Frank;
Great Interview posted on Stockhouse with Phil Deck. Indepth and complete. Thanks for pointing it out goes to Nesmith Chingcuanco--supporter & investor.
Best single read around for all of those just getting in and getting up to speed. To all those that are not in yet--have a read and then try and say, no!
Tom Drolet
here is the web clip--or read the text below.
stockhouse.ca
SHfn Interview: Soaring Certicom Expands Encryption Products, Wants Nasdaq Listing - December 10, 1999
By Chaya Cooperberg (ccooperberg@stockhouse.com)
Certicom's Chairman Phil Deck tells StockHouse in an exclusive interview that there are more licensing deals and encryption products in the works, indicating that in the weeks ahead there shouldn't be a shortage of good news of the kind that caused its stock price to triple since Nov. 1. The stock's surge, which broke through analysts' targets, also reflected a greater visibility in the US. The attention from US investors could well continue as Mississauga-based Certicom gets set to list on the Nasdaq and as it has shifted the high-profile CEO role to a resident of Silicon Valley. Analysts are often confused by the company's revenue model, but Deck provides StockHouse with a clear picture. He also reveals his reasons for the stock's high-flying performance.
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Following a magnificent stock price run that had just culminated in an all-time intra-day high, Philip Deck announced on December 7 that he would be giving up his top CEO job at Certicom Corp [T.CIC]. While Deck will still remain on as Chairman, the move signifies the company's shift of emphasis to Silicon Valley, where the new CEO, current president Rick Dalmazzi, will be located and where an OEM can scoop the most action. "As a lot of our business building goes on over there, it makes sense (for the CEO) to be there," Deck told StockHouse in a special interview.
Shares of the security software maker have nearly tripled since its November 1st close of $20.50, flying on news of impressive licensing contracts for Certicom's technology.
On Monday, December 6, the stock opened at $59-a record high set on the Friday--to briefly peak at $66, before settling back down to $60.
Analyst Brandon Osten, of Sprott Securities, has a surpassed target of $50 on the stock with a speculative buy recommendation. He is reluctant to upgrade the target though until some of the volatility has died down.
"When the valuation keeps going higher, you have to decide what to do," he explains, "but there are enough positive factors right now, not the least of which is expected and recently announced licensing agreements, that could cause our target to go higher."
On December 1st, the company announced a licensing deal with wireless phone standout QUALCOMM [QCOM], to provide its industry standardized brand of encryption, called ECC (elliptic curve cryptography). "I think it's an important beachhead into that customer, and we're very optimistic about what it can do in the future," Deck says. Its fourth major deal with a company in the wireless realm, Certicom has signed agreements with many key industry players such as Motorola [MOT], 3Com Corp. [COMS] and Hewlett-Packard [HWP]. It has been releasing plenty of news on the licensing front lately. In the second quarter, new deals covered a wide range of applications including content protection, wireless network infrastructure, smart cards and enterprise e-business software. Typically, Certicom has been sealing between 10 and 20 new licensing agreements a quarter.
But the question of whether the stock has gotten ahead of itself amid the excitement still arises. Osten expects the stock to continue to bounce within a wide range, in a "two steps forward, one step back fashion." But compared to other companies in the space, such as Verisign [VRSN] and Entrust [ENTU], Certicom may finally be earning a comparatively reasonable valuation despite the massive run-up in a very short amount of time. "It's not cheap, I'll tell you that much," Osten says. "But that can be said for a lot of stocks out there. Fundamentally, the company probably has more going for it right now than a lot of other companies that are seeing valuations in the stratosphere. On that basis, an argument can be made that the stock is not in fact ahead of itself."
As more announcements arrive, the analyst expects momentum to possibly push the stock further. "The stock has always moved on announcements," he says. "It's rarely moved on the basis of its financial performance."
The company's second quarter results, ended Oct. 31, were released December 1, falling slightly short of analysts' expectations. Revenues were US$2.6 million, a 22%-increase over the previous quarter, but with a loss of $5.3 million, or 49 cents a share, including amortization. Analysts had estimated a loss of 43 cents a share.
"Their growth has never lived up to its expectations, and I think that's a pretty fair statement on the revenue side," Osten says. "What's happened is the more announcements we see, the more the Street is expecting back-end licensing revenues." The revenue model hasn't proven itself yet, according to Osten, but investors are "still willing to believe" in it.
The revenue model is a source of some confusion to investors and analysts alike, according to Osten. It doesn't help either that when new license agreements are announced they are notably absent of financial details, or any clue as to how the software will be used. Products used to be licensed strictly on a per copy basis, but Deck contends the model hasn't changed significantly. Certicom now either charges a base line, or upfront license fee, or in some cases an annual fee, and then a royalty fee when the product is shipped. "Most of those are in place in our deals in some form or another," he says. "Virtually all our deals that include elliptic curve include the royalty component." However, he admits that there is difficulty in determining the size of royalties. "Frankly, that means we have to do an analysis of how successful our customers will be, how fast they'll get into the market, and that's notoriously difficult. Some of our customers that look promising don't turn out to ship the product in the end, while some we think are unlikely to ever be successful turn into blockbusters." Basically, to combat that deficiency, Certicom tries to sign up as many companies as possible, playing the odds. "It is frustrating for us that we can't properly model it," Deck agrees.
He also finds Osten's comments that Certicom hasn't met analyst's expectations frustrating. "The fact that we wouldn't perform to what certain analysts put out, is difficult for us to control," is Deck's somewhat annoyed response to the claim. "Many of them try to put forecasts that are above what we would suggest." Quarter over quarter revenue growth has been pretty solid, at 30% over the past six quarters, although the second quarter dropped to growth of 20% over the first quarter. "I think we have an extremely high rate of growth now," Deck says, "it will moderate a bit as we get bigger just because you can't maintain this rate of growth forever." So when will revenues from the spate of licensing agreements and royalties really ramp up? "I would say that we don't expect there to be a spike," says Deck plainly. "We don't expect that some quarter we're going to suddenly announce that our revenues are four times the quarter before." He believes that the ongoing, recurring royalties, and Certicom's business model of using OEM customers as a channel for its products, will grow revenues quickly. "I just don't think it's all going to happen in one quarter, where suddenly the world is different."
Osten agrees with Deck's appraisal. "Right now, we don't see any kind of explosive catalyst that's just going to make the revenues blow everyone out of the water," he says. Certicom's earnings results have also consistently under-impressed industry watchers. "The earnings have never contained any positive surprises for anyone," says Osten. "Not yet, anyway." Nor will they any time soon if, as Deck contends, profitability takes the back burner to growth for the near term.
"We would certainly like to be profitable on an operating basis," he asserts. "How much is that a priority over growth? I think growth is still number one."
Growth will come mainly in the form of internal product development, and continued deal making. "We'll add more technology, we'll add technologies for helping companies set up their certification authorities within their products, we'll have more protocols, we have more platforms to develop, we have more customers to sign up," Deck recites. "We have lots more coming." He says to expect more products to roll out in late January, and while some of them will be wireless related, the company has to consider the needs of its entire customer base. The company has also done some content protection deals, which it hopes to be able to disclose soon.
"What sets Certicom apart from many smaller, start-up security software firms, is it specifically targets the OEM market -- the businesses that could embed the software, and offer it as a feature, rather than the end users who fear hackers and Big Brother."
What sets Certicom apart from many smaller, start-up security software firms, is it specifically targets the OEM market -- the businesses that could embed the software, and offer it as a feature, rather than the end users who fear hackers and Big Brother. "Our theory of security is that end users want it, but they'll never pay for it," Deck says bluntly.
Nearly all the growth will undeniably come in the US market, which currently provides Certicom with about 95% of its business. Deck has said that CIC is "now as much a California company as a Canadian one." But it is arguable how "Canadian" the Mississauga native will remain. While its hearts and minds may reside firmly on this side of the border, in its R&D operations that will double in size over the next year, its soul is being transplanted to Silicon Valley soil. The sales and marketing department located in California, where all Certicom's customers, and potential clients, are based, will probably double, as well, in the near term. The US shareholder base is substantially bulking up, and Certicom plans to respond with a Nasdaq exchange listing. "We've committed to our shareholders that it is firmly in the sights," Deck says. "We haven't confirmed what the timing is and we're still working hard with investment bankers to figure out what the best course of action is. It certainly won't be this fall, but sometime in the new year we hope to do a Nasdaq issue."
Deck believes that talk of the listing and increasing US investor attention are partly responsible for Certicom's upsurge. "I think we've had a good consistent run of producing good financial results, and very strong licensing deals. In that context, our visibility in the US has risen dramatically," he says. Also, as more of Certicom's customers' become public entities, the security software firm is listing in prospectuses as a security supplier. This includes companies such as 724 Solutions, which is now in the process of filing US prospectuses.
The number of licensing deals with familiar industry names is a testament to the potential dominance of Certicom's ECC technology. In encryption, there are now only two standards, certified by the American National Standard Institute, for WAP. One is ECC, the other is RSA, and the difference is in their key sizes. A company called RSA Security [RSAS] is considered Certicom's main competitor. "I think people have recognized that elliptic curve is superior to RSA, technically," Deck says. In fact, he doesn't consider the company a direct foe because its targeted market space is slightly different from Certicom's. "RSA Security is really more focused on the enterprise area," he says. "So we don't face RSA as a significant competitor in that. In their OEM activities, where they had been historically, they seem to have less activity and we don't see them as often." According to Deck, although RSA is firmly entrenched in some areas of the market, such as Web certificates for servers, in others where there is little deployment, such as the wireless realm, for financial transactions and Smart Cards, elliptic curve is being used. "Certainly it looks like elliptic curve will be the crypto system of choice for places where there isn't one that's really dominantly established now."
There has been some worry recently that the competing technology will become a more threatening factor to Certicom when RSA Security's patents expire next year. With free encryption on the market, will companies still be interested in buying Certicom's?
"I think there is a threat, and I think that the company and the Street in general has downplayed the threat of this," Osten says. "We are somewhat cautious of this development." Right now, he says, RSA can work on a Palm Pilot and it can work on a Smart Card, although "the company will tell you it doesn't work as efficiently, and that's a debatable point." The issue facing Certicom is whether customers will demand a lower price from it, once RSA is free, Osten believes.
Deck, not surprisingly, has a different view on the debate. "I don't think any serious analysts have really seen that as a threat," he says. RSA is only patented in the US, Deck points out, and is free everywhere else. He gives an analogy to emphasize the distance between ECC and RSA. "486 chips are pretty cheap, but they don't compete with Pentium, because no one wants one. It's not a price issue. It's a matter of having the right technology for the right applications."
Osten agrees that Certicom's deal with 3Com would support Deck's argument. The Palm VII uses CIC's elliptic curve exclusively. Time will tell how the battle of standards plays out, but Deck can be content with the growing roster of clients in the company's address book as he leaves the limelight. As Brandon Osten says, "He can definitely leave his operational position on a high note."
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StockHouse: Do you believe it's the licenses the company is landing, or the sudden upsurge of interest for Canadian high-tech firms, that is propelling Certicom's share price?
Phil Deck: I don't know if it's the general trend for Canadian tech firms. I think we've had a good consistent run of producing good financial results, and very strong licensing deals. In that context, our visibility in the US has risen dramatically. A lot of our customers have been going public, so in their prospectuses they talk about us as their security supplier, and that includes Canadian companies such as 724 Solutions, who are filing US prospectuses, and cite us as their security provider. So that's given us some visibility. I'm sure our Nasdaq discussions have given us some visibility with dealers, and we've seen a growing interest from US investors. Although we've seen a big run-up in the stock price, they still consider it very cheap compared to the comparables in the market down there.
StockHouse: In your opinion, did the stock get ahead of itself?
" Every quarter we sign 10, 15, 20 new deals, and at some point we try to tell our shareholders about them."
Phil Deck: I can never judge if it's ahead or behind itself. There's certainly lots of comparables in the marketplace that would make it look cheap, on the other hand, it's always amazing to see a stock make the run that it has.
StockHouse: The company's been announcing plenty of licensing deals. Are there more to come soon?
Phil Deck: We try to announce them as soon as we can. A lot of our customers have product releases and their own marketing plans, so they'd prefer us not to. In the QUALCOMM and Sybase cases, even though we weren't at the point where our customers wanted to have us say what they were going to do with our technology, we felt that we had to disclose it. Every quarter we sign 10, 15, 20 new deals, and at some point we try to tell our shareholders about them.
StockHouse: On what side will new deals come? On content protection?
Phil Deck: We talked a bit in the analyst conference call that we've done some content protection deals, so hopefully we'll be at a point where we can talk about those soon. Really, all over the map. We've had a great deal of strength in the Internet and the Wireless appliance sector. We did another announcement like that this morning.
StockHouse: Right. That's the alliance for six companies to support digital payments.
Phil Deck: It's an alliance for encryption in general, for a new financial transaction methodology. That has a huge opportunity to create a standard in a place in the market where there's a real technology void right now. That's a tremendously important opportunity.
StockHouse: What does this alliance do for Certicom? Will there be revenue generating deals eventually realized from it?
Phil Deck: This is very much a deployment plan, a standardization plan with First Data, who does the majority of credit card processing in the US, so they're a tremendously influential company. Certicom, First Data and Cybersafe have really come together to develop a much more efficient, elegant solution for financial transactions than those that have been proposed before. I think it has an opportunity to really be a standard for electronic payments and Internet payments, and eventually wireless payments as well. They've made sure they use the most efficient technology because they want to make sure it's economic even when they're doing very small financial transactions. Ironically, the security needs are greater as the size of the transaction goes down, because people audit the large transactions and let the little ones go by. That's where someone has an opportunity for fraud. So as we get into a world where people spend two cents or five cents on the Internet to look at a picture, or read an article, then securing those payments and doing it efficiently is tremendously important.
StockHouse: It's interesting that the alliance chose to include Certicom's ECC technology, rather than RSA technology.
Phil Deck: I think people have recognized that elliptic curve is superior to RSA, technically. There are places in the market where we think RSA is well enough entrenched, where even though it's not the best technical solution, it will stay, like Web certificates for servers. But there's other places where there's little deployment and it looks like people are keen to use elliptic curve because of its benefits, in wireless, in financial transactions, and Smart Cards. Certainly it looks like elliptic curve will be the crypto system of choice for places where there isn't one that's really dominantly established now.
RSA Security is really more focused on the enterprise area, they're really trying to compete with Entrust, and we don't compete in that market. So we don't face RSA as a significant competitor in that. In their OEM activities, where they had been historically, they seem to have less activity and we don't see them as often.
StockHouse: Really? I was led to believe that RSA Security was your main competitor.
Phil Deck: Well, I think in the lack of anyone else. RSA isn't growing very fast, and they're only in business because they don't have a great deal of emphasis on it. But there's no one else who's really focused on the OEM security market. That's really a market that we've made our own. We've focused on it almost exclusively. Most companies sell through the enterprise channel, and we've decided that security is better built in than added on. So we go directly to the people who build technology products and help them build security in. There's just no one else who's really taken that on as their main mission in life the way we have.
"We're not competing with RSA on a price basis, we're competing with RSA because in the majority of applications where cryptography is important, you can't use RSA."
StockHouse: What about RSA Security's patents running out. Do you consider that a threat?
Phil Deck: I don't think any serious analysts have really seen that as a threat. I mean, anyone who looks at RSA realizes it's only patented in the US. We've done a slew of international patenting deals, or international licensing deals where RSA is effectively free in Europe, and free in other places. Schlumberger for instance has RSA implementation, but they still chose elliptic curve because they needed it for wireless. We're not competing with RSA on a price basis, we're competing with RSA because in the majority of applications where cryptography is important, you can't use RSA. Someone gave me an analogy that I thought was pretty good: 486 chips are pretty cheap, but they don't compete with Pentium, because no one wants one. It's not a price issue. It's a matter of having the right technology for the right applications. I've heard that comment before, but I've never seen anyone who really knows the industry well, give it any credibility.
StockHouse: How big could the Qualcomm deal be for Certicom? Could you give a general idea?
Phil Deck: It's very difficult to give you a general idea without giving you details. One of the ways we try to stay a popular supplier to our customers, is we don't give a lot of background when they've told us not to give any information. I think it's an important beachhead into that customer, and we're very optimistic about what it can do in the future.
StockHouse: The fact that there are very few details every time there is a licensing contract leads to some confusion. I was talking to some analysts who admit that they're confused about Certicom's revenue model. Could you describe how it's changed over the past year?
Phil Deck: I don't think it's changed very much. We charge our customers in three basic ways. We charge a base line license fee, kind of an upfront fee. We charge them in some cases annual fees. And then we charge them royalties whenever they ship the product. Most of those are in place in our deals in some form or another. Virtually all our deals that include elliptic curve include the royalty component. The upfront payments we recognize as revenue on an ongoing basis, and because we've been signing so many customers, that amount has been growing. What's difficult for us to do, is estimate what the royalty bill will be, because frankly that means we have to do an analysis of how successful our customers will be, how fast they'll get into the market, and that's notoriously difficult. Some of our customers that look promising don't turn out to ship the product in the end, while some we think are unlikely to ever be successful turn into blockbusters. If you look at some of the great companies in our customer base now, a lot of them didn't exist three years ago, from Aether to 724. It's very difficult to predict how fast they'll go. Our strategy is to try and sign up every company in the space, and we'll then benefit from wireless in general. It is frustrating for us that we can't properly model it. But what I think we've demonstrated we can do is build good revenue growth at the same time as building in royalty deals that will turn out to be extremely valuable in the future.
StockHouse: There definitely has been good quarter over quarter revenue growth. But it really hasn't performed to some analysts' expectations. Is there some point you expect it to significantly ramp up, and if so, what will it take?
Phil Deck: People can expect whatever they want to expect. The fact that we wouldn't perform to what certain analysts put out, is difficult for us to control. Many of them try to put forecasts that are above what we would suggest. I would say that we don't expect there to be a spike. We don't expect that some quarter we're going to suddenly announce that our revenues are four times the quarter before. We expect that we can maintain very high growth, and that in that growth will be a large proportion of recurring, ongoing, royalty revenue and that the leverage we have in our business model, the fact that we have all these OEM customers that act as channels for us, means that our revenue will be able to continue growing quickly, as we sign more deals. I think we have an extremely high rate of growth now, it will moderate a bit as we get bigger just because you can't maintain this rate of growth forever. On average over the past six quarters we've grown at about 30% quarter over quarter, which is unsustainable by any company. It will probably moderate slower, because we'll have royalty revenues kicking in. I just don't think it's all going to happen in one quarter, where suddenly the world is different. I think maintaining anything close to that kind of growth rate would be outstanding and we'll probably maintain something a little less.
StockHouse: Is profitability or growth the priority on management's agenda?
Phil Deck: We need to demonstrate that we can grow without a corresponding increase in cost. We've really maintained stable costs over the past six quarters or so, when a lot of our growth has occurred. We've been able to demonstrate that we have a very high margin, it's virtually 100% margin. Our growth in costs is mainly limited in that we can't hire as many good people as we want. I think growth is number one. Certainly we'd like to be profitable, at least on an operating basis. A lot of our net loss is non-cash expenses related to acquisitions.
StockHouse: From what industry sector will the most growth come from?
Phil Deck: It's difficult to say. The smart card deal we did with Schlumberger was really focussed at wireless, so I'm not sure if that's in the smart card sector or the wireless sector. It's a smart card for wireless. And a lot of the desktop deals we're doing have a smart card element. It's difficult to cut it up. But I think wireless will continue to be a major growth area for us.
StockHouse: Is the future of encryption really moving toward embedding it in hardware, instead of as a software product?
Phil Deck: In some cases that will happen. That's the case with Smart Cards for instance, so you can get security embedded in hardware.
StockHouse: Is there any news coming out in that direction?
Phil Deck: We work with a number of companies on chip design, Motorola in particular has jointly developed a chip with us to do high speed encryption for wireless. That hasn't been launched yet, but it's been underway for a number of years. It's a wonderful device.
StockHouse: Anything like an infrastructure deal happening with the major OEMs?
Phil Deck: We never speculate on deals that are coming up. People try 15 different ways and we try and avoid them all. I don't think that encryption in hardware is the main part of the market for the time being. It's not where most of our business is now. There's a number of companies we're working on hardware with, and those will come out as time goes by, but that's not where most of our business is.
StockHouse: Thanks for speaking with me today, Phil. |
