Great Elm Group, Inc. (GEG) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, thank you for standing by. Welcome to Openwave’s Earnings Second Quarter 2012 Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, February, 1, 2012. I would now like to turn the conference over to Mr. Mike Bishop of Investor Relations. Please go ahead.

Thank you, good afternoon and thank you for joining us today to discuss the results of Openwave Systems’ second quarter of fiscal year 2012. Joining me today from Redwood City are Mike Mulica, Chief Executive Officer and Anne Brennan, Chief Financial Officer. Before we discuss the results of the quarter, I want to remind everybody that we are operating under the rules of Regulation FD. The second quarter financial results press release was distributed at the close of market today, which includes a non-GAAP to GAAP reconciliation. And if you’ve not yet seen a copy, you can find one at our website at openwave.com. For your convenience, this call is being recorded and will be available for playback from our website for 3 months. Further, any remarks that may be made on this call or in our earnings press release about future expectations, plans or prospects for the company may constitute forward-looking statements for the purpose of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. The actual results may differ materially from those indicated by the forward-looking statements as a result of various important factors. These factors include the specific risk factors discussed in the company’s press release that was distributed today and in the company’s filings with the SEC, including, but not limited to, the fiscal 2011 year-end results on Form 10-K, and any other reports subsequently filed with the SEC. We intend to make forward-looking statements based on management’s outlook as of today. We do not intend to update these statements until the release of Openwave’s next quarterly report and disclaim any obligation to do so prior to that time. We reserve the right to update the outlook for any reason during the quarter. I would like to note that during the discussion of the financial results, unless otherwise indicated, gross margin expense and earnings-related items are recorded on a non-GAAP basis, which excludes stock-based compensation, certain realized losses and impairments on investments, amortization of intangibles, restructuring expense, discontinued operations and any amounts related to unusual events. Please access our financial metrics summary that is available on the Investors section of openwave.com to review Openwave’s historical financial performance and reconciliation of the non-GAAP measures we report to the corresponding GAAP measures. And with that, I’d like to turn the call to Mike.

Thanks Mike and good afternoon, everyone. Thanks for joining with us to discuss the second quarter results. First, I'll give you a quick overview of the revenue from the quarter. The revenue for the first quarter was $36 million and we recorded bookings of $20.4 million. This was comprised entirely of the product bookings. There is a significant improvement from last quarter, $8.7 million in product bookings, non-GAAP EPS with a net loss of $0.06. On last quarter’s call, we highlighted 3 important priorities for the quarter. First was our focus on our IP initiative. Secondly, we needed to conduct an analysis of our product business to determine the strategy to move forward. Third, was to focus on cash conservations despite the low level of bookings last quarter. As you are probably aware with low bookings comes increased cash burn. I'm happy to report we arrived at quarter-end with satisfactory results on all fronts. During the last quarter, we executed a thorough analysis of our business in order to determine a course of action that would maximize the return to our shareholders. The company has made significant investments in mediation, messaging and location products and we believe they can beat the significant growth drivers over the years. However, we made the difficult decision that those products and our employees in those product groups will be most successful being part of a larger organization. Our strategy frees up resources to focus on intellectual property initiatives. One outcome of this analysis was the decision to divide the company into 3 business units: Mediation, Messaging, and Intellectual Property. This was designed to best evaluate each of these 3 pieces and to unencumber each unit for potential sale. As you have seen from our announcement on January 12, we made the strategic decision to pursue the divestiture of our product business units, retaining Jeffries & Company as our financial advisor. We remain completely committed to our current customers, which is why we feel that acquired debt -- an acquiring entity will be better positioned to make strategic investments in our products, so they remain market-leading and innovative. We are in the preliminary phase of exploring potential buyers for the products and we obviously won’t comment on the process. When and if there is something to announce, we will announce it. Earlier this week, we announced that Openwave’s Board adopted a plan to protect our net operating losses. This plan is similar to plans adopted by many other public companies with significant tax attributes. It is designed to preserve our substantial tax assets associated with net operating loss carry forwards or NOLs and built-in losses under Section 382 of the Internal Revenue Code. As of year-end 2011, Openwave had tax attributes including net operating losses and tax credit carry forwards of approximately $1.6 billion before taxes. The NOLs are extremely valuable to Openwave and we adopted this measure to protect our ability to offset income that we expect to generate in future years, particularly from our intellectual property initiative. The tremendous value of our patent portfolio continues to be reinforced as we move forward with our intellectual property plans. As we've said before, we are focusing our efforts on a multi-prong strategy to realize the value of our patent portfolio, which we believe includes intellectual property that is foundational to the Mobile Internet Cloud Computing and we plan to use IP strategically to drive the company's profitability. I'm also pleased to report we have retained a very talented new leadership team driving our intellectual property initiative. Daniel Mendez and Tim Robbins will serve as General Managers of Openwave’s IP patent portfolio business reporting directly to me. Daniel and Tim worked together at Good Technologies to execute a successful patent strategy that resulted in approximately $350 million of licensed revenue for that business. As background, Daniel co-founded Visto Corporation in 1996, which is now part of Good Technologies. And has been instrumental in developing leading industry technologies. He is the principal inventor on multiple patents related to remote access, security and remote synchronization. Tim served as Vice President, General Counsel and Corporate Secretary for Visto from 2004 to 2011. He has a proven track record of solving complex, legal and business problems and extensive experience in managing and settling high-profile IP litigation. He also brings substantial international experience with licensing and corporate transactions completed in over 30 countries. I'm looking forward to their leadership in driving our intellectual property plans to fruition. As we noted on our last earnings call, we did not expect an IP licensing deal in Q2. We remain bullish on our IP initiative and believe there is incredible value in our patent portfolio. We obviously do not plan to share updates on pending IP activity, but we will update you as necessary. Moving to the product business, this quarters’ results demonstrates that we have made substantial improvements in our ability to sell our new products. By moving to a self-contained business model unit, we have already seen significant progress in focus and delivery. In Mediation, we've seen 3 new customers go live in production and we've also signed our first deal with our strategic OEM partner, Juniper Networks. We continue to work with Juniper to expand our collaboration and look forward to participating with them later this month at Mobile World Congress. We have also extended our work with an existing EMEA operator for our smart policy product, which we believe provides operators with the ability to offer innovative pricing strategies. We believe these are significant growth areas in the mobile marketplace. In messaging, we are focused on delivering the latest e-mail MX, Rich Mail and smart user repository product releases. Our messaging customers also continue to embrace our next-generation cloud-enabled mobile optimized messaging architecture. In fact, during the quarter, 2 large customers upgraded to our next-generation messaging platform and continue to make our products part of their long-term cloud strategies. I will now turn over the call over to Anne, to discuss the detailed financial results.

Thank you, Mike, and good afternoon, everyone. In our second fiscal quarter, we have been actively working to drive the IP initiative forward, unencumber the product businesses to optimize them for sale and maintain our focus on cash conservation. We believe we have achieved our goals for the quarter. Overall for the quarter ended December 31, 2011, Openwave posted a GAAP net loss of $0.12 per share and a non-GAAP net loss of $0.06 per share. Reconciliations from GAAP to non-GAAP, profit or loss can be found in our press release and on our website. Revenue for the quarter was $35.9 million, a decrease of $16.5 million or 31.5% quarter-over-quarter. Patent revenues accounted for $15 million of the decrease compared to fiscal quarter 1. License revenue was $9.6 million, a decrease of $0.3 million from the prior quarter’s revenue. License revenue comprised 27% of total revenue. Maintenance and support revenue was $10.2 million, which was a decrease of $0.5 million or 4.4% sequentially from the prior quarter's revenue. Maintenance and support revenue comprised 28% total revenue. This decrease was primarily due to revenue catch up of $0.4 million in fiscal quarter 1 upon the receipt of appeal [ph] in that quarter. Services revenue was $16.1 million, a decrease of $0.7 million or 4.2% sequentially. This decrease was primarily due to fulfilling a third-party hardware order from a major North American carrier for approximately $4.7 million in fiscal quarter 1, partially offset by increases in revenue from a project, which had contractual changes in the quarter, causing the recognition of $3.5 million in revenue previously deferred. Services revenue comprised 45% of total revenue. In the December quarter 47% of revenue related to service mediation products, 35% related to messaging products and 19% related to other revenues. This compares to 35%, 23% and 13% respectively for the prior quarter. Additionally, in fiscal quarter 1, there was 29% of patent revenue related to the $15 million patent agreements. For the second fiscal quarter of 2012, Sprint represented 18% of revenue and V [ph] Telecom represented 12%. No other customer represented greater than 10% of our revenues for the quarter. Bookings totaling $20.4 million in the second fiscal quarter decreased 14.1% from the first fiscal quarter of 2012, which was due to the first -- the fiscal quarter 1, $15 million license bookings. Otherwise, product bookings more than doubled from the prior quarter. Turning now to our gross margins, we achieved a 49.6% blended gross margin for the quarter, a decrease of 16.2 points from 65.8% in the first fiscal quarter of 2012. The gross margin decrease was primarily due to patent revenue recognized in the first fiscal quarter, which had gross margin of 100%. Excluding patent revenue, the gross margin would have been 52.1% in fiscal quarter 1. Licensed gross margin of 97.4% increased by 2.3 points from 95.1% in the prior quarter due to intangible assets becoming fully amortized in fiscal quarter 2. The maintenance and support gross margin of 69.7% increased by 4.2 points from 65.5% last quarter primarily due to decreased headcount. Services margin of 8.3% decreased 9.8 points from 18.1% [ph] last quarter. The decrease is primarily due to a large project with a low gross margin having revenues and costs recognized during fiscal quarter 2 due to contractual changes as mentioned previously. As for operating expenses in fiscal quarter 2, research and development expenses of $7.7 million were $1.6 million lower or 17.2% as compared to the prior quarter, primarily due to lower labor cost as a result of a decline in headcount and offshore development expense. Fiscal quarter 2 sales and marketing expenses of $6.9 million were $1.7 million more or 20.1% as compared to the prior quarter primarily due to lower labor cost as a result of the restructuring announced in fiscal quarter 1. General and administrative expenses of $7.6 million increased to $0.8 million or 11.1% from $6.8 million in the prior quarter, primarily due to an increase of $1.5 million in legal costs spent on patent related initiatives. Our headcount decreased by 18 from the prior quarter to 441, this reduction was a result of the restructuring plan announced in August. Please see our metric sheet posted on the website for a breakdown of headcount by function. As a reminder, the gross margin, cost of revenues and operating expenses I just discussed were all on a non-GAAP basis. On a GAAP basis, in the December quarter, interest and other expense were $0.3 million, which increased $0.4 million as compared to the prior quarter, primarily due to foreign exchange activity. Now turning to the balance sheet. Accounts receivable decreased to $26.3 million at the end of December compared to $6.6 million at the end of September. $15 million related to patent deal which was in receivables at the end of September and collected in fiscal quarter 2. Our DSO increased slightly to 65 days for fiscal quarter 2, up from 63 days in the prior quarter, but within our target range. Deferred revenue decreased to $20.9 million as of December 31, 2011 as compared to $33.8 million at the end of September. The quarter-over-quarter decrease was primarily due to the recognition servicing revenues on a large project previously deferred until the contractual change during fiscal quarter 2, as well as the lower product bookings in the first fiscal quarter. We ended the quarter with $69.7 million in cash and investments, which represents an increase of $3.1 million or 4.6% from $66.6 million at the end of the previous quarter. This increase is primarily related to the $3.3 million provided by operations and included collections of the $15 million patent deal recognized in fiscal quarter 1. As Mike mentioned, we adopted a plan to protect our net operating losses, which is designed to retain our ability to utilize federal NOLs of $1.6 billion to offset future income. The most efficient use of these NOLs is against future earnings of the business. This could approximate the $500 million in potential cash benefit. However, our ability to generate a benefit from the NOL would be limited in the event of an ownership change under Section 382 of the Internal Revenue Code. The actions taken on Saturday are intended to safeguard our ability to use the NOLs. Clearly, there is a lot of activity at Openwave that we expect we will have a transformational effect on the business. Until some of these events occur, we are not in a position to present a forward-looking financial model. Through this transition period, the business model that underpins our current operations will continue as operational financials remain. Operator, we’d now like to open up the call for questions.

[Operator Instructions] And our first question is from line of Scott Sutherland with Wedbush Securities.

Mike, I know you said in your prepared comments, you're not going to comment too much on the patents, but can you give a little more color on maybe the pool of potential companies that you might be talking to or where you are in that discussions with them and maybe an update on the Microsoft, is that other payments expected within the next year and any metrics around getting that?

Sure. So, I need to be a little careful about commenting on the process in general. What I can tell you is that we just received confirmation that we have signed and closed our first product group transaction here as we're sitting in the room. And so, we have just completed the sale of our location business to Persistent Systems. Persistent happens to have been our development partner for that part of our business over the course of years. And we completed that sale and closed it here during the day. I think it's a great example of the strategy that we put in place last quarter, moving past the dialogue into execution. And so, we have demonstrated the ability to be able to identify, sort of the likely buyers that are the best homes for our employees and our customer deployments and Persistent represents that class of company that we think we are going to find across the board for the rest of the portfolio. I'm really excited about the transaction and the representation of the strategy, but also as just a great outcome for the employees and for the customers. And while, we are not going to comment on what the actual terms of the transaction were at this time. I think in terms of insight to the process it should give you a great level of confidence that what we put in place from a strategy standpoint is moving into an execution mode.

And could you comment on the Microsoft deal on the other part of the payment or are you just staying away from that?

There is no update at this point.

Okay. When you look at, obviously, congratulations on that one unit, so I think you look at a location, the messaging and service mediation units and this is one of the 3 then right that you sold?

That’s right.

Yes, can you describe whether this is as a profitable or non-profitable unit. I think you have mentioned in the past only the messaging was profitable?

I’ll let Anne take that question.

Yes, sure. Given that was a product line that was fairly mature. We had taken the decision quite some time ago to carefully monitor the course that was a net contributor to the operations of the business, Scott.

Okay. And lastly, when you look at your OpEx, where do you think your OpEx levels operate [ph] with its restructuring and as part of that how much of those costs will be the patent cost or the IP cost?

Sure, if we go back to restructuring that we announced in August, our target there was to be pretty close to 20. If you look now on the press release schedule, on the state of the P&L, we have actually broken out the IP costs, it gives you a much better idea of what the core businesses are in terms of OpEx and what the costs are surrounding the IP business. So, we are within that target range in terms of what I would call the core product businesses from an OpEx perspective. And in terms of costs for IP, last quarter we had part of the quarter costs there. This is our first quarter of costs for the IP business including the cost associated with the ITC case and they are close to $3 million. So, the future costs related to the IP business should be in and around that ballpark number of $3 million very slightly depending on where we are in the case and that cost associated with it.

Great. Just to confirm the IP costs are going to be $3 million to $4 million and other costs will be around $16 million to $17 million, correct?

Yes, marginally higher on the product business, so probably closer to $23 [ph] million, than $19 million, $20 million.

I’m trying to understand it. The $20 million costs all in including the patent expenses? Or is it $19 million, $20 million, then another $3 million from the patent expenses?

You will see patent expense of $3 million and a variable number in the $18 million to $20 million range for the core businesses.

Okay. So, all in $21 million to $23 million?

Yes.

Our next question is from the line of Charlie Anderson with Dougherty and Company.

So, just real quick on the location business. I think there was about $20 million top line business and it sounds like that was a slight net contributor, so should I peel off $20 million of OpEx annually from that business that kind of goes away, sort of post that transaction closing?

In terms of the question, specifically around the location business and the OpEx savings?

Yes.

No, 10% of the business is classified as Other. We have 3 buckets that we recognize the business in being Mediation, Messaging and Other. And the largest contributor there in the Other bucket is locations and it's a significant portion of that bucket of about 10% in the business. So, the OpEx is going to be a function of that number, so in terms of savings with regards to location in $0.5 million to $1 million range in terms of savings per quarter.

Okay, good. Just real quick on the burn rate of everything else that’s left. It looks like you burned about $12 million from ops, if I sort of look at the $15 million that you got in from the patent deal last quarter. So, just kind of thinking about burn rate from here. Is the right way to think about it, you did $20 million of bookings, you burned about $12 million from operations, so if you are not selling any other business units, you'd need about $30 million to break even in terms of cash of that quarter?

Yes, let me just reiterate some of the earlier remarks. We quoted last quarter at close to $67 million, including this quarter at close to $70 million a net burn. And you are absolutely right Charlie; we had $15 million coming in with regards to the IP business. And so, the net burn for what we might refer to as the product businesses is $12 million. And what underpins that number, there is still a couple of known core product cash flows there with regards to risk. We still have some cash out pulling for risks based on the August announcement is no longer tailing some of those international payments. We got the lease of $3 million, which is ongoing that’s related to the release date. So, the core underlined burn in the business was somewhere close to $7 million. You will notice the last couple of quarters are looking something in sub-pay [ph] in last quarter and $22 million. There will be a continued burn in the business. I’d say obviously of an M&A event in the coming months. And so, the operational burn will be somewhere close to - we are managing somewhere close to that number, but there is puts and takes in any given quarter, so there is some variability to that operational burn.

Got it. And then, in terms of what you're selling still, the mediation piece and the messaging piece, what do you think are the most valuable assets of those 2 business units given that the bookings have been pretty depressed the last couple of quarters. Should I look at some sort of residual value off the maintenance and support off of that, or shall I look at the customer lists, where are we seeing that value derived from?

Still, I think that there is - it's probably a multifaceted equation. I think you will have different perspectives that come from different buyers and so, some of the buyers are going to be financial buyers and some of the buyers are going to be strategic buyers. And they are all going to have a different point of view on how to arrive at what they think the value of that asset is in the context of their plans. And so, it’s as these things are, when you have a good process, it's pretty dynamic. And one of the things that we have tried to create is by unbundling the company into business units. The result of that was intended to deliver a larger community of buyers, because people could get the part of the portfolio that was most consistent with what they were looking for. And we are finding that to be the case. And so, time will tell, but early indications are that we are meeting a good market for the portfolio.

Our next question is from the line of Tom Roderick with Stifel Nicolaus.

This is Chris Koh for Tom. So just a quick question on the products business, so when you look at this kind of $20 million bookings run rate for this quarter, was there any concentration in that number in terms of like a large deal. And in terms of congratulations on that first Juniper deal, in terms of what percentage of that number was kind of your newer products versus legacy?

I think that at a high level it was about 50-50 between both the messaging business and the mediation business. And from my standpoint, it didn't have that large deal that made it up. It was sort of a nice set of transactions that happened across the board. And the good news is that when you have that mix, it takes a level of execution that is real good. And so, the focus that the team got when they moved to an end-to-end model, really put people in the right place end-to-end to execute and there was a lot of good execution during the quarter.

Great. So, as we go forward and kind of look at, okay, you obviously had a difficult quarter, last quarter, this quarter gets better. So, when you say, and you mentioned this in the press release that you feel like you’ve kind of optimized the products business for sales. Do you feel like you can continue to improve the performance off the $20 million that you did this quarter or do you feel like maybe that’s an appropriate run rate going forward?

So, we thought as you said, we saw great improvement from the previous quarter to the quarter that we are reporting on today. We are in the process of selling the product groups. Having said that, the business units are intact and they are designed to execute during the process. And so, there is a lot of focus in doubling down on that execution right now, so it is going to be a bit of a dynamic environment as we go through the quarter, but there is a high degree of focus on the products from an end-to-end standpoint and the R&D that the company put in place in the past is now starting to come to fruition. These new technologies both in message and in mediation are meeting a market. And so, it’s not just a function of reorganization to get focus, there is also a bit of an upswing in demand across the market for the types of things that we are offering. So, will it improve? Time will tell. I can tell you that we will be very focused on making sure that we don’t miss a beat.

Great, glad to hear that. And then just a last one on the products and one quick one for Anne. So, when you look at kind of that media optimizer that I know has been a big focus for you guys over the last few quarters and you went to market with Juniper. Has there been any change in competitive environment, because I think pricing was an issue there. And has there been any like for some of the big networking guys, have they looked to maybe partner with other vendors to compete with you and Juniper?

We continue to see a relatively strong competitive environment. It’s a mixture of the smaller private competitors as well as network equipment manufacturers partnering, so both of those, Chris [ph]. In terms of how we view it, the Juniper dynamic obviously helps immeasurably in situations like that and perhaps opened up a competitive situations too that previously weren’t open to us. So, still fairly competitive scenes, a fairly broad set of competitors, but the partnership with Juniper is as you saw this quarter, we'll continue to see dividends.

Okay and then just one more. This is the one that I meant for Anne, sorry if I confused you, but in terms of that 10% that you mentioned for the LBS business. So, is the $6 million in the Other line or roughly $6 million a quarter. Is it 10% of that or 10% of your overall revenue that you are talking about being the LBS business?

It generally varies by quarter, so generally about 10% of our overall business.

Okay. So, in terms of, if you look at your revenue this quarter was $36 million, so the location business, the others I think it was about $6 million or $7 million I saw. So the location and I am assuming this is average quarter, so like an average it would be like $3.5 million?

Yes, somewhere in the $10 million to $3 million range and the variable there is any services that we deliver in the course of the quarter.

[Operator Instructions] Our next question is from the line of Scott Zeller from Needham & Company.

I wanted to see if there are any updates on the legal actions with RIM and Apple?

No updates at this point.

Should we expect anything in the next, if you could frame out like near term, medium term, should we be looking for anything?

The ITC cadence is a known cadence and it’s roughly an 18-month period and so, we are somewhere around a little better than 1/3 through that process. And we are very confident with the position that we are in and excited about continuing into the process.

[Operator Instructions] And there are no further questions at this time. I’d like to turn the call back over to management for closing remarks.

Great. Thank you, everyone, for your questions. I’d like to thank you for joining the call. I believe Openwave has significant assets that we can capitalize including the intellectual property initiatives and we are moving forward urgently to maximize the value of these assets. Thanks again and I look forward to updating you on our progress.

Ladies and gentlemen, this concludes Openwave’s earnings second quarter 2012 conference call. If you’d like to listen to a replay of today’s conference, please dial 1-800-406-7325 or 303-590-3030 with the access code of 4505424. Thank you for your participation, you may now disconnect.