2008 FINANCIAL REVIEW
RECOVERING SECOND HALF
The introduction of new generation security solutions at several Digital TV accounts together with the migration of some of the Group's largest accounts to the service mode had a strong effect upon the Group 2008 results. Last year, the Group delivered over 25 million smartcards for customers migrated to the service mode.
As anticipated, this change in model affected the profitability of the Digital TV business. On the other hand, both the Public Access and the Middleware & Advertising segments continued to deliver on their positive momentum maintaining a healthy contribution margin in a challenging economic environment.
Once more, the Group confirmed the strong growth trend of the last years, with total revenues and other operating income reaching CHF 1.037 billion. Achieving a compounded annual growth rate of 15% over the last 5 years, the Group continues to materially exceed the average industry growth rate.
With an operating margin of CHF 37 million, second half profitability exceeded expectations, leading to an operating income for the year of CHF 18.5 million. Initial results from cost control measures allowed the Group to reach a result over target, in spite of the 10% average USD exchange rate decline from 2007 to 2008 to 1.08.
The Group continues to exceed the average industry growth rate
CHF 18.5 million of operating profit in 2008
While the weakening USD affected the 2008 top line, Group net revenues grew by 11%. At constant exchange rates, the Group achieved a strong 20.4% growth.
The "Margin after cost of material" (a pro forma non-IFRS item) for the year was at CHF 696.5 million. As a percentage of revenues net of other operating income, the margin after cost of material is down 4.9 percentage points to 66.9%. While the card replacement at EchoStar positively contributed to the revenue line, it had a negative effect on the Group 2008 margins. Net of the EchoStar card replacement revenues, the margin after cost of material as a percentage of revenues would have been roughly at the same level as in 2007.
Compared to the previous year, personnel expenses increased by CHF 23 million. Entities acquired and consolidated for the first time in 2008 added CHF 13.7 million. Net of the newly acquired entities, Group's personnel cost increased by a mere 2.8%, the lowest growth of the last 7 years. This was due, in particular, to cost control in the core conditional access business. Between the first and the second half year, the increase of personnel cost was reduced to CHF 5.3 million.
Other operating expenses increased by CHF 39.9 million. CHF 28 million one- off costs for card replacements at three operators and CHF 7.3 million provisions for bad debt drove most of the increase. Legal costs remained high in 2008.
The Group consolidated operating profit (OIBDA) before depreciation and amortization amounts to CHF 92.2 million. Depreciation, amortization and impairments were CHF 24.2 million higher compared to 2007, mainly due to impairment charges for software assets and active smartcards. 2008 operating profit has reached CHF 18.5 million.
The interest expenses of CHF 16.1 million include interest costs for the outstanding convertible bond, while the net CHF 18.9 million finance expense is mainly driven by FOREX losses. CHF 0.9 million income tax expenses reflect the Group's optimized tax structure.
Overall, the Group generated a net loss of CHF 7 million for the full year. Following the CHF 34.9 million loss in the first half, the Group started to recover profitability in the second half posting a CHF 27.9 million gain. Net loss attributable to equity holders for the full year was at CHF 14.6 million.
Digital TV grows by 26.6%
Digital TV strongly recovered in the second half, generating a 46.1% net revenue growth compared to the first half. For the full year Digital TV achieved a 15.3% growth rate, 26.6% in constant currency. Digital TV has remarkably performed in Europe during the second half, with net revenues increasing by 44.5% compared to the first half. On a full year basis, European revenues were 18.2% higher, 24.8% in constant currency.
Among the Digital TV reference customers, Portugal Telecom deployed in 2008 the full Nagra solution suite, including conditional access, Quative´s Service Delivery Platform, and NagraGuide Electronic Program Guide based on OpenTV STB middleware. The Group acted as the end-to-end solution integrator. Portugal Telecom provided the largest growth contribution of the Group´s European customers in 2008.
In the Americas, net revenues almost doubled compared to the first half, with the EchoStar card replacement as the main driver of this growth. The American Digital TV customer portfolio continues to broaden, with an ongoing inflow of new customers. As an example, TVAzteca, a new customer, was the highest growth contributor of our South American Digital TV business in 2008.
Digital TV achieved a 26.6% growth rate in constant currency
Asian Digital TV sales were roughly at the same level as in the first half. While local currency sales did not grow compared to the previous year, the consolidation took place at a high absolute level, following the 56.5% growth rate achieved in 2007.
2008 operating income for the Digital TV segment was over initial expectations at CHF 7.3 million, posting a recovery in the second half.
Within Digital TV, new business areas continued to grow on an aggregate basis compared to the previous year, but still generated a single digit million operating loss.
Impact of migration to the service mode
In early 2008, the Group stated the intention to push for the migration of the majority of its installed base of cards to the service mode. The Group is successfully delivering on this plan, having completed the migration of over 25 million cards to the service mode in 2008, in addition to the natural growth of its installed base of cards in service mode by more than 7 million units.
Among the customers introducing the new pricing model, the largest one is EchoStar. The Group expects to award to EchoStar a monetary consideration upon the successful signing of a new multi-year agreement. In 2009, the Group expects to net such consideration out against outstanding receivables from EchoStar.
The Group has applied the terms of the new agreement with an upfront payment for each smartcard delivered and a recurring monthly payment from the beginning of 2008. Based on this new model, the Group recognizes the upfront revenue when cards are delivered and invoiced and the recurring revenue on an ongoing monthly basis. The cost of cards is expensed.
In addition to EchoStar, the Group shifted other large operators to the service mode. Overall, the net cash impact, without migration and R&D cost, of the service mode migration amounts to CHF 162 million.
In 2008, the Group also replaced 10 million new generation smartcards for other operators accounted for in the service mode.
The aggregate P&L impact, without migration costs, R&D costs and impairments, of the service mode migration and service mode card replacements in 2008 totaled CHF 92 million.
Public Access grows by 10.8%
Public Access growth moderately decelerated in the second half, with a year-on-year growth of 7.2%, 10.8% in constant currency.
European sales were up 8% in constant currency, with a favorable contribution from the Car Access sector. The American region continued to outstrip the market growing by 39% in constant currency, while Asia and Africa consolidated their revenue contribution, generating sales of CHF 20.2 million. This represents an increase of 11.4% in constant currency, following a particularly strong year 2007, where the Asia region generated a 30% growth rate.
Public Access posted an operating income for the year of CHF 21.6 million. In spite of the difficult market conditions, Public Access operating margin is only 1 percentage point short of the 10% target margin.
Middleware & Advertising in line with expectations
The Middleware & Advertising top line was affected by the USD weakness, with a slight 1.6% decrease of nominal revenues.However, the aggregate Asian and African revenue base has been nominally growing at 11.5%, 23.9% in constant currency, in particular benefitting from the strong development of the Indian market.
On the other hand, the European business was weak in 2008 reflecting a slow down affecting two large accounts. Exchange rate effects further accentuated the slow down, with European revenues down by 6% in constant currency and by 15.4% in Swiss francs compared to the previous year.
At CHF 10.2 million, operating income for the Middleware & Advertising segment was positive for the first time, following initial quick wins envisaged upon the acquisition of a controlling stake in OpenTV.
Strengthened by its success in new segments, the Kudelski Group has consolidated its position as world leader in digital television
Balance sheet and cash flow
New cards in service mode drive the increase of Financial assets and other non-current assets, with a CHF 22.4 million increase of long-term deferred contract costs for cards in service mode. Tangible fixed assets are down CHF 12.1 million, including an impairment of CHF 14.9 million for the residual value of old cards and equipment in service mode.
Most of the increase in intangible assets is related to the CHF 30.3 million additional Goodwill from the acquisition of EmbedICs, EDSI, SkiBadge, Orcus, Pact and Ruzz.
Receivables are CHF 93.7 million over the balance at end of 2007, including the EchoStar receivables earmarked for the aforementioned monetary compensation. The ageing of the outstanding receivables shows that amounts overdue for more than six months went down from 7.9% to 3.3% of total receivables.
Total non-current liabilities increases by CHF 44.1 million including additional bank loans of CHF 33.7 million. Total current liabilities are CHF 103.1 million over the end 2007 balance, mainly reflecting CHF 66.9 million additional short-term bank borrowing to finance liquidity needs in relation to service mode deployments.
The increase of receivables led to a negative CHF 7.4 million operating cash flow for the year. The Group used CHF 100.6 million for investing activities, including CHF 60.7 million for tangible fixed assets mainly relating to smartcards and equipment for customers in service mode, CHF 34.8 million for the acquisition of subsidiaries and CHF 28.8 million for purchases of intangible assets.
Outlook
In early 2009, the Group has completed the migration of large Digital TV customers to the service mode. Between 2008 and end of February 2009, more than 30 million smartcards were shifted to this model.
In 2009, the Digital TV segment will reap the initial fruit of this change in model. Service mode revenues are expected to fully kick in starting in the second half and one-off migration costs will be substantially lower than in 2008. While lower upfront replacement card payments will affect the top line growth, the Group expects improved operating profits and substantially better cash flows.
Both the Public Access and the Middleware & Advertising segments are expected to experience a higher sensitivity to the overall development of the economy. While 2009 growth is likely to slow down, the Group has initiated cost containment measures aimed at maintaining the profitability of both segments.