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Openwave (OPWV)

Q2 2006 Earnings Conference Call

January 26th 2006, 5:00 PM

Executives:

Mike Bishop, Investor Relations Manager

Dave Peterschmidt, President, Chief Executive Officer

Hal Covert, Executive Vice President, Chief Financial Officer

Analysts:

Jeff Kvaal, Lehman Brothers

Justin Boyd, Deutsche Bank Securities

Tom Roderick, Thomas Weisel Partners.

Mike Walkley, Piper Jaffray

Will Power, Robert W. Baird & Co

Scott Sutherland, Wedbush Morgan

James Faucette, Pacific Crest Securities

Erik Zamkoff, Morgan Joseph & Co. Inc

Tal Liani, Merrill Lynch

Hung Hoang, WR Hambrecht & Co

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Operator

Good afternoon and welcome to the Openwave second quarter conference call. Today's call is being recorded and will be available for replay later today. For opening remarks and introductions, I would like to turn the call over to the Investor Relations Manager, Michael Bishop, please go ahead sir.

Mike Bishop, Investor Relations Manager

Thanks, good afternoon everyone and thank you for joining us today to discuss the results of Openwave Systems second quarter of fiscal year 2006. I'm Mike Bishop, Investor Relations Manager for Openwave. Joining me today from Redwood City is Dave Peterschmidt, our President and CEO and Hal Covert, our Chief Financial Officer.

Before we discuss our results for the quarter, I want to remind everyone that we are operating under the rules of Regulation FD. Our second quarter earnings press release was distributed at the close of the NASDAQ stock market and if you have not yet seen a copy, you can visit our website at www.openwave.com. For your convenience, this call is being recorded and will be available for playback from our website for one year. Consistent with our past practice, we've also posted a metric sheet at our website which is available for your review.

Before we begin, I would like to remind you that any remarks that may be made on this call or in our earnings press release about future expectations, plans or prospects for the company may constitute forward looking statements for the purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company's actual results may differ materially from those indicated by these forward looking statements as a result of various important factors. These factors include specific risk factors discussed in the Company's press release that was distributed today at the close of the market and in the Company's filings with the SEC including, but not limited to Openwave System Inc.'s fiscal 2005 financial results on Form 10-K and any other reports subsequently filed with the SEC.

We intend to make several forward looking statements during this call that are based on management's current outlook as of today. We do not expect to update these business outlook statements until the release of Openwave's next quarterly earnings announcement and disclaim any obligation to do so prior to that time. However, we reserve the right to update the outlook for any reason during the quarter. And with that, I'll turn the call over to Dave.

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Dave Peterschmidt, President, Chief Executive Officer

Good afternoon and thank you for joining us. Today I will briefly cover our financial results, our business wins and customer successes in the last quarter and our focus moving as we transition our company to maximize the growth opportunities that lie ahead in 2006. Hal will provide a more detailed view of the financial results and we will then take your questions.

Before I start, I want to provide a brief report card on the results the company has achieved on the past calendar year. When I came to this company a year ago, we began a rigorous planning process to clearly define Openwave's future direction and position in the very fast moving and growing mobile data services market. First, we declared that Openwave would operate to a software business model. We then defined a multi-year transition program to expand Openwave's role from that of an infrastructure software components provider to also providing end-to-end solutions and end-to-end services. A year ago we also embarked on an aggressive program to improve the operating efficiency and financial strength of Openwave. Today, Openwave is capable of delivering on this expanded role in all three areas.

The results of all these efforts are clearly being reflected in the income statement and balance sheet of this company. Revenues for the calendar year have grown 26%. Operating margins have increased from 7% to 18% and gross margins have stabilized at 70 to 72% reflecting a strong software business model. Cash and cash equivalents and investments on the balance sheet have increased from $280 million to approximately $500 million post the Musiwave acquisition. The company is posting positive cash flow from operations and as you will see from Hal's comments is clearly on track to lower DSOs by 40 days, that's four zero days over the next 12 months. We clearly have a sound financial base from which to take the company forward.

Now onto the quarter's results. Openwave continued executing on its operating plan. Our financial results are at the high end of the outlook we provided in October. Our revenue increased 12% from a year ago and our pro forma EPS increased to $0.22 from $0.08 a year ago. That's an increase of 175%. Last year, we set out a goal to improve operating margin, leveraging the value in our business model and these numbers demonstrate our progress. We expect to improve more in the coming quarters. Also during the quarter we strengthened the balance sheet through a successful secondary stock offering. We greatly bolstered our cash reserves and have positioned ourselves to be the first choice for enhanced data solutions for our worldwide customer base.

Overall, the Company's results reflect strong performance for the quarter. We are pleased with this achievement, particularly as we have delivered on a plan during a period of transition for the company. This transition plan of improving the productivity of R&D by leveraging core technologies across multiple product lines is having a direct and immediate impact on our operating margin.

During this period of transition, we have sharpened our focus on systems deals to ensure a balanced mix of licensed services and maintenance revenue. We achieved a booking level of 1.01 to 1 and this number did not include any new large project deals signed this quarter. Moving forward, we expect that bookings from large projects will begin growing again.

I will now talk through some important deals signed in the quarter. The first deal demonstrates the ever deepening relationship we develop with our customers. Building on our announcement in July of 2005, with Telefonica Mobilis Espana to provide an all IP integrated messaging infrastructure, we have further expanded our relationship this quarter. Telefonica has signed an agreement with us to extend the capacity of its mobile access gateway to cope with the strong increase in demand for mobile communication, information and entertainment services.

SwissCom, Switzerland's leading telecom company has extended its mobile access Gateway contract for three more years to offer a range of consumer services that include enhanced consumer Internet browsing and special event marketing campaigns. We continue to see a resurgence of interest in location based services and through a partnership with NEC, we're selected by Vodafone KK in Japan to provide an integrated location solution during the quarter. Our established leadership in location products, coupled with our advanced location middleware allows us to offer high accuracy location solution to mobile operators like Vodafone KK. This announcement is further validation of our continued leadership in the location based services market.

In addition to continuing to demonstrate consistent growth in our core technologies, in the last quarter we have also witnessed growth in strategic areas of focus for the company as we evolve our business from being an infrastructure component supplier to delivering complete handset to network solutions for our customer base. In the most advanced wireless market, Japan, we have collaborated with KDDI to power its web mail using our rich Internet application technology making it easy to use and delivering an intuitive interface closer to that of a regular PC application. Openwave is continuing to innovate and bring the latest wireless data technology to some of the world's most sophisticated wireless data markets.

On the client side of our business, we continue to provide over 50 of the world's leading handset manufacturers and OEMs with the software to deliver the latest mobile messaging and content services. While we continue to develop our traditional base, working closely with the handset manufacturers and with the consistent renewals of our V7 browser and messaging client, we are also witnessing strong traction with MIDAS. And MIDAS for those of you is our Openwave Mobile Integrated Dynamic Applications System. MIDAS is now actively in trials with three leading operators in Europe. This next generation scripted application environment is designed to enable mobile operators to quickly create, customize and deploy powerful new applications and interfaces to mass market mobile devices and I look forward to announcing customer wins later this year.

With the acquisition of Musiwave, we are already beginning to see significant customer traction. In the last quarter, Musiwave signed an agreement with TELUS, Canada's leading telecommunication operator to deploy full track music downloads to mobile phone subscribers. This marks Musiwave's entrance into the North American mobile music download market and we look forward to aggressively driving that momentum in 2006. Musiwave continues to lead the music industry on mobile phones worldwide as we announce today with French operator SFR, one of the industry's first full track mobile music subscription services. We are driving technical innovation and leveraging the synergies between the companies to deliver end-to-end services for our customers. Work has already begun integrating Musiwave into our MIDAS framework, with three of the services, Music on Demand, Smart Radio and Music Wizard already underway.

On the last call, we indicated that a metric of success would be for us to add to our MVNO customer base in the last quarter. And as the market continues to gain momentum, we signed a significant MVNO deal, partnering with InPhonic and NPortal. And we look forward to announcing publicly to the customer later this year. An important area of strategic focus is to extend Openwave's solution base and reach within the industry. And as part of this initiative we're actively building key industry partnerships. In the last quarter, we developed a joint agreement with Sun Microsystems to accelerate next generation application development for mobile phones based on open standards.

The agreement will enable the integration of Sun's Java platform Micro Edition, or Java ME and Openwave's XML based MIDAS to enable operators and developers to rapidly create, customize and deploy powerful new applications and interfaces for mass market mobile phones. Working closely with key industry players including Sun, InPhonic, NPortal, NEC and Thumbspeed, Openwave continues to bring the very latest technologies and solutions to market. As we move into an exciting era of mobile content and services in 2006, I look forward to announcing more partnerships over the coming months as we expect to expand our influence in exciting areas such as mobile video and television.

On the last earnings call, we outlined three milestones we expect to deliver in the last quarter. We once again achieved all three. Now, let me review the milestones and outline three more we expect to achieve in this quarter. We committed to building on our success in the messaging space and I am pleased to announce we signed a deal with UPC, Europe's largest broadband cable operator for additional e-mail and anti abuse licenses as our new integrated messaging solutions gained traction in the market.

Second, we committed to announce an MVNO customer win as we continue to see growth in this market. We remain excited by the strong momentum in the MVNO market and we have signed a very significant MVNO customer through our partnership with InPhonic and NPortal. And third, our commitment was to sign a location technology deal as we see a resurgence of interest in location technology in multiple markets. The announcement with Vodafone KK and NEC continues to validate our belief in the strong reemergence in location technology and services in 2006.

I'm obviously proud of the milestones that Openwave has achieved, not only on the business side but on the financial side as we continue to develop leadership position in the communications industry. For the third financial quarter, let me give you the three milestones we plan to achieve. First, we've talked about the growing opportunity for client software with the silicon players in the industry as complexity increases and the need for faster integration becomes a key requirement. To this end, we expect to win an additional silicon design win with a current or a new silicon player.

Second, based on the MIDAS technology, we plan to launch our first integrated end-to-end services with MIDAS and Musiwave leveraging the synergies of Openwave's customer reach and technology with Musiwave's experience in the music space. For those of you attending 3GSM I look forward to showing you this new end to end service. Third, we see continued momentum in the messaging space and expect to win yet another major messaging consolidation deal, furthering our leadership in the carrier class IP messaging space.

Overall, we are pleased to be able to share with you today, a strong quarter's results. We continue to experience momentum in our core business as we drive our transition to deliver complete solutions for our customers worldwide. We are confident that as we transition, we have a long term business model in place to take advantage of the opportunities provided by this growing wireless data market.

I look forward to talking about the exciting product developments and customer momentum that lie ahead in 2006 with those of you able to attend our breakfast at 3GSM in Barcelona next month. With that, let me turn it over to Hal.

Hal Covert, Executive Vice President, Chief Financial Officer

Thanks Dave, good afternoon. To start, I would like to thank our long term and new shareholders for the support and commitment that you've demonstrated during our recent secondary equity offering. As you may know, it has been the practice of the company during our earnings call to discuss financial results based on a calendar year, even though we report our financial results on a fiscal year basis, which ends on June 30th.

During the recent road show for our secondary equity offering, it became apparent that this practice is creating confusion. Therefore, starting with this call, we will discuss financial results on a fiscal year basis. I would also like to note that we have begun the process to shift our internal planning process to match our fiscal year. Later in my discussion, I will highlight how this change relates to financial targets that we have discussed with the investment community.

Now, I'd like to provide an overview of our financial results for fiscal Q2 '06. Unless otherwise indicated, all numbers are on a Non-GAAP pro forma basis. Revenue for fiscal Q2 '06 was $104.5 million, which compares to $103.3 million for fiscal Q1 '06 and $93.5 million for fiscal Q2'05. This represents a sequential increase of 1.2% and a year-over-year increase of 11.8%. The modest sequential increase reflects a continuing drop-off in large systems revenue during the quarter.

For fiscal Q2 '06 we had approximately $2 million of large systems revenue versus $8 million in fiscal Q1 '06. Going forward we expect our revenue from large systems will begin growing again starting with fiscal Q4 '06. Sequential revenue growth was 7.6% not including revenue related to large systems.

During fiscal 2 Q2 06 we had one customer, Sprint Nextel that represented approximately 21% of total revenue. There were no other customers that represented more than 10% of our revenue for the quarter. Overall, revenue makeup for the quarter from both a category and geographic standpoint was consistent with prior quarters.

Gross margin for fiscal Q2 '06 was 72.4% versus 70.3% for fiscal Q1 '06 and 70.7% for fiscal Q2 '05. The increase in gross margin is primarily due to services gross margin being above the upper end of our target range as a result of favorable revenue mix and tight expense control.

Operating expenses for fiscal Q2 '06 were 57.4 million compared to 61.9 million in fiscal Q1 '06, and 59.2 million in fiscal Q2 '05. The reduction in operating expenses is due to lower R&D expense as a result of streamlining our R&D infrastructure, and leveraging core technology across multiple product lines, and lower G&A expense.

G&A expense for the quarter was lower but still remains above our target range. Headcount as of December 31, '05 was 1,257 compared to 1,297 as of September 30, '05, and 1,351 as of December 31, '04. Operating profit for fiscal Q2 '06 was 18.3 million, or 17.5% of revenue versus 10.8 million or 10.4% for fiscal Q1 '06 and 6.9 million, or 7.4% for fiscal Q2 '05. This favorable comparison is essentially the result of higher gross margin and lower R&D expense.

Pro forma net income for fiscal Q2 '06 was 19.3 million, or $0.22 earnings per share; for fiscal Q1 '06 9 million, or $0.12 earnings per share; and for fiscal Q2 '05 5.8 million or $0.08 earnings per share. GAAP net income for fiscal Q2 '06 was 8.4 million or $0.11 earnings per share. For fiscal Q1 '06 our GAAP Net Loss was 7.7 million or $0.11 per share; and for fiscal Q2 '05 our GAAP Net income was 1.9 million or $0.03 earnings per share. GAAP net income for fiscal Q2'06 included a gain of $3.3 million from the sale of a non-operating asset. Our GAAP net loss for fiscal Q1 '06 included an $8.3 million restructuring charge related to a reduction in headcount and facilities.

Stock-based compensation, which is not included in our pro forma Net Income, was 11.3 million in fiscal Q2 '06 compared to 10.2 million in fiscal Q1 '06, and 1.2 million in fiscal Q2 '05. The increase on a year-over-year basis is due to the new rules for expensing stock options that we implemented starting with fiscal Q1 '06. Pro forma fully diluted shares outstanding for fiscal Q2 '06 were 87.6 million, for fiscal Q1'06 75 million, and fiscal Q2 '05 70.3 million.

During the quarter we added approximately 18 million new shares outstanding related to our secondary equity offering. However, since these shares were only outstanding for approximately 20% of the quarter the weighted average equivalent shares outstanding for the quarter for these shares was approximately 4 million.

The following is a reconciliation of our pro forma fully diluted shares outstanding for the quarter; 75 million as of September 30, '05, plus 4 million as a result of our secondary equity offering. 8 million as a result of assumed debt conversion, and 1 million for employee stock programs. Keep in mind that for fiscal Q3 '06 pro forma fully diluted shares outstanding will include the entire 18 million shares issued as a result of our secondary equity offering. Diluted shares outstanding for fiscal Q2 '06 were 79.4 million, for fiscal Q1 '06 70.1 million, and for fiscal Q2'05 70.3 million.

Bookings for fiscal Q2 '06 were 106 million, which represents a book to bill ratio of 1.01 to 1. Bookings for the quarter consisted of 43.4 million for license, 37.7 million for maintenance and support, and 24.9 million for services. Our maintenance and support bookings for the quarter were a higher percentage than normal due to several projects that were started in prior quarters but had final bookings recorded during the quarter. This included $13 million for two large customers. Backlog as of December 31, '05 was 218.4 million versus 207.3 million as of September 30, '05, and 178.3 million as of December 31, '04.

During the quarter we completed a detailed reconciliation of our backlog; and as a result added 9.6 million to backlog that was not included in bookings for the quarter. Deferred revenue as of December 31, '05 was 53.4 million compared to 69.8 million on September 30, '05, and 73.4 million on December 31, '04. I would like to provide some insight into the reduction in deferred revenue. Customers are less willing to pay in advance for licenses and services that cover periods in excess of one year. This leads to more revenue being recognized on a due and payable, and pay as you go basis. Bookings for these types of revenue remain in backlog until billed; and then are included in accounts receivable, thereby bypassing deferred revenue.

Cash and investments as of December 31, '05 were 594 million compared to 299 million as of September 30, '05, and 280 million as of December 31, '04. A reconciliation of our cash activities for the quarter is as follows. We started the quarter with 299 million. We added 278 million from the net proceeds of our secondary equity offering and we generated 17 million from operations and other activities. The 17 million includes 3.3 million from the sale of a non-operating asset, 7.3 million from stock options, and 6.4 million generated from operations. Please note that we used approximately 117 million in cash for the acquisition of Musiwave on January 13, '06.

Now I would like to provide an update for our accounts receivable. First, billed accounts receivable, which reflect payments due from customers, for which we have recognized revenue, and in some cases have not recognized revenue. Billed accounts receivable as of December 31, '05 were 110 million and represent 95 days of sales outstanding. This compares to 101 days of sales outstanding on September 30, '05, and 77 days of sales outstanding on December 31, '04. Our goal for billed accounts receivable days of sales outstanding is 70 to 80 days.

Next we have unbilled accounts receivable, which reflect future customer billings that have been included in revenue; unbilled accounts receivable as of December 31, '05 were 28.7 million, and represent 25 days of sales outstanding. This compares to 23 days of sales outstanding on September 30, '05, and 38 days of sales outstanding on December 1, '04. Our goal for unbilled accounts receivable days sales outstanding is 10 to15 days. In total, our DSO for fiscal Q2 '06 was 120 days compared to 124 days for fiscal Q1 '06, and 115 days for fiscal Q2 '05. During the recent road show for our secondary equity offering, we indicated that we have a target to decrease overall DSO by 10 days per quarter in each of the next four quarters. The action plans to achieve this goal primarily revolve around improving our internal business processes that relate to customer invoicing and collections, and improving the alignment of revenue recognition and payment terms. These action plans have been implemented and will be enhanced as we move forward.

To date in January, we have collected approximately $6 million, or a reduction of 5 days DSO for past due accounts receivable. So, we are well on our way to achieving our goal for a 10-day reduction in DSO for fiscal Q3 '06. To close on accounts receivable discussion, I would like to point out that, for the most part; our customers have the ability to pay us in accordance with contractual payment terms.

Capital expenditures for fiscal Q2 '06 were 2.7 million compared to 3.3 million for fiscal Q1 '06, and $3.4 million for fiscal Q2 '05. This completes the summary of our fiscal Q2 '06 financial results. There is a reconciliation of our non-GAAP and GAAP net income included with our press release issued earlier today.

Next I would like to provide some highlights for our projected financial performance targets. Before I do that I want to reiterate an obligatory key element of our standard disclosure regarding financial targets. Approximately 30-40% of our quarterly revenue typically occurs in the last month of a quarter; and the pattern for revenue generation during that month is normally not linear. Therefore, we could be in a position where we do not achieve our financial targets for a quarter and not determine this until very late in the quarter or after the quarter is over.

Now, moving on, our policy is to provide fiscal year financial performance targets on an annual basis. However, since we provided financial targets on a calendar year basis for calendar '06 during our last earnings call we would like to avoid any confusion. Therefore, I will highlight our financial targets for fiscal Q3 '06. During our last earnings call, we projected that revenue for fiscal Q3 '06 would be slightly up from the level achieved in fiscal Q2 '06, not including Musiwave. We continue to believe that this will be the case.

As a result, we are targeting revenue to be in the range of $105-107 million for fiscal Q3 '06, not including Musiwave. This target does not anticipate sequential revenue growth for large systems, which is expected to start growing again in fiscal Q4 '06. As pointed out earlier, for fiscal Q2 '06 we had approximately $2 million of large systems revenue versus $8 million in fiscal Q1 '06.

Turning to Musiwave, as previously announced, we closed the acquisition on January 13, '06. For fiscal Q3 '06 we are targeting revenue from Musiwave to be in the range of $5-6 million for fiscal Q3 '06 starting with January 13th. In total for Openwave, including Musiwave, revenue for fiscal Q3 '06 is targeted to be in the range of 110-113 million. Operating expenses for fiscal Q3 '06 are expected to be approximately $2-3 million higher than fiscal Q2 '06 due to payroll taxes, our annual sales force rally, and the 3GSM Conference in February. With these financial targets and the higher share count that we will have in fiscal Q3 '06, approximately 103 million shares, earnings per share are projected to be in the range of $0.18 to $0.20 on a pro forma basis.

The trend patterns and related actions to achieve the financial performance targets that we established for the first half of calendar '06, or in effect the last half of Openwave fiscal '06, during our last earnings call are tracking as planned. In closing, our addressed market is large and growing and we believe that we are well positioned to take advantage of this exciting opportunity. We will provide annual guidance for fiscal '07 during our earnings call in July. Now, we will open the call for questions. Operator, please take the first question.

Question-and-Answer Session

Operator

(Operator Instructions) We'll hear first from Jeff Kvaal of Lehman Brothers.

Q - Jeff Kvaal

Yes, hi. Thanks Dave and thanks Hal very much. I wonder if you could comment a little bit about, well first is, the systems deal and if we are, if you are expecting a systems deal to come in during the first quarter to spur the systems revenue during the second quarter; and how big are the systems deals that you have in the pipeline at the moment?

A - Dave Peterschmidt

Yes, Jeff first off, for us for a systems deal, it must be larger than $10 million. So, that's kind of the minimum threshold for a systems deal; and we're seeing deals, obviously, larger than that. I think the way Hal's described it is a proper way to put it. We believe there will be a systems deal signed and revenue flowing by the time we get to fiscal fourth quarter of '06. Whether it gets signed in the current quarter, or the beginning of the fourth quarter; you know, timing is always the issue that we face. But we clearly have line of sight to that happening.

Q - Jeff Kvaal

Okay, wonderful. Then Hal for you finally; I'm wondering if you, you previously said operating margins could be in the 15-20% range. I'm wondering if you have updated your targets on that metric at all.

A - Hal Covert

No, I think our goals and guidance that we've given are stillin that range and as I indicated earlier in the call we're on track in the programs and actions to make that happen or in place.

Q - Jeff Kvaal

Okay, wonderful. Thanks very much.

A - Hal Covert

Yep. We'll hear next from Thomas Ernst of Deutsche Bank.

Q - Justin Boyd

Hi, good evening. This is actually Justin Boyd covering for Tom tonight. Good afternoon everybody. The first question we have here is on some of the marketing expenses. It has increased a little bit and we would like to get some more color on what it is related? Is it more hiring, increasing compensation, what's the story here?

A - Dave Peterschmidt

Yes, we're primarily front end loaded as we go into the new calendar year because we have our global sales rally; we just had in fact, last week. We have the 3GSM Conference that I mentioned in February, the week of the 13th, or right around that range. So, there's a lot of front end costs; and then keep in mind that at about 60 or so percent of our total expenses are related to people. So, we get back into most of the people paying FICA taxes and other taxes. So, we're a little front end loaded; and I think that will level out as we move forward and get right back into line with our overall model driving towards the, you know, the 15-20% operating profit that we talked about earlier.

Q - Justin Boyd

Okay, so we should then understand that you are actually hiring on the sales and marketing department at this point?

A - Dave Peterschmidt

No, I think we're in fairly good shape there. We always have continuing hiring as we add new people for selective activities, and so forth; but there's no big push to increase the number of people that we have.

Q - Justin Boyd

Okay, thanks a lot, and if I may, a follow up question? A little bit related though about the SFR deal that you announced today. Can you help us understand a little bit how we should expect revenue to flow from this deal?

A - Dave Peterschmidt

Yes, I mean SFR, by the way, this is in conjunction - this is part of Universal Vivendi and Vodafone. This is, flowing is going to be based on subscription uptake rate. So, it's like any new service that a carrier launches. The actual projection of revenue flow is going to be a function of how fast do subscribers subscribe, if you will, to this new service? So, we take a very conservative position in the beginning on these. And quite frankly, with Musiwave being new for us, I think you'll find Hal will be very conservative in projections on these new contracts. He'll be looking more at what the established run rate is when he gives you projected numbers.

Q - Justin Boyd

So, it's based on a subscription charge? It's not related to the number of downloads that the users will make?

A - Dave Peterschmidt

No. Because what they announced is this is a flat fee subscription business. So, this is one of the first. And it's quite interesting, this is one of the most asked for services that previously has not been available by the marketplace and that is, you subscribe, it's a flat fee, and you can download all the music you want to while you subscribe to the service. So it's actually a more guaranteed revenue stream, and it gives you a lot more predictability, if you are the supplier.

Q - Justin Boyd

Okay great thanks a lot.

Operator

And Tom Roderick with Thomas Weisel Partners as our next question.

Q - Tom Roderick

Hi good afternoon guys thank you. I just wanted to add to see if we do get some more clarity here just around some of the structure of Musiwave and what that means for contribution to the model, so Hal I was wondering if you just walk through what the gross margin structure looks like here from Musiwave, and what you anticipate the full model changes being from Musiwave to the gross margin structure, and then you commented that operating expenses will be up 2 million to 3 million next quarter, I presume that's inclusive of the additional Musiwave expenses?

A - Hal Covert

Yes the guidance that we talked about earlier on as I stated does include Musiwave and the expenses as indicated include Musiwave. So going forward as we indicated before we believe Musiwave is going to be somewhere in the $40 million to $45 million revenue range. And we also think that as we indicated before for the current quarter we are in right now, it's going to be neutral to slightly negative for us but it's not going to have much of an impact, and it does, it's included within the EPS ranges that I indicated earlier on. And in our fiscal Q4, next quarter in fact, we think it'll be neutral or slightly positive, and then from there on out going into the beginning of our next fiscal year we think it will start to lineup with our overall target of 15% to 20% operating profit.

Q - Tom Roderick

Okay and just a follow-up on the $40 million to $45 million number, when you laid that out, did the guidance include the idea that you could be winning both the TELUS and SFR deals, or what that potentially be upside to some of the guidance that you laid out their?

A - Hal Covert

I think his Dave indicated earlier, we try to take a fairly conservative look and our estimates with the $40 million to $45 million are based pretty much on the run rate business that we've anticipated there. And I think there's a lot of potential when they move into new customers, in effect new territories, like North America, there's upside potential.

Q - Tom Roderick

One last question if I could. Seems to be just a little bit of a disconnect between bookings being down sequentially and backlog being up, could you just comment on that, and potentially what the linearity of the bookings in this quarter look like relative to the past quarters? Thank you very much.

A - Hal Covert

I think the bookings pattern was pretty typical to past quarters. I think the key as Dave indicated earlier is we didn't have any large systems or project revenue in this quarter, and I would point out that we did add $9 million or so to our backlog as a result of the reconciliation I went through. And it would have been fairly easy for us to include that on our bookings number, but our goal here is to make sure we have transparency, and as a result I ended up highlighting it as I did. But heading into this quarter in the next quarter, we expect his Dave indicated activity around these large systems deals and the bookings to really peak back up again.

A - Dave Peterschmidt

Hey Tom this is Dave. Maybe for everybody's benefit because you're asking a very good question here, if I could help people that may not be familiar. What I came to the company the systems deals that were being done were not necessarily as crisp in the balance as they needed to be between maintaining a strong license component and services level. And so what I did as I basically said I want a reset here, I want to stop doing the systems deals until we get a guaranteed formula that we know that they will result in large license revenue streams, back to the idea that this is a software business model were we want to maintain 45% to 50% of our revenue in license. And so we, if you will, we kind of cavitated the flow of those deals until we came to an agreement on that formula. We started that process back up and so we've been running the last couple quarters without the benefit of those deals as we reset the formula. We're clear now on everything we're doing and we're back in that market and we think that will start to add some interesting aspects were business as we go forward.

A - Hal Covert

And just a highlight one more point on Dave's discussion is that, as I mentioned earlier on in the call, our sequential revenue growth would have been plus 7%, if you take out the activity from the large systems deals from the past. So you can see that our core business is really moving along at the plus 20% annual rates that we talked about, and as soon as these system deals take back in, we think as Dave indicated, we're in great shape.

Q - Tom Roderick

Okay, great for that helpful detail. Thank you both very much.

A - Hal Covert

Yes, you bet.

Operator

We'll move next to Mike Walkley with Pieper Jaffray.

Q - Mike Walkley

Great thanks. Just going off the last question little more on Musiwave, can you indicate if there is any seasonality to the business, and can you also, I don't know if you answered the question about the gross margins this business gives us?

A - Hal Covert

Yes, two points. Number one is that I think with the growth rate right now that Musiwave has and us just getting started with it and the opportunities ahead, I don't think you can really talk about seasonality. And the second point is that I did not indicate a gross margin and will not at this point in time. Later on when we start reporting for Musiwave we do plan on breaking out revenue and gross margins so you'll see that. Right now we believe that the gross margin for Musiwave is certainly is going to be lower than the 70% that we targeted for ourselves, meaning Openwave in the old form. However, we do believe that we get the operating margins of 15% to 20% in line with our overall target. So you'll get more information that when we report our Q3 financial results, a fiscal Q3 results.

Q - Mike Walkley

Okay thank you.

Operator

Moving onto Will Power with Robert Baird.

Q - Will Power

Yes thanks. A couple of questions, I guess I want to follow is quickly first on Musiwave. I know you you've indicated you're expecting a $40 million to $45 million in revenue this year and yet the guidance for the next quarter I guess is, if I heard it right, is 4 million to 5 million, does that imply that you are expecting, that will just continue to ramp over the course of the years or something else there? Then, I have a follow up.

A - Hal Covert

First of all, the guidance for Musiwave for a current quarter is 5 million to 6 million and I would point out that only includes roughly about 80% of the quarter because we didn't close the acquisition until January 13. And as Dave indicated, we are being fairly conservative with this until we get more experience, so there is a lot of opportunity here and we think there's a lot of potential for this to ramp up.

Q - Will Power

Sorry for misquoting that number.

A - Hal Covert

No problem at all.

Q - Will Power

And then on Musiwave I wonder if you could talk about what type what type of cross-selling opportunities you're seeing early on, I know Musiwave has their first contract in North America, I don't know how much that was due to your relationship versus ongoing efforts, but if you could speak toward opportunities that may be opening up for you all in Europe and perhaps likewise here in the US, that would be great?

A - Hal Covert

Yes, actually we are very enthused about that opportunity, and we think there's big leverage there. We have already had Musiwave in 12 different meetings with North American carriers that they previously did not have any relationship or any access to. And we have also had them with about six major meetings in Asia as well which they did not. They in turn have introduced us to significant carrier opportunities in Europe where we did not previously havea relationship with those carriers. So we think that symbiosis is going to be very good for both companies.

Q - Will Power

Okay thank you.

Operator

We'll hear now from Scott Sutherland with Wedbush Morgan.

Q - Scott Sutherland

Great thank you, and a good job on the operating margin guys.

A - Hal Covert

Thanks Scott, appreciate it

Q - Scott Sutherland

The other question I had was on the client-side, climb growth was sequentially, I know there is that QUALCOMM relationship, can you give an update there? And also there is recently a introduction of a free browser out there that you might have seen, can you make some comments on the competitive landscape there?

A - Dave Peterschmidt

Yes, good question Scott. We continue one, the QUALCOMM relationship continues to be a very good relationship for us, and as you heard us talk we think we are in position to also have another major silicon contract develop over the next 90 days. So we believe more and more that is was going to happen here. The other thing Scott that I would tell you with regards to the client-side, and it really addresses the announcement you're talking about in the Wall Street Journal about a point product browser, is we are finding ourselves now more and more in discussions with the carriers about the MIDAS, the V7 as it pertains to this converged service platform that we talked about at our analyst day. So we are actually very pleased and we believe that the market for a point browser product is just not going to be a very rich market for anybody. That if you don't have this tied into a bigger architecture, and it's really about personalization, where this market is going, the MIDAS announcement, the Java ME announcement, what you're seeing us do with MIDAS and Musiwave is this whole thing about how do we help the carrier get the user a very personal experience. And if you don't have all the architecture to let that happen, the point product quite frankly, narrow products on the client-side are just going to fade away. This market has clearly matured.

Q - Scott Sutherland

Yes, any comment on the growth that seems to have paused a little bit this quarter?

A - Dave Peterschmidt

Well I think that's more because what were doing, Scott, is taking this approach this is our primary selling energy is now going to the carriers or the silicon providers, so if you will we're starting a new ramp in a sales prospecting stream, as opposed to all the energy going to the handset OEM.

Q - Scott Sutherland

Okay, Sprint was still a very significant customer and there's very little systems revenue in that systems part of the deal pretty much ramped down. So where is the strength in Sprint coming from at this point.

A - Dave Peterschmidt

Well, one, we just did a huge mag upgrade for Sprint. So part of it is just the fact that Sprint's business continuing to grow, they need more capacity for that installed infrastructure they've got. And I will tell you the other thing is now that the merger's complete, the Sprint Nextel merger is complete, there are an awful lot of discussions going on there about the systems that they now want to develop and go forward with. So I think we've got the best of both worlds there, we've got a company that's got ever-increasing load and transaction rates on their installed systems and now they're talking about so what are the next generation of the things we do.

Q - Scott Sutherland

One last small question. I saw that Verizon Wireless did a deal with Autodesk, and I remember you guys partnered with Autodesk in the past in location based services, are you typically in all their deals or only select deals.

A - Dave Peterschmidt

I don't know it's a good question, let me find out for you. I'll make sure we come back to you on that.

Q - Scott Sutherland

Okay, great. Thank you

A - Dave Peterschmidt

You bet, Scott.

Operator

Moving next to James Faucette with Pacific Crest.

Q - James Faucette

Thanks, I want to just quickly touch back on Musiwave just to clarify what I heard, so you are saying that the new deals on Musiwave is announced in the last little while, in Canada and with SFR those would be incremental to your 45 million type calendar year revenue run rate, is that right?

A - Dave Peterschmidt

Yes, James, here's a way to think about it, what Hal and I have tried to do is look at Musiwave they have as you know over 20 installed contracts throughout the world today. And those have an ongoing run rate, they are predictable, they've got, we know what the subscribers are, we know what the average download per subscriber is. And so that has formed if you will the core basis for those forecast numbers that Hal is giving you.

I mean we've taken a little consideration that says well they're not going to not sign new stuff, but we have fundamentally said that the bulk of what we're putting a forecast some predictable run rate that it is there and is easy to extrapolate. The new deals should, in fact, help us offer some upside, but remember this is not like you turn a service on in 90 days and all of a sudden it's lit up all over the place. It's a function of how well the carrier markets and the subscriber uptake rate occurs. So we're been conservative in projecting any of that into our estimates until we understand firsthand the rate at which subscriber uptake occurs and then the rate at which a subscriber behavior occurs.

A - Hal Covert

Yes the other thing I would point out for you to keep in mind, is that a number of Musiwave's customers are moving from the gross revenue recognition method to the net revenue recognition method. So that's going to drop the revenue that we record from the current customer, so we had to overcome that drop as well as growth along the targets that we've talked about, so as Dave said we're watching us to see how it goes, so I think that the guidance we've given you of between 40 to 45 is good for right now, and in once we get more experience with that then we'll highlight additional information. And I would also like to point out with the move more towards the net approach for recognizing revenue that helps get in the range of the 15% to 20% operating profit.

Q - James Faucette

And just on that point, over what period should we expect for you to bring Musiwave up to that cut that kind of operating margin level?

A - Hal Covert

As I indicated earlier, our belief is for the current quarter we're in right now, as I indicated, it will put slight pressure on us but it is included in the guidance I gave for the current quarter, next quarter should be neutral, then in effect in the first half of our new fiscal year, we should start getting in line with the operating model we talked about 15% to 20%.

Q - James Faucette

It doesn't sound like it but just to be clear, previously I know you're not giving calendar year specific guidance, but previously talked about 2006 being able to generate 15% to 20% revenue growth organically excluding Musiwave. Do you still see all of the elements in place and are things still developing such that you would think that that's a reasonable target?

A - Hal Covert

As indicated earlier when I gave the guidance, I said that we have not really backed away from anything that we said we gave the '06 guidance. But to prevent confusion going forward we just want to talk about fiscal quarter and fiscal year activity.

Q - James Faucette

That's great thank you very much.

Operator

Moving on to Erik Zamkoff with Morgan Joseph.

Q - Erik Zamkoff

Hi, congrats on the nice quarter. Quickly on the operating model and piggybacking the question before me, I was wondering the guidance that you gave for '06, should we think about going forward that that guidance is intact on the calendar side, and the and be adding Musiwave on top of that according to what you just laid out, or should we be thinking about it differently. And that on the fundamentals, and can you give us an update on any developments on the cable side of the world i.e. Sprint Nextel and the deals that they've done with some of the major cable operators?

A - Hal Covert

So let me take the guidance question first and then I will pass it over to Dave. I think the right way to think about it is that we haven't backed away from the guidance that we've given for '06, so we are still targeted to grow at the 20% rate that we've talked about. And were targeted to get within the 15% to 20% operating profit. Now certainly with the way we ended this past quarter at 17.5% operating profit we are well on our way to the higher end of that 20%. So going forward we need to think of just fiscal years, and then I think you can layer on top of that Musiwave at the $40 million to $45 million that we talked about with the bottom-line profile that I indicated earlier on.

Q - Erik Zamkoff

Got you. And then if you would mind, would you just reiterate that for me, I apologize.

A - Hal Covert

On the bottom-line piece of it?

Q - Erik Zamkoff

Yes for Musiwave, what kind of operating margin?

A - Hal Covert

Yes, sure for the current quarter we are in right now we believe that it will neutral to slightly negative that is indicated in the guidance that I gave earlier on, the $0.18 to $0.20 for Openwave for the current quarter. Next quarter, fiscal '04, we believe the be neutral to slightly positive and then we go into our new fiscal year of '07, we believe that it will start going into 15% to 20% operating profit that we've talked about overall.

Q - Erik Zamkoff

And the margin structure remains similar to your overall business?

A - Hal Covert

The margins, at the gross margin level it will be lower, at the operating level it should be in line with our overall business.

Q - Erik Zamkoff

Got you.

A - Dave Peterschmidt

And on the cable side, Erik, that continues to be a very robust part of the market in fact all of the MSOs that Sprint announced in their JV are all customers of Openwave. But I would tell you this is happening around the world, I mean you heard us announce the following business we did with UPC which is a big broadband provider in Europe, and that is actually owned by Liberty Media here in the US. And we just had meetings this last here at our headquarters with one of the largest carriers in Asia-Pacific and it was all about fixed mobile convergence. So that is a clear part of the industry that is happening everywhere and it's going to be a big part of the business for years to come.

Q - Erik Zamkoff

Thanks and congrats and keep up the good work, guys.

Operator

We will hear now from Al Liani with Merrill Lynch.

Q - Tal Liani

Hello thank you. I just fix my name, Tal Liani.

A - Hal Covert

Hey Tal how you doing?

Q - Tal Liani

Right. I heard many versions of this.

A - Dave Peterschmidt

We dropped a letter somewhere there Tal.

Q - Tal Liani

The question I have is just on Musiwave, you had your first success in North America, and when you look at the other carriers in North America at least Verizon just launched its service with wider band and you see, I don't want to say pretty set market, but you do have some decisions being done already on selection of vendors and I'm wondering how long do you think you're going to need in order to penetrate other accounts in North America, and let's say you approach a customer that's already chosen another vendor will it be a replacement or could there be an environment of two vendors?

A - Dave Peterschmidt

Good question Tal. So quite frankly, one of the reasons we were so excited about this third element of our strategy where we talk about components provider and then end-to-end solutions, and then we talk about end-to-end services, meaning we are not selling software, we are offering a solution as a service. That is what Musiwave is doing. To answer your question, because that doesn't require forward investment of both capital equipment and software on the part of the carrier, what we're finding is here in North America even though they've made decisions about music download services, everybody is very willing to sit and meet with Musiwave, because they're feeling is I can turn this service on, it doesn't cost me anything. And I can actually run a couple services in parallel, and I will see what the subscribers like. And it is not costing me the carrier a big capital outlay. We believe we are going to see more and more of that as the carriers look for ways to offer new revenue generating services without having to put a lot of forward investment into them.

Q - Tal Liani

And could it be a dual vendor environment, or do you think?

A - Dave Peterschmidt

Yes, in fact, we've already heard that, that a couple of the major carriers in North America have told us they are more than willing to consider, if you will, a shopping mall type of approach for some of these services.

Q - Tal Liani

Regarding the way it works, when you look at wider when they approach a new customer, they have, the initial quarter, they have low margin because they have to buy all the systems, the hardware to install it etc., and only then revenues start to climb as subscribers download songs and they get their share. So for Musiwave are you going to follow the same business model were at least in the initial quarters, one or maybe two quarters of deployment, margins are going to be low and then grow, or do you have a different type of business model?

A - Dave Peterschmidt

It's a little bit different, and the reason that it's different is Musiwave has data centers set up with excess capacity, so we are not dealing initially, I think Hal as he gets into this will have to put in amortization schedules in place, for how we will amortize those investments are not take quote with each contract. Because that was the appeal of Musiwave, is that they had built out a very scalable data center. Where you do get into initial front end cost, is in the professional services work that has to be done to integrate the Musiwave data center directly into the network of the carrier. So there is some from an expense loading associated with professional services but not quote everyone one of them requires a big investment in hardware upfront.

Q - Tal Liani

Last question on a different subject, can you give us an update on the e-mail business, your strategy was to use it as a bait and sell other messaging on top and in the past you've highlighted a voicemail. You had a few announcements in the last quarters, what's happening this quarter and what's the outlook?

A - Dave Peterschmidt

We see the same thing, as you probably, I don't know if you caught it all or not but we mention that one or three objectives this quarter is to provide another big integrated messaging solution contract. And we just announced that one from the last quarter with UPC which again is part of the bigger Liberty Media Group here in the US. We continue to see the integrated messaging market as a very strong market, we also, by the way, believe that we are the very clear leader there, that a number of major players who quote have messaging solutions, have not been able demonstrate an integrated messaging platform. And we believe that we are in front by quite a lead on that market.

Q - Tal Liani

Thank you.

Operator

And our final question today will come from Hung Hoang of WR Hambrecht.

Q - Hung Hoang

Congratulations on the quarter, guys.

A - Dave Peterschmidt

Thanks

Q - Hung Hoang

When you talk about the significant MVNO deal that you are about to sign. Can you actually give us some more color what services you are offering to that customer base, and then I have a question on your cash flow growth given that you are expecting a 10 day improvement on DSO and that roughly translates to about 12 million per quarter, can we, is it safe to assume, we are going to see operating cash flow positive for the next four quarters as well?

A - Dave Peterschmidt

Let me talk about the MVNO and then I'll turn the second part of your question over to Hal. The MVNO, we've actually signed the contract, so it is not one that we anticipate signing, we signed that contract in our second fiscal quarter, we are not able talk about it because the customer themselves is not ready to do a big press release, so it's premature for us to be able to talk about the services. I'll simply tell you is a very significant MVNO. And as soon as we can we will lay out for you the services, but this is an MVNO that is still bedding down all of their strategy for the different services. We know minimally what we are going to participate in, I think it could involve more services than the initial ones identified. As soon as we can talk about it we will.

A - Hal Covert

Yes, so there's two aspects to the cash. Certainly by driving the DSO down, Hung, we are going to generate more cash and we do expect to be positive from past heading forward. But the bigger opportunity for us as we indicated in the past is we believe that cash flow is going to start mirroring operating profit, so the company has a significant opportunity to throw off a lot of cash as we move forward, and that is our game plan. So again we are excited the DSO piece of it, and we are going to drive it down as we've indicated, but driving operating profit and the subsequent cash flow is really the more important area for us.

Q - Hung Hoang

Okay, thank you.

A - Dave Peterschmidt

Okay, I want to thank everybody who has participated. If I could recap for you, obviously, we are pleased with the results, we believe the hard work of longer-term plan in the transition plan are working, we believe the efficiencies that we've built in the business are now sustainable, and we will continue to show improvement. Obviously cash flow, operating margin and the things that are important and we think we have a very large market that we get to serve. So we are optimistic about her future, and we appreciate everybody's participation. We look forward to those of you coming to 3GSM, be introducing you to a lot of the new things that we are doing, and to the Musiwave management. Thank you everybody.

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Source: Openwave F2Q06 (Qtr Ending Dec 31, 2005) Earnings Conference Call Transcript (OPWV)
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