iPass Inc. Q1 2008 Earnings Call Transcript

iPass Inc. (IPAS)

Q1 2008 Earnings Call

May 08, 2008, 5:00 pm ET

Executives

Tim Shanahan - Director of Investor Relations

Kenneth Denman - Chairman and Chief Executive Officer

Frank Verdecanna - Vice President and Chief Financial Officer

Analysts

Vijay Singh - Janco Partners

JD Abousher - JRT Capital

Justin Orlando - Dolphin Management

Kevin Dede - Morgan Joseph

Presentation

Operator

Good day ladies and gentlemen and welcome to the First Quarter 2008, iPass Inc. Earnings Conference Call. My name is Erika and I will be your coordinator for today. At this time, the participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. [Operator Instructions].

I would now like to turn the presentation over to your host for today’s call, Mr. Tim Shanahan, Director of Investor Relations. Please proceed.

Tim Shanahan - Director of Investor Relations

Good afternoon. Thank you for joining us to discuss our financial and operating results for the first quarter of 2008. I am Tim Shanahan and I’ll be managing the call and introducing the company speakers’, Ken Denman, Chairman and CEO of iPass and Frank Verdecanna, Chief Financial Officer.

Before I turn the call over to Ken, I would like to bring the following to your attention. The date of this call is May 8th, 2008. Our presentation today contains forward-looking statements about events and circumstances that have not yet occurred. Statements regarding our projected financial results for the second quarter of 2008, statements containing words such as will, expect, believe, and should, and other statements in the future tense are forward-looking statements.

Actual outcomes and results may differ materially from the expectations contained in these statements due to a number of risks and uncertainties. These risks and uncertainties are set forth in our press release of today, as well as in our annual report on Form 10-K under the section “Risk Factors” filed with the Securities and Exchange Commission on March 17th, 2008, and is available at www.sec.gov. iPass undertakes no responsibility to update the information in this conference call under any circumstances.

The press release announcing our financial results is available on our website at www.ipass.com in the Press Room section under “Press Releases.” The current report on Form 8-K furnished with respect to our press release is available on our website in the Investor Relations Section under SEC Filings.

In addition, in this earnings call, we will provide non-GAAP financial results. The press release on our website includes text and tables that explain a reconciliation of these non-GAAP results to GAAP results. This earnings call was also being recorded for replay and is being webcast. It’ll also be available on our website for one quarter until next quarter’s call.

I’ll now turn the call over to iPass Chairman and CEO, Ken Denman.

Kenneth Denman - Chairman and Chief Executive Officer

Thanks, Tim. Good afternoon everyone and thanks for joining us today. Our overall results in the quarter continue to reflect the growing strength of iPass’ business model and the progress of our transition away from the dial legacy business.

We achieved first quarter revenues of $48.1 million, an increase over quarter 4 of about 2% if the $2.3 million of additional revenue recognized in Q4 relating to a change in estimate for the recognition of minimum commitment billings is not taken into account.

Our customers’ spending in North America softened in the quarter as enterprises cut back on business travel. But we were able to keep that trend in balance, thanks to the current levels of penetration of our enterprise flat rate pricing, as well as our global customer base.

During the first quarter, companies headquartered outside the United States accounted for 37% of our total revenues and this helped to buffer us from the economic weakness in North America.

When we reported our Q4 earnings in February, we said that we expected our gross margins in Q1 to come in between 60 and 62%. Due to reasons I’ll discuss in more detail, they came in at 57%.

Because of our gross margins, we fell short of a goal that we discussed in last quarter’s call namely: to return to profitability on a GAAP basis in the quarter. The margin issues also are the key to our profit outlook for future quarters. We are focused on fixing the issues that hit our margins and getting back on path towards that goal. Several factors played a part in the Q1 gross margin results and let me share with you what we are doing about each issue.

First, in North America, we had significantly higher 3G megabyte usage per user resulting in higher than anticipated network access costs from one of our US providers.

Second, we saw accelerated usage in venues that are part of our recent strategic expansion of our European Wi-Fi footprint. These new European Wi-Fi venues are lower margin than we typically receive. The good news is, clearly customers had pent up demand for these venues and usage was high. Now that we are delivering users to these venues, we expect that our partners will be more receptive to negotiating a lower pricing structure that can help us improve our margins.

Third, we experienced significantly more dial erosion in the quarter than expected. Traditionally in quarter 1, the rate of dial erosion goes down, since quarter 4 has significant holiday seasonality. We are not seeing the same accelerated erosion trends so far in Q2 and therefore expect the erosion rate to decline.

Finally, the weakened US dollar had a negative impact during the quarter, as we paid some of our network access charges in local currencies such as the euro.

Now, I’d like to share with you some of the steps we are taking to address these issues and increase our broadband margins. First and foremost, we are continually renegotiating our broadband provider pricing agreements, while at the same time looking for better priced alternative venues or networks. In fact, we are currently renegotiating our largest mobile data provider agreement in the US and we are looking for better priced network providers in Europe.

By adding multiple providers in regions, we can direct our users to the lowest cost providers. This proven method has allowed iPass to successfully negotiate better rates with hundreds of providers over the years. Now that we have established significant broadband usage in Europe, we will be working to improve the margins in its high growth region.

The good news is, we believe our gross margins will be between 55 and 56% in quarter 2 and stabilize between 56 and 59% during the remainder of 2008. I would note that despite the decrease in gross margins, we had non-GAAP net income of $1 million in the quarter and with actions to improve our gross margins we expect greater leverage in our model in the second half of the year.

I see some powerful changes taking place in our space as we speak. For instance, the consumerization of IT is a burgeoning trend in our view. Also a form factor change is taking shape in the 3G space and will likely result in new laptop, notebook, and handheld chipsets that will incorporate multimode, multiband access methods, such that external and internal data cards will disappear.

And finally, the advent of more casual roaming relationships with cellular broadband providers all contribute to an environment that we believe will allow iPass to continue to play a greater role in the world of unified mobility. I’ll say more about some of the implications of these trends a little later in the call.

With that, I’ll turn the call over to Frank Verdecanna, our Chief Financial Officer.

Frank Verdecanna - Vice President and Chief Financial Officer

Thanks, Ken. Revenues for the first quarter ended March 31st, 2008 were $48.1 million versus 49.5 million last quarter or 47.2 million when excluding the 2.3 million of additional revenue recognized in Q4 relating to a change in estimate for the recognition of minimum commitment billings. The increase from 47.2 million to 48.1 million represents a 2% increase.

Broadband revenues in Q1 were $24.1 million versus 22.1 million in Q4, a 9% increase. Mobile broadband revenues came in at 17 million in Q1 compared with 15 million last quarter, an increase of 13%. Fixed broadband revenues were 7.1 million in Q2 compared with 7.2 million in Q4.

Software and service fee revenues in the first quarter were 12.5 million versus 14 million or 11.7 million when excluding the 2.3 million recognized in Q4 for a change in estimate for minimum commitment billings.

Dial revenues in Q1 were 11.5 million versus 13.4 million in Q4, a 14% rate of decline. Our combined broadband, software and service fee revenues in Q1 were $36.6 million or 76% of our total revenues with dial representing the remaining 24%. In the quarter, US revenues accounted for 63% of total revenues and international revenues accounted for the remaining 37%.

Network access costs were $20.5 million in the first quarter or 42.6% of total revenues, versus 18.2 million or 36.8% of total revenues in the fourth quarter or 38.6% of the 47.2 million of revenues that excludes the 2.3 million of revenue from change in estimate for minimum commitment billings.

Our gross margin in the quarter was 57.4% compared with 53.2% or 61.4%, when excluding the 2.3 million of revenue recognized from change in estimate for the minimum commitment billings.

Now let’s review our operating income and operating expenses. During Q1, our combined non-stock compensation expenses for network operations, R&D and SG&A was $27.4 million down from $30.9 million in Q4, a reduction of 3.5 million. In short, we exceeded our stated goal of reducing Q4 expenses by $3 million.

We had a GAAP operating loss of $2.2 million in the first quarter compared to a loss of 4.6 million in the fourth quarter. We had non-GAAP operating income of $200,000 in the first quarter versus $386,000 in Q4.

Now I’d like to review our net income and earnings per share both on a GAAP and non-GAAP basis. We had a net loss of $1.4 million or $0.02 per diluted share on a GAAP basis versus a net loss of $30.4 million or $0.49 per diluted share in the previous quarter. As a reminder, the fourth quarter did include a tax expense of approximately $27 million relating to a valuation allowance against our deferred tax assets.

We had non-GAAP net income of $1 million or $0.02 per diluted share in the first quarter compared to $1.5 million in the fourth quarter or $0.02 per diluted share.

During the first quarter, we repurchased approximately 1.1 million shares of our common stock for a total purchase price of $3.2 million, an average cost of approximately $2.90 per share. We finished the first quarter with a strong balance sheet including $70 million in cash and investments and no debt. The overall decrease in our cash and short-term investment balance from the last quarter was primarily related to $3.2 million of stock repurchase activities within the quarter and a cash outflow of about $1 million to purchase source code from a third-party vendor that will enable iPass to manage the cost of and increase capacity for 3G network integrations.

In addition, we had a cash payment from a partner of $600,000 hit the bank on April 1st rather than March 31st. Nevertheless cash flow from operations contributed approximately $400,000 in the quarter.

Now, I’d like to review our projections for the second quarter of 2008. The following statements are based on information available to iPass today. These statements are forward-looking and actual results may differ materially. For the quarter ending June 30, 2008 we anticipate revenues of approximately 47 to $50 million. We anticipate fully diluted GAAP earnings per share to be between $0.01 and $0.04 loss per share. As Ken said earlier this is based on our expectation that our gross margins in the second quarter will be between 55 and 56%.

We expect fully diluted non-GAAP earnings per share to be between break-even and $0.03 earnings per share. The lower EPS range acknowledges the gross margin challenge we experienced in the first quarter. We are addressing those issues and expect improvement in the back half of 2008.

Now, I would like to turn the call back over to Ken.

Ken Denman - Chairman and Chief Executive Officer

Thanks Frank. Now let me give you an update on a few other important items. Last quarter, I shared the details of our operational restructuring that occurred in the quarter four of 2007. As projected, the restructuring reduced our new combined non-stock compensation, network operations, R&D and SG&A operating expenses by $3.5 million during the first quarter.

We ended the first quarter with a head count of approximately 500, down from approximately 575 people a year ago. On an annualized basis, we had approximately $400,000 of revenue per employee compared to $325,000 of revenue per employee last year. Our ability to reduce and control our operating expenses has allowed us to continue to grow revenues with a streamlined efficient workforce.

Our broadband mobile revenues were $17 million in the quarter, an increase of 13% over quarter four. I’m optimistic that this growth will continue and the additional volume should help us increase our margins in this part of the business. Among the new business we signed in the quarter were 10 new Forbes Global 2000 customers, bringing our total to 427 of these blue-chip customers. We continue to meet mobility needs of more than 3500 enterprise customers with virtually no customer churn.

Our customers continue to embrace enterprise flat rate pricing as a tool, a valuable tool to manage mobility costs. During the quarter, over 80% of the Mobile Office deals we signed were under the enterprise flat rate pricing plan. This continued shift from usage-based pricing plans helps us to monetize our off-net users. Off-net users add nothing to our network access costs and thus our margin on these users is very high. We obviously must move the basic users to our enterprise flat rate pricing much faster to help mitigate some of the margin issues we’ve already discussed in the quarter. But the pricing model is in place to get us there.

We have initiated programs to incent existing customers to move to enterprise flat rate pricing in advance of their re-sign date. We also continue to leverage our larger channel partners such as Orange Business Services, Telstra, Chunghwa and other FlexConnect partners. And we developed stronger relationships with systems integrators and value added resellers.

Some notable channel partners in North America include AT&T, Cherry Road, Fujitsu, Global Crossing, SAIC and Sayers. During the first quarter we successfully launched the iPass connect mobility service to North American business people. It’s the first time iPass has offered global broadband roaming and 3G services directly to individuals. This foot in the water into the consumer market will give us valuable experience and data as we look to partner with a strong brand or brands to take this segment forward.

Inside iPass, we will keep our focus largely on the enterprise market but we see a nice opportunity to grow into a greenfield space leveraging our strong enterprise base fabric. Despite gross margins take a hit during the first quarter we had non-GAAP net income of $1 million in the quarter and with decisive actions we are taking to improve our gross margins, we should see greater leverage in our model in the second half of the year.

As I mentioned earlier we believe gross margins will be between 55 and 56% in quarter two and stabilize between 56 and 59% throughout the remainder of 2008. The product mix shift continued to be a challenge in the quarter, but the size of the dial bucket is simply getting too small to be a major factor on an ongoing basis. So, we believe a $2 million revenue hit like we saw in the Q1 with the corresponding margin loss is less likely going forward.

I would like to highlight a strategic change coming to this space that plays ultimately to iPass’ favor. Major players such as Qualcomm and Intel are designing building and launching chipsets that will encompass and interoperate with multiple broadband networks available around the world. This is a replay of the [inaudible] which became Centrino chipset launched by Intel some years ago. Some of you might even remember the external PCMCIA cards for WiFi access some years ago. This capability became integrated over a relatively short period of time into devices.

Today WiFi is embedded in most devices that ship around the world. In future, WiFi, 3G and even WiMAX interoperability may be embedded at the chipset level and external and internal cards will no longer be needed. Qualcomm’s Gobi chipset will be one important development in the future of casual roaming in the 3G world. The new generations of systems will allow users’ devices to be pointed at the best network for them based on the range of needs including cost for throughput, speed, and signal quality and this will fuel the demand for a unified mobility solution, potentially putting iPass in a powerful position amended to the complexity of connectivity, convenience, cost and security across the range of access methodologies.

Once again, and perhaps more than ever when these new devices become widespread enterprises and users will have a compelling reason to count on iPass to simplify their world. We believe iPass can and will play an important role in this coming state and we are working hard with all the major players to ensure we continue to be the unified mobility solution of choice around the world.

With that I will turn the call back to the operator for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of Vijay Singh from Janco Partners. Please proceed.

Vijay Singh

Hi, Ken and Frank. I just have a couple of questions actually, actually a little bit more than a couple of questions. First question is you talked about your margin. The margin hit was also, the dollar was also responsible for it and you have 37% of your revenues coming from international markets. I am just wondering was there not an offset with that or was that being paid in dollars?

Frank Verdecanna

Yeah Vijay., all our business on the sell side is in US dollars. So that doesn’t provide a natural hedge.

Vijay Singh

Okay in US Dollars okay. Now, on the – in terms of going to back your service providers or network providers, you mentioned in the last couple of quarters you have done some very extensive negotiations of contract. On what basis would you go back to them and renegotiate so soon, just to get better prices and get margin lift going forward?

Kenneth Denman

Well, Vijay one of the things that is part and parcel of our model is as our volume grows and we become more important to our partners, we have the opportunity to accelerate the renegotiation cycle, so, that we can actually step in if you will out of cycle. So, even if it’s a two year deal or a three year deal, because of the relative importance and for most of these players we are their largest partner, certainly on the WiFi side.

So, our history in the dial space, we would sort of go back every three or six months and renegotiate deals. The first series of, the first couple of years of WiFi we’ve sort of only went back every two years and then it’s shortening recently to kind of one year. So, the fundamental answer is that, while we took a margin hit and we certainly did particularly in Europe as a result of increased volume on lower margin footprint, the upside or the positive part of that is that, the volume that we are generating gives us the opportunity to go back and have a conversation with these partners sooner.

Vijay Singh

Okay. Okay. Fair enough. On the EFR side, Enterprise Fixed Rates side, what was it as a percentage of total revenue?

Frank Verdecanna

Of total revenues, Vijay, it was about 50%.

Vijay Singh

50%.

Frank Verdecanna

For flat rate and subscription-based pricing plans.

Vijay Singh

So, that’s about pretty much the same as last quarter isn’t it?

Frank Verdecanna

Correct. Correct. We did make progress in the quarter but we also had our largest partner in Europe who had not done a great job of moving their customers over to enterprise flat rate. When they came up for renewal they moved back to kind of a hybrid usage model, which actually lowered that percentage, but we did make it up with other new customers, moving on to flat rate or subscription pricing. So, a bit of a pause this quarter but I think we will see a nice growth next quarter in that number.

Vijay Singh

Okay. And so now you have about 76% of your revenues coming from growth business, even though I see the software continue to be a lumpy revenue stream. But, so in our conversation in the past I mean you had mentioned that that was – somewhere in that range that would be the margin or a percentage of total revenue where you would be comfortable giving a longer term guidance. And yet your guidance continues to be just one quarter forward. I am just saying, I am just asking what needs to happen for the margins to – I am sorry for your guidance to be a little bit more forward-looking?

Kenneth Denman

Well, I think – we continue to look at that and we’ve considered it. As dial continues to become less relevant, that’s one of the factors as we’ve said before, the product mix settles down, both of those things will give us opportunity to look further out, give us greater visibility and comfort that we can go further.

Candidly, if you look at what happened in quarter 1, we had 14% dial erosion, if you compare that to quarter 4 dial erosion of approximately the same level, the 14% in quarter one is actually on, is actually – normalizes the much higher number because of the seasonality in quarter 4. So, that doesn’t represent at this point a moderating of dial erosion. It’s a concerning number and so I think fundamentally we are not at the point yet where we feel it’s appropriate and prudent to try to look further out because even though that number, the dial bucket is decreasing it’s still pretty erratic. But I do think that as we get to the end of the year dial will be 15% or less of the business. At least that’s the trend that we are on and we’ll come back to this issue and look at it more closely.

Vijay Singh

Okay. On the margin side I mean one of the things that actually helps you a lot in mine – as far as my understanding goes is that your off-net users increase, you get into that flat rate pricing situation where your margins actually the cost is lower and the revenue stays pretty stable so that helps your margin. And your off-net users did increase this time again, yet the margins were a little bit challenged. I understand that there is a whole issue with usage in a – in a high usage in a low margin geography but shouldn’t that be an offset or am I reading it wrong?

Frank Verdecanna

No. That definitely should be an offset Vijay and it was an offset. Unfortunately it was just a partial offset to a lot of the challenges that we did see in Q1.

Vijay Singh

So, how does that translate into the software revenues being lower than last year – I mean last quarter when your off-net users continued to go up?

Frank Verdecanna

Yeah actually Vijay if you look at the software and service fee bucket as a reminder last quarter we had $2.3 million of a one time pickup for all the change in estimates. When you pull that out, we actually had growth of 850,000 in the software and service fee bucket, so 7% sequential growth.

Vijay Singh

Okay.

Frank Verdecanna

And that’s were really where the off-net growth in EFR is showing up.

Vijay Singh

Fair enough. And last couple of questions I don’t want to hog too much time, but cash flow this quarter? From operations.

Frank Verdecanna

Cash flow was 400,000 for the quarter.

Vijay Singh

400,000 okay. And the option expenses that you recognized, I’m just trying to educate myself here that option expenses have been about $1.5 million roughly per quarter. I’m just wondering what is the basis of the option award and the strike prices that are set as the stock has continued to go down in the last year, in the last 12 months, but yet the option expenses keep coming on a regular basis, how do I reconcile that?

Frank Verdecanna

That’s the challenge with the accounting rules on stock option expensing. Even though those options are for the most part that’s been granted over the 2 years are underwater, you still actually have to take an expense on the day you grant them. And then, you amortize that over the life of that option.

Vijay Singh

Okay.

Frank Verdecanna

So, using the model that you have to use, there is a value even though the stock price is at fair market value on the date of grant.

Vijay Singh

So, these are the options that were granted in the – way in the past and you’re just periodically recognizing expenses?

Frank Verdecanna

Yeah, this is just the amortization of it. And we’ve also in the past two years have also issued restricted shares, which also do amortize into expense.

Vijay Singh

Just if you can remind me Frank what is the performance-based tranche of that share – of the restricted share? What was the performance based on? What have you articulated, so far for 2008 I think it is, what was the performance benchmark?

Frank Verdecanna

So, we think we had two performance benchmarks for 2008.

Vijay Singh

Yeah. One was revenue and the other one was – was it margin or was it EPS, I forget?

Frank Verdecanna

Well, I think you are thinking of the 2007 restricted share grants that were performance based and the performance metrics were based on 2008 performance.

Vijay Singh

Right. And they were based on revenue?

Frank Verdecanna

Three different metrics, one was 200 million of broadband and software and services revenue. That was 50%. And then 25% was 11% of full year 2008 non-GAAP operating income as a percentage of revenue.

Vijay Singh

Okay.

Frank Verdecanna

And then, the third one was 25% was for 14% for Q4 2008 operating income [inaudible]

Vijay Singh

Got it, got it. Thank you very much. That’s all I have.

Frank Verdecanna

Thank you, Vijay.

Operator

Our next question comes from the line of JD Abousher with JRT Capital. Please proceed.

JD Abousher

Hi Ken, hi Frank. A couple of questions for you, first on the software and services revenue, is it appropriate to look at that as sort of a recurring revenue and tied to the off-net users or is that – could that be more lumpy as you sign deals and that sort of thing?

Frank Verdecanna

JD it could be little bit lumpy because we do have professional services revenue in there, training revenues in there, but for the most part the majority of that bucket is monthly reoccurring revenues. So the general trend you should see quarter-over-quarter is continued growth there.

JD Abousher

Okay, so you do have good visibility on a hunk of it?

Frank Verdecanna

Yeah absolutely.

JD Abousher

And then if I just do my dumb math and I take the broadband users of 295,000 divided into broadband revenues to 24 million and then cut it in thirds for monthly I come up with a roughly like a $27 a month ARPU, is that way out of line or is that okay to sort of use that as a metric?

Frank Verdecanna

Yes, the only thing JD , is you’re taken the whole broadband bucket, which includes fixed broadband.

JD Abousher

Yeah.

Frank Verdecanna

The better way to look at it is take the mobile broadband bucket, which was 17 million in the quarter.

JD Abousher

Okay

Frank Verdecanna

And divide that by the broadband user numbers and you get to a quarterly ARPU of about $58.

JD Abousher

Got you.

Frank Verdecanna

And so it’s close the $20 per month and that’s about right.

JD Abousher

Okay, now the consumer product that you’ve rolled out, and I am a happy user. It’s a great product. Obviously has much higher ARPU even though it’s a great value. Is that indicative that we should start to see the wireless broadband users’ monthly rates go up as you start to sign up more both corporate as well as the individual users to these higher rate plans?

Kenneth Denman

When you say rates do you mean the pricing or the volume of users?

JD Abousher

Pricing. Like, I am paying I think 60 some dollars a months for a 3G and WiFi, versus the $20 ARPU if we do the dumb math. So, it seems like there is a lot of headroom to move people up into higher priced plans for more functionality?

Kenneth Denman

Yeah I think that’s – it’s a very good point and I was a little nervous that maybe you were kind of a fly on the wall, because we actually are in the midst of introducing another – or a 20% price increase in euro-based countries. So in countries where we pay in euro effectively we’ll be introducing over the course of this summer, we have to give notice of course with our customer base; we will be introducing this 20% price increase.

So I think the answer is yes. We’ll be looking selectively as we learn more about the consumer plan, but we are already moving on the enterprise side, given the margin issues that we’ve seen and the impact of the euro et cetera, et cetera that’s a clear opportunity for us and so, we will be moving on that right away. And yes, we will be looking very closely at the iPassConnect consumer side also.

JD Abousher

And then, a final question is, sort of the shift to getting these off-network users to on-net well, great margins on the off-net, the ARPU is lower. Now with flat rate, should we expect – right now, we are roughly 50-50 users, is there a goal some point in the future that we should be sort of 75% on and 25 off or how do you think about that?

Kenneth Denman

Well, I want to drive that number as hard as I can, because it gives us a level of predictability. I don’t think we will see 100%, because I do think there will be a group of users who will continue to want to do sort of casual using, they won’t necessarily want to commit for term contracts, but they are happy to go on a usage basis, some kind of a contractual relationship maybe at a lower commitment et cetera. So if we are up at 80%, I think we will be in the right range. That’s my loose target.

JD Abousher

Okay. So if I just sort of back of the envelope model out long-term, we should be driving revenue per user up on a per user basis as well as getting more off-net to on-net which also drives revenue per user up?

Kenneth Denman

That’s right. That’s right, but there is a subtle issue that I also want to make it clear that you understand. Your math is basically right there. But the fact – and this is really important from a value proposition, because you don’t want to be in the position of just being an aggregator and reseller. The value proposition around off-net is very, very important to us. And that is that users are using iPass to connect not only to our commercial networks, but also to private free networks, home networks, campus WiFi. And then, in that way, we positioned ourself as the universal connection manager and you sort of become the default way that people connect.

IT managers and even consumers get that. They sort of think about that as a software value and they sort of separate it from just connecting. It’s great that we have all this footprint, but it’s more important that we make it easy and we are kind of a seamless way to connect. That value allows us to price on a price-per-seat-per-month basis, software-like pricing. And so, I just want to walk you back to the value proposition, because that’s key to being able to get those software-like rates and frankly, whether people use our network or private networks, we become more indifferent. And frankly, we are happy if they are using private networks, because as we said again, there is no network access cost associated with that, so that’s the end game.

JD Abousher

Great. Thank you very much.

Frank Verdecanna

Thank you, JD.

Kenneth Denman

Thank you.

Operator

Our next question comes from the line of Justin Orlando with Dolphin Management. Please proceed.

Justin Orlando

Ken – first, Frank can you tell me what the depreciation was in the quarter?

Frank Verdecanna

Sure. It was 1.4 million.

Justin Orlando

Ken, given the margin pressure that we’ve experienced here and we are going to continue to experience throughout the year, are we considering further cost reductions so that we can get to profitability?

Kenneth Denman

We are absolutely focused on cost reductions, particularly in the gross margin area. So, Justin , my focus is making sure that we attack these gross margins items item-by-item. As Frank sort of articulated and I think I did as well, we know that we had 100 basis point impact due to sort of accelerated dial erosion and we have some – even in that area, we have some forecast and some tactics to address. We understand the pent up demand at Swisscom. We understand the megabyte usage for the mobile data provider in the US and the impact of the euro, et cetera et cetera.

So the most sensitive part of the model here is gross margin. And if we go and attack those items and find 2 and 300 basis points post haste that is the place where we make the biggest bang for the buck and get us back to our target of GAAP profitability as quickly as we can get there.

We are obviously going to continue to pay close attention to the OpEx and we feel very good about the fact that we took the $3.4 million out. We are going to work extremely hard to hang on to that savings. But I also want to point out that, while we did that, we did not see a reduction in our ability to drive sales and to bring business in. We were sort of still in that sweet spot of right around $20 million. And frankly, one of my goals is on that same spend level to get to a breakout and kind of get to the next tier of bookings and kind of the $25 million level on this same cost basis. So I actually think the bigger opportunity is improving the gross margin, taking network access costs out. And we think we know how to go do that and we are going to go focus on it.

Justin Orlando

Let me have a follow-up to that if you don’t mind. So we were at kind of 57.4 in gross margin in the quarter, you are guiding me not up but down given these things you are working on in the next two quarters and hopefully up again in Q4. So when do I get to GAAP profitability again, if I am only focusing on the gross margin line to get my costs back in shape, but I am not scheduled to do that until Q4?

Frank Verdecanna

Justin , I think on the margin side we talked about Q2 moving to between 55 and 56% and in Q3 and Q4 between 56 and 59%. A lot of the initiatives that we are working on addressing the gross margin issues, we are optimistic that we will see some benefit beginning in Q3.

Justin Orlando

And so -- am I going to be GAAP profitable in Q3, if I am focused only the gross margin cost cuts?

Frank Verdecanna

A lot depends on which end of that range we come into on the gross margin and also, where we are from a revenue perspective. So, I can’t give you a quarter, but we are working very hard on the gross margin side and we do believe we will see leverage there and in the full model in the back half of the year.

Justin Orlando

Let me explore that a little bit more and get back what Vijay’s question was, and that is why aren’t we just going ahead and giving us some guidance here on what we think 2008 is, I assume we are already off budget, starting here in Q1. So you guys have a budget, you went through it, but you probably missed it to here. And so, we need to figure out what this company can do for 2008. And we really need help from you all to do with us and it seems like we are – I think and what you said on this call is that dial was really too small to be a really issue going forward. And yet, on the answer to Vijay’s question you said as soon as dial quiets down, we can talk about giving long-term guidance. So I am confused, I don’t understand and I just want to know why is it creditable that we are not giving longer-term guidance here to the owners of this company?

Kenneth Denman

When I walked through this earlier, I believe I said that dial is becoming less relevant and I also pointed out that by the end of this year, we would be at 15% or below. And at that point – it was at just that point that it couldn’t hurt as it much. So basically Justin , I continue you to point to the fact that we still have some variability in the top-line around the dial product. We have some variability around the product mix. We’ve just come out of a quarter where we’ve seen a bit of surprise – not a bit, we saw surprise relative to gross margin. It was different than what we expected. And we are also in a global economy that’s slowing, if I am kind. And we are in a mobile traveler space. That’s the nature of our product.

So when I look at those things and I look at kind of where we are right now, I mean, I don’t know if oil prices go to $150 and what impact that will have on travel. I -- it’s difficult for me to anticipate the direction of the euro and how much of that I can get hedged. And so, when I look at those things -first of all, we’ve got a great platform. We are growing. Customer acquisition is continuing very aggressively. We’re continuing to grow units. We’re not losing customers. There are a lot of good things going on here. But in order to – to look out a year and give credible guidance, I need to see a few more of these pieces settled down. And that’s what I spoke to when I was answering Vijay’s question.

I think as we get to the end of the year, we’ll be in a really good position to sort of relook at this issue and if at that time it’s appropriate, we will certainly consider longer guidance. But right now, I think the investors are best served with us giving them sort of the near-term look of what we see, because that’s what we’ll have most visibility to.

Justin Orlando

I’m not sure I follow that, actually before you answered Vijay’s question, on this call – I will check the transcript – you said that dial is getting to be too small to be a real issue. It was in your script. And so, I’m confused, I don’t understand it. If there is so much uncertainty out there around this company, but yet the technology is so good then why aren’t we moving to find a larger company, a partner who can take this technology to the next level and give the shareholders some value today before this uncertainty yields even lower value for us?

Kenneth Denman

Well, Justin I think I was very clear, I won’t argue the semantics of what I said but I will say this: This company, this Board will always consider any credible offer consistent with our fiduciary duties. The Board has said that before. We continue to -- as you do continue to feel that the stock is undervalue and the question of whether there is a larger platform out there for us to be aligned with is sort of not the focus of the business – of running the business and fixing the gross margin. Even working with a larger player with a larger brand, the gross margin issue would have to be addressed and will be addressed and that’s going to be our focus. So I appreciate the question and I truly do – that’s where we are right now and I thank you for the call.

Operator

And next question comes from the line of Kevin Dede, Morgan Joseph. Please proceed.

Kevin Dede

Hi Ken, you alluded to trying to keep OpEx consistent with Q1 and Q2, can you be more specific?

Ken Denman

Yes. Basically where – we think we are in a range of reason. We have – there are some sort of minor costs that will come into Q2 over Q1. We had a sales conference; it’s a few hundred thousand dollars, so you have some things like that. But basically, you can think of our cost structure being largely flat or flattish plus or minus a percent or so, maybe 2% at most, just normal inflationary trends. And frankly, we are going to try to beat those down as best we can. There is normal attrition in the business. We are always looking for ways to sort of swallow that as best we can without stopping our top-line growth. So, I am thinking in sort of the 27 – Frank help me – 27.6 to 28.4 range, that’s kind of the range.

Frank Verdecanna

Yeah, that’s a good – it could bounce around by quarter depending on the things that we have going on in the quarter. But I think Ken is right that we should stay within kind of flat to 1 to 2% increase over the remainder of the year.

Ken Denman

And of course, to – so that’s the normal answer. But I think Justin’s point is well taken and we frankly as operators of the business are already all over that which is – whenever you have stress in the model you are always looking for opportunities to manage cost and take other costs out of the business without crushing your top-line momentum.

Kevin Dede

Okay. Can you give us an update on the share repurchase program? Where are you and where do you plan to go and what sort of share count should we look for?

Frank Verdecanna

Sure. So Kevin in the first quarter we had $3.2 million as repurchasing activity, so we took out 1.1 million shares at approximately $2.90 per share.

Kevin Dede

And going forward, Frank? I did catch those comments.

Frank Verdecanna

Okay. Going forward, I think the Board’s plan when they approved the $30 million plan and what we had talked about last quarter was trying to mirror our operating cash flows with the repurchasing activities, so to the extent that we have sizable operating cash flows we will continue that stock repurchase program. In the quarter, we only had 400,000 of operating cash flow, so we got a bit ahead of ourselves on the Q1 stock repurchase activity, but we felt the stock at the time was undervalued and we thought it was a good use of cash.

Ken Denman

But the basic premise or the basic theme around the stock repurchase plan is – just to be very clear – is that the Board has been supportive of us continuing to buy stock back to the extent we generate operating cash flow. And as the management team we think that that’s a good use of cash at these levels, so we are obviously working very hard to generate operating cash flow, so that we have the opportunity to do exactly that.

Kevin Dede

So one of your comments with regard to the gross margin issue in the first quarter was significant 3G use in North America and the plan is to renegotiate some contracts there. I am wondering if you can give us an idea and a roadmap to add to the pool of contracts you have there and perhaps expand to alternative technologies such as the working with WiMAX providers – WiMAX-based service providers?

Ken Denman

You are spot on in terms of the opportunity there. More networks for us is very good news. So whether it’s the WiMAX networks that are beginning to show up or will be showing up or are forecasted to show up, with kind of Sprint and Clearwater in the US, there is a WiMAX network planned with Intel’s support and help in Sweden, there is WiMAX networks appearing in Australia and South America, so as well as the 700 megahertz spectrum that was recently allocated in auctions, to Verizon and AT&T I believe. So all of those additional networks are good news for us, because we plan to and expect to be purchasers and providers of that network access anthology to our customers. And our existing providers know that and they know that they’ll risk losing traffic to those networks and so we think that will provide appropriate pressure or constructive tension to get lower rates.

As it regards the situation that we had in North America with the larger mobile data carrier here, we literally saw an inflection point in our usage pattern. January was very similar to the usage pattern we saw in all of ‘07. And in February and March, we saw megabyte per user really jump. Now of course, our partners saw that as well and they know we are bringing increasing amount of blue chip traffic. So I think they are working with us extremely productively to get to the right deal. With this particular provider, we don’t have a cap. So it’s very important that we get the right deal. But again, the dialog is very constructive.

Having said that, I don’t think it’s lost on that provider, that a couple of other providers in the marketplace were lowering their retail prices. And we had that as an advantage. So there is a way to play this. And I don’t want to – well, we are mercenary with our providers – but there is a way to play this where, they get it, it’s in their interest and our interest, for us to have a good deal, for us to continue to point traffic at them. And your thought about other networks is spot on.

And the Gobi chipset is a – Gobi -- Qualcomm has the Gobi chipset on the boards. So, this is the product roadmap side of this. Intel has the Ultra Mobile PC initiative going and then, you’ve got your WiMAX players, which Intel is also aggressively behind. Those are things that are going to create more networks, more opportunities for us to buy from multiple providers and they know it. And these new lightly loaded networks are going to need users as soon as possible. This really all plays to our strength.

And again, if we can be and we believe we can be the connection manager – the software connection manager that sits in front off that this chipset, in the longer-term sits with mobile data cards in the nearer-term and points providers at – or point users at the right network. It’s a position of strength.

It’s early days; I think this is going to iterate much faster than WiFi did. So, that’s to our advantage, but it – it’s a little bit of a slog and we’re slightly delayed a quarter or so as we see the impacts and we go take that data in and renegotiate deals.

But I remain very, very optimistic about our positioning and our space, particularly because of the new networks and again what we – what I describe as a casual user phenomena in 3G should not be minimized. The marketplace is saying they really want the ability to sort of use whatever network they want to use, and not be tied to a particular network. That’s the constructive tension between the operators, the OEMs, and the chipset players, and we have a chance to play in that phenomena and I think that’s pretty huge.

Kevin Dede

Can you tie your negotiation strategy, the margin guidance that you’ve offered for the balance of the year, and give us some milestones that we could – I don’t know, maybe there is another player that you’re negotiating with, there is I mean specifically Sprint Clearwire won’t really be ready to help you this year. I am just hoping you can give us something tangible nearer-term so that when we look at the margin guidance that you’ve offered there is something we can hold on to?

Ken Denman

Well, Kevin, let me try to do exactly that. First of all, we are not talking to you today about things that we’re going to start doing. These are things that we’ve been working on in many cases now for a month and a half or more as we’ve sort of seen the trends, so we are very, very focused. The one example, specific example I’ll give you in the US is we have one provider who provide a cap basically, so we play at a set price and the usage or our cost is capped at a certain level, it’s unlimited if you will. We have another provider who is uncapped and their rates are lower.

Now, we can move users from one network to the other. If I don’t get the price that I need from the provider who typically has a lower usage price, but they are uncapped and if usage continues to go up, we will put together an incentive plan and move users over to the capped plan and these two providers know what we are doing. They understand the game and that’s an example of real-time dialog and real-time discussions that we have with providers where we sit down and say, “Look, here is how many users we are adding per month and per quarter, you have the opportunity to get those at the right price or we can move them over here.”

So that’s an example of things that we are doing right now. But the point that Frank raised earlier is that we have a major renegotiation right now with one of our providers, because the game is changed in terms of usage patterns. And we’ve shared our data pretty liberally and we’ve asked them to step up and – or the consequence is we are going to move a whole ton of users over to another provider, and we can just do the math on the business case. Even with the cost of the cards we can make it work, and the payback is relatively short. So those are the kinds of – I hope that gives you some of the detail you are looking for on sort of how we are managing these negotiations in real-time.

Kevin Dede

Certainly does help, Ken, thank you. Can you talk also about the business development activities on the software and service side? And how we could become more comfortable with seeing perhaps more growth there? And specifically, how you might be bundling service packages as you take on new Fortune 1000 customers?

Ken Denman

Well, yeah, I can, there is a couple of ways and actually on the one side it’s actually service provided to operators and network providers who for instance, want to use our FlexConnect Solution. Typically we can arm them with our solution, even if they want to white-label it, we are okay with that at a price. And typically the integration or sort of how we position them to be able to use our capability, our software. There is a lot of service that we can wrap around that, professional services. And there is also software that we can bundle such as our device management tool and enable them to take the device management capability to market. We have an Asian carrier for instance who has basically built a managed service out of our device management solution and is going to market with that.

On the enterprise side, there are a number of customers who have, for whatever reason they have their own sort of card, mobile data card, and just one example, they have got a mobile data card that they love more than other mobile data cards. And we are sort of saying, if we have mobile data in that country then you got to buy from us, otherwise, we are not going to make it work – that mobile data card work with our client, for free. If you really want that card and you don’t want to buy it from us, there is a software charge for integrating that card.

Now, frankly, I would rather sell the mobile data card service and have that relationship. But at the end of the day, I will take the software integration fee. So – and by the way, finally handhelds are another opportunity. Smartphones, Windows Mobile, Symbian and even RIM down the road, we’re having good discussions there. So, my point is that integration of Smartphones because there is a symbiotic relationship developing between how people use Smartphones and how they use their laptop, notebooks and PDA and we are finding that we can garner software fees in helping people integrate Smartphones and handhelds into their sort of current iPass fabric.

Kevin Dede

Can you give us an update on the satellite service that you began to resell and what sort of progress you are making there, maybe the subscriber growth you have seen?

Kenneth Denman

Well, we have been – that’s been a slower developing thought primarily because we got tied up with the FCC process for approval to offer the service for a number of months, and only recently, very recently received the sort of preliminary authority to actually offer the service. So in that regard we did suffer somewhat in that we had pent up demand from customers and we literally could not get approval to go forward. We recently got that approval. So now, we are in the process of rebuilding the pipeline and getting started again. But again, it is only within the last month or month and a half that we received approval to restart the – or to be able to provide the service. So we are off and running again.

Kevin Dede

On the theme of alternative technologies, have you struck any reselling deals with other WiMAX spaceservice providers anywhere in the world?

Kenneth Denman

Not WiMAX, we – certainly municipal WiFi, but they’re really – I will say this. We are engaged with the WiMAX players around the world. We recently signed a deal with one of the new players in the aircraft Wi-Fi space. There is a couple of players that are launching since Connexion went down, Boeing’s Connexion solution went down. There is a couple of players that are launching, and we have signed deals with a couple of folks, and will be announcing those soon. But the WiMAX, we are part of the WiMAX forum, so technically we are working on integrations right now and commercially from a business development standpoint we are talking to all the players including that one that you mentioned earlier, and have been by the way. That is not new discussions, we are right in the middle of it.

Kevin Dede

Can you give us a ballpark on card volumes versus the fourth quarter?

Frank Verdecanna

Yeah, in the second quarter we did almost 2000 Kevin and the good news is, already in the second quarter we are approaching that number. So, the 2000 has been kind of the run rate for the Q4 and Q1, but I think we are hitting an acceleration there and we expect that to continue throughout the year.

Kenneth Denman

Now, and we really need to. We are not happy with the level of success that we’ve had there and we think we have studied very hard, the aspects of the value chain, the aspects of packaging, promotion, and really also very importantly in certain parts of world our ability to be able to offer through partners which I think was really a major road block for us in Europe.

We’re channel-based in Europe and we weren’t really – our success in the US has been largely on a direct model in this space although we are starting to have some more success with channel partners in the US around mobile data cards specifically. But we needed a more channel-facing offering in Europe and I think we have just – frankly, well we’ve just put the finishing touches on that with the deal with our major channel partner in Europe. So, I expect the back half of the year we are going to have a lot more success than we had in the front half of the year particularly in Europe, and if we do by definition those numbers are going to grow.

Kevin Dede

Last question for me, can you just give us – I mean you touched on the Smartphone client, the Symbian one. I was wondering if you just give us an indication -- I know they’ve been available for a while, just can you give us an indication on their price acceptance and adoption of those clients?

Kenneth Denman

Well, as you might imagine, the enterprise acceptance of the Symbian client has been phenomenal at Nokia. They – so we’ve had really good adoption there. And frankly we are working more closely with Nokia to make it a broader, a more broader-appealing client so we are already working with Nokia on the next generation of that Symbian client which we will have out in the second part of the year. So I have a lot of high hopes there. We are seeing usage, but we really need to drive that harder and faster.

I am absolutely stoked over our Windows Mobile 6 client. We are just going GA on our new Windows Mobile 6 client and I have to tell you, it screams. It’s very, very fast. The auto connect capability is powerful. It literally looks out, grabs a network, connects very quickly. Our sales team is so excited to be taking this into customers. So anything that’s Windows Mobile 6, some of the HTC handhelds, some of the Trios, and other devices, T-Mobile Dash. Any device that’s Windows Mobile 6-oriented, we have a client that’s going to scream.

And frankly we will be adding that to our consumer offering, to our individual business traveler offering on iPassConnect. That’s the next offering that’s going to hit that service, but we are also now packaging and pushing it into the enterprise space. So I am optimistic about that one. So the numbers are small at this point but I would say the growth rates are high as is typical in early phases of introduction.

Kevin Dede

Frank, you quantified the currency impact in gross margin, I just missed it.

Frank Verdecanna

It was one of the four drivers, so that’s probably about a half a percent.

Kevin Dede

Okay, thank you very much. Thanks gentlemen.

Frank Verdecanna

Thank you.

Kenneth Denman

Thank you, Kevin.

Ken Denman - Chairman and Chief Executive Officer

And thanks to all of you for joining us today. We remain very optimistic about the business for a number of reasons. We continue to experience strong customer acquisition, we’ve stayed at the hit rate of $20 million in bookings despite significantly reduced sales and marketing expense. We are still growing revenues despite dial erosion of $2 million in the quarter in a soft economy. Our pipelines remain solid and we’re still the best in the world at what we do.

We expect to continue our trends in bookings, but frankly, I am hoping for a breakout to the next level. I would like to get and I am pushing our team to get to that $25 million level and above and that’s something that we need to get done. The major trends give us an opportunity to play and even a more important role in unified mobility going forward, again this consumerization of IT, unified communication and all the things that are going on with the chipsets and new networks that are coming into the mix. This is all very good news for iPass.

That said, let me reiterate my comment in my opening remarks. We recognize that gross margins are very, very important to shareholder value, and we are intensely focused on the steps that we can take to improve our gross margins. So thanks again for your attention and your questions and have a good evening.

Operator

Thank you for your participation on today’s conference. This concludes the presentation. You may now disconnect, everyone have a great day.

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