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Smith Micro Software Inc. (NASDAQ:SMSI)

Q4 2009 Earnings Call

February 24, 2010 4:30 pm ET

Executives

Charles Messman - MKR Group

Bill Smith - Chairman, President, and CEO

Andy Schmidt - VP and CFO

Tom Matthews – Chief Strategy Officer

Analysts

Maynard Um - UBS

Scott [Seerly] – Company Inaudible

Chad Bennett - Northland Securities

Rich Valera - Needham & Company

Lauren Ye - JPMorgan

Scott Sutherland - Wedbush Morgan Securities

Kevin Dede - Jesup & Lamont

Ian Gilson – Zacks Investment Research

Operator

Welcome to the Smith Micro Software fourth quarter and year-end 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) I would now like to turn the conference over to Charles Messman of the MKR Group. Please go ahead.

Charles Messman

Thank you for joining us today to discuss Smith Micro Software financial results for the fourth quarter 2009 and year-ended December 31, 2009. By now you should have received a copy of the press release discussing our fourth quarter and year-end results. If you do not have a copy and would like one, please visit www.smithmicro.com, or call us at 949-362-5800, and we will email one to you immediately.

With me on today’s call are Bill Smith, Chairman, President and Chief Executive Officer; and Andy Schmidt, Vice President and Chief Financial Officer and Tom Matthews, Chief Strategy 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 2010, 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, 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 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.

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

Bill Smith

Thanks Charles. Good afternoon everyone and welcome to our fourth quarter and fiscal year ending December 31, 2009 earnings conference call. We are pleased to report a solid financial performance for the fourth quarter where we generated the highest quarterly revenue results in our company’s history of $29.7 million.

In addition to a strong quarter we also posted a record top line performance for fiscal year 2009 with revenues of $107.3 million which represents a 9% growth rate during this economically challenging year. On a non-GAAP basis, our net income for the quarter totaled $8.9 million or $0.26 per share and for the year $25.1 million or $0.76 per share. This reflects an improvement in non-GAAP earnings from 2008 of $21.7 million or $0.69 per share which represents an increase in profits of 16% year-over-year.

Non-GAAP operating margins increased nicely from 24.3% in 2008 to 28.1% in 2009. In addition, non-GAAP gross margins correspondingly increased year-over-year from 83.3% to 90.3%. All in all we are pleased with our financial performance and our demonstrated ability to make significant progress in the face of the difficult economic headwinds the likes of which we have not seen in the history of our company.

The company’s record results in Q4 were highlighted by a very strong mix of revenues across our portfolio of wireless products. Overall our wireless and mobile product categories accounted for 88% of total revenue. This represented a dramatic shift from fourth quarter of last year when wireless product revenues were only 77% of the total. Actual revenues from our wireless product portfolio in Q4 2009 were $26.13 million, which nearly matched our company’s entire Q4 2008 revenues of $26.45 million. This represents an increase in wireless product sales of 29% versus Q4 2008 result of $20.3 million.

These results reflect our concentrated efforts to focus and build upon our core competency as a recognized leader in the mobile software and connectivity solutions arena where we continue to see high growth potential. This financial performance also illustrates the challenges we encountered in 2009 in our consumer facing productivity and graphics business where this group posted Q4 revenues of $3.45 million, down year-over-year nearly 41% from $5.82 million we reported in Q4 2008. Year-over-year revenues for this group were $17 million, down 29% from the prior year of $23.9 million which frankly was a greater decline in revenue than we had anticipated.

Comparing the quarter throughout all of 2009 we continued to broaden our customer base and leverage our go to market strategy by adding three new cable MSOs, two new WiMAX operators, a new European mobile operator as well as new customers in both the PC and device OEM segments. We view these categories of customers as channel sell through partners that serve their users by delivering services and products that enable connectivity to networks, devices and critically important data. Our software helps enhance their products and improve their subscribers’ connected digital lifestyle experience.

With the growing proliferation of connected devices our goal is to build from our foundation of successes in 2009 and expand our go to market channel relationships. Our continued strategy is to serve these new and existing customers who use these wirelessly connected devices which are rapidly expanding beyond smart phones, laptops, netbooks and e-readers to categories that may include portable gaming devices, mobile media players, tablet computers, digital cameras and other consumer oriented devices sold by a range of new potential partners outside of the traditional mobile operators and device manufacturers.

As we look at the forecasted growth for connectivity by 2014, the analysts predict as many as 2.5 billion connected data centric devices will be in use around the world. With this emerging new marketplace, Smith Micro is devoting many of our R&D resources and product development initiatives to build more intelligent service engines and solutions to better connect, provision and manage the user experience in this burgeoning hyper-connected world.

Before we get into this in greater detail I would like to turn the call over to our CFO, Andy Schmidt, to review our financials. Andy?

Andy Schmidt

Thank you Bill. 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 GAAP 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 for both 2009 and 2008 and prior years 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 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 release can also be found in the investor relation section of our website at smithmicro.com.

In detailed manner for the financial modelers let me first provide a difference between GAAP and non-GAAP P&L metrics. In terms of stock compensation, stock comp totaled $2.3 million for the current period broken out as follows, $28,000 for cost of sales, $682,000 selling and marketing, $660,000 for R&D and $974,000 for G&A.

In terms of amortization, the total for the current period was $2.4 million broken out as follows; $1.4 million for cost of sales, $807,000 for selling and marketing and $220,000 for R&D.

Moving on, for the fourth quarter we posted revenues of $29.7 million and diluted earnings of $0.04 GAAP and $0.26 non-GAAP. Revenue for the quarter was an all time record up 12.2% from fourth quarter 2008 and up 7% sequentially from Q3 2009. International revenue was approximately $1.4 million this quarter across all business groups.

Our wireless segment reported record revenues for the quarter of $26.1 million as compared to $20.3 million last year, an increase of 29%. Within the wireless segment connectivity and security posted revenues of $21.3 million compared to $18.1 million last year, an increase of 18%. Multimedia and conversions which includes the Core Mobility suite of products posted revenues of $4.8 million compared to $2.2 million last year.

Offsetting overall gains in our wireless sector our productivity and graphics group posted revenues of $3.5 million as compared to $5.8 million last year, a decrease of 41%. Finally, we reported approximately $115,000 of other revenue which compares to approximately $319,000 for the fourth quarter of 2008. Total deferred revenue at December 31, 2009 was approximately $1.3 million.

Switching to gross profit, non-GAAP gross margin dollars of $27.6 million increased $4.3 million or approximately 19% from the same period last year. Of key significance, while our revenue increased 12% year-over-year our gross margin dollars increased 19% for the same period. As follows, non-GAAP gross margin as a percentage of revenue was approximately 92.9% for Q4 2009 as compared to 87.8% for Q4 of 2008. Non-GAAP gross margins by product group were as follows: Connectivity and security 97.8; Multimedia and convergence 83.5%; Productivity and graphics 76.5% and other revenue 55%. As we have noted before our margins are driven strictly by product mix.

Switching to operating expenses. Non-GAAP operating expenses for the fourth quarter of 2009 of $18.9 million is an increase of approximately $2.1 million from Q3 driven primarily by the acquisition of Core Mobility which closed in October of 2009. The increase in expense is as expected. On a year-over-year perspective non-GAAP engineering expenses increased 40%. Selling and marketing expense increased 13% and admin expense increased 5%. Of note, our administrative expense for this quarter included one-time legal expenses related to the Core transaction.

Total non-GAAP operating expense has increased 23% year-over-year driven by planned infrastructure growth and by acquisitions. Non-GAAP operating margin for the current period was 29.1%, higher than our benchmark 25%. Current period operating margin compares to operating margin of 29.6% for Q4 of 2008. Non-GAAP operating profit for Q4 was $8.6 million, an increase of $800,000 or 10% from the prior year. Non-GAAP net income for the fourth quarter was $8.9 million or $0.26 per diluted share as compared to $9 million or $0.28 last year.

Cash generated from operations during the quarter was an exceptional $4.9 million. The primary uses of cash for the period were the Core Mobility transaction of $6.9 million and capital expenditures of $803,000. Capital expenditures were primarily investment in our ERP system and IT infrastructure. Overall our current quarter has been consistent with Q1, Q2 and Q3 of this year in that our operating metrics and cash flow have all improved significantly over last year’s performance.

Now on review of fiscal 2009 it was a great year for the company. Revenues increased from $98.4 million to $107.3 million, an increase of 9%. A more telling story was the growth of our core wireless business. Wireless revenues increased $16.2 million or 22% in 2009 despite the challenging economic environment. While posting meaningful revenue growth over the past three years, we have significantly improved gross margins which represents the quality of our revenues.

In 2006 we posted a gross profit margin of 64.9%. For 2007 74.4%. 2008 was 83.8% and in 2009 90.3%. In terms of operating margin we have stated consistently that we target 25% as a benchmark while we continue to invest for what we feel will be the future key growth years in the wireless industry. For 2008 we acquired PC Tel, the company’s largest and most successful acquisition. We managed an operating margin of 23.6% in 2008 as we have worked through a significant integration effort. In 2009 operating margins increased to 27.7% despite continuing to invest in meeting the challenges of a worldwide recession.

Likewise, operating income increased 28% in 2009 to $29.7 million. From a profitability perspective we have significantly improved our GAAP performance. Every quarter of 2009 was GAAP profitable with total year diluted earnings of $0.14 as compared to a loss of $0.02 in 2008. From a non-GAAP perspective total year diluted earnings were $0.76 as compared to $0.69 in 2008, an increase of 16% on a revenue increase of 9%.

From a balance sheet perspective our cash position closed at $45.9 million at December 31, 2009, an increase of $9.2 million from the beginning of the year while taking into account acquisitions. Accounts receivable at December 31, 2009 increased to $24.1 million from $18.4 million at the start of the year which tracks with our increase in sales.

Networking capital at the end of the year was a strong $58.7 million, an increase from 2008’s $47.7 million. Cash generated from operations for the year was approximately $18.5 million. Factoring out an expected increase in accounts receivable we generated $24.5 million in cash. The primary uses of cash included the acquisition of Core Mobility for approximately $6.9 million and capital expenditures of approximately $4.8 million.

Again, I would like to emphasize that while we reported record revenues our operating metrics overall demonstrated a very strong performance. Looking forward to 2010 we expect another highly productive year. Despite the choppy economy we expect to significantly improve our business in 2010 by primarily expanding our reach within our existing accounts. As we have previously reported we closed a record number of deals in 2008 and 2009. Many of these deals represented new technologies that were just launching in 2009. We write our deals for the long-run and as our customers continue to roll out our products and expand their networks we will be one of the net beneficiaries of the growing wireless market.

Based on information available at this time, the company is guiding fiscal year 2010 revenues between $125-135 million. In terms of timing we expect to see our typical seasonality with Q1 and Q2 being our weakest quarters. As such it is important to view our business from a year-over-year basis and not a sequential quarter basis.

Similar to 2008 and 2009 the back half nature of the revenue guidance is not conditional on new contract wins but driven by how our customers market and rollout our products. While we review contract and product wins as the key driver to building our business, we are like every other business operating in a recessionary climate. Our customers new and old will determine the level of our success in 2010. If our customer’s businesses succeed we will succeed. As we noted consistently we just need a reasonable economic environment to operate with. We are a dominant player in a very desirable space and we are ideally positioned to benefit from the coming 4G generation of wireless service offerings.

In regard to 2010 gross margins, we expect a product mix very similar to 2009 for approximately 90% gross margins. Operating margin will be revenue dependent. Given the new product opportunities we have ahead of us we expect to continue to invest in our R&D and sales infrastructure. Having said that we have been consistently re-evaluating our business and deploying our assets in the most profitable areas and will continue to do so.

At this time we will once again target 25% operating margin for the year following our expected quarterly seasonality patterns. The back half of the year is more profitable than the first six months of the year. Finally, taxes continue to be in a state of change given the state and federal deficit spending. At this time we are estimating that our 2010 cash based tax expense will be 25-27% of non-GAAP net income. As tax laws change through the year I will provide an update to this metric.

In regard to cash flow if we hit our revenue guidance this year we will generate more than $20 million of free cash flow in 2010. In terms of other housekeeping we expect to file our current year 10-K next week which represents our final audited financial statements for fiscal 2009.

At this point I will turn the call back to Bill.

Bill Smith

Thanks Andy. As we mentioned earlier, going into 2010 we will begin reporting our results in two business line categories; wireless and mobility and productivity and graphics. Our wireless and mobility business entails all products that enable connectivity to networks, devices, data and people. This includes our connection management and security products, our device management suite, our new media management line, synchronization and backup products as well as our communications and messaging portfolio.

Sales results for our wireless products and solutions experienced strong growth in the quarter and throughout the year. We are building software that enables this broad and growing category of connectivity is our core competency and the key growth driver for our business. Our products will continue to evolve and expand to address the growing opportunity for connectivity related solutions.

In Q4 2009 our connection management software suite represented approximately 82% of revenues in our wireless and mobility business segments. The remaining 18% of revenue was derived from the rest of our wireless product portfolio. By comparison, in Q4 2008 connection management software revenue represented 89% of our wireless product sales versus only 11% from our other mobility products.

Simply put, we not only expanded our overall revenue in our core connection management we also gained traction with all of our other wireless and mobility products as we diversified our mix. Contributing to this achievement was the re-emergence of our media management based business which we announced with Verizon as they launched the new VCast media manager that is powered by Smith Micro’s QuickLink media software. Our QuickLink media product serves as a central control point for managing and playing media files including music, video and photos.

In addition, the software is used as a primary tool for managing the interface to online content including purchasing media, archiving and backing up files both locally and to the cloud and other types of media synchronization across PCs, handsets and smart phones. As this market evolves we will continue to focus development efforts to further enhance the web services component and add new features to support multi-screen capabilities for handsets, PCs and other devices. We anticipate launching additional advanced features in the multi-media space in the second half of 2010.

On the connection management front we continue to attract new customers in the carrier OEM enterprise space. During the fourth quarter we announced a new international win with one of France’s mobile technology leaders, [inaudible]. Throughout the year we have also had great success in the cable and WiMAX space announcing deals with the top four operators in the U.S. including Time Warner, Comcast, Clearwire and Sprint.

In addition we also announced a win with a strong regional WiMAX distributor, Digital Bridge. In the cable sector we also had success in broadening our portfolio penetration by deploying capabilities with our device management suite for bootstrapping and updating the handset and automatically provisioning the customer onto the carrier’s wireless network. We continue to see expanding opportunities with our device management technology for provisioning connected devices and services, managing security and enforcing policies.

One great example of these new capabilities is reflected in our recent win with Nokia who selected our DM suite to help manage their mobile workforce of over 120,000 employees worldwide using a wide range of notebooks, smart phones and other devices. The expanding category of customers we now serve creates additional opportunities for us to sell multiple products from our wireless and mobility business segments. We are already beginning to see numerous opportunities and real traction for our new products, further diversifying beyond connectivity software and allows for more deep and strategic relationships with our customers.

As WiMAX continues to roll out in 2010 we expect to see meaningful activity and increasing revenue contributions from these customers as they begin to launch their marketing initiatives on their quest to become a real force in the wireless sector. We are also working aggressively to create support for the coming wave of LTE. Globally over 50 carriers have announced support for LTE in the coming years and the projected capital expenditure in 2010 for LTE build out is anticipated to be over $58 billion.

We believe this is an early indicator of a rebound in the telcom sector, specifically focused on delivering enhanced data services. Much of this will be from tier one customers such as Verizon and AT&T. Smith Micro Connectivity Solutions will be there to support LTE along with HSPA plus transitional technology. We believe that with the deployment of these new networks we will see a dramatic shift in broadband mobile data rate plans that could open up new segments of the market for us to serve.

We anticipate a significant increase in the number of users who purchase metered services. Pay as you go plans to casual users and potential new subscribers to broadband mobile services with emerging internet connective devices. We anticipate that all of these developments will be positive for Smith Micro’s business goals globally.

We also believe all of these rapidly developing changes in the mobile landscape with new, higher speed networks, increased bandwidth and the proliferation of internet connected devices increasing numbers of smart devices with multi-radio supports and continuously improving price points for data rate plans are driving demand for new forms of connectivity; one where the connection is more aware, intelligent and adaptive to the user’s ever changing wireless conditions.

These changes in service offerings and new network types create a need for connectivity software that must be smarter and simpler while making intelligent choices for the user. Smith Micro is deploying adaptive connectivity solutions to leverage our core intelligent connectivity engines in a way that will keep track of a user’s connection history and preferences while maintaining an awareness of changing network conditions across variations of bandwidth, signal strength, network type and more.

This software will understand users’ rate plans, be location aware, understand device attributes, inform to carrier preferences and seamless manage data sessions between 3G, 4G and Wi-Fi networks. This will improve the user experience making it possible for people to just be connected without having to worry about how to get connected.

Our intelligent connectivity service engine core will be the center of our software development efforts and product roadmaps to support PC, smart phone and other internet connected devices in 2010. We believe that there is an urgently developing need for these kinds of solutions and our adaptive connectivity strategy will be the key to propel our future growth and profitability.

On the productivity and graphics side we faced a difficult quarter and year for this business that has been predominately consumer facing. We are encouraged by some bright spots within the business segment with our graphics product line specifically relating to our animation product categories for 3D and 2D solutions anchored by [inaudible] and anime studios. We believe that we are well positioned to benefit from the 3D animation market’s expansion into the personal computer, web, film and TV markets.

Within our patented Stuffit compression line of products we enhanced the appeal of our Stuffit product to enter the managed file transfer services market, a large and growing marketplace. We see this as the next logical evolutionary step for this product line. Given the current macro economy we anticipate continued challenges within this segment of our business in 2010. We believe we will be able to build on the success of our key growth areas in graphics and compression product lines while tightly managing our cost structures to enable solid margins.

Before I open the call for questions, I would like to provide you with these thoughts about our direction for 2010. We entered 2010 with significant momentum in our wireless and mobility business where we grew revenues in that segment 22% year-over-year. We continue to have strong customer relationships and a market poised to explode and offer tremendous growth prospects for many years to come. We are excited about our strategy and the development of our new adapted connectivity solutions which give us a competitive advantage in accessing new revenue sources.

The ongoing demand for our connectivity and communications products positions us to capture telecom spending not only in North America but also in international markets. We have the unique expertise, resources and technology assets to pursue these opportunities and to drive strong financial results. Our balance sheet is healthy with a solid cash position, no debt and we see a very large and expanding addressable market for our products. As we announced earlier in the year our 2010 revenue guidance is expected to be in a range of $125-135 million. We foresee sustainable growth beyond 2010.

We are excited about our prospects and look forward to a prosperous and innovative year. With that, operator, I will open the call for questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Maynard Um – UBS.

Maynard Um - UBS

Can you tell us what the one-time legal expense in the non-GAAP expense was in the quarter?

Andy Schmidt

The one-time legal expense was about $100,000 for Q3 and Q4 both.

Maynard Um - UBS

In terms of greater than 10% customers in the quarter?

Andy Schmidt

Again the usual suspects, Verizon, Dell, Sprint, AT&T.

Maynard Um - UBS

As we look into 2010 are there any changes? I know the Dell deal had some minimums related to it. I wasn’t sure if that was a multi-year type of thing. Are there any changes there? When would you anticipate HP starting to ramp?

Bill Smith

The key in all that is what is going to happen with our key players in my view and that is the primary carriers out there and the new accounts that are coming on tap. We really haven’t seen the big rolls as far as let’s say the LTE push that may come in later this year. Certainly when you consider the cable guys and the WiMAX folks those are ramps that are starting to take place that actually may start pushing people out of 10% so it is hard to comment on that right now.

Maynard Um - UBS

In terms of your 2010 guidance in terms of mix it sounds like consumer didn’t really pick up in the fourth quarter as you maybe would have hoped. As we look into 2010 is there now a greater mix of wireless in your guidance and lower consumer in year?

Andy Schmidt

In terms of how we look at gross margins if you consider our Q4 we will probably have a pretty similar mix where you had consumer at about $3.5 million. Obviously a low number, that is the lowest gross margin type product. But we have added new products too including the Core Mobility products which runs about 80% gross margin. So the net/net on it is we will call about 90% when we look at what mix comes forward.

Maynard Um - UBS

From a full-year guidance perspective if you look historically over the last couple of years and I know you said the first half is going to be weaker than the second half. Typically it has been about 45% of sales in the first half and the balance in the back half. Should we still anticipate that in 2010?

Andy Schmidt

It is not maybe a 40/60 type we have done before. It is kind of hard to predict at this time. Definitely I think the key is look at us year-over-year. Last year we did $23.9 million in Q1 and we are pretty sure we will post favorably to that which is what really counts to show growth. So just take a look at last year and year-over-year look for us to improve each quarter.

Operator

The next question comes from the line of Scott [Seerly] – Company Inaudible.

Scott [Seerly] – Company Inaudible

A quick clarification, did you provide any breakdown between U.S. and international markets?

Andy Schmidt

Our total international is $1.4 million for the quarter across all business groups.

Scott [Seerly] – Company Inaudible

What are your expectations in looking forward over the course of 2010 from the international markets? You have added some new customers but it sounds like it is really LTE dependent so we should really be thinking about that as a second half phenomenon?

Andy Schmidt

My view and I will let Bill and Tom chime in, it still is kind of early market for us. We do best with complexity and we need those markets to show a great deal of complexity but we do have some non, plain old connectivity products we expect to be putting in international. We have some neat deals done we haven’t really announced yet that is going to show some improvement in that sector but overall we still show the North American market growing more significantly in 2010 and that tends to dwarf when we look at overall numbers North America versus international.

Bill Smith

I can add some color on that I guess. The way I view it is I think you are going to see a strong focus on our very large North American carrier customers, the ones we have been servicing for a number of years; Verizon, AT&T, Sprint and T-Mobile. I also think you will start to see a step up in the revenues that we can pick up from the Comcast, Time Warner and the Clearwire side. I think as we view 2010 I think those are the places to put most of the focus. It doesn’t mean we aren’t going to focus in off-shore. We will. But when you start following the money and figuring out where the numbers are moving I think you are going to find that the accounts I just mentioned are where you are going to see a lot of growth.

Scott [Seerly] – Company Inaudible

To follow-up on that front on WiMAX does WiMAX collectively crack 10% by the middle of this year or second half of this year?

Andy Schmidt

It is hard to say we are starting to see some activity. LTE will begin the launch in the second half of the year as well so it may dampen that percentage a little bit. Definitely we see 4G technology as really starting to ramp in the second half of the year.

Scott [Seerly] – Company Inaudible

A quick question on the multi-media and convergent side, within the wireless revenue, it was a relatively big number this quarter. Certainly there was a big contribution from Core Mobility. If I recall correctly your comments or expectations for Core Mobility were probably somewhere in a ballpark of around $12 million or so over the next 4 plus quarters. Was there a big Core Mobility number in there or did the older, multi-media business take a big step up as well sequentially or is that really starting to see contribution already from the new VCast media manager relationship?

Bill Smith

First off I want to reset the core thinking because I saw another number earlier in the week. What we said when we announced the acquisition of Core Mobility is to look for $10-12 million in 2010. Now we obviously picked up some revenues in fourth quarter 2009 and I can let Andy try and break out the mix if you will for multi-media in a general sense.

Andy Schmidt

The key contributors are the Core suite which are multiple products. We also have our multi-media product which we announced at Verizon and we also have what we used to call more traditional device management products. All three are contributing and contributing nicely. The Core suite of products contributes right around half of it right now and as we look going forward again it is going to be a significant contributor. I think one of the key takeaways was those products we picked up on acquisition are performing rather immediately which is great for us. It is always a question mark as we integrate products and look at [inaudible]. The big positive is it is right on track. That is why you see a nice push up there.

Scott [Seerly] – Company Inaudible

To follow-up on that point looking at multi-media and convergence if I back out Core Mobility as we go into March and June how should that trend. I mean, is VCast media manager going to be a big contributor as we go forward into the March quarter and June quarter? Or was there sort of a one-time event that we saw there?

Tom Matthews

The VCast Media Manager launch was a soft launch and it actually was a big contributor to the number you are referencing. Going forward we are not going to be reporting multi-media and convergence separately. I’m not sure how much detail you will break out in the future Andy as we roll it into our wireless mobility segment. But we believe that over the course of 2010 as Verizon really puts some marketing muscle behind that VCast media manager launch we will see that ramp very nicely. Obviously we are pursuing new customers in that area.

Scott [Seerly] – Company Inaudible

On the connectivity side, mobile connectivity, Clearwire had a difficult fourth quarter but seems like it is an improving outlook for them in March. Part of that is product cycle driven. What is your visibility at this point in time as you look across your North American customer base on the mobile connectivity front?

Andy Schmidt

Let me make sure we address the topic that we talked about last quarter which was there looked to be with some of the products a bit of inventory glut. Everything we are seeing right now is very strong sell through. Keep in mind we are agnostic as far as who the vendor is and really almost what connectivity product they are selling into our key carriers. We just care that wireless data plans are being purchased. We are not seeing any unusual inventory issues or what have you. We are seeing strong sell through in all the different carrier customers. In our view it is all very positive. It has had a good start to the year and hopefully we will see some acceleration at the end of the year.

Bill Smith

In answer to your comment about [inaudible] when you look at their numbers they still grew and they grew fine. I think maybe they just had an expectation problem more than anything else.

Operator

The next question comes from the line of Chad Bennett - Northland Securities.

Chad Bennett - Northland Securities

Can you give us an update on the smart phone partner that was supposed to ramp in the first half for the Wi-Fi offload product?

Bill Smith

You have me. I am thinking right now and drawing a blank. In the first half of when?

Chad Bennett - Northland Securities

2010.

Andy Schmidt

We haven’t actually announced a partner in that area. I can tell you we definitely are working in that area but I don’t believe we have announced anybody.

Chad Bennett - Northland Securities

Maybe I mixed it up then. Speaking of another cell phone vendor, you announced Nokia I believe on the call. Is that a deal for your device management product, is that a deal that was done in fourth quarter and what should we expect from that looking out this year?

Bill Smith

It just started in the fourth quarter. It will grow throughout the year. It is an exciting new area for us to focus on. It is an enterprise sale. We are selling to Nokia IT. They are deploying it throughout the Nokia infrastructure. We believe it will also provide a number of other opportunities with other large enterprises especially our Symbian focused where we can deploy pretty much exactly the same product.

We plan on enhancing the product beyond Symbian to add a number of other device operating systems, etc. so we think this is a growth area going forward and helps to build out our overall offerings that we can go to the enterprise. We can now talk to the enterprise about our connectivity and solutions, give you connection management and security and authentication. We can talk to them about device management and bringing devices up and killing devices that are lost [wiping] and we now also have a third offering where we can focus on our Stuffit file sharing capability. We now think we are building out a nice portfolio of products to take into the enterprise.

Chad Bennett - Northland Securities

Who did you compete with on the deal? Do you know?

Tom Matthews

Basically all the usual suspects if you are familiar with that marketplace there are 2-3 guys who have had some long running success in the device management space. The differentiator is in this portal we have created to allow users to easily configure and provision services on their handset. Somewhat of a self-provisioning portal. I think that is an area we find should provide great efficiencies for the customer, low cost, operations, ease of use and that is one of the key differentiators.

Bill Smith

I have been thinking about your first question and it is not publicly announced. What we are focused on is more as a carrier level but you will have to wait until we can talk about it. We just can’t talk about what we are doing on moving traffic from the cellular network to Wi-Fi and whether that be voice as well as data.

Chad Bennett - Northland Securities

I have seen a couple of articles mainly from European carriers that the cellular to Wi-Fi offload, the importance of that is going up in terms of their priorities. I have heard some spot information domestically here, do you feel like that is an opportunity for you in the second half of 2010 or is that more of a 2011 opportunity?

Bill Smith

I don’t know. My crystal ball is not as good as yours. I am not sure about the exact timing. I guess what I would say is that when you hear about events like what happened in New York City during the fourth quarter where AT&T had to stop selling iPhones because they didn’t have enough bandwidth in their network you can start to see the need to offload some of this excess load from the cellular to the Wi-Fi to get to the wire line backhaul is really important.

Yes, it is going to be a subject. There will be a little relief valve as people roll out 4G but if you believe the basic principles of Moore’s law if we build the capability we will use it up. We will be back needing more. So that is how I view that.

Chad Bennett - Northland Securities

It is pretty tough for someone to do that and get around your patents, is that correct?

Bill Smith

That is something, our patents we have not really fully exploited. It is a good subject. We are really working closely. We have new IT legal talent within the company now as to exactly how to deploy these either defensively or offensively and we haven’t really decided yet.

Tom Matthews

We have some great patents in that field I think as we have talked about in the past for roaming capabilities across these different types of carrier networks; Wi-Fi, 3G, 4G, etc. and also we have patents around netting an IP address back into a carriers network and keeping that IP address consistent so they can provide continuity of services as the user moves across these different networks. We believe the power of the technology selling it into the customers where we have these great and deep relationships is much more exciting than worrying about the offensive place of our patents.

Chad Bennett - Northland Securities

The OpEx run rate in fourth quarter on a non-GAAP basis, from a dollar standpoint is that how we should look at OpEx at least in the first half of this year or did we not see the full effect of Core in the quarter?

Andy Schmidt

You saw about 2/3 of Core in the quarter. The acquisition closed later October. So expect a step up in Q1 and as we go through the year again we work hard on managing this as we look at op margin very carefully. You will see a step up in Q1 and again for modeling purposes we always advise people to continue to model it up as we are looking to invest. Again we have a particular plan and pace in mind and any changes really take the form of customers accelerating products, as we call it kind of good problems to have as people get excited about 4G and LTE that is pretty much what drives our investment.

Operator

The next question comes from the line of Rich Valera - Needham & Company.

Rich Valera - Needham & Company

I just wanted to follow-up on the WiMAX question. Clearwire is seeing some pretty sharp acceleration of their WiMAX subs both their retail subs and with their wholesale partners and it looks like they expect them to triple into this year. I have a couple of questions around that. One is, how do you recognize revenue on Clearwire subs and for their wholesale partners and is there a difference there? Can you give any sense of what you have seen in terms of revenue from WiMAX to date?

Tom Matthews

Sure the Clearwire model works more like an activation model. So we see the data a little bit after the fact other than a selling model. Basically it is real-time. There is no channel challenges or question marks. It is what it is. We are seeing a great step up but you have to keep in mind you are starting from zero in that space so great steps up don’t necessarily match a traditional run rate of a Verizon, AT&T or Sprint in connectivity. So the great message is it is stepping up. We are seeing a nice curve on it. They are very positive. Perhaps by the end of this year we will start seeing more recognizable revenue from it. In other words by recognizable I mean more evident revenue where you start seeing the meter being pushed but for right now they are doing a bit of catch up compared to our very, very large customers.

Bill Smith

One thing I could add is as a company the Clear team is obviously very energized. Their recent results were positive. I guess in many camps unexpectedly so. So clearly they think they are on the right track and that wasn’t a pun. I will stop at that point.

Rich Valera - Needham & Company

A follow-up on the Verizon media manager launch, can you say if the revenue you got in the fourth quarter was more of an upfront payment or if it was actually due to actual product use?

Andy Schmidt

As Tom mentioned it was a soft launch so it is more of the former versus licenses and so on. Again, kind of following on to what Tom said that is going to again be more of a later year from a licenses perspective.

Tom Matthews

It will ramp as they really begin to aggressively promote the product.

Rich Valera - Needham & Company

So in the first quarter we wouldn’t necessarily expect a similar level of revenue from that?

Tom Matthews

It is possible. That brings up a good point though. Talking with a different analyst last quarter what may not be evident is what is normal for Smith Micro is up to 10% of our revenue can be more of a customization type revenue. Again it is not a huge part of the business but it is more of a recurring model for us. When you look at all the products we launch and all of the technology we are launching it is very common for us, we do this obviously in tandem with the license model to protect all of our investment, it has X amount either in terms of a customization fee and/or floors we put in as far as license revenue and so on.

So we have that in play typically with all of our products and it is a consistent contributor in the quarter so even though in the example you made the comment on one product we had perhaps a one-time number in a quarter well the next quarter you are going to see a similar type of number from a different product or technology. So it is good to model about 10% of our revenue coming from minimums or more upfront type revenue.

Rich Valera - Needham & Company

One final modeling question, in reference to your comment that you expected year-over-year growth in the first half I am wondering if you could give us any more color with respect to if you still expect year-over-year growth in the non-Core Mobility portion of the business? In other words it seems like we are expecting anywhere from $2-3 million of Core per quarter. Do we think the non-Core business would also grow year-over-year in the first half?

Andy Schmidt

That is a good question. The answer is it should. The question mark we have more so as a company is our productivity and graphics group. As Bill alluded to they have some great ideas and some interesting products coming up but they are definitely more back half because they are doing a bit of rebuilding and regenesis. So that group is going to be flatter if not down. It will be down year-over-year as we did $3.5 million in Q4 and usually hit seasonality in Q1 and Q2. But we will make up for that in our traditional connectivity business. So that traditional connectivity business should be up Q1, Q2.

Operator

The next question comes from the line of Lauren Ye – JPMorgan.

Lauren Ye - JPMorgan

My first question is do you have any of your LTE opportunities already factored into your 2010 revenue guidance?

Andy Schmidt

I would say it is always fair we are making that assumption.

Lauren Ye - JPMorgan

Of your new wins around WiMAX, the cable device management stuff and then Nokia, can you just clarify for me which ones are already receiving revenue and which ones you will be? And at what time I guess they are going live?

Andy Schmidt

With the brand new, the [OTF] for instance, that is brand new. So that is more 2010.

Lauren Ye - JPMorgan

Is it first half 2010 or second half?

Andy Schmidt

It should be ramping throughout the year.

Lauren Ye - JPMorgan

Then what about the four WiMAX carriers? Obviously Clearwire yes but are the other two already starting as well?

Tom Matthews

Yes they have been in play but based on very small numbers of what you see in the press as far as footprint. Some are going faster than others as far as their launches but we track what you read about what they are launching and where they are launching their GOs.

Bill Smith

I think the recent news from Sprint is they plan on launching their first WiMAX handset this year. It should be viewed as positive news. That is a major announcement. There haven’t been WiMAX handsets per se out there that can do both WiMAX and 3G which is what is mandatory for this rollout through all four of the main accounts. They are basically all riding on the same network. So we expect that they will start revving up their marketing engines. All of these companies know how to play that game. We have our fingers crossed. We wish them the best but keep in mind we support all sides in this battle. We just want to see everybody do well.

Lauren Ye - JPMorgan

What about the cable device management solution?

Bill Smith

The cable device management solution is a start. When you start putting devices onto these cable networks especially when you go beyond data devices you need to be able to get them up and running. So this was a start and we are hopeful we will roll out our entire portfolio to all the WiMAX customers so we can talk to them about push to talk. We can talk to them about visual voice mail. We can talk to them about digital media. We certainly want to talk to them about multi-screen technologies. We have a lot to offer these folks. We have great relationships and we are building our relationships stronger.

Lauren Ye - JPMorgan

Has it gone live already or is it going to?

Tom Matthews

We actually have one live one that has not been publicly announced. One area that I think is a big advantage for us is the protocols used for managing the WiMAX chip sets and as you know all of these big cable operators we have mentioned are also part of the WiMAX consortium. They are all needing a system to manage the devices and provision the devices on the network. So that is where we see some interesting opportunity in the WiMAX space. Not necessarily specifically around the cable industry.

Lauren Ye - JPMorgan

Are you factoring these four areas or three areas we just talked about into your 2010 guidance already as well?

Andy Schmidt

Of course.

Lauren Ye - JPMorgan

To try one more time around the operating margin as we look at 2009 the way it kind of expanded over the year, are you still thinking it would be similar kind of expansion levels?

Bill Smith

Similar in performance. Probably the biggest piece that is driving 2010 is the Core acquisition. So as mentioned, we saw a couple of months of the Core expenses in Q4. Now in Q1 we will have the full three months and so on. That, as we always say when we integrate, different groups and different technologies we like to build in a little bit of expectation that it takes a bit of work to do that. So when we look at Q1 and Q2 yes we definitely expect between the revenue seasonality and the Core transaction those are the two drivers to actually be lower operating margin than Q3 and Q4.

Lauren Ye - JPMorgan

With LTE opportunity on your margins, are you accounting for investment already in the guidance you gave of 25%?

Andy Schmidt

Absolutely.

Operator

The next question comes from the line of Scott Sutherland - Wedbush Morgan Securities.

Scott Sutherland - Wedbush Morgan Securities

First of all I want to ask how you are viewing the pipeline. You have pulled some good deals out of the pipeline last year that are ramping up this year. Are you seeing some good sized deals in the pipeline for the future? Maybe are they in cable, WiMAX or still the traditional wireless customers or device customers?

Bill Smith

We have a strong pipeline but as I have always said we need to get the deals closed. We then need to get the product accepted and get the permission of the customer to talk about it. I really am restricted as to what I can say and where it is going to be. I think you should expect to see product moves in all the suspect places. We are going to sell into the 3G market. We are going to sell into the 4G market. It doesn’t matter whether it is LTE or WiMAX. We will sell offshore but we are going to have a pretty strong domestic focus because we are going to be working diligently to deploy more and more applications to our large carriers and the new 4G carriers especially on the WiMAX side.

We look for a lot of growth. We are trying to set ourselves up that when this economy comes back out we are sitting at the top of our game and ready to grow and really move the ball forward. That is all I can say.

Scott Sutherland - Wedbush Morgan Securities

Traditionally in your multi-media segment Verizon had been the main customer there. You have re-launched this and expanded the capability. What is different this time if you land more customers, more sizeable customers in this space? Is there anything specific to this year or is it more 2011 and beyond?

Tom Matthews

I think it is this year and I think it is mostly the back half of this year. There are significant differences in the product. The first product with Verizon was really a music manager. All it really did was side load music to the handset. This is about all media files, types and content and it also has an interesting interface with the cloud and a variety of services that Verizon has not announced and will ultimately be offering. Some of this is going to have to wait until they make their announcements and begin their marketing efforts. We definitely anticipate it being back half of this year.

Scott Sutherland - Wedbush Morgan Securities

Your productivity and graphics was down this quarter which is seasonally a good quarter so maybe was there a weakness in some part of that? Was it just overall weakness in consumer spending?

Bill Smith

As we have talked about now I think I first talked about it in maybe second quarter conference call and then again in the third quarter conference call. We are no longer republishing the VMware product line. We act as a reseller of it, especially in our online areas. So that probably is the single largest contributor to the decline in that business, only aided as much by an incredibly weak consumer spending habit right now. So this was a good news area in 2008. It wasn’t so good in 2009. We are not trying to tell you we think it is going to be great in 2010 either.

Scott Sutherland - Wedbush Morgan Securities

I think a quarter ago you mentioned maybe 2010 would have a 35% cash tax. Right now it is 25-27%. Have you changed anything operationally or is that just further analysis?

Andy Schmidt

It is further analysis. Pretty much how the numbers worked out with what we had remaining on NOLs and so on. So the good news side of it is we are going to do better than we thought and so that should help the modelers out.

Operator

The next question comes from the line of Kevin Dede - Jesup & Lamont.

Kevin Dede - Jesup & Lamont

Can you give us a little more color on the Core Mobility integration and where you are in that process? A little bit on the cross-selling opportunities, portfolio integration and other opportunities you have in developing the products that company brings you?

Tom Matthews

I think from an organizational perspective the process has gone quite quick and we’re nicely integrated organizationally. Core Mobility is a group now that reports into our wireless and mobility organization and they are predominately focused in the multi-media product line. The three products they had were backup and restore functions. We are working to integrate that product line with our multi-media software clients to add a cloud backup piece. They also had the visual voice mail product which has some very nice growth as a result of some good uptake with the Android client and push to talk.

So those two particular products, digital voice mail and push to talk, have been integrated into our communications unit where we have messaging products and where we have our IMS based clients. IM as well as products we call mobile network director which does the switching between Wi-Fi, 3G and 4G networks.

Bill Smith

We can say we are very pleased with early reactions from carriers on visual voice mail. It seems to be the hottest item in that lineup we picked up although we have some good solid leads for both backup and restore and push to talk as well. Visual voice mail does seem to be something a lot of folks want to look at and talk about. Hopefully we can close some deals and get some more deployments. So far to date we are very pleased with what we got from this particular transaction. I would say generally in that sense as far as the quality of the folks, the quality of the technology, both of those areas I think we are exceeding expectations. They have really worked themselves into the mainstream of our wireless and mobility business unit and I know that Rick Carpenter who heads that team is very excited about what he sees in Mountain View and I think that is going to be a strong location for us.

Kevin Dede - Jesup & Lamont

When do you think we might be able to see some announcements on the new win side? Is that more of a second half thing as you expected when you first talked about this deal?

Bill Smith

That goes back to that crystal ball. You have the great crystal ball. I don’t have one. I have to get my sales guys to close the deal. They can never do it fast enough. Just ask them. They will all tell you that. I am never happy with the time it takes to get it done. We have to get it through the process of getting contracts signed and things like that. Then you have to get permission from the customer to talk about it. It kind of talks to me like it probably is a second half event but I don’t want to take my sales guys off the hook. If they can get it done quicker I would love to tell you about it sometime during the first half.

Kevin Dede - Jesup & Lamont

Give us a little more insight on the international market. I know certainly lots of questions on that this evening but I haven’t really heard from you where you think the core connectivity business is there vis a vie say [inaudible] or Auction and Huawei, the competitive environment and the opportunity you bring in the breadth of products you have to pick low hanging fruit I think in some of these major European carriers?

Tom Matthews

I think one of the things is the first thing we do is put in place an infrastructure over there of sales people and a sales organization that can build the relationships. That is what we have done in the last year or so. Andy mentioned we anticipate growth in the international markets. I think it will predominately be from Europe. We are growing from a very low basis though, right. I think it might be very high percentage growth but in terms of the overall percentage of revenues contributed to the company we probably still expect it to be somewhat low next year.

You have 51 carriers who have announced that they are adopting LTE and deploying it. I think there are 24. In 2010 the majority of those carriers are European based carriers. So we see LTE as an opportunity to build new relationships and get in there and be a key provider to support LTE. That is one of the focuses of our sales organization. Then also we are seeing a resurgence to a large degree in our device management business. A lot around provisioning devices. Provisioning connective devices. So those are the types of things we are looking forward to in 2010 for the international markets.

Kevin Dede - Jesup & Lamont

You did a nice job in displacing [Burst] out of HP and I guess I am interested in how you see mimicking that type of process with some of these larger carriers.

Tom Matthews

We really don’t like talking about specific competitors on these calls. Really it is the same process we go through with every single customer. We need to build a case for the value that we bring in terms of the quality of the product, the innovation of the product and the ability to help our customers create a user experience that will satisfy their users for the long-term and keep that customer retaining for a long period of time. Those are the things we are used to doing regardless of the market and regardless of the competitor. I am not sure there is much change in the way we operate in those markets.

Bill Smith

I think when you really focus in on what we are doing with our adaptive connectivity, putting a lot more intelligence into the connection manager it moves the whole paradigm forward. It makes it more difficult for competitors be it the folks you mentioned or be it the guys that develop the operating systems. It is harder for them to keep up. When we can also build in the capability to provide rich analytics because we have the clients then to talk to our back end servers that reside in the infrastructure of the carriers, it makes for a very, very strong and deep and meaningful relationship that really isn’t one that we spent a whole lot of time worrying about competitors. We spend most of our time about how to build better products and move things forward.

Operator

The next question comes from the line of Ian Gilson – Zacks Investment Research.

Ian Gilson – Zacks Investment Research

Normally your interest income and other income combined is a positive. In the fourth quarter it was a negative. Anything one-time in there?

Andy Schmidt

Yes we had a one-time adjustment just through an audit as far as how we are accounting for short-term investments on the balance sheet. Nothing unusual as far as unusual types of investment out in the market. Q1 of 2010 will go back to your typical run rate at very low interest earned.

Ian Gilson – Zacks Investment Research

Which account was the legal expense included?

Andy Schmidt

Legal would have been in the G&A.

Ian Gilson – Zacks Investment Research

The tax rate was a little bit higher in the quarter. A lot more than a little bit high.

Andy Schmidt

The GAAP tax rate ended up averaging out right around 60%. This is end of year provisions, true ups and so on. So the cash taxes came down to just under 18% which was favorable for us as far as how we are estimating. GAAP taxes which are always a bit of a mystery came in right around 60%.

Ian Gilson – Zacks Investment Research

Share count, are we getting options [inaudible].

Andy Schmidt

Share counts are up primarily due to the Core transaction in which case we had approximately 700,000 shares and over the whole year basis we did have about [400,000] shares based on stock option exercises.

Operator

At this time I don’t show any further questions. Management please go ahead.

Charles Messman

We would like to thank everyone for joining us today. I should note if you have further questions please feel free to call us. I would also like to note that we will be presenting in New York at both the Jefferies and Wedbush investor conferences the week of March 8th. If you are attending the conferences or would like to sign up for a one-on-one please do. Of course we look forward to talking to you on our next earnings conference call which we anticipate will be in early May. Thank you and have a great day.

Operator

Thank you. Ladies and gentlemen that does conclude our conference for today. Thank you for your participation. You may now disconnect.

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Source: Smith Micro Software Inc. Q4 2009 Earnings Call Transcript
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