Fluent, Inc.
Q1 2008 Earnings Call Transcript

Published: 28 May 2008

[Operator:]

Good day, ladies and gentlemen. Welcome to the Cogent Systems’ First Quarter 2008 Earnings Conference Call. During today’s presentation, all participants will be in a listen-only mode, and following the presentation, the conference will be open for questions. If you have a question, please press * followed by 1 on your touchtone phone. If you’d like to withdraw that question, please press * followed by 2. If you’re using speaker equipment, you will need to lift the handset before making your selection. This conference is being recorded today, Wednesday, May 28, 2008. Now, I’d like to turn the conference over to Jill Isenstadt with Blueshirt Group. Please go ahead.

[Jill Isenstadt:]

Good morning and thank you for joining us on today’s conference call to discuss Cogent’s first quarter 2008 financial 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 yesterday, Cogent issued a press release discussing the results for its first quarter ended on March 31, 2008. If you would like a copy of the release, you can access it online at the company’s website or you can call the Blueshirt Group at 415-217-7722, and we will fax or email you a copy. This conference call 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 would 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 operations. 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 expectations. For a full discussion of the risks and uncertainties, please refer to yesterday's press release and our recent SEC filings including without limitation, the company's report on Form 10-K for the quarter ended December 31, 2007. The company does not intend and assumes no obligation to update any forward-looking statements. With that said, I'd now like to 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. We have three primary goals for 2008. First, we want to give more consistent results and meet or beat our guidance for the year. Second, we want to continue to strengthen our customer base while winning orders from existing and new customers, and third, we want diversify our business both through internal development and through potential target acquisition. With this goal in mind, we believe we are off to a strong start in 2008. Revenue for the quarter was $24.6 million, ahead of analysts’ estimates. Gross margins were particularly strong at above 70%, leading to a non-GAAP EPS of $0.16 per share. Revenues were driven by strong demand from the Department of Homeland Security, Morocco, Royal Canadian Mounted Police, ANP, and our pipeline of [inaudible] customers. Moving forward, we believe our position with our leading customer is secure, and we are becoming even more optimistic about demand from DHS. The continuing need for increased processing power and the 2- to 10-print conversion is driving sales at this important customer, and we continue to deploy this customer with what we believe is the largest and most efficient AFIS in the world. We think our success with DHS and our other customers is a testament to our technology superiority and our low total cost of ownership relative to our competition. We can point to multiple programs from our competitors that are either not yet operational, have performed below plan, or end up costing much more than originally forecasted. During the quarter, we were awarded a contract by the Department of State and the Bureau of International Narcotics to implement an AFIS for El Salvador National Civil Police. We also got robust followup contracts from LA County, Haiti, and RCMP, and the UK Visa program. In addition to our success with our AFIS products, we are also starting to diversify our revenue stream. From an internal department basis, we saw a nice contribution from our background web check program and ANP and continue to develop our handheld scanner business, where we think we have some really innovative products. This product combined with our core AFIS capabilities could satisfy the growing needs of many state and federal agencies including Department of Defense as well as international customers. These areas along with our initiative in the commercial market will be significant contributors to our growth in the future. Additionally, we are also actively looking for synergies with acquisitions that expand our market opportunities and would benefit from joining with Cogent. With this in mind, we are pleased to announce our acquisition of Maximus’ Security Solutions Division. SSD primarily provides identity management and credentialing integration service and has a long history of designing and implementing multi-technology and multi-application smart card system using biometric technology. They have built an impressive and wide range of established US customers, including the Department of Defense, Department of Veterans Affairs, FDIC, GAC, and NASA with more HSPD-12 cards under management than any other firm. They also have potential of continued growth by helping agencies complying with this directive. SSD has talented personnel as well as is a good growth opportunity with our commercial products. This acquisition enables us to expand our market, and the price of the acquisition was right. It also gives us strategic revenue flow that could be more predictable and more [inaudible] our long-term business. We think this will be immediately accretive to our earnings. To wrap it up, we believe we made progress in all our three main goals for the year in the first quarter. We have a lot of work ahead of us, but we feel it was a solid start for the year. I am going to ask Paul to go over the Q1 results in more detail and also our financial outlook for 2008. Paul?

[Paul Kim:]

Thank you, Ming. I should mention that Thank you, Ming. I should mention that, unless specifically noted otherwise, we are discussing all numbers on a pro forma or non-GAAP basis. First quarter GAAP results included $921,000 in non-cash charges related to FAS 123R regarding the expensing of non-cash stock-based compensation. In today's discussion, I will first give you an overview of our Q1 results, and then provide financial guidance for the full year 2008, and finally finish with an update on our pipeline and opportunities going forward. First quarter revenues were $24.6 million. Product revenues increased sequentially by 17%, while maintenance and service revenues increased by 3% from the fourth quarter of 2007. Revenue contribution during the quarter came from customers such as the DHS, Morocco, ANP, Tennessee, RCMP, Ohio, Los Angeles Sheriff's Department, and Pennsylvania. Gross margins were 70.4% in Q1, compared to 71.5% last quarter. Looking ahead, we continue to expect annual gross margins to be above our long term target range of 55% to 60%. First quarter net and operating income was impacted by $10 million in settlement income related to the company’s settlement agreement with Northrop Grumman. The effect on EPS was $0.07 per share. Operating expenses excluding settlement income as a percentage of revenue were 33% this quarter. In actual dollars, operating expenses excluding settlement income increased to $8.1 million from $7.8 million in the fourth quarter on higher revenues. Excluding stock-based compensation and settlement income, we now project that 2008 operating expenses will be approximately $34 million. Operating margins excluding stock-based compensation of $921,000 were 78% in the first quarter. Of the 78%, 41% relates to settlement income. We recorded $5 million in interest income this quarter. Our tax rate was at 38% during the first quarter. We anticipate the tax rate to be between 38% to 40% for full year 2008. Excluding stock-based compensation, fully diluted non-GAAP earnings were $15 million, or $0.16 per share based on 92.7 million share count. Cash and investment dropped by $400,000 from the fourth quarter to $444 million, or $4.79 per share as of March 31, 2008. The modest decrease is due to cash spent on our share repurchase plan as well as changes in working capital. During the quarter, we generated $39 million in cash from operation. During the quarter, we repurchased 3.9 million shares of common stock at an average price of $9.33 per share, for an aggregate purchase price of $36.6 million. Also, we have continued to repurchase shares during the second quarter of 2008. To date in the second quarter, we’ve purchased 571,000 shares at an average price of $9.16. From the time we announced $100 million buyback in November 2007, we have expended approximately $56 million repurchasing our stock. Accounts receivable decreased to $24 million in Q1 from $31.8 million in Q4. Inventories were $15.4 million at the end of Q1, compared to $11.4 million at the end of Q4. The increase in inventory is due to deferred costs for ongoing projects. $10.7 million of the $15.4 million in inventory balance is comprised of deferred cost of sales for ongoing projects, and the remaining $4.7 million is tangible inventories net of reserves, which is recorded at lower cost to market. Fixed assets were at $33.9 million. Deferred tax assets were $26 million. The balance was primarily comprised of deferred revenue, research and development credits, and foreign tax credits. We believe it is more likely than not that these assets will be realized in the future through generation of taxable income. Accounts payable and accrued expenses were $21.9 million compared to $13.3 million in Q4. Deferred revenues were $37.7 million, compared to $27.6 million last quarter. This increase is attributable to various projects including Maryland, Spain , DHS, and other governmental agencies. Headcount increased to 286 in the first quarter from 260 in the fourth quarter. Now let me move to outlook for the year. We are increasing our full year 2008 revenue guidance to $125 million which will include the acquisition of SSD. We will give you an update on the progress of our pipeline, accounting treatment for major contracts, and guidance as we report in future quarters. This 2008 revenue guidance represents an 18% growth over 2007 levels, and at this time, we continue to anticipate quarterly revenues to be larger in the back half of 2008. As I mentioned, we are anticipating gross margins currently to be higher than our long term range of 55 to 60 points. We are now raising our gross margin targets to be between 62 to 67 points for 2008. Within the annual range, we believe gross margins to be lower in Q2 and Q3 than the 70.4% achieved in Q1. We also believe gross margins to be higher in Q4 than the anticipated margins around the middle of the year. We are anticipating operating expenses to be approximately $34 million for the year excluding stock-based compensation and settlement income, and we anticipate our tax rate to be around 39% during the year. These factors lead us to forecast non-GAAP EPS of $0.49 to $0.52 per share for full year 2008 excluding stock-based compensation. Now before we open it up for questions, let me close by discussing some of the opportunities we’re pursuing. Starting with the DHS, we believe DHS revenues will grow in 2008 based on expansion of the system and the migration from 2 to 10 prints. We have anticipated a slower rollout over a multiyear period, but the exact timeline is still to be determined and may be accelerated from our estimate. We also continue to anticipate additional contract awards during the year both domestically and internationally across all our market segments - border control, law enforcement, civil and commercial. We are currently pursuing many new opportunities including the biometric component of the FBI-NGI program, the DoD’s new biometric program, and the UK national identity scheme. In addition, we have numerous proposals outstanding including Belgium, Algeria, UK Royal Mail, and San Jose, furthermore with the opportunities in Israel, Greece, Turkey, Jordan, Chile, Oman, Libia, Kenya, New York, San Francisco, and many other places around the world. We will continue to update you on the status of these and other major programs on each of our quarterly earnings call. In summary, this year we are pleased with this solid start to the year, especially our strong margin and bottomline performance. We are focused on winning additional contracts, increasing our market share, and building an even broader base of customers. We also will continue to look for opportunities to expand our addressable market opportunities through both internal development and selective acquisitions. Based on current expectations, we believe we will continue to accelerate growth in 2008 and continue to increase our profits. With our strong balance sheet and commitment to leading the market in technology, we believe we can capitalize on the future growth of our industry and continue to establish ourselves as a leader in the biometric market. We would now be happy to answer any questions that you may have. Operator, you may now open it up for questions.

[Operator:]

Thank you, sir. We will now begin the question-and-answer session. (Instructions). Our first question is from the line of Paul Coster with J.P. Morgan. Please go ahead.

[Analyst for Paul Coster:]

Hi. This is actually Mark on behalf of Paul. The timing around some of the larger contracts - is there any reason to believe the FBI-NGI or the UK identity scheme might be different from – are you still thinking it’s going to be late ’08, early ’09, or…can you give us an update there?

[Ming Hsieh:]

Mark, this is Ming Hsieh. The FBI-NGI programs are not in our forecast for this year, so we anticipate a delay for the GI, so any revenue opportunity from the FBI-NGI will be next year. Regarding the UK national identity scheme, I believe the UK is accelerating the program, has selected plan contractors, and the various bidding processes have started, but for that program, we also did not forecast any revenue for this year. Anything we get will be on top of our guidance. We anticipate revenue flow will be from next year or year after.

[Analyst for Paul Coster:]

Okay, and then can you give us the same on the new DoD biometric program?

[Ming Hsieh:]

With DoD, we expect three more contracts will be coming up sometime in June, so we believe DoD wills start spending some money this year.

[Analyst for Paul Coster:]

Can you update us on your backlog and what that would be in 12 months?

[Paul Kim:]

Mark, we announce our backlog once a year when we announce our annual year-end results, so we do not disclose quarterly backlogs. Having said that, we feel very good and very confident about where our current business stands both in terms of pipeline and orders that we have on hand.

[Analyst for Paul Coster:]

Okay, got it. And then, are you seeing any significant changes in the competitive landscape?

[Ming Hsieh:]

Mark, definitely we are watching what is happening with our competition, and definitely we are working very aggressively to bring new products to the market and increase our internal research and development effort. I think our competitive position is very good, and I think definitely we need to watch what the competition is doing.

[Analyst for Paul Coster:]

Okay. That’s all I have. Thank you.

[Operator:]

Thank you. Our next question is from the line of Jeremy Grant from Stanford Group. Please go ahead.

[Jeremy Grant:]

Hi, good morning guys. Can you hear me?

[Paul Kim:]

Yes.

[Jeremy Grant:]

Okay, good. Calling in from a cell phone. First about US Visa, looking at the Q, it looks like most of the revenues are now coming through some intermediaries, I see from DHS, instead of directly. Can you talk a little about that change?

[Paul Kim:]

Sure, Jeremy. This is Paul Kim. There has been any change in the partners or the go-to-market that we have for the US VISIT program. In the Q, we have exact numbers that we have to specific parties, but in fulfilling the needs of Department of Homeland Security, we shift products, we offer services directly with the Department of Homeland Security, or we use logistical partners in fulfilling their needs, so there hasn’t been any change in the way we fulfill the needs for the Department of Homeland Security, and the activity that you note with the Department of Homeland Security being very heavy in the quarter was correct. We were fortunate enough to have a lot business from the Department of Homeland Security and fulfilling the needs that they have for additional processing as well as service capabilities, and we look forward to fulfilling additional needs that they have throughout the course of this year.

[Jeremy Grant:]

Within your guidance, things are picking up towards the second half of the year. Revenue-wise, are you expecting that the pace of DHS business is going to pick up more in the second half of the year relative to the first half?

[Paul Kim:]

I think that’s hard to anticipate what the exact revenues will be on a quarter to quarter basis. Having said that, we do anticipate the overall business from the Department of Homeland Security - the needs for the US VISIT program to be heavier this year than it has been in the prior year.

[Jeremy Grant:]

Okay. Can you talk a bit about the RFQ that the VISIT program has put right now, looking at competitive solution or how that could impact things?

[Ming Hsieh:]

Jeremy, what you are talking I believe is a case study. The US VISIT plan contractor, Accenture, did issue a case study calling for papers for various companies to provide what each vendor’s capability is to test DHS increasing or even more demanding requirement in terms of processing power. So, there were various companies that provided their paper in compliance with DHS that went to Accenture for them to conduct some of the conversion.

[Jeremy Grant:]

Okay, so it was really more of an RFI as opposed to a direct request for quotes and put everything up for competition.

[Ming Hsieh:]

Well, this was a case study, we believe.

[Jeremy Grant:]

Okay, and then the other question I had was shifting to NGI, I think, Kim, we have talked about what architecture they would use going forward and whether there would be an opportunity for you to propose your PMA servers or whether they will be looking for a software-only solution that would run on their existing server base. Now that the IBM [inaudible] in NGIs going forward, has there been any progress how they’ll go forward on that?

[Ming Hsieh:]

Well, we haven’t seen the full impact of the piece yet. That said, we are looking forward for them to pick up studies or benchmark tests to demonstrate various technologies including software or hardware. We believe to that end the selection of the technology is going to be pretty clear. Definitely if you’re looking for the blade-based solution, that solution exists. That one is not magic. Everybody has been using the blade technology for various applications, but at the present time, there is no place in the world that you can point to for successful application for that skill using the blade yet. We are looking forward for that benchmark.

[Jeremy Grant:]

And one final question just on the handheld – you guys mentioned you are looking at some new devices. Can you talk a little bit more about what we might see?

[Ming Hsieh:]

Jeremy, the handheld device is part of the data collection device. We can develop this through our own research and development or we can purchase from the various technology partners, but our focus is at the back end. The more and more handheld devices can be developed or deployed in the field through coding or through our competitors, there will be opportunity for us for coding at the backend, so really we are looking for the backend solutions. Handheld solutions area is one we are interested in, but our main emphasis is at the back end.

[Jeremy Grant:]

Okay, thanks.

[Ming Hsieh:]

Thank you.

[Operator:]

Thank you. (Instructions). There are no further questions at this time. I will turn it back to management for any closing remarks.

[Ming Hsieh:]

Alright. Again, thank you very much for being on the call today, and also we appreciative of your support. We are looking forward to updating you on our progress in the coming quarters. Thank you very much.

[Operator:]

Thank you. Ladies and gentlemen, that does conclude our conference for today. If you’d like to listen to a replay of today’s conference, please dial 1-800-405-2236 or 303-590-3000 using the access code of 1115030 followed by the # key. ACT would like to thank you for your participation. You may now disconnect.