues were from the United States.

[Daniel Meron:]

Okay. Very good. Thank you, good luck.

[Operator:]

Thank you. Our next question comes from the line of Scott Zeller. Please state your company name followed by your question.

[Scott Zeller:]

Hi, Needham & Company. Getting back to the topic of VSOE, can you tell us what the revenue renewal rate typically needs to be in order to maintain VSOE status?

[Paul Kim:]

Sure. What you do is you take a look at the actual renewals that are being quoted during a portion of that quarter and the rate that you have, they have to be consistent and approximately 85% of a rate that you have, has to fall within a very, very short standard deviation of each other so it's a pretty rigorous test that you go through. But for example, say that our maintenance rates were at 10%. If you have say five quotes and three of them come in at 10% and if you have the fourth one coming in at 12% and then the other one coming in at 8%, that does not usually meet the criteria under VSOE, so it's a pretty rigorous type of test that you go through. And we believe that trying to target the rates, the better way to approach it is say okay well, here is the entire contract that we have with the customer, here are the services that we're providing, here are the amounts that make sense for both parties, so the contract is going to be the most suited or what our customers want and the best relationship between the customer and company. And if it doesn't fall within that very tight band than we might not have vendor specific objective evidence, but the fact that we do have a contract that makes the customer happy that makes us happy and that is a very good contract for us to deliver products and services, so that's what makes sense from a business standpoint. And based on the progress that we've had in the first half of 2009, we have not changed our guidance and I would say that our cash flow target for the year is actually higher than what we initially stated when we gave out guidance for the year.

[Scott Zeller:]

So could we assume that people have actually cancelled maintenance now that this change has occurred?

[Paul Kim:]

Absolutely not. We have more business. I mean this is an accounting application and has zero impact on business. I guess what I'm trying to say is this has nothing to do with the rate that the customers are renewing their maintenance contracts. I mean our renewal rates and our ability to support and service our customers is as high as ever and our existing customer base for product services and maintenance continues to grow each and every day. I don't think that I have seen a whole lot of customers not renewing their maintenance because these are highly intensive customized solutions where they get a lot of value and renew their maintenance. Stuff like that continues to happen at the end of each renewal period.

[Scott Zeller:]

Okay. And then, Paul, you mentioned that the change makes some revenue pushed out and treated as ratable, I believe you said, but I thought that the maintenance and services revenue is already taken ratably. So could you explain what the change actually is then?

[Paul Kim:]

Sure. What you do when you have vendor specific objective evidence if you carve out the undelivered element which is the maintenance typically, and then for the remaining piece we record that in the product revenues. That's if you have vendor specific objective evidence. If you don't have vendor specific objective evidence, what you do is you take the entire value of the contact and you record that ratably over the maintenance period. So not just the maintenance, but the product revenue as well.

[Scott Zeller:]

Okay. I misunderstood your earlier comments. I thought you were saying that — okay, that did makes sense. What you did say then is that the product revenue is actually taken ratably.

[Paul Kim:]

Yeah.

[Scott Zeller:]

Okay. I did not get that in the previous comments.

[Paul Kim:]

And when I was estimating the $5-$10 million, that's the overall impact of the combined revenues that have been pushed out from 2009, most likely into 2010.

[Scott Zeller:]

Okay, thank you very much.

[Operator:]

Thank you. (Operator's Instructions) And our next question is from the line of Jay Meier. Please state your company name followed by your question.

[Jay Meier:]

Yes, Feltl & Company. I have — maybe Ming could take this question as it's sort of high altitude. Ming, there's been a lot of activity in large credentialing programs both in the United States and elsewhere. We've seen India, Mexico announced, obviously you talked about Senator Schumer's work, and you didn't mention anything having to do with the TSA and that big funding appropriation that passed not too long ago. Can you give us any idea of how quickly you might expect some of these very large national-type procurements to come to ahead and how do you expect the biometric elements of those procurements to procure?

[Ming Hsieh:]

Well, definitely there is a lot of interest in this area now and we are working with all those potential opportunities. One aspect is by providing some of the new products and the concepts to the customer. Another one is try to work with the selected group of individuals to form a consortium and try to target those opportunities together. So definitely a lot of activity is going on at the present stage and also I believe for the products that we develop, given the past few years, we will have (inaudible) to address those opportunities.

[Jay Meier:]

Well for example, with the TSA funding that came through, AAAE is no longer required to do the background check and enrolment for airport and transportation related employees. That is a very similar application to what you're doing as primed for the UK postal field. Are you seeing any visibility of those procurements besides the RFI or has there been an RFP let for that, and if so, what's the timeline?

[Ming Hsieh:]

Well as you probably know, besides AAAE there's another organization and that's the organization we have been working with in trying to get as the sole source — the language removed from the legislation. So we do see opportunities which continue to pop up and we are working on those opportunities now.

[Jay Meier:]

Okay, thank you.

[Ming Hsieh:]

Right, thank you.

[Operator:]

Thank you. And at this time we have no further questions. I'd like to turn it back to Mr. Hsieh for any closing remarks.

[Ming Hsieh:]

Again, thank you very much for having joined our conference call and we appreciate your support and are looking forward to updating you on our progress in the coming quarters. Thank you very much.

[Operator:]

Thank you, sir. Ladies and gentlemen, if you'd like to listen to a replay of today's conference please dial 303-590-3030 or 1-800-406-7325 using the access code 4106258. That does conclude the Cogent Systems Second Quarter 2009 Earnings Conference Call. Thank you very much for your participation and you may now disconnect.