BlackBerry Ltd (BB) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Certicom Corp. fourth quarter and year-end results conference call.

At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session for analysts and institutional investors. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star zero for operator assistance at any time.

I'd like to remind everyone that this conference call is being recorded on Thursday, June 9, 2005 at 10:00 a.m. Eastern Time. I will now turn the conference over to Minit Ganem. Please go ahead.

Thank you, good morning. And thank you for joining us for Certicom's conference call to discuss results for the fourth quarter and year-end for fiscal 2005.

On the call from Certicom today are Ian McKinnon, President and Chief Executive Officer, Herve Sequin, Chief Financial Officer, Dr. Scott Vanstone, Founder and Executive Vice President Strategic Technology, and Brendan Violo, Director of Marketing.

Let me remind you that all dollar amounts discussed today are in U.S. dollars. This call is also being Webcast live on the Company's Web site at www.certicom.com.

During the call, management may make projections or other forward-looking statements regarding future events or future financial performance. Actual performance, events, or results may differ materially. Please refer to the Company's most recent annual report and other documents filed with securities regulators for a discussion of factors that could cause actual results to differ materially from any forward-looking statements.

I'd now like to turn the call over to Ian McKinnon.

Good morning and thank you for joining us.

I'd like to begin with an overview of the operational highlights for our fourth quarter and fiscal 2005. Then I'll ask Herve to provide a review of our financial performance and our outlook for expenses in Q1 of fiscal '06. I'll return for a brief summary before the questions-and-answer session.

Please turn now to Slide 5.

As we look back on the Company's history, fiscal '05 was in many ways a turning point for Certicom. It validated the strategy that we've steadily been implementing.

One of the most significant events of the year was the NSA's selection of ECC as the exclusive key agreement and digital signature standard to secure all sensitive but unclassified data within the U.S. government. This is a major announcement that essentially makes ECC the standard for all U.S. government communications.

This presents us a tremendous opportunity for Certicom. It greatly expands our potential to win licensing agreements with organizations that manufacture both commercial off-the-shelf products for the government market as well as classified products.

All government technology suppliers will now need to embed ECC technology and as a result, this broadens our addressable market dramatically.

Please turn to Slide 6.

During the year, we made strong progress in our intellectual property and product licensing strategy. This success included a 15-year agreement with General Dynamics for our entire intellectual property portfolio, a contract with Pitney Bowes, and a $3.5 million contract with Research In Motion.

As we deliver on our licensing strategy, we are steadily building recurring revenues and already seeing the impact. Excluding the NSA contract in fiscal '04, we grew revenue 20% over last year and improved our bottom line performance by 33%. Revenue for the year was $11.6 million, compared to $9.6 million last year, excluding the NSA contract, and including the NSA, it was $34.5 million in fiscal '04. Q4 revenues were $3.1 million, compared to $2.6 million in the same period last year.

Slide 7.

This has been a very active quarter for us. In addition to the NSA's announcement, Certicom delivered a number of important operational successes in Q4 of fiscal '05.

These include the following, Borland Software licensed our SecurityBuilder SSL developer toolkit. Our product will give Borland the most up to date and efficient security in its VisiBroker CORBA infrastructure solution.

Apani Networks licensed Certicom's proven SecurityBuilder IPSec toolkit. This will allow them to significantly reduce development costs and accelerate time to market of their virtual private network products. Apani is a leading provider of encryption and access control solutions to secure data flows.

We launched Certicom Security Architecture for Embedded, a platform that allows device manufacturers to quickly create a trusted, embedded computing environment.

Slide 8.

We launched the Certicom partner connection. This is a program where we partner with vendors that provide developers with solutions for embedded devices. Inaugural members of the program include Beep Science, Eracom, Freescale, Green Hills, Intel and Texas Instruments.

Also during the fourth quarter, we announced a board support package called Security Builder BSP for Texas Instruments' OMAP platform. In addition, we created a partnership with Beep Science, enabling to us integrate and resell their software. Beep Science is a leading provider of standard-spaced Digital Rights Management, or DRM technology. This supports Certicom's objective to provide a comprehensive, integrated security platform that addresses the evolving needs of device manufacturers.

To support our long-term growth strategy, Certicom has expanded its sales force. We added new sales representatives and field engineers across offices in Europe and the United States.

Slide 9.

Subsequent to quarter-end, we made a number of other significant announcements. We signed an intellectual licensing agreement with Freescale Semiconductor. We also announced a patent licensing agreement with Pitney Bowes. They have licensed our latest digital signature scheme called Nyberg Ruepple, which offers greater protection against fraud without compromising speed. In addition, Certicom Security Architecture earned FIPS 140-2 Validation.

Our SecurityBuilder GSE-C cryptographic module enables device manufacturers and software vendors to quickly add government-approved security to their products. It saves them from undergoing the time-consuming and costly Federal Information Processing Standards, or FIPS process.

Let me now call on Herve Sequin to discuss Certicom's financial performance in the fourth quarter and for the full-year of fiscal '05. Herve?

Thank you very much Ian, and good morning, everyone. Please turn to slide number 10.

I will begin with a review of our fourth quarter financials followed by a look at our performance for the full fiscal year. As Ian indicated earlier, revenues were 3.1 million for the fourth quarter, compared to 2.6 million in the same quarter last year. Operating expenses were $4.1 million, compared to 3.9 million in the same quarter last year.

Of the expenses in Q4 of fiscal '05, approximately 400,000 was from the one-time cost of increasing the sales force in an employee year-end bonus charge. Excluding these, operating expenses were $3.7 million, in line with our previously provided guidance of 3.4 to $3.7 million. For the quarter, the Company posted an EBITDA loss of $1 million, compared to 1.3 million last year. Excluding the NSA expenses in Q4 of fiscal '04, the EBITDA loss was $800,000.

On a GAAP basis, the Company posted a net loss of 1.2 million, or $0.03 per basic and fully diluted share. This compares with a net loss in the same period last year of 2.1 million, or $0.06 per basic and diluted share.

At year-end, Certicom had $25.9 million in cash, compared to 27.5 million at January 31, 2005, and $36 million at the end of fiscal 2004. Now, please turn to slide number 11.

As I run through the year-end numbers, let me remind everyone that in the second quarter of fiscal '04, we signed a major contract with the NSA. This had an impact on various metrics, most notably the NSA contract impacted revenue gains and also triggered incremental expenses.

For comparative purposes, we will provide a review of the full-year results both including and excluding the impact of the NSA.

Certicom reported revenues of $11.6 million for fiscal 2005, compared to 9.6 million, excluding the NSA contract, in the same period last year. Including the NSA contract revenues in fiscal 2004 were $34.5 million.

Operating expenses for the year were 14.3 million, compared to operating expenses of 13.7 million last year, including the NSA contract-related expenses. And operating expenses were $12 million, excluding the NSA contract-related expenses in fiscal 2004.

The increase in year-over-year operating expenses, excluding those related to the NSA contract, reflect the Company's increasing investment in support of the intellectual property licensing strategy.

The Company posted an EBITDA loss of 2.7 million for the year, compared to a loss of 2.4 million in fiscal 2004, excluding the NSA contract. Including the NSA contract, Certicom's EBITDA was $20.8 million last year.

On a GAAP basis, net loss for the year was 4.3 million, or $0.11 per basic and fully diluted share. Last year, net income, including the NSA contract, was $16.8 million, or $0.49 per basic share and $0.47 per diluted share. Excluding the NSA contract, the net loss in fiscal 2004 was $6.4 million.

Now, please turn to slide number 12.

While Certicom does not provide guidance on revenue or cash position, we do provide guidance on operating expenses. Operating expenses in the first quarter of fiscal 2006, including cost of sales, are expected to range from 3.6 million to 3.9 million.

As Ian mentioned, it's been a very successful year for Certicom. We strengthened our financial position by paying off our debt and building recurring revenues. In fiscal 2005, approximately 45% of our revenues were recurring. It's a huge improvement from just 15% three years ago. With our strong cash position and debt-free balance sheet, we have the financial flexibility to capitalize on our momentum as we enter fiscal 2006. To provide an overview of the business going forward, I will now turn it back to Ian. Ian?

Thanks, Herve. Please turn now to Slide 13.

In fiscal '04, we launched a new growth strategy for the Company and I'm pleased to report that in fiscal '05, we began to successfully execute that strategy. The patent licensing contracts with General Dynamics, Research In Motion, Pitney Bowes and Freescale clearly validate our approach.

Certicom's opportunity is considerably larger today than it was just two years ago.

The NSA purchased worldwide licensing rights to our ECC-based intellectual property in a limited field of use. Then it expanded on that by selecting ECC as the exclusive key agreement and digital signature standard to secure sensitive but unclassified communications. We now expect worldwide ECC adoption to gain momentum much more quickly. As the undisputed world leader in ECC, Certicom is ideally positioned to benefit. The demand for public key security is growing and Certicom is at the forefront.

Within the context of these very encouraging market developments, Certicom is focused on maximizing our market share. We are accomplishing that by steadily penetrating high-growth markets, including government communications, enterprise software, financial services, embedded devices, consumer electronics, and mobile handsets. And as we enter fiscal '06, we have a strong foundation for building our business, and, we maintain our clear and steady focus on achieving sustainable, profitable growth. So at this point, we'd be very pleased to answer any of your questions.

Thank you. One moment, please. Ladies and gentlemen, we will not conduct the question-and-answer session. Please be advised that members of the media and general public will be in a listen-only mode for the duration of the question-and-answer session.

Certicom will be pleased to arrange for any follow-up discussion or interviews of senior management after the call has been completed. To make these arrangements, please contact Brendan Violo at 613-254-9267.

[Operator instructions] Your first question comes from Scott Penner from TD Newcrest. Please go ahead with your question.

Thank you. Herve, if you could just cover off the deferred revenue, it looks like it was down sequentially, down sequentially in Q3 from the high in Q2. I just wanted to understand what the elements are and what's going on there.

Good morning, Scott. Deferred revenue in the last fiscal year grew in the first and second quarter as a result of some prepaid royalty agreements which we made. One was with Research In Motion, which we announced, and the other one, as you know, we are not, for competitive reasons, entitled to announce it.

What we are doing is we are amortizing that revenue over a period of time. And so as a result of that, that will be coming down, as you said, sequentially over a number of quarters until we effectively record that revenue into our accounts.

Okay. And you mentioned the recurring revenue is up to 45% of the total in fiscal '05. Can you just, are you able to give me the exit rate in Q4? Was it 50% or was it around the 45%?

It's still in the same range. It has been fairly stable, growing throughout the period and 45 is about the range where we are for now.

Okay, great. And, I noticed that the services line was a little bit stronger. I know this is project-based revenue that kind of comes and goes, but is there anything more to be said there?

Not really. One thing we should all be reminded is that service revenue for us is really there to support the sale of product revenue so while it's project-driven, it is project-driven to drive very highly-profitable product revenue.

Okay. And then, I guess conceptually, Ian, the market opportunity seems fairly vast here, you are, as you said, hiring salespeople. Is there any thought now that the NSA has effectively marked you guys as the standard to ramping up that sales effort or do you feel pretty comfortable?

Oh, we're very comfortable, Scott. The reason primarily for ramping up the sales organization and while don't give any specific numbers in terms of head count, it's up about 40% on a year-over-year basis, in terms of both adding sales reps and field engineers.

It's really in response to the demand for our products, principally. We've a strong patent licensing organization, as you know, but we're getting many, many unsolicited inquiries and qualified leads coming into the organization now compared to even a year and a half, two years ago.

This is really out of necessity. We've to add more skilled, more confident people in the field to deal with the demand for information about our technology and that obviously results over time in an increased pipeline, which will convert to increased revenues.

So, it, you're right, it's great to have the endorsement, if you will, from the NSA for the technologies in both ECC technologies in both classified and secured, but unclassified. But that is absolutely resulting in just a much broader awareness of ECC and growth in ECC adoption which is increasing our overall pipeline.

Okay. Great. Just one other one and I'll jump off. Herve, what you called the one-time costs for increasing sales, what exactly is that?

Basically, they're hiring fees and moving costs.

Okay. Great. Thanks.

Okay.

Thank you, Scott.

Your next question comes from Glenn Jamieson from McFarland Gordon. Please go ahead with your question.

Ian, with the Freescale licensing agreement, can you give us any additional details around the structure of that deal?

Glenn, I wish I could. At the request of Freescale for their competitive reasons, we've been asked not to provide anymore information than what you see in the press release.

We were hoping, as we always do, to get a stand-alone press release with that contract so we could provide more detail, but we often, as you know, will have situations, and this is not the first, where organizations that we license with will ask us not to disclose any information other than the fact that a license has been signed. So, I wish I could give you more information, but I'm just not in a position to do so.

If I were trying to characterize that agreement, is it more like a General Dynamics licensing agreement than say a Pitney Bowes licensing agreement? Can you give us some sense there?

I can tell you that there's, there are a number of aspects of this contract in terms of both patent licensing as well as products. But beyond that, it's difficult to give you any more information.

Would that licensing agreement contribute to your visibility going forward and help keep that recurring revenue level at 45% or higher than that?

Yeah, this, along with the other contracts that we've got, you know, line up very much with the model that we have, which we talk quite openly about, which is to build recurring revenue. We're not looking for and not trying to sign up one-hit wonders in terms of contracts that will give us a one shot of revenue and then provide no path to the future.

We're trying to make sure all our contracts are structured to provide ongoing revenue through ongoing royalties, for example, maintenance, so, every contract we approach we have that same model, it's just to build the recurring revenue, add to backlog where possible, through other prepaid royalties or ongoing royalties in the, like the GD contract, for example.

Right. And to go back to the notion that your deferred revenue has been declining, depending on the structure of the contracts that you sign, those dollars may or may not find their way into deferred revenue, but, for example, from a General Dynamics case, you've a 15-year contract in place that revenues are tied to the unit volumes with that customer.

I'll ask Herve to provide more details on that, Glenn, but, of course, some organizations choose to prepay their royalties up front as was the case with Rim where they gave us last year 3.5 million of cash up front and then we recognized the revenue, well, in this case over a three-year period. So that, of course, contributes to deferred revenues.

In another case, General Dynamics, that isn't the same model. What they've done is, they've provided us a small, you know, on-material up-front fee, but what they are committing to is a 15-year ongoing royalty payment where every quarter they send us a check, based on the prior three months product volumes that they're shipping. And in that case, of course, it's not contributing to backlog, but certainly is contributing to the ongoing path of building recurring revenues.

Just to add to that, Glenn, I wouldn't look at the movement, either up or down in deferred revenue account as being an indication of our success or lack thereof in the deployment of our strategy. As you know, if customers choose not to prepay, it won't be shown, it will be off balance sheet in the sense that it's part of our backlog of revenues to be recorded later, but because there is no immediate cash transaction, it does not make its way to the balance sheet.

Okay. One last question. Ian, can you go over what your pipeline of IP licensing opportunities looks like currently and maybe give us a sense of how it's changed over the last six months?

And can you give us an idea of which of those market segments that you outlined earlier, which of those segments maybe have some of the biggest near-term potential for you?

Glenn, as you know, we don't provide details on pipeline for competitive reasons, in any of our businesses, whether it be patent or product licensing. I can tell you, though, at a high level, we're very, very, very pleased, in fact, ahead of plan in terms of where we thought we would be compared to March of '04. March as you know, '04, is when we launched our patent licensing business. A year and a bit later, we're thrilled with our progress and as we look forward, I've got to tell you that the opportunities for more patent licensing contracts in the future is very strong. Our pipeline continues to build.

I would say, you know, in terms of opportunities, the consumer electronics space is one that we speak with, you know, very positive views in terms of the opportunities there. We certainly believe that in the defense contractor segment there are large opportunities, as well as organizations that are selling commercial off-the-shelf products to the government that will, in turn, find their way to the public sector. Those firms also represent large patent licensing as well as product licensing opportunities.

I can also just tell you that we are trying to, more and more often, as we build the pipeline, we're trying to combine product and patent licensing contracts where appropriate. We're trying to provide patent licensing contracts to organizations that need that coverage, but we're also trying to find incremental ways of adding value to their businesses by having them recognize the benefits of using some of our product technology.

So, more and more often we'll hope to see combined patent and product licensing contracts. But we're very, very positive with the building of the pipeline in both the product as well as patent licensing businesses.

Can I ask one last question? The latest announcement from the NSA was made early March. Have you seen any acceleration in terms of your licensing opportunities since that announcement has been made? It's been a few months. I would expect that you've started to see some kind of impact.

Yes, we have. There's no question that, and as I say in the press release, "I think that's one of the most significant announcements." It was actually in February of '05, Glenn, at the RSA Conference that the NSA made this announcement. And I think that's probably the most significant announcement for ECC, and as a result, the benefits that will have for Certicom. Probably even more so than the October '03 announcement. The October '03 announcement, of course, was wonderful for us financially in terms of putting ECC on the world map, if you will, more so than prior to that, and really got a lot of attention for us. But I think the announcement of ECC, as the exclusive digital signature and key management standard for secure but unclassified communications, which is the bulk of communications within the U.S. government, I think that represents just a massive opportunity for us looking forward.

So, yeah, it's brought a lot of attention to ECC, you know, in a similar way that it did for the classified market. I just think that it represents a very, very significant upside for us.

Ian, can I add something to that?

Yes, Scott, thanks.

It actually came, I think, as a big surprise to the cryptographic community that RSA was not part of the suite. There's a lot of RSA legacy out there, but the U.S. government's making the statement that they really only want a single algorithm. It makes inter-operability much better and just makes life a lot easier for them. So again, quite a surprise, even for me.

Okay, thank you.

Thanks, Glenn.

Your next question comes from David Wright from BMO Nesbitt Burns. Please go ahead with your question.

Good afternoon or good morning as it were.

Hi, Dave.

Hi. Could you update the number of salespeople that you hired and do you expect to hire more or are you kind of set where you are for the next year or two?

If you look at the sales organization, Dave, as I mentioned a few minutes ago, it's grown about a little over 40% in terms of total head count compared to a year ago, and we made most of that change in the last three to six months, if you will. We wanted to make sure we were ramped up fully by the time we got to the beginning of FY '06.

So, at this point, I would say that we're going to be monitoring the growth, continued growth of the sales force relative to the demand for, in particular, our products. I can tell you though, that we have a couple more ideas that we want to execute. One specifically we'd like to put some resource into Asia. And we've got some activities underway in Japan, but we want to broaden that to Northern Asia in particular for the Taiwan, Korea, China market. So, we do have some plans there.

So, yeah, I think you'll see some ongoing development in evolution of the sales force as we go forward. But I think the most significant changes in terms of both the skill set, the depth, the mix of technically-based field engineers, along with some sales account managers, come from the embedded space, I think most of that change has been made at this point and I think the significant volume of change is now behind us. And we just, we see it as just continuing to really reinforce and enhance the opportunities that we're seeing in the field. So you'll see some additional growth there.

So, incremental but not huge?

That's correct.

Yep.

Sorry, that's correct. But we're going to monitor that and as pipeline grows and demand requires it, we'll add more head count as we need it.

Okay. And I think you've kind of had an unwritten policy, I suppose of, you know, you monitor an area, but you haven't really had a sales rep in a particular geographic region if you don't have a customer yet. Are you still keeping to that sort of policy or have you changed your mind a little bit and it makes sense to drop some salespeople into geographic regions where you don't yet have customers?

I would say it's certainly more the latter. I think the former approach that you mentioned, we were, of course, cautious over the, you know, '02, '03 timeframe as we were watching our expenses very closely. Pre-NSA we were certainly careful not to over invest where we felt we couldn't get some short-term wins and benefit, but, no, I'd say at this point we're very much putting the resources in place where we feel we have not just short-term tactical opportunities, but long-term strategic growth opportunities and as a result, we do have a number of customers over in Asia.

I think this Asia investment, for example, that we're planning, is something that will reinforce our presence there, support the existing customers, but I think there's huge opportunity for is in Asia Pacific that we'll have an opportunity benefit from. I would say we're taking a longer term strategic view of the growth at this point in terms of how we're investing.

Okay, great. Intel shows up on your list of partners along with Beep Science and Freescale and a few others and Beep Science and Freescale have also signed up as a customer. Without predicting anything before it's actually signed, what could you say about Intel being a potential customer or would you expect that they just remain as a partner?

It's being short of talking about pipeline and I'm going to ask Brendan to expand on this somewhat, but we have a product architecture that really brings a lot of our ECC patented technology to the market in a very, very flexible and attractive way for our customers.

We have a strategy that is very appealing to the semiconductor industry, amongst others, so we've had some early success, as you mentioned, from a partnering perspective with Intel, TI, and Freescale, and I think some of those organizations will ultimately license some of our technology as well as being partners to leverage their product sales to other industries. So, they're going to be both partners as well as potentially customers in a general sense. And, again, Freescale is an example of that. Brendan, do you want to talk a little bit more about CSA and how that positions on the market?

Sure, Ian. Hi, David.

Hi.

So, yeah, basically Ian covered a lot of how it all fits together, but basically in addition to our architecture, we're really looking at expanding our ecosystem and adding a number of partners both in terms of chipsets, operating systems, like a Green Hills and other, you know, security protocol providers like the Beep Sciences that we've already partnered with. So, in a lot of cases we're looking to expand our solutions through partners and really go to market with a full platform that device manufacturers are looking for. And as you've noted, some of those partners could become customers in the future. But other ones it will be a partnership going forward. So without getting into specifics, that's kind of how the market will work.

Okay. And, Ian, I guess what we take from your comments is you're very encouraged about the opportunities in that and we've kind of seen, I guess by number, practically one customer announcement per quarter. Should we expect in the coming years, that the rate at which you announce customers picks up?

Are you talking about in general or in a specific area?

Yeah in general. Like should we, because if ECC is being used all over the place and you're being endorsed by the NSA to some extent, there is market expectations that we'd start to see two and three customers per quarter announced at some point in time.

We don't, as you know, Dave, we don't provide revenue and earnings guidance, we tend not to talk about pipeline.

So, it would be, we would love to be able to say yes, we're planning to announce one or two of these per quarter, I can't make that statement. But I would say that we see a significant growth in our pipeline.

I would also say that the patent licensing business, specifically, is one where it's very difficult to forecast timing of how pipeline will convert into contracts. It's more difficult, I would say, than traditional product sales, just by nature of what patent licensing is about. It's a more complex contract negotiation, if you will. So, it's a little more difficult to predict.

But, yeah, I would say that in general, we see a very strong outlook for the Company's growth and one would, I think logically assume that that would result in more contract announcements, more new customers as well as increased business with existing customers. I know it's not the answer you're looking for, but I would expect to have more announcements as we go forward. It's just tough to predict the timing of it.

Yes. Okay. And I think lastly here is, so the 400,000 of expense, that was kind of beyond the guidance range, just wondering what aspect of that was not terribly predictable in the model? Why wasn't that included in, you know, guidance of expenses being, I guess, 3.7 to 4.1 million instead of 3.4 to 3.7?

David, it's Herve. One is, the decision to provide a part bonus to the employee was one that was recommended and accepted by our board at the end of the fiscal year, given the tremendous improvement and successes that we've seen in certain areas during the year. So, we did not have visibility to that one prior to giving guidance.

On the aspect of the increase in the sales force, we have had many of these, which occurred towards the end of the year, so, again, as you know, as you hire people, it's not always clear which channel you will be getting them from and where you'll have to move them to and from. So, that one again, we did not have clear visibility to it, but they are one-time in that respect.

Dave, we actually hired more sales reps in the fourth quarter than we had initially thought we would be hiring. I mentioned that we started to build, converge and build the sales force about three to six months ago. And that really, if you line up with the growth and opportunities and the growth in pipeline, we actually anticipated that we would hire more of those people as we get into our first quarter. Well, I know, a couple of months ago or so, we really started to, we decided to start accelerating that hiring trend, so we moved a lot more of those hiring decisions into the fourth quarter. Frankly, in response to the pipeline growth and to make sure that we were ready for a fast start in Q1. So, there was a, a lot of it's timing, as well.

Sounds like encouraging signs. That's great. Thanks very much.

Thanks for calling in from the U.K., Dave.

Yes.

Your next question comes from Darren Saint from CIBC World Markets. Please go ahead with your question.

Hi, just speaking on behalf of Paul Lechem. I was just wondering, does the outlook, the 3.6, 3.9 million for next quarter, does that include any increase in sales force?

Yes, it does. It's all inclusive of our spending forecast for the current quarter.

So, therefore, if you do, you know, hire on some new staff, then the hiring and the moving cost is included in that, then, so they won't be considered one-time like they were this quarter?

We're not expecting any.

You're not expecting any hiring?

We're not expecting any variance to the guidance. There is enough bandwidth within the 3.6 to 3.9 to provide for all expenses.

Okay. The other thing was is, can you give any sort of metrics, or I guess a little more color on the utilization on the cost of sales on the service side?

I'm not sure what you mean, but let me just try and attempt it. Basically we, on the service side, it's really driven by demand in the marketplace. We have gross margins that we expect that are in excess of 60%. And I must say that we're very fortunate that we've been able to maintain those and we've got, because of the way we run our professional services model, we have a very, very high utilization rate within our professional services group.

Okay.

I can also just add a little bit of additional commentary. When, as was mentioned earlier, the project business does have cycles and when individuals or resources in the professional services organization have spare cycles, if you will, they are all very experienced and very knowledgeable product developers. And so we have the ability to have some of those individuals get involved in development projects and so on when they may not be involved in a services project, if the services revenue is down. So, that's a very, very important level of flexibility in the model that we have. So when they are on PS projects, as everybody says, we have high gross margin expectations, but when they're, during their down time away from PS, they're very productive in terms of the development of our product road map.

So there shouldn't be too much change in the quarter utilization rates then?

Well, let, by way of background there, typically PS organizations run in the area of 70% utilization. We run in excess of 90% of utilization as a result of being able to redeploy our resources to development projects.

Okay.

And yields, when you get into the yields and utilization model, I can tell you that at some point, if the PS project builds to the point where we get beyond our in-house resourcing, we have the ability to hire on a short-term basis, certain consultants, contractors, who can pick up some of that shortfall.

Okay. And I guess just finally, I know you mentioned you don't provide a guidance and this may, not be, might not be able to answer this, but do you know when you might expect to reach profitability?

We don't provide revenue and earnings guidance so it's difficult to give you any specific answer. I can say that you we're in the early stages of executing our growth strategy. As Herve said, we're very pleased with the results we found in FY '05 and we're very optimistic about continuing to execute successfully on that growth strategy.

Really our objective is to build incrementally, to build the recurring revenue through royalties, deferred revenues, and so on that we discussed earlier.

So at some point down the road, we may revisit our position on providing revenue and earnings guidance. Right now our focus is on building the revenue, focusing on growth, and ultimately that will get to profitability, which is our ultimate goal. As you can see, if you look at the last two to three years, you're seeing some steadily improving levels of our bottom line performance and our objective is absolutely to see that trend continue and improve as the top line continues to grow.

Okay, thanks a lot.

Thank you.

Ladies and gentlemen, if there are any additional questions at this time, please press the star followed by the one. As a reminder, if you are using a speaker phone, please lift the handset before pressing the keys. Your next question is a follow-up question from Glenn Jamieson from McFarland Gordon. Please go ahead with your question.

Ian, just back to the idea that you've increased your sales force, can you give me a sense of when you would expect those incremental bodies to be fully ramped up? I would think there's some period of time where they need to get familiar with the product and your customer set.

And then the additional question is, given the increasing demand you're seeing in the product area, are you seeing that the average sale per customer, is there any change in the value of that average sale? Is it increasing as well?

Generally, Glenn, I've got to tell you that we are thrilled with the sales and application engineers that we've added to the field. These are individuals who have come from the industry. They're very technically competent in the embedded space and from a ramp-up perspective, and this is a little bit different for me compared to what I'm used to. I'm seeing a much, much quicker ramp-up in terms of their ability to work with pipeline. We're seeing forecasted items from sales reps that we hired only a month or two months ago. That's partially because we're able to provide them with a strong source of both leads that we have found through events, trade shows that we're involved in. But as I said earlier, there are a tremendous number of unsolicited inbound leads that we're getting from the market that are being handled by these individuals.

And so, of course, there's an element of ramp-up in terms of the technology, but these are individuals that really understand the industry, the technology, the players, and the space in general. So, we're very, very pleased with their progress. So, I'm not looking at, if you will, a traditional 6 to 12-month ramp-up for these individuals to start producing, we already see strong evidence from the pipeline they're working on and the sales cycles they're in that they're already starting to produce.

In terms of demand and the resulting impact on pricing, it is absolutely our intent to drive the average sale price, if you will, contract value, up where we can justify it and without negatively impacting the adoption of ECC or our market share growth. And, of course, that would also, you know, be applicable to royalties, as well.

So, yeah, we're certainly trying to move into models that will provide us sustainable revenue growth but also higher revenue values where appropriate on licensing deals and in royalties where appropriate.

But our primary objective is to see ECC proliferate in the market. We want to be very complementary to the work that the NSA is driving, for example, with the defense contractors and manufacturers of technology-based commercial off-the-shelf products. We want to make sure we're strong partners with those organizations in terms of licensing both patents and products.

If you look at a contract, for example, that combines both products and patents, I think it's fair to say that you'd probably see a higher value on that, for example. So, it's all about making sure that we're providing good value, fair pricing, in a way that we don't stifle ECC adoption, but at the same time, grow revenues where we have the opportunity.

Scott, I don't know if you have any, or Brendan, any additional comments you want to make to that.

No, I think you covered pretty much everything we had to say.

Okay, thank you.

Thank you, Glenn.

Your next question comes from David Wright from BMO Nesbitt Burns. Please go ahead with your question.

Thanks. I just wanted to come back to the breakeven question again. It seems to me that over the years, I've noticed that software companies tend to breakeven roughly around the $30 million revenue mark on an annualized basis. But it seems that you have a targeted customer base in a limited number, actually and therefore, you should breakeven at a much lower level than that.

Is there anything in your business model that suggests something different than that? In other words, I see you're expanding, you're getting more into offering products as opposed to just IP licensing and you're also spreading your sales reps out. Is this going to change your cost structure much or should we still expect kind of a lower level of revenues to breakeven at?

David, you're quite right in your assessment in that we believe that we can reach profitability at a lower level, even with the fact that we've hired new sales reps.

The structure of our revenue stream is slightly different than many of the other software companies in the sense that we have a very high intellectual property business which we are building. And while there may be some products that are sold in conjunction and complementary to the IP, the IP itself is a very profitable sale because there is no follow-on deliverables in the sense that when we have product, we must maintain the service organization, we must maintain a, we must deliver on certain post contract deliverables. We don't have that with IP. So, it makes the model much more profitable. And so the increase of our sales force does not impact that very significantly.

And I would say, David, we certainly see growth in our product business in terms of our outlook, but we see very significant growth as we've said in the past, relatively compared to the product business in the patent licensing side. So we're very positive about the outlook in both of those businesses.

On the product side, you've got to build it in a traditional sense if you will, by adding reps proportionally to the amount of opportunity you've got and that is somewhat of a more traditional model.

Patent licensing, as Herve said, it doesn't have the same cost structure required in terms of the sales and marketing effort, for example, required behind it. It tends to drive up much higher yield per head count compared to more of the traditional product business.

Great. Thanks a lot.

Thank you, Dave.

Thanks, Dave.

Your next question comes from Scott Penner from TD Newcrest. Please go ahead with your question.

Thanks. Just a couple of follow-ups, if I may. Ian, you talked about the NSA. As it relates to the classified business, just wondering if you can discuss maybe the pipeline of the National Security addition of SecurityBuilder, how that's coming along?

Yeah, so, I think, Scott in general, the classified side of the market, so, just to take a step back, we're really in, ECC's in two standards, if you will, we're in classified, the classified standard, which is the standard adopted by defense contractors, and we're in the secure but unclassified standard, which has a broader reach in terms of attracting commercial off-the-shelf products, so both of those segments are going to need to incorporate and embed ECC.

On the classified side, for the defense contractor community, we are certainly working with a number of defense contractors and of course, that is project-driven as they pick up more projects requiring access to that NSA classified algorithm, if you will, that uses our ECC technology. That will drive product licensing opportunities for us.

So, yes, the NSA toolkit, when it was announced, is something that we, a number of quarters ago, we see strong interest in and demand, but it's also, it's not limited to the NSA toolkit. We see strong demand for our overall product, licensing of our products to the defense contractors in general, not limited to just the NSA toolkit.

Okay. Great. And then just, Herve or anyone. With the 45% of the revenue recurring and that obviously increasing dramatically from where it was three years ago, do you have a, you know, a targeted either absolute number or percentage of recurring revenue, when you'd be more comfortable giving some sort of revenue outlook?

You know, at this point, the model is still rolling itself out. We're still in the early stages of the deployment of our intellectual property strategy. We are, we have a model that we're executing on to increase our recurring revenues.

Beyond that, it's early for us to be able to determine when we would return to providing revenue guidance. We may at some point. We're just a little early yet to do that.

Okay. Thanks, guys.

Okay.

Thank you.

Ladies and gentlemen, if there are any additional questions at this time, please press the star followed by the one. As a reminder, if you are using a speaker phone, please lift the handset before pressing the keys. Mr. McKinnon, there are no further questions at this time. Please continue.

Okay, thank you very much for your interest and we'd be happy to take any calls offline if you'd like. Thank you very much.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating and please disconnect your lines.