Financial review

Gemalto further expanded its profitability in 2009 and posted record operating profit and margin, with all segments now reporting profits, and record operating cash flows.

Income statement

Extract of the adjusted income statement:

€m 2008   2009  
Revenue 1,679.9     1,654.4   (2%)
Gross profit 596.8 35.5%   600.1 36.3% +0.8 ppt
Operating expenses 429.3 25.6%   433.6 26.2% +0.6 ppt
EBITDA(1) 218.7 13.0%   224.6 13.6% +0.6 ppt
Other Income & Expense 1.7     4.0    
Operating income (EBIT) 169.3 10.1%   170.6 10.3% +0.2 ppt
Net profit 153.0 9.1%   148.1 9.0% (0.1 ppt)
             
Earnings per share
(€ per share)(2)		            
– basic 1.80     1.75    
– diluted 1.78     1.73    

In accordance with IAS 37 in 2009 Gemalto booked a special provision of €11.2 million to cover the consequences for Gemalto of the situation related to German payment cards identified at the beginning of 2010. This special provision is based on management’s best estimate and takes into account expected coverage from insurance. It is reported on the line item ‘Cost of sales’ in the Secure Transactions segment.

€m 2008 2009  
Operating income (EBIT) before special provision 169.3 10.1% 181.8 11.0% +0.9 ppt
(1)
EBITDA is defined as operating income plus depreciation and amortization expenses. In accordance with the adjusted basis of preparation, these amounts exclude amortization and impairment charges related to the intangible assets identified upon acquisitions pursuant to IFRS 3 ‘Business Combination’.
(2)
The full year 2009 adjusted basic earnings per share were determined on the basis of the weighted average number of Gemalto common shares outstanding during the twelve-month period ended December 31, 2009 (82,519,980 shares) taking into account the effect of the share buy-back on the weighted average number of shares outstanding during the period. The full year 2009 adjusted diluted earnings per share were determined using the IFRS treasury stock method, i.e. on the basis of the same weighted average number of Gemalto shares outstanding twelve-month period ended December 31, 2009 (82,519,980 shares) and considering that all outstanding ‘in the money’ stock options were exercised (5,824,462 options) and the proceeds received from the options exercised (€114,883,551) were used to buy-back shares at the average share price of the year 2009 (4,555,925 shares at €25.22).

Gemalto revenue in 2009 was lower than the previous year by 2% at both historical and constant exchange rates. Revenue from software and services increased by 9% at constant rates to €164 million, accounting for 10% of the Company’s full year revenue and representing a 70 basis points improvement on the previous year.

Gross margin increased by 80 basis points to 36.3%, on the back of performance improvements in all three main segments. Excluding the special provision, gross margin was up 150 basis points.

Operating expenses were essentially flat in value. As a percentage of revenue, operating expenses accounted for 26.2% of revenue, compared to 25.6% a year ago. Other income & expense was a profit of €4 million in 2009, compared to €2 million in 2008.

Consequently, operating income was €171 million and the operating margin 10.3%. Excluding the special provision, operating income came in at €182 million and the operating margin at 11%, an increase of 90 basis points year-on-year. In 2009, Gemalto was successful in achieving its objective of above 10% adjusted operating margin that the Company had set for itself in its 2006-2009 Development Plan.

Net interest income was reduced by the significantly lower market yields on short-term investments, and was down €9 million to €0.1 million. Foreign exchange related costs were down €6 million to €1 million. Other financial expenses of €1 million were recorded during the period. As a result, Gemalto reported a net financial expense of €2 million for 2009, compared to a net financial income of €2 million the prior year.

Profit before taxes was therefore €170 million, compared with €174 million the previous year. Net income tax expenses amounted to €22 million.

Consequently the adjusted net profit for the period was €148 million, or €159 million excluding the special provision, compared to €153 million for the same period the previous year. Basic adjusted earnings per share were €1.75 and fully diluted adjusted earnings per share were €1.73.

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Mobile Communication

€m 2008   2009  
Revenue 948.2     888.1   (6.3 %)
Gross profit 394.5 41.6%   382.3 43.1% +1.5 ppt
Operating expenses 233.9 24.7%   242.8 27.3% +2.6 ppt
Operating income 159.9 16.9%   142.5 16.0% (0.9 ppt)

At constant exchange rates, full year 2009 Mobile Communication revenue was lower by 8% year-on-year.

2009 was marked by a cautious market environment, some customers postponing the roll-out of certain innovative projects, and Mobile Communication reported revenue of €888 million, lower by 8% at constant exchange rate from the previous year.

Gemalto continued to secure new wins in software platforms and operated service contracts, posting a revenue increase of 15% year-on-year for software and services at constant exchange rates. SIM card average selling price in 2009 was lower by 16% year-on-year at constant rates. This reflects some customer delays in the roll-out of enhanced products and services, resulting in a softer product mix improvement.

Gross profit for 2009 was €382 million leading to a gross margin of 43%, up 150 basis points from that of the previous year. It reflects continued focus on value-selling and further improvements in operational efficiency.

Operating expenses, at €243 million, or 27% of revenue, increased as Gemalto continued its efforts to expand its software and services offers, and started to consolidate newly acquired activities.

Through vigilance on expenses and focus on value-selling, Mobile Communication operating income came in at €142 million, representing an operating margin of 16%.

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Secure Transactions

€m 2008   2009  
Revenue 442.8     441.4   (0.3%)
Gross profit 117.9 26.6%   108.2 24.5% (2.1 ppt)
After special provision of:       11.2    
Operating expenses 91.3 20.6%   93.8 21.2% +0.6 ppt
Operating income 26.8 6.0%   14.9 3.4% (2.6 ppt)
             
Operating income before special provision 26.8 6.0%   26.1 5.9% (0.1 ppt)
At constant exchange rates, full year 2009 Secure Transactions revenue was up 1% year-on-year.

Secure Transactions 2009 revenue was €441 million, up 1% year-on-year at constant rates. Migration to EMV chip payment cards continues to spread around the world, and dual-interface contactless cards gained further success in Europe. Revenue increase was limited by some banking customers shifting from registered to standard mail for their card deliveries. In personalization services, revenue progressed by 4% at constant exchange rates.

In January 2010, Gemalto faced an unexpected situation in relation to certain German payment cards, which led the Company to book a special provision of €11.2 million to cover the consequences for Gemalto. A solution was promptly devised, via a simple data initialization procedure; the cards’ software remaining unchanged and their security entirely preserved. This special provision is reported as part of ‘Cost of sales’ in the segment.

Gross profit for 2009 was therefore lower, at €108 million. Excluding the special provision, however, gross margin was up by 40 basis points to 27% for the full year. Compared to the previous year when stop-and-go production hampered efficiency, the second semester gross margin excluding the special provision improved by 370 basis points to 29%, on the back of product mix improvements and enhanced personalization efficiency.

Operating expenses were well contained in value, even while factoring in the newly acquired activities that were consolidated.

Excluding the special provision, Secure Transactions recorded an operating income of €26 million and operating margin of 6%, similar to the previous year.

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Security

€m 2008   2009  
Revenue 215.9     248.1   +14.9%
Gross profit 66.2 30.7%   89.6 36.1% +5.4 ppt
Operating expenses 87.8 40.7%   82.9 33.4% (7.3 ppt)
Operating income (20.2) (9.4%)   7.1 2.9% +12.2 ppt

At constant exchange rates, full year 2009 Security revenue was up 14% year-on-year.

Turning to profit in 2009, Security achieved its goal, on the back of growth in Government Programs, success in e-banking activities and operational leverage.

Government Programs recorded a revenue increase of 18% at constant rates over the previous year. Some up-and-down variations were recorded on a quarterly basis as revenues across this segment tend to remain project-based, with varying delivery schedules. Identity & Access Management revenue was slightly lower for 2009, by 2% at constant exchange rates when compared to the previous year: the adverse global economic context of 2009 resulted in indirect distribution channels for enterprise solutions being focused on inventory optimization, while demand for our innovative e-banking solutions remained robust.

Patent licensing revenue for 2009 was up €6.2 million and amounted to €14.3 million, of which €12.8 million was booked in the first semester.

The Security segment’s gross margin expanded by 540 basis points to 36%. Strong improvements came from delivery ramp-ups in Government Programs. Higher patent licensing activity also contributed to this sharp increase.

Operational expenses were well under control, slightly down in value, leading to a substantial operational leverage.

Consequently, Security posted an operating profit of €7.1 million and an operating margin of 2.9%. Excluding the patent licensing activity contribution, Government Programs and Identity & Access Management activities taken together also exceeded the break-even point, in both semesters. Operating margin variation between the first and the second semester of 2009 was due to the higher patent licensing revenue in the first semester. Reaching profitability was an important milestone for the Security segment, and for the Company, delivering the return on the technological and commercial investments made, and demonstrating operational leverage in this activity.

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Others

€m 2008   2009    
Revenue 73.0     76.8     +5.3%
Gross profit 18.2 24.9%   20.0 26.0%   +1.1 ppt
Operating expenses 16.2 22.2%   14.2 18.4%   (3.8 ppt)
Operating income 2.9 3.9%   6.0 7.8%   +3.9 ppt

At constant exchange rates, full year 2009 revenue for Public Telephony and POS Terminals combined in Others was up 5.7% year-on-year.

Public Telephony revenue declined, in line with expectations and market trends as mobile telephony penetration expands worldwide, while POS Terminals delivered solid growth, following a supplier quality problem that limited deliveries in 2008.

Gross profit increased by 10% to €20 million. Operating expenses were reduced by 3.8 percentage points. As a result, operating margin doubled to 7.8% and operating profit was €6.0 million.

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Balance sheet and cash position variation schedule

Extract of the cash position variation schedule:

€m 2008 2009
Cash and cash equivalents, beginning of period 337 367
     
Cash generated by operating activities, before cash outflows related to restructuring actions 191 224
Including cash used by working capital increase (19) (34)
Cash used in restructuring actions (59) (24)
Cash generated by operating activities 132 200
     
Capital expenditure and acquisitions of intangibles (49) (53)
Interest received, net 10 2
Cash used by acquisitions (14) (74)
Other cash generated by investing activities 0 4
Cash generated by operating and investing activities 79 79
     
Cash used by the share buy-back program (65) (65)
Other cash provided by financing activities 23 14
Currency translation effect on cash (8) 8
Cash and cash equivalents, end of period 367 404
     
Current and non-current borrowings including finance lease and bank overdraft, end of period (23) (23)
     
Net cash, end of period 344 381

Bank overdraft amounted to €1.5 million in 2009 and €7.1 million in 2008. Consequently cash and bank overdraft amounted to € 402 million in 2009 and was €360 million in 2008.

In 2009, operating activities generated a cash flow of €224 million before outflows related to restructuring actions. Payments made in connection with restructuring actions linked to the merger amounted to €24 million.

Gemalto took the opportunity of favorable conditions to accelerate the renewal of older and lower productivity equipment during the period. As a result, capital expenditure and acquisition of intangibles were up €4 million over prior year, amounting to €53 million and representing 3.2% of revenue, of which €39 million were incurred for plant, property and equipment purchases net of proceeds from sales.

In line with the Company’s policy of responsibility towards its business partners, Gemalto opted to support some of its suppliers looking for cash through ad-hoc rapid payment facilities. The accompanying decrease of account payables was offset by improved management of inventory and customer receivables.

In 2009, Gemalto’s share buy-back program used €65 million in cash, the same amount as in 2008, for the purchase of 2,237,313 shares representing 2.5% of Gemalto’s share capital. As of December 31, 2009, the Company owned 5,239,631 shares, i.e. 6.0% of its own shares in treasury. The average acquisition price of the shares repurchased on the market and held in treasury as of December 31, 2009 was €24.74. The total number of Gemalto shares issued is 88,015,844. Net of the 5,239,631 shares held in treasury, 82,776,213 shares were outstanding at the 2009 year end.

Acquisition of subsidiaries and businesses, net of cash acquired, used €74 million in cash in 2009.

The proceeds received by the Company from the exercise of stock options by employees amounted to €32 million.

Consequently, Gemalto’s net cash position was €381 million at the end of December 2009, a €37 million increase compared to the end of December 2008.

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Outlook

Our business has strong fundamentals and prospects. We continue our mission to provide trust and convenience to the wireless and digital world. In 2010 we are focused on growth, actively promoting our expanded product portfolio and delivering more software and services to our customers, in order to further increase our profit, on our way to achieving the objective we have set for ourselves of €300 million profit from operations in 2013.

The financial review is based on adjusted financial information: non-GAAP measures defined as IFRS financial information adjusted for reorganization charges, amortization & depreciation of intangibles resulting from acquisitions, and acquisitions-related costs. See 'Adjusted measures'. Figures in the financial review are at historical exchange rates, except revenue and average selling price variations which are at constant exchange rates, or except where otherwise noted.

Principal factors affecting revenue

In the Mobile Communication segment, sales volumes are directly affected by wireless market developments such as the deployment of new wireless standards, subscriber growth rates in emerging wireless market, and worldwide and regional economic conditions. SIM cards selling prices mainly depend on their sophistication and the availability of competing products. Revenue from software and services has rapidly expanded over the last couple of years, and Gemalto will have to win new application platforms and operated service contracts to achieve the same performance in the future.

In the Secure Transactions segment, revenue from traditional magnetic stripe banking cards is volume-driven, and microprocessor banking cards activity is mainly affected by the progressive adoption of the Europay, MasterCard, Visa (EMV) standard. Provision of replacement cards is a key driver for banking cards demand since all financial cards expire on average within two to four years of their issuance. Innovation is another key driver with dual-interface contactless banking cards gaining further success. The higher the demand for banking cards, the higher the personalization services revenue. Finally, Pay TV revenue varies on a yearly basis depending on the orders placed by the five principal customers of this industry, and revenue in the Transportation sector is volume-driven.

In the Security segment, contracts often require significant investment and lead times and are typically offered through public tenders and procurement procedures. While those contracts generally specify delivery of large volumes over long periods of time, revenue from such tenders may significantly vary quarter on quarter and year-on-year, due to the limited number of large projects, their size, the technical content and range of associated services provided, and the fact that we may or may not be part of the winning consortia. Patent licensing revenue may also vary substantially due to the lengthy and complex negotiation process for large licensing contracts, and the non-recurrence of some of the licensing revenue (lump sum payments). The level of licensing activity directly affects the segment’s profitability, since cost of revenue in this activity is mainly fixed.

Principal factors affecting gross profit

Profitability in all segments is first affected by sales volumes: the higher the volumes, the lower their main components’ purchase price, particularly silicon chip purchasing costs, and the higher the production capacity utilization rates. Product mix is another key factor: sales of higher-end solutions usually yield better gross margins. Since Gemalto constantly renews the sources of chips used in its microprocessor-based products, gross profit is also affected by any delay generated by our suppliers, our supply chain or our customers’ acceptance processes. Finally, while Gemalto tightly controls fixed manufacturing costs and permanently adapts its production and procurement processes, a lack of flexibility or quality issues would negatively affect profitability.