L-1 Identity Solutions Inc. Q2 2008 Earnings Call Transcript

L-1 Identity Solutions Inc. (ID)

Q2 2008 Earnings Call

July 30, 2008 11:00 am ET

Executives

Lisa Cradit - IR

Bob LaPenta - Chairman, President and CEO

Jim DePalma - EVP, CFO and Treasurer

Presentation

Operator

Good morning. My name is Crystal and I will be your conference operator today. At this time I would like to welcome everyone to the L-1 Identity Solutions Second Quarter 2008 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions)

Thank you. It is now my pleasure to turn the floor over to your host, Lisa Cradit. Ma'am, you may begin your conference.

Lisa Cradit

Good afternoon, and thank you for joining us in L-1 Identity Solutions' 2008 Second Quarter and First Six Months Financial Results conference call.

Statements that representatives of L-1 Identity Solutions make during the call that are not historical facts are forward-looking statements made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on management's current beliefs and assumptions, and involve inherent risks and uncertainties.

Any statements made today about future expectations or results are necessarily only estimates. Actual results could differ materially from any forward-looking expectation. Factors that may cause differences between forward-looking expectation and future actual results are fully described in the company's SEC filing. The company expressly disclaims any obligation to revise or update any forward-looking statement. Representatives of L-1 plan to use a number of defined financial terms during this afternoon's call, such as adjusted EBITDA, organic growth, and unlevered cash, free cash flow. Please refer to the company's earnings press release issued this morning for further definition and context on the use of these terms.

With that, I will now turn the call over to Bob LaPenta. Bob?

Bob LaPenta

Thank you, Lisa. Good morning everyone and thanks for participating in our second quarter calendar '08 conference call. I am assuming everybody read our press release today, with a lot of numbers. I am not going to spend any time on the numbers. Jim DePalma will take you through the numbers and provide color on some of the items behind the numbers.

I think overall, it was a very good quarter for us. All of our divisions are performing extremely well, and I am especially pleased with the fact that they are now beginning to work together and we are bidding a lot of our opportunities as L-1 as a joint entity. Bidding activity is robust and we are seeing large national ID, new passport, border security opportunities in Latin America, in the Middle East, Africa and India, and I will give you a little bit more color on that in a few minutes.

We spent a great deal of time, as I am sure everybody knows, on the Digimarc transaction during the quarter. And I am pleased to announce that today, we are still on track of completing that transaction, hopefully in the beginning of August.

You have all read that we changed our offer from a 50% cash, and stock, offer to an L-1 cash offer. The valuation of our previous offer was about $263 million, and the value of our offer today is about $310 million. So, there was an increase of about $47 million. With that, we still believe that this is going to be an exceptional transaction for L-1, both from a strategic and financial standpoint. So, we are pleased with the way that's going right now. I really, I am not going to spend too much time talking about it. We have a couple of more days left on our tender.

Some of the highlights for the six months, we announced a couple of days ago, that the PassCard program that had an initial value at about $105 million, was increased to $215 million, and in addition to that, the PassCard was added on to that program. So, right now, it has a valuation of about $239 million over five years. We believe that as additional cards are added to that program, that's going to continue to increase, and it’s going to be a very, very valuable program for us going forward.

In enrolment services, our IBT division is doing extremely well. Their organic growth this year is going to be well an excess of 20%. We continue to open additional enrolment sites. Right now, we are approaching 600, and for the first half, as noted in our press release, we have enrolled over 647,000 people.

We are bidding on opportunities that will provide substantial upside and we believe that as more states continue to pass laws requiring involvements in schools and nursing homes, by the police departments, healthcare organizations, real estate, and insurance brokers this business is going to continue to grow at a very, very rapid pace.

The demand for HIIDE continues to increase. We announced during the quarter that we booked a $4.9 million order. This was part of a basic ordering agreement of approximately $24 million that includes 4100 in jump kits and Expansion Modules and these with 4.0. So, it basically eliminated the remaining inventory of our 4.0 that secure the metrics. In addition, we had a program that I was talking about earlier in the year for a Middle Eastern country and the budget has been approved for that program. We are now working with the customer to put together a program to deliver either 4.0 or 5.0 depending on the customers’ preference and we are hoping to be able to book that within the next three to four weeks. It's a substantial program for us and we are excited about it, because it will be our first booking for our customer outside of a US entity.

We announced during the quarter that we released our new TouchPrint Enhanced Definition 4800 Live Scan. This captures forensic-quality ten print palm images and the early reception in the market is very favorable and we expect this to be a nice revenue generator for ourselves, as we move forward. Also in the quarter, we announced a B5000, which is a document authentication, our next generation document authentication product. Again, here the reception has been very favorable. We are already booking and shipping quantities of these new devices and we think this going to have a substantial upside in programs like REAL ID.

In Bioscrypt, we have now had them for about four or five months and I am pleased to announce that they are doing extremely well. You may recall that when we acquired them, they were running at about an $18 million run rate. They were loosing $2 million to $3 million in EBITDA. Right now, they have 75 employees. They are well focused and they are growing, north of 20% to 25%.

So, we are very pleased with the way they are performing and we expect continued organic growth. We just released a new 3D Face Reader and we are going to be releasing our new PIV device within the next one or two months. So, things are going very well at Bioscrypt.

Secure Credentialing Division continues to perform and I would say outperform, they are doing exceedingly well. They had $16 million of extensions on existing driver's license contracts, and as you read- finally, the additional grants of $80 million for REAL ID were released. Our state received about $16 million to $18 million of those grants and Digimarc actually in their state received about $50 million to $57 million. We are now preparing proposal. We are responding to requests from our state, in providing solutions for enhanced security, enhanced card production, and we expect this to start generating revenue sometime in the fourth quarter.

Registered Traveler continues to be a program that is starting to build momentum for us. As you know, we are the system integrator on that program. We teamed with Lockheed, General Electric, and VIP. The enrollment of subscribers is starting to pick up, and as you know, we provide both the hardware, we provide the IP, and we get a per subscriber fees. So, as those subscribers increase, this generates additional revenue for us.

So, with the backdrop, I'd say that we are seeing increased activity both in the US and overseas. Our bidding activity is increasing dramatically. We are seeing US programs like HSPD-12 and REAL ID start to really gain momentum and as a result of the momentum we are seeing in the first half, we are issuing guidance in the third quarter of a $140 million to $150 million with EBITDA of about $20 million to $23 million. And we are reconfirming our guidance for the full year at about $555 million to $575 million, with free cash flow somewhere between $60 million to $65 million.

Jim will talk to you about the numbers and he will also give you some color on recent negotiations with the bank in putting together a new bank facility.

With that, I'll turn it over to Jim and then we'll open it up to questions.

Jim DePalma

Thank you, Bob. As Bob noted, the second quarter was an extremely successful quarter highlighted by strong organic growth across all of our segments, expanding operating cash margins and strong free cash flow, healthy bookings, and a growing backlog.

The press release provides a good summary regarding our operating results for the second quarter and six month period. And Bob has covered the key highlights of various targeted opportunities and overall business momentum, heading into the second half of the year. I will cover some of the key items related to our financial performance.

Reported results for the second quarter of 2008, as you know, include ACI, McClendon and the Bioscrypt acquisitions all three acquired subsequent to June, 30 2007. We continued our strong momentum this quarter, meeting the high end of our previously provided guidance on all key metrics.

Revenues of $145 million compared to $135 million to $145 million. EBITDA of $23 million compared to $20 million to $22 million and earnings per share of $0.04 in the middle of our $0.03 to $0.05 range.

On a reported basis, revenue was $145 million for the second quarter, compared to$90 million for the same quarter last year, or an increase of 61%. On a same store basis for the entities under L-1 management for both quarters, excluding ACI, Bioscrypt and McClendon, revenue grew approximately 27% from $90 million to $115 million. On a pro forma basis, revenues increased 22% from $119 million to $145 million, driven by strong demand in our federal and state credentialing and background screening services as well as our Intelligence Services businesses.

Our continued pace of organic growth represents a tangible reaffirmation of our strategic vision to bring together the leader in identity management combining end-to-end multi-modal offerings with high-end intelligent consulting and services.

Our Secure Credentialing business Visage increased by 62% to approximately $32 million due to continued demand by our federal customer to meet their growth requirements and the implementation of the PassCard program. Our long-term relationship in alignment with our federal customer and their key priorities remain very strong as highlighted by the expansion of the PassCard program, as noted by Bob for $107 million to $215 million and the addition of the Border Crossing Card program.

We expect this unit to continue strong growth for the second half, as we begin to deliver on to these key programs. The potential combination of our credentialing business with Digimarc will create a truly unique asset and a specialized identify management provider, which will provide significant backlog, revenues and cash flow, enhancing future growth prospects.

Our Biometric Solution business grew significantly on a sequential basis to $37 million over 70%, reflecting orders from key federal, international and state agencies for multi-modal solutions. In particular, as Bob noted our jump kits solution, which integrates our finger, face and iris offerings, additional high devices and funded development from our DOD customer enhancing L-1's leading position and brand as the multi-modal identity management coordinate for the Department of Defense. We now have over 8000 units deployed worldwide. Continued growth in this business will continue to drive expansion in our gross profit and cash operating margins.

Intelligence Service business continues to make great strides, rolling over 20%, driven by tremendous growth in our human intelligence, analysis and operation support and information systems and engineering businesses, which grew 40% and 20% respectively compared to the prior year's quarter reflecting the addition of key new business wins.

Global full-time equivalents have grown from close to 700 professionals to the second quarter of last year to over 900 at the end of this quarter, primarily driven by our SpecTal unit, which has over 110 cleared specialists have added, over a 110 cleared specialists in the last 12 months to meet demand of new contract wins and existing requirements.

We expect these businesses to continue to grow well in excess of 20%, addressing current contract demand and new bidding activity. We are currently addressing over $200 million in near-term client contract opportunities in this area. It's been a terrific area for us.

As Bob noted, the Background Screening business grew over 23%, reflecting growth and volume of new agencies added to existing state contracts. Texas and Michigan, to name two, and continued growth in our federal programs, HAZPRINT and HSPD-12.

Print volume for the quarter has grown from 240,000 prints to 350,000 in this quarter, and is expected to be at a 1.8 million annual run rate by year end, or approximately $100 million in annualized revenues. Our goal is to continue to outperform customer expectation and capture the significant growth as states implement much needed programs. We have a dominant position in this space and with the number of sites across the country reaching, as Bob noted, 800 by year end in 46 of the 50 states.

Our reported gross margin for the quarter was 33%, compared to 31% in the prior year period, primarily due to improved mix of revenues in our Identity Solutions segment, Passports Printers multi-modal solutions, and our gross margins grew over 5 basis points sequentially as our mix improved.

We expect our gross margins to continue to increase for the balance of the year. Our cash gross margin approximated 39% in the second quarter, when we backed out non-cash amortization.

Operating expenses as a percentage of sales decrease to 26% from 30%. Excluding non-cash items, operating expenses as a percentage of revenues approximated 23%, reflecting effective management of course in our overall operating leverage. As a result, EBITDA for the quarter was approximately $23 million or 17% of revenues, compared to $13 million on a pro forma basis or an increase of 77%.

We continue to target 16% to 17% cash operating margins for the full year and anticipate that the Digimarc acquisition will improve these margins. Looking ahead, we see our cash gross margins reaching an excess of 40% and cash operating expense reducing to the 20% range, as we target 20% EBITDA results for the future.

Other items to note: interest expense for the quarter was $3.2 million related to our convertible notes and borrowings under our credit facility, which decreased by $6 million. And as Bob noted, we have spent the last couple of months, the banks have been terrific. Our requirement, as noted, was about $350 million and we were well over subscribed. And so it's been a tremendous support from the banking community and we are going to be in a position to quite frankly expand the facility.

In connection with tax expense, we recorded $2.4 million during the quarter. Its non-cash, we do not anticipate to be a federal cash taxpayer for at least another three to four years. Weighted average shares outstanding was approximately $74.6 million up from $71.3 in the second quarter of 2007. The increase reflects the shares issued in connection with the Bioscrypt and McClendon transaction.

And just briefly on the balance sheet, just some highlights. We are obsessed and we continue to obsess with collections, as a result our DSO have decreased from 73 days to 63 days. We are targeting 60 to 63 days. Inventory increased slightly by $6 million to address up coming requirements for Biometric Devices and Credentialing Solutions to meet our needs. Goodwill was up $34 million, primarily relating to the Bioscrypt acquisition and accounts payable, just $7 million, increased to the normal vendor cycles.

At the end of the second quarter, we continue to enjoy strong leverage with coverage ratio on our debt to EBITDA, 1.2 to 1 well below our requirement of 4.5 to 1 and this will obviously change, when we complete the Digimarc acquisition.

Bob mentioned unlevered cash flow for the quarter was approximately $15 million impacted slightly by timing of sales and receivables that were done towards the end of the quarter. And as I noted, we continue to focus on working capital.

Small amount of capital expenditures, just a little point on backlog, it grew from $750 million at year end to $800 million at the end of the second quarter reflecting a book-to-bill of 1.4, outpacing revenues by almost 40%. And the Digimarc acquisition is expected to bring our backlog at year end to over $1 billion, positioning us for strong performance in 2009.

That concludes my overview. Back to you, Bob.

Bob LaPenta

Very good, Jim, thanks. And now we'll open it up to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). There appears to be no questions at this time.

Lisa Cradit

No questions?

Operator

(Operator Instructions) There appear to be no questions at this time.

Bob LaPenta

Well, I hope we don't have a technical problem here. We obviously had a problem getting this call hooked up with AT&T, but if that is in fact the case, we thank you for your participation and if there are any questions later on, Doni, myself or Jim will be available to answer them. Thanks very much. And we'll talk to you again in the next quarter.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!