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Executives

Charles Messman - MKR Group

Bill Smith - Chairman, President, and CEO

Andy Schmidt - VP and CFO

Analysts

Maynard Um - UBS

Rich Valera - Needham & Company

Lauren Ye - JPMorgan

Chad Bennett - Northland Securities

Charles John - Piper Jaffray

Larry Harris - C.L. King

Kevin Dede - Jesup & Lamont

Scott Sutherland - Wedbush Morgan Securities

Smith Micro Software Inc. (SMSI) Q3 2009 Earnings Call November 4, 2009 4:30 PM ET

Operator

Welcome to the Smith Micro Software fiscal third quarter 2009 conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions) This conference is being recorded today November 4th, 2009.

I would now like to turn the conference over to Charles Messman with MKR Group.

Charles Messman

Thank you for joining us today to discuss Smith Micro Software financial results for the third quarter 2009 which ended on September 30, 2009. By now you should have received a copy of the press release discussing our third 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 on today are 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 are discussed in the company’s filings with the Securities and Exchange Commission, including its filings on Form 10-K and 10-Q, and could cause actual results to differ materially from those expressed or implied in any forward-looking statements.

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

Now, I would like to turn the call over to Bill Smith, Chairman, President, and CEO. Bill?

Bill Smith

Welcome to our third quarter 2009 Earnings Call. I am pleased to report another strong financial performance highlighted by the strongest quarterly revenue results in our company’s history.

For the first nine months of the year we also posted a record top-line result with the revenues reaching $77.6 million and a non-GAAP net income totaling $16.2 million or $0.50 per share.

During the quarter, we grew our revenue 4% year-over-year to $27.8 million, but more importantly we improved our operating profit performance, where we delivered earnings per share of $0.06 per diluted per share on a GAAP basis or $0.20 per share on a non-GAAP basis.

As we recently announced at our conference in New York, we added Hewlett-Packard, the market leader in the PC OEM sector to our outstanding customer base, giving us two of the top three largest PC manufactures now distributing our connection management solutions on a worldwide basis.

In addition to the PC OEM space, we have made significant progress within the cable sector with Comcast, the first cable operator to launch with our connectivity product. Comcast is in the early stages of the rollout of their mobile WiMAX services, initially targeting select markets throughout the US. We expect to see expansion throughout the remainder of the year with accelerating growth heading in 2010, as they lied up major metropolitan areas. In addition to these new customer launches, we expanded existing relationships with all of our key customers to further enhance the current competitive product offerings as well as delivering new connectivity and media solutions, which I will talk about in more detail later in this call.

On the new initiatives front, we completed significant product development for our new multimedia solution that offers customers multiple point access to their favorite media content including music, photos and video. We expect the solution to be launched commercially with the key customer sometime within the next two quarters.

In addition, we have completed important innovations to our connection management portfolio to support seamless data connectivity for the emerging requirements to grid [ph] data sections between 3G and 4G networks.

As you all know, we have recently announced the acquisition of Core Mobility and I am pleased to let you know that we close the transaction on October 26th. This acquisition has significantly strengthened our suite of embedded mobile software technologies for the handset. While, Smith Micro has over the years becomes a premier developer of wireless connectivity software for the personal computer, Core Mobility strengths were focused on software solutions for the mobile handset.

We see significant synergies as we work to integrate the acquired technologies from Core with Smith Micro’s expanding portfolio. We are particularly excited about combining Core’s OTA synchronization and back up technologies with our new cloud-based media management and PC side loading capabilities to bring an unparallel suite of solutions to serve our customers evolving demands. Strategically, we see a number of major intersections between our combined product road maps. As well as synergies within many of the same customer accounts.

The addition of this new product portfolio will assist us in delivering not only new standalone products and the Voice over IP area such as Push-to-Talk or push-to-X, visual voice mail and voice messaging that will help us to create new combined products by leveraging the Smith Micro IMS mobile client technologies.

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.

Now, I would like to turn the call over to Andy Schmidt, our CFO to review our third quarter financial results. Andy?

Andy Schmidt

First let me go over our customary introductory items. As we have in past quarters we have provided non-GAAP results from the reconciliation of non-GAAP and debt results. The non-GAAP 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 have referred to my prepared remarks both 2009 and 2008 are non-GAAP amounts. Our earnings release which will be furnished to the SEC and Form 8-K contains a presentation of the most directly comparable GAAP financial measures and the reconciliation of the difference between each non-GAAP financial measure provided in the press release and the most directly comparable GAAP financial measures.

The earnings releases can also be found in the investor relation section of our website at smithmicro.com.

In detail matter for the financial model is on the call, let me provide a difference between GAAP and non-GAAP P&L metrics. In terms of stock-compensation, stock comp totaled $2.4 million for the current period broken out as follows, $27,000 related to cost of sales, $705,000 related to selling and marketing, $697,000 related to R&D and $976,000 related G&A.

In terms of amortization, the total for the current period was $2.1 million broken out as follows. 1.17 million related to cost of sales, 631,000 related to selling and marketing and 330,000 elated to R&D.

Moving on, for the third quarter we posted revenues of $27.8 million and earnings of $0.06 GAAP and $0.20 non-GAAP. Revenue for the quarter was an all time record up 4.4% from third quarter 2008, or previous record.

Our year-to-date revenue of $77.6 million is up 8% from 2008. While revenue did not meet analysts consensus expectations, we deal on earnings both GAAP and non-GAAP. Our year-to-date GAAP earning of $0.11 is significantly better than 2008 $0.07 loss.

In terms of non-GAAP earnings, we have now posted year-to-date earnings of $0.50 versus $0.41 for 2008, improvement of 22%. As the ultimate measure of a business with earnings we are very pleased with our earnings performance this year.

That in mind, let me go through our usual detailed analysis and talk about expectation for fourth quarter. Total revenues of $27.8 million increased from revenues of $26.6 million for third quarter of 2008, an increase of 4.4%.

International revenue was approximately $2.5 million this quarter across all business groups. Our Wireless segment reported record revenues for the quarter of 22.7 million, as compared to 19.9 million last year, an increase of 14%.

Within the wireless segment, connectivity and security posted revenues of 21.8 million, compared to 16.6 million last year, an increase of 31%. Multimedia and convergence posted revenues of $835,000 compared to 3.3 million last year.

Offsetting overall gains in our wireless sector, our productivity and graphics groups posted revenues of 5 million as compared to 6.4 million last year, a decrease of 22%. And finally, we reported approximately $169,000 of other revenue which compares with approximately $326,000 for the third quarter of 2008. Total deferred revenue at September 30th, 2009, was approximately 2.3 million.

Switching to gross profit, non-GAAP gross margin dollars of 25.5 million increased $3 million or approximately 14% from the same period last year. While our revenue increased 4.4% year-over-year, our gross margin dollars increased 14% for the same period. As follows, non-GAAP gross margin as a percentage of revenue was approximately 91.6% for Q3 2009, compared to 84.2% for Q3 of 2008.

Non-GAAP gross margins by product group were as follows: Connectivity and security, 96.8%, multimedia and convergence 72.6%, productivity and graphics, 72.5%, and other 72.2%. As we’ve noted before, our margins are driven strictly by product mix.

Switching to operating expense. Non-GAAP operating expenses for the third quarter of 2009 were 16.8 million and this is an increase of approximately $800,000 from Q2 of 2009 and is as expected.

We continue to add additional engineering resources to meet new customer product deliveries scheduled for future quarters. From a year-and-year perspective non-GAAP engineering expense has increased 21%, selling and marketing expense increased 4.5% and administrative expense increased 16%.

Of note, our administrative expense this quarter included one time legal expenses related to the core transaction. Total non-GAAP operating expenses increased 12% year-over-year. Non-GAAP operating margin for the current period was 31.6% higher than our benchmark 25%. Current period operating margin compares favorably to operating margin of 28% for Q3 of 2008.

Non-GAAP net income for the second quarter was $6.6 million or $0.20 per diluted share as compared to 6 million or $0.19 last year. From a balance sheet perspective our cash position closed at 48.5 million at September 30th, 2009, an increase of 11.9 million from the beginning of the year.

Accounts receivable at September 30, 2009 increased to 23.3 million from 18.4 million at the start of the year. Net working capital at the end of Q2 or Q3 was strong 63.4 million. Cash generated from operations for the quarter was an exceptional $5.4 million, primary uses of cash for the period or capital expenditures of $756,000.

Capital expenditures were primarily investment in the ERP system and IT infrastructure. Again free cash flow year-to-date is 11.9 million despite our strategic investments in our business.

Overall, our current quarter has been consistent with Q1 and Q2 of this year and that our gross margins, operating margin, profitability and cash flow have all improved significantly over last year’s performance.

Looking forward to fourth quarter, a key element affecting the quarter is the closing of the Core Mobility transaction on October 26. Typical with most acquisitions we like to see six months of activity before assuming to provide detailed financial guidance related to the acquisition. We have noted before that we expect the Core transaction to bring $12 million to $13 million in revenue in 2010. The other key element for Q4 is the continued challenge in economic environment.

In terms of our existing business and the business climate, our most exposed business area is our Productivity and Graphics group. While posting in a positive Q3 of $5 million revenue, we expect Q4 to be best case $4 million. Our Wireless segment should be solid as it was in Q3 and our Multimedia group revenue is dependent upon customer product launches, which are difficult to predict given general economic conditions.

In terms of the Core transaction we are assuming new product relationships and new contracts. It typically takes us two quarters to square away newly assigned contracts in term of both the timing of the product deliveries and revenue recognition. As such we don’t realize run rate revenue from acquisitions the first quarter to few quarters post closing. However we do incur integration expense during the same timeframe.

In terms of numbers given the Core transaction key customer launches and are expect to decline in our productivity and graphics group, Q4 revenue can range from flat with Q3 to $32 million. Gross margin should be in the 90% range, but operating margin maybe in the 20 to 25% range due to acquisition, integration expense.

With that I will turn the call back to Bill.

Bill Smith

Thank you, Andy. Our Connectivity and Security solutions for laptops, netbooks and other mobile devices represent and unrivaled portfolio of competitive products. Looking at the third revenue increased 31% year-over-year to $21.8 million, which we view as significantly strong growth given the current economic environment.

Business from our largest mobile customers AT&T, Verizon Wireless and Sprint; continued to lever solid performance within the mobile data market. We are encouraged by the long-term growth prospects in these leading carrier customers and are actively engaged in new product development to support these carriers’ rapid 4G network deployments.

In fact 4G deployments have become a major theme for most of our wireless carrier and cable customers for 2010. Just recently announced Sprint expects its 4G service to reach 80 markets by the end of 2010 covering a 120 million people, and Verizon Wireless has accelerated its LTE deployments to cover as many as 30 markets by the end of 2010 and have nearly nation-wide coverage by the end of 2013.

In addition this month both Clear and Sprint planned to launch WiMAX services in Charlotte, Greensboro and Raleigh, North Carolina, Houston, Dallas Fort Worth and San Antonio, Texas. Service rollouts will continue on in Honolulu and now in Hawaii and Maui in early December. In early 2010, larger markets such as Chicago, New York, San Francisco, Houston and Washington D.C. will be among the first cities lined up for WiMAX availability. We believe the expanding 4G marketplace will help drive new growth next year.

With our position as the leader in the development of smart connectivity management, we bring to market capabilities and solutions that span network boundaries, offering advantages to both the mobile operator and their customers. Our products ensure the best user experience and help mobile users maximize their broadband mobile experience while also assisting operators in minimizing data network operating expenses.

A core feature of our connectivity solutions is our ability to solve the inherent problem with connecting to multiple networks from a single device per application. We continue to be innovative around multi-network access capabilities, and improving the end user’s connectivity experience.

Today, consumers increasingly demand seamless access on multiple networks to remain connected in the office, traveling or at home. Our connection management solutions meet this growing and critical need for a seamless experience across multi-network environments. Data is being consumed at an ever increasing rate requiring the offloading of more traffic to private and public Wi-Fi networks.

To address this problem, during the first half of 2010 we are introducing new software solutions that reside on Smartphones and data devices, enabling mobile operators to move the subscribers voice and data session across network boundaries without disruption.

As you may recall we were recently granted the patent that offers our customers a transparent method to connect seamlessly between wireless networks. Our patents in this area create strong competitive advantages with Smith Micro as mobile operators are using this technology to improve bandwidth efficiencies across multiple networks. We view our technical innovation an extensive intellectual property in this area as a core competitive advantage over commodity type connection managers and PC operating system solutions.

Looking at our PC customers, sales to Dell remain strong representing an approximately 12% of our total revenue during the quarter. I’m also very excited to be able to talk about HP our newest PC OEM customer, which we’ve been working closely with since early this year.

Our connectivity solution is now offered on a line of enterprise notebooks, consumer notebooks and netbooks. 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 its contribution to our results this quarter AT&T had a strong quarter with us, edging up slightly to 11% of our revenue. And Verizon Wireless represented 33% of this quarter’s revenue. I continue to be pleased with our progress in achieving a broader, more balanced customer base between carrier, PC OEMs and enterprises as all contributed strongly to our results during the quarter. I am also pleased with the significant progress we’ve made within our new product development for the quickly evolving wireless network markets.

Within our multimedia and convergence group, we made significant progress and completed our next-generation multimedia product which is built around a robust interface and offers access to a full suite of media resources. Media consumption is rapidly evolving into an on-demand model. Consumers are driving this changing behavior as they move toward offers that provide consistent access to the media across all device types and connection options.

Our carrier customers recognize the need to support this demand for their subscribers. However, they also require a software solution that can be delivered across various mobile devices, mobile and PC operating system platforms and wireless networks.

Our next-generation media solution solved this problem and allows carriers to offer a branded suite of media management products. Our new QuickLink Media provides access to PC based and cloud-based mobile multimedia content across the broad range of mobile devices running their proprietary operating systems or established platforms such as Windows Mobile, Java, BREW, Android or Symbian.

As we move forward, this opens the door for new features demanded by end-users such as media repositories or your personal media locker, media management and sideloading for mobile devices.

This quarter our device management initiatives resulted in new agreements that expanded our relationship with HTC to support their smartphones running Android, including the recently launched Hero device at Sprint. In addition, we have continued forward progress in delivering our device management service suite to Huawei for new Asian market deployments.

Let’s now turn to our productivity and graphics group that focuses on distributing products to business and consumer segments. While the retail market remains challenging due to the softness in the consumer spending, we were still able to manage our business profitably.

We performed better than expected in Q3, as Andy noted earlier, at the segment represented $5 million in revenue. During the quarter, the group remained focused on launching the new service within the StuffIt family that allows users to not only compress files, but also share files, stored in the cloud and access online from the cloud.

In addition to launching this new StuffIt file transfer service, I mentioned in our last call that we have own a new imaging license agreement with a leading Fortune 100 corporation. As we reported last month, that customer win was Microsoft, now uses our patented compression technology to compress images stored on their servers.

I’m pleased with the progress we’ve made with this account, and we believe we can capitalize on similar opportunities in the future.

Before I open the call for questions, I would like to address our revised revenue guidance for fiscal the year 2009. As Andy stated in his remarks, several factors have impacted our revenue guidance, most particularly the flat economic climate which is impacting Smith Micro and causing our customers to manage inventory more tightly and deploy new initiatives with more caution. Despite this operating environment, we continue to grow as represented by our record third quarter revenue results, and our bottom-line performance is extremely healthy.

Specifically during this quarter, we saw a slower than expected new product rollouts on the part of several Smith Micro customers. This impacts near-term revenue expectations for 2009, but does not change our positive outlook for these customers’ initiatives in 2010. As a result, we are revising our annual guidance for this year, 2009 to $105 million to $110 million.

I’d like to reiterate that our relationships with our customers remain very strong. Further, new customer opportunities continue to grow. We remain on track to deliver these new products, some of which are currently in trial phases for these new customers. We remain well-capitalized as our cash balance is approximately $40 million following the Core Mobility transaction and our average quarterly cash generated through operations has exceeded $5 million per quarter this year. These results are the direct result of the company’s ongoing commitment to discipline costs and expense management.

Our carrier customers are in the midst of an unprecedented period of change driven by new smart devices that have raised consumer expectations and a demand for advanced mobile connectivity and converging mobile services.

Over the next several years, we expect to fulfill the demand to provide many of these services, most of which will require complex connectivity solutions over multiple networks and area in which Smith Micro excels.

The build out of 4G networks is about to accelerate and we expect to participate in that build out by building the next mobile experience.

With that, operator, I would like to open the 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

Just few questions here, first one, in terms of the push-out of the new product, obviously they are going to get pushed out into some timeframe, but should we be thinking about those push-outs going into early 2010 and so it would be incremental to kind of our revenue forecast?

Andy Schmidt

Let me try to give you some color, and doing so may be help you understand some of our thinkings. When we looked at third quarter and really going into the final week of third quarter, we still believe we could make that quarter. We had delivered software. We have seen some customer push outs, but there was a major offering there, the software had been delivered, but we couldn’t recognize revenue until we had acceptance.

That acceptance did not come as quickly as we accounted on, that program has been somewhat delayed. I think that’s reflective of the economic environment and that was pushed into fourth quarter. If that was it, we probably wouldn’t have changed guidance, because we wouldn’t just push revenue from Q3 and Q4, but as we enter Q4, now we’re about a month into it, we’re starting to see some talk about some other delays that rollout of new offerings.

We also have the advantage in a strange sense that our conference call came later than some others. Many of you listened to the Novacel conference call last week, and the fact that they talked about their MiFi devices not selling through to the level that was expected. And we looked at our own forecast, because MiFi is sold into both Verizon and Sprint. In the case of Verizon, every MiFi device comes with our connectivity software solution. We looked at our own forecast and quickly had to readjust those as well.

When you combine all of this, we decided that it was prudent to reduce the guidance for the year and to bring the numbers down a bit for Q4. As we look at 2010, I guess we have to wait and see where the numbers actually come in for Q4. We’ve really moved our guidance from 1.10 to 1.15 down to 1.05 to 1.10. If by chance everything breaks the right way and we hit the upper-end of our new guidance, it’s the bottom end of the old guidance, nothing has really changed.

So, I really think to answer your question in the best way, we really need to see what the results are for Q4. We are obviously operating in some very challenging times. These are economic conditions none of us have seen like before, but I think that we have proven that we could still deliver on the profitability and the bottom line results and this company is going to fine. Our customer relationships are incredibly solid and we look forward to 2010 and continued growth.

Maynard Um - UBS

Second question. If I take the midpoint of your guidance, it implies that your OpEx is probably going to be somewhere around $20 million. How much of that is coming from integration cost and are those one-time in nature or ongoing?

Andy Schmidt

The integration cost would be about $2 million and that’s going to ongoing. So, that’s basically a base line for what we pickup in Core Mobility operations.

Maynard Um - UBS

Just given the uncertain revenue outlook, can you just talk about then your plans on the OpEx side? Are there any price? It sound like you were going to continue to add R&D resources for the future products, but given kind of the uncertainty and the decline in revenue guidance. Can you just talk about your plans on the OpEx side, any changes there?

Andy Schmidt

Well, no, not really. I mean again as you pointed out, we do plan on adding resources in engineering. We have been very tight in how we manage the sales and marketing and administrative part of the business like most others. I think the thing to keep in mind is, given the guidance that we put out here, we’re still looking at growing in Q4.

So as I pointed out, if you just do it through a quarterly basis, we’re going to be worst case flat as what we’re seeing in guidance, and then anywhere up to $4 million incremental. So, once again, that gives us room to add what we’ve considered to be run rate expense, while still hitting op margin numbers we would expect to. The key difference being really in Q4 is the acquisition of Core. As I pointed out, that’s going to be, let’s say around $2 million in expense. It’s very difficult, basically a month and half of a quarter to really nail a revenue number on it, so that’s the questionable part as far as op margin is concerned in Q4.

Operator

Our next question comes from the line of Rich Valera with Needham & Company.

Rich Valera - Needham & Company

With respect to the $12 million to $13 million of revenue you’re expecting from Core next year, can you give us a sense of how you expect that flowing through the year? It sounds like, probably back half weighted, but any color you could give on maybe how back half weighted that might be would be helpful.

Andy Schmidt

Rich, traditionally we try to talk more about 2010 at your conference, and that’s probably where we’ll talk more about it. We need a little bit more time to get a better feel for how we’re going to get these contracts transitioned over before we could really comment on that. So, let’s wait till early January before we start talking timing of that revenue stream. I guess the thing that we can say is, for those of you looking for guidance for 2010, as we have in the past, we usually always give that in early January after Needham conference and that is our plan for next year.

Rich Valera - Needham & Company

I will look forward to that. Separately, I was wondering if you could give more color on the HP deal, how it may be similar or different to the Dell deal, because I understood that with the Dell deal you recognized a royalty on every PC shipped essentially and I don’t believe there was an activation component necessarily in that. Can you contrast or compare how the HP deal works with the Dell deal?

Andy Schmidt

Sure. Let me start by answering that in terms of what devices were on. Again with Dell, as we have said before we are on specific business caliber, Laptops, not the whole suit. So that’s one element. The other element is we are building more than just a connection manager certainly for Dell its more of a complete what they call portal. So it’s a different type of products on a more limited base of Laptops, because of this we have a bigger fixed component to the contract. So there is more of a regular recurring revenue with less of an upside that we use on a base contract.

HP on the other hand ships on all their devices, so it’s broader and it’s a contract that’s more of a Smith Micro model contract where it will take less on a regular quarter mode and have more in a variable upside. With that contract that just launched, our current quarter we have not seen the variable piece kick-in. There is two elements of that, one again like, any launch, it starts fairly modestly and then grows fairly probably just play in timing. The variable part of this requires information that basically could be a one to two month lag. So for the September 30th period, we’re launched with HP, but we don’t have the variable piece kicking in yet. Does that help?

Rich Valera - Needham & Company

Right, so that should kick in the fourth quarter though?

Andy Schmidt

It’s going to start, but again with all other contracts we start somewhat modestly and then we pick up from there.

Operator

Our next question comes from the line of Lauren Ye with JPMorgan. Please go ahead.

Lauren Ye - JPMorgan

Just wanted to clarify again on this HP relationship, so you are saying that it’s going to be on all the laptops consumer and enterprise and that folks. I mean, how does it exactly modestly start when you are just kind of putting in on all PCs?

Bill Smith

The variable part is the PC information that’s lagging in other words its more of a information lag. Okay.

Andy Schmidt

When you are looking at activations and a revenue stream is based on that you’ve got to get it through the channel into the consumer hand and get it activated that, we have to build in time lag.

Lauren Ye - JPMorgan

Okay. So it is an activation model is what is like a…

Andy Schmidt

The back part of – the back there is two components for the revenue, the back part it has an activation component and has a nice opportunity for upside. There is a floor components which gets paid on a recurring quarterly basis.

Lauren Ye - JPMorgan

Okay. Great, and what date it exactly started.

Andy Schmidt

Well I don’t (inaudible).

Lauren Ye - JPMorgan

When did HP

Andy Schmidt

I don’t have the answer to that, I could get back to you on that exactly, so the data started shipping.

Lauren Ye - JPMorgan

Okay. No problem I was –

Andy Schmidt

I would just be making it up. I don’t want to do that I think I would rather get to…

Bill Smith

I have to find out Lauren.

Lauren Ye - JPMorgan

Okay. That would be great. And then just next the 5 million in productivity and graphics why was it up this quarter and then I guess why you are forecasting it down so much next quarter what’s the, what’s there?

Bill Smith

Well, part of the up is a the seasonal launch of the stuff its product which is usually again end of September timeline even though its ends of the quarter we have a big push. Another part of it is we are forecasting for the consumer to be very light and the way we see it, it’s not any different what Novacel guided on in terms of inventory, again it’s a different product, but a similar scenario, where we are seeing the big box stores being tremendously cautious on inventory and then in some cases we have big box stores that are actually cutting back significantly on software as a category. So, we are not seeing as much opportunity as far as presence in big box stores and then it’s further complicated by a reduction in inventory they are carrying.

Andy Schmidt

Obviously, one of the old adages of sales as you can’t sell from an empty wagon, the problem here is if they don’t carry enough the inventory and the shelf is bare people are going to buy a competitive product, because we won’t have the opportunity. You need to capture when the purchaser is standing there or you don’t.

Lauren Ye - JPMorgan

And then just on your margins this quarter does it run at your expectation or with the overall, did it come in higher than you expect and what was the reason?

Andy Schmidt

The 31% is tremendous and we always talk about once we circuit into the run rate its very ease to leverage model and this is how we have designed it. So like everyone else, I believe that’s, I mean we think we are doing things in the recessionary climate. We’re really watching the expense side. We are investing where we should be, which is in our R&D side, but everywhere else would be very prudent and very cautious and that’s how we can actually leverage basically 7% incremental growth from Q2 ‘09 to Q3 ‘09 in revenue and leverage that in it’s a four points on the operating margin line. So part of it’s the management what we’re doing here and part is the way we’ve built this model.

Lauren Ye - JPMorgan

Okay. Was there any projects that were delayed that contributed to maybe better margin as well?

Andy Schmidt

No, absolutely not. In that effect that 31% includes the Core transaction, one time legal expenses. So again it could have been better even.

Lauren Ye - JPMorgan

Then just lastly, please talk about netbooks from Verizon and AT&T. I think it was a full quarter in Q3. How does that trend, and were they up to expectations?

Bill Smith

I knew this question was coming, and I have been thinking about how to answer it. I talked obviously with key executives at the PCO, OEMs that we do business with. The netbook space seems to be tracking nicely. What I can’t tell, and what I am concerned about is that it may be cannibalizing other devices. So, while we may see netbook sales go up, we may see other device sales go down, and the net is kind of a push for us. So that’s kind of how I view it. I think when I talk to PCO OEMs netbooks can go up and the concern is does it eat into more profitable notebook sales. I don’t know the answer. That’s a question you have to ask them.

Operator: Our next question comes from the line of Chad Bennett with Northland Securities.

Chad Bennett - Northland Securities

Couple of questions. I think this question has probably been asked a few different ways. Andy, in the guidance you gave for the third quarter, you’re not assuming any core revenue, core mobility revenue in that guidance. Is that how we should take it?

Andy Schmidt

So you’re referring to fourth quarter?

Chad Bennett - Northland Securities

Fourth quarter, yes.

Andy Schmidt

Yes. In fourth quarter first and foremost, we have to make up at least $1 million deficit from the productivity and graphics group, that that’s our first challenge. Our second question Mark that we’re really looking at is as Bill commented too, there is some key product launches where we have got complete software but we are waiting to see if our customers are ready to go. That’s another uncertain point.

And then with the core mobility there will be revenue, but as far as how much of, what we would assume to take is again these are brand new products that we’re actually taking on. We know the customers, and of course we’ve talked to them, but it’s a whole different animal as far as getting into a quarter and saying okay, and let’s talk about product acceptance and so on. All that brings together $4 million range hence why we say okay flat to $32 million.

As Bill pointed out, if we perform at a certain level will be at the bottom end of the guidance that we gave previously. So there is a lot of variability in play here, there is going to be a core revenue its just difficult right now to say exactly what its going to be, we have an idea what it can be. But, there is a lot of pieces and flucks right now relating to Q4.

Bill Smith

The other part is, you have to work at the Rev-Rec rules. I mean, we may get revenue but are we allowed to actually recognize that revenue on our books. Was the work done on our, during the period of time that we owned the company, these are questions that have to be taken on a case-by-case basis and makes it difficult to actually give you an absolute number for Q4. When we begin to enter 2010, hopefully by that time, we will have a better feeling, we will run the business for a couple of months. And we then will understand more about it and we will give better guidance.

Andy Schmidt

Just following up one more time on that, and not being in (inaudible) about Core. The key, you have to remember is they were not a public company, so since they are not a public company they can have arrangement in place where they say they are delivering the software, but we will give you these other things in the month of February. We can’t recognize revenue into those circumstance, that’s up to us actually get better clarification with the customer and that’s the type of thing that you have to actually get in there and get that clarifications settle before you can assume you are going to recognize the revenue in that period.

Chad Bennett - Northland Securities

So since the transaction is closed, its right for us to assume that all the customer relationship contracts and business related to Core Mobility transferred with out seamlessly I guess.

Bill Smith

Yes. You should take that as a true statement.

Chad Bennett - Northland Securities

I think this probably proves it out. You indicated you are still comfortable with 12 million to 13 million next year from Core?

Andy Schmidt

Yes. Based on what we know right now we have no reason to give you a different number.

Chad Bennett - Northland Securities

The product announcement that you talked about for first half of 2010, the software solution for moving voice and data traffic across multiple networks that I believe you indicated will be actually a software solution on smartphones. Did you indicate that you have a customer for that and will that be the typically Smith Micro deal where it’s kind of a license or royalty per units and is the customer actually a handset vendor or is it the carrier?

Andy Schmidt

Yes, we have indentified the customer. It will impact obviously a number of handsets and we are hoping that it will launch as planned in the first half of the year. It’s probably a carrier.

Chad Bennett - Northland Securities

So the carrier dictates to the handset makers what they are going to put on their handset for this type of functionality?

Andy Schmidt

In this particular case that’s what has to happen.

Chad Bennett - Northland Securities

Potentially any moving data across networks whether it’s LTE, WiFi, WiMAX or whatever seems like a pretty big potential opportunity for you guys. Is it too early to tell or are you just in call your [conservatism] about it?

Andy Schmidt

I think it’s too early to tell. We need to see it deploy. We need to see it in operation and make sure to seamless as we all believe is going to be and then we will see what the uptick is and based on that then we can come forward and say this is what we think the growth potential is. I guess I cautioned you not to get ahead of us on this. This is new technology. New technology needs to be prudent in the real world and it can only happen after a launch. If any delay in the launch, it gets moved a little bit and all these are things we are dealing with in the current times and are possible. So, that’s why one of the employee would be in cautions.

Chad Bennett - Northland Securities

I’m just saying you’ve not talked too much about ‘10, but considering 4G rollouts really start ramping in a big way in 2010 with your customers, you got contacts which I think is ramping pretty aggressively right now that will even be more so in 2010. You have HP that’s really nothing this year, relatively speaking. Potentially a 10% customer in 2010, putting words in your mouth. I was in 2010 backing out Core Mobility, a pretty good growth here.

Bill Smith

That’s why I like my job better than your job. I’m going to wait until January to forecast this and will do a good job as we possibly can. I think I’d like to see us get a little bit more clarity that the consumer is going to start spending money, and then we can become bullish about these kinds of things. All of the points you bring out are well thought out, they’re all valid, and they’re all the reasons I’m very excited about our business case, but today is not a day to be excited. We came in short on the top-line. So, I can’t feel great when you come in short, even though it was the best quarter we’ve ever had.

Chad Bennett - Northland Securities

I thought I’d give it a shot Bill.

Operator

Our next question comes from the line of Mike Walkley with Piper Jaffray.

Charles John - Piper Jaffray

This is Charles John sitting in for Mike. Bill, maybe I’ll just follow-up with your guidance for Q4. Just curious, is this caution on the inventory, is it an across the board reaction from all your customers or is it just maybe one or two particular customers that are largely contributing to this lowered guidance and increased caution

Andy Schmidt

From an inventory standpoint, our biggest exposure to our internal forecast model was for software to be shipped with my MiFi devices. When another comes out and guides down substantially and says, there is an inventory glut, a big account like Verizon that causes us to pause because then we have to look at our own forecast and either take it off the table or substantially reduce it. That’s something that we just had to reactive and frankly we didn’t know that until they made that announcement last week.

So, as far as for the retail products in the consumer channel, I don’t think it takes a lot of time to figure out that a lot of people are worry whether this is going to be particularly good holiday season. I just think this is the time to be very, very cautious and that’s how we view it. The inventory question for us really on a consumer front is that we have so much inventory in the channel because that’s how we really book our revenue anyway. Our concern is that they don’t put enough inventory into a store and the shelf become empty than we lost the sale. Every consumer that comes to buy, they buy a compression product and buy the comparative compression product, because ours is not there and the lost sales to us. So, it’s a little different twist from our standpoint is to how we view inventory, but in the case of Novatel, that something that I am going to be very sensitive to.

Charles John - Piper Jaffray

Then maybe just a more high level, for instance you’ve announced $200 network so you have all three carrier of networks now and (inaudible) getting pretty aggressive with launch in multiple cities. So earlier in this call when you talked about cannibalization on the AT&T and Verizon networks, when we look at the Sprint/Clearwire opportunity, should we view this as maybe slightly more incremental with less cannibalization versus the opportunity at AT&T and Verizon or they viewed pretty much in the same bucket?

Andy Schmidt

I think it’s all the same bucket.

Operator

Our next question comes from the line of Larry Harris with C.L. King. Please go ahead.

Larry Harris - C.L. King

Couple of questions. First, in terms of the fourth quarter with the $2 million or more incremental operating expenses related to Core Mobility, is that going to be mostly in R&D? Could you provide some sort of general sense as to what the split might be?

Andy Schmidt

Good 70% of it’s going to be R&D and balance is going to be a split between selling and marketing and G&A.

Larry Harris - C.L. King

Looking at the gross margin performance here over the past couple of quarters, the 91.6% in the third quarter and I guess an estimated 90% in the fourth quarter. I know you are not just providing 2010 revenue guidance, but with the addition of Core Mobility and some of the new products, we do anticipate that the gross margins in 2010 will be roughly the same or increase even from the levels or would go down with these new products? If you’re looking at a similar gross margin what we have seen in the sale of second half of 2009.

Andy Schmidt

Yes, the Core Mobility transaction sell through software. So, once again its pure software that’s not in a box, it performs similarly to our wireless metric so to speak. Now, having said that, we will talk more about this in January what the model is. We will be looking at a little bit different real estate on a P&L when we start considering maintenance and service to where we may reshuffle some of the expense from R&D line up costs of sales to [net some] zero gain, but the model shifts a little bit from a metric perspective, but looking at it apples-to-apples with how we do business today, Core Mobility fits in pretty neatly with how we run our business and how we sell software. So, it should be very similar profile.

Larry Harris - C.L. King

This new multimedia products, do they also have similar kind of gross margin, where a multimedia is today?

Andy Schmidt

Yes, it will be a pickup in the multimedia right now is still bit of an average and its just lower revenue than it will be in the future and so that will starts skewing up to look more like a wireless product.

Operator

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

Kevin Dede - Jesup & Lamont

Bill you mentioned you had software on WiFi with Verizon, but not with Sprint, can you give us understanding why that is and what the differences that we are thinking at those carriers about that product?

Bill Smith

In the case of Verizon, Verizon is very focused on the user experience, not to say that Sprint isn’t. But the Verizon software has been adapted to help the user get them Wi-Fi up and running, get it configured and all that kind of thing. So it has multiple purposes, it’s a branded experience for Verizon. Sprint just hasn’t done it that way. That’s a question you ought to ask Sprint.

Kevin Dede - Jesup & Lamont

What do you think happens as Sprint starts to think about giving their subscribers that ability to roam between 3 and 4G? Do you think it means that they will handle that software that allows that transition themselves, or do you really have a shot there?

Bill Smith

Let’s be very careful, because you’ve just mixed [metaphors] there. When you start talking about going between 3 and 4G, between EVDO and WiMAX, that’s all a part of our connectivity manager, and that’s something that we know how to do better than anybody in the world, and we’ve covered it with a number of patents.

In some of floor it was Wi-Fi, which is a slick little device that allows you to stick one of those in your home and have a number of users using Wi-Fi to access it and then talking that over a 3G line to give connectivity. It’s a totally different [analyst]. So when you’re talking about going between networks, going between 3G and 4G, that’s the home run spot for us; that’s a place that we better own that going forward. That’s something that we know we’ve got a covered and I think that’s a place we should be in without a doubt (inaudible).

Kevin Dede - Jesup & Lamont

Can you give us some more insight on your, obviously it’s been a time and effort revamping the QuickLink Media and I got the impression that you’ll have a customer to talk about in the next two quarters. Can you give us some more insight on how you see that coming together?

Bill Smith

I have talked about this in conferences now for some number of months where we talked about the importance of the three screens, whether you come from the Telco space or you come from the cable space. Do you want to own control over these key three screens, the screen on your mobile device, your PC screen or your television. This is part of the technology that we are building the enablement for and making this concept into a reality.

Giving the example, I have use many times before. If you have friends and family photo and you have folks come over to your home. You can sit them down in front of the TV and do a slide show, and all the data resides in the cloud. If you are sitting in the office, you can show a co-worker the same photos on the PC, and if you are out, you can hold up your BlackBerry and show the same photos that you took from your summer vacation.

All with the same experience, just three different display devices, very different display devices, all service by a single carrier and as all driven from the cloud. There is no computing capability on a television, so that’s how you get it done, what we are building, what we are designing, what we are leading and with our multimedia products going forward is the enablement of that kind of experience. I think it’s very, very powerful.

Kevin Dede - Jesup & Lamont

So, in that case and in this instance you would require that a client reside on the mobile device and the network.

Bill Smith

Well, you need a client and you also need and this is one of the reasons we were so intrigued, one of the reasons we closed the deal to acquire Core Mobility you need to have the technology to get that data from the wireless device. Let’s say you take photos utilizing your cellular phone, which that has a pretty cool camera, you going to get it to the cloud and one of the things you’ve got to be able to do is do the backup and restore and move that data and you have to move it effortlessly and you know it’s got to be just, real easy process for the consumer to use. That’s what we’re all about, that’s what we’re doing.

Kevin Dede - Jesup & Lamont

Okay can you give us a sort of an update and where you think Verizon is thinking about their own Beta with the onset of all the (inaudible) devices they have coming on versus the legacy work that they have done with real networks and where you thinking you might be able to get some leverage on there media portfolio?

Bill Smith

I really can’t comment on thinking’s of Verizon that’s a question you need to ask Verizon and I just have to leave it that.

Operator

Our next question comes from the line of Scott Sutherland with Wedbush Morgan Securities. Please go ahead.

Scott Sutherland - Wedbush Morgan Securities

So, Bill you talked a little bit earlier about, maybe some substitution of the netbooks versus the notebooks. Can you talk about is there any difference in pricing between the two as the cannibalization occurs?

Bill Smith

You mean from our point of view?

Scott Sutherland - Wedbush Morgan Securities

Yes, from your point of view.

Bill Smith

No, it’s push.

Scott Sutherland - Wedbush Morgan Securities

Okay.

Bill Smith

But the issue is that it’s not incremental.

Scott Sutherland - Wedbush Morgan Securities

Okay.

Bill Smith

One replaces the other.

Scott Sutherland - Wedbush Morgan Securities

Okay, understood. Can you talk about on the operating margins side or the core margins. Two things, you first of all talk about maybe a few quarters of integration expenses, but after you get through those, can you talk about does Core get to your corporate margins or are they add to corporate excluding those integration expenses.

Andy Schmidt

That’s the one, I said in my prepared remarks. We need to run it for a couple of quarters and then we can get better clarity as far as how we expected to run.

Scott Sutherland - Wedbush Morgan Securities

I guess maybe you know look at, do you think this is something that was similar, you year out so that they can get to the similar corporate operating margins?

Andy Schmidt

It’s always our goal, but if you tuck anything else we got to drive it for while and we get a lot better feel for it and again keep in mind our op margins are quite often driven by opportunity to the extent you have better than expected opportunity your op margins go down in the short-term, because again you are investing in developing products. So that’s why we say we need to drive that for a while and see exactly what the opportunities are. To better the opportunities perhaps to lower the op margin in the short run.

Scott Sutherland - Wedbush Morgan Securities

Okay. Lastly on the WiMAX front especially international and working with Motorola you didn’t talk much on that international front and I think you had to think 40 different engagements you are looking at or people you are talking to? Can you give an update there and how that’s going?

Bill Smith

All the WiMAX efforts through Motorola I believe they had nicely, they are still very bullish on what they are going to get close and as soon as we have things we can talk about from them we will come to the street and let you guys know.

Scott Sutherland - Wedbush Morgan Securities

You think this is maybe the 2010 event without giving the quarter?

Bill Smith

Yeah, I guess probably. You are seeing this how its now in November, yeah, I guess it’s probably 2010.

Operator

We have a follow-up question from Rich Valera. Please go ahead.

Rich Valera - Needham & Company

Hi Andy, just wanted to circle back on the OpEx level for Q4. I think you did say you expected around 20 million, is that correct?

Andy Schmidt

As far as total dollars, it could be way around 20 million. Again, depending on the revenue, it’s going to put you somewhere between 20 and 25%, of margin percent.

Rich Valera - Needham & Company

Great and in terms of absolute dollars, how should we think about that figure going forward? Does it stay flattish at 20 million or does it actually creep up as you move into 2010?

Andy Schmidt

Well, you’ll be hearing that answer in person in January.

Rich Valera - Needham & Company

Okay. So as a baseline, assuming sort of 20 million as a starting point, would that be a reasonable starting point?

Andy Schmidt

For modeling perspective that’s not bad.

Operator

Thank you. This now concludes the Q&A session. I would now like to turn the call back over to management for any closing statements.

Bill Smith

I’d like to thank everyone for joining us today. I’d also like to let everyone know that we will be presenting next week at the Merriman Conference in New York. The webcast will be available on the website in the Investor Relations Section. Should you have any further questions, please feel free to call the MKR Group or Smith Micro.

Thanks and we look forward to talking to you at our year end results conference call.

Operator

Ladies and gentlemen, this concludes the Smith Micro software fiscal third quarter 2009 conference call. If you’d like to listen to a replay of today’s conference, please dial 303-590-3030, or toll-free 1-800-406-7325 with the passcode 4174721. ACT would like to thank you for your participation. You may now disconnect.

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Source: Smith Micro Software Inc. Q3 2009 Earnings Call Transcript
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