ICx Technologies, Inc. Q1 2008 Earnings Call Transcript

Executives

Jessica Bartlow – Director of Investor Relations

Hans Kobler – President and Chief Executive Officer

Deborah Mosier - Chief Financial Officer

Analysts

Manav Patnaik - Lehman Brothers

Paul Coster – JP Morgan

Jeffrey T. Kessler – JPK Consultants

Brian Ruttenbur – Morgan Keegan

James Ricchiuti – Needham and Company

ICx Technologies, Inc. (ICXT) Q1 2008 Earnings Call May 13, 2008 4:30 PM ET

Operator

Welcome to the ICx Technologies first quarter earnings conference call. (Operator Instructions) It is now my pleasure to turn this over to your host, Jessica Bartlow.

Jessica Bartlow

The company’s Q1 2008 earnings release was issued today at the close of market and is posted on the company’s website at www.ixct.com. Representing the company today are Hans Kobler, President and Chief Executive Officer; Debbie Mosier, Chief Financial Officer; and Colin Cumming, CTO and President of Detection.

Before I turn the call over to Hans for his opening remarks, allow me to read the following Safe Harbor Statement. This conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by indicating the belief or expectations of management and include, but are not limited to, statements regarding the outlook for the company’s future business and financial performance.

Forward-looking statements are based on management’s current expectations and assumptions, which are subject to inherent uncertainties, risks, and changes and circumstances that are difficult to predict. Actual outcomes and results may differ materially due to various factors that are summarized more fully from time to time in the company’s filings with the SEC.

ICx disclaims any obligations to update or revise any of these forward-looking statements whether because of future events, new information, a change in its views or expectations, or otherwise.

The company will comment on adjusted EBITDA results and organic revenue growth, which have been included, together with a reconciliation of explanation compared to U.S. GAAP results in today’s press release.

I would also like to note that the company will present at the upcoming JP Morgan, Morgan Keegan, and Stephens investor conferences. Details can be found on our website.

At this time it is my pleasure to turn the call over to Hans Kobler.

Hans Kobler

Q1 was what I would call a typical and normal ICx quarter, although a lot better than what we thought only two weeks before quarter end. We grew more than 30% organically without any major big wins or special events. We expanded margins again and continued to invest heavily in innovations and building a strong platform.

Our revenues grew 34.5% to $36.3 million. That’s about $4 million above the high end of our guidance. Growth was strong across all three divisions. We believe we are on track with our strategy to leverage advanced technology to establish us as the sensing technology leader in the fast growing security market space.

The more we reach out and touch customers, the more we see the clear need for better, more advanced and network-centric sensors. This causes a big pull and resulted now, for the fifth quarter in a row, us growing more than 30% organically. We did this through a series of small, diversified sales to our blue-chip customer base and as I said before, without any major program wins or any special events.

With that growth and the confidence in it, we continue to invest heavily in product innovation and as a result have a fast-growing and expanding product portfolio at the beginning of its life cycle. We also continue building out and expanding our operating platform, which we outlined earlier.

For the quarter, let me flag a few operational highlights for you. Some of it has already been announced in press releases.

Detection landed a $17 million multi-year classified contract in IDIQ for advance chem-bio defense. For obvious reasons I cannot give you a lot of details here, but we already started our development efforts and expect to have great benefits from this in the future.

Also, our Bio Systems group won a $4.8 million development contract for next generation bio defense. Chem-bio remains a very important investment focus for us as this area continues to be a major threat and lacks good solutions. Getting government funding here is obviously critical for us to keep innovation going.

Our Radiation group received orders for $4.4 million from our OEM partner, Thermo- Fisher, for our spectroscopic hand-held radiation detectors. And that was followed by a record booking month in March, which gives us a lot of confidence in the radiation segment.

Our newly formed Transportation team is now providing intelligent transportation systems in New York, California, Hawaii, and we are about to sign a fairly large deal with Orange County. We are very bullish on intelligent transportation systems. Not only can we leverage much of the know-how into security and emergency management, but the ICx market in itself is huge and has very attractive margins.

Our Imaging group continues its roll. They’ve sold thousands of cameras into the market and they also just introduced the first continuous zoom lens camera which is focused on the Homeland Security market. There is a lot of activity here and we are also starting to see and chase some of the larger programs as well.

Lastly, our Radar group has been selected by General Dynamics to provide advanced radars for small robots. They join our Fido Explosive-Sniffing in this emerging growth market. We believe the markets for robots in land, air, and sea has huge growth potential and we are very well positioned to become a major player here. On robots people generally want more sensitive, more accurate, faster, lighter sensors that need to work well together. And that’s pretty much the mission statement for ICx.

Now these are all important tactical wins for us, but considering the opportunity to build the sensing unit space, it is important to keep the bigger picture in mind. In that regard we are quite encouraged by some of the strategic trends that give us confidence that we are on the right track.

First is that we see continuous increases in the average deal size from our current diversified customer base. Historically we have grown 30% plus, fueled by a lot of little sales to a diversified customer base. We now see that the average deal size, with that same customer base, is coming up. And we believe that will help us a lot to maintain our high organic growth over the next few years. In addition, we have room to grow for upside once we start winning some of the larger programs which we are also chasing.

Second, the build-out of our value-added reseller channel that we embarked on earlier in the year is proceeding very well. I mentioned last time that we are adding this additional channel because we firmly believe it will expand our reach much more efficiently. During this build-out we obviously have to incur some set-up costs, which explains why our current sales and marketing expenses are unusually high, but this should burden us only for a couple of more quarters and then come down as we gain efficiencies.

Thirdly is, we submitted our first proposals for a few large multi-year programs. And ICx has never won a big program. We were chasing the smaller deals. Winning some of those larger one will provide a lot more stability and predictability to our business. We see a lot of activity here and believe we are very well positioned to earn some of those rewards later in the year.

Fourth is our R&D area. Our heavy R&D investments are on track and we see that our innovation focus is paying off. A couple of examples:

First, Stride, it’s our stationary spectroscopic radiation detector. We basically took the identifying technology, put in an extension, and have now received the first commercial order. This is a device that can be very easily added to existing security installations and provides an instant and accurate radiation screening in critical facilities such as airports, without adding much manpower. And that’s a key issue for the GSA today. We are in testing here and we are very bullish about the prospects.

The second example is our Griffin 600. After several years of development, this portable mass spectroscopy analyzer is now in prototype testing with several customers. The current IMS market is in the hundreds of millions of dollars and mass spectroscopy is called the gold standard of detection for a reason. The standard well in labs. Now, we’ve demonstrated we can shrink that equipment down to a desktop and again, are bringing laboratory detection quality to the field. That’s a huge opportunity for us that we will start exploiting later in the year.

Third example is a TSA. They are actively using our PaxPoint now in several of the airports. As we said earlier, we can detect and screen dangerous liquids without opening a bottle and our sensitivity is magnitudes better than anything else in the market. We remain optimistic that there is a lot more to come, both in the United States as well as international for this very important product.

Fourth example of our R&D investment is Fido FastGate. It’s a product that we introduced at one of the shows a couple of months ago. It’s the Fido technology in a ticket screener. It’s in successful beta testing in the Statue of Liberty. You go to the second level, you put your ticket in, and it will be tested for explosive residue. You could do the same testing with a driver’s license, a metro card, or a boarding pass, again, lots of opportunities to come.

We take the feedback we get on those heavy investments as very encouraging signals that our focus on innovation and technology leadership is right and our heavy investments will have huge payoffs in the future.

Next to the internal innovation focus we also are in the final stages of discussions to add a few more promising technologies through acquisitions. These are technologies that compliment us well, where a lot of time and effort has gone into the development, so it makes a lot more sense for us to buy rather than build internally.

I am stressing those trends because much more than the tactical wins of today’s numbers; they make us bullish that we’re on the right track to become the sensor platform of [inaudible] security. We believe our innovation will continue to drive 30%+ organic growth. With that and some small acquisitions we expect to ultimately carry us to very attractive profitability with EBITDA margins probably in the mid-20s. We are on track for the year and more importantly on track for our long-term game plan.

At this point I would like to turn the call over to Debbie for some additional comments.

Deborah Mosier

For the first quarter of 2008 we reported revenue of $36.3 million, an increase of 34.5% compared to $27 million in the same period in 2007. Top line came in roughly $4 million higher than the high end of guidance, primarily due to earlier than anticipated revenue recognition of certain detection product orders and a significant research and development award that we were not expecting until Q2.

This growth is pretty much all organic aside from a small acquisition. Organic growth for the quarter is 34%, marking the fifth consecutive quarter of 30% plus organic growth.

Revenue growth was strong within each of our three divisions. In Detection revenue increased 29.5% year-over-year to $19.6 million, driven primarily by continued strong showing in our explosive and radiation detectors. Surveillance was up 42.6% year-over-year to $10.8 million with particular strength coming from the delivery of prototype integrative surveillance platforms under a significant research and development contract.

And in Solutions revenue increased 37.7% year-over-year to $5.8 million with increased product deliveries due to the reemergence of the ICx-3 program and growth in our intelligent transportation solutions business.

Company-wide our gross margins came in at 43.8%, up from 43% in the first quarter of 2007. Within Detection gross margins came in at 49.1% due to high product revenue. Surveillance gross margins for the quarter were 36.4%, somewhat lower as a result of a higher portion of revenue from research and development contracts and delays in certain product sales into Q2. Finally our gross margins within Solutions were 39.7%.

Total operating expenses for the first quarter were $27.4 million compared to $21.7 million in the same period in 2007 and down 3.1% from $28.3 million in the fourth quarter of 2007. The breakdown of the components of total operating expenses were as follows: G&A expenses were $9.6 million, or 26.6% of revenue, compared to $9 million, or 33.3% of revenue, in the same period last year, and $11.7 million, or 28.2% of revenue, in Q4 2007.

We continue to focus on controlling G&A and are proud of the results we have shown to date, particularly considering that Q1 2008 included significant public company costs and ongoing costs associated with our company-wide enterprise software implementation. We believe that once the new system is in place we will be able to effectively control our costs.

So, the marketing expenses during the quarter were $7.8 million, or 21.6% of revenue, compared to $4.7 million, or 17.5% of revenue, in the same period a year ago, and $7.1 million, or 17% of revenue, in Q4 2007.

Research and development expenses during the quarter were $6.7 million, or 18.4% of revenue, compared to $4.6 million, or 17.1%, in the same period in 2007, and $5.9 million, or 14.3% of revenue, in Q4 2007.

As Hans noted earlier, ICx is committed to making prudent, deliberate, and strategic investments in our sales and marketing and research and development programs. We believe that this is a good use of capital and will further solidify our position within the market, help foster product innovation, and enable us to better compete for increasingly large opportunities.

Adjusted EBITDA for the quarter was a loss at $6.7 million compared to an adjusted EBITDA loss of $5.8 million in the prior year quarter. For the quarter our net loss was $12.1 million compared to a net loss of $9.5 million in the year ago period. The year-over-year increase in operating expenses and a $2.1 million gain on the sale of DiscOps in the prior year first quarter were the primary reasons for increased net loss.

Net loss per share was $0.36 compared to a net loss of $1.22 per share in the year-ago period. Weighted shares outstanding were 33.7 million at March 31, 2008, compared to 9.8 million at the end of March last year. As of March 31, 2008, we had cash and cash equivalents of $54 million and account receivables of $27.7 million and we remain virtually debt-free.

As of March 31, 2008, we had total funded backlog of approximately $46 million and unfunded backlog of approximately $215 million. I should note that much of our business is indirect and is often booked and shipped in the same quarter, never showing in our reported backlog. At the end of March our days sales outstanding were approximately 70 days, in line with our expectations.

Turning to guidance, I am reaffirming the guidance we provided during our Q4 2007 conference call. For the year we expect revenues of $177 million to $184 million and an adjusted EBITDA loss of $2 million to $7 million.

I would also like to elaborate on a point made earlier and that is to reiterate that because we recorded almost $4 million of additional revenue during the last two weeks of March, we expect a commensurate decrease in Q2 revenue, to reflect the timing of business that shifted to the first quarter. Additionally, we accelerated some of our internal research and development into the first half and expect this number to come down in the second half.

That said we still expect to arrive at the same price for the first half of the year according to our six-month plan. Finally, because our business is highly cyclical and heavily weighted toward the second half of the year, we expect strong increases to the top line in both Q3 and Q4.

With those comments complete, I would like to turn it over for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Manav Patnaik - Lehman Brothers.

Manav Patnaik - Lehman Brothers

Can you give us a little more color on your surveillance units and when you expect to see on the product side the top line start ramping up and seeing some more announcements from there?

Hans Kobler

In Surveillance we are chasing some larger opportunities and I think what we are learning is it takes a little bit longer to win the larger ones. We’re doing pretty well on imaging, as I mentioned earlier. There could be something coming here and we are very bullish about our platform business in the second half of the year, or even earlier. So I think platform will accelerate quite a bit very quickly.

Manav Patnaik - Lehman Brothers

On the Solution side the intelligence transportation systems, and what else is in the pipeline out there that we should be looking out for?

Hans Kobler

I think Debbie mentioned earlier that in Solutions with our control business, three contracts that completely fell got pushed out in 2007. We see that coming back. There’s some revenues coming here. And Olympics is taking off nicely. And the rest is really some of the larger programs that we mentioned will happen in that area. You should expect some announcements here in the next quarter or two.

Manav Patnaik - Lehman Brothers

In terms of the share repurchase that you announced prior, can you give us a quick update on that?

Hans Kobler

We haven’t executed on it yet because my lawyers held me back. They said we want to watch the window and we still are intent on doing that, we sit on $40 million plus of capital which nobody gives us credit for at this point. And we still think our stock is a lot cheaper than a lot of the acquisition targets that we see, so we’ll buy some. As soon as we are allowed to, which is probably in a couple of days.

Operator

Your next question comes from Paul Coster - JP Morgan.

Paul Coster – JP Morgan

You’re pursuing for larger scale programs with responding to some RFPs. As you do that will you be going after them as prime or sub and what does it do to your business model?

Hans Kobler

Yes, yes, and we shall see. For the most part, we try to be the technology provider for the crimes. We would like to be the Intel chip for them building the computer and that’s the core of our business model. Now, there are a couple of exceptions in areas where we believe we have such unique expertise that we are better served being the prime that we might run at those directly.

We have done so in this quarter, I don’t want to reveal at this point what it was but it’s usually in areas where we have a huge technology lead. So more likely so in the CBR and chem-bio space as well as in the platform space, in those areas we might prime, and obviously we have to manage for that cooperation very carefully.

But generally we prefer to be the sub and focus on what we are good at, which is building the best sensors and making them work together.

Paul Coster – JP Morgan

When you get off to the prime business presumably it will be there will be some tradeoffs in terms of gross and operating margin but aggregate, bottom line is positive.

Hans Kobler

Our IM sensor business is north of 50% and if you are the prime and you outsource some of that and you have subs, you don’t get that margin on that, obviously.

Paul Coster – JP Morgan

The intelligent transportation systems opportunities that are opening up, that’s new to me, and new to many people I think. Can you give us some sense of who’s funding it and what the objectives are and what kinds of technologies are being deployed there?

Hans Kobler

It’s not really new. We didn’t talk that much about it because we didn’t win anything meaningful. Now we started winning meaningful contracts so we talk more about it. It’s basically management of transportation networks. We got into the business through our video management group that started running video cameras for San Francisco, etc. and then used the same software platform to leverage it into security.

They also had the expertise to be the prime on complete contracts. That could be from running traffic signals in the Diamondback Stadium in Arizona to running lights or guiding buses quickly through the city. At the end of the day, the soft ware is the same, not much difference if you tell a traffic light what to do or if you read a remote radiation detector. And it’s also project management.

We always liked the transportation business because it’s a natural add-on to security. If you think about what happened in Katrina, one of the key issues there was to get the people out of the city. A very logical thing would be ultimately, in our vision, that at some point transportation, county sheriffs, police, emergency management, they operate on the same system.

Paul Coster – JP Morgan

And its state funded?

Hans Kobler

State funded and in this case locally funded. Hawaii is state funded. The deal we have here in Orange County, it could be city funded.

Paul Coster – JP Morgan

The infrared camera activity, you said that it’s picking up. What is the nature of that activity?

Hans Kobler

Again, two-fold, we have good traction in what we historically have done to grow the business, which is the many middle sale with many partners. Broad channel will help a lot for the imaging business in the commercial markets.

But we also have been focused for quite a while on some larger programs and we think we’re going to have some good news at some point this year that we will be part of some programs.

Operator

Your next question comes from Jeff Kessler - JPK Consultants.

Jeffrey T. Kessler – JPK Consultants

I’m interested in your expansion of your robot facilitation activity. Clearly you’ve been working with one partner but now it seems you’re working with another one, or perhaps even more. I’m wondering if you could just elaborate a little more on what you’re doing in the entire field of say, enabling companies that manufacture robots.

Hans Kobler

We worked with Fido with many different robotic platforms. Not only iRobot, we worked with Foster-Miller and many others. We want to be the central provider of choice for robots. And what I like about the Radar deal is the number of sensors you add to that. And it’s just really on track for where they have to go because for them it’s all about payload. And you bring the payload down by building the smallest, lightest, and most efficient sensors, and you bring it further down if you build several of those and have common parts.

Now we’re doing common parts already, we’re starting to do that in radars and cameras. We built the smallest radars for [inaudible] marine so it’s really nicely aligned with what we do. And it’s just the beginning, I should say.

Paul Coster – JP Morgan

Can you set yourself up as a standard provider of sensors for robots, in other words having them manufacture to a standard that you’re going to build to?

Hans Kobler

I don’t think you need a lot of standards. Right now I think our robots you can plug in an Ethernet cable and that could be it. But what we like to do is build the worlds’ best sensors and make them really tight and light and then you can put those on whatever you want to put them on. That could be a little helicopter, a UAV, or it could be any platform that the [inaudible] purchases.

Paul Coster – JP Morgan

At the recent ISC show the sales force, at least your sales force, was absolutely gushing over, you made a quick mention of FastGate ticket screener that’s in use at the Statue of Liberty. Obviously they wouldn’t be gushing if it was just related to the Statue of Liberty, which is a one-off. Can you talk about the types of applications that you’re marketing this to or that you may even have contracts for? If you could just give us some idea of what’s going on there.

Hans Kobler

Sales people always have a propensity to gushing. We are prototyping it right now. We did thousands and thousands of tests. On Fido it has proved highly accurate. We captured three people that walked through that that had explosive residue on it and it was a justified catch; expect they were police people that handled explosives. We know the technology works. We’re very bullish about it.

We are now looking for the right market for that. That could be a critical infrastructure, high-risk facilities. When you come to visit us in our office, we will screen your driver’s license. So we believe there is a good market for that and in the first blush the sales people said that, we haven’t sold anything commercial yet.

Paul Coster – JP Morgan

But there are obviously companies in the identification area that you could team with on this?

Hans Kobler

Yes, that’s the logical thing. In fact, we have people here today.

Paul Coster – JP Morgan

You’ve been mentioning a radar technology for ports and underwater use and I’m wondering if you’ve also considered combining this with some of the new sonar technologies that are out there.

Hans Kobler

I’m not sure I mentioned an underwater radar today.

Paul Coster – JP Morgan

Port use.

Hans Kobler

I think what I was bragging about was that our radar is very good for over-water use, which is a key challenge for the ports. It’s a key challenge for the Statue of Liberty where you have the waves, which causes a lot of false alarms and we have demonstrated and have worked on that for quite a while, which is interesting for the ports. Now, we are working on a few applications as well that are more focused on the DMV market.

Operator

Your next question comes from Brian Ruttenbur - Morgan Keegan.