惠普 (HPQ) 2003 Q3 法說會逐字稿

Good day and welcome everyone to the Opsware Inc. third quarter 2004 conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over to the Director of Investor Relations, Mr. Ken Tinsley. Please go ahead, sir.

Thank you and good afternoon. With me today at our headquarters in Sunnyvale are Ben Horowitz, our CEO; Sharlene Abrams, our CFO; and Marc Andreessen, our Chairman. During the course of today's call we will make forward-looking statements regarding future events or our future financial performance, all of which are subject to risks and uncertainties. Actual events and results may differ materially from these statements. Please review our Form 10-K, filed with the SEC on May 1st, 2003, and our reports on Forms 10-Q and Form 8-K filed with the SEC for discussions of important factors that may cause the actual events and results to differ.

By now, you should have received a copy of our press release that was distributed after the market closed today. If you have not, it is available on the Investor Relations section of our website at opsware.com.

In addition, an audio transcript of this call will be posted on our Web site following the call. Now, let me turn it over to Ben.

Thanks, Ken. Today, we have much to discuss. Before I address the acquisition of Tangram Enterprise Solutions, which we announced this afternoon. I will cover the highlights of our strong third quarter. During the quarter, we signed a deal with NEC, the largest deal we have ever done, excluding ADS. We posted revenue of $5 million, which was at the high end of our previous guidance. Our deferred revenue and advances increased to over $10 million. As we forecasted, we maintained positive cash flow from the software business. We generated pro forma cash flow from operations of more than $1.2 million and ended the quarter with over $56 million in cash.

It is important to note that during the quarter we paid the largest remaining liabilities from the managed services business. We expect to generate positive cash flow from the software business in the fourth quarter, as well.

Additionally, this quarter we extended our position as technology leader by co-authoring and launching DCML, or Date Center Markup Language. I will talk more on this in a moment.

During this quarter, we saw more signs that our market continues to develop nicely. According to IDC, worldwide server shipments, year-to-date, have already exceeded total shipments of 4.6 million units in all of last year. Significantly, more servers will ship this year than in any previous year. IDC further estimates that the total servers in production worldwide will double over the next five years.

Since the shift that to Web-based architecture began eight years ago, server accounts in the average enterprise have increased up to 100 times, with no change in management processes or software. The result of this massive server explosion is a series of problems in security, quality, and labor costs within IT. We've designed Opsware to uniquely addresses these problems.

As a result, we have made excellent progress in our first full year in the software business. Since our last call, we have continued to win significant deals. Most significantly, NEC, which I will address in a moment. Second, a large deal with another agency of the U.S. Department of Defense. This project will utilize Opsware in multiple data centers, located both domestically and outside the continental U.S.

Third, The Hartford, another major win for us in the insurance agent industry. And fourth, a large financial services company in the Northeast.

Additionally, we made an important upsell to Northup Grumman, the prime contractor on our other major project with the Department of Defense.

Excluding EDS, our average deal size for all deals signed by Opsware has increased to over $600,000, up from over $500,000. Our large deal size is unique among our competitors, and allows us to more rapidly build a profitable business.

Awareness of Opsware is also increasing dramatically. Incoming sales leads have tripled since the beginning of year. Further, enhancing our leadership position last quarter in conjunction with Computer Associates and EDS, we have launched the first industry standard for data centers, called DCML. DCML is an open standard that facilitates interoperability across IT systems and defines the make up of a data center environment. Given the large number of technologies and complexities and the data center, a standard like DCML is quite powerful. At launch of DCML in October, 25 companies endorsed the new standard. Among them, BEA systems, Mercury Interactive, Micromuse (ph), NetIQ (ph), and Tifco (ph). Since then, we've grown to over 50 companies, including EMC software and Fujitsu Systems. To put the early success of DCML into perspective, similar initiatives have typically taken one to two years to gain such wide industry support. DCML has also garnered interests of IT organizations worldwide, including major corporations such as Lehman Brothers, Best Buy, CS First Boston and First Data Corp. Early traction for this initiative has been exceptional, as demonstrated by the number and caliber of countries endorsing it, as well as the volume of activity around the standard. Within a month of launch, their have been over 10,000 downloads of DCML technical documents. As the initiator of the standard, and the author of these documents, long-term, we think that the proliferation of DCML will increase demand for Opsware.

On the partner front, in Q3 we significantly expanded distribution capabilities with a multiyear, multimillion dollar deal with NEC. Under the agreement, NEC will market, sell, and support Opsware in Japan, initially targeting their 100,000 customers. This is our initial move into the Asia-Pacific market, which is forecasted to have $175 billion of IT spending in 2003, according to IDC. Additionally, NEC is in the process of evaluating Opsware for use in its outsourcing and e-business services, one of the largest in Japan. We are very pleased to have such a strong partner in that region, as we expanded the business beyond the U.S.

Our relationships with Hewlett-Packard and EDS are progressing nicely. Importantly, EDS is beginning to see indications of future labor savings and cost savings from using Opsware. For example, EDS recently determined the need to apply three emergency passages to three software programs. Opsware discovered that 880 servers in their environment were vulnerable, and applied the patches to them in two hours. Without Opsware, this task would have normally taken EDS 445 hours to complete. With Opsware, not only did they reduce the labor requirement by 99 percent, but they also secured their environment far more quickly. This efficiency is imperative in EDS's stated effort to lower security delivery costs -- service delivery costs. In fact, EDS's CEO Michael Jordan, recently stated that the Opsware and Microsoft alliances are critical factors in our ability to move forward.

On the product front, I am pleased to report that we shipped Opsware System 4 in September. This is the most significant release of Opsware to-date -- it's more broadly applicable across IT, and has already expanded our sales opportunities.

Now, onto the acquisition of Tangram. Today, we announced that we signed a definitive agreement to acquire Tangram Enterprise Solutions for $10 million in stock. Tangram is a public company located in North Carolina, and provides software to identify, manage, and secure critical IT assets, including desktops, infrastructure devices, and a wide range of software. The acquisition further advances our market lead in three ways. First, with the support of over 30,000 software products and components, it enables Opsware to adapt more smoothly into existing environments. Second, combined with Opsware's powerful patch management, bio tracking, and secure infrastructure of Tangram's asset oversight, completes a powerful data center security offering. And third, Tangram provides the foundation to extend Opsware automation to Windows, LINUX, UNIX, and Macintosh desktops and other infrastructure devices.

The transaction also brings over 200 customers to our existing installed base, including 25 percent of the Fortune 100. Notable customers include Philip Morris, Unocal, Bristol-Myers Squibb, Marriott, Owens-Corning, Merrill Lynch, Sheel, Prudential, AT&T, and MCI to name a few.

From a financial standpoint, Tangram is currently operating at roughly cash flow breakeven. We believe that there are opportunities for efficiency gains in the areas of G&A and sales and marketing, over time. The $10 million purchase price represents less than 2 percent of our market capitalization. The transaction is expected to close in February, 2004, and is subject to customary closing conditions and regulatory review.

In summary, I am pleased with the progress we made this quarter. With two quarters of positive cash flow from the software business, our financial model is proving out. Our acquisition of Tangram expands our reach within large IT shafts (ph), adds more than 200 new customers and further expands our lead in IT automation.

Now, here's Sharlene to provide more detail on our financial results and outlook.

Thanks, Ben. As we previously forecasted, we generated another quarter of positive cash flow from the software business. Excluding amounts paid for liabilities from the managed service business, we generated over $1.2 million in cash flow from operations on a pro forma basis. A reconciliation between cash flow on a GAAP basis and pro forma cash flow, is provided in the table immediately following the statement of cash flows in our earnings press release.

For these past several quarters, I stated that we were expecting to pay approximately 10 to $12 million for remaining liabilities from the managed service business. During Q3, we paid $11.7 million, and have satisfied the majority of these items.

We ended the quarter with over $56 million in total cash. At October 31st, deferred revenue and advances from customers grew to $10.2 million, up from $7.8 million last quarter.

Turning to the P&L, net revenue was $5 million, compared to $4.3 million last quarter. As in prior quarters, the bulk of our revenue comes from our EDS $52 million guaranteed contract. For conservatism, and until we establish vendor-specific objective evidence, we recognize all revenue routably (ph) over the term of the maintenance contract. To reiterate how we treat and record customer contracts, there are three categories other than revenue into which a customer contract can fall. First, if we sign a contract and have met the criteria for revenue recognition, the amounts are recorded as deferred revenue, except for the amounts recognized in current period revenue. This is true whether or not we have received cash.

Second, if we sign a contract and receive cash, but we have not met the criteria for revenue recognition, the amounts received are included in advances from customers.

Third, if we invoice a customer, have not yet received cash, and have not yet met the criteria for revenue recognition, the amounts are not reflected anywhere in our financial statements.

Gross margin improved to 77 percent, and operating expenses were down slightly from the prior quarter.

Now, turning to guidance. As we stated, we are managing the business to cash. We reaffirm our expectation to generate positive cash flow from the software business in Q4. We reiterate our total anticipated cash collections of 22 to $25 million for the full year. We expect revenue of approximately $6 million for Q4.

We will provide guidance which incorporates the operations of Tangram at a later date.

We now invite your questions.

(OPERATOR INSTRUCTIONS). Andy Schroepfer with Tier 1 Research.

If you can hear me okay, I apologize for the background noise here. I wanted to see if you could give out a customer and if you gave that and I just could (technical difficulty) wireless connection let me now. I will start with that one.

Yes, we announced, as you heard, five new customer deals, in terms of what we have announced. We have not been giving, nor forecasting, an actual total customer count. But, that can be added to the number of customers we previously announced in addition with the Tangram acquisition we add over 200 customers on that side.

Excellent. On the acquisition, (technical difficulty) these guys?

Actually, we came across them from customers. It was pretty interesting. There was a tremendous amount of satisfaction and happiness from the customers that we shared in common, in particular, EDS was extremely enthusiastic about their product offering. And based on that, we took a look at their technology, which we thought was quite fantastic and impressive. And then the Company itself turned out to be quite affordable from our standpoint. And we were very impressed with the people -- the caliber of their engineering team in particular.

Excellent. Of the 200 customers, how many would you say are -- what percentage would be quick upsell opportunities? Or is that going to be just a long-term sort of battle it out for the customers?

Yes, we are not yet forecasting what we are expecting on the upsell side or on the maintenance side so far. But, if you look at their numbers (technical difficulty) public company, they are doing about 2.5 million per quarter in revenue and about 1.5 million of that is on the maintenance side. And, we think that those 200 customers are right up our alley, in terms of the kind of customers they are -- just about all of them are Fortune 1000, and they had big contracts like (indiscernible) environment, which looks like a good mask (ph) will be ready to forecast all the Tangram business as well as the Opsware business at the end of next quarter for next year.

Great, do you think this is something that can accelerate your efforts on the lower end product?

We do intend to continue the Tangram product, which is a bit lower end than Opsware, in terms of entry-level opportunity. So, in that sense, absolutely.

Excellent. And then a final question. In terms of what you would have expected at the beginning of the quarter in terms of customer reception to the messaging, would you say it was better-than-expected? Or would you say was worse?

Customers to which (Multiple Speakers) (indiscernible) I'm not sure I quite follow?

Just the reception to the days in your automation pitch -- would you say, going into this quarter, it ended up being better or worse than you expected?

I think it was a little better than we expected. And, I think the numbers reflect that. So, our deal size is going up dramatically. $500,000 average deal size previously -- so 600,000 now and that is for the total of all the deals. So you can imagine a big increase this quarter.

And then the business itself came out very well -- $1.2 million in positive cash flow. Again, as far as operating (indiscernible) the software business is really good and we're pleased to have the deferred revenue and advances over $10 million. So all those things came out really well. We are quite pleased this quarter.

Fantastic. Same here. Thanks, guys.

Tim Klasell with Thomas Weisel Partners.

Yeah first question. First question on System 4 -- were any of the five new customer Systems 4? Or does that a later date?

Yes, all the new customers are System 4. System 4 shipped in September. So, even the ones who purchased prior to System 4 shipping were expecting it and are deploying it.

Okay. Very good. Then on the Tangram acquisition, when do you expect that to close?

We are expecting a February close for Tangram.

Okay. Finally, Sharlene, VSOE (ph)? Any update there how you are tracking towards that?

We are tracking well. I think I have stated before that we expect to get that late in calendar 2004.

Okay. Very good. Thank you very much.

Damian Rinaldi with First Albany Capital.

Good afternoon. Can you compare and contrast the product price points and/or the average deal sizes? And channel that Tangram has with your own and describe how those mesh? Or, if they don't mesh, what you think you're going to need to do to make them fit?

Sure. The first thing to understand is that one of the things we are most excited about is adding the Tangram capability to the Opsware solution. First, the ability to integrate into new environments with their capability to recognize over 30,000 products -- software products -- and others when they plug in. So, we immediately capture the entire inventory of the environment.

Second, they really extend our security capabilities and enable us to basically have a complete security offering, independent of Data Center Automation, in many ways, we have patch control -- we've got the ability to stop viruses in their tracks. In addition to our file tracking capability that we previously had. So that is pretty exciting.

And then we also extended portions of the (indiscernible) to the desktop, so the first thing it does is it just improves our own product and our ability to sell it and have it do well.

Now Tangram itself, average deal size is about $140,000 in comparison to our average deal size of about 600,000. So, there may be new low-end opportunities, (indiscernible) primarily a direct sales channel other than in Europe, where they do have some indirect but that is similar to, you know, most companies are direct in the U.S. and indirect in Europe, it's so large, it's a very sophisticated distributor. So in that sense, it's really pretty similar channel-wise to what we already doing. It does give us another price point -- it does give us another functionality point. But, again we think that the combined solution is incredibly interesting and extremely powerful.

Okay. Thank you very much.

Catherine Egbert with CEUT.

Good afternoon. One quick question. Did your relationship with NEC contribute at all this quarter, either to current revenues or to deferred revenue?

No, it did not.

When do you expect it will start contributing?

We have not forecasted that yet, but it will either be in this current quarter that we are in or the following quarter, we should see something probably in the category of advances.

Okay. Very good. Thank you.

Mark Lamb with The Shemano Group.

Great quarter, everybody. A couple of quick questions -- I'm going to keep you guys on here all day. Marc, can you talk a little bit about your thoughts on DCML? Marc is on the call right?

Yes, you bet.

How it affects the Company overall in the industry?

We think DCML is extremely exciting --- bascially what we've done is introduced the concept of a standard for describing data centers and applications and service within data centers and all the different constituent parts of a data center. And, it has introduced the concept of a standard for that and this is something customers had not even been previously aware that there could be such a standard. They are very excited about -- they are excited about it the minute they hear it -- it gives them great comfort that when they are adopting something like Opsware, that they are adopting something that is going to have a long-term strategic path within their environment that they're going to be able to plug and play elsewhere in conjunction with lots of other products like my other monitoring products or security products or whatever. But, they are not getting locked into proprietary sort of one-way streets and so it makes them much more enthusiastic about adopting and then it also gets them all fired up about all the different things they are going to be able to do with DCML. Just as an example, we can now take the Tangram products, for example, into the customers and explain how you know we can make (indiscernible) with DCML and about how you can build DCML descriptions of you know 30,000 different software products that you might be running in your data center or some subset of those --- they express those with DCML. So people just get really fired up by that kind of thing. Obviously, we've also seen a very broad level of enthusiasm from other industry participants, including a lot of other software vendors and increasingly the Harper (ph) vendors and so forth. And the fact that we been able to go from -- I think, starting about 25 endorsers at (indiscernible) to over 50 now and that's -- people are coming on board now at an accelerating pace and it's a rate of adoption that I've never seen before. So we think it is going to be over the next 12 month -- we think it's going to be a big deal.

It is pretty unique. I have never seen anything quite like it. Most everybody I can think of is in DCML. What groups are not in that DCML group? What are the names?

Yeah, their couple of big names that still aren't in. Some of the big system vendors are still thinking it through. Our experience with big systems vendors -- companies like IBM -- you know or Sun -- they tend to take their time on these kinds of things. They want to make sure they are making a commitment that they are going to live up to over the long-run. The fact though that there is really no alternative to DCML. It's not a standard (indiscernible) in the sense that there is no competitor -- other then, you know, proprietary. Basically, what is happening in the industry right now is you're increasingly getting a choice of vendor, whether you are going to be proprietary or whether you're going to support DCML -- there is really no third path to take and so we think in the long we'll able to get just about everybody signed up.

Great. That is great. A quick question on the acquisition. How long has this company been around?

Axle, it was founded in 1984, I believe. So it's been around almost 20 years. They have made incredible technical progress there. Their technology is really quite impressive. And, the customers are just soired (ph) it. They think it is, you know, five or ten times as good as anything in the space.

On the business front, clearly, they have not been as successful as they might have, given their great technology. But, that has just turned into a terrific opportunity for us.

Yeah, do you to take that -- does it complement your software do you actually incorporate it into the software -- the 4 system or is it an add-on?

Yeah, it is primarily going to become part of the Opsware product and the Opsware product family. We will continue to offer the Tangram products stand-alone, but we have already some great ideas about exactly how we're going to integrate them -- the first 5 steps of integration which look really, really good. And again, very powerful and it's one of these things where when we were -- back in the days when we were Loudcloud (ph), we built Opsware -- we used to build all the machines so Opsware new everything that was on them. As we go into these really complex IT environments and introduce Opsware, learning about what is on those machines has been more difficult. And, with the Tangram technology, we can recognize 30,000 different elements in a data center, including virtually every piece of software on the market. Plus, it is designed very elegantly and can be easily extended to incorporate more. So, our customers, you know, with their Opsware systems, will know everything in the environment before they go to make a change, and they can do so as a result of a huge amount of confidence.

It sounds like -- I think you mentioned 200 clients that they have?

Yes. 200 clients.

How many of those are in overlap -- what percentage?

Very few overlapping -- I mean, there is EDS overlaps. And I believe, actually, that is just about -- I would have to review their customer list -- but no more than 1 to 3.

Wow! That is fantastic! A quick question on the new government project. Is it a different division or arm of the Federal Government than the Defense Department?

Yes, it is within the Department of Defense -- it is within a completely different organization -- it is a completely new opportunity supporting, you know, a different effort.

Okay. And can you talk about about how much -- or how that is going to help revenue -- can you expand on it at all?

Well, it is quite a significant deal. It's multiple data centers -- cross-continants for the full functionality of Opsware. We think it is a tremendous initial opportunity. We think it has got great growth potential over time. It is one of the things that I would love to disclose who it is but they would have to kill me.

(laughter).

So, I won't do that. It is an incredibly significant agency within the Department of Defense and one that we really have been coveting and are quite pleased to have on.

Great. Thanks, guys. Great quarter.

(OPERATOR INSTRUCTIONS). Steve Lee, private investor.

Hi, I have a question regarding the typical contracts you guys have -- typical contracts I guess you guys increase from 500 to $600,000. Over the life of the contract, how long does it take to recognize the 600,000. Over how many quarters?

Yeah, so this gets into Sharlene's favorite topic vendor specific evidence. I will give it to her to explain.

I mean, a contract consists of the license, the maintenance, and any professional services -- once we have delivered the license and professional services, and we recognize routably (ph) at this point, over the remaining term of the maintenance contracts which are typically one year contracts.

Okay. Thank you.

Scott Richter with Bank Equity Partners.

Talk a little bit about competition, both from the smaller point solution vendors as well as the larger vendors that you are seeing out there -- if anything has changed, in terms of landscape, given some of the acquisitions and so forth that's gone on over the last quarter.

Yeah, I think the landscape is still emerging, competitively, and I think it has not dramatically changed from last quarter. It is pretty much as it was. We are seeing (indiscernible) the same mix, but a very scattered mix of competition. So a bit different competitors and different deals. And, you know we think it will likely, over the next 12 months, as the category gets more concretely formed, we will start seeing more consistency out of the competition. But, certainly not yet.

What you say that given that your deal size has been increasing, fairly consistently, would you say that you typically see the larger vendors out there or the smaller guys still nipping at the heels a little bit?

The smaller guys are still present, but, we think getting less significant. We think, though, that it is hard to predict exactly where the landscape is going to go at this point. Our larger deal size, we think, is just indicative of our own ability to improve our differentiation and improve our position in the market and clarify it -- becoming the clear technology leader. With things like DCML. I mean, this is a pretty big initiative. And, to have 50 companies signing up and all the major analysts saying this is the right architecture for data center automation, and you should be DCML-compliant in the fact that we authored the spec organized the approach. This gives customers a lot of comfort that if they dealt with us, they are betting on the right architectural strategy and the right long-term solution. So that has enabled us to basically recoup a lot of that value in terms of our pricing and our deal size.

That make sense. Then, talk a little bit about just sort of dovetailing on that, moving now into the desktop a little bit more with the acquisition and why the rationale there? And, what your view is on how the technology evolves as it relates to that?

There are really three things, again, with Tangram, that we are excited about. One is the ability to fit into virtually any environment that has been put in-place since 1984, including mainframes and other kinds of technologies that they go out and recognize and understand.

And then secondly, it gives us what we think is going to be a royal beating security solution for managing and controlling files and patches and everything that causes security problems.

And then finally, one of the things that a lot of our customers have been interested in is there are certain functionalities in Opsware, although managing the data center, managing the applications on those servers, managing the server environment -- it is a real problem they face. Some of the functions that they do on servers need to extend to the desktop -- functions like security and inventory in particular. And Tangram gives us the architecture, the distribution capability, and the frame and the technology to do that. So, it really is a nice addition to the product family, and we think that we really got the best of (indiscernible) technically, in this case.

And then just finally -- you mentioned patch management, with respect to EDS, talk about if that is driving demand for the greater solution, in general, or if that is just an adjunct at this point? You've mentioned security quite a bit here, and how that enters into the patch management -- just talk about that a little bit.

I think if you look at IT budgets right now, the two things, the two budgeted items that we slot into most deeply are, security and IT consolidation. And, so, you know, this certainly helps a lot with both of those. And, we are seeing real dollars being spent in those areas. So, we are pleased that we've been able to really round out our solution in both places.

And so, using patch management as an entree I guess then, to open up security budgets for the solution -- is that the answer?

If you look at, sort of the big security problems in organizations today, they can be thought of as a couple of categories. One is problems that -- where there are known fixes available, but for process reasons and reliability reasons and maintenance window reasons, they have not applied those fixes or applied those patches. That is the patch management side.

On the other side are things like, you know, Melissa -- things like viruses and other things that spread across computers that need to be controlled in real-time. So if, you know, somebody calls in and boom -- I've got a virus -- it is imperative that my (indiscernible) can shut down that program across desktops and servers and with the Tangram acquisition, we get that capability. So, we think the combination of the two is quite powerful.

It makes a lot of sense. Just to clarify, did you say it was 465 hours on the right implementation to 1 percent of that?

Yes.

All right. Thanks.

Dion Cornet (ph) with Duke and Sorejoe (ph).

This is Decatur Jens. Good afternoon, everyone. I'm just trying to understand the numbers a little bit better. If you look at the sequential increase in revenue, it was up about 800,000. Assuming that was on top of the 4.2 that EDS has maintained for the next few years -- that 800,000, if you assume that that came to halfway through the quarter, that would imply 6 million in new bookings. Are there some upfront costs that biased that? Or, did you really do more than $1 million per customer on average, in terms of incremental business?

Yes, we are not actually disclosing those kinds of information -- in particular, we don't disclose bookings. In general, we try to stick to the financial numbers that are audited by Ernst & Young -- and that is not something that falls into that category. I will let Sharlene elaborate.

Yes, once we have delivered everything, the remaining revenue gets recognized over the remaining term of the maintenance agreement. So, that could be, since most maintenance agreements are a year, it could end up being recognized after the implementation is done -- it could be six months less -- nine months. So that can vary. So, you cannot just do straight math. If you want to -- we can take an off-line, if you want to go into all of the, you know, specifics of revenue recognition.

(Multiple Speakers) Provide that sort of rough breakdown of the $800,000 increase, how much of that was implementation-related? And how much of that was recurring revenue?

We recognize -- because we don't have (indiscernible) we cannot split the various elements. So, this is the entire contract being recognized over the (indiscernible) term life (indiscernible) service.

Okay. It looks like your guidance for Q4 may be very fairly conservative, then. Because the rough approximation here -- assuming you did not get all the business day one in the quarter and that came to, you know, halfway through the quarter, that would imply that you would get 1.6 million incremental revenue in Q4, since you have the full quarter to recognize it -- 1.6 on your 4.2 million from EDS and you're at your $6 million number already. I mean, is that meant to be a very conservative number, or am I making a bad assumption and the wrong math there?

Again, we recognize EDS on a cash basis. Okay? And that has specific guaranteed payments. Okay? And in the rest is recognize over the remaining terms of the contract after implementation. Again, that is why -- so we basically know, at this point, when we went into this quarter, roughly what revenue should be.

Tangram made about $900,000 in their September quarter. Your $6 million guidance -- is that all organic or does that constitute a few hundred thousand dollars from Tangram, depending on the closing date?

There's nothing from Tangram. (multiple speakers)

There's nothing from Tangram (Multiple Speakers) like the right number for Tangram either. But there's nothing in that number from Tangram.

Okay. Based on some channel calls, it sounds like you guys may have won a deal in UK and other in Italy -- is that accurate? If so, how would those sold? Direct or through a channel partner?

We did not announced any of those things. So, I will not comment on that.

Okay. All right. Well, thank you very much.

Mark Allen with Grotsky Associates.

Congratulations on the good quarter, guys. Great execution. I want to see if you could elaborate a little bit on the government contract that you closed, and what potential that deal has?

Yeah, so, it is an extremely significant contract. It is with an agency that does -- (indiscernible) -- I don't want to give you information I should not but it's a -- (multiple speakers)

Well, I like the extremely significant part -- (laughter)

Responsible (ph) data centers -- we think the initial deal is a fraction of what the opportunity is. Probably, certainly less than half but probably less than 25 percent of what we think the overall opportunity is.

This is Marc. I been spending a lot of time in particular in D.C. with our federal team and with some of these customers and prospects -- and as we said on past calls -- we think the Federal sector and specifically defense and intelligence, but also some of the civilian agencies are just a really big opportunity, which I think we've been able to exploit so far in which we have very high expectations for in the future. The reason is because they have very -- sort of -- the problems we talked about, they have in sort of very large form, which is they have implemented a tremendous amount of technology over the last ten years. They have very complex systems -- very complex networks. And they have huge opportunities to improve everything for efficiency and, you know, labor costs, and speed of deployment and so forth. And then, in general all these agencies just have an enormous appetite for new technology. You know, even on a civilian side, it's just a huge upside for new technology in general. So, we tend to fit very well in there and then we also tend to have a lot of credibility in that sector -- in part because of our experience very large-scale implementation like EDS which is of the same kind of scale as we see in these large government agencies. And then also just our track record -- a lot of our folks working on our Federal side have similar expenses with companies like Netscape and Oracle and others and so we tend to have a lot of personal credibility -- we tend to run into actually less competition in the Federal sector also, as a consequence of that, which is also nice (multiple speakers) deal is going to be very large. So, in general we like it a lot in this sector.

Good job. I wanted to also see if you could comment on Europe. If I recall, you set up a division, maybe four or five or maybe six months ago with one of the guys from Cisco coming over to run it. Has anything been transacted via that? Or in Europe, any pipeline developing?

Yeah, we're pretty pleased with the development of the opportunity out there. We have not announced any transactions on the UK side, were that is setup, yet. But, we see that market as certainly an interesting opportunity. They are about, in terms of market development, I would characterize them as about twelve months behind were the U.S. is, in terms of server deployments, Web-based architecture, and the other things that drive our opportunities. So we are feeling very good about how we are positioned there and what the opportunities will be down the line.

Okay. I have one last question. On the Hewlett-Packard site, is anything coming through the pipeline on that? Pipeline developing, strong, taking a little time -- any comments?

Yes, we are pretty happy with the opportunities that we have identified with them -- we've had quite a few customers come through -- quite a few prospects originate over on that side. And, we're definitely looking forward to developing further. We don't have, you know, any majorly significant developments to report at this time. But that is tracking well.

Okay. Great. Congratulations.

Scott Richter with Bank Equity Partners.

Just one quick follow-up, Sharlene. Will thh Tangram affect VSOE (ph) at all? You do you just anticipate or you just anticipate recognizing revenues as they are received? When you close on that?

So, they will not affect revenue recognition -- they will not affect getting VSOE for Opsware.

Okay. There will be no impact?

No.

Thanks.

Donovan Gao with American Tech Research.

Can you talk a little bit about the number of sales, or at least initial sales engagements or sales meetings, you're having now versus, say, last quarter -- how that is tracking? Is it getting easier to get in the door now, than a few months ago?

Yeah, one of the things that we said on the call was that incoming leads have -- and this is kind of the easiest metric to understand without going into all of our, you know wizardry about how we go from a lead to a qualified prospect and so forth -- but a lot of leads people calling us has tripled since Q1. So if you look at Q1 and then you look at Q3, Q3 has three times the number of incoming leads as Q1. So things are picking up well in that respect.

We also have identified quite a few opportunities through our DCML effort, so we are pleased with that.

Okay, then how would it track, say versus Q2 -- because as of Q1 you are essentially a brand new offering?

Yes, it is a pretty smooth trajectory -- so if you plotted Q1, Q2, and Q3, it is a straight line.

Okay. And then Sharlene, can you talk a little bit about the cost structure going forward and how we should think about it? Maybe a long-term model, in terms of gross margins, R&D expenses, those types of this have been fairly flat during the last two quarters. When does that start to trend up?

So, I will give guidance on the next call. Because obviously Tangram will have an impact on that. But, you know, at this point, I mean, if I'm just talking about Opsware for, you know, next quarter we're -- we said we will maintain being cash flow positive.

Okay. Can you talk at all about a long-term model, without specifying a timeframe?

So, I would anticipate that we should look like, you know, a normal software company. And there are many out there, you know, similar to let's say, Mercury, etc. (multiple speakers)

Okay. And then finally, can any of you talk about, just anecdotally, any data points, maybe without mentioning, you know, specific customer names on ROI or payback periods other than EDS?

We have spoken about a number of customers in the past with this regard. But, we are, in general, customers are able to get payback in less than twelve months on the software, in general, there are fairly significant labor cost savings that happen almost as soon as they are deployed. So, we have been pleased with that. That is a good part of the selling argument. And, you know, once we get to that stage, which tends to be after we have identified the budget and identified the fit. That tends to go quite well.

Thank you.

Joshua Banterice with Joseph Stevens.

Congratulations on your quarter. I came in a little bit late on the call, so I missed a little bit. And the question -- primarily goes -- Marc, you were in a magazine article -- I cannot remember the name of the magazine. This is 2.0 you were in. And I recall reading in there that as far as the adoption of your guys' product, it may be a hard sell to begin with, but once people realize what the capacity of the units are, it should get easier and easier as you go along. And, I was just curious to know as far as the adoption of your product and the integration into other companies, issuance of that product, has it become easier? And do you expect it to keep going that route? And, if so, for how long and to what degree?

This is Marc. It is definitely easier. Every quarter, it gets easier -- in the sense of customers have more and more knowledge each quarter when we walk in the door. You know, a year ago, that's probably what I said in the article, and I think like a year or a year and a half ago -- take three or four hours to get people to just have a basic understanding of what we were trying to talk about. Six months ago that would come down to an hour. You know, these days it's half an hour. People just know a lot more about it -- they know more about the category -- they know more about the technology, they've go to people have used it. they have heard about what EDS is doing -- doing increasingly and so forth. All that is definitely getting easier. You know more references and all the rest of it.

On the flip side, this is still a very -- this is an overall technology buying environment, characterized by long sale cycles. And I think every tech company you know sort of has this -- it is just a fact of life that sale cycles are kind of back to waht they were in the early 90s which is -- these can take quite (indiscernible) and customers tend to have very specific cycles -- decision-making processes and cycles and procurement processes they go through. Before they will buy a piece of software. So, that doesn't necessarily mean that the sale cycle is accelerating at a rapid rate. But, you know, I don't frankly think we need it to because, you know, we start working on deals early -- we work on them for long time -- we get very wired into these organizations -- the deal sizes very large when we do them -- we're able to win them. And so, it seems to work.

Okay. And my next question is like, once like, Company says okay, well great, we'll go ahead and take you guys on as helping us with our data systems and what not -- how long from the point of sale does it take for you guys to actually be able to integrate your system and get it up and running to 100 percent capacity within that environment?

Yeah, that is a great question. It really depends a lot on the account and the size of the account. The factors that kind of determine it are things like number of devices managed, number of pieces of software in the software stack, amount of functionality applied, new technologies incorporated, number of data centers that they are deployed on, the number of internal systems that we are integrating with. And, it ranges -- on the short end, we've had customers come up fully functional in two months. And then on the longer end, a large deployment over many data centers for several thousand servers might take five or six months. So it varies quite a bit. You know, even -- potentially if there is a big integration, it could be even longer than that. So, somewhere is -- but generally the range is about two to six months.

This is one of the reasons you can imagine we are excited about Tangram is because their product capability to quickly analyze and discover a lot of the details around the systems that people are running should make it easier for us to be able to go through that cycle.

Okay. And I'm sorry for taking so much time, but it's my final question, I promise. As I don't know if you guys remember the debacle over at Sun Micro -- obviously a lot of people do -- but when they would go out and they would sell products to ABC Company and ABC Company would default, primarily just go bankrupt and not be able to pay them -- I know that you guys are working somewhat on a degree of, okay, we'll install your system -- things upon that nature. Once you install a system fully up and running -- and this may be a question that was asked earlier, and if so I apologize beforehand. But, how long, once that system is up and running, before you guys actually see full payment for that? And, once that is done -- once you guys do receive full payment, will there be residual payments, as far as going back in to help Joe and Susie of the Company be able to figure out different product updates and what not?

So, first of all, we invoice up-front. You know, it just depends on the terms of the contract. But generally, we get paid within 60 to 90 days of contract signing, regardless of the implementation.

The EDS Deal is prorated over three years. But the other deals for the most part are -- we get the cash up-front. (multiple speakers)

And as far as the second part?

Sorry?

As far as the second part of the question, as far as like product updates and things of that nature -- like a lot of companies work with licensing contracts and things of that nature. Like if you need to go in there to help these people update their system and what not, will that be an ongoing payment cycle with them? Or is it usually just a one point-of-sale?

Maintenance, we get up front and professional services, we would invoice upon signing the contract.

Okay. Thanks a lot guys. I appreciate you taking the time and good luck in the future.

One other thing I would note real quick is that the other problem that a lot of companies have during the bubble, including Loudcloud, actually, was a lot of the customers in the bubble were dot-coms -- our customer base is entirely blue chip. So, it's customers like EDS and Met-Life and a lot of these others that we have been talking about. So the odds of any significant number of them going bankrupt is extremely low.

That is all the time we have for our question-and-answer session today. I'd like to turn the conference back over to Mr. Ken Tinsley for any additional or closing remarks.

Great (indiscernible). Thank you very much and thanks everyone for your participation today. As always, if you have any questions, feel free to contact us here in Sunnyvale. Thank you.

That does conclude today's Opsware Inc. third quarter 2004 conference call. You may disconnect at this time. We do appreciate your participation.