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Hi, all--

Well, Stan beat me to the punch, but I spent several hours listening to the call and transcribing, so I'll go ahead and post my notes nonetheless. Boy, it's an exercise in futility with Stan patrolling the boards. ;-)


Senior VP for Marketing Ed Macbeth opened the call, with Jason Hart and Mark Lustig, CFO, on deck. Macbeth introduced Hart, who reviewed the last few quarters.

Hart noted significant improvement in business fundamentals in the last three quarters. He emphasized two key themes that are now increasingly characterizing the business – simplification and standardization of global systems, and simplification of products and services to improve the business model. Hart noted five areas in which the company is improving:

1. Focusing on revenue growth in named G1000 accounts (in the US government and governments abroad)
2. Reducing expenses and conserving cash (managing headcount, consolidating facilities, reducing discretionary expenses)
3. Improving communication (creating an entrepreneurial culture)
4. Achieving greater efficiency (simplification of legal structure and implementing new ERP and CRM systems)
5. Investing in high-growth areas of the business (including government employee and citizen ID projects and extending smart enterprise ID solutions to partners)

As a result, the business is improving fundamentally across a number of areas, including operating completely in Q1 using an Oracle ERP system, growth in the commercial sales pipeline, and growth in the HSPD12-like government pipeline globally. He noted the launch of a new website with greater focus on business solutions, and highlighted the firm's increasing cooperation with leading technology vendors through the launch of the Actividentity identity program (with Citrix, Microsoft, Novell, and Sun)

Hart reiterated that the company now has the focus, management and marketing to grow in 2007. He then pointed out two highly visible wins from last quarter for their smart employee ID solution for two police departments – one in the US and one in Europe. He also pointed out the uptake of smart employee ID solution in a new government department in the UK. He also mentioned new sales of enterprise single sign-on offerings in an Asian company as a precursor to full smart employee ID there.

Hart enumerated other successes: increased penetration in the health-care market, with sales in countries like Sweden, additional licensing to a very big east-coast bank and a large healthcare provider. AI made further sales to: Singapore, HP, Northrop Grumman, more to the Dept of Defense, and to a previously announced large European defense contractor. In total, they seemed to play upon previous sales successes to grab a larger foothold of the market, as Hart stressed multiple times on the call.

Hart concluded his opening remarks by saying that he was pleased with growth in the smart employee ID solution for 2006 and going into 2007-2008.

CFO Mark Lustig was up next and discussed the financials:
• Revenue in the most recent quarter was $14.6 million vs guidance of $13.5-15 mil – a 27% increase year over year from $11.5 million
• 33% of total product revenue came from governments, down from 54% in the prior quarter. Lustig was at pains to stress that these were normal levels of booking in the quarter. They look particularly low because bookings were abnormally high last quarter.
• Enterprise product revenue was 45% of total revenue, compared to 35% in the prior quarter, which was relatively flat in absolute terms
• Financial-service product revenue was 22% of total revenue – an increase of 50% in dollar terms – due to strong token sales in Europe. It was 11% of total sales in the prior quarter.

Lustig reiterated several times that the revenue mix would continue to fluctuate in the future, due to the prolonged sales cycle for larger transactions, the related accounting, and the “lumpy” nature of government contracts and overall market growth. He continued with more financial notes:

• Overall gross margins came in at 69% for the December quarter, compared to 72% for the September quarter, and up from 55% for the June quarter
• Margins were slightly lower due to stronger software revenues in the December quarter. (This sounds odd to me.) Gross margin will continue to fluctuate based on product mix.
• Operating expenses came in below the guidance of 14.3-15.3 mil, due to focused control on headcount-related costs, travel, and marketing program spending, among others.
• The company continues to focus on rightsizing the operating-expense base, but expects it to fluctuate due to headcount changes, reset of payroll taxes in the US, and efficiencies due to implementation of global ERP system.
• The company profited from $800,000 in currency gains.
• Cash and equivalents increased by $7 million.
• Deferred revenue stood at $14.3 million at the end of the quarter, compared to $14.7 mil in previous quarter

Lustig detailed many other aspects of the income statement, and went on to provide guidance on this quarter:

• Revenues for the March quarter to come in at $14-15.5 million.
• Gross margins in the 60-70% range
• Expenses will be around 14-15 million, including additional stock-based comp of about 800k. The increase in expenses was explained in the Q and A (below).
• Expects a loss of 6-9 cents per share on GAAP basis
• Cash and cash equivalents to decrease between 4-6 mill, driven by changes in working capital – leaving cash on the balance sheet of between 130-132 mil

Hart returned and expressed great optimism for the company and its prospects. He stated that the market is maturing, and was very hopeful for 2007-2009. He noted some the industry trend toward ID badges in the last year for commercial and government customers, and believes the company is well-positioned to capture sales of employee and government ID systems. He cited numerous positives for the sector and the company:

• The identity market is predicted to grow in double digits over the next few years
• The drivers of the business are strengthening – government laws on id theft are coming into play and electronic security is becoming increasingly complex
• The company continues to invest in R&D, and is consulting with industry and government leaders to maintain its leadership position in the public sector

The company wants to capitalize further on its leadership position to ensure success in the citizen access market. Part of that strategy involves restraint on expenses and focusing on high-profit areas. Therefore, they intend to leverage their position in domestic HSBD12 US federal government contracts to get access to overseas HSBD12-like federal contracts. Hart laid out the tactical focus in 2007 – to leverage the firm's leadership in the smart employee ID market for commercial and government clients and help them address the convergence of building access, visual identification, desktop login, remote access, encryption, and digital signatures.

In the process Hart expects business to trend more toward software, but he emphasized that the company still clearly needs the hardware to help solidify leadership, and for revenue and competitive advantage. He noted that 2007 may see changes in the business model. He left that a bit vague, and I'm not quite sure what his comment portends. In sum, Hart sees the market and the company at an inflection point, where the company can begin to accelerate. That concluded the presentation.

A couple analysts jumped on to probe the Actividentity brass.

Sean Jackson asked about the uptick in projected operating expense in the current quarter. Lustig explained that salary expense will go up in this quarter because of new headcount additions who arrived at the end of the last quarter. Jackson also asked about the wide gross margin range (60-70%), and the CFO responded by saying that software sales were lumpy (my word), and that he was only comfortable with a wide range.

Hart popped in but was unwilling to disclose much strategy. However, he did say that they formed a new strategic business unit for public-sector solutions with Robert Brandewy. The unit focuses on a small number of key global opportunities in that space. Hart added that he was very confident in the strength of AI's IP for these projects. As well, he noted that the revenue forecasts do not include speculative government contracts – and emphasized that forecasts only included sales on which they have some transparency. These speculative contracts could affect results substantially. Trailing off, he said that current forecasts also include HSPD12 income still coming in.

Hart then explained what HSPD12 is – an employer to employee ID card – and Actividentity is a leader in the market. He discussed upcoming government-imposed deadlines that will be of significance to AI. By October 2008 all US federal employees must have an ID card. In total, he said that 5.5-6.5 million expected employees need ID badges, of which 3.5 million are in the Dept of Defense, which is an existing customer. 1 million government employees have already chosen AI, and they expect another 1 million are left who have yet to pick up some ID solution. (If this sounds a bit confusing -- at times, the numbers were thrown around without much reference to where they belonged and what portion of those figures that AI could scoop.) Hart expects further growth in first-responder areas as well.

There is also an October 2007 deadline – by which some percentage of deployment must occur, and 1 million employees have yet to be spoken for. In response to the analyst's question, Hart wouldn't say much more, because of the competitive nature of the RFP contract. He later said that he couldn't mention agencies by name, because he'd “had his finger slapped” for doing so in the past.

Hart also touched on their tactical approach. Due to heavy competitive pressure in the market, AI is trying to leverage its strengths to show employees how to use the cards instead of just issuing them. He sees good revenue opportunities here, but still greater opportunities lie in taking this leverage to Europe and Asia, which the company has been doing.

Hart has been seeing increasing penetration of their smart employee ID card, especially at the higher end in the G1000 accounts. Revenue continues to improve there. However, government revenues will also continue to increase in absolute terms, as the HSPD12-like solution gains traction in Europe. The product mix is evening out between commercial and government, and Hart was pleased with the increased traction in markets overall.

In response to the question of proposed decreased government funding, Hart answered that the company is not tied to the success of HSPD12, because the company is taking the business globally as well. If revenues fall from declining HSPD12 sales in the US, Hart seemed confident that they would be made up overseas with sales that have already begun. As for the penetration in the first-responder area, he expects the uptake to be slower than predicted, and expects more forward-thinking local agencies (police departments, etc) to begin uptake slowly, while others watch to see what happens.

In response to a question of the impact of Vista as it relates to smart cards – Hart felt that Vista lays a good foundation for desktop access to cards. The need to integrate physical cards will be one of the key driving factors. Customers will look to gain value by eliminating tokens, the proximity cards, and then moving to logical access and thereby removing passwords. AI is supporting the Microsoft strategy to make ID solutions ubiquitous in the environment.

Hart could not comment on time frame of the vendor decisions of previously announced purchase decisions by countries like Germany, UK, and Australia.

In sum, AI management seemed pretty upbeat about the future, but let's hash it out on the boards some.

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