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Openwave Systems Inc. (OPWV)

Q3 2006 Earnings Conference Call

April 27th 2006, 5:00 PM.

Executives:

Michael Bishop, Director of Investor Relations

Harold Covert, Executive Vice President, Chief Financial Officer

David Peterschmidt, President and Chief Executive Officer

Analysts:

Erik Zamkoff, Morgan Joseph & Co, Inc.

Thomas Roderick, Thomas Weisel Partners

Michael Abramsky, RBC Capital Markets

Jeffrey Kvaal, Lehman Brothers Financial

Sterling Audi, JP Morgan

Justin Boyd, Deutsche Bank

Scott Sutherland, Wedbush Morgan Securities

Tal Liani, Merrill Lynch

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Operator

Good afternoon, and welcome to the Openwave Third 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 Director of Investor Relations, Michael Bishop. Please go ahead, sir.

Michael Bishop, Director of Investor Relations

Thanks. Good afternoon everyone. And thank you for joining us today to discuss the results of Openwave Systems third quarter of fiscal 2006. I’m Mike Bishop, Director of Investor Relations for Openwave. Joining me today from Redwood City is David Peterschmidt, our President and Chief Executive Officer, and Hal Covert, our Chief Financial Officer.

Before we discuss our results for the quarter, I want to remind everyone that we’re operating under the rules of Regulation FD. Our third quarter earnings release was distributed at the close of the NASDAQ stock market, and if you’ve not seen a copy you can find one at our web site at http://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 have also posted a metric sheet at our website which is also available for your review.

Before we begin, I’d like to remind you that any remarks that may be made on this call or in the 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 the specific risk factors discussed in the company’s press release that was distributed today at the close of market and in the company’s filings with the SEC, including but not limited to Openwave Systems, Inc. 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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David Peterschmidt, President, Chief Executive Officer

Good afternoon, and thank you for joining us. Today, I’ll briefly cover our financial results, our business wins, customer successes in the last quarter. Hal will provide a more detailed view of the financial results, and we will then take your questions.

Before I run through the specifics of the last quarter, I want to provide a brief report as we continue to find Openwave’s position in the fast growing mobile data services market. When I came to this company, we outlined 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.

We have successfully completed the first phase of this transition. Over the past year, we have continued to demonstrate momentum and growth while focusing on internal alignment and resource prioritization, ensuring we have a sound financial base from which to take the company forward. Openwave now has the management team, organizational structure, and operational processes in place to focus on delivering high value solutions and services to our customers, enabling them to realize the potential of the mobile data market.

As we enter the second phase of our transition, you will see us executing long-term strategic partnerships with key customers around the world as our focus shifts to delivering the end-to-end technologies, solutions and services designed to drive value in this very dynamic market.

Now, on to the results. We continued to execute on our operating plan. Our financial results are in line with the outlook we provided in January. Both Openwave and Musiwave performed well this quarter, and our revenue was $113 million, the highest it’s been since 2001.

Our pro forma EPS increased to $0.21 from $0.07 a year ago, an increase of 200%. We achieved bookings of 125.3 million, resulting in a bookings level of 1.1 to 1, and this number did not include any new large systems deals.

Overall, the company’s results reflect a strong performance. We are pleased, particularly, as we have delivered this during a period of internal focus for the company.

Let me now describe some of the more important deals signed during the quarter. You will see that these deals clearly reflect our success in developing long-term relationships with major industry players. As more consumers are using their mobile phones to access mobile content and services, we are working with carriers to help them increase overall access, as well as to provide a more compelling user experience.

Building on our strengths with the Openwave Mobile Access Gateway, last quarter Openwave and Cingular reached a multi-year commercial agreement for the Openwave Mobile Access Gateway Version 6. This agreement will involve both companies working together to deliver our reliable and scaleable data infrastructure for the growing mobile data traffic, including browsing, MMS, and downloads. We hope to grow our relationship with Cingular as a strategic vendor for enabling access to their content and services.

Building upon the success of our Mobile Access Gateway expertise and market leadership we’ve extended our product line in this arena to include a suite of products we call ‘Mobile Edge’. Mobile Edge is designed to help operators increase their portal value and enable revenue generating off net content, an increasingly significant market opportunity as nontraditional portal players enter the mobile internet space.

As part of our commitment to help operators build subscriber value and better tailor services to meet different consumer segments, we announced an agreement with Business Objects to identify joint development opportunities around real-time business intelligence solutions.

These solutions will be designed to enable network operators to better analyze, understand, and capitalize on mobile device subscriber behavior. We view subscriber intelligence as a key tool to enable operators to launch micro segmented and individual services for their consumers as a point of differentiation for their business.

Mobile operators have access to a wealth of subscriber information that when leveraged responsibly and strategically can be an invaluable asset in strengthening their subscriber relationships and enable them to deliver highly personalized valuable information and services.

The strength of Openwave’s relationship with operators around the world and our expertise in mobile content, development and delivery, coupled with Business Object’s deep expertise and business intelligence presents a powerful opportunity for mobile operators to grow their revenue.

Our messaging line of business continues to pave the way for our broadband, wireline, and wireless customers to come together and capitalize on digital convergence. In the quarter, we secured a deal with Comcast to support the delivery of their quadruple play, video, voice, data, and mobile services across networks. At the outset, we are providing Openwave voicemail, and have also signed a larger strategic agreement to provide Comcast with Openwave’s next generation, IP based messaging platform for the delivery of converge messaging services.

We also signed an agreement last quarter with BridgePort Networks, the leader in mobile Voice-over IP convergence, to foster a combined intellectual property portfolio that represents landmark innovations in the broad field of fixed mobile convergence applications. The agreement extends an original Openwave patent license with BridgePort Networks and fosters a combined intellectual property portfolio.

As operators continue to invest in IP multimedia subsystem, or IMS networks, and underlying infrastructure, Openwave is providing core service enablers and applications that help operators start deploying IMS services immediately on today’s network, and integrate them with established non-IMS services, like browsing, location, and messaging. The collaboration with BridgePort Networks helps bring our support for IMS to the next level, expanding our messaging capabilities to support seamless roaming between fixed and mobile networks.

On the handset side of our business, this quarter we saw growth in our core handset technologies and continued uptake of our V7 Framework, browser, and messaging clients, as well as strong traction with MIDAS or the Openwave Mobile Integrated Dynamic Application System.

We are delighted to announce our relationship with O2 today. Our relationship with O2 will enable them to deliver a mobile messaging experience based on our adapted messaging platform and MIDAS software that is dramatic, simpler than the fragmented and often complex consumer experiences offered today.

Also this quarter, Motorola purchased a two-year unlimited use site license for the complete V7 phone suite of Openwave handset technologies, including instant messaging, MMS, EMS clients, and the industry leading Mercury Edition of the Openwave browser. Openwave’s next generation Mercury browser enables a richer user experience by expanding access to full web content and improving browser performance on mobile devices.

As you will remember, we also announced that Sagem Communication’s licensed the V7 phone suite for integration into its newest handset, the MYW7. The Sagem MYW7 mobile phone is the first Sagem 3G phone to feature V7, and builds upon the successful launch of multiple 2 and 2.5G handsets with V7. The V7 phone suite is a one-stop solution for meeting operator requirements for dynamic content management, browsing, and integrated messaging, including multimedia messaging, e-mail, and instant messaging.

In addition, we announced that we will work with KT Freetel, Korea’s second largest mobile phone operator, to jointly develop KUN3.0, a next generation browser based on our V7 Mobile Browser. We’re also leveraging key partnerships to broaden our handset capabilities, offering Sonim's Push-to-Talk Client, and an agreement with Pulse Mobile to integrate the Avatar Technologies on to the V7 Framework.

We continue to gain momentum with Musiwave globally. TELUS, Canada’s leading telecommunications operator, launched their music service with Musiwave’s full track music technology. This marks Musiwave’s entrance into North American mobile music download market, and we look forward to aggressively driving momentum in 2006.

Musiwave continues to gain traction with its new service offerings, including smart radio, which allows mobile consumers to access customized and streamed music processing, programming, based on each user’s personal taste. Smart Radio is currently in trials with French operator Orange, and is now available on mass market Java handsets from Motorola in addition to Symbian smart phones.

In the MVNO space, we are delighted to be working with InPhonic and Nportal to support the upcoming launch of the family oriented Disney mobile wireless service, providing a variety of rich media messaging and advanced browsing technologies, specifically catered to the needs of the unique MVNO market. We have also extended our MVNO expertise to the Asia-Pacific market and launched a specialized business unit to help companies bring personalize mobile services to the region.

On the last earnings call, we outlined three milestones we expected 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 this quarter.

First, we committed to secure an additional silicon design win with a current or new silicon player. This quarter, we entered into an agreement with a leading OEM platform supplier for GSM, GPRS, EDGE, and WCDMA platforms to pre-integrate the Openwave phone suite, V7, including the Openwave Mobile Browser, Mercury Edition, and Openwave messaging clients into their platform. We look forward to announcing further details of this strategic win in the coming months.

Second, based on the MIDAS technology, we planned to launch our first integrated end-to-end service with MIDAS and Musiwave. The integration has now taken place in three services: Music OnDemand, music wizard, and smart radio will be commercially available in May.

Third, we committed to securing a major messaging consolidation deal which we achieved by securing a strategic agreement to provide Comcast with Openwave’s next generation IP based messaging platform for the delivery of converge messaging services.

I’m obviously proud of the milestones that Openwave has achieved, not only on the business side but on the financial side as well, as we continue to develop and strengthen our leadership position in the communications software industry.

For this, our fourth financial quarter, let me give you three milestones we plan to achieve. First, secure a major systems deal, as we continue to drive long-term strategic engagements with our customers. Second, as we continue to witness strong momentum in the messaging space, win another major consolidation deal, furthering our leadership in the carrier class IP messaging field. And third, as our customers continue to focus on the rapid launch of simplified and value services to the consumer, additional MIDAS and V7 design wins.

I’m pleased to be able to share with you today a strong quarter’s results. I look forward to taking the company forward into the next phase of our transition, as we focus on driving long-term strategic relationships with key customers around the world.

We will be hosting our Annual Analysts Day in New York in July, closer to the beginning of our fiscal year, and I look forward to sharing our vision for 2007 with many of you in person at that time. With that, let me turn it over to Hal.

Harold Covert, Executive Vice President and Chief Financial Officer

Thanks, Dave. Good afternoon. As you may know, in the past 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.

Starting with our earnings call last quarter, we began discussing our financial results on a fiscal year basis. Going forward, unless indicated, we will refer to fiscal year financial results. I would also like to note that we have completed the process to shift our internal planning process to match our fiscal year.

Now, I would like to provide an overview of our financial results for fiscal Q3 ’06. Unless otherwise indicated, all results are a non-GAAP pro forma basis.

Revenue for fiscal Q3 ’06 was 113 million, which compares to 104.5 million for fiscal Q2 ’06 and 106.3 million for fiscal Q3 ’05. This represents a sequential increase of 8.2% in a year-over-year increase of 6.4%.

Musiwave generated 8.2 million of revenue for the quarter, starting from January 13, 2006, the date that the acquisition closed. For fiscal Q3 ’06, we did not have a meaningful level of large systems revenue compared to approximately 2 million in fiscal Q2 ’06 and 13 million in fiscal Q3 ’05.

During fiscal Q3 ’06 we had three customers that represented more than 10% of our total revenue on an individual basis: Sprint Nextel 16%, Cingular 14%, and Motorola 13%.

During the quarter, we completed multi-year license and maintenance and support arrangements with Motorola and Cingular. Revenue related to licenses for these arrangements was recognized in full during fiscal Q3 ’06 while the revenue for maintenance and support will be recognized ratably over the contract periods. These transactions position Openwave’s technology to be utilized well into the future.

As a result of the Motorola and Cingular transactions, our license revenue for the quarter, which was 51.4% of total revenue was above the high end of our target range of 45% to 50% of total revenue.

From a region standpoint, we have strong revenue generation in the Americas and a drop-off in revenue in EMEA. For the quarter, the Americas represented 59% of total revenue, EMEA 18% including Musiwave and Asia 23%. The issue in EMEA relates to the volume of our sales pipeline as opposed to any underlying changes or our position in the marketplace.

To effectively address our EMEA sales pipeline in a timely manner, we have made a number of key changes to the EMEA management team, including hiring a new general manager. Going forward, as the new EMEA management team gains momentum over the next several quarters we believe that EMEA will represent approximately 25 to 30% of our total revenue, including Musiwave. This profile is in line with historical patterns, taking Musiwave into consideration.

Gross margin for fiscal Q3 ’06 was 71.4% versus 72.4% for fiscal Q2 ’06, and 69.1% for fiscal Q3 ’05. Not including Musiwave our gross margin for fiscal Q3 ’06 was 73.5%.

Our gross margin for fiscal Q3 ’06 was favorably impacted by license revenue, somewhat offset by services gross margin, due to services revenue. For the quarter, we did not have a meaningful large systems revenue stream, and the revenue drop-off in EMEA was a factor. Going forward, our services gross margin should return to the targeted range as revenue increases.

Operating expenses for fiscal Q3 ’06 were 62.2 million, compared to 57.4 million in fiscal Q2 ’06, and 63.7 million in fiscal Q3 ’05. The $4.8 million increase in operating expenses for fiscal Q3 ’06 when compared to fiscal Q2 ’06 is the result of incurring an approximately $4 million of operating expenses related to Musiwave for the quarter.

Headcount as of March 31st ’06 was 1,438, including 180 from Musiwave, compared to 1,257 as of December 31st, ’05, and 1,359 as of March 31st, ’05.

Operating profit for fiscal Q3 ’06 was 18.5 million or 16.4% of revenue versus 18.3 million or 17.5% for fiscal Q2 ’06, and 9.7 million or 9.1% for fiscal Q3 ’05. Not including Musiwave fiscal Q3 ’06 operating profit as a percent of revenue was 18%.

Pro forma net income for fiscal Q3 ’06 was 21.8 million or $0.21 earnings per share. For fiscal Q2 ’06, 19.3 million or $0.22 earnings per share. And for fiscal Q3 ’05 5.3 million or $0.07 earnings per share. The GAAP net income for fiscal Q3 ’06 was 9.6 million or $0.10 earnings per share. For fiscal Q2 ’06, 8.4 million or $0.11 earnings per share, and for fiscal Q3 ’05 our GAAP net loss was 2.6 million or $0.04 per share.

GAAP net income for fiscal Q3 and fiscal Q2 ’06 included a gain of 3.8 million and 3.3 million respectively, from the sale of non-operating assets. Our GAAP net loss for fiscal Q3 ’05 included a $4.5 million restructuring charge primarily related to facilities.

Stock based compensation, which is not included in our pro forma net income, was 10.7 million in fiscal Q3 ’06 compared to 11.3 million in fiscal Q2 ’06 and 1 million in fiscal Q3 ’05. The increase in stock based compensation on a year-over-year basis is due to new rules for expensing stock options that we implemented starting with Q1 fiscal ’06.

Pro forma fully diluted shares outstanding for fiscal Q3 ’06 were 103.2 million. For fiscal Q2 ’06 87.6 million. For fiscal Q3 ’05 71.2 million.

The following is a reconciliation of our pro forma fully diluted shares outstanding for the quarter: 74 million as of December 31st, ’05 not including shares related to our secondary equity offering and convertible debt, 18 million as a result of our secondary equity offering, 8 million as a result of assumed debt conversion, and 3 million for our employee stock programs.

Diluted shares outstanding for fiscal Q3 ’06 were 95 million. For fiscal Q2 ’06, 79.4 million and for fiscal Q3 ’05 67.1 million.

The increase in shares outstanding for fiscal Q3 ’06 reduced our non-GAAP earnings per share for the quarter by $0.04 or from $0.25 to $0.21. This compares to $0.22 non-GAAP earnings per share for fiscal Q2 ’06.

Bookings for fiscal Q3 ’06 were 125.3 million, which represents a book-to-bill ratio of 1.11 to 1. Backlog as of March 31st ’06 was 230.7 million versus 218.4 million as of December 31st ’05 and 166.4 million as of March 31st, ’05.

Deferred revenue as of March 31st, ’06 was 48.1 million compared to 53.4 million on December 31st ’05, and 57.8 million on March 31st, ’05. As we’ve pointed out during our last earnings call, 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 a pay-as-you grow 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 March 31st ’06 were 501.6 million, compared to 594 million as of December 31st, ’05, and 274.5 million as of March 31st, ’05.

A reconciliation of cash activities for the quarter is as follows: We started the quarter with 594 million, we paid 113.9 million for Musiwave net of cash and investments acquired, and generated 20.6 million from operations and other activities. The 20.6 million includes 3.8 million from the sale of a non-operating asset, 19.8 million from stock options, 4.5 million used for restructuring payments, and 4.1 million generated from operations.

Capital expenditures for fiscal Q3 ’06 were 2.2 million compared to 2.7 million for fiscal Q2 ’06 and 3 million for fiscal Q3 ’05.

Now, I would like to provide an update for our accounts receivable. First, billed accounts receivable, which includes payments due from customers for which we have recognized revenue and in some cases have not recognized revenue. Billed accounts receivable as of March 31st, ’06 were 91.3 million including 9.6 million for Musiwave, and represents 73 days of sales outstanding. This compares to 95 days of sales outstanding on December 31st, ‘05 and 74 days of sales outstanding on March 31st, ’05.

The 73 days DSO for the quarter reflects a reduction of 22 days when compared to fiscal Q2 ’06. Our goal for billed accounts receivable Days 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 March 31st, ’06 were 66.2 million and represent 53 days of sales outstanding. This compares to 25 days of sales outstanding on December 31st, ’05 and 24 days of sales outstanding on March 31st, ’05.

During our last call we stated that our goal for unbilled accounts receivable days outstanding was 10 to 15 days. Since we established that goal, we made a business decision to offer selected customers installment payments that must be paid within a one-year period if a customer enters into a multi-year arrangement for Openwave’s technology. Customers that we offer installment payments to must be of strategic importance and have a strong financial position.

During the quarter, we entered into this type of arrangement with Motorola and Cingular. These transactions are the primary reason for the increase in unbilled DSO. Payment due dates for these arrangements are driven by a specified date as opposed to fulfilling contractual requirements, like volume levels or other deliverables.

From Openwave’s viewpoint we are using our working capital to enhance deployment of our technology with strategic customers that have a strong financial position. Given that we expect to continue to offer installment payments on a selected basis our goal for unbilled accounts receivable DSO is 40 to 50 days.

In total, our DSO for fiscal Q3 ’06 was 125 days compared to 120 days for fiscal Q2 ’06 and 98 days for fiscal Q3 ’05. Going forward over the next four quarters our goal for total DSO is 110 to 130 days.

In summary, I would like to make two points regarding accounts receivable. First, billed accounts receivable or DSO is a reflection of our execution effectiveness, i.e., do we produce accurate invoices in a timely manner and collect from customers in a reasonable timeframe.

As indicated during fiscal Q3 ’06 we reduced our billed DSO by 22 days, and we are approaching our target range of 70 to 80 days which we expect to achieve within the next two quarters.

Second, unbilled accounts receivable DSO is tied to business decisions to offer installment payment terms or payment terms based on specified contractual milestones. We only offer these types of arrangements to customers that are of strategic importance and have a strong financial position.

In effect, we are using the strength of our balance sheet as leverage in the marketplace; therefore, the level of our unbilled DSO should be evaluated in the context of our overall financial performance.

This completes the summary of our fiscal Q3 ’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 related to our projected financial performance targets. Before I do that, I want to reiterate a key element of our standard disclosure regarding future financial targets. Approximately 30% to 40% of our quarterly revenue typically occurs in the last month of the 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 do 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, so we will be providing our 2007 financial goals during our July 2006 earnings call.

However, I would like to make the following point. Our goal is to achieve our revenue and operating profit targets in a progressive sequential manner. We are on a continuous improvement track to achieve this goal as we prepare to enter fiscal 2007. However, keep in mind that we are subject to lumpiness in our business as it relates to large deals. Now, we will open the call for questions. Operator, please take the first question.

Question-and-Answer Session

Operator

We’ll go first to Erik Zamkoff with Morgan Joseph.

Q - Erik Zamkoff

Hi, good afternoon gentlemen. Nice quarter.

A - David Peterschmidt

Thank you.

Q - Erik Zamkoff

I was wondering if you could provide a little more detail into your viewpoint of how you can help a carrier monetize off portal browsing? Because that seems to be an issue. There was, you know, a lot of press on that at CTIA, and I want to understand how you fit into the equation in order to potentially prevent a carrier, someone like a Google, from coming in and turning the carrier into a dump pipe.

A - David Peterschmidt

Well, it’s a good question, Erik, as one of the big ones on the agenda. One of the things that I mentioned in my part is, with some of the new mobile edge suite, what we’re able to do with the off net browsing is, the problem has been is for the carrier, we can’t stop the carrier from making the decision if they want to do something with a portal. I mean that’s up to them to decide if in fact, they really do want to be a commodity transport rather than be a value add service capability. But where there is a blend of both going on, what we’re able to do with mobile edge now is track where that user goes when they go off net. And the importance of that is that’s about the profiling of the user so that you can present a much more personal type of target marketing to that user and this is becoming really important to the carriers as to how they monetize that subscriber, and if they lose sight of that subscriber when they go off net, they lose a major piece of information. And what we’re able to do now with mobile edge is track the subscriber when they go off net for them, and show what happens, so that’s the piece of the equation that we’re involved with.

Q - Erik Zamkoff

Excellent, thank you.

A - David Peterschmidt

Next question, please?

Operator

We’ll go next to Tom Roderick with Thomas Weisel Partners.

Q - Thomas Roderick

Hi, guys. Good afternoon.

A - David Peterschmidt

Hey, Tom.

Q - Thomas Roderick

So, there was once a time, I guess, when Openwave broke apart its messaging, its client, and its infrastructure business, and now we’re seeing more deals where you’re integrating multiple products, particularly on the messaging front. What’s driving some of that from a customer standpoint? Are you seeing this trend of IMS pushing a lot of consolidation of purchases for these multiple technologies? And then how much synergy can you achieve from the installed base of your gateway platform that’s really been a strong driver for many years in terms of turning customers on to newer technologies, as you’ve done over the past few quarters here?

A - David Peterschmidt

Yes, so, Tom, there’s no doubt that we’re seeing a much higher demand about integrated messaging platform. It’s -- the whole convergence is driving the need that the platform has got to be integrated between, you know, whether it’s voicemail, e-mail, video mail, that that’s got to be a much tighter integration. In fact, the other thing that’s happening with MIDAS now, since that’s a dynamic user defined environment is we’re truly getting the end-to-end effect and request for that to be tied together. That’s what the O2 announcement is all about, is that they’re using MIDAS and the integrated messaging. In fact, we’re going to do some unique design work together, and O2, as you know, has been acquired by Telefonica, and they think the ability to monetize traffic on the integrated platforms is going to be very large. So, that’s a big part of what’s happening right now. Let me go to the second half of your equation. As you know, Marc Levante has joined us as our Chief Technology Officer, coming out of the CTO Office at Vodafone. And Mark is absolutely convinced that the installed base of Mag gateways that we have out there are going to be able to have natural extensions to them, that we’re looking at right now, that will enhance even more traffic in the future with these new services going through those gateways. And this is something that we’ll talk about probably later on when we get to the Annual Analysts Day, but it’s something that Mark is spending quite a bit of time on right now.

Q - Thomas Roderick

Great. And let me, if you wouldn’t mind, let me just make a quick follow-up question here for Hal. Great job on the bookings this quarter, really nicely up sequentially there. It seems like you would have plenty of visibility into the forward business with that big a bookings number. Perhaps I missed it, but and if I did maybe you could repeat it, but if I didn’t can you give us a sense of how we should think about guidance for this upcoming quarter?

A - Harold Covert

Yes, I think on the call I mentioned that we have the sequential momentum, both from a top line and a bottom line standpoint. But you have to keep in mind that we have lumpiness in our business. And I think Dave mentioned early in the call that our goal is to sign a large systems deal this quarter, so and then we also indicated that we’d give more full guidance during our Analysts Day in the July timeframe.

Q - Thomas Roderick

Okay. So, just in terms of what folks can maybe think about being the delta between normal course of business and what systems deal might contribute this quarter, any further detail you can offer there?

A - Harold Covert

No, I think I’ve filled in as much as I can at this point.

A - David Peterschmidt

Nice try, Tom.

Q - Thomas Roderick

Do my best. Thanks, guys.

Operator

We’ll go next to Michael Abramsky with RBC Capital Markets.

Q - Michael Abramsky

Yes, thank you very much. Just a question on Motorola, was this a onetime payment? It’s kind of broken up? And, you know, because of the strength of Razor, do you see sustainability in Motorola’s business or do you think, you know, this is, you know, we’ll see a large part of this now but maybe a little bit less later on?

A - Harold Covert

Yes, I think there’s two or three points. Number one is that, this was for a transaction that’s a multi-year, as I mentioned. A big chunk of the license revenue will be paid within the 12-month period that I mentioned. The maintenance and support that’s related to that goes over multi-years. But the more important factor here is that we’ve locked in our technology for the next couple of years, we believe, and also have given us a platform to really move forward along the track of these large systems deals that we’ve talked about in the past. So, that’s the key, we believe, again, locked in our technology and positioned ourselves for future growth.

A - David Peterschmidt

Hey, Mike, this is Dave. I think, you know, in case, I wasn’t clear enough on my part of the speech, this is pretty significant, because this is V7 but also the Mercury browser, which we just announced, and it really – and if you think about the momentum that Motorola has got in the handset business, this is a huge endorsement of our stuff, not just V7 but also the new Mercury browser which just came out. So, we’re pretty excited about what this represents for us going forward.

Q - Michael Abramsky

That’s good. And so I’m just trying to get a little bit granular on the license, though like did you book most of that, I sort of figure it’s about 7 million of license, did it come into this quarter?

A - Harold Covert

Yes, as I indicated in my script, the license piece of both the Motorola and the Cingular deals did come into this quarter

Q - Michael Abramsky

Okay.

A - Harold Covert

That’s why our license revenue as a percent of total revenue was high. But, again, as Dave indicated and I think have pointed out earlier on, this is really a platform now that we can leverage for future growth.

Q - Michael Abramsky

Okay. Your EBIT margins were a little bit lower than expected, it looks like on higher R&D, and you had originally talked for guidance of 2 million to 3 million OpEx, but it went up by 5. Could you talk about what’s different for you? It sounds like, you know, you had higher costs related to Musiwave? And what the trend might be going forward?

A - Harold Covert

Yes, just to clarify one thing, overall our EPS as we indicated earlier, was $0.21 which was above the high end of our guidance. Our operating profit was 16.4% which was in line with our expectations. The 2 million to 3 million that you indicated was really related to core Openwave not including Musiwave expenses, because we had not disclosed Musiwave expenses when we talked about that on the last call. So, our operating expenses went up by 4.8 million of which Musiwave was 4 million, so we actually didn’t go up quite as high on that 2 million to 3 million that we had talked about earlier on. So, we’re actually a little bit ahead of what we had planned on, not only from an EPS standpoint but also from an operating profit standpoint.

Q - Michael Abramsky

Thanks. And what were those expenses related to Musiwave? If you could just give an idea of what’s involved, and what the costs, types of costs are?

A - Harold Covert

Oh, sure. It’s the normal selling and marketing and R&D expenses that relate to the revenue that we generated.

Q - Michael Abramsky

So, this OpEx trend, you know, now that you are, know that Musiwave is part of that, is that more like your kind of margin trend going forward?

A - Harold Covert

No, I think – a couple of points. Yes, going forward, as we did this quarter we will break Musiwave out from a revenue and gross margin standpoint. We won’t be from an operating expense standpoint, but as we indicated last quarter, we said that Musiwave would create a little bit of pressure on our operating profit this quarter, which it did in line with our expectations. Now, going forward into the next quarters, as Musiwave’s momentum picks up and as we pick up, then our operating profit targets are, we believe, going to be in line with the 20% that we’ve talked about in the past. So, we’re on track to achieve the goals that we outlined earlier on in our previous guidance.

Q - Michael Abramsky

That’s excellent. And then just a last question, you have been talking about the large systems deal for I think two quarters now. What are sort of the major things that need to happen for you to kind of catalyze that deal, you know, how are things going, and perhaps why is it taking a little bit longer than maybe you might have expected?

A - David Peterschmidt

Yes, Mike, we’re actually right on schedule that we projected two quarters ago. We said it would be the fourth quarter, fiscal fourth quarter of ’06, before those types of deals started to take place because they have about a nine-month gestation period.

Q - Michael Abramsky

Okay.

A - David Peterschmidt

And we started selling those deals again about nine months ago.

Q - Michael Abramsky

Okay.

A - David Peterschmidt

And the only thing left to do is just the normal thing. We’ve done all the work with the prospects where we have those deals out there, and our belief is that there’s probably four or five weeks of work left on a couple of those deals.

Q - Michael Abramsky

Okay.

A - David Peterschmidt

And it’s more just the finalization of negotiations, it’s not a – there’s no further definition, there’s no further scoping, it’s just now what happens when you get to the negotiation period.

Q - Michael Abramsky

Thank you very much.

A - David Peterschmidt

You bet.

Operator

We’ll take our next question from Jeff Kvaal with Lehman Brothers Financial.

Q - Jeffrey Kvaal

Thanks very much. Hal, I’m wondering if we are sort of thinking about the moving parts in your revenues, sort of until your Analysts Day, should we think about organic growth in the underlying business plus some growth in Musiwave, and then sort of an ambiguous amount of systems deal? Is that the right way to think of it?

A - Harold Covert

Yes, I think it is. And I think one of the things that we’ve been talking about, and we will probably take some additional steps on is to try to define our revenue streams more clearly at our Analysts Day. Because I think as the elements get more complicated it’s just not simple, it’s not enough just to provide license, maintenance and support and our services. So, we’ll think about how we can provide more information, but the track you’re on I believe is right. We have systems deals, we have content deals, we have a lot of activity going on now as we increase the breadth of our product offering.

Q - Jeffrey Kvaal

Should we think about the Motorola and Cingular deals as being steady from quarter-to-quarter, or just recognize every quarter at a flat rate?

A - Harold Covert

No, I think this will be typically, typical of our other large customers, where we sign these deals and then as we do add-on business, growth takes off, and more traffic, and things of that nature, then you’ll see the revenues increase very similar to past patterns.

Q - Jeffrey Kvaal

Okay, the Motorola it would be tied to unit shipment?

A - Harold Covert

You know, again, all these licenses are different, so we don’t really get into a lot of detail about that, but as you know, we sign license deals and then volume and activity levels picks up, we saw new applications and services, and we have a continuous revenue stream from these large customers.

Q - Jeffrey Kvaal

Okay.

A - David Peterschmidt

Hey, Jeff. This is Dave. The way that I think, and by the way you bring up a good point, we need to help you at the Analysts Day on this, we’ll spend some more doing this. But you probably remember, you know, we pointed out that, obviously, Sprint, everyone – Sprint Nextel everybody knew has been a big, long-growing customer, and in August we showed you a profile of how we built-up from, you know, 10 million a year to 100 million a year. And that we were very optimistic that we now know how to do that for other accounts. And I think the way to look at Cingular and the Motorola is that that’s tracking down that strategy that we laid-out for you, that you’ll start to see us sign some deals and that they will track towards growing those to be annual year-on-year growth revenue accounts.

Q - Jeffrey Kvaal

Okay, all right.

A - David Peterschmidt

And we’ll come back and revisit that profile with you to help you start projecting out when you see these.

Q - Jeffrey Kvaal

Okay, so quarter-to-quarter some lumpiness, but annual growth is the way to think of it?

A - David Peterschmidt

That’s right. We’re looking at the big accounts, obviously, like a Cingular and Motorola, just like we have done with Sprint that says ‘annually we expect those to grow’ and that there’s a profile of that type of growth and how to project it, and that’s the way I think you should think about these particular two accounts.

Q - Jeffrey Kvaal

Okay.

A - David Peterschmidt

And, hopefully, we’ll be able to talk to you about more of those accounts coming into the stream.

Q - Jeffrey Kvaal

Dave, do you mind talking a little bit more about the consolidation deal that you had in your milestones? Is that more along the lines of the Comcast deal that happened?

A - David Peterschmidt

Yeah, when we say consolidation, what we mean is consolidating messaging platforms and what’s really driving that, Jeff, is this whole convergence between fixed and mobile and we’re just seeing a lot of activity right now, quite frankly, throughout the world. We’re seeing, we’ve got some projects in Asia right now, as well as Europe, as well as North America. And we think Comcast represents the beginning of a market segment that’s going to start to grow.

Q - Jeffrey Kvaal

Okay, thanks very much.

A - David Peterschmidt

You bet.

Operator

We’ll go next to Sterling Audi with JP Morgan.

Q - Sterling Audi

Yeah, thanks. Hal, Dave. In terms of -- I want to go back to the June quarter and the fiscal year outlook, and some of the comments that you made. We understand that there’s lumpiness around the system deals. We hear that you’re saying that the system deals scheduling is on track, you’re in the final throws here for the system deals. But are you backing away from some of the fiscal ’06 goals that you kind of set forth because you’re worried that a system deal may not close, or are you still kind of, I guess, dedicated to those fiscal year goals? That’s what -- I’m little confused by some of the mixed in commentary.

A - David Peterschmidt

Sterling, are you sitting with Tom Robert?

A - Harold Covert

Well, what we were trying to do Sterling, and in fact, actually say that on a sequential basis, quarter-over-quarter, we’re tracking in line with the guidance and the targets that we’ve talked about in the past.

Q - Sterling Audi

Okay.

A - Harold Covert

And that we’re heading in that direction, actually right into fiscal ’07, but we always want to caution people two things. Number one is that the third month of our quarter has 30% to 40% of our revenues, I indicated. And, also, that these large systems deals could create lumpiness, both from a positive and a negative standpoint in terms of revenue generation or slowdown, so, you know the key point here is that our desire and certainly our planning process is to grow sequentially every quarter, drive continuous improvement towards our targets, and that’s the track that we’re on.

Q - Sterling Audi

Okay, because some of the -- it just sounded little bit fuzzy. I’m watching the stock and after hours, I can see the confusion, and there was confusion earlier in the quarter about still the shift from calendar year to fiscal year talk. I just want to be clear, you’re still believe in the annual fiscal year goals that you set here for fiscal ’06, and you’re still on track for the system deals?

A - Harold Covert

That’s what we said, and that’s what we just repeated, and we are.

Q - Sterling Audi

Okay.

A - David Peterschmidt

Sterling, I mean to help Hal out here, I think you will always hear him give you those two qualifiers as long as he’s sitting in the CFO chair.

Q - Sterling Audi

I’ve been working with Hal for about eight years so, yeah, I agree. Let me just do two housekeeping, well, one housekeeping. In terms of Musiwave. In terms of the clients serve and server breakdown of revenue, Musiwave goes in the client revenue budget?

A - Harold Covert

We actually broke-out Musiwave separately.

Q - Sterling Audi

But in terms of your metrics page?

A - Harold Covert

Yes. And I will double-check to make sure that’s the way they did it. It’s probably on the server side.

Q - Sterling Audi

Okay. And then Musiwave I think came in a little bit better than expected. You know, how should we be thinking about the ramp here, you know, with Musiwave and especially with TELUS and some of the other accounts that they won recently?

A - Harold Covert

Okay, Sterling, two quick points. One is, it is in the service, I check my notes here. And then going forward, you know, as we indicated for Musiwave, we had originally given guidance of 40 to 45 over the next four quarters, 40 to 45 million. Now, obviously, we were headed -- that guidance this quarter, so we expect to see good momentum from Musiwave inline with our overall targets of growth for Openwave.

Q - Sterling Audi

Okay, great. Thanks, guys.

A - David Peterschmidt

Yeah.

Operator

We’ll go next to Thomas Ernst with Deutsche Bank.

Q - Justin Boyd

Hi, good evening guys. This is actually -- this is Justin Boyd on behalf of Tom.

A - David Peterschmidt

Okay.

Q – Justin Boyd

We have a question here on the competitive landscape. We’ve been seeing lately a couple of transactions where VeriSign and Amdocs are getting into the content management space. What comments can you offer us in terms of how do you feel that is a threat for you, or what are your strengths or weaknesses in front of this potential new competitors?

A - David Peterschmidt

Yeah, now, Amdocs would be a totally new phenomena for us. I don’t think we have ever encountered Amdocs in any of our accounts, at least in the business that we do. So, we’re probably not too qualified to help you there. With regards to VeriSign, the issue, the differences between Openwave and VeriSign is everything VeriSign does is hosted. So, their -- if you talk to them their strategy is they leverage their expertise in running big data centers to run hosted applications for the carriers. So, we don’t classically run into VeriSign very much. Now, obviously, Musiwave is a hosted application, and if we extend other avenues, like video and things like that with Musiwave then there could be some overlap with what VeriSign does, but we would not think of them in the classic sense of in the competitor profile with us.

Q - Justin Boyd

Okay, thank you. And if we can have another question here? You mentioned in your initial script, you mentioned the Avitar’s and that kind of product. We wanted to ask you if you are seeing a lot of activity in that space? And if there is at this point any meaningful revenue on that sense?

A - David Peterschmidt

It’s just starting, and most of the Avitar interest that we’ve seen has been in Asia, as you might expect, especially within the Japanese market.

Q - Justin Boyd

Okay. Have you seen any interest in the U.S. or Western Europe?

A - David Peterschmidt

We’ve seen some, but I wouldn’t say that today it’s a meaningful part of the market yet. We’re seeing people starting to experiment and starting to have interest, but it’s too early yet to project if they’re, you know, what kind of market is forming up.

Q - Justin Boyd

Okay, fair enough. Thank you very much.

Operator

We’ll go next to Scott Sutherland with Wedbush Morgan Securities.

Q - Scott Sutherland

Great, thank you. Good afternoon.

A - David Peterschmidt

Hey, Scott.

Q - Scott Sutherland

You know, first, it’s good to see you guys following back into ’02, can you kind of talk about what the near-term revenue opportunity is? And what kind of longer term if this kind of trial moves to deployment?

A - David Peterschmidt

Yes, Scott, this trial is probably going to take us through the summer, and so I think that this opportunity is one of these that’s going to occur as far as, you know, turn into revenue and solid deal structure is probably, you know, in the September ending quarter, that it will finish up a lot of the testing and the development over the next 60 to 90 days.

And, like I said, they’re pretty excited about it. They think it’s going to have but that particular project and what they do today is going to have some good impact for Telefonica, which we obviously already have a deep relationship with. So, the project, itself is a pretty big project.

Q - Scott Sutherland

Okay. On your backlog can you talk a little bit about composition of what increase was it kind of pure licensing services and maintenance? Or did you have any sort of projects or systems in there? And is there any systems revenue left from the Telstar deal, because it looks like you’re not recognizing any more there.

A - Harold Covert

Yeah, I mean the overall backlog for the most part reflects the composition of our revenue streams. And I think, as we’ve indicated, there is essentially no meaningful amount of the large systems revenue remaining any longer. So, you know, going forward I think that’s a good sign, and, you know, we’re back to kind of our core business. And then as we move into signing more of these large systems deals that should add some additional momentum.

Q - Scott Sutherland

Is there any Musiwave in there?

A - Harold Covert

A very small amount. Musiwave, the nature of their revenue streams really doesn’t result in much backlog. It’s transaction based as you know.

Q - Scott Sutherland

Okay. And how have you professional services gross margin, was that 30 to 35 historically? Is that your goal, or what was it?

A - Harold Covert

Yes, that’s our stated goal, and we’ve been in that range in the past, and we think we’ll return there fairly quickly.

Q - Scott Sutherland

Okay, and just two more questions. You know, again, down the systems pipeline. I think this quarter, the one you’re going after this quarter, you’ve qualified as non-North American midsize deals, and I heard you on the call it sounded like it was possibly your turn of the larger deal. Can you kind of re-qualify that deal, and do you still expect to do three this year, or three to four this year?

A - David Peterschmidt

I think, Scott that we still got the opportunity for three or four. And I still believe they’re also spread out between the three major geographic areas of the world Asia-Pacific, Europe, and North America.

Q - Scott Sutherland

And about the one this quarter, I mean, again, I thought it was non-North American potentially?

A - David Peterschmidt

It could be, it depends on some of this is going to depend on how we want to do some things, which is a nice place to be.

Q - Scott Sutherland

Okay. Lastly, I get back to you is the again, the Cingular, Motorola deal. I mean it sounds like you’ve got some of the licensing this quarter, and it falls down to the maintenance stream. Is it, to get those growing to a bigger level you have to sell new components, or the stuff you’ve already licensed, could that grow beyond certain capacity thresholds and grow?

A - Harold Covert

Well, I think the thing to point out, keep in mind that we have a number of different types of relationships with both of these customers, so we expect the revenue streams, as we’ve discussed in the past, to continue on much like they have in the typical fashion, and I think Sprint, as Dave indicated earlier, is one of the primary examples. So, it’ll be a combination of the different relationships that we have with them, driving revenue as we go forward.

A - David Peterschmidt

Yeah, and Scott, just something that I think is going to bode very well for us is that, obviously, Cingular now being part of a much bigger operation, the win that we got this quarter is putting us back in a good position at Cingular, and I think it sets us up to have discussions for the other parts now of the mother ship that Cingular belongs to. So, I take this as a beginning of a design win that has a lot of room to maneuver if you will, to get additional business.

A - Harold Covert

Operator, we’ll take one more question.

Operator

And our final question will come from Tal Liani with Merrill Lynch.

Q - Tal Liani

Hi, guys. I have a few questions, if you don’t mind. I apologize, I don’t have access here from the hotel room to computer, so some of the numbers I have are from memory. Nextel Sprint was down, if I remember correctly, three quarters in a row, from 26% of revenues to 18 million this quarter which is way below that. Is it Nextel, I know that they’re trying to reduce professional services spending, is this part declining, why we see declines and what is the outlook for that?

A - Harold Covert

Yeah, I think there’s a couple of reasons why. First of all, if you remember, the large systems deals that we had with Sprint Nextel are trailing off now and we’re moving into more of the normal growth mode that we would have with them. And the second thing, this quarter, in particular, our revenue overall was a larger number because of Musiwave. So, we still continue to see a lot of opportunity at Sprint Nextel. I think Dave has indicated in the past that that’s one of our target accounts to doing more system deals, so there’s nothing but I think a solid profile with Sprint Nextel.

A - David Peterschmidt

Yes, Tal, we continue to be very bullish on our relationship with Sprint.

Q - Tal Liani

Okay. The Cingular, Motorola – hello, can you hear me?

A - David Peterschmidt

We sure can, go ahead.

A - Harold Covert

Yes.

Q - Tal Liani

Sorry. Cingular, Motorola, Cingular in the last few even months and years signed on these one-off deals with vendors limiting substantially the up side, so if you look at two years ago they converted them to sort of almost a one-off license fee from percentage of revenues or recently Metro City reducing the rate substantially from 6% to about 2%. And the question was asked few times, I just want to ask it one more time in a different way, is the licensing fee you’ve got from Cingular for this particular activity, not other activities, but for this particular activity, is it a one-off license fee that after that you don’t see much up side from this kind of activity? And then the up side is coming from you gaining other types of businesses with Cingular, or that it’s not this kind of deal?

A - Harold Covert

Yes, so, again, we don’t really disclose that level of detail. I think the thing to point out is that in most of our relationships we have multiple relationships with our customers, and we always have continuing business with them in one form or another with our license revenue streams. And the key for us, just like it is for any company, we have to continue to add value, and if we do that then we’ll generate revenue going forward, and that’s the position that we have with Cingular today. It’s a great opportunity. I think as Dave indicated earlier, because of all the activity on their side.

Q - Tal Liani

And the final question is about the guidance, you didn’t provide guidance for next quarter which, as far as I remember it is a change from prior policy. But just to make it clear if you, if I reduce the $7 million in Motorola and Cingular licensing revenues this quarter, that means if you don’t get about $20 million of large systems bills next quarter, it will be difficult to hit the consensus of 125. So, is it -- is this the case that you look internally and you say you do believe you’ll get systems deals but in order to make the guidance you will have to get it? Or not the guidance, sorry, the sort of consensus revenue estimate?

A - Harold Covert

Yes, let me just make a couple of points. First of all, as you know, our policy is to give annual guidance.

Q - Tal Liani

Right.

A - Harold Covert

And we’ll continue with that policy unless we see a reason to add information or data points as we think is appropriate to help understand where our business is going. Now, going forward for the next quarter, as we said that our momentum indicates to us that we’re on track, and Dave has talked earlier on about signing a deal, a systems deal this quarter, so, you know, I think we’ve given a lot of information to help understand where we’re going.

A - David Peterschmidt

Yeah, Tal, the thing I would point out to you is we pointed out the Motorola and the Cingular deal not because they’re both ad hoc to the normal flow of revenue and flow of our business, but rather because they are strategically significant and what they represent for the future. Plus just under reporting standards the size of the deals, require that we at least announced they were more than 10% of revenue. But I wouldn’t look at us talking about those as “that was exceptional to the normal run rate business of Openwave”. That is just, in my mind, a very standard part of the way we do business.

A - Harold Covert

Yeah, I just want to emphasize Dave’s point, we disclosed these particular deals because of them being more than a 10% customer.

A - David Peterschmidt

Right.

A - Harold Covert

This is not unusual for us.

Q - Tal Liani

And a very quick question, final question. Musiwave, great execution. Any chance to see you in the market in accounts of lighter than -- in big accounts like Verizon or other accounts, or is the market set for now and it will take time to penetrate to other accounts?

A - David Peterschmidt

No, we don’t think the market is set at all. In fact, you know, we have a heavy focus on Musiwave getting into the North American market. They’re in here today with TELUS, and TELUS is being incredibly aggressive in deploying Musiwave. And we believe that the other major carriers in North America, even if they’ve already selected some type of music download service are clearly interested in entertaining discussions with Musiwave. And taking the approach that they may have multiple music services available, and they’ll let the consumer decide what they like the best.

Q - Tal Liani

Got you.

A - David Peterschmidt

So, we don’t see it cut-off in any way. Operator.

Q - Tal Liani

Great.

David Peterschmidt, President and Chief Executive Officer

Okay. Thanks Tal. And just in closing, thank you everybody. I know it’s been a long call today. Thank you for your interests in us, and we look forward to seeing you in July at the Analyst Meeting.

Operator

Ladies and gentlemen, this does conclude our conference for today. Once again, we thank you for your participation, and you may disconnect at this time.

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Source: Openwave Systems Inc. Q3 2006 Earnings Conference Call Transcript (OPWV)
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