In The Boardroom With...

Nick Andrewes
Analyst
Equity Research
LAZARD CAPITAL MARKETS
30 Rockefeller Plaza
New York, NY 10020
www.lazardcap.com

SecurityStockWatch.com: Nick, thank you for joining us today. Please give our audience an overview of your background and your role at Lazard Capital Markets.

Nick Andrewes: I’m a sell-side technology analyst covering security technology and data
services space. On the security focus of my coverage, I cover companies that provide identity solutions; physical security devices such as secure credentials and logical access security devices such as authentication tokens. I joined Lazard Capital Markets in September 2006 from Janney Montgomery Scott where I also was a sell-side analyst covering security technology companies.

SecurityStockWatch.com: You recently published a report regarding Identity Technology. Please share with us the highlights.
Nick Andrewes: We published an industry piece covering specifically the Government Identity Technology. This report is a high-level analysis of the overall revenue opportunity and the revenue growth advantages for companies with government ID technology exposure. We also discuss the technologies that we feel are important in the space, such as secure credentials, biometrics, and ID management software.

One of the core theses in the report was the given the focus on security and the identification of national threats, spending in this area should be more insulated from reduced spending, if we are in fact heading into a recession.

With so many projects underway both in the U.S. and internationally, we decided to give an overview and analyze some of the largest projects that we felt were most important to government ID Technology companies, as well as identify the companies most likely to benefit from these projects.

We estimate total government-funded ID technology market revenue could reach $6.9 billion by 2010 growing at roughly 15% annually, significantly outpacing other government technology sectors. I see the strong growth prospects coming from large-scale projects such as national ID programs, social services programs, voter fraud prevention, residency status, border crossing, and in transportation infrastructure.

While the convergence of physical and logical access is likely 12-18 months away from critical traction on the enterprise side, mandates such as HSPD-12, establishing a standard for secure identification issued by the federal government to its employees and contractors should lead to strong industry growth in 2H08. I believe we have just entered a strong growth cycle, which could last 5-10 years, depending on the speed of rollout of these projects.

The standard for secure IDs issued by the U.S. government to its employees and contractors should lead to strong growth in 2H08 as agencies race to meet the year-end 2008 deadline. Homeland Security Presidential Directive 12 (HSPD-12) established a mandatory standard for secure identification issued by the federal government to its employees and contractors, also known as FIPS 201 (Federal Information Processing Standard 201).

We expect consolidation to continue, as companies look to broaden product offerings to provide a comprehensive suite of solutions, we believe the fast-growing ID Technology space will become a target to augment growth in an otherwise slowing spending environment.

SecurityStockWatch.com: What is your perspective on the market drivers for these companies at the present time?

Nick Andrewes: We continue to see strong market drivers, some of the projects that we have been speaking about are finally being starting to take shape. Final regulations, contract awards and expanded deployment is a main theme of the next 12-18 months. While we always caution that investors need to be patient as the timing on government projects typically get pushed out, the commitment by government entities to the projects are not wavering.

An illustration of this point is the FBI’s Next Generation Identification (NGI) system, the potential size of the project has not changed, but with the protest following Lockheed’s award of the potential $1 billion contract, the timeline for project start was pushed out several months. Recently the protest was dropped, an the system integrator is ready to begin work.

We expect implementation of several other biometric programs, such as US-VISIT 2 to 10 prints and EU-VIS countrywide rollouts, to make 2008 and 2009 a much better year for biometrics as well. Beyond 2009, the EU is proposing an electronic travel authorization system to register the entry and exit of non-EU nationals similar to the US-VISIT program, suggesting still more growth opportunities.
On the credentialing side, The Real ID Act, which call for the revamp of state issued driver’s licenses has been in the works for several years. There was significant pushback from state regarding the federal mandate, which led to delays in the program, but with the uncertainty surrounding the new rules ended, we expect REAL ID to become a significant growth driver in the credentialing market starting late 2009. Other programs such as the Passport Card and enhanced driver’s licenses, which would allow for non-flight travel to Canada and Mexico, will be drivers in the coming years. Internationally, we continue to see strong demand from ePassport programs as well as national ID programs.

SecurityStockWatch.com: One will read in your report that for Government-focused ID Technology, there is, “Rising demand driving opportunities, even in an economic downturn”. Much has happened in the capital markets the past couple of months – is this still the case?

Nick Andrewes: On of the main points we are trying to make is that government-focused business holds risks such as contract pushouts, but if we head into a recession, companies with fixed contracts in place should fare well. We think our statement continues to hold true, our analysis of historical data shows that in past economic slowdowns and recessions, government spending on information technology has been less vulnerable than Enterprise spending.

As you know, the markets have been pretty volatile over the last several months, and despite the increasingly popular notion that the worst of the credit crisis is over, it is still very hard to predict what the impact will be on consumer and enterprise spending for the rest of 2008. I think the confidence level of C-level executives is not very strong, and corporate technology budgets will likely suffer in the near-term.

On the other side, government programs that are in place are attractive to companies looking to increase growth, L-1’s recent announcement that they are buying Digimarc’s ID Systems business shows the market opportunity in the REAL ID program. We believe the offer price values the company at roughly $14, which was a 60% premium to where the Digimarc stock was trading prior to announcement.

SecurityStockWatch.com: Which companies are you covering at this time may we have a brief thumbnail on each?

Nick Andrewes: ActivIdentity (ACTI-$4PT)) provides identity solution for government, enterprises and financial services firms that enable organizations to manage digital identities for secure physical and logical access. We rate ActivIdentity a BUY; the stock has come under significant pressure and currently trades below net cash value. Risks include disruptions due to management changes, continued operating losses, increasing competition, and lumpiness and delays in government business.

Cogent (COGT-$15PT) is a leading provider of Automated Fingerprint Identification System (AFIS) solutions with superior technology, poised for growth fueled by the increasing demand for government mandated authentication solutions. We rate the company a BUY, as it is well positioned for several large-scale contracts that will likely be awarded in 2008 and 2009. Our $15 PT equates to roughly 20x our estimated 2008 EV/FCF.

Digimarc (DMRC-$13PT) is a supplier of secure media solutions used in a wide range of security, identification, and digital media content applications. Its digital identification division issues nearly two-thirds of U.S. driver licenses. We rate Digimarc a BUY with a price target of $13, which equates to roughly 10.6x our 2008 EV/EBITDA estimate. Risks include slower-than-anticipated industry growth, high up-front investment, contract delays, and increased competition.

L-1 (ID-$20 PT) remains the leader in the identity technology market, with solutions including credentialing, fingerprint services, biometrics and security/intelligence consulting. We project organic revenue growth in excess of 20% in 2008. The company has product depth and breadth that is unmatched in the industry, in our view. Our $20 price target equates to 20x our 2008 EBITDA estimate. Risks include acquisition integrations and dilutive effects, slower industry growth; increasing competition; and capital requirements.

LaserCard (LCRD-$14PT) manufactures secure optical memory cards and other cards that includes both optical and contactless chip. We rate LaserCard a Buy as it should enjoy a tailwind throughout the decade from the increasing demand for secure digital ID cards from established contracts that have not yet begun full-scale deployment. Our $14 price target equates to roughly 35x our F2009E EPS and 12.3x our F2010E EPS. Risks include lumpiness of revenues, slower-than-anticipated industry growth, key contract delays or losses, and increased competition.

VASCO (VDSI-NM) is a dominant player in the high-growth area of strong authentication for financial institutions and is, in our view, positioned for substantial and profitable revenue growth. While valuation of 0.5x 2008E P/E/G is interesting, but we maintain our HOLD rating as sales cycles lengthen, the commotion in financials continues and concerns regarding IT spending remain. VASCO’s biggest risks are the highly competitive marketplace and the potential deterioration of the overall business environment.

SecurityStockWatch.com: Are there any recent awards or contracts with these companies you care to mention?

Nick Andrewes: As part of the government of Angola’s National ID Card Program, it has contracted with LaserCard for an initial eight million cards, a $90 million contract with the opportunity for follow-on orders for an additional 12 million. LaserCard will provide card personalization systems, printer consumables, installation, and training.

L-1 was awarded the prime contract by the Department of State for the Passport Card in March. We believe roughly 150k applications for Passport cards have been accepted by the Department of State. The contract has a potential value of $107 M over five years. L-1 expects to ship 200-300k cards in 2Q and to generate $10-$15 million in revenues from the program in 2008.

Digimarc recently announced it would issue new secure driver’s licenses for the state of New Mexico's Motor Vehicle Division. Digimarc replaced existing system with a secure driver license issuance system, designed to ensure that only one valid license is issued to one legitimate applicant, helping fight driver license fraud and identity theft.

On the consumer side of the business, VASCO recently announced that the Brazilian bank Banco Itau would issue 1.6 million one-time password tokens to its customers. The strong authentication market continues to grow outside of the U.S.

Outside of our coverage, one of the most exiting programs out there, the FBI NGI project, which will be an upgrade to the existing national fingerprint and criminal history system maintained by the FBI, was awarded in February to Lockheed Martin. This was an estimated $1 billion contract, where Lockheed will work with the FBI to determine a biometric system, and could potentially see an award of this program in 3Q.

SecurityStockWatch.com: Nick, many thanks for your time today. Are there any other comments you would like to make?

Nick Andrewes: Thank you for the opportunity to share my thoughts with you and your audience. I think these next couple of years will continue to see focused attention on Identity Technology and the value surrounding ones identity both in the physical and logical/digital world. I think it’s an exiting time to cover this space as government programs that I’ve been tracking for years are now finally coming to deployment. Finally, I’d just like to say that I appreciate the work you and your colleagues are doing here, as it’s a great site for investors looking for information and ideas.

mandatory disclosures:

ANALYST CERTIFICATION

All of the recommendations and views about the securities and companies in this report accurately reflect the personal views of the research analyst named on the cover of this report. No part of this research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst in this research report.

IMPORTANT DISCLOSURES

Lazard Capital Markets LLC makes a market in ACTI, COGT, DMRC, LCRD and VDSI securities.

DISCLAIMERS

This report has been prepared by Lazard Capital Markets LLC (“LCM”) in New York. It may not be reproduced, redistributed or copied in whole or in part for any purpose. This report has been approved by, and is being distributed in the US or to US persons, by LCM, which accepts responsibility for its contents in the US. Transactions undertaken in the US in any security mentioned herein must be effected through LCM or another US-registered broker-dealer, in conformity with SEC Rule 15a-6.

Neither this report nor any copy or part thereof may be distributed in any other jurisdictions where its distribution may be restricted by law and persons into whose possession this report comes should inform themselves about, and observe, any such restrictions. Distribution of this report in any such other jurisdictions may constitute a violation of US securities laws, or the law of any such other jurisdictions.

This report does not constitute an offer or solicitation to buy or sell any securities referred to herein. It should not be so construed, nor should it or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever. The information in this report, or on which this report is based, has been obtained from sources that LCM believes to be reliable and accurate. However, it has not been independently verified and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties. The information or opinions are provided as at the date of this report and are subject to change without notice. The information and opinions provided in this report take no account of the investors’ individual circumstances and should not be taken as specific advice on the merits of any investment decision. Investors should consider this report as only a single factor in making any investment decisions. Further information is available upon request. LCM does not accept any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of this report or its contents.

Lazard Capital Markets LLC
30 Rockefeller Plaza, New York, NY 10020
Member NYSE and FINRA