BlackBerry Ltd (BB) 2006 Q3 法說會逐字稿

Welcome to the Certicom Corp. third-quarter 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 on Thursday, March 2nd, 2006 at 10 AM Eastern time.

I will now turn conference over to Tanis Robinson, Investors Relations Consultant. Please go ahead.

Good morning, and thank you for joining us for Certicom's conference call to discuss results for the third quarter of fiscal 2006. On the call from Certicom today 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 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.

Now, I will turn the call over to Ian McKinnon.

Thank you, and good morning, everyone. Well, it's been a very good quarter for Certicom, and I will go through some of the operational highlights that contributed to that performance. Then Herve will go through a discussion of our financial performance for Q3 and our outlook for expenses. After a brief summary, we will be pleased to take your questions at the end of the call.

Please turn now to slide five. We're very pleased with what we achieved this quarter. We've steadily executed our strategy and won new customers, with a focus on closing agreements based on multi-year recurring revenue. We are now seeing increasing new customer design wins translate into higher revenue, and continue to build a foundation of recurring revenue.

This validates our growth strategy and focus on closing licensing agreements in key vertical markets. With ECC adoption grow rapidly, the market for Certicom's technology is expanding. Our objective is to capture as much of that opportunity as we can.

Please turn to slide 6, and I will go through some of the operational highlights for the quarter. A key contract in Q3 was the signing of a multi-year, multi-million-dollar licensing agreement with a global manufacturer. The customer did not want to be named for competitive reasons. But I can tell you that they licensed our security software for a number of select products. We said before that we're working on many large agreements with multinational companies, and this contract is evidence that we're making progress.

We also had a number of product license design wins during the quarter. Varaha Systems and Realm Systems both licensed Security Builder IPSec. Varaha, an emerging leader in the mobile convergence industry, will use our toolkit to provide security in dual-mode voice and data mobility solutions. Realm Systems will use Security Builder IPSec to build a proven, standards-based VPN into its mobile enterprise platform.

We also licensed Security Builder Crypto to Zeetoo of Malaysia. Zeetoo will build ECC into its financial trading and secure messaging applications. And we believe this win is evidence of our continued progress and potential in international markets, including the Asia-Pacific region.

Slide 7 -- another important achievement in the quarter was the launch of Certicom Security for DRM, a comprehensive platform that delivers robust digital rights management as part of a trusted platform. It secures multimedia-capable phones, handheld devices, consumer electronic devices, and set-top boxes at every level, from the silicon up to the application.

Our Java version of Security Builder GSE earned FIPS 140-2 validation, offering vendors another module to help sell into the important government market. It's also another first for Certicom -- we are the first company to offer these modules in both Java and C programming languages that also meet the U.S. government's Suite B requirements.

Slide 8 -- we signed a design win licensing agreement with Sony-Ericsson -- again, for Security Builder IPSec -- subsequent to quarter end. They will be using our toolkit to securely add VPN functionality to 2 models of their smartphones. So clearly, we're gaining traction in the growing mobile VPN market, and increasing our presence with European-based manufacturers.

Another high-growth market is DRM, and Certicom is making substantial inroads there as well. Subsequent to quarter end, we announced a partnership agreement with Freescale Semiconductor to enhance DRM capabilities on mobile devices. We've integrated Certicom Security architecture with one of their multimedia processors to create a trusted platform and robust DRM. This builds on our already-strong relationship with Freescale.

So at this point, I'd like to ask Herve Seguin to review Certicom's financial performance in the third quarter of fiscal '06. Herve?

Thank you, Ian, and good morning, everyone. Could you please turn to slide number nine?

Revenues for the quarter were $4.4 million compared to $3 million for the same period last year. The higher revenue was driven by an increased number of customer wins and an increased royalty revenues from Certicom's products and intellectual property, including revenue from the multi-year agreement signed with a global manufacturer in December 2005. Recurring revenue totaled $1.8 million during the quarter, representing approximately 40% of Certicom's third-quarter revenue.

Operating expenses were aligned with expectations at $4 million, compared to 3.5 million in the same quarter last year. In the increase was due to a number of factors, including the strengthening Canadian dollar, the fact that this fiscal year we initiated the practice of accruing a portion of annual bonus payments; higher third-party direct cost of sales resulting from product sales mix, and increased sales commissions due to [our rise] in revenue.

On a GAAP basis, the Company posted net earnings of $142,000 or $0.00 per basic and fully diluted share. This compares with a net loss in the same period of last year of 909,000 or $0.02 per basic and diluted share.

Certicom maintains a strong cash position at $21.4 million in cash at quarter end. This compares with 22.5 million at the end of the second quarter and 27.5 million at the end of the same period last year.

Now if you could please turn to slide number 10, and I will run through our year-to-date numbers. Revenue for the nine months ended January 31st was $10 million, up from 8.5 million in the same period last year. Operating expenses for the nine months were $12.1 million, compared to $10.2 million last year. The increase was primarily due to the same factors I mentioned in discussing the quarter.

The year-to-date net loss on a GAAP basis was $3 million or $0.08 per share, basic and diluted, compared to 3.1 million or, again, $0.08 -- per share basic and diluted income in fiscal 2005.

Can you now turn over to slide number 11, and I will discuss our operating expenses outlook. Operating expenses for the fourth quarter of fiscal 2006, including cost of sales, are expected to range in the 4.5 to $4.9 million. The increase over Q3 is due primarily to the fact that we expect to pay bonuses at year end, as we anticipate that we will meet our internal corporate objectives for fiscal 2006.

We report in U.S. dollars, but the bulk of our expenses are paid in Canadian dollars. So given the strength of the Canadian dollar, we continue to face expense pressures. However, Certicom has a solid track record for prudently managing expenses, and are steadily winning more business. With a strong cash position and debt free balance sheet, we will continue to focus on achieving long-term and sustainable profitability.

Now, I will turn the call back to Ian for closing remarks.

Thank you, Herve, and please turn now to slide 12. I will give you a summary of where we see Certicom today and where we are headed.

Our market is clearly growing, both for ECC and for our technology. This is being driven by government standards which specify ECC for field of use, and is translating very quickly into private-sector demand. The trend is particularly visible in key verticals such as DRM, government, and mobility.

Certicom has a clear strategy to capitalize on our growing market. We're focused on maximizing our share of the large opportunity in front of us through continual innovation and launching new products and solutions that meet customer needs in targeted verticals. At the same time, we're focused on signing multi-year, recurring revenue licensing agreements.

We've demonstrated discipline and focus in executing this strategy, and it is clearly yielding results. In addition to the revenue growth we saw this quarter, we're seeing more design wins with larger customers, and building our recurring revenue stream.

We're still in various stages of the sales cycle with a significant number of multinational companies. These types of agreements take time to conclude. But we are very encouraged by the level of interest in our technology. We are on track toward achieving our goal of delivering sustainable, profitable growth over the long-term. So at this point we would be very pleased to answer any of your questions.

(OPERATOR INSTRUCTIONS) Scott Penner, TD Newcrest.

Herve, can you just do me a favor and review what we should read into the deferred revenue movements of Certicom, quarter to quarter, and what the significance, if any, of the increase this quarter is?

First, you shouldn't read anything into the movement in deferred revenue, because what really that represents is agreements we have signed where we have actually received cash or we've allowed to bill the customer. As an example, it would include the maintenance agreements that we signed, where the customer pays us on an annual basis for maintenance services. Those revenues then get recorded as revenue ratably over the term of the agreement. So, if it's 12 months, we will take it over 4 quarters.

So that's really the bulk of what's in there. It also includes any prepaid royalties that we would sign with customers whereby they would be paying upfront. So, it's a representation of where we end up parking revenues that we can't record immediately because of revenue recognition rules.

So over the course of time, you have seen that it goes up and down. And I would expect that will continue. What's more important from our perspective is the agreements that we sign that may not represent revenue immediately, but are long-term, recurring revenue with, as Ian has mentioned, some of the multinational companies we're dealing with.

Right. Okay, I noticed that this quarter, the services revenue as you reported, was down slightly from Q2. I guess I wanted to understand how much of that services is the maintenance part of the business -- and then just any comments on the components that may have dipped quarter-to-quarter?

Well, the maintenance revenue in fact is quite consistent, and is growing over time. This is not an [arrow], but it does grow over time as we continue to sign new agreements.

The fluctuation from quarter to quarter depends on the timing of the service revenues or the timing of the contracts for services revenue that we may obtain. So you may have fluctuations quarter to quarter, but generally speaking, our service business is very healthy and continues to grow.

So Scott, it's Ian. So we said a number of times in the past that our consulting revenues, which is part of that services line, is really tied directly to our product license sales. And depending on any given contract we sign, there may or may not be an amount of service that's required as part of that contract for delivery to that customer.

So what we're really focused on is the growth in the product and patent-licensing business. And you'll see the service line in particular as it pertains to the consulting revenue -- it will grow over time, we believe. But it will have ups and downs in any given quarter depending on how much is required for any given customer situation.

Right. So if I could ask to pin you down a bit, I have understood in the past that the maintenance support revenue is around 60, 65% of the services revenue.

Repeat that? I'm sorry, I missed it (multiple speakers)

I just understood in the past that the support maintenance revenue of the services line was about -- call it 60, 65%.

[Above] the line.

Okay. And then just to understand the operating expenses, heading into Q4, is there any way for you to kind of discuss with us what of that increase quarter over quarter is related to the operations, and what is related to the bonus accruals?

You know, we don't provide that kind of detail. I don't think it's appropriate. And certainly, we couldn't do that on this call, because we've certainly not disclosed it anywhere else.

So, no, we don't discuss -- what I can tell you is that there's 2 factors that are significantly impacting. And obviously, we've discussed the bonus. But there's also the Canadian dollar which, as you can see from what it's doing these days, that's really having an impact on our costs on a quarterly basis, which ends up challenging us continually.

I think maybe Scott, the way I would look at it is look at the actuals of our prior quarters, say, over the last three, four quarters. And you can trend that against the Q4 forecast.

Right, so that (multiple speakers) --

(multiple speakers) way to answer that question without directly answering it.

So the trend that's developed in the past few quarters is probably a better indication of where we are heading next year?

We don't provide expense guidance beyond one quarter, Scott. So I'm really trying to address your question of what accounts for the Q4 forecasts in terms of expenses relative to comparison to prior quarters.

But it's fair to say that the bulk of the increase, quarter over quarter, will be the bonus accrual that we're making.

Okay, that's great; I appreciate it. And just -- Scott, I wanted to ask you -- RSA's announcement about becoming Suite-B-compliant -- I'm sure you have a view on exactly what they've done to do that and what, if any, impact you would expect it to have.

Yes, good morning, Scott. RSA, of course, has released a Suite-B-compliant toolkit. And I think that's marvelous. It just shows that we are seeing great adoption now. You know, I've been waiting many years for this to happen. I've always believed, of course, that ECC is technologically superior to any crypto system that is out there. We've been saying for the last five or six years that ECC is next-generation technology. That's no longer true. It's here today. And again, we are seeing that through RSA and various other multinationals who are adopting the technology rapidly.

So you wouldn't expect it to have any competitive impact?

No, I don't.

Greg Reid, Wellington West Capital Markets.

First question -- I'm not sure, maybe for Scott. Just on the next-generation DVD standard, the AACS spec -- just wondering your comments or your thoughts on the opportunity there. And I guess for DTCP, you've kind of gone after some of the hardware guys. Do you expect that there's opportunity to license through the replicators? Or how would you approach that opportunity down the road?

Well, as you know, AACS is a replacement for the CSS, the content scrambling system that was broken three or four years ago. So now they're putting a much more sophisticated technology in place. And the public key portion of the technology is Elliptic Curve Cryptography, which again, we are very excited and happy to see that.

DTCP -- again, people are recognizing that for longer bandwidth, less computing power, you get superior strength to anything else. So DTCP, which again is part of a DRM solution, has adopted Elliptic Curve Cryptography. This is all good for us. I don't know if I've answered your question or not.

I'm just wondering is -- in terms of a revenue opportunity and ability to license, let's call it, some of the replicators who currently pay royalties on each disk manufactured -- you know, is that something that you are in discussions with now or is it still a little bit away?

This is Ian; we don't discuss specific pipeline opportunities, as you know. But I can tell you, in a general sense, as Scott said, we're thrilled to see more and more standards as in the DRM space and other sectors, adopting ECC for all the reasons that we've discussed in terms of the efficiencies and the capabilities that ECC brings. It's that far superior technology in many organizations, many standards bodies, AACS being one of them -- one of many, are seeing the benefits in ECC.

So as is generally the case when you get into these, this level of adoption, that represents growth opportunity for Certicom. So we certainly will be, in general, looking forward to discussions with firms where it's worth our while and inappropriate for us to discuss opportunities for licensing of our patents, licensing of our products which, as you know, contain many of our patented implementation techniques, along with a combination of our services.

So these are all opportunities. But as Scott said, in a general sense, we are thrilled to see this, because it just reinforces really the global adoption, the global move to ECC, and it's -- after 21 years, I've got to say, on a Scott's behalf -- he is too modest to say it, but this is really, I think, a vindication of his vision, of his outlook on the market 21 years ago when he founded the company. It's happening now. ECC is here today.

And we were at the RSA show a couple weeks ago. And compared to prior years, the general sense -- I'm going to talk now about RSA, the algorithm, as opposed to RSA, the company -- there's no question that the broad consensus is that RSA, the algorithm is yesterday's news. ECC is here today. RSA, the algorithm is yesterday's story. And people are moving very rapidly to adopting ECC and Suite B in the case of government suppliers. The whole trend has moved very rapidly from the NSA announcement a couple of years ago with ECC and Suite B to the private sector.

So, that's why you're seeing our focus on consumer electronics and DRM, where we see great adoption of ECC in addition to the mobility, government, and sensors market -- it's quite significant. And we've seen a tremendous movement in that ECC adoption trend just in the last 6 to 12 months.

Okay, thanks, Ian. And I don't mean to push; I just want to ask just a general strategy question, because it might impact how long it takes you to sign up guys, etc. Just back on AECS, if that went forward, would you expect that you would go through licensing authority, so you would just have to deal with one body, as opposed to trying to go directly after different people?

We won't answer that directly, Greg. I can tell you that we will pursue the most appropriate avenue for us to maximize our revenues. And as we've stated in the past, we also want to pursue the avenue that is also going to drive the greatest level of ECC adoption. And we balance those two views. But we are pursuing many, many discussions with -- as we've stated in the press release, large multinational organizations, some of whom will be looking very closely at AACS and other standards. And we will determine what the best and most appropriate model is. But we're not prepared to disclose that specifically in any one opportunity or one standard.

okay, all right, thanks. And just the last two, I think in the past, you've disclosed the percentage of revenue that is recurring. I was just wondering if you could say that again. And also, with SafeNet buying nCipher, is there any impact on you at all in terms of your relationship with nCipher?

Well, on the first part of your question, Greg, as I said earlier, our recurring revenue is approximately 40% of our quarterly revenue this quarter. But it's growing.

And on the nCipher acquisition, we think that's tremendous in terms -- nCipher has been a partner, as you know, of ours. They've licensed many of our patents about a year ago. And we would certainly hope that with the acquisition of nCipher by SafeNet, that that will continue to accelerate the proliferation of the nCipher products, which means the proliferation of ECC. So I think it drives the whole adoption.

Glenn Jamieson, MGI Securities.

When I look at estimates for the next 12 or 18 months for your Company, there seems to be a wide discrepancy in terms of what revenue you can generate. And I think the large deals that you referred to in your comments drive in large part what we can expect for revenue in the next little while. So can you just go back and comment, relative to the large deals that you've been working on, what we can expect in terms of timing of completing some of these transactions?

And maybe more importantly, of the transactions that you think are likely to close sooner than later, what is their nature in terms of the immediacy of revenue recognition? We've talked in the past about some deals that pay you upfront; some deals that start to pay you immediately because the customer is actually using the technology today, but you've deferred over a period of time. And then there are those transactions where the customers have yet to really build you into their products, and depending on how quickly those products get to market and ramp up, your revenue goes that way. So can you just go back and give us some more color on those areas?

You asked a lot of questions, there, Glenn. But good morning. And thank you for that. I'll try to answer that as generally as I can, because obviously, I can't mention specifics. But the model for us has been, very clearly and simply stated, that we are focused on signing contracts that cover multiple years and allow for ongoing, recurring revenues. And we work very, very diligently -- and sometimes it delays closing on individual cases -- to make sure that we get that structure in place.

What we are trying to avoid is lucky revenue, where we get one contract and it gives us a big hit in one quarter, and then there's no follow-ons. That is essentially what we are trying to avoid. And so far, we've been quite successful in doing that.

You know, depending on whether -- on the nature of the contract or the customer, you'll get varying approaches. So there is no one particular way to implement this model. We've mentioned in the past that some customers -- and frankly, not many -- if they will prepay royalties -- they'll look at, say, three, four years, for example; determine the amount of royalties that will be paid, and they will pay us cash upfront. And then we will spread the revenue recognition over that period of time. That's not all that common, but it does happen on occasion.

The more common approach is where an organization will pay us each quarter over a multiple-year agreed-to royalties on a set of products. And that's much more common. On occasion, you'll get a situation where there will be an upfront licensing fee. In fact, most of these contracts will have an upfront licensing fee where they will licensed our technology -- it might be a perpetual license fee, for example; it could be a subscription for the actual license. And then on top of that you've got the royalty component, which is spread out over multiple years.

So you know, we could get a significant hit in any given quarter, depending on the size of the upfront licensing fee. But what we are really focused on is that multi-year recurring revenue, which -- as you know, it doesn't provide significant hits in any given quarter, but provides a steady, ongoing flow of revenue, which frankly makes the business that much more predictable.

Herve, I don't know if you want to add anything.

No, I think you've hit it. That's fine.

Okay, just a follow-up, then -- internally, I would think that you would have some larger opportunities that you would expect to close sooner than later.

Yes.

And I don't want you to talk about those in particular. But are the ones that you're most hopeful on of the nature that it would take time for the customer to build your technology into new products and have them ramp up in the marketplace?

Well, a couple of comments. So first of all, in the design win space -- I'll address your second question first. In the design win space, where someone is licensing our technology to embed in a products that they are developing that will ultimately pay royalties -- yes, there is a timeframe, but there's a delay, if you will. So they will typically pay an upfront licensing fee for the technology, and then they may take three to six to nine months to essentially build and implement the security solution that will be embedded in a handheld device, for example. And then the royalty commences when that product starts to ship. So it could be six- to nine- -- maybe even a 12-month lag from the licensing agreement and our announcement to when the royalties start to kick in. That's traditional in the design-win business. And some of the risks are -- if that product does not sell well, then that will show up directly our royalties. If it exceeds expectations, then that also will show up in a positive sense.

Now, I can also tell you, to your first question, that I -- [does say] that every quarter, it seems, when I present to the Board, we have more and more proactive discussions with extremely large multinational organizations. And I know I'm sounding like a bit of a skipped record on this. I mention it at every analyst call. But the list of very significant, strategic, large multinational companies talking with us it seems every quarter has grown.

So we are expanding the Company and investing to make sure that we are able to handle all those opportunities effectively and in a timely manner. Some of them, Glenn, we've been working on for some time, and are in the latter half of the sales cycle. Some are early on. And I've got to say that we are continuing to build that level of pipeline, and it is overwhelming some days in a very positive way; it's gratifying to see that amount of proactive licensing discussion recurring.

And I will also say that many of those discussions -- in fact, I would say the majority -- involve the licensing of both our patents as well as our products. That's a very, very important trend that we've seen in the last year. And it's allowing us to evolve our model where you've got organizations that want the patent protection, want that patent coverage, but they also want our products in order to get a number of ROI benefits. It allows them to reduce their expense so that they don't have to go out and hire a huge ECC crypto development organizations. They can use our products to build those solutions so it keeps their costs down.

Secondly, it allows them to get these products that they are designing their security solution to -- it allows them to get those products out quicker. We've got some very interesting ROI examples on that front where the learning curve has been very rapid.

So there are some real benefits in terms of being able to implement the efficiencies and techniques that are found in our products, in addition to the protection and the comfort of having a patent licensing agreement with us as well. So we're seeing a real integration, if you will, or confluence between the product and patent-licensing business on those proactive discussions. And they are growing. And as Scott said, we're talking to more private sector companies that are responding to the ECC adoption trend than ever before.

Maybe I could add to that, Ian --

Sure, Scott.

These large multinationals -- they have very strong, world-class cryptographic groups. So I'm finding it very encouraging that they are looking at us and saying we can do it better. So, you know, from my viewpoint being in the cryptographic community, that's very exciting.

Okay, well, thanks for that additional detail. Herve, can I ask you just a couple of specific questions on your revenue this quarter? You've said that that large contract you announced in December was reflected in the quarter. Do you classify that revenue as recurring revenue?

A piece of it. (multiple speakers) As we said, this is a multi-year, multi-million-dollar agreement. So it will be recorded and recognized over time.

Okay, the recurring portion -- your recurring revenue looks to have increased about $400,000 sequentially this quarter. Is that roughly equivalent to the recurring portion of the contract that you announced?

I'm not going to give you that level of granularity. I can tell you that our recurring revenue keeps on going. That agreement was included in there. But I can't provide any further guidance or help to you on that. Otherwise, it would be selective disclosure.

Could we say that you only had a partial inclusion of the recurring portion in this particular quarter because it was signed partway through the quarter?

You know what? I really need to stay away from answering that (multiple speakers)

(multiple speakers) I will tell you, it was a material contract (multiple speakers) we issued press when we did. It was released the day we signed the contract. We got as much warning as we felt we could from the customer to protect their competitive issues, and enough to be compliant with regulatory requirements, but it is material. (multiple speakers)

Just to close out, we're really limited by our contract as to what we can say on this agreement.

Okay, fair enough. One last question -- if I go back and look at your Q2, my belief is that there were some license sales that probably slipped out of Q2. And I would imagine that you closed some of them in Q3. Can you try to quantify what the impact would have been in Q3 in the deals that you would have expected to close the prior quarter?

Well, you know, we're not going to qualify, quantify that number. But what I can tell you is that we have recovered on some. We always said that we were expecting to recover it over time, but not all at once in one quarter. So, we've recovered some of it and we've still got some ways to go.

But one thing I want to just make sure you understand is that we're still continuing to build on our recurring revenues, and you'll see that as we move forward.

David Wright, BMO Nesbitt Burns.

Good morning, and congratulations on the numbers. I'm going to try some of these questions which you might dodge, but what the heck? I will try anyway. (LAUGHTER)

How much one time revenue for back payments in the quarter?

Sorry? How much one time --?

Like, you know, so that new customer, or the new contract that you had -- perhaps they were already shipping product. So how much [were] the payments?

You know, David, we don't provide that kind of detail on our revenues, so (multiple speakers)

Is it possible that it was an immaterial amount of less than 10%?

I'm not going to put any quantities on it, but it's possible, because in any contract, there's always an element of upfront cost. (multiple speakers) upfront payments for licensing and so on.

I think that's a fair comment, David. As I stated on the earlier question, there's always an element of upfront payment.

Dr. Scott Vanstone. Nice try, David.

Yes, (LAUGHTER) I've got more slices at it here. You mentioned that your recurring portion is about 40% of revenues, so about 40% is about 1.7 million. Now last quarter, when you had what seemed to be a perfect storm of issues, you still reported 2.2 million of revenue. So I guess my question is what is kind of -- what would you describe as your new kind of floor of revenues? Should we assume that it's higher in Q3, or going to be higher in Q4 than (multiple speakers)?

You know, I think maybe we heard one of your colleagues say that our recurring revenues seemed to have grown by about 400 quarter over quarter. The last time I think I said that our recurrent revenue out of the 2.2 million was somewhere in the area of close to 60%, or 50 to 60%, and now it's sort of 40. The number has gone up, but the percentage is down because of that calculation and the common denominator in the equation.

But I think -- suffice it to say that the level of recurring revenue is -- where it is right now is the base that we continue to work on. Our objective -- and you are starting to see the results of it -- is that recurring revenue is starting to build and continues to build. Our model is to grow recurring revenues.

I mean, I'd love to be at the point where we are upwards of 90% of recurring revenue. But we're moving towards that.

David, we still have a dependency, of course, every quarter on signing new business. And that's not going to go away.

Okay, good. I hope not. So and I think just said that you would suggest that you haven't fully recovered from last quarter, that there's still stuff that you had hoped to sign last quarter that maybe you will pick up next quarter or the one after (multiple speakers)?

There's still some. As we said, we won't recover it all under one quarter. And I think part of the background behind that, Ian, has been focusing on is the fact that we're dealing with a different environment -- many more multinational, multi-year, very significant agreements are being worked on. We're making sure in the process that, wherever possible, these agreements are structured such that they fit into our business model of building recurring revenues over time.

Okay, slicing your revenues by vertical industry, and one that I keep getting asked about is the military -- and you had signed sort of a military contract year ago. What percent of your revenues would you say today, roughly, is from the military? And would you be expecting that to grow in the coming year?

You know, David, we don't provide vertical revenue information. However, I can tell you that we have a good array or selection of customers. And we keep on growing them. Ian can add some more flavor to that. We signed some of the last year [plus], and we continue to work on them.

David, I can tell you that in terms of outlook, the sectors that represented the most significant revenue growth for us are in the area of consumer electronics; what we call the government sector, where we are licensing to organizations -- not just defense contractors, but also private sector suppliers to the government, who also sell to a much broader range of private sector customers. So -- and I guess a third area, which is continuing to grow for us, is mobility.

Those are probably the three sectors that really represent the largest growth opportunities.

David, maybe if I could just mention that at the RSA show, the NSA spoke and reconfirmed their commitment to Suite B. [That] was only ECC. So we see that as only good for us.

Yes, absolutely. Okay, thanks, Scott. So -- and I guess Sun also at the RSA spoke and talked about embedding ECC into their products. Do you have Sun as a customer currently that you have announced?

At this point, as you know, we are in discussions with many of the major multinational companies. We can't comment at this point. At this point, Sun is not a customer. I can tell you that. But as you know, we are speaking to all of the major manufacturers in the world today.

okay, and now on your bottom line -- so you've reached profitability this quarter. You had mentioned that you would have an uptick in costs for a number of reasons. Do you think you can maintain breakeven or profitability going forward, or (multiple speakers) this level of revenues?

As you know, we don't provide revenue or earnings guidance. I can tell you absolutely, though, we are focused on getting to and sustaining a profitable growth over time. We have talked a lot about recurring revenues today, so I'm not going to repeat that. But it is certainly something that we're very pleased to see and we're going to do all we can to maintain that trend where possible.

But I think the main message I would leave with you is that our focus is on the long term, continuing to focus on the long term to invest as appropriate to make sure that we really are able to capitalize on this very significant ECC adoption growth curve, which -- I think that's probably the best way to answer your question at a high level is the ECC adoption curve is going to drive revenue growth, and as a result, profitability for us. And we've never seen the level of adoption that we have seen, as I said earlier, in the last six to 12 months. It is really starting to take off in very significant and dramatic ways for us.

Okay, I will go quickly -- still got a couple more if I can still go. With profitability in the quarter, I would have thought that your diluted share account would have been higher, Herve. But is that the number that we should be assuming, 38 million for the coming year, if you were profitable?

You cut out --

Sorry. So you were profitable in the quarter, so I would have expected that your diluted share account would have been higher. But you reported it as 38 million.

David, it's all in the calculation. We have roughly 38 million shares outstanding, plus another about 6.5 million options. And depending on the calculation, that's how it flows into the numbers. The point is that 38 million shares and $142,000 of profit -- it's decimal point that reports back to zero.

Got it. Ian, could you -- I don't know if you can do this. But when you look at your pipeline, comment qualitatively on -- how much would you say is the pipeline of product that are already shipping today versus products that are kind of design wins in the future?

I would say the bulk of what we're talking to multinationals about today, and in terms of our pipeline, is about product that is available today.

It's also, as I've mentioned earlier, very much integrated with our patent portfolio. So, design wins -- I think you mentioned that as well; and in some cases, you can refer to some of these multinationals as design wins -- there are on occasions enhancements or changes that we have to make to some of our products, that we would make available to all of our customers. But for the most part, we are continuing to develop new products, new technologies. We continue to file, on average, 10 to 20 new patents per year.

So certainly, new products will continue to be an important part of future revenue growth. But most of discussions that ongoing and active today, with all of these, all the pipeline, including the many multinational firms, are based on product that's available today.

Peter Misek, Canaccord Capital.

Just a couple questions. Firstly, on customer concentration, did you guys have any customers that were greater than 5%?

Yes. In this quarter, we did. I'm not going to give any you more color, because I can't (multiple speakers)

Well, no, I know you have to for accounting purposes file that anyway, right?

Yes. You'll see it when we file our quarterlies in the next several days.

And last quarter there wasn't a 5%-plus customer, correct?

Last quarter -- I'm trying to remember. But likely not, but that happens. I will say it's cyclical, or it all depends on the agreements and the timing of agreements.

Can you help me understand -- we have talked to some of the folks at the DTLA, the licensing authority for the DTCP consortium. And they seem to be really expanding DTCP, where it's going into, etc. And I think how ECC is the encryption methodology. You know, as it spreads and radiates, is there any possibility to talk to the DTLA directly or to get involved in some way there instead of trying to pursue each consumer electronics firm separately?

Peter, it's Ian. Again, without talking about the specifics behind the DTCP model, certainly, we agree with their comments. We see DTCP evolving and expanding in terms of where that particular standard is going. We certainly see it in the area of, for example, wireless communication, which is a very, very fast and evolving trend. DTCP offers very significant capability in that area and others. But we find that we are very comfortable continuing to execute the plan that we have in terms of maximizing our revenue on DTCP, and we will, as I said earlier, a couple questions ago, we will make sure that we have a model that's going to maximize revenue but also will maximize ECC adoption as well.

I don't know if, Scott, you want to add anything to that?

I would. Peter, currently we like to get in front of the customer, because we would like to show them not just DTCP but other technologies that we have that they may not be aware of. So going through one central licensing agency, we don't get that opportunity.

Okay. I know you guys have been asked this 17 ways to Sunday, but sort of thinking about the impediments to signing some of these bigger players -- you know, we've tried to hunt down some of them, ask them about you folks, etc. And it always comes down to a question of, you know, are you guys actually just a patent troll, are you trying to add value, etc.? And some of the folks we spoke to said they may or may not take a hard line with you.

What is the impediment? How do you stay friendly and nice and you don't go down the route of an NTP or RIM, or do you have to go down a route of an NTP or RIM.

Well, Peter, it's Ian. We have stated a number of times that our strategy is to -- and Scott just really hit the nail on the head earlier with the last question. We're trying to with all organizations as appropriate introduce not just the benefits of licensing our patents, but also the benefits of licensing our technologies, our products and services. We have clearly demonstratable benefits that organizations -- large multinationals, as I mentioned earlier -- find in using our products as well as licensing our patents. So it gives us an opportunity, frankly, to come in with a much more added value approach then the classic patent troll, who simply derives revenue [through] courts.

Having said that -- and by the way, I will give you some other examples, one specific from an unnamed company who is interested in licensing our patents, but they also have been using, testing our products. And they found that they were able to reduce the number of servers from another crypto scheme where they were using 15-plus high-end servers -- they were able to reduce that to one or two servers using ECC. And they were able to get to that point by using the efficiencies of ECC that are found through implementation techniques that we have in our toolkit product. So that's the kind of value that we can bring. You won't get that kind of discussion with a classic patent troll.

Having said all that, where we are entering into discussions with organizations that are currently using ECC, we will try to approach it in a very proactive, businesslike way to hammer out a reasonable win/win contract. In the end, we will defend our patents, if necessary. We will make sure that people who are using ECC are paying for that privilege.

Last question -- is there any way around your patents for and an ECC deployment to be Suite-B-compliant? I mean, one of the key issues when we try and check with potential customers, etc., is that they often also say that they may try and work around it. And, Scott, I don't know if you can help me understand that. They were talking about various implementations of ECC, etc., and trying to suggest that they may be able to skirt your patents.

Peter, as you likely know, the basic technology was put in the public domain in 1985. You know, I heard the first talk given on this subject and I came out of the lecture believing that if this is secure, it definitely is technologically superior. And we studied security for many years at the university and decided, yes, this is good. And we started looking at how to implement this efficiently.

So we've been implementing this for almost 20 years. And we have a huge amount of experience on how to do this in the most efficient and cost-effective manner. Other companies, other groups have only in the last five or six years realized the benefits of ECC, and have started to research how you implement them. So I would say, if you want to have a very efficient implementation, we are the only way to go.

Peter, it's also fair to say that in terms of our patent filing program, which has been administered and managed effectively for some 15-plus years, we file our patents in many, many geographic jurisdictions. And the reality is that not everyone will know where we have patented technologies, patented techniques. So it's --

In fact, Peter, as recently as last year, we came up with a new piece of ECC technology which the community is very excited about. And it's called fast verification of ECDSA signatures. People have been working to try to improve that for years, and we found a beautiful mathematical technique that --

I think you showcased that, Scott, at the ECC conference, correct?

Yes, we did. Absolutely, and we are seeing a lot of interest. It does have a return on investment for people who implement it.

Paul Bradley, Fraser McKenzie.

A couple of quick questions. I just wanted to I guess Ian go back to the [nature] -- multi-year, multi-million-dollar contracts with large organizations. I'm just trying to make sure I understand the characteristics of this. Is it the case then, typically you're looking at an upfront license payments, perpetual license, presumably, for the software development kit? And then you are anticipating getting a stream of maintenance payments on the kit or kits that you sell? And then over and above that, there are royalty payments each time something ships with the technology embedded? (multiple speakers) Is that the correct way of characterizing it?

Yes, I will ask Herve for [some] detail. But those particular revenue streams you have highlighted are accurate. There's a licensing fee, this maintenance, and there's ongoing royalty. The only one I would add -- or two is that the may be some ongoing royalties from patents as well as professional services.

Okay. Now, when you talk about multi-year, is that because the client constrains you to say this arrangement will only run for five years? Is that because these products typically go out a cycle? I just wondered what the constraint there is rather than this sort of running on indefinitely?

Well, I think the reason -- when we speak of -- when we look at how we license our products, we don't provide corporate-wide licenses. They are typically for a group of products or a very specific product. And if a Company wants to then deploy the technology on another one, then generally speaking, they need to sign another agreement.

So upfront, they will pay a license fee which is a perpetual license fee for our toolkit, so it allows them for a certain number of engineers to use this technology to implement on a given platform or platforms, and that's the perpetual nature of it.

Then what they need to do is -- once they start to ship it and deploy it, then there's a deployment fee or a royalty that they need to pay us on every platform or device shipped out. So that's the royalty piece of it.

(multiple speakers) As Ian mentioned, for the length of the time that the customer needs to provide maintenance and upgrades to the products, then the customer signs an annual maintenance agreement with us.

The fourth piece of that is, to the extent the customer needs some very unique expertise which they may not have, then we would have some professional services that will help the customer maximize the efficiency of the implementation of our technology on their platform.

Paul, I will just add, what we don't want to do and what we absolutely try to stay away from is what we call buyout, where the customer may want to pay one lump sum for all of what Herve just described, to get it behind them so that they take the hit in one quarter. And this Company many years ago used to take those kind of deals on occasion.

We absolutely stay away from them, because it helps you in one quarter; it gives you a big hit, for example, in one quarter. But it really creates a significant amount of lumpiness that is very tough to recover from. So we're the ones that are pushing for the multi-year, ongoing royalty commitment.

Right. And just to not belabor the point there, multiyear being, I don't know, a defined period of time for a particular product the client is going to ship -- for the purposes of the contract you're negotiating with them?

Well, when we speak of multi-year, the multi-year nature is mostly on the deployment, because the perpetual piece of it, like the deployment of the toolkit, it's perpetual license to use it forever, but (multiple speakers) restricted, the field of use is restricted to a platform or a product.

Right, okay. So you restrict the use there. They come back, they would have to pay again to use it on a different platform?

Yes.

Right, fine. Now, if I look at -- we've talked about recurring revenue in the current quarter. If I look at that now, how much just in proportionate terms would be maintenance on software development kits you've sold versus royalties on product that's shipping?

You know, one is I don't have the number of the top of my head. And secondly is we've never disclosed that number. I'm not ready to do that at this point.

Okay, well let's put it a slightly different way -- is the royalty component a material portion of that number?

Material number -- well, it's not part of that number. They're different numbers. I mean, we have the maintenance stream, (multiple speakers) a maintenance revenue stream and we have a royalty revenue stream. So when you look at the financial statements that we produce, when we talk about -- when you look at the retail lines, there's a product, an intellectual property revenue stream, and a service revenue stream. The royalty is in the product and intellectual property, and the maintenance is in the services.

Right, okay. And when you talk about recurring revenue, you're talking about a blend of the two?

Yes, there's the blend of the two.

Okay, fine. Next question then -- if I look at the product in IP, I think the past you have split out the proportion of those numbers that's pure intellectual property. Can you do that for the current quarter?

No, we've not done that that I can remember, at least in the four years that I've been here.

Okay, well, I thought I had seen on previous financial statement -- fine. Jump to a slightly different questions. I think Peter Misek had just asked you about whether people can get around your patents. I just wanted to make sure I understood the response there from Scott.

So the basic technology was in the public domain in 1985. So if somebody is not concerned about efficiency, presumably, they can implement this using the basic technology. And although it might be inefficient, it would still be ECC?

Scott, do you want to address that?

I'm sorry?

Would you like to answer that question?

Sure. No, I think that -- yes, it's likely possible to implement ECC without infringing some of our patents. But people that I talk to want efficiency.

Oh, no, I can well understand that. But just to make sure that I am clear on that. So you could put it in place, somebody in fact could be using it already. And providing they hadn't gone -- or they hadn't tried to implement the efficiencies that you've discovered over the years and patented, they would still be using basically public domain information to do that?

Yes, but Paul, there are also protocols (multiple speakers) that actually -- the arithmetic mechanisms that make them work. For instance, ECMQV -- that is a protocol. The underlying kind of guts of it is ECC. But if you -- that's a Certicom technology. That's a technology that is being endorsed by the U.S. government (multiple speakers) all key exchange within (technical difficulty) so if people say they are using ECMQV, it doesn't matter how they implement it. If they implement inefficiently or efficiently, that's a protocol that we have ownership to.

Okay, and just to understand -- you've cited the particular example of the U.S. government there, though presumably, that's covered under the patents that were sold to the NSA, so --

Not necessarily, no. (multiple speakers) we license in a very narrow field of use to government. So if you want to sell this commercially -- the AES, which is a symmetric key mechanism -- that is being adopted worldwide. If you're familiar with the DES, which came out in the mid-'70s, that was the most widely used cryptographic algorithm in history. It's being replaced by AES. And so if history repeats itself, it will go around the world. The key agreement mechanism for that being suggested by the U.S. government is ECMQV.

And then -- sorry; I had one other question which I just want to grab. Oh, yes -- I think you were asked sort of the nature and size of the bonus accruals. Clearly, you don't particularly want to disclose that. I just wanted to understand sort of what you look at internally, then, as the performance parameters you're looking at in terms of objectives having been achieved at the end of the year. Is this return on investment? Is it sales targets? I just wondered what generally you're looking at there.

First of all, Paul, -- it's Ian -- all employees; management, myself included -- have a series, a set of goals every fiscal year based on the fiscal business plan that we have approved by our Board. The Board of Directors has approved a bonus program that essentially is broken down into two components -- personal goal achievement and corporate goal achievement. And you can appreciate that the personal goals are going to be specific to that individual and their area of responsibility.

The corporate targets we all share. And the corporate targets are based on both topline as well as bottomline performance, along with one or two other nonfinancial metrics -- customer satisfaction, for example.

So that is the primary driver. So it's very much a sort of topline, bottomline set of goals. And because we don't provide revenue or earnings guidance externally, we don't provide those specifics internally to all employees. We simply say that there are financial topline and bottomline targets. And when we those targets, all the employees are eligible for a cash bonus.

Okay, sorry -- one last question, and thank you very much for that. You were asked -- clearly asked many, many times about the nature of the discussions you're having with these large multinational corporations. Do you actually have any sort of unpaid pilot projects running with any of those people, or is that not a step that you feel is necessary to take?

We often don't -- in fact, it's interesting you asked that. We used to have a lot more of those in past years. We've actually seen a number of pilots, if you will, or evaluations reducing to a certain extent. Some organizations do ask for and receive a 30-day evaluation of some of our products, and we are happy to oblige.

But we are actually getting far fewer of those requests. I think it reflects on the reputation of the Company, the reputation and quality of the products and technology. And I think it also reflects on the fact that there is a growing installed base of customers that are successfully using these products.

So yes, we do provide some ability to test the product. We don't very often, though, get into pure-play pilots in the way that you may think. A pilot is something that we typically will try to avoid. But evaluation of the product? That's fine.

Ralph Garcea, Credit Suisse First Boston.

Just a quick question on the SafeNet/nCipher deal -- are there change of control provisions in your agreements, so if something like this happens, the nCipher agreement you have doesn't just carry over to SafeNet, and you [will] renegotiate a new contract with them? Or how does that work when a smaller entity you've signed a deal with gets taken over?

You know, Ralph, I can tell you that there are some provisions in our agreement for a number of these types of things to happen. But I think they are too specific for us to be able to answer them any further than what I've just said. But generally speaking, in this case here, assignment would probably not be a bad thing, to the extent that nCipher is fostering adoption of the technology and through the process of it, it can enhance our revenue model.

And then just returning to the December contract, was the upfront license fee greater than 500,000?

I can't disclose that, Ralph; sorry.

Okay, quick housekeeping -- on the tax side, is it safe to say you won't be paying tax for the next three to five years?

It's probably reasonably safe to say that. If you look at our filings, we have in the area of $125 million of tax loss carryforwards that we will be taking advantage of as we move forward. So I don't anticipate paying taxes -- at least not in this next decade.

And do you have a geographic split on the revenue side? I don't know if you gave that.

You know, generally, our revenue at this point is very North-American-centric. But we are seeing and making some headway in Europe. And we're now starting to see tremendous demands in the Asian marketplace. In fact, we will establish a presence in that sector in 2006.

I mean, the December contract -- again, it's a global manufacturer. But would that be recognized as Americas revenue? Or how do you -- you recognize it where product -- (multiple speakers)

We recognize it with who we are doing business. So these multinationals may have facilities around the world. But our contract is whoever the source country was. And that's how we recognize the revenue, because we don't know where they would be shipping that product from or to.

And lastly, the headcount in the quarter?

Our headcount is still at about -- slightly over 100 employees, and it's about that. It may fluctuate a couple percent up and down. But it generally is there, and it's stable at this point. And we're comfortable with the number of employees that we have.

Greg Reid, Wellington West Capital Markets.

Long conference call, so I will be quick. Just one follow-up -- on the licensing side, you talk about lots of expanded opportunities with a bunch of companies you're negotiating with. I'm just wondering what the bandwidth is on management's side. Ian, is it just yourself and Tony involved in that, or have you added people to that process?

Oh, no, that's a good question, Greg. We in fact have added to the executive team and the organization in general to deal with those. You may recall about a year ago, we said that we had increased our sales costs by investment by roughly 40% on a year-over-year basis. So we've added some additional people in the field.

But I think specifically -- when you get into some of these large strategic opportunities, as you're probably aware, you need a high degree of executive involvement. And I would say most, if not all, of the executives are involved in working with our account managers to develop those opportunities. So David Sequino, our VP of Sales and Marketing; Scott Vanstone; Tony Rosati; myself; our CTO based in Foster City office, Bill Lattin; our VP of Product Development, as appropriate, Ross Bennett -- we are all directly involved on virtually all these opportunities. In some cases, all of us are involved, depending on the size and complexity. So it's very much an executive team effort combined with the capabilities of our field account management group.

So we added Bill Lattin, CTO, as you may know, roughly six months or so ago. Part of the reason for that in addition to his leadership in helping to map out a technology roadmap that will allow us to grow in line with the industry and in line with ECC adoption, ensuring we've got the right technology roadmap in place. The other primary benefit of having people like Bill and others join is to bring presence to the field where we are closest to these largest opportunities.

There are no further questions at this time. Please continue.

Thank you very much for your time, everyone. And don't hesitate to give us a direct call if you have further follow-up questions. Thank you.

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