Fluent, Inc.
Q2 2008 Earnings Call Transcript

Published: 11 Aug 2008

[Operator:]

Good afternoon, ladies and gentlemen. Thank you so much for standing by. Welcome to the Cogent Systems second quarter 2008 earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions) As a reminder, this conference is being recorded today, on Thursday, the 7th of August 2008. I’ll now turn the conference over to Ms. Jill Isenstadt, Investor Relations for Cogent. Please go ahead.

[Jill Isenstadt:]

Good afternoon and thank you for joining us on today’s conference call to discuss Cogent’s second 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. Jim Jasinski, Executive Vice President, will also be available to answer questions during Q&A. After the market closed yesterday, Cogent issued a press release discussing the results for its second quarter ended on June 30, 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 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 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. An industry research group recently issued a report that supports our real growth in our industry. Their research predicts that the current $3 billion market for biometric will be more than doubled over the next five years to $7.3 billion, with fingerprints being the dominant form of biometric identification. We believe we are well positioned to grow at an even faster rate than our industry. Last quarter I outlined the three major objectives for 2008, which we believe will allow us to execute on our goal for the growth. First, we want to deliver more consistent results and then meet or beat our guidance. Second, we want to continue to strengthen our installation base while obtaining orders from existing customers and winning new business. Third, we want to diversify our businesses, both through internal development and through external target acquisitions. The second quarter offered another (inaudible) in achieving our goal. Financially, we believe we are on track for a strong 2008 and return to year-over-year growth. Revenues for the second quarter were $26 million. Non-GAAP gross margin was solid at 65% and non-GAAP EPS was $0.09 per share. Importantly, we also added $11 million for our deferred revenue, bringing the total to over $49 million. And I’m pleased to announce that we have received a strong order from some of our larger customers that we expect to ship over in the coming months. This gives us even higher layer of confidence that we will be able to meet albeit our target of $125 million in revenue for the year. And importantly, we are becoming increasingly confident that we will continue to grow in 2009. This confidence is based on both growing 2009 backlog from existing customers, partners, and a number of key opportunities where we have either already submitted a bid or have the order to compete for such a program. Some of these programs such as FBI-NGI, UK’s maximum identity scheme, DoD’s biometrics contract are well known. But we have more than a dozen sizeable opportunities. We expect to be awarded it within the next six to 12 months. While some of this improvement may end up being delayed, we believe many will not. And our near-term pipeline is stronger than ever than it has been in many years. Also we are highly encouraged by our current relationship with key customers and partners like DHS, LA County, Royal Mounted Canadian Police, Egypt National Police, and Morocco National Police, which provides us with a solid platform for future growth. The DHS continue to expand the positive power [ph] of its system to accompany both normal growth and conversion from two to tenprint, and we expect to benefit from this trend well into 2009. In addition to our success in our core AFIS product, we are also committed to diversify our revenue stream. This quarter we got our first contribution from the main acquisition of MAXIMUS Security Solutions Division, which primarily provides identity management and transition integration service. I’m pleased to report that the integration of SSD has gone very smoothly and will have combined work forces with our difficult operations. We can get a full contribution from SSD in the third quarter and our intention is to grow this business and (inaudible) generate more profit over the next couple of years. From our ongoing state of operations, we continue to get good revenue contributions from our various background check programs. From a development perspective, we continue to develop our handheld identification business. At this time, we believe we have cutting edge product that’s already for [ph] the market. At this note, we are currently in trial with the Department of Defense for handheld market modalities, in other words, checking fingerprints as well as other biometrics. This device is fully integrated with our complete AFIS solution. Feedbacks have been strongly positive for our product. While our caution is that this is a new opportunity and it will be conservative on the full cost of this [ph] opportunity until we have a material order in hand. We fully believe that we have the most innovative product in the market, a testament to our ability to continue to diversify our product line and expand our market. Finally, we continue to enhance our energy [ph] and solution offerings. To wrap up, we believe we made the programs in all our three main objectives for the year. Our financial results are on track and we have been very pleased at the pace of incoming orders from the second half of the year and are increasingly comfortable with our financial target for the year. Our pipeline of opportunities is robust and the pace of biometric activity appears to be picking up. Based on the current near-term opportunities in the market, the combination of all these factors make us very excited for the remainder of 2008 and 2009. I’m now going to ask Paul to go over our Q2 results in more detail and also our financial outlook for 2008. Paul?

[Paul Kim:]

Thank you, Ming. I should mention that, unless specifically noted otherwise, we are discussing all numbers on a pro forma or non-GAAP basis. Second quarter GAAP results included $869,000 in non-cash charges related to FAS 123 regarding the expensing of stock-based compensation. Second quarter revenues were $26 million. Product revenues remained flat from the first quarter, while maintenance and service revenues increased sequentially by 20% due in part to the inclusion of SSD. Revenue contribution during the quarter came from customers such as the Department of Homeland Security, Rwanda [ph], Winnipeg, as well as RCMP. Gross margins were 65% in Q2, down from 70% last quarter, but still well within our range we projected for the quarter. Looking ahead, we continue to expect annual gross margins to be between 62% to 67% for 2008, which is above our target range. Operating expenses as a percentage of revenue were at 32% this quarter. In actual dollars, operating expenses increased modestly to $8.4 million from $8.1 million excluding the settlement income in the first quarter on higher revenues. Excluding stock-based compensation and settlement income, we continue to project that 2008 operating expenses will be approximately $34 million. Operating margins excluding stock-based compensation of $869,000 or 33% in the second quarter. We recorded $4.1 million in interest income this quarter. Our tax rate was 38% during the second quarter. We anticipate the tax rate to be between 37% to 40% for the full year 2008. Excluding stock-based compensation, fully diluted non-GAAP earnings were $7.7 million or $0.09 per share based on a 90.5 million share count. Cash and investments dropped by $13.6 million from the first quarter to approximately $430 million or $4.76 per share as of June 30, 2008. The modest decrease is due to cash spent on our acquisition of SSD, our share purchase program, and a $9.3 million tax payment to the government. During the quarter we repurchased 570,000 shares of common stock at an average price of $9.16 per share for an aggregate purchase price of $5 million. From the time we announced $100 million buyback in November 2007, we have expended approximately $56 million repurchasing our stock. Accounts receivable increased to $36.9 million in Q2 from $24 million in Q1 due to timing of shipments. Inventories were $15.9 million at the end of Q2 compared to $15.4 million at the end of Q1. Fixed assets were at $35.4 million. Deferred tax assets were $26 million. The balance was primarily comprised of deferred revenue, research and development, 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 $14.7 million in Q2 compared to $21.9 million in Q1. Deferred revenue was up $11.1 million to $48.9 million compared to $37.7 million last quarter. This increase is related to various ongoing projects. Deferred revenues have increased 77% in the last six months for the company. Our headcount increased to 332 in the second quarter from 286 in the first quarter. Now let me move on to our outlook for the year. Based on our backlog entering the year and strong orders from existing customers, we are increasingly comfortable with our full year 2008 guidance of $125 million and non-GAAP EPS of $0.49 to $0.52. In summary, we are pleased with our solid first half of the year and are expecting to see a significant ramp in revenues in the second half of the year. Encouragingly, this ramp in revenues is based almost all with orders and backlog in hand. Some of these orders and backlog will extend into 2009 giving us more confidence that we will be able to continue to grow next year. Additionally, we expect a number of significant programs to be awarded over the next year and the pace of biometric activity appears to be robust. Currently, we are waiting to hear back on more than ten bids outstanding and have well over a dozen bids that are in process at the company. We are focused on winning additional contracts, increasing our market share and building an even broader base of customers. With our strong proven technology, we believe we can capitalize on the opportunities ahead of us and continue to establish ourselves as a leader in the biometric market. We’d now be happy to answer any questions that you may have. Operator, you may now open it up for questions.

[Operator:]

All right. Thank you, sir. (Operator instructions) Our first question comes from the line of Brian Ruttenbur with Morgan Keegan. Please go ahead.

[Brian Ruttenbur:]

Okay, thank you very much. The first question I have is the drop in cash, the interest rate, what are you getting right now. It’s a real simple one.

[Paul Kim:]

The interest rate that we’re getting right now is probably between 3% and 4%.

[Brian Ruttenbur:]

Okay. You don’t have anything funny going on in terms of mortgage rate securities or anything like that. This is just straight, what, CDs and things like that?

[Paul Kim:]

We have CDs, we have commercial paper, we also have corporate bonds as well as US governmental securities at the company. At the end of 2007, we disclosed that we had approximately $20 million of auctionable rate securities. I’m pleased to report that that balance has been fully redeemed with the exception of approximately $4 million, $5 million. And we feel very comfortable with the cash and investments in terms of the quality of the investments as well as the liquidity of the possessions that we have.

[Brian Ruttenbur:]

Okay, very good. And then the obvious question is going to be the FBI, what’s the status of that program and their RFP?

[Jim Jasinski:]

Two parts. As you know, the contract for the system integration has been awarded to Lockheed Martin. And if they are in the process of initiating the steps to select the AFIS supplier or suppliers, the first step was done in late July, early August, in which you had to respond to an RFI to become qualified for them to consider you to do the actual system testing itself. That system testing we expect to be initiated in the fall of this year.

[Brian Ruttenbur:]

And so when would the award take place for the FBI to you guys potentially?

[Jim Jasinski:]

I would anticipate sometime in 2009.

[Brian Ruttenbur:]

Would that be first half of 2009?

[Jim Jasinski:]

I would think so, but it’s hard to predict. It depends on how well they maintain their schedule. So the first step is to get qualified. Then if you are qualified, you will be invited in to do a demonstration system and evaluation of that, and then there will be an award thereafter.

[Brian Ruttenbur:]

Great. Thank you very much.

[Operator:]

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

[Jeremy Grant:]

Thank guys and congratulations on the quarter. Wanted to ask a little bit more about the DoD opportunity you were talking about, specifically with the handhelds in multi-modals, I assume we’ve talked about before, but I think you will be able to talk a little more now than you could before. Can you explain a bit more about the products and how it’s being tested?

[Paul Kim:]

Jim, do you want to cover that?

[Jim Jasinski:]

Sure. We have been working and developing a handheld product that has three modalities; face, iris, and fingerprint. The product has been demonstrated to the Department of Defense. And the Department of Defense has started placing orders. The product we believe is the cutting edge and significantly superior to any of the product that’s on the marketplace today. And that’s the feedback that we are getting back from DoD who we’ve demonstrated to.

[Jeremy Grant:]

This is being looked at as an alternative to some of the devices like the HAIDE and whatnot that have been used?

[Jim Jasinski:]

I don’t know exactly what DoD’s plans are for. I would suspect that that would be an alternative, but they certainly are not saying that this is a replacement or a substitute to get going us that this product is clearly superior to everything else that’s on the marketplace.

[Jeremy Grant:]

Okay. And that’s big news. Can you talk a little – you said DoD is placing orders. Are you guys able at some point to say more in terms of what the magnitude is or expectations?

[Jim Jasinski:]

As you know that DoD is a major consumer of biometric products and we believe that this is a significant first step. And we are going to continue to penetrate that marketplace over time.

[Jeremy Grant:]

Okay. And the fingerprint technology, obviously we know you had that. The face and the iris, is that something you developed internally or you license in technology or algorithms from other partners out there?

[Ming Hsieh:]

That technology has been developed internally.

[Jeremy Grant:]

Internally, okay. And the other question I had was just on getting a little more color on the quarter. I think Paul mentioned it was DHS, Rwanda, Winnipeg, and RCMP. I know we get more breakdowns when the Q comes out, but can you give a little bit of a breakdown as to how much revenue came from each of the major customers this quarter or are there others that were notable that we didn’t hear from?

[Paul Kim:]

In addition to these customers that you just mentioned, we have various background checks from at least four or five states. We also have ongoing revenues from existing contracts that we are working on outside of these four customers. But the thing that we can’t say is DHS gave a solid contribution during the quarter and that was the largest portion of our revenues during this quarter. So we had a very strong performance from the Department of Homeland Security, as you know, in Q1. And that trend continues to be the case in Q2.

[Jeremy Grant:]

Okay. And the pickup in deferred revenue by $11 million and change, able to say how much of that is coming from DHS versus other customers?

[Paul Kim:]

None of that is from the Department of Homeland Security. That’s actually a very good question. Deferred revenues get recorded when we have billings that are ahead of revenue recognition and the primary chunk of the 77% increase from the beginning part of the year are due to various projects that we have, contracts both domestically as well as internationally. So those revenues will get recorded in the future. And that’s part of the reason on why we are getting increasingly confident in our ability to achieve or exceed our targets that we have set out for this year in addition to having those future revenues well into 2009.

[Jeremy Grant:]

Okay. Are you able to give a rough percentage as to how much of the deferred will be considered funded backlog that you would recognize in 2008?

[Paul Kim:]

100% of the balance in the deferred revenues will be recorded as revenues in the future.

[Jeremy Grant:]

But not necessarily this year?

[Paul Kim:]

Not necessarily this year.

[Jeremy Grant:]

Okay. Do you have any estimate of how much would be this year, I mean just roughly to – so we can pencil in from that?

[Paul Kim:]

It should be more than half.

[Jeremy Grant:]

Okay. All right. I’ll drop back in the queue and let some others in. Thanks.

[Operator:]

All right, thank you. (Operator instructions) Our next question is from the line of Paul Coster. Please go ahead.

[Mark Streeter:]

Yes, hi. It’s actually Mark Streeter [ph] on behalf of Paul. Congrats on the quarter. Couple housekeeping questions. Gross margin is pretty strong again during the quarter. You said 62% to 67% for the year. How sustainable is that into ’09? Do you think it’s going to be that or you think it’s going to go back to your long-term target of 60, 65-ish?

[Paul Kim:]

Mark, this is Paul. Based on the orders that we have on hand as well as the orders that we anticipate on getting in the foreseeable future and then combining that with the bids that we have outstanding in the proposal that we are working on, we believe that our ability to achieve our long-term growth target range of 55% to 60% is extremely good. And it’s quite possible that the above 60% gross margins that we have achieved so far in the first half of 2008 will be sustainable into 2009.

[Mark Streeter:]

Okay, perfect. And then what do you think the – I mean obviously it depends on how your stock price trends, but what are you anticipating for share count by the end of the year?

[Paul Kim:]

We believe that it’s certainly possible that the share count will continue to decrease.

[Mark Streeter:]

Okay. And then regards to US visit, I think there is initially some concern with budget cuts, but the actual funding for the two to tenprint conversion is actually fine. What are we seeing from them? Is it on track or is it actually increasing faster than what you are expecting internally?

[Jim Jasinski:]

The DHS continues to have continued deployment and utilization of the matters. And the growth rate is as anticipated and the funding is maintaining that with the growth rate.

[Mark Streeter:]

Right. Okay, thank you very much.

[Operator:]

All right. Thank you. And our next question is from the line of Nick Andrewes with Lazard Capital Markets. Please go ahead.

[Nick Andrewes:]

Hi, good quarter guys. Could you guys just talk a little bit about your relationship with Northrop Grumman now? And what do you guys expect how the revenues are going to flow for this year from the settlement?

[Paul Kim:]

So – I’ll answer the question about revenues and then I’ll turn it over to Ming who can discuss the status of the relationship. In terms of revenues, we anticipate on beginning to record revenues related to the Northrop Grumman agreement in the next six to nine months.

[Ming Hsieh:]

In terms of activities with Northrop Grumman, we have lots of engineering activities working with them and to build out the products and the service together.

[Nick Andrewes:]

Okay, great. Thanks.

[Operator:]

All right, thank you. Our next question is a follow-up from Jeremy Grant. Please go ahead.

[Jeremy Grant:]

Hi, thanks. I had a couple more. The first was the UK national idea, saw that was a small award, the first task order that came out last week. And I know the big biometric database is one of the next task orders, the first [ph] to come out. Can you give just a little color as to what the timing is of that opportunity?

[Ming Hsieh:]

Jeremy, as you probably note, the large portion is going to be competed against the marketable prime contractors.

[Jeremy Grant:]

Right, right, the products that are out there.

[Ming Hsieh:]

Our own service teams are working under the opportunities.

[Jeremy Grant:]

Okay. And UK suggested when that task order will come out to the five primes? That comes, I mean, later this summer, early this fall or it could have slipped to ’09 in terms of the release of the RFP?

[Ming Hsieh:]

I believe that it could be something in ’09, but now those problems are under our 2008 guidance anyway. So –

[Jeremy Grant:]

Okay. I’m just trying to look ahead to see what more is coming. I also have – there was I think a project in Algeria that’s been – you’ve been waiting to hear news on, is there any update there?

[Ming Hsieh:]

That should be some contract award later on this year.

[Jeremy Grant:]

Okay. And the other question I had was I guess just to dig a little deeper into US visit in terms of where they are focused right now. Obviously, we’ve seen the visible part of it, which is the deployment of the cross-match readers for the tenprint at all the entry points. What pace are they moving on in terms of getting more matters in for tenprint? And I guess another question is, how much of this – what percentage of this would you say gets wrapped up by the end of ’08 and how much carries forward into 2009?

[Jim Jasinski:]

They have done an upgrade, a technology upgrade for the current systems, the twoprint systems and also the ability to continue to grow the tenprint. As you know, they are going through an evaluation and we are participating in that evaluation. We still believe that we are offering the most cost-effective and best performing solution, and we are confident going forward after that.

[Jeremy Grant:]

Okay. Good. And the only other question I had was actually related to acquisition. Wondering if you could comment a bit about what kind of interest you are seeing from the Defense Department outside of the handheld world for biometrics in developing applications for the common access card, smart card that DoD uses?

[Ming Hsieh:]

Well, we are working with our SSD group and submit the proposals. We are working on the various opportunities in the identity management services. As you’ve probably seen, we are still forecasting our gross margins should be about 60% range for the remaining of the year. So we are absorbing other service group into our system integration group.

[Jeremy Grant:]

Okay. I believe that’s what all I had. Thanks guys.

[Paul Kim:]

All right. Thank you.

[Operator:]

(Operator instructions) And there are no further questions at this time. Mr. Hsieh, please continue for any closing comments.

[Ming Hsieh:]

Again thank you very much for being on the call today and I really appreciate your support. We look forward to update you on our progress in the coming months. Thank you.

[Operator:]

Thank you, ladies and gentlemen, this does conclude the Cogent Systems second quarter earnings conference call. You may now disconnect. Thank you for using AT&T conferencing. Have a very pleasant rest of your day.