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Executives

Charles Messman – IR

Bill Smith – President and CEO

Andy Schmidt – CFO

Tom Matthews – Chief Strategy Officer

Analysts

Chad Bennett – Northland Securities

Scott Searle – Merriman

Larry Harris – CL King

Lauren Ye – JP Morgan

Scott Sutherland – Wedbush Securities

Smith Micro Software, Inc. (SMSI) Q1 2010 Earnings Call Transcript May 5, 2010 4:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Smith Micro’s fiscal first quarter 2010 earnings 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, May 5, 2010. I would now like to turn the conference over to Charles Messman of MKR Group. Please go ahead.

Charles Messman

Good afternoon. Thank you for joining us today to discuss Smith Micro Software’s financial results for our first quarter ended March 31, 2010. By now you should have received a copy of the press release discussing our quarter results. If you do not have a copy and would like one, please visit us at www.smithmicro.com, or call us at 949-362-5800, and we will immediately email you one. With me on today’s call are Bill Smith, Chairman, President and Chief Executive Officer; and Andy Schmidt, Chief Financial Officer; and Tom Matthews, Chief Strategy Officer.

Before we begin the call, I want to caution that on the 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 product 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 Forms 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 conference call are made on the basis of the views and assumptions of the management regarding future events and business performance as of 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 the call.

With that said, I’d now like to turn the call over to Bill Smith, Chairman, President, and Chief Executive Officer. Bill?

Bill Smith

Thanks, Charlie. Good afternoon, everyone, and welcome to our first quarter ending March 31, 2010 earnings conference call. We are pleased to report another solid financial performance where we have posted our fifth consecutive quarter of revenue growth while generating the highest quarterly revenue results in our company’s history of $29.9 million. This represents an increase of $6.1 million over Q1 2009 or 26% jump-in revenue over the same period last year.

In addition to robust topline growth, we posted strong earnings with GAAP net income of $1.6 million or $0.05 per share versus $278,000 or $0.01 per share in the prior year’s first quarter. Non-GAAP earnings were up sharply, posting $6.2 million or $0.18 per share versus $4 million and $0.13 per share we reported in the first quarter of last year. This reflects an improvement in non-GAAP earnings from Q1 2009 of $2.1 million or an increase of 53%.

Our non-GAAP profit before taxes also increased nicely from 22.6% for the Q1 of 2009 to26.8% in Q1 2010. In addition, non-GAAP gross margins correspondingly increased year-over-year from 86.3% to 92. 6%. Overall, we are pleased with our results and the direction and trajectory of the key operating metrics within our business. We are excited about the accomplishments w achieved during the quarter. And in spite of the continued unsteadiness in the macro economy, particularly in the consumer sector, we are pleased with our great start to this fiscal year.

We remain vigilantly focused on our strategy, delivering on innovative R&D initiatives, executing on our tactical plans, and expanding our presence globally to achieve continuously improving results to be in our business objectives for the 2010 fiscal year. Revenue results from within our wireless and mobility business unit continues to be the driving force for Smith Micro.

Sales from our wireless and mobility software and services were approximately $27 million in Q1, up a commanding 40% year-over-year. This mobility focused business unit accounted for 90% of the topline in the quarter, which is up from 81% of revenues for that business in Q1 of 2009. We are delighted with the performance of this business segment and we are optimistic about the growth prospects it holds. We continue to place heavy emphasis on this business segment as we concentrated our efforts and aligned resources to expand our leadership position in the mobility software arena.

As we discussed on the fourth quarter call, product sales from outside of our mobility business during the quarter faced more challenging environment. Revenue from our productivity and graphics business totaled $2.8 million for the quarter, which is down from $4.3 million or 34.7% from Q1 2009. While we continue to run the productivity and graphics business with acceptable margins, we remain acutely aware of the ongoing challenges of the economic environment in the consumer segment. And we are working hard to enhance our product offerings and fine tune our strategy and business models to help transform this business into a growing unit again.

Looking ahead to the remainder of the year, we continue to see high growth potential for our software to serve users of mobile Internet connected devices in the expanding 3G world. We are also in the process of gearing up for the coming of 4G services as the WiMAX footprint continues to expand and LTE begins to rollout at the end of this year.

These new networks were catalysts and enable the prospect of even greater market expansion for connected device growth and provide the potential for even greater adoption of our mobile software on a global basis. Overall, we are pleased with this quarter. The progress we are making on our strategic R&D initiatives and the feedback we are getting from key customers on the opportunities ahead.

Before we delve into this in greater detail, I’d like to turn the call over to our CFO, Andy Schmidt, for his review of the numbers. 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 and a reconciliation of non-GAAP and GAAP results. 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 refer to in my prepared remarks for both 2010 and 2009 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 differences between each non-GAAP financial measure provided in the press release and the most directly comparable GAAP financial measure. The earnings release can also be found in our Investor Relations section of our website at smithmicro.com.

In detailed manner for the financial modelers, let me provide the difference between GAAP and non-GAAP P&L metrics. In terms of stock compensation, stock comp totaled $2.8 million for the current period broken out as follows; $28,000 for cost of sales, $803,000 selling and marketing, $625,000 R&D, and $1.35 million for G&A. In terms of amortization, the total for the current period was $2.25 million broken out as follows; $1.5 million cost of sales and $750,000 for selling and marketing.

Moving on, for the first quarter we posted revenues of $29.9 million and diluted earnings of $0.05 GAAP and $0.18 non-GAAP. Revenue for the quarter was an all-time record, up 25.5% from first quarter 2009. International revenue was approximately $2 million this quarter across all business groups.

Our wireless segment reported record revenues for the quarter of $27 million as compared to $19.3 million last year, an increase of 40%. Within the wireless segment, connectivity and security posted revenues of $22 million compared to $18.5 million last year, an increase of 19%. Multimedia, backup and messaging, and mobile device products posted revenues of $4.9 million compared to $730,000 last year.

Offsetting overall gains in our wireless sector, our productivity and graphics group posted revenues of $2.8 million as compared to $4.3 million last year, a decrease of 35%. And finally, we reported approximately $126,000 of other revenue, which compares with approximately $280,000 for the first quarter of 2009. Total deferred revenue at March 31, 2010 was approximately $1.8 million.

Switching to gross profit, non-GAAP gross margin dollars of $27.6 million increased $7.1 million or approximately 35% from the same period last year. Of key significance, while our revenue increased 25.5% year-over-year, our gross margin dollars increased 35% for the same period.

As follows, non-GAAP gross margin as a percentage of revenue was approximately 92.6% for Q1 2010 as compared to 86.3% for Q1 of 2009. Non-GAAP gross margin by product group were as follows; wireless 93.7%; productivity and graphics 84%, and other revenue 48%. As we have noted before, our margins are driven strictly by product mix.

Switching to operating expenses. Non-GAAP operating expense for the first quarter of 2010 of $19.7 million is an increase of approximately $800,000 from Q4 of 2009, driven primarily by increases in headcount and seasonal trade show expense. The increase in expense is as expected. From a year-on-year perspective, non-GAAP engineering expenses increased 33%, selling and marketing expense increased 16%; and administrative expense increased 34%. It should be noted that administrative expense includes the cost of additional facility space and leasehold improvements.

Total non-GAAP operating expense has increased 28% year-over-year, driven by a planned infrastructure growth and by acquisitions. Non-GAAP operating margin for the current period was 26.7%, higher than our benchmark 25%. Current period operating margin compares favorably to operating margin of 21.6% for Q1 of 2009. Non-GAAP operating profit for Q1 was $8 million, an increase of $2.8 million or 55% from the prior year.

Non-GAAP net income for the first quarter was $6.2 million or $0.18 per diluted share as compared to $4 million or $0.13 last year. Cash generated from operations for the quarter was approximately $5 million. The primary uses of cash for the period were capital expenditures of $1.3 million. Capital expenditures were primarily leasehold improvements and investment in the ERP system and IT infrastructure. Overall, we posted yet another strong quarter of improved operating metrics and very strong cash flow.

Looking forward to the balance of 2010, we are pleased with our first quarter performance and consider it a good start for the year. At this time, we are not changing our revenue guidance, but as previously stated, we will consider changes to our guidance at the midpoint of the year. Also at this time, we will hold steady with our previously announced guidance of revenues between $125 million and $135 million, gross margins of around 90%, and we will continue to target operating margins of 25% with the caveat that acquisitions tend to lower our op margin from one to two quarters post acquisition due to integration related expenses.

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% to 27% of non-GAAP net income. As tax laws change throughout the year, I will provide an update to this metric.

In terms of housekeeping, we expect to file our current period 10-Q this week, which will represent our final financial statements for the period. At this point, I will turn the call back to Bill.

Bill Smith

Thank you, Andy. Our wireless and mobility business encompasses all products that enable connectivity to wireless networks, devices, data and people. As we mentioned earlier, revenues in the quarter from this business increased 40% over first quarter of 2009. Sales within the segment were led by our QuickLink Mobile suite of connectivity and security software, which were up 3.4% sequentially from the prior quarter and over 19% year-over-year.

This product segment continues to be an important driver of our overall growth, as we deliver intelligent connectivity solutions to key wireless carrier customers such as Verizon, AT&T, and Sprint. These three carriers all contributed nicely in the quarter with each accounting for a minimum of 10% of our revenues. And Verizon, our largest customer, came in at 28% of our overall revenues for the quarter.

Other customer segment collectively enabled revenue for the connectivity product line to grow by a healthy $7.7 million over the same period a year ago. These additional customer categories include cable MSOs such as Time Warner and Comcast; WiMAX carriers including Clearwire and PC OEM manufacturers Dell and HP.

Sales results for the product lines we acquired from the Core Mobility transaction, which closed in Q4 of 2009, also contributed nicely to the 40% jump in year-over-year topline growth. These newly acquired product lines include synchronization and backup software, visual voicemail solutions, and push-to-talk communication software. I am also pleased to say that Verizon recently began shipping our push-to-talk software on their Blackberry handsets at the beginning of the second quarter.

Our communications product lines from the Core Mobility acquisition are tracking nicely with the prior guidance we’ve provided of $10 million to $12 million for this fiscal year. Looking at this business unit, excluding additional revenues from the Core Mobility acquisition, our organic growth topped 27% for the first quarter on a year-over-year basis.

Much of this growth came from our mobile device management and multimedia management software lines, which were both meaningful contributors during the quarter. We remain excited about the overall growth prospects for our mobile device management and mobility management products and the contribution they are making to significantly enhance our portfolio of mobility solutions.

Creating software that enhances the connected visual lifestyle by delivering intelligent connectivity solutions is our primary differentiator in the market and key enabler of continued growth for Smith Micro. We currently command a clear market leadership position in branded Connection Management Software segment today. We are working diligently to further innovate in this area.

We will leverage our IP and enhance our technology to better collaborate and serve our prominent and growing customer base of device manufacturers, cable MSOs, and wireless service providers around the globe.

Our products would keep evolving to address the growing opportunity for connectivity related solutions. We will continue to expand beyond client-only products to include client and platform based offerings, providing more intelligent solutions designed to simplify the connectivity requirements as more complexity is introduced into the wireless networks.

Throughout the world, we are seeing significant investments in 4G technologies such as Clearwire’s WiMAX market expansion plans to cover up to 120 million pops by year’s end. Moreover, the impending launch of LTE networks, such as Verizon’s, with their stated plans to cover 100 million pops in 25 markets by the end of the year. Globally, over 50 carriers have announced support for LTE in the future. And we’ve engineered our software platforms and intelligent service engines to capitalize on the growth presented by these developments.

The evolution of higher speed wireless networks supporting a vast number of globally connected mobile devices of various types present an exciting opportunity for Smith Micro’s adaptive connectivity solutions. A key component of our growth strategy is to deliver mobility solutions that are more intelligent, aware and agile enough to meet the users’ evolving connectivity needs, as they operate across more complex wireless environments and changing network conditions.

Our adaptive connectivity software and platforms will identify users’ evolving connection patterns and behaviors and automatically adapt to changing network conditions to deliver the best possible service. These solutions enable greater bandwidth utilization, enhance customer support, and a better overall user experience. We plan for our solutions to be more tightly integrated with the carriers’ networks, operational support, and billing systems to better understand the users’ requirement and more effectively support their needs in a simpler and less obtrusive way.

In the near future, there will be more and more connected devices supported by metered service plans, pay-as-you-go offerings, and other innovative rate plans, which we will need to work across mobile networks in the most effective and least cost manner. Our adaptive connectivity solutions will have the flexibility and capabilities to support our customers in innovative ways and set a new standard for supporting connected mobile devices.

While we are focusing much of our energy on preparing for the growth driven by the exploding adoption of mobile data services, we continue to remain optimistic about the prospects within our productivity and graphics business unit. The rapid adoption of 3D products and service represents an opportunity – an interesting opportunity for further growth within our animation product line and toolsets. The escalating consumption of bandwidth and increasing transfer of large files driven by video, high-definition photos and graphics is creating an opportunity for the deployment of our compression technologies in new and innovative ways.

Our portfolio of products continues to evolve, and our strength of intellectual property and breadth of technologies is being put to use in ways that we expect will drive new revenue for this unit. We are working hard on executing efficiently with key product lines in this business, and we are creatively exploring ways to revitalize the unit and bring it back to a level of material contribution in the near future.

Before I turn the call over for questions, I’d like to offer some further observations and perspective on our business. As we look to the coming quarters and beyond, we see the potential for astonishing growth with more globally connected devices driving a need for a diverse array of connectivity solutions and services. And our forecast by 2014, as many as 2.5 billion connected data centric devices will be in use around the world.

A critical factor enabling this growth is the emergence of higher speed networks such as LTE and WiMAX, which will drive increased adoption of new mobile broadband services. Other drivers include improved smartphone functionality, more devices with multi-load radios, and emerging form factors such as netbooks, tablets, mobile Internet devices, as well as new embedded devices providing machine-to-machine connectivity.

We are at the very beginning stages on a long-term trend toward an increasingly connected world. This emerging new mega market for globally connected devices provide Smith Micro with the opportunity to leverage our capabilities for delivering mobility solutions that better manage data connections, mobile devices, and uses critical content and information resources.

We are deploying R&D resources to build more intelligent connectivity software and service platforms. These solutions will support our customers as they grapple with the challenges of supporting more subscriptions, evolving business models, and many more different device types. We’ve just completed a solid first quarter, growing revenues and earnings and making great strides towards executing on our business and product plans for the calendar year at hand.

We have great expectations for our company in the near-term and can see significant opportunities emerging for us in the future. There is lots of work ahead to execute on our strategy, expand our global presence, and continue to improve metrics for all aspects of our business. We believe we have the right technologies, team and market timing to make Smith Micro a continued success story for years to come.

And with that, operator, I’ll turn the call back to you and open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) And our first question comes from the line of Chad Bennett with Northland Securities. Please go ahead.

Chad Bennett – Northland Securities

Yes. Just a couple questions. First, Bill, can you talk about – you obviously – you are seeing the 4G ramp coming. Is there any way to quantify how significant 4G related revenue could be in the back half of the year? I mean, do you think it can be 10% of the business by then?

Bill Smith

Okay. I don’t know that I really want to try to break that – I'm really not prepared to break that up. So I’m not sure I could give you any real help here. I would say let’s just kind of think of that from a macro level, you’re going to see continued rollout of WiMAX by Clearwire and others that are working on that system. And we will start to see at the end of the year the beginning of the rollout of LTE by Verizon. All that’s good for us. They are all our customers and we wish them the best, and hopefully they are extremely successful.

Chad Bennett – Northland Securities

Okay. And then good news on – what I take is a cross-selling success with Verizon on the push-to-talk product. So that obviously is an incremental win for the Core Mobility business I would assume? And can you give us a sense of how material that was and what you replaced there?

Bill Smith

I think it’s just another example of the strength of our overall connectivity portfolio. We sell the Verizon Connection Management Software in the form of VZAccess Manager. We sell to Verizon multimedia client software and look for that to continue to grow and prosper. And now we also talk to them about push-to-talk software. There are other products that we are working with Verizon on, and as soon as we can, we will be happy to talk about that. But this is part of our strategy, as we entered the 2010 year, if you think back to our year-end conference call, we talked about – the focus would be to go much deeper and much broader in our major accounts. And we are executing on that. The numbers prove that point. And it’s up to us to make sure that it works out for the whole year and then at the end of the year we can see where we’ve really gone.

Chad Bennett – Northland Securities

What did you replace there, Bill? Did they have a push-to-talk product beforehand on that kind of Blackberry?

Bill Smith

They did not have a push-to-talk product on Blackberry. It’s something new.

Chad Bennett – Northland Securities

Okay, got it. And then last question, the cloud-based multimedia product and launch with Verizon, is that still kind of a second half event when they kind of, I don’t know, remarket that product, for lack of a better term?

Bill Smith

Let me just say this. I’m not going to talk about unannounced or unlaunched at Verizon. I’d get myself in trouble on that. But I can talk about our product plans and I can reassure you that it is our product plan to launch a cloud-based multimedia product offering before the end of the year. And you can interpret that.

Chad Bennett – Northland Securities

Yes. This is the media manager product you announced the last fourth quarter, right?

Bill Smith

Right.

Chad Bennett – Northland Securities

Okay. All right. So that – okay, got it. All right. Thanks. That’s all I have.

Bill Smith

Thanks, Chad.

Operator

Thank you. Our next question comes from the line of Scott Searle with Merriman. Please go ahead.

Scott Searle – Merriman

Hey, good afternoon, guys. Nice quarter. Just a couple of housecleaning items. In terms of your 10% customers, anymore granularity in terms of where AT&T and Sprint were above 10%?

Bill Smith

We’re not going to try to break that every quarter. We’ve done it in prior years. But I think as the company is getting bigger, we’ll just kind of identify where the large customers are and clearly there is no surprise Verizon, AT&T, Sprint, for that matter, Dell are all large customers.

Scott Searle – Merriman

Okay. But Dell was not above 10% customer in the current quarter. Is that correct?

Bill Smith

I think they just made it.

Scott Searle – Merriman

Okay. And then in general, Bill, just from a standpoint of macro demand in the enterprise market, you guys have been pretty cautious in the fall and during the first quarter about just the economic impact on the enterprise. It seems like based on the results that the mobile connectivity business is still very healthy. So are things generally improving there? Are we starting to see a pickup? And how does the channel look in general from a mobile connectivity standpoint?

Bill Smith

Okay. I think I’ve said on a number of calls that we don’t need a robust economic environment to be very successful. We just need to have some kind of activity. I think what we have today is some kind of activity, and you are starting to see the results of that. Typically, on the seasonally adjusted view, we would expect Q1 to be sequentially down from Q4. It wasn’t. It was up. This bodes well, but it’s only one quarter? We’ve got three more to go before the year is up. And if we continue to execute and we get a little bit of luck, and obviously – I think we’re fortunate we don’t have a lot of exposure to Greece, Spain, Portugal or Italy. I guess we’re in pretty good shape.

Scott Searle – Merriman

Okay. Just on the OpEx front sequentially, Andy, how should we be thinking about that in the graphics business in general? Is that profitable on an operating basis?

Andy Schmidt

Let's start with the first question. And yes, through the year, you’re going to see us again continue to invest in R&D. As you know, we’re going to provide $800,000 quarter-to-quarter sequential, and that’s (inaudible) we’re going to see as we go through the year. It is consistent in terms of that nature. In terms of the other question, our productivity and graphics group as a whole, we find a way to run that profitably no matter how we run it. When we first bought it back in 2005, they were about $10 million, $11 million annual revenue, and it was a profitable business. So it’s a business we can see go up and down that way. We ensure that it contributes.

Scott Searle – Merriman

Okay. And on the V CAST Media Manager front, are you getting better sense in terms of what the revenue contribution from that business could be as we get into the latter portion of 2010?

Tom Matthews

Scott, this is Tom. We don’t normally obviously talk about specific product line revenue from a specific customer. Andy gave you an indication as to the growth of Q1 2010 over Q1 2009 for the non-connectivity related mobile products, of which a large percentage of that was the multimedia product line. So we are showing it ramped pretty nicely.

Scott Searle – Merriman

Just a –

Bill Smith

I guess I can add a little color to that and just simply say that we called out probably for the first time in a number of conferences, a strong contribution from mobile device management as well as multimedia. So we are pretty excited about what we are seeing in both of these product areas. They are core to our strategy, and they seem to be executing nicely. So we’ll just have to sit back and watch and see how our big customer Verizon moves forward in the multimedia area.

Scott Searle – Merriman

And just one last follow-up. In terms of pricing, as we’re starting to get out into the complexity that LTE brings and more features and functionality that you are bringing to the mobile connectivity manager. Are you able to actually bump up pricing at all or should we still continue to think about it just being stable as we look out into the future? Thanks.

Bill Smith

Okay. I think there is a couple of ways to look at it. I think it’s always conservative to look at it as it’s going to remain stable. However, the complexity is getting enhanced. So that gives us opportunities where the price can actually go up. The good news is that none of what I just said talks about the price going down. Volumes will go up. The price is really going to stay the same or go up. And those all bode well for us.

I think the other thing to kind of watch for, as we go into the balance of the spring and the summer and early fall, is just start to see a number of product announcements roll out from Smith Micro that really address where we are going. We’ve kind of talked about a lot of the things we are doing in the area of clients, and we are also now starting to talk even more and more about what we are doing about clients that are supported by platforms. And I think you should be looking forward to seeing that string of product announcements as they come to the forefront. The important part about it is that with almost no exception, they are all 100% internally developed. So our engineering and marketing teams are focused, they are executing, and there is a lot of excitement around here.

Scott Searle – Merriman

Okay, thanks. Nice quarter.

Operator

Thank you. Our next question comes from the line of Larry Harris with CL King. Please go ahead.

Larry Harris – CL King

Yes, thank you and congratulations on the results for the quarter. You mentioned obviously you don’t have a lot of exposure to Greece and some of those other countries. But are we thinking that – sometimes you have new technologies introduced to create discontinuity. And with the introduction of 4G not only in the US but in international markets, could that introduction allow you to maybe penetrate some of those by international markets where LTE is introduced where you may not have a stronger presence today?

Tom Matthews

Larry, this is Tom. Definitely. That’s part of our strategy. Obviously global expansion is critical for us. It’s a huge market out there. And as Bill, I think, referenced earlier, there are 50 carriers and they have identified LTE as the technology that they are going to support. There is a lot of 3G carries moving to HSPA plus as well. And we do less than 10% of our revenue internationally today. So, as customers move from 3G to 4G or HSPA plus as well, they have got to handle multiple kinds of networks. There is an additional amount of complexity associated with managing those connections, and that represents an opportunity for our adaptive connectivity strategy. It’s a big part of our expansion plan is going after the LTE carrier build-outs.

Larry Harris – CL King

Great. Okay, thank you.

Operator

Thank you. Our next question comes from the line of Lauren Ye with JP Morgan. Please go ahead.

Lauren Ye – JP Morgan

Hi, thanks. Bill, can you – you've overly kind of talked about the potential acquisitions going forward. Could you just update on your strategy around this? Is there any technology that you’d like to tuck in or get into?

Bill Smith

I have nothing that I really want to talk about now. We're very excited about the early success of the Core Mobility products. We see a lot of leverage from all of the products, but especially you kind of have to call out visual voicemail. It’s kind of a hot ticket item. Additionally, as we launched at the CTIA conference a month or so ago, we did acquire streaming video tech – technology when we acquired what we called Ava [ph] technologies. And Ava brings – that was kind of a hole in our product line.

We didn't have a strong answer in streaming video. Now we think we have a best of breed answer. A product that doesn't require a client on the remote device to function as it runs within the browser. It adjusts to varying wireless network conditions on the fly to ensure the best possible service level and best possible user experience. Those kinds of things are pretty exciting. And we will continue to look for those kinds of opportunities. They are out there.

We go out and look and talk to a number of firms all the time, but I think the other point is the point that I made earlier. We're also pretty busy developing product internally. We have got a lot of – lot of muscle now, and we can get a lot of product done. And you are going to see a pretty impressive rollout in the coming months. So you just have to kind of come and watch, and you will start to see all of these pieces falling into place in an incredibly cohesive strategy to develop and deliver connectivity software both from clients, from servers, from platforms, the service of a very broad and growing market.

Lauren Ye – JP Morgan

Great. My next is just around guidance. So, Q1 you exceeded, it sounds like your internal expectations. I know you are reiterating guidance. I just want to make sure is this a function of you just trying to stick to stick to the plan and you wanted to give new guidance at the midpoint of the year, or is there some business-oriented change that might have required you to move some revenue forward, I guess?

Bill Smith

I think we beat your estimates as well, so –

Lauren Ye – JP Morgan

Yes.

Bill Smith

I think we beat them all, but I think the key point is that we said we would review it at the midpoint of the year. We tend to be a little conservative at times and don't want to get in front of the market. Obviously we're pretty excited about getting off to such a strong start, and we'll see where we are at the end of Q2, and we'll speak to that question then.

Lauren Ye – JP Morgan

But there isn't anything business-wise where you are a little softer in the back half?

Bill Smith

No, no.

Lauren Ye – JP Morgan

Okay. And then I guess my other question is also around guidance around your operating margin. So you came in at 28.8% for Q1 and you are still targeting 25% for 2010. Has there been a change there in terms of new products with Verizon or whoever customer that would require more spending in the back half?

Tom Matthews

I think Bill maybe hinted to it a little bit lightly is, we have more than a few new products that are coming out. In the past year, with the size of Smith Micro, we were running to stay up with customer demand, if you will, as far as new products and so on, and now we're not only doing that, but we're getting ahead of our customers in terms of new innovative products and new technologies. So we have no lack of things to do in terms of new product development. So we are looking ahead at not only this year, but 2011 and '12, in terms of having – being a completely different company frankly in terms of product reach and looking more like a platform company, frankly. So with that in mind, we're going to continue to invest. And again, we feel that our partnership with Wall Street is, we're going to invest, we’re going to create some tremendous leverage in the model, but we'll be pretty prudent and we’ll make sure we target 25 points is a minimum performance.

Bill Smith

Let me add some color to that because while we will become a very strong platform company, we are still going to be the absolute dominant provider of client-soft – software that runs on handsets and PCs. So we're not going away from what we do. We're adding to it.

Lauren Ye – JP Morgan

Got you. I guess just specifically then, I guess I just want to understand from quarter-to-quarter, are we expecting a step-down – or not step-down, I understand you always kind of beat your 25%,, but just wanted to gauge like quarter-to-quarter, should it be any less or more operating margins for the back half?

Andy Schmidt

We encourage people to model at 25%, and that, again, we don't expect anything, kind of your questions are, do we expect anything bad given we had such a good Q1? The answer is no. But in the same regard, we want to keep people grounded and that we are investing. And as I said in my prepared remarks, any types of acquisitions we might do, and Tom and Bill, in particular are tremendously active looking at different technology opportunities because we’ve just brought up a couple here in the couple quarters, be it Core Mobility and Ava. There is so much opportunity out here in terms of making a make-buy decision or do we actually develop the technology? Do we buy the technology? Everything is still on sale given this kind of economy, to be honest with you. So with that in mind, there are a lot of variables we're playing with. But we still feel that given all these variables, we can hit 25%.

Lauren Ye – JP Morgan

Got you. Yes, I don't think I was asking about is there something bad to happen, but I guess I just wanted to understand your guidance versus the quarter in March. So let me just ask my last question, which is around netbooks. I just wanted to get some details around Dell. Are you actually giving what the number is this quarter, or are you going to stay away from that?

Andy Schmidt

You mean total Dell revenue?

Lauren Ye – JP Morgan

Yes.

Andy Schmidt

We're trying to keep away from customers specifically. They tend to give us a call afterwards and don't like us talking so specifically about them. So we’re just trying to let people know who the big guns in a particular period. But the key focus that we're trying again to keep people on is look at our guidance. Again, that's the big number that matters, and who contributes most is more of a subset.

Lauren Ye – JP Morgan

Okay. Then I guess my question is, can you give us a color around the volumes on net books? Have they kind of accelerated like you – or a lot of us thought it would? Or has it been kind of more damp than originally thought?

Bill Smith

I guess the answer is, it is kind of flat. I don't see huge excitement around netbooks, and I don't think it's any one vendor or any one carrier. It just seems to be across the board.

Tom Matthews

And keep in mind, that's not necessarily the catalyst or that which would create inflection point for Smith Micro. We are looking more at 4G in general, relations that will drive. That's more of the key for us.

Andy Schmidt

And the rate plans, the changes we anticipate happening with the service offerings when LTE comes out to try to drive more consumer-oriented broadband mobile services as opposed to what is really today still predominantly an enterprise service plan. Maybe more adoption on the netbooks at that point.

Bill Smith

And I guess the last point in this area is that if you look at the market dynamics, laptop sales are clearly growing, yet, that looks are not keeping pace with laptops. So you just – I think the consumer is looking at and say, you know, I want a more feature-rich PC and desk volume. Everything that we say, while these are different segment views, there is a marketplace. At the end of the day, we look at the market in general and we say, this is a market that’s exploring and it’s going to grow at a very rapid rate. And all this should bode extremely well. We are very confident with the guidance we provided at the start of the year. We have reiterated it a number of times. We'll review it at the mid-year, and we'll take it from there.

Lauren Ye – JP Morgan

Thank you very much, guys.

Operator

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

Scott Sutherland – Wedbush Securities

Great, thank you. Good afternoon, guys, and good quarter.

Bill Smith

Thanks, Scott.

Scott Sutherland – Wedbush Securities

I wanted to follow up on that last question, that train of thought, when you look at your connectivity business, how much of it is leveraged towards traditional laptops versus net books currently?

Unidentified Company Speaker

It doesn't make much difference. Honestly, it's all kind of the same thing to us. It's a – basically today pretty much a Windows 7 connectivity client, and we don't much care whether it runs on a full blown, full power PC, or whether it runs on a net book.

Scott Sutherland – Wedbush Securities

Okay. I just kind of want to build on a last question, but if you are seeing like 80 or 90% more of a laptop versus a net book is – with the iPad launch, a huge

Andy Schmidt

We don't normally – Scott, we don't (inaudible) I'm sorry. We don't normally disclose that, but the bottom line is, I think it's still predominantly laptop oriented, and net books are – as Bill said earlier, it's somewhat flat, and it's a much smaller percentage.

Scott Sutherland – Wedbush Securities

Great. And that was my next question. I just wanted to comment on basically some comment that iPad might cannibalize from the low-end Linux base type netbooks, and I'm not sure if you really in that market what your thoughts are there?

Unidentified Company Speaker

The iPad obviously is a pretty slick little device, and it's up to the individual. I mean, clearly Apple has a strong following. I’ve got a couple of them sitting next to me here in this room that are big Apple backers. And I don't fault them for it. I think I like to have a real keyboard and things like that. So I guess I probably would never use it, but that's what makes the world go around.

Scott Sutherland – Wedbush Securities

Okay. As you look at the connecting devices, the laptops, the netbooks (inaudible), what are the devices do you think are maybe this year or maybe – do you see devices more next year, different categories, up and coming that you will be attacking?

Bill Smith

I think clearly, all of the smartphones are a huge play. And the growth and the options that are available to the consuming public are really pretty awesome. I mean, it all started out as – with a BlackBerry, then along came the iPhone, and now you have Google with all the Droids. You have got HP buying Palm and reinvigorating that platform. You have the announcement at CTIA and then earlier in Barcelona by Microsoft of their new Windows mobile 7. I mean, this is an exciting lineup of technology. We are equal-opportunity arms merchants to all of those folks. So it bodes extremely well for us. We don't pick favorites. We want to work with all of them. Clearly it's a little bit more difficult to work with Apple and we haven't been able to do that yet, because they tend to also think they are a software company. But the rest, there is a lot of opportunity, and I think that's a pretty exciting space.

The PCs aren't going away. The laptops aren't going away. The Macintoshes are clearly not going away, and we built software for all of those platforms. We build software for the Linux platforms. We don't care what you want to use. We just want to be able to provide you with a service or a software offering that will get your job done. And that job could be getting you hooked up to begin with. It could be doing things like multimedia applications. It could be executing things like visual voicemail, voice-to-text, push-to-talk. And now I’m streaming video. I mean, there's a whole lineup of products that we build now as it really addressed the broader market. Multimedia is a big play, so I know that's a long-winded answer, but it's a big market and it's growing rapidly, and it's an exciting plays to be, and we're right in the center of it.

Scott Sutherland – Wedbush Securities

On the outperformance this quarter, was there anything one-time or is it kind of business as usual, and these are the trends we are seeing that’s driving your business?

Unidentified Company Speaker

You know, several of my comment about Q1 does bring into certain marketing events. Obviously some that you at tend toed. , it is pretty much run rate as usual.

Scott Sutherland – Wedbush Securities

Great. And lastly, Andy, I was going to beat you up on the margins, but then can you give us anything there, but can you give us the contribution of Core Mobility?

Bill Smith

It’s basically – you are talking about the gross margin or are you talking about revenues?

Bill Smith

The revenues of Core Mobility. I think you gave us organic growth.

Andy Schmidt

The revenues are pretty much in line with the guidance we gave there. It would be about $12 million to $14 million. So they are performing exactly as expected.

Scott Sutherland – Wedbush Securities

Great. Thank you.

Bill Smith

Sure.

Operator

Thank you. (Operator instructions) And at this time, I’m not showing any further questions. I would now like to turn it back to management for any closing remarks. Please continue.

Bill Smith

Thank you, everyone. We thank everyone for joining us today and remind everyone of that. The questions, please feel free to give us a call at the office. We’re also will be attending some conferences, specifically the JP Morgan Conference in a couple of weeks in Boston. So hopefully we’ll get a chance to see you then. Thanks again.

Operator

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

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Source: Smith Micro Software, Inc. Q1 2010 Earnings Call Transcript
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