Napster F3Q07 (Qtr End 12/31/06) Earnings Call Transcript

TRANSCRIPT SPONSOR

Napster, Inc. (NAPS)
F3Q07 Earnings Call
February 8, 2007 5:00 pm ET

Executives

Alex Wellins - The Blue Shirt Group
Chris Gorog - Chairman of the Board, Chief Executive Officer
Nand Gangwani - Chief Financial Officer, Vice President

Analysts

Mike Olson - Piper Jaffray
Christopher Rowen - Soleil Securities
George Sutton - Craig-Hallum
Darren Aftahi - ThinkEquity Partners
Alan Davis - D.A. Davidson & Company

Presentation

Operator

Good afternoon, ladies and gentlemen and thank you for standing by. Welcome to the Napster third quarter conference call. During today’s presentation, all parties will be on a listen-only mode. (Operator Instructions)

Today’s conference is being recorded Thursday, February 8, 2007. At this time, I would like to turn the conference over to Alex Wellins with The Blue Shirt Group. Please go ahead, sir.

Alex Wellins

Thanks for joining us on today’s call. With me today are Napster's Chairman and CEO, Chris Gorog, and the company’s CFO, Nand Gangwani. Today after the market closed, Napster issued financial results for the third fiscal quarter. The earnings release referenced in this conference call can be accessed from the investor relations section of Napster's website at www.napster.com, as can a webcast of this call.

I would like to remind you that during the course of this conference call, Napster management will make forward-looking statements including predictions and estimates. These statements, including any statements regarding the company’s path to profitability, relationships with AOL and with wireless carriers, subscriber growth and churn, sales of music-enabled cell phones and the effect of such growth on the Napster business, expectation for future revenues, operating costs, subscriber acquisition costs and net losses, growth of the Napster Mobile service, interoperability with popular music playback devices including cell phones, the proliferation of Windows DRM enabled cell phones and the strength of the Napster brand, involve a number of risks and uncertainties. Actual results may differ materially from any future performance suggested in the company’s forward-looking statements.

We refer you to the company’s Form 10-Q for the quarter ended December 31, 2006, on file with the SEC for important risk factors that could cause actual results to differ materially from those contained in any forward-looking statements. We expressly disclaim any obligation to update this forward-looking information.

With that said, I will turn the call over to Chris.

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Chris Gorog

Thanks, Alex, and thanks everyone for joining us on the call today. Napster posted record revenue of $28.4 million, up 21% year over year and 11% sequentially in our third fiscal quarter. At the same time, we reduced our net loss by approximately 44% year over year, as a result of our expense management and focus on path to profitability, while at the same time, we added nearly 50,000 new subscribers during the quarter.

Napster was quite productive during Q3 and in recent weeks, resulting in a number of important new partnerships that are key to Napster's future growth and strategic position. These include a strategic partnership with AOL to take over their music subscription business and deeply integrate Napster into AOL, one of the top music destinations on the web. We expect this agreement to increase our subscriber base by more than 50% at the end of the March quarter.

We also recently announced a new Napster mobile agreement with KDDI, Japan’s second-largest mobile carrier, giving us the top two carriers in one of the most active mobile usage countries in the world.

Napster Mobile also made its debut in Europe on Telefonica’s O2 mobile network in Ireland. Telefonica is one of the world’s largest wireless companies serving over 140 million customers around the globe.

I will provide more detail on operations and these initiatives, as well as some thoughts on the very fast-evolving windows-based mobile market, which we believe is a game-changing development for Napster, giving us access to a vast new eco-system of tens of millions of handsets and mobile customers. But first I will ask Nand to review our Q3 results and our guidance for our fourth quarter.

Nand Gangwani

Thanks, Chris. As Chris reported, Napster's revenues for the third quarter of fiscal ’07 were $28.4 million. This was above our guidance and represented growth of approximately 21% over the prior-year period and 11% over the immediately preceding quarter.

Third quarter revenues included approximately $2.1 million in non-recurring prepaid card breakage and $300,000 of software development revenue related to the customization of software for the Japan launch.

Revenues from the U.K. and Germany represented approximately 16% of revenues for the quarter.

As of December 31, 2006, Napster's total worldwide paid subscriber base, including university and Japan subscribers, was 566,000, up 9% from September 30, 2006. This includes approximately 40,000 university subscribers.

Gross margin, including non-recurring revenue, was 30% for the quarter versus 27% for Q2. Gross margin excluding non-recurring revenue, which had no direct cost of revenue, was 24%, down 1% from Q2 gross margin, excluding non-recurring revenue. This was primarily due to negative margin hardware sales during the holiday promotional period.

Operating expenses for the quarter totaled $18 million, up from $16.5 million in the prior quarter, as anticipated, due to seasonal increases in marketing spend and additional promotion campaigns leveraging MP3 device bundles.

On a line item basis, compared to the prior quarter, R&D spending increased to $2.9 million from $2.3 million, primarily due to the reimbursement we received in Q2 from a Japan joint venture.

Sales and marketing expenses increased to $9.2 million from $8.5 million due to seasonal marketing programs.

G&A increased slightly to $6 million from $5.7 million, primarily due to increasing professional fees related to legal and other matters.

The loss from a consolidated entity of $1.3 million reflects a portion of the loss from our joint venture with Tower Records Japan. The increase relates primarily to the launch-related marketing and promotional expenses, as expected.

As of December 31, 2006, we have recognized losses from the joint venture that equal our capital investment. We have no further commitment to fund the losses of the JV and will not recognize any further portion of their losses unless we make future capital contributions.

The income from discontinued operations represents the net tax benefit from the favorable resolution of previously provided tax contingencies of our former consumer software division.

GAAP net loss for the third quarter was $9.5 million, or $0.22 per share, favorable to our guidance for a loss of $0.30 per share.

Napster ended the period with 157 full-time employees.

Moving to the balance sheet, we ended Q3 with $80.9 million in cash, cash equivalents and short-term investments.

Now, to guidance: looking ahead, the expected addition of several hundred thousand subscribers migrating from AOL will result in record subscriber levels at the end of our fiscal year. We will see the revenue impact of the new subscriber influx when we report our June quarter, as the migration of the majority of AOL subscribers is expected to occur very late in the March quarter.

We currently anticipate revenues to exceed $26 million in the fourth fiscal quarter, noting again that the third quarter revenues included approximately $2.4 million in non-recurring revenues.

We expect operating expenses to decline substantially in Q4 and beyond, as marketing spend is reduced after ramping up for the holiday period and as we focus on integrated marketing partnerships like our AOL deal rather than broad-based online advertising.

We are projecting a net loss for the third quarter of approximately $9 million, or $0.21 per share.

Now, with respect to our cash balance, after payment to AOL for our acquisition of AOL Music Now subscribers and AOL related marketing expenses, we expect to conclude our fiscal year with approximately $60 million in cash, cash equivalents and short-term investments. We feel comfortable that we have sufficient cash to fund operations at least through the end of calendar 2008.

I appreciate your attention and now Chris will bring you up to date regarding recent developments.

Chris Gorog

Thank you, Nand. Napster announced one of the most significant deals in our company’s history on January 12th. We acquired the very substantial subscriber base of AOL Music Now, and simultaneously announced that we have become AOL’s exclusive music subscription partner going forward.

AOL’s existing 350,000 subscribers will have the opportunity to migrate over to Napster at the end of March, and we expect that the majority will do so, which should increase, as Nand mentioned, our subscriber base by over 50%.

As importantly, we have established a strategic marketing partnership with AOL going forward, whereby Napster will be deeply integrated into AOL’s free ad-supported music website, which last month was number one in unique visitation of all music websites, with over 22 million unique monthly visitors.

As these over 20 million unique visitors each month are enjoying AOL’s free programming, they will be presented with Napster download buttons, with high-profile placement and deeply integrated throughout the site, which will direct AOL’s visitors to an up-sell page to Napster, customized to the artist the visitor is interested in.

Napster will be directly linked through these download buttons on every artist’s page and adjacent to every single song in the site. We will also be promoted on AOL Music’s homepage, and within the AOL video player that pops up with every video streamed on AOL.

The integration of Napster into AOL music is quite comprehensive, and includes many other important placements, including integration into AOL Radio, which is programmed by our partner, XM Satellite Radio.

We are very pleased to be in the position to accelerate our market share so significantly with our agreement to take over AOL Music Now subscribers, and we look forward to working with AOL going forward to maximize new subscriber uptake.

Moving on to another important subject for Napster, we are pleased to see very substantial evidence that Windows-based music-enabled cell phones are now really beginning to take off. The day the iPhone was announced several weeks ago, I was walking the convention floor at CES in Las Vegas, viewing thousands of square feet of Windows Media DRM music-enabled cell phones from Samsung, Motorola, and Nokia, all of which are compatible to Napster, and none of which are compatible to iTunes.

Samsung, Motorola, Nokia and other telecom giants expect to ship hundreds of millions of these Windows music cell phones over the next few years, whereas Apple projects 10 million units next year for the iPhone.

This radical change in the device world is what we have been signaling for some time, and it is very exciting to see it now happening. You can get a jump during early adoption on the massive global Windows ecosystem with a closed platform, but the Windows ecosystem, shared by thousands of companies around the world and 95% of PC users, has always eventually come together and prevailed, as it did with the PC and as it clearly is doing now.

With analysts now projecting shipments of standalone MP3 players declining over the next few years, and shipments of music-enabled cell phones dramatically increasing, we believe that music-enabled cell phones powered by Windows technology will become the leading portable music devices. This provides quite simply a game-changing opportunity for Napster.

The greatest obstacle to Napster's growth thus far has been that no manufacturer emerged in the MP3 player space with a bona fide commitment to compete with the iPod. As consumers migrate to enjoying their portable music on their cell phones, Napster now finally is beginning to feel the wind at our back, with most of the major cell phone manufacturers in the world backing the technology that powers Napster.

To take advantage of this opportunity, we must execute with powerful alliances with mobile carriers, and we are doing just that through our Ericcson partnership and with DoCoMo, Cingular, and other very significant carriers around the globe, with many more to come.

To give you a quick update on the Cingular handsets that are in the marketplace, the very well-advertised and successful Samsung Blackjack and the Cingular Sync from Samsung, and now the Cingular 3125, are all Napster compatible.

Other major handset providers will be releasing Windows music phones through Cingular in the coming weeks and months. Napster remains the top music provider on Cingular’s deck and is the only service with in-box marketing support for all of Cingular’s Windows DRM-enabled phones.

We recently announced another significant carrier partnership in Japan with KDDI. This is the second-largest mobile network in Japan, with over 20 million mobile phone subscribers. This puts Napster Mobile now at the fingertips of over 60 million mobile subscribers across Japan when combined with the 40 million mobile subscribers on DoCoMo’s platform.

We have begun generating sales from Napster Mobile and expect this revenue to continue to grow and become meaningful in the latter part of calendar 2007. We have found that global carriers are keenly interested in the music subscription model to drive customer acquisition, new hardware purchases, accessory sales and customer retention, but also to drive adjacent products like DSL. We believe the carriers and the music subscription model will enjoy a long-term and successful marriage.

Changing subjects for a moment, digital rights management is an issue that sparks heated debate and has recently been brought into focus again. Apple has just called for the elimination of DRM, which is completely understandable now that Apple is about to be surrounded by hundreds of millions of Windows-based music phones. The timing of Apple’s newfound philosophy, after perpetuating a closed, proprietary system for almost four years, seems unlikely to be a coincidence.

In any event, obvious questions emerge from the discussion. Will the record labels drop DRM requirements? Will Apple ultimately license its Fair Play DRM? Regardless of what happens, we think the Napster kitty, if you will forgive me, is sitting very pretty on this issue.

If nothing changes, we have the massive emerging Windows Media music phone ecosystem to attach to. If Apple finally decides to open up their DRM and license Fair Play, as they have previously refused to do, we could also then attach to the iPod installed base. And if the labels ever do in fact decide to drop DRM, interoperability issues would vanish, which could be a great growth catalyst for Napster.

All of these scenarios illustrate very well that by keeping our eye on what is best for consumers, and by creating the most open, legal platform available, all options before us seem very attractive for Napster.

I will make one additional observation about the DRM debate. The biggest problem with DRM is not the concept, but the execution. Needless to say, when consumers are faced with a confusing array of DRMs, which are not interoperable, of course they will want it done away with. If the labels, however, believe they must have DRM to protect their intellectual property, they are clearly the only ones in a position as the content owners to straighten DRM out and to make it work for consumers.

There is only one way to do this, and it is actually a very simple solution: the labels should refuse licensing to any party that is a purveyor of a closed system. It is the marketers of closed systems that have created this problem, and to continue licensing them is to continue to perpetuate the problem.

The fact that three European nations and a U.S. class action consumer lawsuit are all demanding that Apple open up its closed system should speak for itself.

Now, before I conclude my remarks, I will make a quick comment on our examination of strategic alternatives. We are continuing discussions in our ongoing review of opportunities to further enhance shareholder value, while at the same time we are aggressively focused on growing our business, as our recent activity should indicate.

As stated previously, we will not be taking questions on this subject and of course, there is no certainty that Napster will enter into any transactions.

In regards to growing the business, and in closing, I would like to mention a recent billboard article entitled “Internet Brands Leave Music Services to Experts” which discusses Napster's recent deals to consolidate some major competitors. Those of you who have followed Napster since our launch over three years ago will certainly remember the skepticism out there that Napster could compete successfully against the giants that were entering the space. You will also recall that we were always very confident that we could perform at the very highest level against these large companies.

We are very pleased to be proving it. Controlling our own infrastructure, managing the most well-known brand in the space, and deploying 100% of our focus to this complex business has resulted in the leadership position we find ourselves in.

I am pleased to reiterate Nand’s guidance that we will have a healthy fourth quarter, and we expect a very strong quarter in Q1 as we welcome AOL subscribers to the Napster family.

Thanks so much for your attention this afternoon and we will now open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Gene Munster with Piper Jaffray. Please go ahead with your question, sir.

Mike Olson - Piper Jaffray

It’s actually Mike Olson here for Gene. I had a quick question about the DRM discussion that is in the market right now. There is obviously a lot of commentary out there about it, but one thing that we took note of today was the head of Warner Music saying they are not likely to drop DRM, and it does seem pretty unlikely to us that the labels are going to drop DRM. I am just wondering, what is your take on that?

Chris Gorog

Well, Michael, it is perhaps an unanswerable question. I am certainly not surprised that the head of one of the major labels made such a statement. I certainly heard it reiterated by the label heads in my recent discussions with them. I think the labels are obviously highly concerned about protecting a $40 billion industry.

I would just go quickly back to my comment that certainly, I would have to say if I were in the shoes of one of the major label heads, before I considered throwing the doors open to DRM altogether, I would certainly consider very, very seriously what I said in my prepared comments, which is I think that they have unwittingly created a lot of dysfunction in the marketplace by licensing these closed proprietary platforms. If you really break it down, that is the issue.

If I were in their position, I would absolutely go forward with not licensing closed platforms. I think it is getting to the point of really being hurtful to the industry, particularly their industry, and I would then look at what a successful open DRM ecosystem looks like before I moved on to the prospect of eliminating it altogether.

Mike Olson - Piper Jaffray

Okay, and a quick question about DoCoMo and KDDI. Just in general, what has the feedback been? Secondly, do you think that KDDI was kind of feeling some heat after DoCoMo signed on with you guys? Do you think the same thing could happen in the U.S. with some of the other carriers feeling heat from Cingular integrating with Napster and thinking they need to keep up with everyone else?

Chris Gorog

Yes, let me just make a quick note. So Michael, with respect to DoCoMo, we are extremely pleased with how we have launched with DoCoMo. The level of integration, the level of marketing support from DoCoMo can only be characterized as very, very strong and very committed to the Napster brand, which is hugely exciting for us. Obviously they are a very, very powerful player in that market.

KDDI is also a powerful player. They are number two but they are very strong and we were delighted that, having seen the success that we had with DoCoMo, that KDDI wanted to jump on the bandwagon with the Napster brand. We are expecting good results from KDDI. We have just begun getting started with them, but the Japanese market continues to be a very bright spot for us and very exciting.

With respect to any learnings we might take from the Japanese market and look to what might be happening in the U.S. market, I think that there remains a substantial opportunity for us in the U.S. market beyond the number one carrier in the market. We will just have to see. I don’t really have anything to report today, but I think that there is, the wireless carriers are constantly reviewing what is the best strategic approach for them into this market.

I think they have all begun, certainly Cingular leading the band, to see the wisdom of the music subscription model, and what a successful retention tool this can be for the wireless business. So this is something Cingular is quite excited about and I think it is very likely that you will see some of the other major carriers going deeper into how they approaching the music business and I think they will continue to evaluate who they should be partnering with.

Obviously we talk about the brand a lot. The Napster brand ends up being very helpful to partners as they try to market new technologies and products, and I think that continues to be an important calling card for us with the wireless carriers.

Mike Olson - Piper Jaffray

Okay, just one last one and then I will turn it over. You mentioned that you might slow down some of the broad-based Internet advertising and have a greater focus on the AOL related marketing. I’m just wondering: what do you believe in the past has been your most successful advertising channel? Do you think you might be giving up something if you slow down the wider Internet advertising, or is it the right thing to do to take a more specific approach?

Chris Gorog

You know, Michael, we do think it is the wisest thing to do. Our most successful channel has been some of our better strategic marketing relationships and business development deals. That is why we are optimistic about our relationship with AOL. Obviously we are very optimistic about our relationship with AT&T and Cingular in the U.S. market. I think you will see a much deeper concentration from us not only on executing some of these very important key relationships but also creating some new ones. So I think that is going to be the focus.

We have been successful in creating a lot of triallers through paid advertising in the past, but it is just not the most efficient way for us to approach the market. I think it was helpful for us to catalyze a market share position in our early years, which thankfully we are able to point to where we stand now, as I think good ROI for that.

But I think it is time now for us to ratchet back and create more efficient customer acquisition models and interestingly, because of the market share position that we have created, and again because of the brand, more opportunities are opening up for us. The fact that we were chosen by the number one wireless carrier in the United States to have a very primary relationship with has a lot to do with the market share position we have created.

I think we will be able to create more opportunities for ourselves in this regard and we will create more efficient ways to create new customers.

Mike Olson - Piper Jaffray

Thank you. Congratulations.

Operator

Thank you, sir. The next question comes from the line of Christopher Rowen with Soleil Securities. Please go ahead.

Christopher Rowen - Soleil Securities

First of all, are the mobile subs in the sub count?

Nand Gangwani

The sub count actually has various minimum number of mobile subs, as we have discussed in the past. We just launched our relationship with Cingular and most of the folks towards the end of the quarter were in the trial phase. Starting this current quarter, we should start seeing mobile subs enter our total sub count. As Chris pointed out, it will start having a material impact towards the end of the year, as most of the marketing and promotional activities kick into full gear.

Christopher Rowen - Soleil Securities

Great, and so in order to help us out with forward modeling, can you give us some indication of dollars per sub for the mobile side, and maybe some gross margin characteristics?

Nand Gangwani

In terms of the revenue, it should be fairly similar to what we experienced currently. There will be some differences, depending upon who does the billing, but in terms of the gross margin, without giving the specifics, I do not think we are going to break it out right now.

The gross margins at a very high level will be lower for over the year services, primarily because of the carrier revenue share. But that will be offset by the fact that we will not have to pay any bounties or any marketing expenses. The revenue share will be the marketing expense for that entire transaction.

For the side-loading side, the gross margin -- side-loading meaning where people use the telephones as their MP3 players, where the delivery is not over the air. In that case, the gross margin will be pretty similar to what we experience with our current products.

Christopher Rowen - Soleil Securities

So when you say similar, it will be similar to a Napster To Go, so a $15 a month?

Nand Gangwani

That is correct.

Christopher Rowen - Soleil Securities

Okay, and then, can you give us an indication of the revenue impact, or maybe the dollars per sub of the AOLs coming over? I imagine fewer of those are to go. What would be a good average price to think about?

Chris Gorog

Well, Chris, as you know, we have had a lot more success in the portable tier than our competitors, including AOL, so the lion’s share of the AOL subscribers that are coming over are $10 subscribers.

Christopher Rowen - Soleil Securities

Okay, and last question, we have seen MSN partner with Real and now AOL with you. Do you care to handicap if we will see Yahoo! go to a partnership as well?

Chris Gorog

All I will say is we would be delighted to partner with Yahoo!, but I cannot speak to their strategy.

Christopher Rowen - Soleil Securities

Okay. Thanks a lot.

Operator

Thank you, sir. The next question comes from the line of George Sutton with Craig Hallum. Please go ahead, sir.

George Sutton - Craig-Hallum

Could you give us an update on the pre-Napster concept, both in terms of how it is working from a customer acquisition perspective and then also from an advertising perspective?

Chris Gorog

Sure, George, great question. I think the headlines with the free service are we continue to attract very top-tier clients. We continue to execute at the very highest level in terms of CPMs. We are very interested in continuing to evolve this model. It has been successful for us with customer acquisition to some degree. Obviously when you are providing someone with the ability to enjoy free music, the sales cycle is longer but it does give us an opportunity to message to those users the value of a Napster subscription.

I think that going forward, you are going to see us continuing to tweak the model, not only figure out a way for it to be more successful symbiotically with the subscription service, but also be more successful in its own right.

I think the most significant thing we did obviously to change that model, which you will recall, George, back in late summer, is we ended up replacing the free service at www.napster.com with the subscription up-sell, so we have lessened the visitation directly to the free site purposely so we could get a greater conversion to subscribers.

So we continue to work on tweaking that inter-relationship and I think it really is incumbent upon us as a company to continue developing our approach to how to create a great paid offering and a very competitive free offering in the music space, so we will continue developing it.

George Sutton - Craig-Hallum

I think the answer to that was that conversion rates have not meaningfully changed at this point, from what we had talked about previously?

Nand Gangwani

George, actually our optimization of the workflow has definitely done well and succeeded. Our conversion rates have gone up very significantly in the last quarter as compared to the previous quarter. I think it increase more than 50% quarter over quarter, so we are definitely pleased with our execution on that front.

George Sutton - Craig-Hallum

Okay, great. And then, with respect to the AOL people that you will be migrating over, can you just give us a sense of what sort of conversion rates we should be expecting, and are there any numbers outside of a certain band that would change the terms of the deal?

Chris Gorog

Well, George, the terms of the deal are that we only pay for the subscribers that do migrate over, so to the extent that there is attrition prior to the migration, which will happen in late March, we do not pay for them. Once they become Napster subscribers, they will be treated like any other Napster subscriber and probably be consistent with our customer churn rates.

With respect to churn we have actually reduced our churn rates over the last 12 months, also by about 50%, so that continues to head in a very productive direction.

George Sutton - Craig-Hallum

Okay, thanks, guys.

Operator

Thank you, sir. The next question comes from the line of Darren Aftahi with ThinkEquity. Please go ahead with your question.

Darren Aftahi - ThinkEquity Partners

A couple of questions: in the press release, it says you are looking to increase your sub base from AOL by more than 50%. That would imply, by my math, and 80% to 81% conversion rate of the AOL subs, so two questions with that: one, am I off base there? Number two, since most of those are PC-based subscribers, will there be a transition up-sell period where you are trying to up-sell to the Napster To Go product? And I have a follow-up.

Chris Gorog

Darren, I think that when we transition the subscribers over, clearly there will be some attrition. It is not exactly scientific how we are able to project that, but our assumption, based on some information that we received from AOL in the past, transitions that they have gone through, we think that this is a reasonable expectation that we will increase our subscriber by roughly 50%. Hopefully more than that, but I think that is a reasonable judgment at this point.

I’m sorry, Darren, your next question was?

Darren Aftahi - ThinkEquity Partners

My other question is given that most of your installed base is portable subscribers, would you try in the transition migrate those to a portable subscription up-sell to the $15 product?

Chris Gorog

Actually, during the transition, we will just want to transition them over, but once they are a member of Napster, we will definitely be introducing them to the opportunity to increase to the premium tier.

Darren Aftahi - ThinkEquity Partners

My last question is in looking at the costs associated with that AOL transition, is it just incremental marketing costs, as you being the exclusive provider for AOL music going into fiscal ’08?

Nand Gangwani

The money we paid out to AOL includes our marketing costs with respect to the AOL transaction to the extent that we exceed a certain number of triallers over the period of fiscal ’08. We will be giving them a bounty per trialler.

Darren Aftahi - ThinkEquity Partners

So there is an earn-out on top of what was put in the press release, so to speak?

Nand Gangwani

Right, if they exceed a certain number of triallers. That is correct.

Operator

Thank you, sir. The next question comes from the line of Alan Davis with D.A. Davidson. Please go ahead, sir.

Alan Davis - D.A. Davidson & Company

Just a couple of questions here: I guess first off, it sounds like in the March quarter guidance, perhaps the wireless subscriber growth is not quite hitting quite as soon as maybe you previously expected. I am wondering if you could just kind of break out your assumptions today versus three months ago, and how much of your expectations, if they have been brought down, are lower wireless expectations versus maybe just more careful marketing spend as their effect on revenues in the quarter? Then, maybe how much one-time revenues is included in that guidance.

Nand Gangwani

I do not think we have lowered our wireless guidance. We have always said in the last couple of calls that we will expect the wireless initiatives to really kick into full gear at the end of calendar ’07, and we are still comfortable that that will happen.

What is happening with the March quarter, a couple of things to reiterate over there. Number one is obviously we spoke about the last quarter having about $2.5 million of non-recurring revenues. The second is we spoke about significantly reducing our marketing expense this quarter, so we do not have a lot of visibility into how the top of the funnel would do over the next couple of months when we radically decreased the marketing spend. And then the third is again, we have very little visibility into the exact timing of the AOL transition, which is why we guided that we are exceeding 26 million, to be conservative.

Alan Davis - D.A. Davidson & Company

Okay, and then on the AOL subscribers and that business coming in, I guess working my way down the income statement, I am wondering if you can give us a little bit more in terms of its effect on the operating cost line. We have gone through revenues and gross margins, but I am curious, as much as you can give us in terms of how much that will change the operating expense line for you guys.

Nand Gangwani

We definitely will be amortizing the acquisition costs related to the customer base that we bought as a separate line item and the marketing expense, too. Right now, since the timing is uncertain, I cannot give you an exact number but the amortization of these expenses for this quarter is incorporated in the guidance that I gave you of $0.21 per share.

Alan Davis - D.A. Davidson & Company

Okay, and anything on a pro forma basis for AOL in the second-half of the year, or just on a run-rate basis in terms of how accretive that deal will be for you guys?

Nand Gangwani

If you exclude the amortization of the acquisition costs, the deal will definitely be generating a positive impact on the operating line this calendar year and going forward.

Alan Davis - D.A. Davidson & Company

But you are not willing to go into anymore detail on that though?

Nand Gangwani

No, at this point, we will not break that out in more detail. We will see how the transition does and maybe in the next call, I will be able to give you more details on that.

Alan Davis - D.A. Davidson & Company

Okay, great. Thank you.

Operator

Thank you, sir. The last question is a follow-up question with Chris Rowen with Soleil Securities. Please go ahead, sir.

Christopher Rowen - Soleil Securities

Nand, do you have any breakage in the guidance for next quarter?

Nand Gangwani

In the guidance for next quarter, I do not have any prepaid card breakage. It was the majority of the non-recurring revenue this quarter, or the December quarter.

Christopher Rowen - Soleil Securities

And then, what percent of revenue this quarter was from subscribers?

Nand Gangwani

I think it was well over 86%, 88%, which is what we have been doing the last couple of quarters, but I will get back to you on that number. I do not have that right off the top of my head right now, but our subscriber base continues to grow, so that -- but there is not change in that trend. It would be a little higher than what we did last quarter.

Christopher Rowen - Soleil Securities

And then finally, maybe a good closing question for Chris, I think I was not alone in terms of when the AOL deal comes out saying that that kind of price is the value of a sub, and then that might reflect the value of Napster. Do you have any kind of counterpoints to the idea that if $45 per sub is what you paid, then that is what Napster is worth?

Chris Gorog

Well, I think that you have to look at it a little more broadly than that. I think you have to look overall at AOL’s strategy and what they are trying to do in the free space. I think you also have to look at their infrastructure. As you know, they built their business off the back of a third-party company. They tried to put together a substitute for that, which really did not work out well for them. Obviously they did not have any brand presence whatsoever outside of AOL, so I think that there is a lot of very significant differences between the value we have created here at Napster and what they did over at AOL.

Christopher Rowen - Soleil Securities

Okay, fair enough. Thanks.

Chris Gorog

Okay, guys. Operator?

Operator

Yes, sir, that is your final question. Please go ahead.

Chris Gorog

Okay, very good. Thank you very much for joining us this afternoon and we will see you on the next call.

Operator

Thank you, ladies and gentlemen. This concludes the Napster third quarter conference call. You may now disconnect. Thank you for using AT&T teleconferencing.

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