Openwave Systems Inc (OPWV) F2Q10 (Qtr End 12/31/09) Earnings Call Transcript February 4, 2010 5:00 PM ET
Good day, ladies and gentlemen, thank you for standing by. Welcome to the second quarter 2010 earnings conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Thursday, February 04, 2010.
I would now like to turn the conference over to Mr. Mike Bishop. Please go ahead.
Thank you. Good afternoon, everyone, and thank you for joining us today to discuss the results of Openwave Systems second quarter of fiscal year 2010. Joining me today from Redwood City are Ken Denman, Chief Executive Officer; and Karen Willem, Chief Financial Officer.
Before we discuss the results of the quarter, I want to remind everyone that we are operating under the rules of regulation FD. The second quarter financial results press release was distributed at the close of market today. If you've not yet seen a copy, you can find one at our website at openwave.com. For your convenience, this call is being recorded and will be available for playback from our website for three months.
Before we begin, I'd like to remind you that any remarks that maybe made on this call or in our earnings press release about future expectations, plans or prospects for the company may constitute forward-looking statements for the purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
The actual results may differ materially from those indicated by the forward-looking statements as a result of various important factors. These factors include the specific risk factors discussed in the company's press release that was distributed today, and in the company's filings with the SEC, including but not limited to, the fiscal 2009 financial results on Form 10-K and any other reports subsequently filed with the SEC.
We intend to make several forward-looking statements during the call that are based on management's current outlook as of today. We do not intend to update these business outlook statements until the release of Openwave's next quarterly earnings report and disclaim any obligation to do so prior to that time. We reserve the right to update the outlook for any reason during the quarter.
Now, I would like to turn the call to Ken.
Thank you, Mike and good afternoon everyone. The wireless data arena continues to be one of the most dynamic and fast moving sectors in the economy. Openwave is making a significant impact for our customers and the impact is showing in our financial result. Our topline was again a bit better than we anticipated this quarter at $49.7 million. Our non-GAAP EPS was $0.04, again above plans into the revenue and our effective expense management practices we have instituted over the past year.
Bookings were at $46.5 million in the second quarter, a substantial improvement compared to Q2 of last year. Gross margins returned to their historical range in this quarter as we expected. In margin profile, the backlog is 60% to 63% and we believe they will fluctuate, but on average overtime it will be in this range. What we demonstrated the bookings improvement from last year we are aiming to improve even more. The pipeline continues to improve as our most valuable customers return to buy product and services and the newer members of our sales staff become more productive.
Additionally, there are some very large deals out there that were broken into smaller sizes at the quarter end and the remaining portion of those deals are low hanging fruit pipeline for quarter three and four. We think carrier buying patterns will shift towards software soon and we expect to see a more robust bookings level in the second half of the year.
The market continues to move toward Openwave. We need to be cautious however and temper the hype with a dose of reality, the news outlets love a good story, the [stress] data of mobile networks highlighted by sluggish speeds and outages hitting entire metropolitan areas, but it makes good headlines, but it is still early days for a phenomenon mostly centered on carries like O2 and AT&T who offer iPhone.
The holiday outages are leading indicator of a much larger problem and we believe it will only worsen it as more sophisticated devices enter the mainstream global market. As evidenced by recent earnings announcements from equipment manufacturers like Ericsson, operators worldwide maybe spending less on their existing network infrastructure, but they are not yet ready to spend more on next-generation equipment.
4G technologies like LTE are seen as long-term solutions and operators are still highly focused on short-term solution to add and manage network capacity. We continue to see our customer's buying patterns reflect incremental patch type purchases. We firmly believe that as data demand continues to rise, these unprecedented and unpredictable data searches will drive operators toward solutions involving hardware and software to solve their capacity shortage, both near term and leveraging their existing 3G assets and longer term as they migrate their network to4G or LTE, where our ability to dynamically manage and to add value to traffic in the IT data path becomes even more critical.
Truly, traffic management software solutions will allow operators to work smarter with their current investments and strategically plan for future growth. In more complete understanding of the context around their network traffic, who is consuming what content, when and on what specific devices will enable them to predict and to respond to traffic patterns ultimately accommodating more traffic on existing infrastructure and addressing their operational concerns while creating new revenue opportunity.
At Openwave, we see the data demand curve continuing to rise, fueled first and foremost by increasing video consumption. Projections like streaming video will grow seven-fold from 530 petabytes consumed globally today and 3500 petabytes in 2014. In the near future, bandwidth will be further compromised by connected non-phone devices such as the new iPad, navigation systems, home security, e-book, camera and in-car systems to name a few.
The planned rollouts of all IP-based 4G networks are absolutely necessary to help operators accommodate greater data demand in this new world but so is in network software solution to monitor, manage and finally monetize finding all the different types of traffic in real time across the entire device portfolio.
Without smart softwares, the new networks will be as inefficient as the old ones. We have been diligently working over the last year to realign Openwave's product portfolio with the demand we are now seeing surface. Given the current market dynamics, our products are launching at the right time. This quarter we plan to bring to market several new products in the areas of analytics, policy management and video optimization designed to enable our customers to maximize bandwidth on today's and tomorrow's network. These new offerings are evolutionary pieces that add to the value of our Integra IP mediation framework, leveraging our existing software install base on delivering rapid value to new customers.
These products arrived at the beginning of an industry transition. We are confident that the capacity shortages in the face of growing video consumption are a harsh reality our customers need to address soon. Our savviest customers are already acknowledging our value proposition and have begun to align their budgets for necessary hardware and software investment and for those more cautious customers; our mindset has always been pay as you grow.
First we tackle the data tsunami as the bandwidth problem reducing total cost of ownership and then as a strong growth opportunity increasing return on investment with new tiered service and pricing models based on smart policy management and subscriber analytics.
Specifically, Openwave's new traffic and data mediation offerings allow an operator to manage traffic in near real time with the ability to enact policies to compress certain types of traffic when the network nears capacity or offer new tier pricing and service offers targeted at specific subscriber segment. Further, we believe that our in network mobile analytics offering affords operators the valuable opportunity to leverage aggregated subscriber data activity and to be used as a powerful targeting tool for mobile advertising or for content providers.
Within the 4G network which will be entirely IP based, software solutions like Openwave's will be even more important to dynamically support the monitoring and management of all types of data, messaging, internet and video traffic.
Openwave still has work to do to demonstrate to some of our customers that an increase in hardware alone will not solve the totality of the problem. The unpredictable nature of today's traffic also requires a dynamic software based solution. We will be working harder than ever this year to demonstrate the true value of our approach and partnering where we see appropriate and help us deliver a seamless solution to the carrier.
Next I would like to highlight a few of the new products we introduced and wins we secured during past quarter. We announced the next version of Integra our context-aware, mediation and policy management solutions designed to provide operators with the flexibility to select a deployment architecture and features that meet their specific needs while reducing overall total cost ownership.
Integra is an open, all-IP framework that accesses a single control point for an operator to manage all forms of traffic. It enables value-added services including content adaptation, web and media optimization, network security, policy control and dynamic charging and campaigning.
We also introduced the mobile internet ready set, a pre-packet solution that provides operators and emerging markets with a central point to launch and control new revenue generating mobile internet services at an attractive entry level price point.
We also signed a deal for an Integra upgrade and passport service with Vodacom South Africa, a leading African communications group providing mobile communications and related services to more than 40 million customers. Our passport services enabled mobile operators like Vodacom to offer their subscribers on-demand, pay-as-you-go, mobile internet access which include targeted data service promotions that are metered according to time, type of service and consumption levels among other choices.
I am also proud to note that the GSMA, the premier telecom industry association, shortlisted Openwave's Passport service as a finalist in Best Internet Service category for the organization's 2010, Global Mobile Awards. On the channel side of our business, we worked with Alcatel-Lucent to close an Integra deal in Q2 with an operator in the [Benelux] region helps shape and smooth the operator's data traffic and seamlessly address their bandwidth challenge head on.
In our messaging line of business, operators continue to demand our suite of mobile, e-mail and voice solutions that use IP based, bandwidth optimized technologies to simplify the different loads in messaging across an operator's network.
This quarter, we signed a deal with Time Warner Cable, the second largest cable company in the US for a bundled set of our messaging offerings that included Rich Mail, Network Address Book and our Notification services. Messaging traffic growth maybe the single most difficult factor to navigate in the data storage tsunami due to its inherent characteristics and users expectation for limitless storage and high performance.
Openwave's messaging solutions ensure that service providers can manage the growing amount of content being shared with low cost, infinite content storage, while our personalized communications dashboard to simplify the various acts communicating. Reporting e-mail, voice, chat, post, tweet and whatever comes next.
In summary, we would characterize the second quarter as consecutive improvement on company's fundamentals, and we're moving forward with momentum. We're working towards achieving the goals we laid out in Q4. The first of which is posing a substantial improvement in bookings compared with fiscal 2009 that but one-to-one our better book to bill ratio for the year. We continue to believe revenue should be approximate same as 2009, and we expect to be profitable on a non-GAAP basis and cash flow positive for the year. Again, fluctuations in any given quarter are to be expected. So those are the high level financial goals for 2010.
The third quarter should be exciting. Next up is Mobile World Congress in Barcelona, but we will talk more in depth about openly its pivotal role in a 4G all IP environment. We also have live demonstrations of our new products in the areas of policy management, analytics and video optimization. We're planning to be in Barcelona for the show. I invite you to come join our Investor Event to see these products in person. Please contact Mike Bishop, if you're going to attend.
We're also planning to go to a few conferences in February and March, so if you aren't able to make it to Barcelona, we hope to see you in San Francisco or New York. Now, I would like to turn the call over to Karen to provide more details on our financial results.
Thank you, Ken. Good afternoon everyone. Before I begin discussing the numbers, I would like to note that unless otherwise indicated, gross margin expense and earnings related items are reported on a non-GAAP basis, which excludes stock-based compensation, realized losses and impairments on investment and goodwill, amortization of intangibles and other acquisition related costs, restructuring expenses, and professional expenses related to unusual events.
Please access our financial metrics summary which is available on the investor section of www.openwave.com, to review Openwave's historical financial performance, as well as for reconciliations of the non-GAAP measures we report to do corresponding GAAP measures.
During the second quarter of fiscal 2010, Openwave continue to improving its fundamentals. Revenue and bookings improved year-over-year and our EPS was markedly better than last quarter and last year. I'll now go over the details of the numbers. Overall, for the quarter ended December 31st, 2009, Openwave posted a GAAP net income of $213,000, on a non-GAAP basis, net income was $3.5 million with earnings per share of $0.04. Our reconciliation from GAAP to non-GAAP income or loss can be found in our press release. I'll now turn your attention to the detailed results for the December quarter.
Revenues for the quarter was $49.7 million, a decrease of $100,000 or 0.2% quarter-over-quarter and an increase of $1.7 million or 3.5% year-over-year. The year-over-year increase was primarily attributable to services delivery related to a contract with the major North American carrier. License revenue was $13.3 million increasing by $2.9 million or 27.4% sequentially, which comprised 26.7% of total revenue. The year-over-year decrease was $556,000 or 4.12% from $13.8 million in the prior year.
The quarter-over-quarter increase is due to purchase of additional licenses for major carriers in the Americas. Maintenance and support revenue was $16.2 million up $370,000 or 2.3% sequentially and comprised 32.5% of total revenue. The year-over-year increase was $251,000 or 1.6%. Services revenue was $20.3 million, down $3.3 million or 14.1% sequentially, which comprised 40.8% of total revenue. Year-over-year services revenue increased $2 million or 10.9%. The quarter-over-quarter decrease is attributed to the recognition of revenue in Q1, 2010 from two major North American service providers.
The year-over-year increase in revenue is due to accelerated delivery schedules for a major carrier which occurred in both the first and second quarters of fiscal year 2010. The regional breakdown in revenue in December quarter indicates that 61% of our revenue originated from customers based in the Americas, 13% from EMEA, and 26% from Asia.
This compares to last quarter's breakdown of 65%, 14% and 21% for the Americas, EMEA and Asia respectively. And last year's December quarter breakdown of 59%, 17% and 24%. For fiscal quarter two, Sprint accounted for 37% of revenue. No other customer represented greater than 10% of our revenue for the quarter.
Turning now to our gross margins, we reported a 60% blended gross margin for the quarter, an increase of 4.5 points compared to last quarter, and 2.2 points lower than the same period last year. The increase in gross margin quarter-over-quarter is primarily due to the increase in license revenue and lower cost of services. The year-over-year decrease in gross margin is primarily due to a non-recurring high margin project in fiscal quarter two of the prior year.
Gross margin on license revenue increased 0.3 points to 98.1% compared to 97.8% for the September quarter, and increased 1.5 points compared to 96.6% for the same period last year. This year-over-year increase is due to lower third party software cost.
The maintenance and support gross margins of 71.4% decreased 1.5 points from 72.9% last quarter and decreased 0.5 points compared to 71.9% for last year's December quarter. The quarter-over-quarter decreased was primarily due to an increase in employee-related costs. Services margin of 25.9% increased 0.8 points from 25.1% last quarter and decreased 1.6 points from 27.5% last year. The quarter-over-quarter increase was due to lower third party costs.
As I previously mentioned, the year-over-year decrease is primarily due to a non-recurring high margin project in fiscal quarter two of the prior year. As for operating expenses for fiscal quarter two, research and development expense was $9.6 million. Expenses decreased $141,000 or 1.4% quarter-over-quarter and $1.9 million or 16.7% year-over-year. The year-over-year decrease is primarily as a result of our Burlington, Massachusetts site closure. For fiscal quarter two sales and marketing expenses of $10.9 million increased $360,000 or 3.4% from $10.6 million in the prior quarter an increase by $1.1 million or 10.7% from $9.9 million in the second quarter last year.
The quarter over quarter increase is attributable to higher labor cost. The year-over-year expense increase was primarily driven by higher employee related costs and additional investment in our channel program.
Fiscal quarter two general and administrative expenses of $6 million decreased by $1.4 million or 18.8% from $7.4 million in the prior quarter and decreased year-over-year by $900,000 or 12.9% from $6.9 million in the prior year. The quarter over quarter expense decrease is due to end of year audit and legal fees incurred in fiscal quarter one.
Year-over-year decreases were primarily attributable to lower labor costs, professional fees and facilities costs due to our Burlington site closure. Our head count decreased by 12 employees from 608 at the end of September to 596 at the end of December. The primary driver for this decrease relates to our fiscal quarter two restructuring the closure of our Broomfield, Colorado site as we continue to drive efficiencies in our offshore development centers and the ongoing consolidation of our research and development organization.
On a gap basis stock based compensation expense for fiscal quarter two was $438,000 compared to $547,000 in the prior quarter and $929,000 in the same period prior year. The year-over-year decrease was due to the decline in the fare value of options granting and the reduction in the number of option investing.
On a GAAP basis in the December quarter interest and other income was a charge of $220,000 which compares to a charge of $1.2 million and a charge of $1.4 million in the September 2009 and December 2008 quarters respectively.
The quarter over quarter and year-over-year reduction is due to the lower level of impairment of our auction rate securities compared to prior periods. As we previously disclosed the product value of our option rate securities was $21.6 million which now compares to a written down value of $12.3 million of which 74% is covered by insurance.
Also on a gap basis, income taxes were an expense of $119,000 in the December quarter compared to an expense of $498,000 last quarter and $1 million in the December quarter last year. The quarter over quarter and year-over-year decreases are primarily related to the release of a withholding tax reserve of overseas entities within fiscal quarter two of 2010.
In the December quarter Openwave bookings were $46.5 million. Our current backlog is $189 million compared to $193 million last quarter and $217 million in fiscal quarter two of last year. Deferred revenue decreased to $48 million as of December 31, 2009 as compared to $49.8 million in the September quarter and $62.6 million in fiscal quarter two of the prior year. The year-over-year decrease of $14.6 million is primarily due to several transactions in which revenue was recognized from the Americas and Japan customers.
Accounts receivables decreased to $30.4 million in December from $36.4 million at the end of September and decreased from $54.6 million at the end of the second quarter last fiscal year. Our overall DSO decreased by 11 days sequentially from 66 days at the end of September and decreased by 47 days from 102 days at the end of December last year to 55 days at the end of December this year.
We maintain our overall target of 80 days. Now turning to our cash and investment balances we ended the quarter with $128.5 million in cash, cash equivalents and short and long term investments. Cash provided by operations was $6.3 million which compares with $8.8 million used in the previous quarter.
The increase in cash from operations is primarily attributable to timing of payments received from customer. Depreciation and amortization including amortization of intangibles for the quarter totaled $1.9 million of which $1.5 million was depreciation.
Openwave continues on the past to be a long term profitable company. We are encouraged by the daily trends we are seeing as the wireless data market continues to push mobile carriers in our direction. We continue to expect fiscal year 2010 revenue to be at the same level as fiscal year 2009.
Given that we've experienced a strong revenue level in Q1 and Q2, and that our view for the full year remains unchanged we expect to see a step down in revenue in the second half with fiscal quarter three being our seasonally weakest quarter. We expect bookings for the fiscal year will show substantial improvement over fiscal 2009 and as Tim said we think we can achieve our full year book to bill ratio of 1 to 1.
We continue to expect the full year of fiscal 2010 to be profitable on a non GAAP basis and cash flow positive. Operator we would now like to open up the call for questions.
Thank you. We will now begin the question-and-answer session. (Operator instructions). And our first question comes from the line of Matthew Hoffman. Please go ahead.
Matthew Hoffman - Cowen & Company
Ken you mentioned that from deals variable deals were broken up and made smaller I guess toward the end of the quarter and then pushed into the fiscal third quarter, the March quarter here but I also hear you talking down the back half of the year help us reconcile what's going on on the marketplace right now with your guidance and was that mostly licensing business that was pushed out or was it sort of just give some color on that if you wouldn't mind.
What we were talking about there was the fact that as we came upon the end of the year and we began to look at what we could get done with the customers what their appetite was what kind of packaging they wanted to try to accomplish and what we thought we could accomplish within the quarter it became clear that there was a more appetite to take little less risk, choke the deals if you will for kind of the work that we would do over the next two or three quarters get that in the back and then began in the New Year attacking the projects again.
So these all being refining and a lot of that has to do with you know candidly sweating current platforms and what they can do to tweak it and add more. So that's one example. We saw a smaller amount of deals that did involve license and new platforms so there was a mix.
The reconciliation though you have to be careful of is not to mix the bookings question with the revenue question you know the revenue question is really one of how is revenue is going to flow out of the backlog and except for whatever we do this will ship that's a very different box you know if we decide to sort of close up the deal in the quarter and get that on the books as opposed to try to fight for the bigger deal where you might not get hold in the quarter so to speak on the bigger deal and that would be a good thing.
So the important thing to note is that we are still engaged with those customers on those deals, there's extra or next part of the projects that have to be completed and we will go get those. I do want to just point out that we clearly had pressure from our customers to drive some projects farther, get those projects done leading up to the embargos season for the holiday given the pressure that all the networks are under and so that did drive stronger services revenue and stronger revenue in the first and second quarter.
Matthew Hoffman - Cowen & Company
Can shift gears a little bit I want to ask you about one of the new products you mentioned and that's the video optimization product I have heard you mention that before but can you just set the table for us on video and estimate the percentage of video traffic right now going over, let's just say domestic wireless networks and what is the value proposition for the product in terms of bandwidth improvement that your customers will see with the product and talk about the reception you are seeing for it? Thanks
This is a very important product for us, obviously. This is where we have added video optimization to our media optimization package. We have always had a web optimization, but critically we see as soon as three years down the road, that up to 70% of the traffic could be video-based.
And so, that's obviously putting a huge strain on networks and will put a greater strain going forward. I'm not going to tell you where we think we are today, but I will tell you in terms percentage of video traffic, will tell you that it's early days, teens maybe, but this number is rising very, very rapidly and it's also rising as the percentage of enabled devices continues to grow and we see the slope of that curve being very high.
Things like the iPad will contribute to an accelerating focus there. So, and from our perspective there is multiple aspects to how you manage this base. Obviously, there is the compression capability, but we're not into brute force compression. Of course, we can compete on that basis, but we think it's all about contextually aware compression, which is the advantage that our platform provides is that we have a sense of the different kinds of media that we're actually focused on. That drives a different tactics for compressing and we think more elegant compression.
And you just there alone you can get up to 30%, in our mind of incremental throughput. But, again it's contextually where it's very important because the nature of video is it can be very spiky, very unpredictable, very event-driven. So, you really got to have an intelligent solution that does the analytics on the front end.
Then you get into cashing, the ability to cash and cash out even at the node level which when you combine that with some of our location capability, allows us to look at various aspects of the network and identify where traffic might be different or changing in one part of the network versus another and the ability to look at what are the top ten downloads in some period of time, top fifteen downloads in the most recent period of time, any particular location and rather than downloading, thousand times you download once in that area.
So, those are examples, I can give you kind of other attributes and features which we think are critical, but I don't want to go on too long. But there is some really important work being done at Openwave about how we stepped into the video optimization and how we added video optimization. Incrementally, that competes very differently, again not a brute force stock, but a contextually aware it led and analytics driven which then allows us to be a bit more predictive as we turn and what we learn into policy.
Matthew Hoffman - Cowen & Company
Go it. Last question from me, and then I'll pass it over to the next guy. Karen, you actually anticipated a lot of the questions with your script, but the one thing I don't think I heard was whether the new expense levels that you are showing on the income statement this time around in R&D and G&A, especially, whether they are sustainable? I know you have closed some facilities and sounds like maybe this is the new run rate we should expect moving forward?
Well, what I signaled in the past is that our target is mid to high 20s, we still depending on the quarter vastly within that range and this current quarter that we are in we have mobile world congressed feature and so we have some other, we had a lot of unusual event. So, I would say still keeping in that range but of course I did see we generally have been rationing those expenses down and we are still looking for ways to improve but we are getting close to the target.
Thank you. And our next question comes from the line of Scott Sutherland with Wedbush Morgan Securities. Please go ahead.
Scott Sutherland - Wedbush Morgan Securities
Great, thank you. Hi Ken, Hi Karen. So, first of all I'll go back to the last question, these deals being broken up in small pieces. First of all I just want to be clear this in fact impacts your bookings number, not the revenue number in the near term, is that correct?
Yes, that is correct. As you recall we have drilled the visibility into our revenue because the carry central large backlog and our view of the year has not changed, we are still flat year-over-year, its just that as Ken mentioned some of our customers put a lot of pressure to get completed to install faster than we had originally forecasted so it put some of the revenue from the second half to the first half, but no change for the year.
Scott Sutherland - Wedbush Morgan Securities
Okay. As you get the smaller important pieces of these deals. How much going forward of the less of the deal to do you really have to do, are they now more inclined to go, do you kind of happens modestly tropic you have them really hooked in, that would give them part of the deal they are keeping the other pieces in later quarter do you feed up a better bookings here in the coming quarter or is that not true?
No I think that's true, at least what you are talking about incumbent or now incumbent or where we have a relationship and they have gone initially with our project or maybe smaller. In every case maybe the thing that is a bit troubling if we didn't sort of have a total picture. In every case the deals are size larger but let me get through the contacting process, its actually procured of purchase and more chunks but we feel very good from our perspectives that it doesn't make sense to do the first part and not second and the third part and that's why we have to answer your question, we do think it's all being included to get the rest of those potions of those deals.
Scott Sutherland - Wedbush Morgan Securities
You have talked about some of the improved bookings and you finally have some new products coming out and I know we have already talked about the video product, but these three new products, have you been testing that building a backlog of orders and is that going to start contributing bookings here in the March quarter or more in the June quarter?
I think we are going to, June quarter, that's the punch line. I would say as it regards to the new products, could we have some success in March, we're out there now pushing these products, but we're not in GA. Where will be a GA in March on a video optimization, but we're out there swinging and to be sure. But I would say, Scott, I would focus on June, if I were you, so when these products will have any impact on our bookings. I do believe they will have an impacts on our bookings we're optimistic.
Scott Sutherland - Wedbush Morgan Securities
Alright, the last and the big question is you have always said revenue recognized over four to six quarters, you have really had three reasonably good bookings quarters after some poor quarters and you expect better bookings in the back half of this year. So, I think everyone is really in season when does the kind of real sequential revenue growth not withstanding these sometimes higher professional services revenue quarters, real sequential revenue growth start to return into that, we are looking two or three quarters out kind of what's your guess here.
This year will be flat and there is always surprises, we could get some if we get any of the folks suddenly by capacity we can have some up sight clearly on revenue but generally speaking as our couple of quarters, no doubt we are looking in 2011 like we said for the gross to really start occurring.
Thank you. Now next question comes from the line of Paul Treiber with RBC Capital Markets. Please go ahead.
Paul Treiber - RBC Capital Markets
Good afternoon guys. Could you provide some commentary in the level of carrier interest that you are seeing specifically for your accelerator product and data compression and optimization versus carriers taking a more holistic approach to managing mobile data?
Fundamentally, one of the things that we see in the market is there is a lot of interest in media optimization, because generically the payback is very quick, given the trends that I have discussed and the slope of the curve and the growth. It's a major paying point. So, folks are very interested in a solution. There are a lot of point solutions being flogged out there and you could make a chase of the payback period, relatively short, and so folks that are really, really short term beyond their thinking can say okay, four or five, six months I can get a payback and I'm just going to go here.
We are getting a lot of interest as we talk about the broader problem and how you don't want to solve this thing three or four times in the next year, year and a half and taking our customers through an education that talks about the needs to incorporate analytics with media optimization and smart policy to really have the biggest bang for the buck and total cost of ownership that is dramatically above what you get for the point solution. So, that is the battle that's going on in the marketplace right now.
I think that we are doing very well with the message, because again, these folks are thinking about what is the next investment cycle that they are going to really double down on and it's pretty clear that payoffs from LTE are too far out to solve the intermediate problem and we believe that we have the intermediate solution. So, it's been very well received, as I said right now, out with customers, doing our demos, getting side-to-side, we were happy to go head-to-head. And I think if you have the chance to get to Barcelona, you are going to get a feel of the vibe that we're creating in the marketplace.
Paul Treiber - RBC Capital Markets
When related to that, to what extent does the new products you have coming in the next quarter or two fill in the rest of the pieces of that puzzle?
Well, very importantly, I just need to be clear it's very obvious that video optimization is a major paying point and we were missing that piece. So, that will be a major portion of taking the overall platform and making sure that it addresses not only these other parts that are intellectually challenging and very important, but again, we have to address video optimization, because it's just a key part. So, that's an example of where there was a hole, we had to fill that hole.
And it was making it harder and tougher to get over the hump when customers could be distracted by point solution that addresses that paying point directly. They wanted to go with us, good reputation, we scale like crazy, etcetera, but we need to fill this also, this one is very important.
Taking our analytics package to the next level is also very important because folks realize that they are kind of blind, they need better dashboards and again, once you do this, what can you do on the back-end to help generate growth or give your customers options around, do they pay differently for the use of additional capacity and some of our billing options like our passport, combined with our smart policy products. We now have a full story that's my summation here. We now have a full story with these last three elements and I think we can go toe-to-toe with anybody.
Paul Treiber - RBC Capital Markets
And are you seeing carriers build in like policy management combined or video optimization, the roadmap, so they can offer either tiered services directly to customers, like a daily video on-demand plan?
So, that's the dialogue that we're having. That's the discussion that we're having. It's about how can I have options? How can I have flexibility? How can I handle the peaks, handle the fact that traffic is unpredictable, event-driven, but also how can I market to my customers in a friendly way and give them the option of buying by the drink or buying more in a very friendly fashion and as you all know, who have been around Telco for a long time, overlay billing solutions are very, very painful for carriers.
Typically, it's a lot of money and a lot of time to get something done. So, to the extent that things like passport can on the fly, instantaneously give the user, who is maybe running out of their particular package or have used most of their buy to give them the opportunity instantaneously to top-up or to buy a different package so that they can continue to use. We're getting great traction with that module.
Paul Treiber - RBC Capital Markets
And lastly, could you just provide an update on your channel strategy to target markets outside of North America and non-Tier 1 operators?
I'm not going to talk about non-Tier 1 but I would also highlight the fact that we do expect to have and we are having some success with Tier 1. I think we mentioned we mentioned at least one of those successes in my earlier comments. So, we continue to do the work with Alcatel-Lucent as an example and we have wins with Alcatel-Lucent in non-Tier 1 markets.
We have deals in the pipeline. We have done a lot of training and this is the thing that typically and it's underestimated and we have done it. We have underestimated the amount of training that you have to do to get a major partner up to speed. And so we have had wins in both emerging markets and in Tier 1 markets with names of the likes of Alcatel-Lucent.
We've also extended our reach into other partners including some of our software development partners who have obviously a lot of proximity and knowledge about our product and who are loving the thought that they can wrap their services around our product suite and go to market in hard places where we're happy to have them take the products in.
I would say that one of the things that we've learned in the last year is that it's really important to have a mix of regional partners. And those regional partners might look like global partners, and Alcatel-Lucent would be a example of that but having a global strategy with global partners is really tough but working with their regional teams whether it's Latin America, Africa or parts of Asia, is where the success comes in.
So if we bond with the local teams, train them, we can really extend our reach and we're executing on that strategy. And then you have more regional partners, Atos Origin, for instance, in some parts of the world, VSG and others where we're getting good traction. So, the punch line is our channel pipeline is growing, our ready-set offering, which is a product design to into those markets, is now live. So, we were matched up getting the deals, doing the training and now having products that are more channel-friendly and so for calendar year 2010, we're going to be pushing hard.
Thank you. And our next question comes from the line of Tom Roderick with Thomas Weisel Partners. Please go ahead.
Chris Kho - Thomas Weisel Partners
This is Chris Kho for Tom Roderick. I hate to beat this horse to death, but back to that kind of smaller chunk-sized deals, is there anything that you see out there in your conversations with carriers that lead you to believe that there will be a catalyst say after the next two quarters that could potentially get them to start spending in bigger chunks, given that it seems that everyone in the room knows that they're going to have a more holistic approach towards managing their data traffic? Is there anything that would cause them to maybe suddenly say, hey, wake up and let's start doing these deals in a more substantial fashion?
Yeah, I believe there is, especially in the timeframe that you talked about, getting out a couple of quarters. What we're seeing is a couple of things. First of all, the operators are spending in a way that they are comfortable with, where they are buying vehicles, where it's a little easier for them to push the button because they have to do less explaining, quite frankly. So, think of that in terms of radio asset purchased, Radio Access Network purchase, backhaul purchase. Those things are easy for them and they know how to do that and they have done that for years.
But that only takes you so far, quite frankly, as we all know. Then when you get into the data center as they begin to make decisions about what's the next generation of spending, how do they package it between the expense and capital, what platforms do they bet on, it becomes a little more difficult for them to make those decisions and they have been involved in some instances and sweating the current assets, seeing how much they can get out of them while in parallel they do that planning.
Quite frankly, I believe that we're reaching the point of diminishing returns of the Radio Access Network and the backhaul without having more efficient data center capability, more efficient leverage for the software and that's where we come in. So, I do think we're getting there. There is a lot of interesting work going on where operators are trying to understand which platforms do they put in, how do they support those platforms, how do they pay for those platforms that's a combination of software and hardware.
So, we're doing really good work with our customers. There is a lot of intimacy being developed. I think we're listening very well. We're responding to how we can best support them going forward. While it's painful at this point to not see the larger platform deals being done, I am very comfortable that we are making the right progress and that we are getting positioned on the product side. We're building our proof points that this is where the next leverage comes from to handle what is absolutely something that has to be handled. And again, I think we're reaching diminishing returns on those other kinds of investments and our day is coming.
Chris Kho - Thomas Weisel Partners
And then as a somewhat related question, so you mentioned that you're emphasizing more on like what the world will look like once LTE is rolled out. When do you think they will start spending as far as software investment in anticipation of the LTE build out?
As it regards to LTE, my own view is that LTE is a little further out. The spending will probably start in the late 2010; up to 2011 is where you start the spending. The impact, actual impact of having those networks online; I don't think we see until 2012 or 2013, frankly. They will be out there early but they won't be fully blown out.
They will be lightly loaded. The challenge for operators, quite frankly, is how do they manage heterogeneous networks? How do they manage 4G? How do they manage 3G, 2.5G, Wi-Fi, WiMax? That is the real challenge and optimize all of those networks. And again, I think software is going to be key to solving that problem.
So, there is no holy grail in terms of hey LTE is here, bang it in, all your troubles are solved. That's just not going to happen. The question is going to be how do you optimize every part of the network in all of the networks and that's going to take a lot of intelligence. So my perspective is LTE is a little further out. I do think you will start seeing spending late this year of some consequence and more next year but frankly by the time LTE is integrated and rocking and rolling you are two to three years out.
Chris Kho - Thomas Weisel Partners
Okay. So, just to clarify, you see potentially them spending a little more just on the integration points and we don't have to necessarily get there as far as functional 4G access yet before you guys potentially start seeing some larger deals flowing through?
Thank you. And our next question comes from the line of Scott Zeller with Needham & Company. Please go ahead.
Scott Zeller - Needham & Company
Going back to an earlier question around Tier 1 and others, could you give us a sense from the bookings how it was distributed amongst Tier 1 and then lower tier?
Typically we don't really give you that kind of level of detail. But suffice it to say that as we were talking more about the channel, as it relates to channel and as I mentioned in my script, we've been increasing our spend actually in sales and marketing in order to get that channel revved up. We spent a lot on documentation, a lot on training and we've really been revving up both the large resellers as well as the smaller regional resellers. So Ken did you want to add something to that?
No and we don't have a detailed number to give you. I don't think we'd ever give you that. The broad rush thought is the data says 35% to 40% of the business was with a couple of our larger players. You can take that. There is probably a significant portion of our revenues that's still coming from many of the large Tier 1 players. We are having success with second and third tier players. We mentioned some of them on the call. In the past we've talked about places like Qatar, we talked about Vodafone or Vodacom.
So we are having success and we are having wins with smaller and smaller markets. I do think that now that our channel partners are coming up on the first phase of been trained we're going to see more of those. We're certainly counting on it. But I'm sorry; we don't provide a more detailed breakout than I can give you. So I'll just stop rowing on.
Scott Zeller - Needham & Company
Okay. And there was a question earlier about expense management, actually a couple of questions and I wanted to see, Karen we understand the run-rate you have had but will it be flexible to the guidance you gave which is for a bit of a weakening of revenue in the second half?
Yeah, as you can probably imagine, I'm watching those expenses very carefully and whether its not tons of room to go, there is still some room to go and I'll keep working on it. We'll keep working on trying to cut some but like I said earlier, we do have a couple of big events this quarter that you do have to come out in the quarter. But we are watching.
We've continued to get savings out of the engineering organization as we close to sites. At the same time we increased our offshore development resources in order not to hinder our new development. But there is still room to work on it and Ken's over here eyeballing me because he is saying hurry up and do some more.
And I would tell you the work that we've done in terms of consolidating centers, certainly we thought we would get cost savings but we are actually operating more efficiently as an engineering operation. We actually organized to be more efficient. We have too many under scaled centers. We have fewer sale centers up. We have fewer centers now that have critical mass and we're actually getting more from less if you can believe that, it's true.
So we haven't suffered in my view at all. I think we're actually delivering more value from an engineering perspective. I would also say that we are very cognizant of the fact that we want to be a profitable business and breakeven or profitable is the name of the game. We think we're going to be profitable for the full back half of the year. We do have the seasonal down quarter and you could bet Karen and I are all over that in terms of trying to figure out how to make sure that it's a sold quarter nevertheless.
Scott Zeller - Needham & Company
And the last question is around gross margins. The license has been jumping around a bit. Good gross margins this quarter due to the licensed performance. What do you think in the second half we should expect?
I think we'll stay in our target range. The 60% to 63% still looks from what we can see right now to be very solid but I will also tell you that I certainly expect things to continue to be up and down. We're just aren't consistent all the time. It's dependent on the mix of the deals as it is installed but I would say we do expect to hold in our target margins.
Scott Zeller - Needham & Company
One last question, if I could sneak it in. When you talked about visibility because of the backlog, what revenue components are the most visible of the three revenue lines?
Well certainly M&S is always your easiest because its over a certain period of time. Its for two years or three years or whatever it is. So that's the easiest. But with the license and the services, what essentially happens is we booked a deal, we put in the backlog and then we schedule the installation and we work with the customer on that installation and then typically we book on a percent complete.
There are other ways depending on the accounting. There other ways but typically percent complete. So as its going in over two or three quarters and being tested by the customer et cetera we're taking the revenue as it goes. So we can see that. The thing I was alluding to is a customer sometimes doesn't have all his hardware or he has a holiday or he wants to slow or speed up installation or again test it. Those are the things that change the timing a little bit one way or the other a month or two in any direction.
(Operator Instructions) And our next question comes from the line of Kevin Rendeno with Blackrock. Please go ahead.
Kevin Rendeno - Blackrock
Most of my questions were answered. Let me try and attack the enterprise value question if I could. If you look at the equity value and you strip out the cash, which I think was about $1.50 a share in cash you're left with a business that is basically valued at $0.60. You have $190 million some odd of sales, $2.50. No matter how you slice it, the business should be worth one times.
Add the cash, stock is $4.00. However, the stock is $2.00. So, sort of half of where potentially it could be trading at a very conservative way you have cash. You had issues a year ago with some of your cash and getting at it. Where do you stand on uses of cash, especially with a share price as low as where it is?
Well the share price is lower than we would like it to be and it's lower than where we think it should be and we're focused on fixing this business, standing this business up, making it very clear that not only is the patient well again, but the patient is going to live and live long. So the focus is to operate this business well, establish our credibility with customers and with shareholders.
One of the reasons that we have the cash and that it is helpful and its kept us in the game quite frankly is that when I'm chatting with AT&T or Sprint or Telefonica, they know we're not going to blow away. They know that we're a serious Company and I have to tell you a year and a half ago, that wasn't the case. So I and the Board will continue to evaluate on a quarterly basis the strength of the Company, the comeback of the Company and make decisions about the uses of cash strategically from here. But, as we sort of just come out of the emergency room, I think we can afford to take a quarter or two and make sure that we are able to walk.
Kevin Rendeno - Blackrock
And one follow-up question to that. At the end of the day this is always a sequentially down quarter, December to March. So this shouldn't be any surprise. Was I misunderstanding some of the earlier comments about weakness? It's normal seasonal weakness, correct?
Correct. You are exactly right.
Kevin Rendeno - Blackrock
So, you weren't talking about anything other than what we normally should expect and actually where the estimates are already in terms of revenues?
Yeah what we're alluding to is if you go back and you look, the prior two years Q3 was our weakest revenue quarter in everyone of tiers. So you're exactly right. Its just our normal seasonality of the March quarter following what is usually a pretty good December quarter.
I think Kevin you raised a really important point. Thanks for tuning that up because we'd be remised to sort of avoid the normal seasonality that we see in the business. We've improved some things. Things have definitely changed but when you ignore those trends you do it at your own peril.
Kevin Rendeno - Blackrock
Yes, the estimates are there already. So that shouldn't come as any surprise. And lastly, you mentioned a patient out of the emergency room. What is it or when is it that you actually feel like you are on the right path? Is it a quarter of having a substantially higher than 1:1 book-to-bill ratio? Is it bookings? Obviously, these revenue quarters are based upon your current backlog.
So, when do you actually start taking a bow or when do you actually start convincing yourself that you are at a different place? When does that come? What is the metric? I'm not asking for a specific quarter, but what is the actual metric that would allow you to think that you know what; we're ready to go here?
So, we didn't come here to sort of just focus on getting the patient out of the emergency room. That's our job. We came here to deliver this business back to a growth business and when the Company delivers a substantial above 1:1 book-to-bill, then we will begin to think that we have done what we came here to do. So, I hope that is clear. We want to run, not walk.
And this concludes the question and answer session. Mr. Denman, please continue.
Ladies and gentlemen, thank you very much for joining us for this quarter's conference call. We look forward to sharing our next earnings results in the April timeframe. I hope I could see you at Barcelona and if not there I will look forward to seeing you in San Francisco and New York. Have a good evening.
Ladies and gentlemen this concludes the Second Quarter 2010 Earnings Conference Call. If you'd like to listen to a replay of today's conference please dial 1-800-406-7325; for international participants, 1-303-590-3030 and enter the access code 4202622 followed by the pound key. The replay will be available until February 18th, 2010. We would like to thank you for your participation. You may now disconnect.
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