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Executives

Mike Bishop – IR

Ken Denman – CEO

Anne Brennan – CFO

Analysts

Charlie Anderson – Dougherty & Co.

Tom Roderick – Thomas Weisel Partners

Scott Sutherland – Wedbush Securities

Matt Hoffman – Cowen & Company

Scott Zeller – Needham & Company

Peter Wright – PAW Partners

Openwave Systems Inc. (OPWV) F3Q10 (Qtr End 03/31/10) Earnings Call Transcript April 28, 2009 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Openwave Systems third 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, Wednesday, April 28, 2010.

And at this time I would like to turn the conference over to Mike Bishop, Investor Relations. Please go ahead, sir.

Mike Bishop

Thank you. Good afternoon, everyone, and thank you for joining us today to discuss the results of Openwave Systems third quarter of fiscal year 2010. Joining me today from Redwood City are Ken Denman, Chief Executive Officer; and Anne Brennan, Chief Financial Officer.

Before we discuss the results of the quarter, I want to remind everybody that we are operating under the rules of Regulation FD. The third 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 Web site at openwave.com. For your convenience, this call is being recorded and will be available for playback from our Web site 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 purpose 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 risk 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 over to Ken.

Ken Denman

Thanks, Mike, and good afternoon, everyone. To begin, I’d like to welcome Anne Brennan, who assumed the role as Openwave’s Chief Financial Officer on April 1. I’m sure many of you are already familiar with Anne and she has been a key financial leader within Openwave for the past ten years. She brings more than 20 years of experience in corporate finance, serving more recently and by President of Finance and also as an interim CFO in early 2008.

Prior to joining Openwave she had a long career and held various financial positions with Racal Group. And brings a wealth of financial expertise to her new role and we look forward to her strong financial leadership. For those of you who don’t already know Anne, I look forward to making the introduction.

On today’s call, I will first discuss the financials and then cover the market and our products. In last quarter’s call, we suggested revenue would take a one quarter dip. Sitting here today I have to admit that revenue was even lower than we expected a quarter ago.

We closed the quarter with revenue of $40.1 million and bookings of $41.1 million. As we look ahead however we remain confident we expect revenue to bounce back so we expect Q4 revenue to remain below the level we saw in the first and second quarters of FY10. All along, we caution that in our business revenue and bookings can fluctuate quarter-to-quarter and this quarter is clearly evidence of that.

We continue to believe we will end the year with solid bookings growth for fiscal 2009 and as we said before we continue to expect revenue growth in 2011.

Openwave has been continuously improving since I was appointed as CEO in November of 2008. We have lowered expenses, improved R&D efficiency, and productivity and dramatically improved the sales pipeline.

We have also been working diligently to rearchitect our portfolio based on new market opportunities and working rapidly to bring new products to market.

The revenue this quarter is a product of bookings made in prior quarters and the lack of book ship business we typically experienced from our largest customers. This quarter we didn’t see the usual levels of book ship business and we continue to see the impact of the $155 million bookings level in fiscal year 2009.

In addition, the bookings and revenue results this quarter were shaped by a last minute delay in purchase from two of our more significant customers. Entering Q3, we had a view of the pipeline for the second half of the year that we felt comfortable with. And right through March 1st we continue to feel good about it. Unfortunately, in the last two weeks of the quarter despite all the right signal, checks, verifications and processes, some deals begin to move out of Q3.

As we look closely at this result and specifically at the customer concentration risks that drive the results there is evidence of improvement despite the overall bookings level. Thus highlight that we made considerable progress in diversifying our revenue stream.

Over the past ten quarters, our two largest customers represent on average 35% of bookings while this quarter they collectively represented less than 10%. What this means is that we’ve successfully expanded our customer base to offset much of the gap.

The concentration risk has always been an overhang and it’s finally caught up to us. It is unfortunate but we now must exploit the opportunity to grow from here with the possibility of better margins. We are currently scrubbing the pipeline processes and pushing for earlier completion of deals that pushed into Q4.

At the core we believe the story has not changed. In fact, our view of fiscal 2011 has opportunely changed based on Q3 results of our Q4 prospects. We needed our new products to play a major role in 2011 and we believe they are well positioned to do so. The recent product launches, expanded customer base, and improved company fundamentals leave this company in a much stronger position than we entered fiscal 2010.

The stronger position reflects the continuous improvement we have seen over the past 15 months. We have a good opportunity in front of us and are well prepared to capitalize on opportunities as they present themselves.

We are gearing up, have the right products in the right place at the right time. We remain bullish on our business because the market dynamics and consumer demand are driving an immediate business deals for our new products.

The overwhelming increase in data demand is forcing service providers to get ahead of the traffic. They are now hitting their networks and to prepare for the not too distant future. This past quarter we introduced our set of products into the market that we believe will help our customers’ best address the situation, both from a traffic management and a revenue generation perspective.

Two months into the official margins of our latest products specifically, video optimization, policy management and our newest analytic offering were already seeing strong interests and traction from carriers large and small.

We believe carriers are getting to ship their priorities away from extending a life of their legacy network assets toward a decisive focus on selecting the right platform for managing and optimizing their growing data traffic (inaudible) predominantly by video content.

Demand for our flagship media optimizer product which optimizes video traffic as real. We have focused our engineering and presales work on the successful market launch of this product, which has quickly yielded tangible interest and opportunity.

We began several customer trials and pilot this quarter, which we feel our teed to early wins and asserting a leadership position in the nascent video optimization category. In addition, we have numerous RFPs, port video optimization and active engagement and we have developed a very robust pipeline for the product in the short period of time of launch.

Fundamentally, we believe that media optimizer will be a market leader for Openwave. The solution is designed to be content-aware taking into account the device, the type of content, subscriber attributes, as well as real-time network addition.

We used advanced techniques by content-aware compression, pre-patching, dynamic content detection, and intelligent cashing so that the optimization and delivery of video is intelligent, policy-driven and can easily be linked to tier pricing and upsell revenue opportunities. We believe that this product is a core element in our customers’ ability to manage growing traffic qualities.

I am happy to report that the traction we have with us in the two months since announcing the product is evident of what we believe are permanent abilities.

We are well-positioned to help our customers succeed as we hit a major turning point for mobility. We are entering an era of constant productivity driven by myriad connected non-phone devices. This phenomenon will increase the strain on networks requiring dynamic, adapt a software solutions that can manage the uncritical nature of tomorrow data traffic and introduce new ways to monetize this traffic.

What we’re (inaudible) NTTIA that typically service (inaudible) industry both echoed a similar resurgence of innovation and we saw operated and breaking new ways of thinking about the broader echo system applications and infrastructure. For Openwave this provided key touch points for us to connect with the current and potential customers and launch our new portfolio.

Our customers buying patterns with remaining reflective of incremental pat side purchases to address their bandwidth problems. In many cases, they are increasing their licenses to support additional throughput. One customer in EMEA license initial capacity support (inaudible) increase the number of transactions per second flowing through their network. These levels are unprecedented but not unique to any one customer. All of our customers are looking for ways to not only manage but incrementally grow revenue from this demand.

On the channel side of our business, our relationship with one of our middle eastern operator customers continues to grow and is a good example of how an initial small instance of Integra place to a strategic partner like Alcatel-Lucent can generate results in a short period of time.

Over the last four months there has been a noticeable increase in data usage with this operator who started out with capacity to accommodate a small level of TPS and then since added capacity to accommodate as much as 12 times the initial level to keep up with their growing traffic volume. We expect to see this upgrade progression continue over the coming quarters and replicate to start small grow and growth phenomenon with other customers that are beginning to experience in similar capacity crunch.

In addition, we secured another deal through our relationship with Alcatel-Lucent for our Traffic Mediation products in West Africa, w which represents a net new customer for Openwave.

In the quarter we also signed a deal with Lebanese mobile operator, Alfa, which is upgraded to Integra to help them address bandwidth challenges head on by shaping their data traffic. With Integra installed Alfa can eventually monetize their mobile traffic ahead of the competition.

We also secured a deal with Cable & Wireless worldwide, one of the world’s leading Communications Company for several products from our Traffic Mediation suite including Integra, Web Adapter and Web Security. These products are expected to help enable C&W worldwide to bring flexible managed services to their major enterprise customers outside the carrier roll.

Last quarter we introduced Smart Policy which is designed to help operators move from static policy management to the dynamic enactment of policies in near real-time based on time of the traffic pattern, special events and user profile. Smart Policy combines an IP mediation framework residing directly into data path. And context-aware policy engines that aggregate and analyses session data. Operational analytics to influence decisions in real time, enabling charge against notification services to build the users without for services when appropriate.

We announced a partnership today with F5 Networks to provide intelligent integration of our products to enable dynamic policy control and enforcement with user and service level awareness and part of Openwave Traffic Mediation solutions for wireless operators worldwide. During this technology partnership our Smart Policy and Integra products will be integrated with F5 big IP solutions.

We also announced a latest version of our Passport service last quarter. Passport entered in network software identification and reclamations version that can be used by the operators to inform their users when they are close to their roaming prepaid premium or service limit. And they can offer any number of times or volume-based extension.

In addition, we launched the latest version of our analytics version which gives operator the ability to build rich subscriber profile and segments that leverage unique subscriber insight. This aggregated subscriber data activity can be used as a powerful targeting tool for mobile advertising or for content providers.

We continue to make inroads with our messaging product offering with ongoing renewals for Email Mx messaging platform. This past quarter we relaunched our directory product offering as a smart user repository to meet the evolving customer progress for subscriber profile repository. A common infrastructure needed in a 4G environment. Openwave Smart User Repository offered operator high speed, low licensing user profile and policy acceptance specifically designed to assist them in addressing increasing traffic load.

One of our longstanding Tier 1 North American operators has already deployed this product and is currently processing in excess of 2.5 billion series a day.

I will now turn the call over to Anne to review the quarter’s financials.

Anne Brennan

Thank you, Ken, and good afternoon, everyone. I would first like to say that I am very pleased to be working alongside Ken and the management team at Openwave. We’re excited by the opportunity and their working diligently to continue building the business.

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 investments and goodwill, amortization of intangibles, restructuring expenses, and (inaudible) 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 the corresponding GAAP measures.

Overall, for the quarter ended March 31st, 2010, Openwave posted a GAAP loss of $0.05 per share and a non-GAAP net loss of $0.02 per share. Reconciliation from GAAP to non-GAAP loss can be found in our press release. I'll now turn your attention to the detailed results for the third fiscal quarter.

Revenues for the quarter was $40.1 million, a decrease of $9.6 million or 19.4% quarter-over-quarter and a decrease of $4.5 million or 10.2% year-over-year. The quarter-over-quarter decrease is attributable primarily to lower services revenue. The year-over-year decrease is due to higher license revenue received in fiscal Q3 of the prior year.

License revenue was $12.5 million, a decrease of 700,000 or 5.5% sequentially, which comprised 31.3% of total revenue. The quarter-over-quarter license decrease is due to two specific license transactions that have occurred in fiscal Q2. Year-over-year license revenue decreased by $4.1 million or 25%. The decrease year-over-year is a result of a large license revenue transaction from a major North American carrier which occurred in fiscal Q3 2009.

Maintenance and support revenue was $15.2 million, a decrease of $900,000 or 5.8% sequentially which comprise 38% of total revenue. Revenue decreased sequentially due to a consolidation of a support agreement with a large carrier. Year-over-year maintenance and support revenue was flat.

Services revenue was $12.3 million, a decrease of $8 million or 39.2% sequentially, which comprised 30.8% of total revenue. The quarter-over-quarter decrease is attributable to several large projects that required accelerated delivery schedule in the first half of fiscal 2010.

Services revenue year-over-year was flat. The (inaudible) revenue in the March quarter to an increasing change in mix of our international business. 53% of our revenue originated from customers based in the Americas. 16% from EMEA and 31% from Asia. This compares to last quarter's breakdown of 61%, 13% and 26% for the Americas, EMEA and Asia respectively.

For the third fiscal quarter of 2010 Sprint represented 27% of revenue. No other customer represented greater than 10% of our revenue for the quarter.

Turning now to our gross margins, we achieved 65.2% blended gross margin for the quarter, an improvement of 5.2 points over last quarter. As mentioned before this growth margin improvement was attributable primarily for proportional increase in license revenue.

Gross margin on license revenue increased 1.5 points to 99.6% compared to 98.1% prior quarter, and increased 1.4 points compared to 98.2% for the same period last year. The quarter-over-quarter and the year-over-year increase is due to lower third-party royalty.

The maintenance and support gross margins of 71.1% decreased slightly by 0.3 points from 71.4% last quarter and decreased slightly by 2.0 points compared to 73% for the same period last year. The reduction year-over-year is primarily due to the consolidated support agreement mentioned earlier.

Services margin of 22.9% decreased 3.0 points from 25.9% last quarter. The lower margins are a result of accelerated delivery schedules in Q2 and resulting on services revenue in fiscal Q3. The year-over-year services margins increased by 6.5 points to 22.9% compared to 16.4% for the same period last year. Fiscal Q3 of the prior year was impacted by lower margin projects which included third-party components.

As for the operating expenses in fiscal Q3, research and development expenses were $10.6 million, an increase of $1 million or 10% from $9.6 million in the prior quarter, and a decrease of 225,000 or 2% year-over-year. The quarter-over-quarter increase is a temporary occurrence due to an overlap of employees as we transitioned operations from our Broomfield offices to our offshore development center.

The year-over-year savings are attributable to the consolidation of our development center. Fiscal Q3 sales and marketing expenses of $10.9 million were flat compared to the prior quarter. Year-over-year expenses increased by $1.1 million due to higher labor costs and increased investments in marketing events and trade shows in fiscal Q3.

General and administrative expenses of $5.7 million decreased 300,000 or 5.8% from $6 million in the prior quarter and decreased by $1.7 million or 23% from $7.4 million year-over-year. The quarter-over-quarter decrease is a result of lower labor costs and lower costs associated with fixed assets disposals.

The year-over-year decrease is attributable to lower facilities costs as a result of our Burlington, Massachusetts and Broomfield, Colorado site closures and lower professional fees.

Our head count decreased by 17 employees from 596 at the end of December to 579 at the end of March. The decrease in head count is primarily due to the closure of our Broomfield Colorado site as announced last quarter. We see our metric sheet posted on the Web site for a breakdown of head count by function.

Stock-based compensation expense for fiscal Q3 was $541,000 compared to $438,000 in the prior quarter and $706,000 in the same period prior year. The year-over-year decrease was due to the decline in the fair value of options granted and the reduction in a number of option investing.

On a GAAP basis, in the March quarter, interest and other income was again a $1.5 million, which compares to a charge of $220,000 and a charge of $2.3 million in the prior quarter and the March quarter 2009.

The improvement from the prior periods is due to the receipt of $1.7 million due to a legal settlement finalized during the quarter. The year-over-year improvement was also impacted by cost incurred with our foreign exchange hedging program in the prior year.

Income taxes increased to $1.1 million in the March quarter compared to $170,000 last quarter. The increase is primarily related to a statutory expiration of liabilities in the prior quarter.

Our current backlog is $186 million compared to $189 million last quarter and $198 million in fiscal Q3 of last year. Deferred revenue decreased to $43.4 million as of March 31, 2010 as compared to $48 million in the December quarter and $61 million in the same period prior year. The quarter-over-quarter and year-over-year decreases are attributed primarily to the release of revenues, a service delivery milestones are met.

Accounts receivables decreased to $25.7 million at the end of March from $30.4 million at the end of December and $31.6 million prior year. Our overall DSO increased by three days from 55 days at the end of December to 58 days at the end of March. Year-over-year DSO increased by six days from 64 days in the same quarter prior year. The quarter-over-quarter DSO increased was mostly attributable to unbilled receivables as a result of several large professional services contracts achieving revenue milestones and advance of billing milestones. We maintain our overall target of 80 days.

Turning now to our cash and investment balances. We ended the quarter with $123.6 million in cash and investments, which represent a decrease of $4.9 million or 3.8% from $128.5 million last quarter. Year-over-year cash and investments increased by $1.9 million or 1.6%.

As of March 31, we hold approximately $9.3 million in fair value of auction rate securities recorded in long-term investments due to the current illiquid status. In the third fiscal quarter of 2010 we sold three auction rates securities for $3 million, resulting in a realigned works of $200,000.

As for operating cash flow we used $3.3 million of cash in the March quarter compared to generating $6.3 million in the December quarter. The decrease is attributable to the timing of changes in certain working capital items as well as the decrease net income from the prior quarter.

Depreciation and amortization of intangibles for the quarter totaled $1.7 million of which $1.2 million was depreciation.

Looking forward to the fourth quarter our revenue should marginally improve over the third quarter given the cumulative effect of prior quarter bookings. Additionally we expect the company to be profitable on a non-GAAP basis due to the strength of the margins. At the end of Q4, we expect our cash balance to be approximately 120 million.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Charlie Anderson with Dougherty & Co. Please go ahead.

Charlie Anderson – Dougherty & Co.

Good afternoon. Thanks for taking my question.

Ken Denman

Hi, Charlie.

Charlie Anderson – Dougherty & Co.

Ken, if you could just kind of walk through a little bit, little bit more commentary on why and you see at your outlook and to (inaudible) push, I wonder if the new products are any part of that discussion, people maybe holding off there? And then I have a follow-up.

Ken Denman

Okay, great. So first of all, bids have nothing to do with our new products, completely unrelated. The packages that we are talking about here the multiple packages were all related to do current products, frankly, across the board. So literally we had set of products that represented both sort of mediation, both (inaudible) Integra, upgrades or additional license purchases as well as messaging and frankly, also location, it was pretty broad set. And by the way it’s not unusual in the pattern of business that we do with our largest customers.

Charlie Anderson – Dougherty & Co.

And then I wondered if you can kind of quantify as you went to market with some of the new products as they went live. Based on the web site hits or business you pilot, does it meet expectations, does it exceed expectations, anything sort of that would be great? Thank you.

Ken Denman

Okay. Well, I think your question, Charlie was about trials.

Charlie Anderson – Dougherty & Co.

Yes, just sort of the -- if you can kind of quantify interest in the new products that.

Ken Denman

Yes, I can certainly give you some context. And actually we are very excited about what we’re seeing on the media optimization front, also the other new products that we’re working with customers on. As I said in my prepared comments our Smart Policy analytics and all three are getting great traction. I think we are being seen as a leader, again, and an elevator and customers both existing customers and maybe more importantly, customers we don’t’ have current relationship are really interested in talking to us. So we’re having lots of meetings, lots of good interest.

I would tell you that the features that are being tested on the media optimization side specifically in our 3G video trial area are dynamic optimization, offline optimization, content detection, dynamic URL handling, bandwidth shaping, just in time delivery, iPhone support. So, those are the kinds of the things that we are testing and demonstrating in our pilots and trials.

We are also showing the advantages, cashing and the advantages of offline prepatching as an independent process in which we can get even more compression than on the fly, which obviously in the cashing state that the core infrastructure, capacity for the operator. So those are all things that we’re seeing great results against that were demonstrating not only our dexterity but in this emerging space. We’re demonstrating that it really works, which is not something that all competitors can say. And against that we’re seeing a range of compression results anywhere from as low as 30% for particular types of codex to as high as 70% or 80% in search situations for other codes.

So we’re really hitting the ball hard and I started to say on the front end of this answer that we in fact just completed a trial with a major European operator earlier this week and in a fairly short period of time about 13 days we’re able to demonstrate the capability and we know that other players have taken several months to get through their testing and haven’t been able to hit the ball in all cases. So we’re really excited. We got some great results to share with other providers around the world.

Charlie Anderson – Dougherty & Co.

Do you expect bookings from remain in this product in Q4, then if you could maybe talk about the bookings level in Q4, maybe on a growth basis or a book to bill ratio basis? Thanks.

Ken Denman

I do expect that we will see some level of wins in Q4. I’m not going to provide the number, but I think that we will see media optimization wins in Q4. Previously, I had described when asked in terms of timing, the question was when would we see media optimization become a contributor to the business and we pretty much focus people on sort of back half of this calendar year, we said we’d being the market in fiscal year '11 Q1, and but we said we wouldn’t see any real impact until second quarter or the December quarter. We’re now based on product coming out BGA, beginning of April and trials going very well and being in negotiations with customers. I do expect that we will see wins in Q1. So effectively, leading you down path that says we think we’re going to see media optimization contribute to bookings as early as Q1 of FY11.

Operator

Your next question comes from the line of Tom Roderick with Thomas Weisel Partners. Please go ahead.

Tom Roderick – Thomas Weisel Partners

Hi, Ken; hi, Anne. Good afternoon. Thanks.

Ken Denman

Hi.

Tom Roderick – Thomas Weisel Partners

Just in terms of breaking Part D declines quarter-on-quarter in revenue and bookings it seems that the issue between the two maybe a little bit unrelated, but maybe digging a little deeper if we look at the breakouts in revenue it would suggest that North America was weak this quarter and that Sprint was down. Does those trends essentially play out on the booking side as well? And then I have a follow up question related to bookings if you don’t mind.

Ken Denman

Okay. You bet, Tom. So first of all, it’s really important that I point out that the revenue and bookings are lower than expected for the same reason. So mainly two customers sell the complete deals. At the end of the quarter the deals contain some book and ship business and so that really is a very related thought. And if you look at the packages that we didn’t get done and consider our revenue content, obviously, was pretty good number. These were not tiny packages; they were medium size packages and contain a level of revenues. So they are very tightly tied. It will be in the state to separate them.

Tom Roderick – Thomas Weisel Partners

Okay. And those were the North American customers?

Ken Denman

Well, there were significant customers as how I would characterize it.

Tom Roderick – Thomas Weisel Partners

Fair enough. And just in speaking about you had kind of two bigger deals, the two customers that sell the complete deals at the end of the quarter. What part of it surprises you the most? Just the fact that they didn’t get done and you’re getting assurance that that they would. Are these deals still in the pipeline? Or did these carriers continue to spend on some similar types of solutions but just not your, any competitive loss that you need to be aware of you?

Ken Denman

Okay. So first of all, two different customers, more in one side than the other, but I would say the first one was more of a sort of a normal slip that you see sometimes, sponsors think they are lot loaded and for whatever reason they don’t get the deal done. Doesn’t happen often when you’re really well aligned, but happens occasionally. The other case I would just describe it as there was a kind of about real reset by the customers, think of it as a pause, and a broader issue then Openwave was just a hey we want to recalibrate, reprioritize, make sure our (inaudible) go in and why and we got caught up in that. So that’s how I would characterize it. I’m not sure if I answer the full part of your question, the second part.

Tom Roderick – Thomas Weisel Partners

Now that’s helpful, that’s good color. And then Anne, just want to ask follow-up for you. You mentioned in your commentary on revenues that the decline in services was due to accelerated delivery schedules in the first half. Was there any component of your delivery schedule that there were services recognition in Q3 that was surprising to just a point standard and is there any of that work that kind of gets a) lingering work that can carry it over into Q4 that could be beneficial there?

Anne Brennan

Yes, the first part of the question is that the higher service revenue in the first half and as we disclosed on prior calls that was the case. The ship number that Ken refer to in his response was did impacted services line. And answer to your final part of our question will we see some of that come back in Q4? And the answer is yes, we should.

Ken Denman

One other thing, Tom, I want to come back. I now remember the thing that I was uncomfortable, I was trying to remember second part of your question, to me, which you asked the question was any part of as a result of sort of competitive loss that have an impact hereinafter? And the answer to your question is absolutely not. We were well down the road. It wasn’t a matter of stopping and decide to go somewhere else. We were far beyond that tier back point. This was really administrative or process oriented within the customer not about competitive loss or more different decision being made. So absolutely want to take that off the table.

Tom Roderick – Thomas Weisel Partners

Okay. We’ll get down. I’ll turn it over to others but thank you for the clarity. Appreciate it.

Operator

Our next question comes from the line of Scott Sutherland with Wedbush Securities. Please go ahead.

Scott Sutherland – Wedbush Securities

Hi, great, thank you. Good afternoon. Ken, why don’t I go further what Tom asking. On the two modest size deals in the bookings is it something that going to quote you on fiscal Q4 and so you get more comfort that your two customers are continuing to buy from you?

Ken Denman

So, we’re going to see some of these patches close in, in Q4. And I would also point out that it’s not sorted to just two deals. But the answer is absolutely great seasonality of course in Q4. What I would also say is I think it’s imprudent to when you see the customer take a pause and think slip just automatically say, oh yes, we’re going to get all of that, that and done in the next quarter, whenever customer takes a pause, I absolutely believe in, we fundamentally believe we’ll absolutely see some of those packages close. I just don’t want to really, really go, oh yes, it all happens in this quarter for sure. I think that would not be a prudent approach. I don’t think it implies anything different about our relationship, anything different about the customers’ willingness to buy with us, their confidence in us; it has more to do with just process issue that would ever you get packages reloaded to bill again. If you have the prospect that I may be talking to you about one or two of these several, think of it as packages, one or two might not close this quarter but in general, we will see the most important elements of the business back in this Q4.

Scott Sutherland – Wedbush Securities

Okay. As you look at your guidance for fiscal Q4 for a marginal improvement revenue we’re typically used to services being down fiscal Q3 and back in Q4, so you’re not sure of the something in services that can keep that line weak or other parts of lines weak, where that guidance? And then secondly, can we get a guidance, your high level set that you expect growth in fiscal 2011, to get that growth you need to have a positive to build or imagine, you have pointed 45 million to 50 million of bookings, are you ready to commit to a level of bookings in fiscal Q4 at that level or higher?

Ken Denman

First of all, let me just take on the question broadly. I don’t want to forget the first part of your question. We will come back to that. But I am going to take on the last part directly just over that we’re clearly got. As we started the year FY10 we talked about seeing a view of revenue, we said it’d be largely flat. So I think fundamentally there was a view take it from that but said we get to a revenue of 192. I just want to be clear. We don’t think that’s likely given what is happened in this past quarter. Are we going to be at a one to one book to bill for FY10? Clearly, that remains a goal. So I’m not going to pause there and give you a chance to either redirect me or in a different direction or I’ll come back and answer the services question.

Scott Sutherland – Wedbush Securities

It sounds like you’re still committing some sort of growth in 2011, some of the revenue numbers somewhat the low 182, is that correct?

Ken Denman

So we see revenue growth in 2011. I’m absolutely saying that. The bookings level in 2009 was 155 million. So we’re going to see improvement year-over-year for sure. I think that’s fairly clear. Question you’re asking is are we going to see revenue growth off of wherever we end up with FY2010, are we going to see revenue growth in 2011? And we’re clearly saying that we’ll see revenue growth in 2011.

Moving back to your services question, we will continue to see a base line of services revenue, the mix of services can go up and down. If you recall the feedback that we gave you all in the first half of the year we were under a lot of pressure as we were being pushed by customers to help sort of improve and tweak their system to get more sort of just base line capacity out of existing systems, there were some upgrades of platforms, so there is a lot of pressure. It’s not atypical as you pointed out.

As we run up to the end of the calendar year to see services running fairly high. As we gotten into this year, and we’re doing a lot of new product work we’re seeing quite frankly a little over utilization level of services groups, some of that’s going into our marketing efforts as we’re positioning the new products and eservices team, technical folks are contributing to the business development work there. We also have a ton of pilots and trials and things like that going on. So a lot of that work is not billable per se. Because obviously we’re setting up to get the new product position with new customers. I do think we will see services revenue move back in the right direction though as we walk on.

Scott Sutherland – Wedbush Securities

Lastly, quick question for Anne. This R&D over last you talked about being moving facilities how much impact in cost was that if you can quantify?

Anne Brennan

When you look at the R&D expenses for quarter it is one-off. We should go back towards the run rate that we had experienced in prior quarters. So if you look at it from a macro level or target mix 20s to the high 20s. And as a proportion of that R&D is generally in the 35% to 40% range. And we expect going forward that the R&D expense we will be trying to build at (inaudible) level.

Ken Denman

So we’re really under sort of constructive pressuring there which is we’re well enough towards GA dates on new products. So there is clearly pressure. A, to deliver these new products because we think they are right for the markets. And B, to do it in a way that we remain and can be profitable going forward. So that’s what we intend to do.

Scott Sutherland – Wedbush Securities

Great, thank you.

Operator

Our next question comes from the line of Matt Hoffman with Cowen & Company. Please go ahead.

Matt Hoffman – Cowen & Company

Hi, Ken. Couple of, I think there really just clarifications to this point. But let’s first speak about the services revenue. Whether the move here by some of your operator-customers manage services. Is that a wider impact that services line, was that any impact tin the substantial drop you have in services revenue quarter-on- quarter?

Ken Denman

No, I wouldn’t say that. I don’t think that’s the case at all.

Matt Hoffman – Cowen & Company

Okay. So help me understand then. The revenue goes down, but you are not losing share and it’s not going to manage competitors. Are the operators then pulling that those services that you were doing for them, are they puling them back in-house or they just not doing them, is there going to be some sort of service degradation there?

Ken Denman

In this particular case I think there was a combination of services that was really about in install and deploy. That typically what services means. Occasionally, there is additional professional services associated with tweaking, optimizing and we’re doing a fair amount of tweaking and optimizing some platforms as customers we’re trying to expand and stuff like this. So this is not managed services that sort of the impact here. We didn’t lose contracts for managed services platforms if that’s where you headed.

As Scott pointed out we typically have seen some fall off in services in general in Q3 which is kind of a seasonal thing. People run hard to get their sort of budgets and packages, used and burnt. In this case, I would say there was some impact on our side. We may have impacted the services just in terms of where we are directing people based on our priorities. But both license and services in this lower booking and revenues numbers. And I think my guidance here would be that you’re overly focused on services relative percentage of the total of bookings of revenue that’s went down.

Matt Hoffman – Cowen & Company

I guess our focus is because that’s the part of the model that really to go substantial fall here, in the quarter, so just I was trying to get better, two of our business which is a bit relatively consistent through the year, I’m just figuring out what change?

Anne Brennan

I think we just going back to the first half of the year where the services revenue was higher, and actually dollar and we’re seeing the impact of that in Q3.

Ken Denman

Sorry, what I would ask you to do is the matter is actually look at the services revenue for the first two quarters of the year. I would characterize it we ran hot and in fact I would say that we had to engage a fair number of contract work, not contract work, to keep up with what was the apps for us. And on the other side we ran it a lighter that we might have normally runs seasonally but I wouldn’t say dramatically so.

Matt Hoffman – Cowen & Company

Okay. Couple other questions here. Anne, I think you had some comment on the R&D spending, I just want to make sure I heard everything correct is R&D was up pretty substantially. And I think you said it was to support new projects. Can I assume that those new projects that you are looking to engage in, these are the new products? Can we assume there is a cost related to media optimizer or some of the new products, you are investing in the new products here?

Anne Brennan

Yes, there is an investment in the new products that particularly this quarter though if you remember in Q2 we announced the closure of our Broomfield development site. We transferred that R&D effort from the highest location to the overseas development center in Q3. So we actually have an overlap of costs in Q3. We anticipate that that was one-time cost and I believe moving forward the R&D expense comes back to the region that we’re seeing something.

Matt Hoffman – Cowen & Company

So you think it should still be in the 9.5 million quarter range, not the 10.5 million sort of range? I know you won’t give specifically guidance but should we think that that million dollars is being the duplicate costs plus the new product expense?

Anne Brennan

If you move back to the trailing quarter that’s indicative of the level of R&D spend that we would expect going forward. So if you look at our model again it’s mid to high 20s which R&D approximately 35% to 40% of that roll number.

Matt Hoffman – Cowen & Company

I just want to make sure I get the model in the right place. All right. I guess that’s it all. Pass it over to the next person, but good luck out there.

Ken Denman

Thanks, Matt.

Anne Brennan

Thank you.

Operator

Our next question comes from the line of Scott Zeller with Needham & Company. Please go ahead.

Scott Zeller – Needham & Company

Thanks. Another services question. Sorry, apologize for that. But I wanted to ask about the visibility of the services revenue because I would imagine since that’s rolling off of deferred that it probably of high visibility and if that’s the case could you give us some guidance for the forward couple of quarters on services?

Anne Brennan

There’s two parts of the question. First part is with regards to revenue piece, if I swing back to the comment that Ken made earlier with regards to the reduction in bookings and then the impact on book ship, that impacted our services revenue this quarter. If you compare that to the ones couple quarters is lower because we had explained that, we had accelerated revenue in the first half. As we go forward, the overall model in terms of proportionate revenue shouldn’t change essentially.

Scott Zeller – Needham & Company

Okay. So it sounds like the current stage of revenue distribution is what we should expect going forward, roughly the balance of revenues?

Anne Brennan

Yes, obviously, as we plan in short-term the visibility does tend to happen in the services line and this is one of those quarters where we have seen a movement quarter-on-quarter in terms of the proportion of revenue that released the services of 40% in Q2 and is 30% this quarter. So there is a certain element of variability to that line is that really services.

Ken Denman

That is not hide back to the kind of projects and deals that we close. Some projects and deals that lend themselves to more services content. Package that has a best trigger for implementation in the (inaudible). In some cases we may actually start to work that risk if we’re very sure that the projects going forward and we’ll step up and move with lightning speed to get that done. Because that’s what the customer requires.

In other cases, customer may close the deals, but they haven’t actually done the staging work or purchase the equipment if that’s on their side. And they take longer to get going so that that project may not actually appear on the services line until some subsequent quarters. So there is variability. It is dependent upon the model that the customers using. Some customers are using more in-house source resources than others. And in this case I would actually say this is more a function of a decision or a process where a customer actually sort of a mid year, mid cycle have to relook and began to do some reprivatization. I don’t think it has a detrimental impact to us going forward. But it’s just in some cases larger organizations when they do these looks they sort of pause to get detection row in and for everybody to get the much more so that things move forward again. We don’t see that there is anything more than an administrative pause.

Scott Zeller – Needham & Company

Will the margins on forward quarters for services be lower than we would expect due to unused capacity or idle head count?

Anne Brennan

Good question. We monitor our capacity requirements closely. Trimming ranges in terms of PS margin are in the mid-20, so we don’t expect that to change very immediately.

Ken Denman

I’m just going to take this opportunity just to frame the services question because I think it’s (inaudible) to frame this. One of the reasons we really are excited about our new products is the margin profile of the new products is fundamentally different from sort of our traditional or legacy products. Whatever you have a new product cycle and we have engineered these products to be very competitive from an installed and deployment.

When you have a chance to rearchitect new products you can design them in a way where they’re appropriately configured, that’s like is you don’t have to do a lot of customizing or any customizing and/or very limited work on the frame. So the punch line here is the relative portion of license compared to as a percentage of total deal size we think it will be higher. This is another reason why our new products are very important. They do change our revenue profile, they change our margin mix and I will stop there.

Scott Zeller – Needham & Company

Okay. And I guess high level question to sum it up. I guess I am confused on why in the previous couple quarters the guidance from the team has been especially flat year-to-year revenue when you knew that the services were going to be pulled dramatically forward. I mean I guess if you saw that coming, it’s hard to believe that the company would have been flat year-to-year with revenue. Was there a dramatic change in the license performance versus what you expected earlier in the fiscal year?

Ken Denman

Because this is really an opportunity for us to expand our customer base. One of the reasons for excitement about the new products that is would you look at the incumbent base that we have, there is a high level of customer concentration risk in it, sort of the top few customers. And of the things that we have been missing is that rationale the compelling reason in some cases to upgrade, we clearly have that now with the nature of the content associated with the mobile data growth being more related to video than anything of high percentage of the content hitting our works now are increasing percentages in the video content.

So with us solving a very relevant problem not only, this mean that we can move our products into more of our existing customers, but very importantly, we have a compelling reason for new customers, people that we’re don’t have a relationship today to talk to us. So the other thing that I would mention is we see a short of selling cycle, shorter sale cycle with media upgradation. And as I mentioned earlier, we see a shorter deployment cycle. So if you look at the net of that I think we can have a bigger impact faster with these products and services.

Scott Zeller – Needham & Company

And then looking forward to fiscal '11. What percent of revenue do you think new solutions could make up versus your total mix? And then what do you think legacy solutions to be?

Ken Denman

Well, we’re not giving guidance on that level or sorry I can’t take you, I can’t go there with you. But I can tell you that we do see that our new products will be the growth driver for this business for FY11. And we’re really excited about that. Because first of all, we’ll take media optimization, analytics and Smart Policy into customers but we’ve also established a situation where these products certainly media optimization and Smart Policy are also serviced today versus our core mediation platform Integra.

So we actually see that both driving net new business on their own while at the same time emboldening decisions by customers to either upgrade to or expand their Integra platform. So it’s going to drive a current platform that we say that the art for all IP but it’s also gives us sort of new blades to half cut there. But it’s clearly the growth driver. It’s key to establish both high growth and high margins as we go forward.

Scott Zeller – Needham & Company

And relates to how your legacy solutions, do you see a long scale on that, you don’t see that as but you see that as a flat business or more of a declining business?

Ken Denman

Our experience and I think this will be the case here as well is that we will see a relatively long tale. If you think about networks around the world 2G is that sort of an emerging markets in “non-large western markets” 2G is going to be around for a long time and to the extent you are situated out there, those will be out there for a while, so think about countries like Indonesia or India. But certainly 2G markets for a long time. 3G markets also is to the extent that we have deployed Integra those are work forces, they are highly scalable, and they are going to be out for a long time. Our opportunity is to go in and put in more blades.

So the other thing that I had mentioned is we develop newer versions of our legacy products so the doc releases continue to extend a life of those products. We also focus on migration path between from one product set to the other. We certainly have done that with building the migration path between for instance, media optimization and Integra. It’s actually more work done really on migration, at least for the most recent versions in Integra is literally dropping or thinking of it has the direct connection or a blade or a servicing it.

Scott Zeller – Needham & Company

Okay. Thank you, very much.

Operator

Our next question comes from the line of Peter Wright with PAW Partners. Please go ahead.

Peter Wright – PAW Partners

Hi. First I just want to get clarification. At last quarter you said you expected bookings to be greater than revenues for the year and you expected revenue to be flat. Now after this a lot in the quarter your suspicious are revenues will not be flat for the year but you think you will do better from the 40 million so it sounds like you expect revenue to be in the 180 worst case to maybe 185 in that order? So, A, is that right and B, what do you now expect bookings to be since you were expecting bookings to be in excess of revenues which probably would have put that close to 200

Ken Denman

First of all, I will step back Peter and reiterate if we weren’t clear I will go ahead and begin make sure that I am clear. We felt that we had a sort of flat revenue which would have been approximately 192. Clearly, I said that’s not likely given the quarter that we just gone through. And in (inaudible) quarter. And next aspect of your question are we going to be at a one to one book to bill for FY10? Clearly, that remains our goal.

Peter Wright – PAW Partners

You expect be there, you could be there but get no revenues, so the question is what do you expect your bookings to be this year? At this point what’s your best guess for bookings for this year? Where you are for nine months and what do you expect for fourth quarter be?

Ken Denman

We’re not giving quarter-to-quarter guidance. So I was very clear in terms of what we’re going to say. We’re saying that we clearly, going to be fighting and we have a goal that for getting a one to one book to bill for the year.

Peter Wright – PAW Partners

And where are you after nine months for book?

Anne Brennan

The bookings in terms of book to bill slightly under one to one, the number is 0.97.

Ken Denman

0.97, something like that.

Peter Wright – PAW Partners

So you think your bookings would be significantly in excess of 40 million because you have already identified the spec revenues be in excess of 40 million and bookings to be in excess of total revenue for the year?

Ken Denman

That’s our goal for the year.

Peter Wright – PAW Partners

Second, Ken, you have been doing this since what November of '08?

Ken Denman

Yes.

Peter Wright – PAW Partners

In terms of being the CEO of the business, right?

Ken Denman

Yes, that’s correct, Peter.

Peter Wright – PAW Partners

So you now have about 18 months under your half and six quarters that you printed obeyed the first quarter really can’t be considered necessarily your quarter. I don’t see a lot of progress in this business as a shareholder and the stock went down in '08 because every stock went down, but in terms of the fundamentals of the business you flop in a long, $180 million to $200 million rate while at the same time we are having unprecedented demand for smartphones and network, stresses and you are in the meat of the market and it didn’t happen. So, A, why? You are not to go to all the details I’d like 30,000 foot view and B, I’d like to see some metrics that you could tell me and everyone else that we should measure open way between now and the end of the year to assess whether you’re really making significant progress towards building a growth business?

Ken Denman

First of all, Peter. I disagree. I think since I’ve been here we had seen significant improvement in the fundamentals of this business and this business has a much more hardened basis and a much more sound fundamental base across the board. We’ve reestablished and rebuilt our relationship with our customers that financial fundamentals have improved, we have a platform for growth, we’ve been invested in our product set, we’ve repaired the reputation in terms of quality, we’ve repaired our reputation in terms of delivery, and we’re now positioned out somebody that people want to talk to around the world.

Our new product set which is not unusual to have kind of 4 to 5 quarter cycle to get new products teed up, say are teed up, right at the point in which the market is ready to buy fundamentally, the whole mobile data, that’s occurred so far for most operators, they’ve done with, operators typically they press the button around procurement vehicle that they have, have had already in place, which is about more radio assets, more cell sites, more back haul, more distributions and only now has the full force of the honk slot is beginning to come clear are they looking at the content that is really behind the mobile data and they are finding that the content of highly video based which we predicted a year ago and which is why we drove our products in this direction that we’ve driven it. So we now have right at the preface of the next buying cycle to where the operators need to get more efficiency in their data center to manage, boo to optimize video and can manage bandwidth around video. We have the right products at the right time. So I respect your position, Peter.

We, on the other hand, believe we are seeing a lot of traction, not fully required to in the numbers but also because we’re ahead of the curve; that's not unusual. So, we’re committed to delivering for this business and I think that you can watch our success in delivering new products, particularly media optimization, into the market place. You can look at our wins and judge us on that basis and I am willing to be just on that basis. And the business is the going to be just on that basis. So, thanks very much for your questions and thank you all for your questions today.

Peter Wright – PAW Partners

Hold on. Specifically, what is the metrics that you want us to measure you by between now, forget the end of fiscal year, end of the calendar year and that's 7, 8 months, to show us that you are involved in this (inaudible) and you are going to get a gazillion amounts of orders with new products. How is that we should measure you? Because based on this quarter, it's hard measure it.

Ken Denman

So Peter, I will say you can go -- you can measure us on new customer wins, new product wins, and growth in 2011 and that will be a function of bookings and profitability. So that’s what I would suggest you should measure us on. Okay.

Operator

Thank you, sir. And there are no further questions at this time; if you have any closing comments?

Ken Denman

So, thank you very much for joining us this afternoon. The opportunity we have before us is significant. We are well positioned to be a major player in the media optimization space as a key enabler to our all IP data and traffic mediation story which will be crucial to operator success in the near future. Along with IP messaging capability, we see a strong growth path for Openwave. And we are focused on and optimistic about growing our bookings, revenue and margin in 2011. Thanks very much.

Operator

Thank you, sir. Ladies and gentlemen, this concludes the Openwave Systems third quarter 2010 earnings conference call. Thank you very much for your participation. You may now disconnect.

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Source: Openwave Systems Inc. F3Q10 (Qtr End 03/31/10) Earnings Call Transcript
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