Fluent, Inc.
Q3 2008 Earnings Call Transcript

Published: 24 Nov 2008

[Operator:]

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Cogent Systems third quarter Earnings 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). This conference call is being recorded Wednesday, November 5, 2008. I would now like to turn the conference over to Jill Isenstadt of The Blueshirt Group. Please go ahead, ma'am.

[Jill Isenstadt:]

Good afternoon, and thank you for joining us on today's conference call to discuss Cogent's third 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 today, Cogent issued a press release discussing the results for its third quarter ended on September 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 direct comparable GAAP financial measures, and information in 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 conditions, 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 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 31, 2007. The company does not intend and assumes no obligation to update any forward-looking statements. With that said, I would 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. At the beginning of this year, we set three main goals for the company. Deliver more consistent results, solidify our customer base and diversify our revenue. I am pleased to report that we are making strong progress in achieving all these goals. As we've projected, we experienced a strong uptick in third quarter revenues and earning per share. Revenues grew by 35% sequentially and 6% year-over-year as we experienced strong demand from the Department of Homeland Security, Morocco and from a broader cross selection of other customers. This year has been notable from diversify our revenue stream outside of DHS with no other customer accounting for 10% of revenue to-date. Gross margin continued to be strong. Non-GAAP net income grew 180% year-over-year and we reported $0.14 non-GAAP earnings per share. While the microenvironment has created uncertainty in many companies, we believe our exposure to the current slowdown is minimum. Governments have counted for more than 95% of our revenue base. Also our traditional businesses strategy of generating cash from each contract and having tight control in operation expenses, continue to generate cash each period. We have no debt and we believe we'll soon to have $0.5 billion of cash on our balance sheet. We believe building and maintaining a strong cash balance puts us in inevitable position to potentially capitalize on the opportunities in the marketplace created by the current liquidity crunch and the tough economical environment. In the third quarter, we generated $34 million in cash from operations and ended the quarter with $456 million in cash and investments. This we will have to continue to execute extension plan, consider making target acquisitions and are making selective key hires. On this note, I am pleased to welcome a new member of team at Cogent. Mr. Tom Hopper has joined us as Chief Technology Officer. Mr. Hopper has 25 years of career at FBI. Twice being awarded the FBI Director Award for the Technology Achievement, and was instrumental for creating biometric technology and standards. He was the key person in charge evolving fingerprint compression technology and Universal Latent Workstation Software, which have been adopted worldwide for the criminal justice communities. Turning back to our results; we continue to receive solid orders from US-VISIT program and already building backlog for 2009. The proposed budget for this program appears to be solid for next year. We believe the President-elect Obama and the Democratic Senate and House has a strong support for the homeland security efforts and have consistently loaded for the budget of the US-VISIT program in the past. Overall, we are encouraged by our order flow from the prospects of the EHS and expect our momentum at this key customer will extend well into 2009. We are also encouraged by the continuous pace of new biometrics opportunities in both international and domestic market. We are very happy to report today a significant contract win with the US Census Bureau estimated at $10 million contract. We will be providing the Bureau with program management, system integration, software development, data collection, customization, and operation support all of them which will be used for processing request of criminal background checks on temporary employees, respondents, and career appointees. In anticipation of 2010, this annual census, the US Census Bureau expects to hire a huge temporary workforce where will be a need to do background checks running through the Federal Agencies. The award of this contract is another step towards diversifying our revenue stream and to further improve our visibility in 2009. We also expect half dozen of major programs to be awarded in the next six months, including major programs in Europe, Africa, Asia, South America, North America, and Department of Defense. We believe that defense industry worldwide has started to embrace the biometrics as sophisticated and a cost effective means of identifying both friendly forces and adversaries. As such, biometrics is starting to become a more important part of defense strategy especially considering the nature of the current worldwide conflicts. Currently, we are working with Department of Defense on various potential opportunities. As some of you know them you know that Fusion is a handheld market model device that is capable of capturing, storing tens of thousands records consist of forensic-quality fingerprint latent images, iris images, photos, geometrical locations and the text data for onboard watchlist searching, fully ruggedized and the weight is under 1.2 pound. The Fusion is designed for the field and fits a cargo of standard technical trousers. It is unique in the marketplace and the interest from the DoD and the Law Enforcement Committee has been high. In third quarter, we began shipping this device and have recently received material for another for 2009. We believe the handheld units are considerable source of expertise for Cogent and that we have a significant technology advantage in this market over our competitors. We continue look at to expand the audience of our lighter version of the handheld BlueCheck device, which were recently reordered by the Los Angeles County Law Enforcement Agency. We believe the Fusion have a broader application outside defense community. Overall, we expect the handheld units to be a meaningful contributor to the revenue in 2009. To wrap it up, we are pleased with the progress that we are making. We've had an uptick in the revenue and earning in the third quarter, have a strong confidence in our fourth quarter outlook and are now building deferred revenues and backlog for 2009. We expect to enter into 2009 with a strong backlog and we have are currently encouraged by the current orders pending from the DHS, which will receive the new orders, which we will recognize in 2009. We've trained number of the biometrics agent program to be awarded over the next six months, and we believe we are expanding it on top of the [dated] basis to our handheld mobile business and our SSD division. In this difficult economic environment, these factors and our customer base of domestic and foreign government and [organizations] give us a strong confidence that we can continue to grow in the coming years. I am now going to ask to Paul to go over Q3 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're discussing all numbers on a pro forma or non-GAAP basis. Third quarter GAAP results included 903,000 in non-cash charges related to FAS 123R regarding the expensing of stock-based compensation. Third quarter revenues were $35 million, product revenue grew by 42% from the second quarter, while maintenance and service revenues increased sequentially by 20% due in part to the incorporation of SSD as well as maintenance revenues starting from the Morocco contract. Revenue contribution during the quarter came from customers such as the DHS, Morocco, Rwanda, Pennsylvania, Stanislaus County, Veterans of America, the State of Chihuahua and RCMP. Gross margins were at 71% in Q3 up from 65% last quarter. Looking ahead we expect gross margins to be higher than previously forecasted. We now believe gross margins to be between 65% to 70% for all of 2008, which is three points higher than the range previously stated on our last earnings call. Operating expenses as a percentage of revenue were at 26% this quarter. In actual dollars, operating expenses increased to $9.2 million from $8.4 million in the second quarter on higher revenues. Excluding stock based compensation and settlement income, we now project that 2008 operating expenses will be slightly higher than previously forecasted at approximately $35 million. Operating margins, excluding stock based compensation of 643,000 were at 45% in this third quarter. We recorded $4 million in interest income this quarter. Additionally, we received $1 million in settlement income from Holland related to our protest of a contract award. Our track record is clear that we can turn these protests into net income and cash flow for the company. We believe, we have the best technology in the marketplace and will continue to contest unfair competition for awards. This gain was partially offset by currency losses in the period. Our tax rate was 37% during the third quarter. We anticipate the tax rate to be approximately 38% for fully year 2008. Excluding stock based compensation, fully diluted non-GAAP earnings were $12.6 million or $0.14 per share on a 90.4 million share count. Cash and investments increased by $26 million from the second quarter to approximately $456 million or $5.5 per share as of September 30, 2008. During the quarter, we generated $34 million in cash from operation. Accounts receivable increased to $41.6 million in Q3 from $36.9 million in Q2. Inventories were at $22.9 million at the end of Q3, compared to $16.1 million at the end of Q2 increasing with our sales growth. Fixed assets were at $36.5 million. Deferred tax assets were at $36.6 million. The balance is 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 at $31.7 million in Q3 compared to $14.7 million in Q2. Deferred revenues were up $23.8 million to $72.7 million compared to $48.9 million last quarter. The increase is related to various ongoing projects and reflects the growth of our backlog on some key projects. Deferred revenues have increased 93% in the last six months for the company. Our headcount increased to 348 in the third quarter from 332 in the second quarter. Now, let me move on to our outlook for the year. Based on our backlog entering the quarter and strong orders from existing customers we are reiterating our full year guidance of a $125 million. Based on our higher expectations of growth and operating margin, we now forecast our non-GAAP EPS at $0.50 to $0.55 or $0.43 to $0.48 per share if you exclude the settlement income recorded in the first quarter. Given our current backlog for orders, we currently believe that the risk remaining in the year relates primarily to revenue recognition issues should they arise. In summary, we're pleased with our strong third quarter results as revenues continue to ramp over the second half of the year as planned. Our orders and backlog to-date gives us good visibility as we head into Q4 as well as 2009. And we're confident that we can achieve our financial targets for the year. Our business is getting stronger even in the current economy as we continue to generate cash, drive revenues from an increasingly diverse customer base and build our backlog for 2009 and beyond. On this note, we're pleased announced a new contract with the US Census Bureau that Ming highlighted, which should add close to $10 million to our 2009 pipeline. Additionally we have just started to ship our Fusion product line, had our first full quarter of SSD in Q3 and do not express to recognize any revenues in 2008 from our Northrop Grumman partnership. All of these factors should be growth drivers in 2009. Additionally we believe the demand for biometric solutions continue to grow and that we're well positioned to take advantage of the many opportunities ahead of us. We're now happy to answer any questions that you may have. Operator, you can now open it up for questions.

[Operator:]

Thank you, sir. (Operator Instructions) And our first question comes from the line of Brian Ruttenbur with Morgan Keegan. Please go ahead.

[Brian Ruttenbur:]

Thank you. In the fourth quarter do you anticipate generating similar levels of cash that you did in the third quarter, first of all?

[Paul Kim:]

Brian, we believe that it's certainly possible. We had very strong cash generation in the third quarter, but if you take a look at the accounts receivable at the end of Q3, its at $41.6 million. We believe a big chunk of that could be collected in Q4. Not to mention, invoices that we have issued for projects that we had occurring during the month of October.

[Brian Ruttenbur:]

Okay. Now, according to your guidance, fourth quarter should be stronger than third quarter is that correct?

[Paul Kim:]

Fourth quarter should be roughly equivalent. I mean, we have a range there.

[Brian Ruttenbur:]

Right.

[Paul Kim:]

I mean, there is certainly a possibility that it could be stronger than the third quarter, yes.

[Brian Ruttenbur:]

Okay. And I was just trying to figure out is this a backend weighted quarter or are they equal weighted throughout. If its equal weighted or should dollar be committed now, then your cash generation should be equivalent or better than last quarter. Is that right to think that way?

[Paul Kim:]

Yeah. I think, directionally it's correct, but please keep in mind as you already know that we have a number of very significant customers. And based on exactly when the payment is due and more importantly when they actually pay us it can really swing the cash-flow amount during the course of the quarter. Don't get us wrong. We anticipate a very good cash collection during the fourth quarter and we anticipate the fourth quarter to be possibly stronger than the third quarter in many aspects. So we're very optimistic, but at this point in time, if you have one particular customer, that issues us payment and says December and January it can impact the cash forecast.

[Brian Ruttenbur:]

Okay. And then the $10 million contract that you got from US Census, that doesn't start until the or the majority of that's going to get booked in 2009, correct?

[Ming Hsieh:]

Majority of those revenue will be in 2009. Yes. You are correct.

[Brian Ruttenbur:]

Okay. And the forecast for 2009, I know that you haven't come up with anything yet, but you should be getting certain payments. You don't anticipate. Let me just rephrase it. You don't anticipate 2009 being down from 2008. Do you expect it to be up?

[Paul Kim:]

Well, we do not give 2009 guidance until we close out 2008. I believe we stated previously that our intention has been to grow faster than our addressable market. We believe we certainly achieve that. Having said all of that, if you take a look at the levels of business right now and I will just use a couple parameters. Deferred revenues are near record levels. So, that is all future revenue. Now some of it is long-term, but a huge chunk of that is short-term. If you take a look at the number of contracts that are going to flow into the 2009 pipeline and revenues, we know that we are going to have a very strong showing from the Department of Homeland Security. We have announced a contract such as Egypt, which will likely be revenues in 2009. We also have contract such as Hong Kong. We anticipate additional business from LA County. We have one contract in Maryland. We know that there is going to be material revenues, both in the product as well as the service and the maintenance side for Morocco. We have our partnership with Northrop Grumman, which is going very well. We have other jobs such as Santa Cruz, Spain, Texas, New York, not to mention the background check programs in Georgia, Pennsylvania, Florida, and Tennessee. In addition to some credentialing work that we picked up from the DoD, as well as from the State of Alabama. And the handheld business that Ming talked about in his script. So we like the outlook that we're seeing for 2009.

[Brian Ruttenbur:]

Okay and is the FBI and UK business go on track for '09 awards?

[Ming Hsieh:]

It is correct those UK and there is various opportunities in UK for the post office, as well as they call the National Identity Scheme. So those programs still is on track.

[Brian Ruttenbur:]

Right. And there is, and no delay on the FBI?

[Ming Hsieh:]

I do not, Jim you probably could answer.

[Jim Jasinski:]

Essentially the award was always intended to be in the first quarter, towards the end of the first quarter of 2009 and that still remains to be the target.

[Brian Ruttenbur:]

Right. Thank you very much.

[Operator:]

Thank you, our next question comes from the line of Nick Andrewes with Lazard. Please go ahead.

[Nick Andrewes:]

Hey, guys good quarter. Can you guys just talk a little bit about the new contract, that you guys talked about what the Fusion the DoD and how we should think about the Fusion product and shipments of it going into 2009?

[Ming Hsieh:]

Actually we expect the Fusion devices are not only ordered from the DoD we also expect the Fusion device to be ordered from the other federal agencies. So the revenue will flow in 2009.

[Nick Andrewes:]

If you can give us little more details about what other agencies outside of the DoD you guys expect to, that you guys are currently speaking with regarding the device?

[Ming Hsieh:]

Device we have our state local government and we also have other federal agencies.

[Nick Andrewes:]

Okay, and you said that should be a significant contributor to revenues. Should we interpret that to be a 10% revenue contributor in 2009?

[Ming Hsieh:]

We're still feeling that's backlog till now and at the present time and we believe this is the current order we have is in a multi-million dollars range has not gotten into the seven digits yet.

[Nick Andrewes:]

Okay.

[Ming Hsieh:]

Haven't got into eight digits, we have multi-billion dollar order for the Fusion device at present time.

[Nick Andrewes:]

Okay. So you said multi-million dollars right, right now for Fusion and you expect to have maybe some eight digit orders in the future?

[Ming Hsieh:]

That's kind of common digit whether they include decimal or not. Whether we expect more other will come in and remember we have just introduced a device about a month ago.

[Nick Andrewes:]

Okay, great. Paul, could you talk a little bit about the, it looks like R&D ticked up in the quarter sequentially and then G&A costs came down significantly in the quarter. Can you talk a little bit about what is supposed to be going on there?

[Ming Hsieh:]

We continue to develop new products. We are building the wares of the handled products, we are building our own LiveScan product lines, as well as the whether new match or technology.

[Paul Kim:]

As far as the fluctuations and the G&A in Q1 and Q2 that is largely related to our yearend and our 10-K and our annual filings, and their costs largely related to the auditors that we soak up in the first couple of quarters. So that kind of went away in the third quarter.

[Nick Andrewes:]

Okay. So we should expect, the sort of the operating expense we should think about when we start modeling out for the rest of the year and going forward into 2009?

[Paul Kim:]

Yes. I mean we will have additional expenses in the first two quarters as we have our annual audits done, but it should normalize in Q3 and Q4. That's the same as we keep the headcount the same.

[Nick Andrewes:]

Okay, great. And just on the DoD, the BOSS programs can you give us some updates in there?

[Ming Hsieh:]

We have (inaudible) the program for both as a prime for the BOSS-U and as a subcontractor for the BOSS-R. So that contract could be awarded this year.

[Nick Andrewes:]

Okay. They are still on track sir, so the end of November timeframe possibly?

[Ming Hsieh:]

Yes.

[Nick Andrewes:]

Okay, great. Thanks guys.

[Ming Hsieh:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Paul Coster with JPMorgan. Please go ahead.

[Unidentified Analyst:]

Yes, hi. It's actually [Martin Strauss], on behalf of Paul. Thanks for taking our questions. Most of our questions have been answered, but can you just give us you know, what you guys are thinking how the competitive landscape is expected to change given the recent combination between two of your competitors?

[Ming Hsieh:]

I think, definitely we are looking up as for this is upcoming years. Definitely now we have little less people to deal with now, less competitor there we believe the weaker companies that continue to be consolidated with the technology [coding] we have, and with the cash position we have, and with the customer base we have, with the market position we continue penetrates to our competitors territory. We are very optimistic with Cogent's position, and we are looking to continue to expand our business.

[Unidentified Analyst:]

Okay. That's all we have. Thank you.

[Ming Hsieh:]

Thank you.

[Operator:]

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

[Jeremy Grant:]

Hey thanks guys, and congrats on a solid quarter. Wanted to dig in a little bit to the deferred revenue number, obviously this is really sky rocketing quiet a bit. I think last quarter when you mentioned it, it was going up, you said none of it was coming from DHS, it was all coming from other projects. Is that still the case here or is there any DHS revenue contributing this quarter?

[Paul Kim:]

Yes, Jeremy, this is Paul. So, this quarter we do have a portion of deferred revenues that's being driven up by DHS. We also have a number of other contracts. About $20 million of the $72 million of deferred revenue is for various smaller contracts. Many which you probably haven't heard off, in addition to our unrecognized portion are growing maintenance base. If you take a look at our maintenance and service revenues for this quarter, you can see that that's been trending up nicely as well. I think that this is the first time in the company's history when our maintenance and service revenue were at a levels that we just posted.

[Jeremy Grant:]

Okay, and so, should we assume that some of those number sort of continue forward and continue to build as you get product base out there?

[Paul Kim:]

Yes, absolutely.

[Jeremy Grant:]

Okay, and can you give a little color about DHS. I mean, I would ask you for a percentage and sometimes you tell me and sometimes I got to wait till the Q comes out. One, can you talk about that and two, can you sort of talk abut the pace you are seeing now. The information we are getting around Washington is, with the end of the administration coming up, big pushes in DHS to get certain millstones met in the VISIT program. And sort of, I wonder if you talk about the pace of spending in the second half and whether you are seeing that uptick from the first, as well as sort of how the '09 picture looks around that. But that's a lot of course, to throw out at you but I will leave it to you there?

[Paul Kim:]

Jim, do you want to take that one.

[Jim Jasinski:]

Sure, I think that we continue to see the numbers of users, the size of the database and number of transactions to continuously grow and the success of the system, the identifications that are being made and the response times are still unparalleled in the industry and DHS recognizes that, its very pleased with the performance of the system. We've the transition going from the 2 to 10 and that's will take place during 2009, which is part of what their goal was before the administration ended. So I don't think that there has been any issues or challenges that are indicating any threats to the progress of the system or as continued to growth the system.

[Jeremy Grant:]

Okay, and I guess if I can shift little bit to the FBI. There was a question asked about whether the time line is on track. We were hearing that the bake off that was supposed to start in early October was postponed at least temporarily. Is that still on hold?

[Jim Jasinski:]

No the bake off is, they are proceeding with the bake off.

[Jeremy Grant:]

Okay. I wonder if you could talk a little bit about the protest in Holland and you know really I guess I'm trying to get an idea how is that recognized in the quarter, is it considered product revenue, is it where is it showing up on the income statement?

[Paul Kim:]

I will answer that question and then I'll turn it over to Ming who can comment on that. So it's not showing up in the revenues, it's recorded in interest and other income.

[Jeremy Grant:]

Okay. So was it something that drove the gross margin at all this quarter?

[Paul Kim:]

No.

[Jeremy Grant:]

Because it's down there.

[Paul Kim:]

It's below operating income its where--

[Jeremy Grant:]

Right. Okay, now that makes sense.

[Ming Hsieh:]

Yeah, for (inaudible) Jeremy for where is the government procurement programs. We to are seeing, the cases, the competition is not fair. In those cases at Cogent it is definitely is going and try to filed the protest, so we're not going ahead to file the protest but could don't do find, find answer competition, when we filed a protest we get our money back.

[Jeremy Grant:]

Only this is I mean you had the (inaudible) with Northrop, you had the US Army a couple of years ago, you probably had a record of winning these things.

[Ming Hsieh:]

Well, definitely this another of our business, try to file the protest--

[Jeremy Grant:]

Sure.

[Ming Hsieh:]

(inaudible) We will spend to those procurements and showing our case and we do get the result from those protests and with a winning record.

[Jeremy Grant:]

Okay. So as I am just, back to Paul as I am looking on the income statement he said it was about a $1 million, other net line associated to 376,000. So that was taking out some foreign currency adjustments and things like that.

[Paul Kim:]

Yes.

[Jeremy Grant:]

Okay. And other question I had was on the census and first of all congratulations on that. I know there's been a couple of parts, one has been to build the infrastructure to fingerprint all these temporary employees. The second part has been the actual enrollment services. If I am understanding right you guys sort of got the first part, but they are still sorting how to do enrollment? Or is more to the setup that I am seeing?

[Ming Hsieh:]

I think you're correct. Jim could add little more for Jeremy.

[Jim Jasinski:]

Yes. We're primarily functioning in the backend process for the systems integration and support for the service that will provide the criminal check.

[Jeremy Grant:]

Okay. So this can be product sales or just really more services.

[Jim Jasinski:]

Its probably, it's a combination of both.

[Jeremy Grant:]

Okay. And census there has been a lot of talk about I mean the latest things constitutionally mandated to happen in 2010, but there's been a lot of obviously IT problems that have been in the news. And there's been some question on fingerprints. We need to fingerprint half million temporary employees. Are we actually going to have the time to do it? Can you talk a little bit how the contract set up, so, god forbid you are not able to actually go forward with actually taking prints from everybody. Are you still getting paid in this or is there something that could be susceptible on this occasion?

[Jim Jasinski:]

Because of both products and service we'll get paid for the complying with the terms and conditions of the contract. We are very confident so that we will be able to represent completely.

[Jeremy Grant:]

Okay. That's all very good. And I guess, any other question I had, Paul could you just give a little more color on the gross margins, obviously coming in really high this quarter, which is certainly nice to see. What is it that's driving the higher gross margins?

[Paul Kim:]

I think it's largely due to the introduction of enhanced technology across our product line. That in addition to getting efficiency with the larger workforce that we have deploying ourselves that the growing number of contracts.

[Jeremy Grant:]

Okay. And last question I had was just talking about the Fusion fixture. I know one of your competitors in this space just announced what was a pretty significant deal in a foreign market in the Middle East. Wanted to know if you guys are spending time trying to market this abroad as well, one of the key themes talking to DoD seems to be interest in having allies collect fingerprints as well on other biometrics and what is that opportunity as you see it?

[Ming Hsieh:]

Jim, could you answer first for the DoD and over the overseas markets.

[Jim Jasinski:]

Sure, the Fusion is a part of the overall system that we see DoD being able to deploy for biometrics fingerprints, facial, iris. The Fusion opportunity is significant within DoD itself. There are many commands, many organizations, but it goes beyond just simply DoD, it also goes to the civil agencies where we see a similar type of demand for that product. Which gives the ability to do the searching both locally and also through a network. So, you look at federal sector, you got DoD and the federal agencies, then you go on there and look at the state and local governments and which we have been talking to with the same product, because it is a ruggedized version that has certain advantages over other parts in the line and it all depends on how the customer is setting up his database. And then internationally of course we are looking at the same setup of customers, both civil and military customers, because while the technology has been developed here in the United States, its applications are fairly well worldwide.

[Jeremy Grant:]

Okay

[Ming Hsieh:]

Yeah, in general the response for our products both from the customers and in the visitors, in domestically and internationally was very, very positive. So, we are looking to build the programs, not only in the domestic, here for the DoD, but also international market.

[Jeremy Grant:]

Okay, that's all I have for now, thanks.

[Operator:]

Thank you. Your next question comes from the line of Brian Gesuale with Raymond James. Please go ahead.

[Brian Gesuale:]

Hey guys, great job on the quarter here. A lot of the questions have been asked and you guys answered them quite well. I just want to talk about the buyback, you guys are generating pretty gaudy levels of operating cash flow, looks like close to $55 million year-to-date, stocks have been depressed. You are sitting on a load of cash. Should we look for perhaps a more aggressive buyback to ensue once your window opens up again?

[Ming Hsieh:]

Well, we did, a process, a pretty aggressive buyback programs, but from my point of view there is no way of success to continue this buyback of the stock to get the stock price a little higher. Our strategy we have got to build a business, we believe that the only way to get the stock back on track is how do we grow our business, how do we continue to make the money and we're slightly [differ] the acquisition targets.

[Brian Gesuale:]

Okay, terrific and then you know Paul you kind of alluded to the fact that you are gaining visibility into the business is that maintenance line and service line kind of grows overtime and as your install base grows. At this mix of business shifts, should we look at that business being perhaps even more than 20%, 22% of revenue is this something that can be 25%, 30% of revenue overtime and really pad visibility for you as you put together your bottoms up forecast.

[Paul Kim:]

I think, percentage wise we like it at the low percent just because that probably means that we have a target of growing our product revenues. We certainly don't anticipate our product revenues to slowdown. We wanted to grow as fast as we can. But in absolute dollars, we believe that the maintenance and service revenues will continue to grow as we get beyond this year looking out into the future. This was the first quarter where maintenance and service revenues for quarter was above $10 million and we believe that it's likely that it will, continue to be at over $10 million and it will continue to grow. The other thing that you know we like about our business is the product lines, continue to diversify. Ming in his script talked about our handheld devices for both fusion as well as BlueCheck. As those devices get deployed as those units get out to the various people that are wanting them. We believe that will produce another line of product stream as well and the line up product stream for that as well as maintenance and services and other things that we're working on that we have ready to be deployed might not be as lumpy as how you have typically seen the AFIS contracts in the past.

[Brian Gesuale:]

That's very helpful. I think you guys have done a very nice job expanding the products and customer base and visibility seems to just be improving right along with that. That was all my questions. Thank you.

[Operator:]

Thank you. (Operator Instructions) Your next question comes from the line of Jeffrey Kessler with Imperial Capital. Please go ahead.

[Jeffrey Kessler:]

Thank you. Thank you very much for taking my question. With your increase in deferred revenue and your probably fairly good view of what of the margin in that deferred revenue is and with the increase in your product business relative to revenues overall. Could you talk a little bit about how product mix shift and the increase in deferred revenue what you've got back there, could impact your gross margin going forward positively or negatively. I know you don't make estimates, but if you could give us some guidance on the gross margin impacts of these two factors.

[Paul Kim:]

Jeff, when we went public over four years ago, right around four years ago, our gross margin target was at 55 to 60 points. We have consistently tried to strive to have our gross margins be 60 points or higher. This year is coming out much higher than that. Based on what we see in our deferred revenue the product mix, the introduction of new technology, as well as the product streams that we see going forward. We don't see any indication that will change our gross margin target or even the gross margin that we will end up achieving this year. We don't see any factors that will impact our gross margin going back below 60 points based on the business that we currently and based on the business that we currently see.

[Jeffrey Kessler:]

Okay. So even as your mix shift slowly turns towards maintenance and service, you are confident enough in the margins, that that's going to keep that margin mix shift will maintain itself where you're talking out as well?

[Paul Kim:]

Based on everything that we see absolutely, I mean, an example as the incorporation of SSD business. We bought that as you know over a quarter ago, this was the first quarter where we incorporated that business. And that business when we bought it was largely a service organization. Since buying that business we sized it up appropriately, we've merged a lot of the employees that we had from that business into our own in terms of introducing technologies and products that we had to offer to their customer base. And within a record amount of time, this is the first full quarter that we incorporated our business. Our gross margins are above 70 points. So we through the use of our technology through use of the efficiency and cost sizing, as well as other efficiencies that we have here at the company have shown that we can achieve superior gross margins even when we takeover businesses, when the products as our company might have not been able to achieve those gross margins. So we feel confident in our ability to achieve superior gross margin based on everything that we see.

[Jeffrey Kessler:]

Okay. Good stuff. Thank you very much.

[Operator:]

Thank you and management I showing that there are no further questions, we'll turn it back to you for closing comments.

[Ming Hsieh:]

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

[Operator:]

Thank you. Ladies and gentlemen that will conclude today's teleconference. We do thank you again for your participation. Now at this time, you may disconnect. Have a nice day.