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Smith Micro Software, Inc. (NASDAQ:SMSI)

Q2 2009 Earnings Call

August 3, 2009 4:30 pm ET

Executives

Charles Messman - MKR Group

William W. Smith Jr. - Chairman of the Board, President, Chief Executive Officer

Andrew C. Schmidt - Chief Financial Officer, Vice President

Analysts

Maynard Um - UBS

Chad Bennett - Northland Securities

Richard Valera - Needham & Company

Lauren Ye - J.P. Morgan

Scott Sutherland - Wedbush Morgan

Larry Harris - C.L. King & Associates

Kevin Dede - Jesup & Lamont

Ian Gilson - Zacks Investment Research

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Smith Micro Software fiscal Q2 2009 conference call. (Operator Instructions) I would now like to turn the conference over to Charles Messman of MKR Group. Please go ahead, sir.

Charles Messman

Good afternoon, and thank you for joining us today to discuss Smith Micro Software’s financial results for its second quarter 2009, which ended June 30, 2009. By now, you should have received a copy of the press release discussing our second quarter results.

If you do not have a copy and would like one, it is available at www.smithmicro.com, or by calling 949-362-5800, and we will email one to you immediately.

With me today on today’s call is Bill Smith, Chairman, President and Chief Executive Officer; and Andy Schmidt, Vice President and Chief Financial Officer.

Before we begin the call, I want to caution that on this call, the company may make forward-looking statements that involve risks and uncertainties, including without limitation forward-looking statements relating to the company's revenue guidance for fiscal 2009, its financial prospects and other projections of its performance, the company's ability to increase its business and anticipated timing and financial performance of its new products and potential acquisitions.

Among the important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements are changes in demand for the company’s products from its customers and their end-users, new and changing technologies, customer acceptance of those technologies, new and continuing adverse economic conditions, and the company's ability to compete effectively with other software companies.

These and other factors discussed in the company’s filings with the Securities and Exchange Commission, including its filings on Form 10-K and 10-Q, could cause actual results to differ materially from those expressed or implied in any forward-looking statements.

The forward-looking statements contained in this release are made on the basis of the views and assumptions of management regarding future events and business performance as of the date of this release and the company does not undertake any obligation to update these statements to reflect events or circumstances occurring after the date of this call.

At this time, I’d now like to turn the call over to Bill Smith, Chairman, President, and CEO. Bill.

William W. Smith Jr.

Thanks, Charles. Good afternoon, everyone and welcome to our second quarter 2009 earnings conference call. I am pleased to report another strong financial performance. We achieved the strongest second quarter revenue results in our company’s history and for the first six months of the year, our strongest top and bottom line performance as well.

During the quarter, we grew our revenues 11% year-over-year to $26 million. But just as important as our strong revenue growth is our operating performance during the quarter. Our earnings per share were $0.04 per diluted share on a GAAP basis, or $0.17 per share on a non-GAAP basis.

Looking at a couple of key indicators by which we measure our business, our gross profit on a GAAP basis of $22.1 million, increased by $4.1 million or 23% from second quarter of 2008.

Our continued strong performance is also reflected in our non-GAAP gross profit of 89.7%, which compared to 81% for second quarter of last year.

During the quarter, we continued to deliver high value data connectivity offerings to meet our long-term mobility strategy. Looking across the different areas of our business, we continued to add new customers in new market segments and we believe these new customers will have an impact on our financial performance during the second half of the year and beyond.

We’ve significantly expanded our addressable market by signing our first cable operator, Comcast, who recently began offering mobile broadband services. We also built upon our leadership role in WiMAX connectivity solutions by securing a new customer, Digital Bridge Communications.

Based on our continued success with customers, both new and established, we anticipate the company’s revenues will remain on track during the second half of the year. As most of you know, our revenues tend to follow the timing of our customers’ new product and service launch initiatives, and while our customers have expressed concern over the general economic situation, our ability to continue to add new customers is helping us to perform at a growth level consistent with our revenue guidance.

As we have consistently conveyed, our business model continues to generate significant free cash flow from operations as evidenced by how our cash position grew to $43.8 million during the second quarter. We view this quarter’s solid cash flow and record revenue results as reflecting well on our strategic direction, both short-term and long-term.

Our Quicklink family of software products, which facilitates connectivity to mobile networks, remains the key growth driver for the company as revenue for this group increased 55% year over year from $12.9 million to just over $20 million in the second quarter of 2009.

Our mobility line of products, which includes our connectivity and security and multimedia and convergence products grew 27% from $16.8 million in Q2 2008 to $21.4 million in Q2 2009.

Looking to the remainder of the year, we remain positive about our future opportunities, our ability to expand into new markets, add new customers, and extend our leadership role as the preeminent software provide in the mobility and connectivity marketplace.

Later in the call, I will discuss in greater detail our opportunities within our business segments and our overall view of the markets in which we operate. But now I would like to turn the call over to Andy Schmidt, our CFO, to review our second quarter financial results. Andy.

Andrew C. Schmidt

Thanks, Bill. Okay, first let me go over our customary introductory items. As we have in past quarters, we have provided non-GAAP results and a reconciliation of non-GAAP and GAAP results. The non-gap results discussed on this call net out amortization of intangibles associated with acquisitions, stock compensation related expenses, and non-cash tax expense to provide comparable operating results.

Accordingly, all results that I refer to in my prepared remarks for both 2009 and 2008 are non-GAAP amounts. Our earnings release, which will be furnished to the SEC on Form 8-K contains a presentation of the most directly comparable GAAP financial measures and a reconciliation of the differences between each non-GAAP financial measure provided in the press release and the most directly comparable GAAP financial measure. The earnings release can also be found in the investor relations section of our Web site at smithmicro.com.

All right, let’s discuss our detailed second quarter results. For our second quarter, we posted revenues of $26 million and earnings of $0.17 per diluted share. Total revenues of $26 million increased from revenues of $23.5 million for the second quarter of 2008, an increase of 11%. International revenue was approximately $1.8 million this quarter across all business groups.

As noted on our SEC filings, we are now reporting the following business segments: Wireless, consumer, and other. Wireless includes our Connectivity and Security and Multimedia and Convergence business units. Consumer represents our productivity and graphics units and our other category remains unchanged from 2008.

As such, wireless reported record revenues for the quarter of $21.4 million as compared to $16.8 million last year, an increase of 27%. Within the wireless segment, connectivity and security posted revenues of $20.1 million compared to $12.9 million last year, an increase of 55%. Multimedia and convergence posted revenues of $1.3 million compared to $3.9 million last year.

Slightly offsetting overall gains in our wireless sector, our productivity and graphics group posted revenues of $4.3 million as compared to $6.2 million last year, a decrease of 30%.

And finally, we reported approximately $281,000 of other revenue, which compares with approximately $396,000 for our second quarter of 2008.

Total deferred revenue at June 30, 2009, was approximately $3.3 million.

Switching to gross profit, non-GAAP gross margin dollars of $23.3 million increased $4.3 million or approximately 23% from the same period last year. Of key significance, while our revenue increased 11% year-over-year, our gross margin dollars increased 23% for the same period.

As follows, non-GAAP gross margin as a percentage of revenue was approximately 89.7% for Q2 2009 compared to 81% for Q2 of 2008.

Non-GAAP gross margins by product group were as follows -- connectivity and security, 95.2%; multimedia and convergence, 62.1%; productivity and graphics, 74.2%; and the other category, 64.4%. As we’ve noted before, our margins are driven strictly by product mix.

Okay, switching to operating expenses -- non-GAAP operating expenses for the second quarter of 2009 of $16 million is an increase of approximately $600,000 from Q1 of 2009. This change is as expected. We continue to add additional engineering resources to meet new customer product deliverables scheduled for future quarters. From a year-on-year perspective, non-GAAP engineering expenses increased 16%, selling and marketing expense increased 6%, and we’ve kept our administrative expense flat.

Total non-GAAP operating expenses increased 9.4% year over year, which is significantly lower than the 23% increase in gross margin dollars.

Non-GAAP operating margin for the current period was 28.1%, higher than our benchmark 25%. Current period operating margin compares very favorably to operating margin of 18.7% for Q2 of 2008. Non-GAAP net income for the second quarter was $5.6 million or $0.17 per diluted share as compared to $3.6 million or $0.12 last year.

From a balance sheet perspective, our cash position closed at $43.8 million at June 30, 2009, an increase of $7.2 million from the beginning of the year. Accounts receivable at June 30, 2009 increased to $22.1 million from $18.4 million at the start of the year.

Net working capital at the end of Q2 was a very strong $55.9 million.

Cash generated from operations for the quarter was an exceptional $5.3 million. The primary uses of cash for the period were capital expenditures of $2.4 million. Capital expenditures were primarily lease hold improvements related to new facility space, a new ERP system, and a new IP telephony infrastructure.

Again, free cash flow year-to-date is $7.2 million despite a strategic investment in our business.

Overall, we had a very good quarter and we’ve had a great first half of the year. Despite [global economic challenges], revenues are up year-on-year but of key significance, our gross margins, operating margins, profitability, and cash flow all improved significantly over last year’s quarterly and six-month performance.

Looking forward to the balance of 2009, we expect our business to continue to improve. As the first half of the year was strong in terms of winning important new details, we expect to continue to invest in our engineering infrastructure. As we look to the balance of the year, we expect our existing key customers to continue to perform well, given the challenging economic environment. We are excited that our new customers expect to launch their new products on time but can’t comment at this time as to the pace of the new product launches.

All of our deals are multi-year in nature and represent a long-term commitment by our customers. However, products are often launched in a segmented manner, so revenues from new products start modestly and continue to grow over time. The resultant pace of the new product launches will be a determining factor in our revenue growth over the next couple of quarters.

With regard to gross margin, we expect our product mix to remain stable and expect mid- to high 80% gross margins. Operating margin will continue to be revenue dependent with 25% being our benchmark.

Taxes continue to be in a state of change given the state and federal deficit spending. At this time we are estimating that our 2009 cash-based tax expense will be 25% to 30% of non-GAAP net income. As tax law changes through the year, I will provide an update to this metric.

Finally, at this time we are reiterating our revenue guidance of $110 million to $115 million for 2009.

In terms of housekeeping, we expect to file our current period 10-Q on Tuesday.

At this point, I'll turn the call back to Bill.

William W. Smith Jr.

Thanks, Andy. Our connectivity and security solutions for laptops, netbooks, and other mobile devices represent an unrivaled portfolio of competitive products. Looking at the first half of 2009 versus the first half of 2008, the revenue associated with these product lines increased by a significant 62%.

During the quarter, we began to deliver new solutions to enable our customer subscribers to be on the cutting edge of mobile broadband capabilities. This is reflected in a new multi-mode connection management solution we recently delivered to Comcast that allows end users to roam between WiMAX and EVDO technologies, a first for the marketplace.

While this is the first cable company to begin offering mobile broadband services, we believe that other players in this market segment will be very active in the coming months as they launch new wireless services that converge with their land line offerings.

In the 4G space, Clearwire, in combination with Motorola, both customers of ours, continue to launch WiMAX services in markets such as Atlanta and Las Vegas. We announced a new WiMAX customer, Digital Bridge Communications, which will deliver WiMAX services in 15 U.S. markets.

Overall, we are beginning to see a lot of activity with regard to mobility solutions for 4G networks from our leading customers who have become more public about their network rollout plans for 2010.

We see this as a great opportunity for us as we build upon our clear leadership in 4G connectivity solutions.

I am pleased with our pipeline and new sales activity as we reach the halfway point of 2009. Our strength has notably been fueled by demand for mobility services and new devices that continue to broaden overall market. Nearly all of our carrier customers are in the process of offering netbooks either through trials or strong promotional campaigns.

While it’s clearly too early to project how large the trend could be, early results are showing significant promise. And our customers are requiring more and more new product development as they refine their product rollout strategies.

Needless to say, we are excited about the potential with netbooks in the marketplace going forward.

As we indicated in the first quarter of 2009, we began work with a second large PC OEM customer and have made significant progress towards completing the initial product development. We look forward to more discussions about this new customer relationship after their product launch later in fiscal 2009.

Turning to our other PC customer, Dell, sales remain solid, representing approximately 13% of our total revenue during the quarter. Overall this vertical market is relatively new and has significant upside.

We see great opportunities with both of our PC OEM customers as we broaden our connectivity product solutions across a wider mobile computing product segment.

Looking at our carrier customer base and their contributions to our results this quarter, Verizon Wireless had a very strong quarter with us, edging up slightly to 36% of our revenue. I continue to be pleased with our progress in achieving a broader, more balanced customer base between carriers, PC OEMs, and enterprises, as all contributed strongly to our results during the quarter.

Our multimedia and convergence product lines represent the combination of three major product initiatives -- device and server management solutions, IMS or rich communication suite solutions for fixed mobile convergence, and PC-based and cloud-based mobile multimedia management.

Starting with our media management solutions, we have worked hard through the first half of the year to retool our technologies to address the growing need for synchronizing and managing data and media files across multiple platforms and the web. The combination of our PC media management and extensive support for side-loading data from hundreds of handset is being enhanced to leverage some of our over-the-air capabilities used in our device management business to address wireless synchronization to cloud-based services.

As we continue to augment the product line with advanced features that create a more integrated user experience, we are better serving existing customers such as Nextel International and LiveWire, while pursuing additional growth opportunities with new customers.

We have continued to make progress with our device management product, as new agreements expand our relationship with HTC for Android device management clients and for further server product deployments with our partner, Huawei.

We are excited to see opportunities in the device management space arising within the cable and WiMAX service providers and in this quarter, we delivered our first solution to a new cable partner in the U.S.

We are actively integrating the technologies and capabilities that device management brings into our connectivity and security product line to further differentiate Smith Micro offerings to support our customers’ wireless services and mobile broadband offerings.

Let me turn now to our productivity and graphics group, which is focused on distributing products to the business and consumer segments. As expected, in the retail channel we saw a decline in revenues mainly due to seasonality, as well as the overall economic environment. The group reported revenue of $4.3 million, in line with our expectations. As we stated in the first quarter, we expect this run-rate of approximately $4 million plus to continue throughout the remainder of this fiscal year.

We continue to be opportunistic with the productivity and graphics group in finding and building new product offerings to address new emerging markets. We are successfully diversifying our customer base through new deals with major companies that continue to find value in our products, especially our patented Stuffit technology.

For example, we won a new Stuffit imaging license agreement this quarter with a leading technology fortune 100 corporation and also launched new publishing products and updates to our leading compression, utilities, and graphics products.

We also recently relaunched Content Paradise, a new online marketplace and creative platform for hobbyists, artists, and graphics professionals.

Overall, this remains a profitable business segment for the company.

Now, before I open the call for questions, I would like to leave you with these thoughts. Our strong financial results in the second quarter of 2009 show that Smith Micro continues to perform well. Our new customer agreements and the demand for our innovative connectivity line of products both signal the strength of our existing relationships and our ability to open doors to new markets and new customers such as Comcast, the first cable operator to launch a national high-speed wireless data broadband service.

We remain extremely well-positioned to move aggressively, to leverage our strong cash position, to make strategic technology acquisitions to capitalize on new opportunities as our markets evolve.

During the first six months, our operating cash and cash equivalents grew to $43.8 million, and our disciplined approach to cost and expense management gives us a strong financial position and we remain debt free.

We are very optimistic about both the opportunities ahead of us in the latter half of 2009 and with the product and business strategies with which we have positioned ourselves.

We remain in line with the revenue guidance of $110 million to $115 million that we provided at the beginning of the year.

Where our customers have mobile connectivity and mobility software needs, we add value. Through a combination of innovation and execution, we bring an unprecedented product portfolio to life. The increasing diversification of our customer relationships help strengthen our company to succeed. We will continue to drive to the market new technologies that enable our customers to better manage their mobile connectivity, mobile media, and mobile devices.

This fundamental product strategy reflects Smith Micro's philosophy to enrich the experience people have with their computers, mobile devices, and wireless networks.

With that, Operator, I would like to open this call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Maynard Um with UBS.

Maynard Um - UBS

Thank you. You commented that revenue will be determined by customer product releases. Can you just talk about what’s embedded in your revenue guidance and in particular, are you not assuming some customer launches in the back half? I’m just trying to get a sense of what level of conservatism is built in. And then I have a follow-up.

William W. Smith Jr.

Okay, fine. Well, I mean, I think we see that there will be a consistent flow of new customer launches throughout the back half of the year. We have anticipated that but as I’ve always said, when you are selling OEM software, new deals tend to start slow and then build up over time. So I think we’ve probably taken that as a basic outlook when we looked at the back half of the year. We feel very strong about the second half of the year and look forward to the third and fourth quarters.

Maynard Um - UBS

Okay, and then can you just talk about your expectations for business mix in the second half? And then also maybe kind of a split if you can between Q3 and Q4 from a revenue perspective?

Andrew C. Schmidt

Well, let’s just start with the product mix, or business split, as you call it -- it should be somewhat consistent with what you saw this quarter. Obviously with the wireless sector being the primary growth area, consumer, as we said before, is going to run somewhere in the fours every quarter. Splitting Q3 into Q4, we won't do that, per se. We have to just kind of wait and see how it comes together but we expect, and as Bill pointed out, the launches of our -- the new customer, new product launches, you basically start slow and build so our expectation is that what will launch in Q3 would grow in Q4. That seems to be logical. You know, an example Bill brought up as a new customer, Comcast -- you’ve seen in press releases they’ve launched but only a few cities, and then they will basically -- you know, they launched in Portland as per the press release but you will see them launch in other cities as they go forward. So that’s just a perfect example of a segmented launch.

Maynard Um - UBS

Okay, and the last one and I’ll get back in the queue but related to your PC OEMs, can you just remind me of the revenue recognition? Is it based on activation or sell-in? And I’m just wondering if you’ve reached the minimum threshold that you had in the contract?

Andrew C. Schmidt

Okay, typical contracts are in sell-in. Sometimes, depending on the technology -- and again, it’s more technology driven. They are activation based but we don’t see a sell-in type inventory lag that you might expect on an activation model, so that’s not particularly relevant for us. The key relevance is how fast are they launching and what kind of marketing programs are they putting together. That helps.

Maynard Um - UBS

And just in terms of whether you’ve reached your -- because you’ve talked about the contracts having a minimum. I’m just wondering if you are experiencing the upside relative to those contracts now?

Andrew C. Schmidt

Well again, in very select cases, if we have quite a bit of up-front engineering work to do, as we have customers that may launch slowly, we have may minimums. Those again really aren’t in play as far as driving our numbers any particular way, so I don’t think there’s any real relevance at this point as far as our minimums are concerned.

Maynard Um - UBS

Okay, thanks.

Operator

Your next question comes from the line of Chad Bennett with Northland Securities.

Chad Bennett - Northland Securities

A couple of questions -- regarding the second half of the year, even at the low-end of your guidance range, you are looking at $30 million quarters -- and maybe this is piggy-backing on the prior question -- so are we -- can we kind of get a sense for how much of this is existing customers and programs that we are aware of right now and how much of this is new customers? And then if we can drill down a bit more and try to get a sense -- I don’t know if you have your arms around it yet, or your carrier customers do, kind of what the embedded assumption is for the netbook opportunities out there in the second half? I imagine it’s more of a 2010 event but any color you can provide.

William W. Smith Jr.

I think the way to look at it -- I am starting to understand the line of questioning. As we look at Q3 and Q4, we know what our customer mix is -- whether they are in public hands or not, they are known to us. So we are comfortable with the guidance we have given you and we have reiterated at least three times already on the call and I have no problem doing it again, but we feel comfortable that we will make our numbers. I mean, it’s not a walk in the park and never is but we’ve got a strong team, we’ve got a strong mix of customers, an incredibly strong portfolio of technologies and we are executing on a business case that just seems to work.

As far as the netbooks, I am very excited about the netbooks. I have not forecasted in large numbers for netbooks because I don’t know yet that the consumer is going to adopt netbooks. So while I am hopeful that the consumer will adopt it and that it will become very successful, I think if there’s a lot of activity in that area and a very strong attach rate, that should be viewed as up-side.

Chad Bennett - Northland Securities

Okay, and then Bill, another one for you -- can you talk about the impact of 4G upgrades on your business, which I assume are pretty positive? Verizon, I think it was last week was pretty specific in their 4G rollout in 2010. AT&T has gotten more detailed about their plans in 2010 and then the guys like Clearwire on the WiMAX side I think are probably even more aggressive than they were three, four months ago about how quickly they want to get networks up and running. Just in general, can you talk about that upgrade and the impact on your business?

William W. Smith Jr.

Well, yeah. You know, we’re in the wireless connectivity business. I mean, we make it possible for folks to get hooked up to the wireless Internet, get their jobs done, execute on what they are doing. And when you could move from 3G, 3.5G to 4G, and suddenly you are looking at wireless data rates that are very much on par with wireline rates, you know, that’s got to bode extremely well for us. I think it’s going to bode very well for our carrier customers and our carrier customers are becoming broader. You know, we’ve talked for some time about the fact that the cable folks would enter the wireless space and now we can actually put the first name on the dotted line and tell you who it was. Well, there’s more to follow and our current carrier customers that come from the telecom side with their plans to roll out LTE are excited.

So you’ve got a lot of activity in the marketplace and it’s a worldwide marketplace -- I mean, we tend to focus heavily on North America but it is broader than that. You are seeing the rollout of both LTE and WiMAX, WiMAX leading the way, LTE to follow soon. And this is going to bode well. It’s great from a connectivity standpoint, it’s great from a multimedia and convergent standpoint because we are going to talk about transmitting voluminous amounts of data over a wireless infrastructure that really for the first time is really up to it. I mean, this is an infrastructure that is not taking a back seat to wireline.

So when we hit the 4G world, this is a very exciting time and I think it bodes extremely well for Smith Micro as well as our customers.

Chad Bennett - Northland Securities

Okay. And then a quick one for Andy -- Andy, were there any other, besides Dell and Verizon, were there any other 10% plus customers in the quarter?

Andrew C. Schmidt

No.

Chad Bennett - Northland Securities

Okay, and then Verizon in particular, 36% of revenue I believe this quarter, obviously revenue was sequentially up and Verizon I think was 28% last quarter. Was there anything specific that drove the Verizon revenue or did you see some netbook business or just kind of generally speaking, is there any explanation for the strength from Verizon?

William W. Smith Jr.

Without getting into a lot of details because we just can’t right now, your net takeaway is that we are selling multiple products to Verizon, many of which have not been publicly announced and you are seeing that affecting the revenues.

Chad Bennett - Northland Securities

Got it.

William W. Smith Jr.

You know, we’ve talked for a long time about the strength of the portfolio and as this unveils itself, I think you are going to see why we have been so strong about this. I mean, carriers that we do business with tend to like to do business with us. They tend to want to buy more from us and this may be the start of a trend.

Chad Bennett - Northland Securities

Are these products -- just to probe a little more, are these products obviously inside the connectivity grouping?

William W. Smith Jr.

They are inside the wireless grouping, which is then much broader, so you’ll have to bear with me on that.

Chad Bennett - Northland Securities

All right. That’s all I have. Thanks, guys. Good quarter.

Operator

Your next question comes from the line of Richard Valera with Needham & Company.

Richard Valera - Needham & Company

Obviously noticed you filed the shelf here, gentlemen, and you have a strong balance sheet but I just wanted to see if I could get any color on the thoughts on the shelf, presumably maybe for some opportunistic M&A but Bill, if you could shed any color on that, that would be great.

William W. Smith Jr.

You know, we have nothing planned. We have been extremely inquisitive. We are very much out in the marketplace looking at added technologies and business cases that we think would be additive to what we do. We of course do everything by first talking to our current customers. We make sure they think it’s a good idea, something that they want to buy. And so this is really more an effort just to position ourselves to be opportunistic. We have no plans to use the shelf at the present time but by putting it up, it just makes it that much easier for us to enter the marketplace if all the moons line up.

Richard Valera - Needham & Company

That’s helpful. And Andy, with respect to gross margin, very strong this quarter. How should we think about that going forward? Do we think it could stay at these kinds of levels, sort of near the 90% or might that bounce a little bit lower again with some mix shifts?

Andrew C. Schmidt

Yeah, [just as I had talked], probably again the mid to high 80s is where we expect the balance of the year to fall. So again, very strong performance but it can move a tick or two depending on product mix, as you kind of referred to.

Richard Valera - Needham & Company

Great. And then Bill, just wondering how you are seeing the market in terms of competition and pricing. I know you have one private competitor out there that maybe hasn’t been as disciplined as you on price. Can you just describe how you are seeing the market, I guess particularly in the connectivity space with respect to pricing?

William W. Smith Jr.

Well, you know, one of the things that we are seeing a very consistent trend towards is the need to add more and more power to the overall connectivity software. That tends to fly in the face of pricing pressures and rather lead us more to an increasing price point, so these two factors tend to work against each other and for us it tends to work out in a more positive way. So we continue to stay very focused. We’re very cognizant that competition is there. However, we understand our role as the absolute leader in this space. We have more technology to bring to bear than anybody else that’s out there that we compete against, and we’ve clearly leveraged that as part of our overall business case and our muscle.

So we think we can not find ourselves in a lot of pricing pressures. We frankly see that our biggest issue is just building out the new technologies, getting them to the marketplace on time to allow our customers to launch their offerings.

Richard Valera - Needham & Company

Great, thank you. And Andy, just quickly, if you could give the stock comp and amortization by OpEx line item.

Andrew C. Schmidt

Sure. Okay, stock comp, total of $2.483 million, made up as follows: cost of sales line, $56,000; selling and marketing, $703,000; R&D, $688,000; G&A, $1.036 million, again for a total of $2.483 million.

Amortization, total of $2.138 million, made up as follows: cost of sales, $1.179 million; selling and marketing, $632,000; R&D, $327,000; again for a total of $2.138 million.

Richard Valera - Needham & Company

Great. Thanks very much, gentlemen.

Operator

Your next question comes from the line of Lauren Ye with J.P. Morgan.

Lauren Ye - J.P. Morgan

I just wanted to once again try to understand the operating margin in the back half a little bit more. So if your product mix is similar and connectivity is the growth area and you mentioned gross margins to be in the mid to high 80s, I guess I just wanted to understand the 25% op margin kind of guidance you are going at. Is it because that you are increasing a little bit your operating margins as I guess customers are launching, or is this for new customers? Or I guess is this more just conservatism on your part?

Andrew C. Schmidt

You know what, it’s all of the above. Conservatism, always -- we’d like to beat the numbers but we continue to build very aggressively for the future but more so from a contract win perspective, so when we look at building resources, we’re not out speculating. We’re basically staying up with customer demand. As Bill said before, when we look at competitors, we bring more technology to bear but something else that we are seeing from the very large customers is there’s a lot of -- let’s call it supplier consolidation going on where if you look at the wireless sectors of the big carriers, they are very profitable and they are leading the ship in those companies. They are looking at how can they actually manage their new initiatives and they are looking at -- they will always look at consolidating projects with strong players and that’s where Smith Micro sits.

But for us, we always have to be looking at building our infrastructure to be able to stay up with this pace, so we’ll always hedge back to that 25%. This quarter it was 28%, which was fantastic. Can we operate at the level? Of course, but again our key objective right now, having won these contracts and see this really tremendous opportunity ahead is staying up with it and actually staying ahead of it.

Lauren Ye - J.P. Morgan

Okay, and then Bill, you know, just around the netbooks again, so Verizon and AT&T, they are shipping. Can you just talk about the trends that you are seeing at least? Was it kind of to your expectations? Are you expecting this ramp to kind of be like a product cycle where it will taper off or continue to proliferate maybe long-term?

William W. Smith Jr.

You know, I wish I could answer those questions. I mean, a lot of it really lies in the reaction of the consuming public to the netbook. If the consuming public embraces the fact that they are light, they are small, they are easy to carry, they still have a nice sized keyboard, unlike some of the PDAs which, for my fat fingers, you know, become a problem, then you are going to see the netbook phenomenon accelerate. And I guess I am hopeful that that’s the case but I don’t know that’s the case.

So in my earlier question, you know, I haven’t really built in a real expectation for netbooks per se. I just have this sixth sense that says I believe that these have a great opportunity to be incredibly successful and if they are, that should bode well for both us and our customers. So that’s how I view it. It’s an opportunistic thing. I think it has the capability to have a big upside. How big -- I’ve got to leave it to those of you that call yourselves analysts because you have the crystal ball and I’ve never been very good at that, so I’ll have to leave it to you, Lauren.

Lauren Ye - J.P. Morgan

What about just the initial things that you have seen so far? Has it been to your expectations?

William W. Smith Jr.

Well, I didn’t have an expectation -- see, that’s the whole problem. You know, they have done reasonably well and there has been good attach rates and -- but I didn’t watch these things and say well gee, I expect that the industry will sell X hundreds of thousands of units, you know? And so at this point, I think it’s time to collect data. I think that that data collection can go through the end of the year and then we can really look at it and say okay, based on run-rates of actual sell-through for the second, third, and fourth quarters, this is what this looks like and this may be what it means then for 2010.

Andrew C. Schmidt

Just to add on to what Bill is saying as well, you know, they’ve just been out now for maybe a quarter and a half, so when you see that a product like this is launched into summer, it’s a little bit type of an awkward marketing timeline. We’ve got back-to-school coming up in this quarter, which will be interesting based on the demographic profile of who might be buying these. And then we are going to get into your prime retail selling season, you know, the fourth quarter. So those two quarters bring different types of marketing programs, opportunities for the carriers and others. So at that point, certainly as Bill said, by the end of the year we should have enough data to really see how did this all go.

Lauren Ye - J.P. Morgan

Right. I guess I was just -- another way to ask it was just how much of expectation did you embed in your guidance? Is this a lot that’s in the 100 to 115 guidance or is this kind of just the icing on the cake?

Andrew C. Schmidt

More the icing -- back in January we didn’t know a lot about these devices, so you can rest assured it wasn’t really built into the forecast.

Lauren Ye - J.P. Morgan

Okay, and just a last question is just around the legacy connectivity -- how is that trending?

Andrew C. Schmidt

It’s been doing well. The legacy connection business, connection manager business -- you know, again it’s been stronger and stronger every quarter as you can see from the total wireless sector and then as we broke out just the pure connectivity piece, up 55% year over year, it’s doing tremendous, especially in light of LTE and everything coming out. I think we are starting to really see some broad demographics come into play with this product.

William W. Smith Jr.

That’s actually a strong point, you know. As you start to see the rollout of WiMAX and LTE, that’s all new software royalties for us because all the old cards, all the old software, all the old USB devices, et cetera that are out there are going to be thrown out and all new ones have to march in to take their place. So this is just another reason to be extremely bullish about our business case as we head into 2010 and beyond. So we feel really, really good about things.

Lauren Ye - J.P. Morgan

Okay, great. Thank you.

Operator

Your next question comes from the line of Scott Sutherland with Wedbush Morgan.

Scott Sutherland - Wedbush Morgan

Thank you. Good afternoon. Good quarter, guys. A couple of questions -- first of all, I know you’ve won a few WiMAX deals and you are getting some traction on bids with Motorola -- can you give an update there? And how material are you seeing WiMAX for this year, or is that more future years?

William W. Smith Jr.

I think you are going to see your first -- well, you are seeing your first rollouts through Clear and then that’s going to then dovetail into the rollouts for the cable guys, of which we have just put a name on the first one, that being Comcast. So -- and there will be others to follow. We have talked about some of the other offerings in the WiMAX space.

As far as Motorola, Motorola we expect to really start generating more business for us pretty much non-North American business in the last half of the year. They’ve got a lot of activities underway and we’ll just have to wait and see but we think that will be a strong catalyst for us.

So you know, the WiMAX space, it’s just getting started. It’s not going to knock your socks off yet but as they build out their platform and they light up more cities and countries around the world, for that matter, you know, I think it has the capability to be a very successful technology offering. We just kind of have to wait and see.

Scott Sutherland - Wedbush Morgan

Looking at the competition side of things, Microsoft with Windows 7, you know, we’re kind of -- you know, who is going to potentially adopt that. Do you see any of the functionality there being more competitive? And you had a pretty interest patent we read through. Can you talk about -- does that provide any protections or how you would use that?

William W. Smith Jr.

Okay. You know, when you talk about Windows 7, Apple has had wireless connectivity built into their operating system for a year or two, I don’t know. It’s been a while. Wireless connectivity built into operating systems tend to be extremely vanilla, not particularly feature rich and in some cases, not even particularly that easy to use. So I guess as I view the offering by operating system outfits of wireless connectivity, that doesn’t particularly cause a problem.

You know, one of the things that we do is we provide branding opportunities to our customers, operating systems don’t do that. We provide the capability to launch hundreds of new devices. You know, if you want to wait for the next release of Microsoft’s operating system to launch your device, you are probably going to perish so I don’t think that’s going to work either.

You know, I’m not particularly concerned about it. It’s something that we have to continue to push the envelope. I alluded to the fact that we are trying to pack more and more technology inside of a connectivity client and therefore -- or thereby redefine the definition of what a connectivity client is. This is not a game that really plays well for those who write operating systems that take months and years to get a product built and launched and then another year or so to get it right. So I think that’s really not a big challenge.

I think the trick for us is to continue to execute -- to build the best of breed technology for all our customers and our customers are large. They are demanding and they expect that and they are willing to pay for it and we are willing to do what it takes as far as from a staffing and from a planning and an execution point of view to keep this market growing.

Scott Sutherland - Wedbush Morgan

Okay, maybe lastly, one of the questions we were trying to understand last quarter is as you move into this PC OEM model and they are paying you and then those devices get shipped to carriers, have you thought a little bit more of how to think about the revenue model of how you are getting paid by both the device OEMs and the carriers and which predominates over time?

William W. Smith Jr.

I think that -- I think history has to play this one out. The carriers and the PC OEMs are heavily focused on providing a high quality software solution that’s easy to use to reach their goals from a marketing standpoint. And to the extent that their goals intersect, then they could be competitive. But in many cases, they don’t and in that way, it’s just a broadening of the marketing more than a competitive kind of thing in the marketplace.

So I don’t know how to answer that question better.

Scott Sutherland - Wedbush Morgan

Okay. We’ll talk about that over the next few quarters. Thanks a lot, Bill.

Operator

Your next question comes from the line of Larry Harris with C.L. King & Associates.

Larry Harris - C.L. King & Associates

Thank you. I’m intrigued by the announcement of the order or the relationship with Comcast, and so I just want to make sure I understand it -- if say I’m in Portland, Oregon and I sign up for the Clearwire service through Comcast, I would be getting a disc or a product, a Smith Micro product. If on the other hand I just go directly to Clearwire and sign up for the service, your customer would be Clearwire. Is that correct?

William W. Smith Jr.

Okay. I think if you sign up for the wireless broadband data service offered by Comcast, you will get your software from Comcast and it will be built by Smith Micro and branded to Comcast. Now, the fact that you know that that’s operating under the Clearwire network is really not how it’s sold. It’s sold as a Comcast offering. It also, by the way, could be operated under EVDO and then it’s working on somebody else’s network and our software will seamlessly move you back and forth between WiMAX and EVDO.

Now, the second part of your question, if you went directly to Clearwire and you signed up for the service from Clearwire, you would get connectivity software from Clearwire that is also built by Smith Micro and it would be branded to Clearwire. In both cases, they are our customers and we are very proud to have them and we look for their continued success.

Larry Harris - C.L. King & Associates

Great, and just one other question -- in terms of your working with Comcast, and I assume you’ll probably be working with one or two other cable operators here, do you think there are some opportunities, maybe not immediately, but a couple of years down the road with some of the innovative products that you’ve got in the multimedia type area that could find some applications with the cable operators?

William W. Smith Jr.

Most certainly. We’ve talked about this at investor conferences, et cetera, where we talk about the three screen strategy. And the three screens are the screen on the wireless device, the screen on the television, and the screen on your PC. And it really doesn’t matter whether you come at this challenge from the cable side or whether you come at it from the telecom side because they are all moving towards the center and when you move towards the center, you are looking for a way to put together service offerings that allow you as a carrier to make money and to then deliver the output of these services to any one of these three screens. And that’s right in our wheelhouse. This is something that we have been really focused on. We are working with all types of customers in creating these kinds of solutions and we think it’s really exciting for the future. I mean, we think we’re really one of the very few, if maybe not the only one, who can actually under one roof have all this technology and the ability to create such unique outcomes.

Larry Harris - C.L. King & Associates

Great. Okay, thank you.

Operator

Your next question comes from the line of Kevin Dede with Jesup & Lamont.

Kevin Dede - Jesup & Lamont

A question for you regarding Verizon, specifically the multimedia technology development work you are doing, that web interface capability that you are developing, is that something that you think might give you some leverage in dislocation RealNetworks at Verizon on their multimedia side? Or can you just give us kind of an update on how you see your development positioning you better?

William W. Smith Jr.

Well, first off we’ve not talked about anything about multimedia at Verizon, and really have no plans on talking about it right now. So I don’t know how to answer your question because I don’t know where the question is coming from on this one.

Kevin Dede - Jesup & Lamont

Well, I mean, you just talked about adding new functionality to your multimedia side, so I -- just thinking that out loud here --

William W. Smith Jr.

That was a good extension -- it was a good extension. That’s a logical customer to go to and I would look forward to being able to talk about that if and when I get that opportunity.

Kevin Dede - Jesup & Lamont

Okay. Can you give us just some more detail on some of the functionality you are adding to the multimedia side?

William W. Smith Jr.

Well, one of the biggest areas is historically, you know, we started in this business of wireless multimedia by focusing on music and when we look at it going forward, music is there but it’s just sort of part of the product. It’s really heavily built around photos, as well as full motion video. It’s built around the capability of warehousing all that data in the cloud and that cloud offering coming from carriers as a service offering going forward, and us allowing -- and that allowing us to build some very unique multimedia software that speaks to the cloud, as well as side loading in all types of medium.

So it’s an exciting place. There’s a role for us again from the standpoint of compression. We still believe that the compression play is there. It just hasn’t quite materialized but as this market gets bigger and the load becomes stronger on the carrier’s networks, some of our unique patented compression is a very strong play.

Kevin Dede - Jesup & Lamont

Can you give us a taste for your development at Dell, maybe the number of platforms that they have included you on and how in -- I mean, I know you talked a little bit about Windows 7 coming out already and some of the features that you bring, but how do you plan to defend your position within Dell and prevent them from taking essentially that connectivity manager solution in-house?

William W. Smith Jr.

Okay, when you look at Dell, our software ships on all of their enterprise class PCs. And the market that they are going for is the enterprise market. Now, by definition, the enterprise market is looking for a high degree of security and user authentication. It’s looking for safeguarding the overall enterprise infrastructure from a data standpoint. None of these things that I just alluded to reside in any operating system provided connectivity.

Additionally, and this was actually a question I guess I didn’t quite answer that was asked earlier, we do have patent coverage. We have some things that are pretty exciting. One of the things that carriers are becoming particularly intrigued with, as the amount of wireless data continues to grow and expand, and in spite of the fact that the networks are going to continue to get faster, there’s always going to be that moment where we use up all the bandwidth that they are capable of offering. So then you look to how do we offload, how do we move some of this wireless data to other kinds of pipes like wireline pipes? And one of the best ways to do that is to seamlessly move the data from the cellular network to the WiFi network. That’s an area where we have some pretty strong patents in and nobody else can really enter that space without being confronted by those patents.

So we have a lot of things on our side -- we know our marketplace better than anybody else, we have the broadest technology offering that’s available anywhere in the world, and we back it up with strong patents to defend our position.

This is a strong company that is getting incredibly stronger and so we will continue to execute, we will continue to focus, but I think at the end of the day we are going to come out on top.

Kevin Dede - Jesup & Lamont

Okay, Bill, one last thing for me because it’s still a little sort of hazy in my mind, is that same capability of switching between WiFi and the cellular network, does that come in handy in trading data off between say WiMAX and the cellular network?

William W. Smith Jr.

Well, it could be between any of the cellular technologies and offload to the wireline backbone, which is what you end up doing once you move it to WiFi.

Kevin Dede - Jesup & Lamont

Right, okay. And that -- is that through that IMS piece, that zip client that you add through --

William W. Smith Jr.

It’s actually built into our connectivity clients and it’s part of now multiple patents that we have been successfully awarded and we are in a pretty strong spot.

Kevin Dede - Jesup & Lamont

Very good. Okay, well, thanks, guys and congrats again on a nice job.

Operator

Your next question comes from the line of Ian Gilson with Zacks Investment Research.

Ian Gilson - Zacks Investment Research

I have a couple of questions. On the netbook market, and we’ve heard a number of announcements of OEMs coming out with new netbooks and a number of announcements of netbooks being purchased by carriers, or subsidized by carriers, then market them to their subscribers. Obviously the second mechanism one that you were going for at the moment, but is there a big enough market to do what you did at one time at Apple in the netbook market?

William W. Smith Jr.

I guess let me try to answer it this way -- we don’t know how big the netbook market is going to be yet. We all think it might be a very exciting market, so let’s make the assumption that maybe it is and so we believe that one of the most significant distribution channels for netbooks, because by definition they have to be wirelessly connected to be of value, is going to be through the carrier resale network that they have. And that’s a place that we are very, very strong. We also are focused on the PC OEM marketplace and we would like to play in that market through our PC OEM customers where they are not selling through the carrier network. And when they are selling through the carrier network, the carrier is most likely going to insist that the connectivity client be theirs and be branded to them, not to the PC OEM. Conversely, when it goes through more traditional distribution channels, you may see it as a connectivity client branded to the PC OEM. We’d like to play in both. We think we are very strong on the carrier side and we’ll just wait and see.

I think we just have to wait and see how well-adopted these devices are.

Ian Gilson - Zacks Investment Research

Okay. Last question -- how many deals that you consummated in the first quarter generated material revenue in the second quarter?

Andrew C. Schmidt

First quarter 2009, that would be zero.

Ian Gilson - Zacks Investment Research

How many are likely to generate significant revenue in the third quarter? This is the first quarter deal consummation.

Andrew C. Schmidt

It’s going to depend on just how strong the launches are. Probably again on an individual basis, none of them will be particularly material when you start comparing them to the Verizons, the Sprints, the AT&Ts, but all together, let’s say, they might show a blip there in the radar. Q3 is just the start. Q4 is going to be obviously a bigger start and then these are really big 2010 players.

Ian Gilson - Zacks Investment Research

Okay, fine. Thank you.

Operator

Thank you and at this time, there are no further questions. I would like to turn the call back over to management for any closing remarks.

Charles Messman

Thank you again for joining us today for our second quarter earnings conference call. If you have any other questions, please feel free to call us. Thanks again and we look forward to talking to you on our third quarter conference call.

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