BlackBerry Ltd (BB) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Certicom Corp second quarter 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. [OPERATOR INSTRUCTIONS]. I would like to remind everyone that this conference call is being recorded today, Thursday, December 8th, 2005 at 10:00 a.m. Eastern Time, and I will now turn the conference over to John Vinsig [ph], Investor Relations representative. Please go ahead.

Good morning and thank you for joining us for Certicom's conference call to discuss results for the second quarter of fiscal 2006.

On the call today from Certicom are Ian McKinnon, President and Chief Executive Officer; Herve Seguin, Chief Financial Officer; and Dr. Scott Vanstone, Founder and Executive Vice President Strategic Technology. Let me please remind everyone that all dollar amounts discussed today are in U.S. dollars. This call is also being webcast live on the Company's website 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.

Now I'll turn the call over to Ian McKinnon. Ian?

Good morning, and thank you for joining us. I hope everyone has had a chance to review the news release that we issued this morning. I'll discuss some of the highlights for the quarter, and then Herve will go through a discussion of our financial performance and our outlook for expenses. And after a brief summary, I'll be pleased to talk -- take any of your questions at end of the call.

Please turn now to slide 5. This quarter was an unusual one for Certicom. After many quarters of steadily increasing revenues and improving the bottom line, we experienced a drop in revenue. The primary reason is that there were delays in closing anticipated contracts. However, we're at various stages of the sales cycle with a number of very large companies for exciting potential agreements that will provide recurring revenues over a number of years. But we're finding that as we move up the value chain and negotiate with multinational companies for longer commitments, these contracts take more time to close. Management is disappointed with the results this quarter. However, our strategy is on track and our long-term outlook remains positive. We've an increased the number and size of companies that we're talking to and our focus is on closing as many of these contracts as possible. As we grow and sign more contracts on the recurring revenue model, we expect to steadily increase the stability of our revenue on a quarter-to-quarter basis. Our focus is on maximizing the long-term opportunity for Certicom. We had success in the quarter in two of our key vertical markets -- consumer electronics and government. In both markets we signed intellectual property licensing agreements and launched new products.

Please turn now now to slide 6 and I'll cover some of the operational highlights for the quarter, which was a very active period for Certicom. The intellectual property licensing agreement with D&M Holdings was important for a number of reasons. D&M is a leading consumer electronics company with well-known and respected brand names, including Denon and Marantz. D&M has licensed our ECC technology to implement Digital Transmission Content Protection, or DTCP, into its products. DTCP prevents consumers from making unauthorized digital copies of protected content. The agreement is key for Certicom because it is our first DTCP win and pushes ECC into the digital rights management arena. It's also a clear validation of our ECC technology and patents in the consumer electronics market. Another important achievement in the quarter is that we signed a intellectual property licensing agreement with nCipher. Certicom will help them meet the latest requirements from the NSA for securing classified and unclassified government communications. We'll also help them satisfy the growing demand for ECC. The agreement allows nCipher to use our patents in its hardware security modules and software solutions. Turning now product launches. We introduced a product called Certicom KeyInject, targeted at the consumer electronics and smart device market. It's an anticloning product that protects set top boxes, mobile handsets and other devices. Our KeyInject solution gives the manufacturers of these devices more control over their outsourced manufacturing process and helps prevent the cloning of devices and replacement parts. This product demonstrates that Certicom is working to drive growth through continued innovation.

Please turn to slide 7. Another product we launched during the quarter was a new version of Security Builder SSL. The updated version now includes the recommended algorithms to enable vendors to quickly and easily meet the NSA's requirements for securing government data, known as Suite B. This is the first protocol module to meet the Suite B requirements, which state that ECC should be used for key agreement and digital signatures. This module will help us take advantage of the growing demand for ECC as companies work to meet U.S. government standards and help drive further licensing revenue for Certicom. Also during the second quarter we announced that we've developed what we call fast ECDSA verified. This new implementation reduces the time needed to verify an ellyptic curve digital signature algorithm by 40%. New technology such as this will provide our customers with a significant competitive advantage. I'm also pleased to announce that we appointed Bill Lattin as Chief Technology Officer. With more than 20 year of experience in security, encryption and standards, Bill is well-qualified to lead our technology strategy. Although we have a vast and rich portfolio of patents, we always have two important goals -- to maximize the value of our current technology portfolio and to continually innovate to maintain our competitive advantage. In October we hosted our second annual ECC conference. Again it was a great success. The three-day conference drew leading experts in cryptography and security from all over the world including Australia, Europe and the U.S., and we had more than 100 attendees. Headline speakers from companies sufficient as Bell, RIM, Nokia and XM Satellite Radio talked about the future of ECC.

Turning now to slide 8. I'll review our announcements subsequent to quarter end. Our Java version of Security Builder GSE recently earned FIPS 140-2 validation, offering vendors yet another module to help sell into the important government market. It's also another first for Certicom. We're the first company to offer FIPS 140-2 validated modules in both Java and C programming languages that meet Suite B requirements. We signed another licensing agreement, and this time with mobile computing company, Realm Systems. Realm licensed Security Builder IPSec to build a standards-based, virtual private network into its mobile enterprise platform.

Slide 9. We also launched Certicom Security for DRM. A comprehensive platform that delivers robust digital rights management, or DRM, implementation. It secures multimedia capable phones, handheld devices, consumer electronic devices and set-top boxes at every level from silicon to the application. In conjunction with the launch of Certicom Security for DRM, we announced a partnership with Elliptic Semiconductor to offer pre-integrated hardware that enable chip designers to include hardware-based security for digital rights management.

So at this point, I'd like to call on Herve Seguin to discuss Certicom's financial performance in the second quarter of fiscal '06.

Thank you very much, Ian, and good morning, everyone.

Please turn to slide number 10. Revenues for the quarter were $2.2 million compared to $2.6 million for the same period last year. As Ian mentioned this was primarily due to delays in signing contracts with large multinationals. Operating expenses were in line with expectations at $4.1 million compared to 3.4 million in the same quarter last year. The increase was due to the strengthening Canadian dollar as well as higher third-party direct cost of sales resulting from product sales mix and the fact that we initiated the practice of accruing a portion of the annual bonus payments. On a GAAP basis the Company posted a net loss of $2.3 million or $0.06 per basing and fully diluted share. This compared to a net loss in the same period last year of $1 million or $0.03 per basic and diluted share. At quarter end, Certicom had $22.5 million in cash compared to 25.1 million at the end of the first quarter and 29.1 million at the end of the same period of last year.

Please turn to slide 11, and I'll run through the year-to-date numbers. Revenue for the six months ended October 31st was $5.7 million, up from 5.5 million in the same period last year. Operating expenses for the six months were $8 million compared to 6.7 million last year. The increase was due primarily to the same factors I mentioned in the discussion for the quarter, as well as higher sales costs related to commissions, travel and employee relocations in Q1. The year-to-date net loss on a GAAP basis was $3.1 million or $0.08 per basic and fully diluted share compared to $2.2 million or $0.06 per share basic and diluted in fiscal 2005.

Now could you please turn over to slide number 12. While Certicom does not provide guidance on revenues or earnings, we do provide guidance on operating cost, and for the third quarter of fiscal 2006, including cost of sales we are expecting expenses to range from 3.8 million to 4.1 million, unchanged from our guidance in this past quarter. Certicom has a solid track record of prudently managing its costs and we expect to continue to do so and intend to maintain our current expense structure as we fund future growth. Certicom has a strong cash position and debt-free balance sheet. As a result, we have the financial strength and flexibility to continue to execute our growth strategy.

To provide more details on Certicom's position and outlook, I'll turn the call back over to Ian.

Thanks, Herve. We're now on slide 13, provide a brief summary of where we see Certicom today and in the future and then open up for questions. ECC adoption is steadily growing. The U.S. government has standardized on the use of ECC and the NSA's recent Suite B announcement specifically provides the details of its use for key agreement and digital signatures. We're seeing increasing demand in the public and private sectors. Certicom has exciting opportunities in the high growth vertical markets that we're targeting. We're actively looking to maximize market share by innovating in the encryption field and launching new products and solutions that meet customer needs. So despite our disappointment with Q2, we are progressing through the sales cycle with a significant number of large multinational companies. Our focus is on contracts that deliver multiyear recurring revenues. We're very confident in executing this plan. With the world's largest and most recognized portfolio of ECC patents, coupled with continual innovation we have a strong foundation for building our business. We are committed to delivering sustainable profitable growth. So at this point we'd be pleased to answer any of your questions. Operator, we're ready for the Q&A.

[OPERATOR INSTRUCTIONS]. Scott Penner, TD Newcrest.

Thanks. Herve, maybe first of all, you could just go through the higher third-party cost of sales? Which products are involved, and what do they contain? It seemed to have quite a big impact on the margins.

Okay. Firstly, the -- on some of these products that we deliver, there is a hardware element where we have to obtain third-party products. For instance, we talked about the relationship we have with nCipher where some of their hardware security modules are incorporated into our -- into the delivery of the product solutions that we provide to our customer. So that's an ingredient and mostly the impact that it had on the current quarter. We will from time to time see that. It has -- we've seen an increase in the last quarter depending on the demand for the solutions that would require these hardware security modules. We will see from time to time a higher demand for it.

And, Scott, it's Ian. Just to add to that. We're bringing out products and solutions that may, in fact, require the incorporation of hardware security modules. In this case that's what you're seeing in the financials. We ensure that we get a high margin markup that's appropriate and just for your information, from a -- a commission perspective, we commission the sales force only on the margin, not on the full third-party revenue amount. Products like KeyInject, for example, have a very high average sale price. They're very, very competitive. We have a unique offering in that market. And we believe that will drive significant growth for Certicom, that particular solution, for example, does require some third-party hardware security modules. So we will ensure that we're modelling that into our future business models as we go forward. But Herve's right. It's really been a sort of one-up situation. It's not something that we get a lot of, but the more KeyInject solutions, for example, that we sell the more we'll see of that. So we obviously have to ensure that we're modeling for that.

Okay. And just on the -- talking about as the business matures going after larger opportunities, should we really guard ourselves for while the business is in this stage increasing quarter-to-quarter volatility, both positive and negative?

Scott, again, it's Ian. I can tell you that there's really two facets to our business. I'll say there's the sort of the day-to-day regular operations of the business and that part of the business certainly, I would have to say, let us down in Q2. There's no two ways about it. We -- also as we've stated had a number of contracts slip out. So I am -- I personally, short of providing guidance, which you know we don't do on the revenue or earnings front, I don't want to go through another quarter like Q2, we're certainly not planning for it. We are in -- as I've stated many times in the past and I'll continue to state, we have never had so much opportunity facing this Company as we do today, and all of the opportunity that we're working on, all of the various large multinational accounts that we're trying to close are all very well-qualified, they're funded projects. We are at various stages of negotiations with all of those organizations and certainly we need to be able to announce those, of course, Scott, to provide confidence to the market that those types of contracts are closing, and we'll do that as quickly as we can once those contracts are closed. Sometimes we get situations where companies don't want us to make an announcement for competitive reasons. They don't want their market to know the kind of technologies they're licensing from Certicom so in that case we'll probably make some generic references without mentioning company names, just to provide some guidance to the market that contracts have been closed.

So to sum up, we have to ensure that our regular tactical business continues to contribute and that's something that I expect will continue in terms of growth from that business and I would certainly hope that these contract negotiations proceed that you'll see evidence of these larger strategic contracts being closed that will, I think as I've stated in my comments, they'll add to the stability of the recurring revenue model. Every one of these contracts has a multiyear component to it. It has quarterly royalties that will contribute to the recurring revenues, so as we bring more of those in it'll augment our traditional business, if you will, and I think that will provide us long term sustainable growth and profitability. So I'm not planning on -- I don't want a repeat of Q2. Again, every now and then you're going to get a bad quarter. We certainly had one in Q2. I'm not suggesting that we won't have a bad quarter again. But certainly, it's not something that and is not the norm. I expect to see growth from this Company. I expect to see growth being contributed by the sales force, and we have the people and the pipeline to do it.

Just looking at -- and I appreciate your answer, maybe looking at it from another way. Do you have the resources to -- as people are chasing the larger deals and the deals that are probably better from the long-term perspective, do you still have the resources to land some of the smaller ones in order to backfill a quarter like this?

Yes, I do. I'm not concerned about that. I will say that as the business grows and as the pipeline grows, and I've got to say that over the last 6 months -- 6 to 12 months, this pipeline of large strategic accounts have grown dramatically. It's one of the reasons why we've added people like Bill Lattin, we've added other people in the organization within the product management group to help on business development activities. So it's not just a question of adding more sales reps. We certainly have the right number of sales reps in place to drive the day-to-day business. We've got people in place to drive the strategic account negotiations and as the business requires, we will continue to add more resources. But as I said today, I can tell you that we have not had any discussions, we're not planning -- on the one hand, we're not planning any corporate-wide downsizing because, frankly, we need all these resources to close and deliver these accounts, so to your specific point, we will add resources as we need to ensure that we're investing and driving the growth. So as I said today, in conclusion, I'm confident that we have the resources necessary to close the business that's in front of us, and as these contracts closed, based on delivery requirements, we may in fact, I suspect, add resources on an as-needed basis.

Okay. And just lastly, Herve, just looking at the expenses this quarter as you define it being 4.1 million and your guidance for next quarter, I would presume you're looking at a higher revenue for next quarter. How do I -- just looking at the cost, variable component of the extra revenue would seem to suggest that you're going to be at least at the high end of your guidance.

At any given quarter, we have some element of costs that are up or down. In this quarter, we mentioned specifically the third-party costs which was an element. I can tell you that in the common quarter we're not looking at that at this point as being a significant factor. So there's a number of factors on quarter-to-quarter basis. We still believe that the range we're in is the right one in terms of guidance for the quarter. At this point in time, we -- I don't believe that we're at the high-end, but as the quarter progresses, we'll have a better view of it.

Okay. Thank you.

Thanks, Scott.

Thanks.

Peter Misek, Canaccord.

Hi. Thank you. Actually, it's Duchen Batariche [ph] on behalf of Peter Misek. Question also on the pipeline. Is there anything that you can tell us that -- anything new that you've learned in dealing with these larger multinational -- something that -- something different that perhaps wasn't available to you last quarter?

No, Duchen, I can tell you that we've, in fact, started down a fairly active set of negotiations of more firms than we had even three months ago. So that -- the list of -- and I use the term loosely, but strategic multinational accounts, that list has grown. So we're getting more opportunity. I would say that the thing that is a common characteristic to all of them is the fact that they are all seeing the benefits, not only of ECC technology, because they're virtually all -- for the most part, not exclusively, but for the most part, they're all ECC-based opportunities. They're all being -- there's an interest in ECC and Certicom because of the government endorsement of ECC and Suite B. And as we've stated many times, as goes the government in terms of standards, so will go the private sector. So that's one facet or one attribute to -- that's common, I think, to most of these organizations.

When you get into the consumer electronic space, however, that's not really going to be even indirectly impacted by government, I think the key there is that we're seeing more standards organizations adopting ECC in its standards infrastructure, and we saw that with the DTCP and the D&M win. I think they're simply seeing the benefits of ECC in small constrained devices where it is the absolute best technology for that environment and they saw the benefits that the saw. And they see the same benefits that the NSA saw, so I think it's all related as -- in summary, to the increased adoption of ECC both through the government initiated programs like Suite B but also just the sheer growth in the demand for high-quality security in constrained devices in area such as consumer electronics. So we are seeing more and more of these large multinational opportunities come along -- at the risk of repetition, I also want to state that these are contracts that we expect to close in the short term, long term and mid-term, so these are not contracts that are four or five years out in terms of closing. These are contracts that we are very focused on getting to the Finish Line as quickly as possible. And they are at various stages but a number of them are contracts that I've stated in my comments that we want to and expect to close the majority of as quickly as possible.

What do you see as main constraints to closing? Is it just justifying why they should license from Certicom, or is it a price negotiation issue? Are they -- is it just a bureaucracy issue, these large companies having to go through certain channels to sign on the dotted line?

Yes, from my experience there's nothing abnormal here in terms of the time cycle. As I said earlier, many of these contracts, many of these opportunities didn't exist 12 months ago. I just started talking about these opportunities really, oh, six to nine months ago in terms of the magnitude and volume of them. So large contracts of this type take 6 to 12 to 18 months in terms of the sales cycle. And we're well along with many of them. There's nothing abnormal from my perspective in terms of how much time it takes. The contract negotiations are very typical. It starts off with the business rationale, the business justification, the business case on the customer's side to justify why the technology is a competitive advantage for them. It moves to the business terms in terms of negotiations around pricing. Then it flips over to the contracts group, who try to take their pound of flesh on pricing and the legal group who try to structure the contract. So these are all typical, very normal attributes of a business or of a sale. And when you're dealing with firms of this magnitude -- and obviously we're talking of multinationals who have billions and billions of dollars of revenue -- they have their processes. And they're no more onerous than we all can imagine. They're typical for large organizations. Certainly, if we were dealing with smaller organizations, I suspect the contracts would go through quicker and they'd be significantly smaller, so we're talking about very large recurring revenue multiyear contracts so those types of agreements don't go through in a matter of days or weeks. It's going to take months, if you will, to get these through organizations of the nature that we're talking with. So nothing abnormal here. Pretty much the normal sales cycle for large organizations.

Great, great. Last question for you is that the recent DRM partnership with Elliptic Semiconductor, does this target a different market than, perhaps, some of these larger multinationals or is that more geared towards that market?

It's very much geared to it. It's all part and parcel of our focus on consumer electronics. What this partnership does, and we're looking at various offerings in this area, it allows us to provide IP cores in the consumer electronics DRM space. So it's very complementary to our overall press there. I mean, what you saw with the D&M Holdings was a patent licensing agreement, but there are also some very, very strong technology and product offerings that we can bring to these same organizations and so partnerships with firms like Elliptic Semiconductor, the announcement of our Certicom Security for DRM platform all add up to a comprehensive offering that includes both patents, but also some very strong technology products that we're bringing to the consumer electronics space for DRM.

Okay. Great, thank you.

Thanks.

David Wright, BMO Nesbitt Burns.

Thanks very much. Good morning,.

Good morning, David.

Good morning.

The contracts that you're currently in negotiations of, are you in general expecting immediate revenues once the contracts are signed that would impact the quarter?

Dave, I can tell you that there's a mix here. There -- and I'll break them into two or three categories. On the one hand, category 1, there are absolutely some contracts that will contribute some immediate revenue plus provide ongoing royalties per quarter over many, many years.

Yes.

So some -- the second category is we are -- we're closing contracts that may not yield not only immediate revenue, but they may not yield revenue for a couple of quarters. It takes, in the design win space, for example, when we sign a contract, the product that we're being embedded in or that our technology's being embedded in may not ship for three to six months so we start to get royalties when those products in our customers' products -- when those products start to ship. So that's really a second category where we may not see revenue for a while, but again that revenue is recurring revenue quarter-by-quarter, multiyear. And the third category is where a contract will come in, and we'll start to experience immediate recurring revenues, again, on a quarter-by-quarter basis through royalties, so --

How was that different from the first?

The first I mentioned that some of the -- in the first category, there is an immediate up-front payment that we can recognize.

Oh, okay. So that one has a past infringement element to it or something.

Well, it may not have infringement, but it may be immediate revenue that we can recognize from licensing some of our products. There may be a perpetual license that has revenue associated with it that we can recognize immediately and then the royalties may start immediately or they may start three, six, nine months down the road.

Okay.

In the -- in some of these sectors where we're dealing, some of these organizations -- some of these companies deal in very fast product turnarounds where products need to get out the door very quickly and they have -- there may have a one to two-year life cycle so there's an immediacy in many of these companies to get product to market as quickly as possible, and some of the benefits we provide is a time to market benefit that they couldn't get otherwise.

And, David, there's also a maintenance element in many of these contracts so while the revenue stream in terms of royalties may be delayed by six to nine months for the purposes of integrating our solutions into our customers' end product, during that period of time, there still is some hand-holding and helping and, therefore, there's a maintenance agreement associated with that.

Also I'll add one comments. Short of providing any specific guidance, Dave, that we've done modeling within Certicom on all of these agreements that we're working on and made a judgment in terms of the number that are going to close. And so we have a pretty good idea of what our recurring revenue per quarter looks like, sort of on a per-quarter annualized basis, say, starting in the next 6 to 12 months, and I can tell you that if we look at it compared to today, we see some quite significant recurring revenue on a quarter-to-quarter basis coming in that will provide a lot of stability that obviously we didn't have in the second quarter. So as these contracts close, it provides a very, very comfortable -- I won't say revenue cushion. That's probably too strong. But it provides a very strong revenue foundation quarter-by-quarter to build the business on top of, much more than we've had to date. Today what we have is much better than it was a few years ago, but as I look out 6 to 12 months, it will grow quite significantly in my estimation.

And adding in what Herve just said, so should we see the services line move up as a leading indicator?

Maintenance revenue will always grow as a proportion to the number of licenses that are being sold. Absolutely.

Okay. The products that you've announced in the quarter, the KeyInject and the Security Builder and the other couple, do they have different sales cycles? Are they -- should we be thinking that those products actually have a more immediate need and someone just comes along and says, okay, I'll start using that, or do they also have long-term sales cycles?

Well, the typical sales cycle for our traditional products, our protocol tool kits and newer products, as you mentioned, such as KeyInject, they all tend to have an -- on average, I'm going to say anywhere from three to nine months for a sales cycle. KeyInject, we've already had a number of sales that have occurred with that. We haven't announced them because they're not -- they're not -- companies that we've been able to get released from. But they're typically in the, as I say, in the six-month range. When you're getting into the much larger deals, as I've said earlier, they can take in the neighborhood of up to year, maybe a year and a half to negotiate, depending on the scope and scale. But the products that we've announced should not be that long. It's typically in the six to nine month range in my estimation.

Okay. Great. And with all the news that's going on in the government area, and I realize that you've really only announced a couple of defense contractors so the numbers might be a tad sensitive, but can you give us any sense that your government contractor business is growing?

I can tell you that -- yes. And I guess the thing about the government market, as a general comment, is that it doesn't move as quickly as, say, the private sector or commercial sector so we have -- if you look back to 2003 with the NSA announcement, that was obviously very pivotal for us. That whole standard of ECC and Suite B has taken approximately about a year and a half for the whole Suite B architecture to be announced, and as you know, it was announced earlier this year. So that is a catalyst that allowed contractors to start actually having a Suite B architecture to build to -- or the definition to build to which was missing up until earlier this year, had not been issued by the NSA. So as a result of that, we now are able to -- we've always seen a lot of activity with the defense contractors. They've had to hold off until they've had some architecture issued by the government to build to. So we're very confident on the government supplier side, both defense contractors but also the general suppliers who provide products in to the general government usage, which tends to be commercial off-the-shelf products. All of those sectors are quite active. You've seen some public announcements from other firms who have indicated their commitment to ECC Suite B in their current but also future products. There are a number of organizations who are -- who have made those statements and I think that just reinforces the fact that there's a recognition of the adoption of ECC and the need to have it embedded in products that are sold to the government market as well as to the private sector.

Great. Thanks. We look forward to the announcements.

Thank you, David.

Thanks, David.

So do we.

Glenn Jamieson, MGI Securities.

Ian, it was about three months ago that you announced your patent licensing deal with D&M Holdings in the DTCP space, and that's an area that appears to have good opportunity for you. Have you seen any impact since then in terms of your discussions with other users of DTCP technology? Has that licensing deal accelerated the discussions that you'd be having with those players? And would it be reasonable to assume that if you're successful with further licensing in that area, that might further speed up discussions you're having with some of the other players in that area?

Yes. Short of -- Glenn, thanks for the question. Short of getting specific about any one organization, there's no question that the D&M announcement has had a positive affect on the recognition of our ECC patents in the DTCP standard. We continue to conduct discussions and are at various stages of discussions with firms who use DTCP. We have not disclosed, as you know, who or how many firms that we're talking to. But I'd say the general high level impact of that contract was very positive and it can only have a positive effect on the organizations that we're speaking with. So, yes, it has helped, to varying degrees depending on which company you -- we're talking with.

All right. And then I think we've talked a fair bit about the consumer market as being a good opportunity and the government or military markets as providing some nearer-term opportunities as well. Have there been any other areas that have popped up recently that look more promising nearer-term than, say, you would have thought 6 or 12 months ago?

I would -- yes. I would say that there are opportunities today that we wouldn't have envisioned 6 or 12 months ago. So absolutely there are areas, and they may be sort of related to the consumer electronic space. There are companies that are adopting technology because of some standards that are adopting ECC that we didn't see necessarily moving as quickly as we thought they would a year ago. So I would say if you just generally categorize the constrained device market -- not necessarily wireless, but any company in the constrained device space. Some of those organizations that we're talking to today that I've alluded to, the large multinational accounts, some of those organizations are in related sectors to the device -- the constrained device market. But are very, very, very rapidly moving to adopting our technology. I'd say the other market that we saw maybe six months ago but not a year ago is the whole KeyInject market place. So this is really a manufacturing solution, if you will, not really an embedded solution, it's a bit of a departure for Certicom in some ways but one that's being received very, very well. Many of the components from KeyInject solution came from work we have done in prior years at places like XM Radio, for example. And we've been able to package up those components and had quite a positive response to the market for -- to KeyInject in the area of anticloning, for outsource manufacturing, for the automated injection of keys, which is a very critical area in the manufacturing process. So that's something that we had -- had an eye on about a year ago. But the -- today it's much more -- it's moved much more aggressively in terms of opportunity than I think we initially envisioned a year ago.

Just a further question there. In the KeyInject area, and you're talking about outsource manufacturing, I think we'd be looking at some of the MS companies, the Flextronics of the world that -- those types of companies or maybe some of the ODMs that are in Asia right now. Is that the type of market that you're discussing there?

Yes. One example would be the fabless design marketplace, firms that design ICs and then go to third-party foundries in China, for example, to have those products manufactured. They want to make sure that if they have requested a hundred thousand products be manufactured that 110,000 don't get manufactured. In other words, we're trying to kind of help them control the gray market, the market where additional products leak into the market that are not necessarily authorized, if you will, by them. And we have processes in place that prevent that -- those products from being used in the market that they're target at. So the whole -- the notion of outsourcing into third party products is an area where this KeyInject solution is targeted.

And when you talk about constrained devices, can you give some specific examples of some of the related devices in the consumer electronics market, for example, that you might think provide some opportunity?

Well, if you look at the whole supply chain of the digital media -- the flow from the end point, the terminal or flat screen through the DVD, the receiver, through to the set-top box, I mean, that whole supply chain is an area of opportunity for us. And, again, you just -- if you follow standards like DTCP and where that standard is being incorporated and adopted, that one area. If you look at the related flow of digital media in terms of some of the set-top or the -- or the PC market where there's some download into laptops or PCs where signals are being transmitted to a flat screen in a wireless mode from a wireless access point product, I mean, that's all in the consumer electronics space for transmitting digital media. So there are a series of products and segments there that we think is -- represent opportunity for us.

Ian, why don't you mention the sensor market?

Actually, maybe, Scott, why don't you?

Thanks for interjecting. That's good example.

I can do that, Glenn. Yes. The sensor market, these are extremely constrained devices. Typically, these devices are going to be the size of dust. And the -- if you want security on this, the only thing that will work -- and it's high grade security -- is Elliptic Curve Cryptography. So we've been doing a lot of work on standards bodies. We -- we are editing the security portion of what's called the Zigbee standard, and we see this as a huge market going down the road.

Okay. And then can I ask one last question just back on the KeyInject aspect. Given that you're likely talking to some larger consumer electronics manufacturers in Asia that would all either have internal manufacturing capability or being used in some kind of outsource partner, is it reasonable to assume that some of the contracts that you'd be negotiating currently would have an element of the KeyInject technology in part of a broader discussion?

Absolutely. One of our objectives, as I've stated in the past, is that we want to see some of our -- for example, our patent licensing discussions start to incorporate in a broader sense more of our product, more of our solutions so there's no question that we're trying to, when we talk with organizations, it's not just about the potential patents that they need to license or should license. It's that plus also the incremental value we bring in capabilities such as KeyInject and other areas. So we've had some evidence of that in the past. You may recall the Freescale contract last year. We stated that that's a combination of both products and patents, and we want to see a tighter integration in terms of our sales cycle around trying to provide a blended set of technologies in incorporating both products and patents, so absolutely.

Thank you.

Thank you, Glenn.

Paul Bradley, Fraser Mackenzie.

Good morning. A number of questions, just to pick up on a number of points there. Can you just clarify for me, when you talk about recurring revenue, can you just explain how you would define that in terms of the components that make that up?

Paul, good morning.

Good morning.

It's really made up -- recurring revenue's made up of a number of factors. Firstly, we talked a minute ago about the maintenance revenues so companies license our tool kits. They pay a percentage of the purchase price on an annual basis in order to provide updates, upgrades, hub line support, those kind -- that's one stream of revenue. The other stream of revenue is the -- is royalties, and that comes in really in two forms: One, which is the more common form is customers -- or our customers will end up paying us a royalty on the basis of their end products being deployed. So that's one method of doing it. Another way will be as we've seen in the RIM agreement, for instance, of a year plus ago where they bought a prepaid, predetermined number of units -- receipts at the time we signed the contract so that one we have a great visibility in terms of the revenue stream over a period of time. So those are the main elements of the recurring revenue as we have today. So that's -- those are the main areas.

And, Paul, it's Ian. I expect the bulk of our recurring revenue in the area of royalties to be latter category, in other words, companies that are sending us a royalty check every quarter for the products that they've shipped that embed our technology. It's always nice to get somebody like RIM who will prepay for a block of seats and give us the cash up front, in which case we will spread the revenue recognition out over a number of years, but that's more the exception than the norm. So recurring revenue for us isn't necessarily always reflected in backlog or deferred revenue.

Okay. And just for my education, to be a little bit more precise about playing on deployment, are we talking there strictly a royalty based on licensing of intellectual property, or are we also talking where they have used, say, your software kits to develop something that goes into their product and then they pay a royalty on shipment at that point is well?

Paul, it's on both situations. If we take, for instance, the case of General Dynamics where we have of a 15-year agreement, they have contracted to pay us a certain fee for every product that they will ship. We -- they did not, in this particular agreement, license any of our software tool kits. On the other hand, we have other agreements whereby we license the tool kits and the -- our customer contracts to pay us -- I'll call it a deployment fee or a royalty on the deployment of those products into theirs. So there's -- so that one is coupled with the licensing of software tool kits.

Okay. Looking forward and built around the opportunities that you've been discussing on this conference call, is it correct then that the bulk of the future revenues you would expect to get, be those a recurring form, are based around strict IP sales, or do you anticipate the use of software tool kits to implement is also going to increase?

We've said in the past, Paul, that we expect growth in both of those areas. We have also -- I mean, certainly there's a lot of growth potential in the patent licensing area because it's really coming from zero, if you will a year and a bit ago. But as ECC adoption grows, we expect to see royalties from both -- growth from both our products as well as our patent business.

Okay. Just on the DTCP, is that part -- you've talked about various discussions going on with large multinational corporations. Is that DTCP a significant component of those or just a -- one facet of many discussions?

Paul, I think it's one facet of many discussions. We are having, as Ian mentioned, we've got a number of discussions going on with various multinational companies and they entail a broad spectrum of the products that -- the product portfolio we have.

Okay. Now jumping back to a question that I think was asked right at beginning of the call, what's the current headcount and how many people should I understand are actually engaged in sales, marking, contract negotiation-type activities?

Well, we currently have -- at any given point, we're about 100 people company, and we don't disclose very specifically who we have -- how many people are directly customer facing. One thing we did say is that we increased that substantially in the last year in order to have many more people customer facing, and we don't provide that information purely for competitive reasons. We just wouldn't want to have that information in the marketplace.

I thought we were all in sales, Herve.

Well, that's a good point. We have 100 people in sales.

Okay. But I could use some industry norms and come to some conclusions there. Next question, just to understand things. You spoke about on a specific contract nCipher, IP licensing agreement with them to put, I guess -- or use your intellectual property in developing hardware modules. Maybe I'm a little bit confused here. They are providing these under the NSA agreement, or they're going -- doing stuff around the outside that? I just wasn't quite sure why they needed to license patents from you.

Scott, maybe you can take that question.

Yes. I've known those people for years. I know them before they started the company, and I've talked to them about Elliptic Curve Cryptography for a long time, and they were adamant, we will never license until we have a customer. And it turns out now they're now -- they have a number of customers in Europe who want to use ellyptic curve technology and they're actually non-government people. They also have a big presence in the U.S. government, so I'm sure that they will at some point move to implementing Suite B so they just only had to take a license at this stage.

Right. So the license at this point is to supply European customers who would not be caught -- or would not be included under the umbrella of the -- your previous IP licensing agreement with the NSA.

That's correct.

Okay. If they deal with U.S. customers, they presumably can fit under that umbrella, and then they have no requirement to license any additional intellectual property from you?

Well, they want to sell commercially. As opposed just to the government, and to sell commercially, they need a license from us.

Okay. Maybe that just brings me on to just one other quick question there, which is, if you're looking at supplying their type of devices to a government market, is that a relatively small opportunity? Is that sort of -- I don't know, tens of thousands of devices as opposed to hundreds of thousands, or how should I understand that?

Maybe Herve's better to answer this.

Paul, I'm not sure I have the answer to that.

Okay.

Certainly I would think that at the price point, it's probably not hundreds of thousands of devices.

Right.

But it certainly can be thousands of devices over periods of time, whereby our solution would incorporate the nCipher hardware security modules.

Okay. Last question because I'm sure other people want to ask things. In terms of -- you've spoken about large multinational corporations. I'm assuming it's correct that you're talking to specific divisions of these on specific opportunities. These aren't, I don't know, products that are being launched across the entire organization, if you'd like.

Oh, no, it varies. Some of them are corporate-wide agreements.

Right.

Some of them are with divisions that have products that are significant revenue contributors to the overall corporate revenue flow, so it really depends on a case-by-case basis but, no, some of them are very much company-wide.

Okay.

And on those organizations where we talked to divisions, they're also a great opportunity for some follow-on activities with them.

Right. Okay. And are they existing customers? I mean, do they already use software tool kits for doing other stuff, or are they essentially brand new customers to you, or potentially new customers?

Paul, we have both. We have existing customers where we're expanding our relationship and new names.

Okay. Thank you very much, indeed.

Thank you, Paul.

Thanks, Paul.

Scott Penner, TD Newcrest.

Yes. Herve, I don't think I heard you actually mention the percentage of recurring revenue.

The percentage of recurring revenue this quarter is in excess of 60%. And -- but I don't want to mislead you to think it's going to be 60% at this point all the time. It's because they're recurring, and they're -- we're working off a lower revenue base for the current quarter.

Right. And do you differentiate internally between your IP licensing revenue and royalty revenue?

To a certain extent we do, but it's -- as we mentioned, we have royalties from two streams. One is directly from IP and the other is from our royalties -- royalties driven off the software licenses. So while we know what they are, we don't particularly pay a tremendous amount of attention at this point, because to us it's all recurring revenue.

Okay. And Scott, I wanted to ask you a quick question maybe. It was a few months ago now but there were a couple of noticeable announcements out of RSA relating to BSAFE contracts, whatever the terms were at both Sony and Nintendo related to game consoles. Now we have, obviously, some extremely high volume new generations coming up. What -- I don't know if those security decisions have been made on the new consoles, but obviously the content there is extremely valuable. What is your knowledge about the security and the product decisions that those companies may have made?

I don't think they have told people what key size they're working at. Typically it's 1024 bits, and that's not particularly secure these days. The U.S. government is now saying you should be moving away from that. You should be over two thousand at least. You should be at 3,000 bits, so I think that they have to move it up, and that's going to happen.

And I think the other aspect related to that, Scott, is that you've got some legacy products in these organizations who have years ago made some commitments to older technology, and there's an element here of that legacy product line needing to play out. But as Scott says, as the product lines evolve and security evolves, they're simply not going to be able to achieve the levels of security they need unless they move to ECC. Scott's right in saying that the recommendations are to increase the security and if you go onto the NIST website, there's a clear explanation of the difference in terms of performance between RSA and ECC. That's a government benchmark, and I think it's reflective of why many organization are moving to ECC. But there's an element of legacy here with some organizations where you'll continue to see for some period of time -- less and less, we believe, over time -- the use of older technologies.

Great, that's all. Thank you.

Thank you.

Cory Houston, Wellington West Capital Markets.

Hey, guys. Can you hear me?

Yes, Cory.

There's a number of licensing administrators out there, most notably for DTCP for you guys. Are you interested in getting involved with there, now that the DTCP standard is being set and there's going to be a lot of people lining up for that?

Yes. I may ask Scott to talk about that as well, but most of these -- many of these licensing authorities are organizations that really represent standards bodies who have endorsed the standard and they need to put a licensing authority in place to issue certificates that, in the case of DTCP includes ECC. So we may be talking to them and without getting too specific, we're, frankly, more interested, in some cases, not exclusively always this way, in dealing with the direct companies that are embedding those certificates in their products. But we're open to talking to the licensing authorities. We really have to look at this from an ROI perspective in terms of where do we think we can get the most return for our investment. But we certainly are aware of the DTLA, for example, which is the licensing authority for DTCP. They, again, represent the group that formed the DTCP standard, and -- but as you can note from the D&M Holdings contract, we went directly to the -- in that case, one of the organizations that's implementing DTCP, and we think that's a lucrative way to target that market. I don't know if you've got any additional comments, Scott?

Yes. I agree with you, Ian. We like to go directly to the company themselves as opposed to the licensing body. It gives us an opportunity to upsell them on other things or other technologies and our software, which we perhaps we wouldn't have the opportunity to do if we just went through the central licensing authority.

Okay. Great. Thanks.

Thank you, Cory.

[OPERATOR INSTRUCTIONS]. Mr. McKinnon, there are no further questions at this time. Please continue.

Thank you very much, everyone, for your interest in Certicom, and please give us a call if you'd like to get further information.

Ladies and gentlemen, this concludes the conference call for today. Thanks for participating. You may now disconnect your lines