BlackBerry Ltd (BB) 2007 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Certicom Q1 fiscal 2007 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, September 7, 2006 at 10 AM Eastern time. I will now turn the conference over to [Dana Broadworth], Account Executive. Please go ahead.

Good morning and thank you for joining us for Certicom's conference call to discuss results for the first quarter of fiscal 2007. 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 of 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 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 will turn the call over to Ian McKinnon. Ian?

Good morning and thank you for joining us. We will start off today with an overview and review of the operational highlights for the quarter, and then Herve will go through a discussion of our financial performance and outlook for expenses. And after a brief summary, we will be pleased to take your questions.

We are now on slide 5. We are off to a very solid start in fiscal 2007. Over the last year, we have worked hard to establish relationships with large multinational companies, and I am pleased to report this is translating into incremental contract wins. Signing agreements with global multinationals is an important part of our strategy as we drive ECC adoption and work to build an increasingly strong recurring revenue base for Certicom.

We also saw continued momentum in design wins. Design wins are important in building a solid financial future for this Company. Design wins typically involve a delay between winning the specification to designing, producing and selling the product. However it is an excellent way to ensure Certicom's ECC Security Solutions are embedded in our customers' products while providing recurring royalty revenues.

We have built in our accomplishments in fiscal 2006 with progress across our five target markets, and we are steadily building multiyear recurring revenue contracts.

We are now on slide 6. During the quarter GE's security business licensed our ECC technology and while we can't disclose the applications for competitive reasons, I can tell you we are very pleased to be closing contracts with companies of this caliber. Philips also licensed our ECC patents, in this case for DisplayPort Content Protection or DPCP. As part of the digital rights management market designed for protecting digital content, the DPCP standard is an early stage technology that could be adopted by computer and electronic manufacturers delivering video and audio digital content to a display.

And as a new digital content protection standard, it has already been adopted by the Video Electronics Standards Association. Other uses for DPCP include the protection of content on TVs, projectors, DVD players and displays. And this contract win demonstrates Certicom's continued progress in one of our five target markets, specifically digital rights management.

Also during the quarter, Fortress Technologies licensed Certicom Security Architecture. Certicom's ECC based algorithms will be incorporated into Fortress Technologies' FIPS 140-2 solutions in order to meet Suite B requirements as defined by the National Security Agency. As we have explained in the past, Suite B is a set of NSA security recommendations to protect both classified and unclassified information and the inclusion of ECC in this NSA standard is very significant for the industry and for Certicom.

Slide 7. Another win during the quarter was a strategic partnership with IdentiPHI, an industry leader in enterprise advanced authentication, single sign-on and endpoint management solutions. IdentiPHI is a key partner of Dell's and is strongly focusing on growing their government revenues. They intend to use the Certicom Security Architecture to add a FIPS 140-2 validated module that includes Suite B algorithms to their authentication products.

We also launched Certicom security for Silicon Design Protection. This toolkit will help fabless semiconductor designers protect proprietary chip designs and prevent gray market chip theft. And finally in June, we were honored to win the Canadian Advanced Technology Alliances Award for private sector leadership in technology.

Slide 8. We intend to continue that role of leadership and innovation with the Third Annual ECC Conference, which will take place November 14 to 16 in Toronto. We have distinguished speakers from prestigious companies such as Microsoft, Philips, Seagate and QUALCOMM. We hope to see many of you there. You can register for the conference on our website at www.certicom.com.

Slide 9. Subsequent to quarter end, we successfully completed a bought deal equity offering, raising gross proceeds of CAN$26.2 million, or US$22.2 million. We intend to use the proceeds to execute our growth strategy as we aim to take advantage of the considerable opportunities in front of us today. At this point, I would like to ask Herve to cover the Company's financial performance in Q1. Herve?

Thank you, Ian. Good morning, everyone. Please turn to slide 10. Revenues for the quarter were $4.7 million compared to $3.5 million for the same period last year and compared to $5.1 million quarter-over-quarter. The higher year-over-year revenue was driven by an increased number of customer wins and higher royalty revenue as ECC adoption gains momentum.

Operating expenses were in line with expectation at $4.5 million compared to $3.5 million in this same quarter last year. The increase year-over-year in operating expenses was due to the strengthening Canadian dollar, higher sales commissions related to increased revenue and a planned increase in product development cost. I should point out that starting this quarter Certicom is reporting operating expenses excluding cost of revenue, depreciation and amortization and stock-based compensation.

The number for the first quarter of last year has been adjusted for this in order to facilitate a meaningful comparison. The reason for this change is that we are now selling more solutions that include third-party costs which makes the cost of revenue very difficult to predict.

On a GAAP basis, the Company posted a net loss of $1.2 million or $0.03 per basic and fully diluted share. This compares to a net loss in the same period last year of $800,000 or $0.02 per basic and diluted share. The net loss first quarter included $363,000 of income taxes paid which represent a withholding tax related to the Company's business in Asia. Because the Company does not pay income taxes in North America due to its substantial tax loss carryforwards, it cannot deduct this amount as a foreign tax credit from income taxes otherwise payable. Certicom maintains a strong cash position with $21.8 million in cash at quarter end. This compares to a $24.7 million at the end of the year and $25.1 million at the end of the same period last year. The quarter-over-quarter difference is primarily due to timing in booking orders. Following the equity offering, which was completed in August after the quarter end, our cash resources now stand at approximately $44 million.

Can you please turn to slide 11, and I will discuss our outlook? For the second quarter of fiscal 2007 excluding cost of sales, as we mentioned before, we expect our operating expenses to range in the $4.6 million to $4.9 million. With our strong cash position, steadily growing business and increasing recurring revenue base, Certicom has a strong financial strength and flexibility to execute our growth strategy. Now I'll turn the call back over to Ian for final remarks.

Thanks, Herve. We are now on slide 12. So in summing up, we continue to make progress in design wins and in signing multiyear recurring revenue contracts, both of which build a strong platform for our future growth. We are taking advantage of unprecedented ECC adoption in the marketplace and are winning license contracts of new multinational customers. We are making steady progress in each of our high potential vertical markets and we have a clear strategy for growth to take advantage of the increasing adoption of ECC in the market to create value for Certicom shareholders. So at this point, we would be very pleased to answer any of your questions.

(OPERATOR INSTRUCTIONS). Scott Penner, TD Newcrest.

First of all, I would like to ask about the services revenue. It is certainly stronger than I had been expecting. I know this is a volatile number, but this is two pretty strong quarters in a row at a time when I would think the profile of your customers is actually less demanding of services. So I'm hoping you can just give a little bit more color there.

Certainly, Scott. The services revenue -- the high services revenue this quarter is probably what I will call a blip. We have had some agreements which were bundled in with some product offering, whereby just by the nature of the product are classified as service, but there -- so I would -- there has been no significant increase in the level of service revenue over the last few quarters. So it is just a question of structuring of the agreements.

So, Scott, it's Ian. If we have a product based contract and we have to add some additional features in, for example, which we do occasionally, that can be the type of example. But, as Herve said, this is not something that we view as a concern and we're very comfortable with the mix.

And on the expenses, I think your guidance coming out of this quarter was $4.6 million to $4.9 million. I was actually a little bit disappointed to see it come in a little bit below that range. So I'm wondering if you could just talk about where you're spending money and why it may -- why you may not have spent the amount you thought.

You know, there is no particular reason other than some of the timing. As you know, in the quarter we hire some people. We expense some money for certain development and programs, and sometimes there is a question of timing. So I wouldn't read anything into that. We continue on plan, at least our internal plan is on target for our spending and our deliverables.

Thanks for that. And then lastly on the income taxes, I certainly don't want to overplay it, but are there any other of these sort of little pockets of profits which you may have to take out of the tax line?

There are to the extent we're successful in Asia. I should mention as well that it is a little premature, but as we start to grow in Asia, we will be looking at an appropriate Asian tax strategy in order to minimize the amount of taxes that we will have to pay from these countries. And it all has to do with the -- because of our tax situation in North America, it all has to do with the Canada or U.S. tax treaties with each of these jurisdictions. I can tell you that we have got the structure in place for certain countries right now where there is no taxes payable. We just have to keep on working with the various jurisdictions in which we sell.

Glenn Jamieson, Orion Securities.

Ian, I'm wondering can you go back over the five target markets that you've identified and just give us an update in terms of what you're seeing with potential deal flow and which of those markets you're most optimistic about in the nearer-term.

The five target markets are government which is typically government suppliers, such as defense contractors; mobility which, as an example, would be companies like RIM Motorola for their handset business; software enterprise companies, such as Oracle Sybase. And I would have to say that those three of the five are markets that we have been in for some years and we continue to see growth, and I will come back to that in a moment.

The remaining two markets are digital rights management and sensors, and we have indicated in the past that sensors is an area where we are seeing growth. But it is probably the earliest stage market in terms of pipeline but where we see tremendous growth long-term. And, for example, it is where standards such as the ZigBee standard, which incorporates ECC technology for public key requirements, has already been adopted and that should drive royalty revenues as the ZigBee standard is picked up and embedded in various sensor-based products and industrial automation and so on.

Digital rights management, we see tremendous upside there. We have talked in the release about the success with Philips and the DisplayPort Content Protection. That is one of a number of DRM standards that have standardized or moved to incorporating ECC technologies. And that opens up a huge array of opportunity for us with consumer electronics companies and media-based companies in terms of where digital content needs to be protected.

Having said that, the government market continues to be pretty strong for us and shows increased promise as Suite B, for the NSA grows in adoption by use for -- by both defense contractors as well as other companies who are supplying commercial off-the-shelf products to the unclassified government market. Mobility continues to grow. We have seen a lot of uptick with a number of mobility manufacturers.

And finally software enterprise companies, many of these organizations -- I mentioned a few earlier, Oracle, Sybase and others -- will also be moving to incorporate Suite B in their [earnings] over time in order to line up with the government Suite B ECC standards. So we are very, very pleased with the progress that we are making in all of these target markets. Some are more advanced and mature than others, but they all represent significant upside.

If I were to try to pick the two that we may see news flow from in the nearer-term, is the digital rights management and the mobility market, are those two good areas to focus in on?

Yes, I think of the five, I think the four that represent the most significant revenue short-term and short of providing guidance are the DRM, software enterprise, mobility, and government market, so three of those four are mature. They continue to provide ongoing revenue in terms of pipeline opportunities. DRM is the most recent, but we believe it will start to generate revenue for us. DPCP is an example. But as we said, sensors is probably the earliest in terms of maturity, so I suspect the revenue in the sensor marketplace will probably be somewhat longer to start seeing some consistent flow compared to the others.

And Herve, can I ask you one or two financial questions?

Sure.

Your receivables jumped up at the end of the quarter. Is that just timing of collections, nothing to be read into that?

Well, it is not just timing of collection. It's also timing of booking orders. So what you're seeing is as -- you know, in a 90-day period, we ended up having more orders towards the end of the quarter, so they get billed and aren't collected yet. But we track two measures. We track DSOs and obviously they're up this quarter as a result of that. But we also track sort of distribution across 0 to 30 and 30 to 60 and so on and so forth. And our current 0 to 30 is at an all-time high, which is, as you know, a really good sign.

Right. So if we were to look at your receivables balance today, it would probably be a more normal level?

That's right.

And one last question, Herve. It's a smaller detail, but your CapEx for this quarter, it was equal to what you spent all of last year. Is there something that has changed (multiple speakers) capital intensive?

Sure. We are in the process of upgrading and we are just about done now, our infrastructure. So our storage banks and storage farms and things like that. So it is just a normal high-tech company periodic upgrade of its infrastructure.

Will that go back to historical levels in the coming quarters?

We expect so.

Lawrence Rhee, Genuity Capital Markets.

Could you just provide the percentage of your total revs that came from recurring sources?

Our current revenue still continues to inch up. It is now well over 40% for the quarter.

So I guess as you're saying, the services revenue component that was higher than expected, I guess there is some recurring revenue piece in there, or is it all on the product side?

It is all on the product side. I just -- there is a small amount of service revenue which we include in there which just comes in every quarter from some of our accounts, but generally speaking, it is mostly on the product side and it is mostly royalty-based.

Got you. Now I think after last call, you were talking about increased investments outside North America, I think in Asia. Can we expect the trend of kind of R&D and sales and marketing expenses to go upwards or would they still remain comparable to prior quarter in terms of percentage of revenues?

First of all, we are seeing continued revenue growth in the future coming from Asia-Pacific and we're quite pleased with the progress we're making there.

We announced earlier last quarter that we have announced plans to increase our product development organization in order to generate new products to drive ECC adoption where we certainly think the Asia-Pacific market is one of the markets that will benefit from that. And I think we will see some planned increase in the sales costs as a result of our global expansion, but I wouldn't say it is anything beyond what we have discussed to date in prior meetings. And some of these sales expansions if you will, some are direct costs. Some are sales agents who represent the Company and get paid only on commission from sales they make, so they are not direct costs, and we have a mix of that.

And just last question with respect to revenues in Q1, is there a seasonal component here in terms of explaining the sequential downtick in revenue from Q4 to Q1?

Sorry?

That was just my question.

When we look at our year, we typically have a somewhat weaker first and second quarter, followed by a very strong third and fourth quarter. So it is -- when we look at the trends over the years, they really follow that and this year is no different.

Thanks, guys.

I will just add that we're very pleased with our Q1 results. It is the strongest Q1 that we have had in many years, certainly since Herve and I have joined. We didn't look back further than that. So we are very pleased with the performance, and it is certainly well on track with our internal plan. I know we don't, as you know, provide revenue guidance or earnings guidance, but we are very pleased with the results.

David Wright, BMO Capital Markets.

Thanks. Good morning. I was wondering what drives your seasonality. Is it the way you have structured your compensation plans, or is there -- because I am wondering what seasonality there is in April that makes your April quarter stronger than your January quarter?

We are probably no different than many companies in this space, and I'll let Herve comment as well. But wherever you have got a summer month, that has some factor, vacations. And we deal with two quarters, by the way, where we have summer months. Our Q1 and Q2, we deal with both of July in Q1 as well as August in our Q2. So that has some bearing and, of course, just in general some of our prospects take a little longer to close in that period of time to deal with vacation schedule. But having said that, we have been able to maintain a strong performance in Q1 despite the summer months. And so we are quite pleased with the results.

Okay. Getting back to the vertical markets discussion, when you look at your defense business or opportunities, you have mentioned in the past that obviously an increasing market opportunity with Suite B coming and that sort of thing, and so now we're finally starting to see the odd announcements per quarter. Could you in any way describe your pipeline in that market the way you have described other parts of your pipeline a year or so ago where you said, wow, things are really opening up now? Do you see the defense business as really opening up, or you're still kind of adding 5's and 10's instead of 10's and 20's, if you know what I mean?

Yes, I understand. So overall, we are continuing to see many, many large multinationals continue to come into our pipeline. Just by comparison to a year ago, we are working with companies today on opportunities that we were not talking to a year ago.

We have obviously closed some very large accounts that we have been able to issue press releases on most out. I will also remind you that short of material contracts, there are occasions when we are not able to announce a signed contract due to the customers' competitive situation. So we in fact have closed more contracts than we have been able to announce publicly.

We always try to push as hard as we can to get the public announcement out, but having said that as a general comment relative to the defense sector, we are absolutely seeing a higher volume of pipeline. And frankly over the last three years since our NSA contract was signed, we were expecting we would see a higher volume of defense contractors licensing with us earlier in that cycle.

But having said that, while it has taken a little bit longer, we are seeing some very, very major defense contractor names in active discussions with us. And I would say every quarter it grows in terms of opportunity. So we are very pleased with how that sector is progressing. It has, as I say, taken a little longer than we thought it would, but it is I think in line with the NSA's plans. There are a lot of activities underway there, from a pipeline perspective.

Thanks. Don't mean to get you to repeat yourself, but I was actually put on hold by the operator when you answered one of the questions earlier about services. So the service business which is tied somewhat to your product revenue, I think Herve said that it took a bit of a blip in this quarter. So what was it about the business this quarter that made it maybe less recurring and why would that not happen next quarter as well?

I am not sure I understand the nature of your question.

So --.

So we had a blip in revenue and in services. Our product revenue as a result of that probably looks more flat year-over-year. And one would -- if you go back and maybe I could try and reiterate what goes into the recurring revenue piece, which is our royalties, our maintenance revenue and a small portion of our service revenue. So that continued to grow on a quarter-to-quarter basis from that perspective.

This is in the service portion that is "the blip." Do you need other contracts in order to continue to build that, or could the contracts that contributed this quarter also contribute next quarter?

I'll put a different spin on answering your question. The service revenue, as Herve said, has an element of a blip to it in terms of the volume. But they're all tied. All those service revenue dollars are tied to contracts that involve products.

We don't very often do just pure play service contracts. They are typically tied to larger product-based contracts. So every contract that I can think of in Q1 -- and correct me if I'm wrong, Herve -- but virtually all of them are royalty-bearing multiyear recurring revenue based. There is no change. We have a good volume of new business, of contracts in Q1. They're all ongoing recurring revenue based. Some of the revenue just happened to be booked into the service line as opposed to the product line for the reason that Herve has mentioned before.

The split between -- obviously we are tied with, in terms of the GAAP rules on revenue recognition in terms of where the revenue gets allocated. So when I talk about the blip, it really has to do with the structure of the agreement with our customer.

That's helpful. Thanks. Now that you've got the money from the financing you did, could you be at all more specific on how you intend to use it? Is it mainly for being able to show people that you're funded if you have to go to court or are there products that you intend to now develop that you hadn't developed before so we would see R&D expenses rising more than in the past or something?

So, David, don't expect to see our expense line goes up as a result of us getting this cash. As we have said before, it is in support of our business plan. One of the factors that went into play is the fact that we are now dealing with a different breed of customers than we were a year or 18 months ago.

We are now dealing with very big multinational companies and we want to make sure that we have got the right balance sheet, that they will not have second thoughts about wanting to partner with us to become part of their strategic product plan.

The other one is there is no doubt that we want to give ourselves the option to protect our IP if and when we want to. We have always said that we want to -- our first line of approach is to make sure that we end up with a solution which is business-driven, but we certainly want to have the option if that doesn't go the way we want. Thirdly, and we did mention that as well, is we are focusing on doing some what we call tuck-in acquisitions which, while we believe that the bulk of it will be paid for through our stock as a currency, that there will be some requirement for some cash and that is there as well.

Great. And lastly any update on DTCP-type contracts? You have had one or two. Should we expect more in the near-term, or is that a longer-term initiative at this point?

I wouldn't say it is longer-term. But I can't talk specifically about pipeline, as you know. But I would say that overall we are pleased with the progress that we are making in the DRM space, of which DTCP is one of the standards that incorporates ECC. Certainly, DTCP is what we have been mentioning for about a year and half, two years now. And we are pleased with the opportunity and progress that we see there.

We are coming to the point, as we said in the past, where we are going to have to at some point, make some decisions if any of those discussions drag on for an unreasonable period of time or if it seems that we are not getting or are making the progress that we would like. But having said that, I can't really comment about what contracts might close in the future. But we are certainly optimistic about the opportunities there and the pending contracts that we believe we will be able to bring in and hopefully report.

Thank you very much for your comments.

Peter Misek, Canaccord Adams.

I guess, just stepping back for a second, one of the challenges looking at Certicom and [about] you folks is always trying to put some milestones or guideposts or even yearly metrics. And it has obviously become difficult, at least for my part, other people may have it easier, but to try and gauge. Because when we go out and we talk to big firms, there is a clear acknowledgment of the value of your intellectual property portfolio.

But can you help us, at least give some milestones, because to the extent that we don't have milestones it makes analyzing Certicom, at least in our case, a lot more difficult? Is there any pipeline, booking, market size, anything you could either provide us today or in the near reasonable future that can help us guide in that respect?

I think back to MOSAID and how they ran their business and they have made some attempts at guideposts. Maybe if you could just at some point offer that up, that would just be a first comment I would make. The second -- the question I had, was recurring revenue up sequentially? You talked about it being over 40%, Herve, but if you could help me understand that question, that would be great.

Okay. Let me take your first question, Peter, and then I will give up to Herve for recurring revenues. First of all, we appreciate the difficulty that you and your peers are in in terms of being able to determine or project future growth given that we don't provide revenue or earnings guidance. And clearly, we have a difficult time with that as well in terms of helping to make sure that you are in line with where we see the plan.

We have a strategic growth plan as we have discussed that covers the next five years. We are very, very confident in executing against that plan. I can tell you that we are on track and slightly ahead of our internal plan in terms of our Q1 performance. We're very pleased with that result.

But I will remind you that we have always focused on longer-term revenue growth. We stay away from short-term revenue blips and I know that you're aware of this, Peter. But as an example, if I have the choice between taking a one-time, $1 million contract with no future recurring revenue versus a $3 million contract from the same customer for the same opportunity that includes recurring royalties through revenues but that is spread out over two, three, four years, I am certainly going to opt for the latter. We do not want one-time blips in our performance.

We certainly could be -- could have been profitable had we been taking that approach but that is very short-term in terms of our outlook. We have a steady level of recurring revenue contracts building. They take time to generate revenue initially through royalties, through the design win process.

Once those products start to ship, we expect to see and are seeing regular contributions to our quarterly revenue. But it is a step process as opposed to a very significant blip. And I would just say that from a milestone perspective -- and Scott may have some comments on this as well -- there are many different metrics, if you will, or milestones, if you look back historically, that we could point to.

One of them of course is simply trying to ensure that we're getting as many announcements about contract signings out that we can with the permission of our customers. And as I said earlier, we do have a number that we have not been able to announce for competitive reasons. So I would look at the trend of those and the volume of those on a year-over-year basis.

If you look at the security industry, it is not the type of industry that moves overnight to adopt a new technology. This is an evolutionary versus revolutionary shift that we are seeing. And there is no question that we have seen that shift occur, with the baton now having been handed off to ECC as a result of the Suite B announcement from RSA, the algorithm, which was very dominant for 28 to 30 years, as you know. I think that is probably the most important reference point. Once you are in, it takes a long time to be adopted and accepted as the new standard, which ECC now is.

But once you are there, and it doesn't occur overnight, you are in a very, very strong position for decades. And as the NSA have stated, they want to see Suite B and ECC grow in terms of adoption and proliferation. They want to see it be the global standard. That is their vision. That is certainly our vision and we are investing for that sole purpose. Their time frame at the NSA, which will drive government standards and ultimately private sector standards, is 25 to 50 years, and that is a long-term view that really in our view will sustain significant revenue growth over the long-term. Scott, at the risk of extending the answer here too long, do you want to add anything?

Yes, I would. Of course, we are seeing a huge uptake in elliptic curve cryptography. But what has to occur -- and we have known this for a long time and we're now seeing it happen -- is the creation of a public key infrastructure based on elliptic curve cryptography. What has been in place now, as Ian said, for the last 20 years is an infrastructure that supports RSA. That infrastructure has to be replaced and we're starting to see it happen. And as that happens, we will se a far greater uptake in the usage of our technology. So it is certainly just a matter of time.

Herve, do you want to talk to recurring revenue?

Certainly. On a recurring revenue basis, our absolute dollars from quarter-to-quarter has gone up from last quarter to this quarter. From a percentage standpoint, it has gone up more significantly only because last quarter had such a high common denominator to the equation.

In other words, revenue was higher in Q4 than Q1, so the percentage is (indiscernible).

Yes.

So if we just step back for a second on milestones, for example, if we look at the next-generation DVD disks, and not to belabor this question. We look at HD protocols really across a bunch of DRM standards. I can't think of a case where ECC is not in some way, shape or form incorporated. Does that mean that HD becomes mass-market? If we look out two to three years, we should expect Certicom's market opportunity to grow 50%, 100%, or largely a lot more than it is -- I guess some future even rough, really rough idea of that would be really helpful, because obviously the quarterly stuff is something that we preoccupy ourselves with. But if you execute on a yearly plan or even on a multiyear plan, then in the end, investors, I'm sure, will be happy. The question that I am really having is understanding the more longer-term nature of what you're trying to execute on.

Fair enough, and that is a reasonable perspective and quandary as well, and we struggle with that as well in terms of trying to convey that. But in our strategic growth plan, we did talk about a very significant expansion in our total addressable market from what we saw a year and a half ago, and it grew essentially on a cumulative basis over a five-year period from $2.5 billion a couple of years ago to now in the neighborhood of $6 billion. And a large percentage of that -- and we haven't announced which vertical market represents what portion of that, but certainly DRM for example to your point is a very significant portion of that opportunity. And we have increased that total addressable market in part because of the very point you mentioned. We have seen a dramatic increase in the number of DRM standards incorporated in ECC. And that was simply not the case two years ago.

Two years ago it was for the most part just the DTCP standard. Well, since then, we have seen a significant number of more standards such as the DPCP standard, AACS as well. So absolutely we expect over some period of time, and again it gets back to your milestone question which is tough to provide the answers on specifically, but we expect to be getting royalties from the various products that are shipping that contain those various standards and that is absolutely our mandate and our vision.

But again to Scott's point, it takes time for a standard to, A, be adopted and to start being embedded in the infrastructure of a manufacturer's products and manufacture of DVD products, for example, and to start to ship. But we're seeing that. We're seeing AACS shipping now in various products from certain manufacturers. DTCP has been shipping in some amount of volume, not significant, for a period of time. Some manufactures have fairly high volumes of shipment. And we expect to see other standards that are following suit. DPCP, I think you'll see Philips start to be very aggressive in pushing with that consortium, the DPCP standard. So I want a royalty on every DVD player and flat screen and set-top box and hard drive and various other media that have protocols or standards that use our technology. That is our mandate.

Scott, again at the risk of belaboring it, do you want to add anything?

Yes, I wouldn't mind adding something. I am very excited about this DisplayPort Content Protection, DPCP. And I am not sure it is clear to people that although we say Philips licensed, yes, they are going to be the licensing authority or the standard. So they will be licensing to other companies to implement our intellectual property. So it is certainly I think more than just licensing Philips. Also it is a flavor of our technology that is, although very efficient, rather complex to implement. So we are hoping that we will see a lot of design wins out of this where we actually have to help people to build hardware and software to implement this on top of the intellectual property licensing we have done with the Philips consortium.

Scott Penner, TD Newcrest.

Herve, I just wanted to clarify one thing that I think you touched on in answering David's question, and that is that there -- when looking at the split between services and product this quarter, there was an element of the business which may have normally been characterized as product but because of a certain level of customization was simply bucketed in the services?

Yes, it had to do with what we had to deliver to the customer. So it was bundled in. It is a bundle of existing products and we had to put some special services in order to deliver an application. As a result of the characterization of the agreement, it ended up we had to record all of it as service revenue.

But economically you would consider it equivalent, let's say, to the near normal product service mix?

It was very much in line with what we normally do. It was just, as I say, just because of the way it was contracted.

That's important. I also wanted to ask Ian, you mentioned obviously there are contracts that you don't announce but which you do sign every quarter, and in the public markets we see only the announced ones. Is there any way for you to either quantify or even anecdotally mention whether the volume or maybe more so the potential revenue related to contracts that you are signing but not announcing whether you are seeing that -- whether you're seeing that increase steadily and kind of year-over-year?

Yes. I just want to make sure I answer your question properly, Scott, but we always push to get contract announcements out. I would say the average percentage would be at least 50% plus result in press releases coming out within a month or two to three of the contract signing.

In some cases our customers want us to wait until the product is actually shipping. So in that case it is a delay, but we typically -- so we have press releases that are lined up to be issued when the customer's product ships. So that could be, say, four, five, six months after the contract has been signed. And of course it goes without saying that any material contract that's signed would be announced the same day.

We have stayed away from talking about the number of design wins that we've won on any given quarter, but we do, Scott, talk about design wins on a year-over-year basis. And as we stated at our year-end, FY '06 we won well over 20 design win contracts compared to less than 10 the year earlier. And so that is one milestone or point of reference for you. Not every one of those gets announced though, but I think if you look at the trend of design wins and, of course, this year we plan to and we're budgeted to make well beyond the number that we achieved in 2006. So that's a very, very important metric for us.

It is fair to say that the profile of those design wins is now moving up in terms of the more multinationals and higher revenue potential associated with them?

Absolutely. And that has been a very important theme that, as you know, we have been emphasizing for the last year or so. The names that you have seen recently GE, Philips -- there have been many other names that you have seen. These are representative and I want to remind you that in the design win, as we've stated, it typically takes some period of time, for example three to six months, nine months in some cases, from initially winning the contract before we are then designed and built-in or embedded into that product. And when it ships nine months later, that is when the royalties start to be paid to us on a quarterly basis. But there is a timeline there.

That's very helpful too. Thank you very much.

Paul Bradley, Fraser Mackenzie.

I think most of my questions have been answered. I just wanted to double-check on a couple of things. Just on the recurring revenue, you said that is greater than 40% for Q1. I am assuming that is 40% of total revenue, so recurring revenue was around $1.9 million.

It's of the total revenue, you are correct.

Okay, perfect. And then just on the product revenue, that is a mix of royalties, so software royalties, maintenance revenue, and I think you were saying in this current quarter -- maybe that is not usual -- some element of the service revenues as well?

For the recurring revenue, that is correct.

Perfect. And then my second or maybe third question was just to go back to a comment that was made in the overview. You were explaining that your definition of operating expenses excludes I guess cost of goods sold. And one reason for that is that you now have more solutions with third-party components. I'm wondering if you can just elaborate and explain what that statement means.

Certainly. We announced a product last year called KeyInject, which is a product, as Ian mentioned in the overview, which deals with the gray market area. That includes having to bundle our technology with hardware components that need to be purchased from third parties. So to the extent that we deliver one of those KeyInject solutions, then obviously there will be some third party involved in it. And we have a number of these proposals out and so it is very difficult to judge the timing three months ahead when we give you guidance. So that is the reason why we pulled it out of the equation.

Okay.

So that piece will be variable, but it will be variable consistent with revenue growth.

Should we draw any conclusions about the success of KeyInject from that?

It is a relatively new product. We are gaining some traction. We're very pleased with what we're seeing at this point.

It is not the only product or solution, Paul, that uses these hardware security modules. We sell them in other environments. Herve was really using KeyInject as an example.

As an example.

Okay. Thank you very much indeed.

Lawrence Rhee, Genuity Capital Markets.

Just a quick clarification. Would any component of the services, I guess, blip this quarter maybe be explained by -- sorry, would that be a precursor to the expected royalty revenues or current revenues that you expect in the six to nine-month period from some of your major agreements you announced over the past six months?

Good question. As you know and as we mentioned, we signed all of our agreements with a royalty component to it. It is very much in line with our revenue recognition model of building recurring revenues, so there are some upfront revenues. And sometimes to deliver the application, there are some professional services that are required. But definitely it is in line with our model of recurring revenues as the customer embeds our security applications into the product and the product gets rolled out.

Sorry, so that would explain there would be some -- you would recognize some services revenue prior to you recognizing the count of recurring revenue stream as the product rolls out?

In fact the revenue -- the service revenue would in most cases be recognized all the time before royalties are recognized. Because by the time the royalty checks start to come in, the product has been embedded in the product and we have provided the customer with the required services to help the customer implement that application.

Got you. So just looking at the trend of your services line over the past five quarters, basing it not for a trend in that line item specifically, that would indicate if -- there obviously is product sort of royalty-based revenue to come in the next six to nine months.

That could be an indication. In some ways you are right, but remember that not every product sale requires a service revenue. Some of our customers are very sophisticated and have the ability to implement that themselves into their product suites.

The only thing I would caution you on is that I wouldn't necessarily try to look for trends on our service line because it really, as we've stated in the past, it fluctuates from quarter-to-quarter. It will go up one quarter and down the next and simply because, as Herve said, some of our contracts require integration services, implementation services, others don't.

David Wright, BMO Capital Markets.

Just a couple of quick follow-ups. On headcount, has there been any change or any plan change for sales reps in the sales rep headcount?

We said at the beginning of the year with our FY '07 plan that we would be adding some sales headcount, some sales and marketing expenses. I think the most significant area of increase though is in the area of product development. And that is the area that we really highlighted. We really want to get new products developed this year that will help to drive ECC adoption in future years. So that is probably the most significant increase from a headcount perspective but, yes, there has been some increase in sales.

But the issue is not that you're missing or you don't have enough people to find the deals. Your emphasis right now is on building the products.

It is certainly getting the deals, but we're very comfortable we've got the right profile and right headcount in the field to get those deals. It is very much as you say on building new products and sustaining the health of the existing product base that we have.

And just one for Herve, which is your deferred revenue number. For most of our software companies, deferred revenue means essentially prepaid maintenance agreements. How do we interpret your deferred revenue number? Is it prepaid IP license agreements?

In this quarter there is a little bit of IP prepaid, but the bulk of it is renewals of some very significant maintenance agreements.

So this is a number we should watch and expect it to continue to grow as an indication that your business is growing?

It is very dangerous to look at that simply because it doesn't reflect the state of our signed contracts. I view the deferred revenue as a parking lot item on the balance sheet. Simply it just reflects the timing of revenue recognition versus the amount of invoicing that has gone out. We have many contracts whereby we have signed an agreement where customers have committed to pay over a long period of time some royalties based on shipments or based on passage of time. But because they haven't been billed, they never hit the balance sheet. So it only tells a little bit of the story and I think it could be misleading to look at fluctuations in the deferred revenue account as an indicator of revenues.

Terrific. Thank you.

Glenn Jamieson, Orion Securities.

Ian, I just wanted to follow-up on your comments about design wins. You said that in fiscal '05, you had fewer than 10 design wins, about 20 in fiscal '06. Can you tell us where you're at with design wins year-to-date in fiscal '07?

I also stated we don't discuss that number on a quarter-by-quarter basis, so it would be difficult for me to answer that. We certainly do discuss it on a year-over-year basis. But I can tell you that in terms of our internal plan -- in fact I don't think we even budget for it on a quarter-to-quarter basis. We really only have an annual target. But having said that, we are very pleased with the results of our Q1, both from a top-line perspective as well as the nature of the contracts we won and the large multinational names associated with those contracts. So from our internal plan perspective, we are on track and in some cases ahead of plan.

Would I be safe to assume that in the first four months of this year you have more design wins than what you've publicly announced?

Well, I can tell you that -- yes, as I said, we have some contracts that we can announce, some that we can't or delayed because of customer competitive requirements. But I think it is safe to say if you look at the FY '06 design win guidance which as you stated is over 20, we clearly want to exceed that in FY '07. And on a quarterly basis, we have some indication or ideas of what we have to be booking in order to maintain that growth on a year-over-year basis for design wins.

And then just one last question. You mentioned materiality of a contract, and I just want to make sure I've got the right understanding. You could sign a contract where there was a firm commitment to a dollar value that you would deem material and you would need to announce that versus a contract that you could sign that would have payments tied to volumes that were uncertain and you wouldn't need to announce that. But while it may be material over time, it wouldn't be material upon signing of that contract; is that right?

Let me just back up a little bit. When we talk about materiality, we are really speaking to needing to file a material change report with the Interior Securities Commission. So that is what we're discussing here. So we may have what we consider as a very important contract in the Company but we don't need under regulations to disclose it.

We do want to disclose it as soon as we can, because as we discussed with Peter a minute ago, it is one of the milestones to show you some proof points on the execution of our business plan. So that -- I wanted to make that distinction.

However, when we look at materiality of a contract, we look at what has been contracted for and what we can monetize. And I'll use the term take or pay. So over a period of time they have to pay us a given amount, given some certain milestones, whether it is volumes or given the passage of time, but definitely at the end of the period we will have collected certain amounts.

In other -- so those we were able to calculate because we know for sure that that is contracted revenue to the Company. On the other hand, when we sign a contract where it is simply based on the shipment, on the customers' shipments, while we may have some high expectations of the shipments and even have some expectations of volumes from customers, there is a greater amount of risk because of the fact that it is not -- it did not occur at this point. And as you know a lot of the products that we are into are early stage products or new generation products. And there is always some risk in terms of adoption, and not just adoption but the sheer volume of what we can expect from a customer. Does that help you?

Yes, that's very helpful. And just a final question. Is $2 million a threshold for materiality for you now?

At this point in time given the size of the company, that is a threshold number that I tend to look at as an annualized revenue number. As the Company grows, obviously that threshold will go up, but at this point in time it is a reasonable number. It is somewhere in the area of a little higher than -- somewhere close to 15% of the Company's annualized revenue. So it is based on last year, so it is a significant amount.

(OPERATOR INSTRUCTIONS).

Okay. I think that's it. Thank you very much for your interest this morning. I just would also like to remind you that we're holding our annual general meeting at the Hockey Hall of Fame at 10 AM on September 21. We look forward to seeing many of you there. Thank you very much.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. You may now disconnect your line.