Thanks Jean,
And to Clear_Laker too...
April 20, 2004
Def Chris Donaghey Identix Incorporated
Rating: Neutral Price Target: NA
Estimate Bias: Up Risk Rank: Speculative
IDNX: Keeping a Finger on Security: Initiating
Coverage
Initiating Coverage
Summary
* As the market leader in biometrics, we believe that IDNX is well positioned
to benefit from widespread market acceptance of this technology, particularly
with the endorsement of the technology by the Department of Homeland
Security.
* Recent corporate actions including the divestiture of the Services segment,
streamlining of operations and headcount reduction, gaining 100% ownership of
Sylvan Identix Fingerprint Centers, and the acquisition of Delean Vision
demonstrate an increased focus by the company on its core business.
* However, even though the first two of these actions removed substantial
liquidity risk for the company, an element of execution risk was introduced,
coupled with existing uncertainty as to the profitability timeframe. We are
therefore rating the stock Neutral in the absence of near-term profitability
and steep valuation.
* That said, the homeland security sector has been hot lately, and we expect
to see more positive news flow than negative. As such, we believe many
investors may be willing to overlook valuation concerns to get a piece of the
homeland security action, and the stock could respond strongly to news items.
* Our estimates for FY04 are revenue of $71.8 million and a loss per share of
$0.22; our estimates for FY05 are revenue of $78.6 million and a loss per
share of $0.10.
* Our FY05 estimates could prove quite conservative should the US-VISIT
program ramp more quickly than anticipated. However, given the uncertain
timing, we currently look for the company to achieve profitability in early
FY06.
Fundamentals FYE - Jun 2003 2004E 2005E
Price (Apr 19, 2004) $8.07 EPS Actual Old New Old New
52-Week Range $8.94-$4.15 1Q ($0.08)A NA ($0.05)A NA NA
Mkt. Cap. (mil.) $694.8 2Q ($0.07)A NA ($0.06)A NA NA
Shares Out. 86.1 3Q ($0.06)A NA ($0.06)E NA NA
(mil.)
Float (mil.) 84.5 4Q ($0.04)A NA ($0.05)E NA NA
Avg. Daily NA Year ($0.24)A NA ($0.22)E NA ($0.10)E
Trading Vol.
(mil.)
Book Value/Share $2.35 P/E NA NA NA
Dividend/Yield $0.00/Nil EV/EBITDA NA NA NA
ROE (6/03A) NA Revenue $92.5 $71.8 $78.6
(mil.)
Debt/Cap. NA Operating NA NA NA
Margin
Est. 5-Year EPS 25% Mean EPS NA ($0.21) ($0.11)
Growth
Convertible No Short Interest (000) Estimate 2004 2005
Changes
Index Membership Russell 2000 3/04 7721
2/04 7385
1/04 6879
12/03 6863
Opinion
Recommendation
After several false starts in the past decade, the biometrics industry appears
to be positioned at the edge of rapid adoption and substantial growth
The tragic events of September 11th served as a catalyst for the biometrics
industry. Driven by homeland security applications this time around, the
"mission, mandate, and money" for biometrics finally emerged. Within weeks of
the attacks, government think tanks began publishing reports touting the
benefits of biometrics as a critical technology component needed to ensure our
security. Three specific applications of biometrics cited in a report
commissioned by RAND in October, 2001 include:
* Controlling access to sensitive facilities
* Preventing identity theft and fraud in the use of travel documents, and
* Identifying known or suspected terrorists.
A key program aimed at accomplishing the latter two is the U.S. Department of
Homeland Security's (DHS) multi-billion dollar United States Visitor and
Immigrant Status Indicator Technology (US-VISIT) program. US-VISIT addresses
the daunting task of managing the entry and exit of hundreds of millions of
visitors to the United States every year. Considered the "mother of all
biometrics programs," US-VISIT requires the capture of fingerprint and facial
biometric data and storing the information in a database and on a U.S.-issued
visa or foreign passport. The biometric information is checked against
watchlists and used to verify the identity of the visa holder upon entry and
exit from the U.S. We believe that if successful, US-VISIT could start an
avalanche in the adoption of biometrics for other security applications and
beyond.
In our opinion, Minnetonka, MN-based Identix Incorporated (IDNX) is very well
positioned to benefit from rapid adoption of biometrics. In business since
1982, IDNX is the largest pure-play biometric company, and the only company
with end-to-end capabilities (image capture, database creation, and database
mining) in both fingerprint and facial recognition biometrics. IDNX' systems
are used in local, state, and federal law enforcement agencies throughout the
United States. We believe IDNX is a frontrunner to be a key biometrics
technology provider to the US-VISIT program.
Even without US-VISIT, we believe IDNX should be able to grow its business
substantially through other channels such as:
* Other large government programs such as the Department of Defense's Common
Access Card and the Transportation Workers Identification Card
* New product offerings such as the IBIS Mobile Identification System for
law enforcement
* Equipment upgrade and expansion opportunities, and
* International opportunities such as the UK's biometric passport pilot
program and Saudi Arabia's national ID card.
Our current expectations are for FY 2005 revenue growth of 41% without any
contribution from US-VISIT. With US-VISIT, we believe it may be possible for
IDNX to post 100% revenue growth or better in FY 2005.
That said, we do not expect IDNX to be a profitable company until 2006 at the
earliest (quarterly profitability achieved in early 2006). The company took
several actions during fiscal 3Q04 that should improve its margins, but IDNX
has yet to provide a specific timeline for achieving profitability. Since it
is not profitable, we value the shares of IDNX using a price-to-sales approach.
IDNX currently trades at 8.8x our FY 2005 estimate and 7.5x trailing twelve
months' revenue, well above its five-year median of 3.75x TTM revenue. Though
steep, we believe this valuation can be sustained near-term given the growth
expectations for 2005, the recent margin improvement initiatives, and
excitement about the sector.
Thus, despite very bright top-line expectations, we are initiating coverage of
IDNX with a Neutral rating based on limited profit visibility, a lofty
valuation, and continued concerns about the company's recently awarded $27-
million blanket purchase agreement with DHS that has been contested twice by an
unsuccessful bidder (see below). Nevertheless, homeland security stocks over
the past several weeks have shown strength on relatively little or no news. We
would not be surprised to see IDNX shares continuing to respond to additional
contract announcements as many investors throw caution to the wind in an
attempt to get a piece of the homeland security action. From a fundamental
viewpoint, we would be inclined to upgrade IDNX and believe higher valuations
could be supported should the company commit to a profitability timeline and
successfully resolve the DHS Blanket Purchase Agreement (again).
Investment Positives
Biometrics Positioned for Substantial Growth...Finally
Biometrics is the use of technology to verify an individual s identity based on
physical characteristics (such as fingerprints, irises, voices, and faces),
with the most common applications focusing on fingerprints and facial
recognition. Biometrics recognizes, captures, and analyzes unique biological
characteristics of an individual, and is considered to be more secure than a
traditional password, since it cannot be copied. Primarily as a result of
homeland security programs (both domestic and international), the growth
prospects for biometrics appear strong. The Freedonia Group and the
International Biometric Group, two biometric industry researchers, predict
compound annual growth rates for the next five years of 42% and 54%,
respectively (we believe the Freedonia Group's estimates are more realistic).
Given its broad product offerings in what are expected to be the largest
markets, fingerprint and facial recognition, we believe IDNX is well positioned
to achieve the market growth rate, if not exceed it through additional market
share capture.
Figure 1: The Biometrics Market, 1992-2012 (in millions)
Technology 1992 1997 2002 2007 2012
Finger and Fingerprint (IDNX) $5 $15 $45 $200 500
Hand Geometry 2 5 17 75 200
Face Recognition (IDNX) NM 3 15 100 300
Retinal & Iris 1 3 10 75 275
Voice Recognition NM 1 5 50 175
Signature Analysis NM 1 3 25 75
Other Technologies NM NM NM 25 75
Total Market $8 $28 $95 $550 $1,600
Source: The Freedonia Group
US-VISIT: The Mother of all Biometric Projects:
As a result of the passage of the Enhanced Border Security Act of 2002, the DHS
created the U.S. Visitor and Immigrant Status Indicator Technology (US-VISIT)
program that mandates the use of biometric data for all foreign citizen entry
documents (visas and passports). The goal of US-VISIT is to help secure our
borders, facilitate the entry-exit process, and enhance the integrity of the
immigration system. By October 26, 2004, the Act requires that all entry
documents issued by the U.S. to foreign nationals include biometric identifiers
and are machine readable; that the machines necessary to read these documents
are installed in all U.S. ports of entry; and that nations participating in the
visa waiver program include biometric data in machine readable passports. The
October 26th deadline is likely to slip as the DHS recently submitted a request
to Congress to extend the deadline by two years, but we believe the
infrastructure buildout necessary to implement US-VISIT should commence in
IDNX s fiscal 2005.
DHS expects to award the prime systems integrator contract for US-VISIT in May
2004 to one of three teams led by Lockheed Martin, Computer Sciences
Corporation, and Accenture. At the request of DHS, IDNX, as a potential
technology provider, has not aligned itself exclusively to any of the three
teams; however, IDNX has reasonably close ties to each of the three leads. The
final system will be a combination of hardware and software, and we expect IDNX
to compete for at least portions of both. The fingerprint database software
contract will likely be awarded to a vendor with Automated Fingerprint
Identification System (AFIS) products. AFIS is a mature market with 2003
revenue of roughly $300 million and more than 40 vendors worldwide. We believe
IDNX is best positioned to capture the contract to provide the fingerprint
scanning hardware for each of the 211 visa-issuing posts overseas, an
opportunity we estimate could be worth roughly $20 million to $50 million in
product revenue. We expect IDNX to market is Automated Biometric
Identification System (ABIS) product for the facial recognition database
component of the program, but the timing of this award is questionable.
(This shows that Cross Match has done themselves some serious damage in their pusuit of protests)
Recent DHS Contract Win Endorses Identix Technology
On October 3, 2003, Identix announced that the Department of Homeland Security
(DHS) awarded IDNX a five-year, blanket purchase agreement (BPA) to provide its
Live-Scan booking stations to the Citizenship and Immigration Services (CIS),
as well as to other departments within DHS. The contract calls for at least
$27 million in spending over 60 months and DHS placed its first order for $2.3
million on October 7th. *******(based on conversations with its customer, IDNX
believes this contract has the potential to increase in size to more than $50
million)*******. This BPA award was subsequently challenged by a competitor,
resulting in a 5-month long recompete procedure. In March 2004, DHS announced
IDNX was reconfirmed as the winner of the BPA, but this decision, in what
appears to be an act of desperation, was again challenged by the same
competitor. We believe IDNX will be reaffirmed as the winner, likely on a
shorter timeframe, as DHS is not required to go through a lengthy technology
re-evaluation. Though it has clearly caused delays in revenue generation, *******we
believe IDNX could emerge from this process in a stronger position with DHS,
particularly since one of its only competitors has now ***severely damaged*** its
relationship with DHS.*******
At roughly a $5 million revenue contribution per year over the next five years,
this BPA, on a stand-alone basis, does not propel IDNX into profitability.
However, we believe there are several important implications of this contract
that will benefit IDNX longer-term (we believe these same implications are the
primary reason the unsuccessful bidder challenged the contract award twice).
As a BPA, any division within DHS (CIS, Customs and Border Protection,
Transportation Security Administration, etc.) can make a purchase without
requiring a competitive bid, shortening the time required for the procurement
process. Also, the contract has no spending cap, allowing for additional
spending beyond upgrades for existing systems. Most importantly, we believe
this highly visible contract enhances IDNX s ability to win other homeland
security contracts such as the U.S. VISIT program.
Other High Profile Biometrics Programs
In addition to the US-VISIT and CIS opportunities mentioned above, IDNX is
actively pursuing and expanding numerous other programs both domestically and
internationally. Some of these programs include:
* U.S. Department of Defense Common Access Card (CAC) - The CAC is a smart
card that contains biographical and fingerprint biometric data and is
required to be carried by all military personnel. IDNX sold a 5.4 million
user license to DoD's Defense Manpower Data Center in February 2003 for
its BioEngine fingerprint recognition technology to upgrade fingerprint
records of all DoD military and civilian personnel.
* U.S. Transportation Worker Identification Credential (TWIC) - Similar to
CAC and managed by the Transportation Security Administration, the TWIC is
expected to be a biometric-enabled identification card for approximately
12 million workers in the aviation, maritime, HAZMAT, and other
transportation industries.
* International Opportunities - Outside the United States, IDNX has
opportunities to provide imaging systems and software for several other
countries including Saudi Arabia (a $25 million potential opportunity),
the United Kingdom (IDNX recently won a 10,000 person pilot program for
biometric-enabled passports), Serbia, and Pakistan.
Recent Sale of Low-Margin Government Services Business to Boost Gross Margin
In February, 2004, IDNX announced it had agreed to sell its Identix Public
Sector (IPS) government services business to Alion Science and Technology
Corporation for $8.85 million. By selling this subsidiary, IDNX not only loses
a distraction and simplifies its story, but also should see a significant gross
margin improvement. In 2Q04, IDNX's product business posted a gross margin of
35.7% while the services business saw a gross margin of 8.1% resulting in a
total firm gross margin of 25.3%. After the sale of IPS, we expect gross
margin to improve to 35% by 4Q04.
>>>That's the end. IMO, these folks have done their homework on Identix. Chris has confirmed nearly everything that Isit has been saying over that past few years.
Thanks for keeping us ahead of the curve, Isit.
clear laker
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