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Smith Micro Software Inc. (NASDAQ:SMSI)

Q4 2010 Earnings Conference Call

February 24, 2011, 4:30 pm ET

Executives

Charles Messman – IR

Bill Smith – Chairman, President and CEO

Andy Schmidt – CFO

Tom Matthews – SVP and Chief Strategy Office

Analysts

Richard Valera – Needham & Company

Larry Harris – CL King & Associates

Charles John – Canaccord Genuity

Chad Bennett – Northland Capital Markets

Lauren Choi – J.P. Morgan

Scott Searle – Merriman Capital

Kevin Dede – Brigantine Advisors

Operator

Good afternoon, ladies and gentlemen. Thank you for standing-by. Welcome to the Smith Micro Fourth Quarter and Year End 2010 Financial Results Conference Call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Thursday, February 24 of 2011 and I would now like to turn the conference over to Charles Messman. Please go ahead, sir.

Charles Messman

Good afternoon and thank you for joining us today to discuss Smith Micro Software Financial Results for our fourth quarter in December 2010 and full year 2010 financial results. By now, you should have received a copy of the press release discussing our quarterly 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 immediately e-mail one to you immediately.

With me on today's call are Bill Smith, Chairman, President and Chief Executive Officer; Andy Schmidt, Vice President and Chief Financial Officer and Tom Matthews, Senior Vice President and 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 related to the company’s quarterly revenue guidance. Financial prospects and other projections of its performance, the company's ability to increase its business, and the anticipated timing and financial performance of new products and potential acquisitions.

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

These and other factors discussed in the company's filings with the Securities and Exchange Commission, including its filings on Form 10-K, 10-Q and 8-K, could cause actual results to differ materially from those expressed or implied in any forward looking statements. The forward looking statements contained in this released [ph] are made on the basis of the views and assumptions of 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 this release and call.

With that said, I would now like to turn the call over to Bill Smith, Chairman, President and CEO. Bill?

Bill Smith

Thank you, Charles. Good afternoon, everyone and welcome to our fourth quarter ending December 31, 2010 and full year 2010 earnings conference call. We are pleased to report another great quarter with solid financial results and outstanding fiscal year performance. They ousted our seventh consecutive quarter of revenue growth generating the highest quarterly revenue results in our company's history of $35.3 million.

This represents an improvement of $5.6 million over Q4 2009 or an 18.8% increase in the revenue over the same period last year. In addition to our strong revenue growth in the quarter, our bottom line was very solid with GAAP net income of 5.8 million or $0.16 per diluted share, up 375% over net income of $1.2 million or $0.04 per diluted share in Q4 2009.

Pro forma earnings per diluted share totaled $0.37 for the fourth quarter, up from $0.26 in 2009. Full year revenues for 2010 totaled $130.5 million, up 21.6% over the $107.3 million in 2009. Our non-GAAP net income for the full year was $33.9 million or $0.98 per share versus $25.1 million or $0.76 per share for the full year 2009.

All in all, we are delighted with a fourth quarter and full year 2010 financial results. We are pleased with our continuous progress in building our business while demonstrating steady growth for the past seven quarters. We accomplished many great things in Q4 and throughout 2010 from both a financial and business operations perspective.

We see the road ahead holding great possibilities for further growth as many exciting transitions taking place in the mobile and wireless industry unfold. We have embarked on a new era of broadband mobile internet service with 4G and LTE coming to life at the end of the year.

We see new products and form factors poised to drive adoption of mobile internet services at a level never before seen. Each day seems to bring new developments and Smith Micro is in a great position to capitalize on many of the emerging opportunities. But before I get into our perspective of some of these developments in the future, I will turn the call over to Andy Schmidt, our CFO to discuss our fourth quarter and full year 2010 financial results in more detail. Andy?

Andy Schmidt

Thank you, Bill. Okay. First, I will go over our customary introductory items. As we have in past quarters, we provided non-GAAP results and reconciliation of non-GAAP and GAAP results. Non-GAAP results discussed in 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 from 2010 and 2009 in 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 differences between each non-GAAP financial measure provided in the press release in the most directly comparable GAAP measure. The earnings release can be found in the investor relations section of our website at smithmicro.com.

In detailed manner for the financial modelers, let me provide difference between GAAP and non-GAAP P&L metrics. In terms of stock compensation, stock comps totaled $3.1 million for the current period broken out as follows

$25,000 cost of sales, $835,000 selling and marketing, $742, 000 R&D and $1.54 million for G&A. In terms of amortization, the total for the current period was $2.1 million, broken out as follows: 1.3 million cost of sales, $706,000 selling and marketing and $62,000 R&D.

Okay, moving on. For fourth quarter, we posted revenues of $35.3 million and diluted earnings of $0.16 GAAP and $0.37 non-GAAP. Revenue for the quarter was an all-time record, up 18.8% from fourth quarter 2009, and up 3.7% sequentially from Q3 of 2010. International revenue was approximately $2.1 million this quarter across all business groups.

Our wireless segment reported revenues for the quarter of $32.1 million, as compared to $26.1 million last year, an increase of 23. Within the wireless segment, connectivity and security posted revenues of $27.6 million, compared to $21.3 million last year, an increase of 29%.

Multimedia backup and messaging and mobile device products posted revenues of $4.5 million per period as compared to $4.8 million last year. Offsetting overall gains in our wireless sector, our graphics – our productivity and graphics group posted revenues of $3.1 million, as compared to $3.4 million last year, a decrease of 10%. And finally, we reported approximately $182,000 [ph] of other revenue, which compares to approximately $115,000 for fourth quarter of 2009. Total deferred revenue at December 31, 2010 was approximately $1.7 million

Switching to gross profit, non-GAAP gross margin dollars of $32.6 million increased $5 million or approximately 18% from the same period last year. Non-GAAP gross margin as a percentage of revenue was approximately 92.3% for Q4 2010 compared to 92.9% for Q4 of 2009. Non-GAAP gross margin by product groups were as follows: wireless, 95%; productivity and graphics, 78%; and the other 50%. As we've noted before, our margins are driven strictly by product mix.

Switching to operating expenses. Non-GAAP operating expenses for fourth quarter of 2010, $21.4 million with an increase of approximately $0.5 million from Q3 driven primarily by investment in our engineering infrastructure. From a year-on-year perspective, non-GAAP engineering expenses increased 12%, selling and marketing expense increased 19%, administrative expense increased 7%, total non-GAAP operating expense has increased 13% year-over-year primarily driven by planned head count conditions.

Non-GAAP operating margins for the current period was 31.6%. Current period operating margin compares favorably to operating margin of 29.1% for Q4 of 2009. Non-GAAP operating profit for Q4 was $11.2 million, an increase of $2.5 million or 29% from the prior year. Non-GAAP net income for the fourth quarter was $13 million or $0.37 per diluted share as compared to $8.9 million or $0.26 last year.

The current quarter includes a favorable tax adjustment of approximately $2 million or $0.06 per share as compared to a favorable tax adjustment of $2.9 million or $0.08 per share last year. Cash generated from operations for the quarter was an exceptional $9.3 million.

Primary uses of cash for the period were capital expenditures of $2.1 million for leasehold improvements and I.T. infrastructure. Overall, our current quarter has been consistent with our first three quarters of the year and that our operating metrics and cash flow have all improved significantly over last year's performance.

In a review of fiscal 2010, it was a record year for the company. Revenues increased from $107.3 million to $130.5 million, an increase of 21.6%. More telling story was the growth of our core wireless business. Wireless revenues increased $29.3 million or 33% in 2010. While posting meaningful revenue growth over the past three years, we have significantly improved gross margins which represent the quality of our revenues. 2008, we posted a gross profit margin of 83.8%; 2009, 90.3% and in 2010, 92.7%.

Terms of operating margin, we have seen improvement over the past three years. We managed an operating margin of 23.6% in 2008. 2009 operating margins increased 27.7% despite significant investment and meeting the challenges of the worldwide recession. 2010, we increased our operating margins yet again to 29.8% while continuing to invest in our engineering infrastructure.

Likewise, operating income has increased 31% in 2010 to $38.9 million. From a profitability perspective, we’ve significantly improved our GAAP performance. (inaudible) every quarter in 2010 was GAAP profitable with total year diluted earnings of $0.36 as compared to $0.14 since 2009.

From a non-GAAP perspective, total diluted earnings of $0.98 compares favorably to $0.76 in 2009, an increase of 29% on revenue increase of 22%. From a balance sheet perspective, our cash position closed at $72.6 million at December 31, 2010, an increase of $26.7 million from the beginning of the year.

Accounts receivable at December 31, 2010 increased to $29.8 million from $24.1 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 $94.6 million, an increase from 2009's $58.7 million. Cash generated from operations for the year approximately $24.7 million, factoring out increases in accounts receivable, we generated $31.2 million in cash.

Primary uses of cash were for capital expenditures of approximately $6.3 million. In terms of housekeeping, we expect to file our year-end 10-K this week which will represent our final financial statements for the year. At this point, I will turn the call back to Bill.

Bill Smith

Thanks, Andy. Revenues generated from our wireless and mobility product segment continue to fuel the company's revenue growth and profitability. Our wireless and mobility segment posted revenues of $32.1 million in Q4 2010, up 22.7% over Q4 2009.

On a full year basis, revenues from this segment totaled $118.7 million in 2010, up 32.7% from $89.4 million posted in 2009. For the fourth quarter and full year, revenues from the segment accounted for 91% of the total revenue for the company. Our productivity and graphics product segment produced roughly 9% of the revenues in the fourth quarter ending 2010, totaling $3.1 million. This is marginally down from the $3.4 million posted in Q4 of 2009 but up nicely from the prior quarter in 2010 by 19%.

Revenues from this segment for the full year of 2010 were $11.4 million versus $17 million in 2009. This represents a year-over-year decline in revenues for this non-core business of 33%. Although we are pleased with the sequential rebound of revenues for the segment in Q4, we continue to explore options that will enable the segment to contribute to our core business in new ways going forward.

As I mentioned earlier, we are witnessing many exciting transitions taking place in the mobile and wireless industry. We are seeing new wireless networks with new protocols delivering increased speed and capacity. Innovative devices like Tablets and compelling smartphones are coming to the market at an increasingly accelerated release rate.

Some have projected that the number of downloaded mobile applications has now eclipsed 10 billion. Phone sales globally are now outpacing the world's birthrate by a factor of nine to one. Mobile devices are increasingly becoming the primary way that many access the internet and in some markets, these devices are the only way that users can connect to the global internet.

Mobile data consumption continues to accelerate at a rate that nearly tripled each of the past three years with no signs of slowing down. Although, much of this data growth is driven by the adoption of smartphones, laptops still appear to be the king of mobile data usage.

According to Cisco's recent visual networking index report, the average mobile laptop user generates 22 times the amount of data that the average smartphone user consumes on a monthly basis. By 2015, laptop usage will still account for 50% of the data consumed over the mobile internet. Laptops will be used for mobile computing in ways that will deliver a better user experience than a smartphone or even a Tablet can deliver.

We believe that the experience of consuming mobile data services rendered via laptop coupled with the higher speeds promised from the 4G networks will continue to lead to robust growth for our core connectivity business for some time to come. As enterprise customers begin to sort out the new offices between broadband networks, speeds, coverage footprints and modern devices, we believe that the upgrade cycle from 3G to 4G will start in earnest. This will be good for our business.

In addition to the benefits from this coming upgrade cycle, we expect our business to benefit from a new dynamic of consumer subscribers, who may use 4G mobile broadband as a replacement service for fixed broadband in the home. The timing of this opportunity remains subject to network build offs, marketing campaigns and the implementation of innovative pricing strategies.

Controlling the connectivity experience by delivering insight into usage patterns while improving manage ability through a use of our technology will help our product deliver solid growth and remain the connectivity software of choice. While we see laptops with embedded modems, USB downloads and other mobile broadband modems as key drivers to our success for the future, we are busy innovating and improving and prepare to deliver new solutions that will make the connectivity experience on smartphones, tablets and mobile hotspots even more compelling.

The key initiative in this area is our quick link mobile hot spot manager powered by Smith Micro software or secure on device API. The hot spot manager technology enables ways to manage a mobile hot spot whether on a smartphone or tablet or self contained hot spot modem with fine granularity and robust security for each connected end point.

As carriers move to more metered data rate plans, the ability to manage, understand and allocate usage across each device connected to a mobile hotspot becomes a compelling and needed feature set. Our software technology will enable ways for Smith Micro and it’s carrier customers to deliver a more uniform set of features and experiences across multiple device types manufacturers and form factors.

From a mobile hotspot puck to a smartphone to a tablet, we are excited about – by these technologies and we are encouraged by the reception we are receiving at both carrier and device manufacturers alike. We believe these products along with our device management clients and the Smith Micro DNA platform will enable our company to establish an increasing and meaningful presence in the smartphone and tablet market going forward. We look forward to reporting more to you on these developments at the upcoming CTA conference next month and on our next conference call.

Before I turn the call over for questions, I’d like to comment on the revenue short fall that we are expecting in Q1 as reported a little over two weeks ago when we set Q1 guidance in the range of $15 to $20 million. As discussed in our conference call on February 9, we are facing a major unanticipated order short fall from a key customer due to an inventory backlog.

We believe this issue will be alleviated overtime and we will get back to a normalize state of license sales to that customer. While we view this as a temporary setback, we are working to mitigate the possibility of this ever happening again. Aside from the continued product innovation that we expect will add new opportunities, we spent much of 2010 investing in establishing presence in markets – in new markets with the goal of expanding and diversifying our customer base.

This geographic expansion initiative is ongoing and it is part of our strategy for the next five years. We were pleased to report at Mobile World Congress, this past week two new wins with both Telecom New Zealand and Bakrie Telecom in Malaysia selecting Smith Micro as their connection management software partner over our competition from this region.

We are gratified by these early successes and hope to add more wins in Asia-PAC and in Europe this year to expand our customer base and further mitigate the risk for any single customer in the future. We had an absolutely tremendous 2010 and we are excited about our business prospects in 2011 and beyond.

We are really just at the beginning of 4G mobile Internet of the 4G mobile Internet revolution and we are poised to participate in expanding ways. The launch of these new high speed networks will enable new subscribers, connected devices and business models that will benefit from our lineup of products and technology. We are focused on continuing to innovate, execute and getting back to an exciting growth and profitability in the near-term.

With that, operator, I will turn the call back over to you for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Our first question comes from the line of Richard Valera with Needham & Company. Please go ahead.

Richard Valera – Needham & Company

Thank you, Good afternoon. Bill, I was wondering if you got anymore feedback from your large customer on what caused the slow sell through for them in the fourth quarter.

Bill Smith

Yeah, we are (inaudible) discussion with the customer. I think we have a pretty good understanding. I think a lot of it has to do with timing on launch of their 4G offerings, maybe it was a little later than was originally anticipated. But I think all of this problem will work itself out and we just have to be patient and unfortunately it does set up a less than normal quarter for us in Q1 of 2011. But you know, as we said a few weeks ago, we look for some recovery in Q2, so maybe we can get back to a breakeven position and then back to normalcy in the back half of the year.

Richard Valera – Needham & Company

When you think of the back half of the year, you know, getting back to let's just say similar levels than what you saw in 2010, do you see that being driven primarily by a rebound in connection manager? Do you think there will be significant contribution from the hotspot manager that, I guess, you are shooting for some wins, I guess, in the second quarter.

Bill Smith

It is going to be a combination of things. Clearly, we expect to see strong sales of our connection manager of products across the board. All of our customers we have no reason to believe that that won't be the case. But clearly, we are excited about what we see happening with the mobile hotspot manager. We think we are going to see very broad adoption. We are very excited about it. We have a nice lineup of customers in the final stages and we need to get all of that under contract and then get them to allow us to tell you about it and we will come racing to the street and give you some good news unlike the bad news we gave you a couple weeks ago.

Richard Valera – Needham & Company

Great. And just one more if I could, just wanted to get your guys take on the impact on Tablet computing and the iPad in particular. Obviously, doesn't use a connection manager and could theoretically cannibalize laptops, but there might be a play on the hotspot (inaudible). Can you give us a sense of what you think may be the impact of the iPad was in the fourth quarter and what you think it could be going forward and where your play is there?

Bill Smith

We think Tablets in general are a great play for us. As far as your first comment replacing a laptop as a Tablet user and as a laptop user, I know most devices serve a purpose. Clearly, if I’m entering data then I want to transmit, I want to do it on my laptop. I’ve got a better keyboard and everything to work with. If I’m just reading data and downloading data, the tablet can work almost as well or just as well. And so, I think they both have their place. I don't think one excludes the other. That's how I see that market opportunity. And maybe I’ll kick it over to Tom.

Tom Matthews

Rich, it is Tom. Just, at least in the short-term we certainly believe that the enterprise is still driving the mobile broadband service subscriptions. And I think, you can look at a number of reports and survey enterprise customers and you’ll see the tablets are predominantly being used as a personnel device in the enterprise, not necessarily sanctioned, challenges managing those types of devices.

So the laptop we think will continue to drive the business for mobile broadband subscriptions and given some of the initiatives Bill mentioned earlier, our hotspot management solution, we are all over the device management client for number of Android devices. There is no reason why we can't see some wins coming from Android tablets. With that product line we think there’s opportunity to expand the business with the tablet not really happy role our business.

Bill Smith

Yeah. I think when you really look at the hot – the whole mobile hotspot market, the tablets really the ideal device to use it as a mobile hotspot. When you use your phone as a mobile hotspot get somewhat precludes using it as a phone for voice calls. And so that’s somewhat problematic.

So we actually see that our play with those – our mobile hotspot manager, as well as our mobile hotspot maker software will have a very strong play on both the tablet and the smartphones going forward. We’re particularly excited about it. It is opening up some very large opportunities and we’re looking forward to being able to talk more about that and hopefully we’ll be able to do some of that at CTIA for those of you who are going to be there.

Richard Valera – Needham & Company

Okay. That's helpful. Thank you.

Operator

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

Larry Harris – CL King & Associates

Yes. Thank you. I had a question about the multimedia area. It looks like the sales were down on year-over-year and I recognize that there are a number of different product lines such as Device Management, software and Push-To-Talk and Visual Voicemail and other items. Just wondering what accounted for the year-over-year decline in overall revenues?

Bill Smith

Well, I think, and I can of talk to this in past conference calls. I really believe that if the multimedia, the battle for the multimedia market has been won by Apple and Google. And we really are not investing further in that segment and nor do I think we should. So you’re just seeing it decline because that's not really where we think is the best place to deploy our assets.

Andy Schmidt

Yeah. And kind of following on, this is Andy, as we said before, it’s always going to be a little lumpy. Some of the other business types that are in that category are new businesses for us and so it’s subject to a little bit of lumpy quarter-to-quarter performance and really there are some front startup cost type revenue, that then transfers over into loyalty-type model, which is our common model, but it’s starts small.

So long story short, it was not down a lot. They both – year-over-year they both in the 4 million category which is still a very – it is a very nice amount for us. If you went back another year and it wouldn't be on the radar at all. So I would expect this area to be a little lumpy as we go forward and then fill in probably more toward 2012.

Larry Harris – CL King & Associates

And with the Device Management software on some of these new 4G Android, smartphones be a contributor?

Tom Matthews

Larry, this is Tom. Yeah, absolutely. We’re launching on a number of new HTC 4G devices that are beginning to ship into the U.S. here in the next quarter or two. Verizon, AT&T and T-Mobile are sporting some of the Android devices that we’re shipping out.

Larry Harris – CL King & Associates

Great. And what are your current thoughts in terms of a tax rate for 2011?

Andy Schmidt

Sure. We as you can tell ended up 2010 in really good shape. All of the legislation needed to pass passed at the last minute and so that was great. When we look into 2011 here given that we've got a slow start here in Q1, it’s probably good to start modeling with a 25% pro forma tax rate, in other word cash base and 45% GAAP tax rate.

Larry Harris – CL King & Associates

Great. Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Mike Walkley with Canaccord Genuity. Please go ahead.

Charles John – Canaccord Genuity

Thanks. Thanks for taking my questions. This is Charles John sitting in for Mike. Hi, Bill and Andy.

Bill Smith

Hi, Charles.

Charles John – Canaccord Genuity

Bill maybe just two quick one for you going back to your largest customer. They are done with the major phone launch and now they are just ready to refocus their attention on monetizing their 4G network. Maybe you could just share your views and how quickly you think, they go about this – the iPhone sales and stocking, et cetera. Is that still the big priority there or do you expect to see a shift in resources to the store manager actually promoting the data cards?

Bill Smith

Well, part of that question, I think you’ve really got to ask Verizon. I’m not qualified to answer that. But I do believe that, as the 4G network footprint continues to get larger, that will bode well for very strong marketing campaigns and clearly we’re hopeful that happened sooner instead later and that should fuel a lot of sales and start moving things forward.

I think the thing that all people say, are you disappointed with some of the early numbers coming from that customer of deployment of 4G. And I think you have to kind of measure that a bit because I think you have to look at it and say the footprint really isn't that large. And so, until the footprint is large enough and is meaningful, I think that's really the gating item.

Charles John – Canaccord Genuity

Okay. That’s – thanks for that. And then maybe just building on Rich's earlier question on tablets, the Motorola and DENSO had launched today, required the two-year contract with the carrier and also a data plan at certain price points. So does this make the case for maybe with micro hotspot manager slightly stronger versus just a non-contract, non-carrier affiliated tablet? I would just appreciate any thoughts the usage model we are seeing out there with tablets and how Microsoft might benefit?

Tom Matthews

Yeah. Charles, this is Tom Matthews. How are you?

Charles John – Canaccord Genuity

Good.

Tom Matthews

The usage sensitive or metered rate plans are key component of our strategy for the hotspot manager. And one of the key value propositions is presenting information to the user as to how much data is being consumed. It’s very difficult for people to gauge how much data they are actually using. If they share that hotspot across multiple devices or if they share that with multiple people, they need to keep tabs on the amount of data that’s being used and they may run into build shop situation. Clearly, that's a very positive thing for us and it’s one of the key value propositions for that product. So we view it’s very good for that business.

Charles John – Canaccord Genuity

So longer term when you look at Android tablet trends out there, if it’s directly tied to a carrier contract, that's a positive versus just a tablet, I would say, Wi-Fi for example?

Tom Matthews

Well, I mean, I think, the tablets represent a great opportunity for us, both with our Hotspot Maker software and the Hotspot Manager software. I said, I think tablets are probably the way a lot of users are going to go to create mobile hotspots that’s going forward.

Charles John – Canaccord Genuity

Okay. All right. Thanks, guys.

Operator

Thank you. Our next question comes from the line of Chad Bennett with Northland Capital Markets. Please go ahead.

Chad Bennett – Northland Capital Markets

Yeah. Just a couple questions. Andy, I don't know if I missed it. Can you give kind of customer concentration or customer percentage breakdown?

Andy Schmidt

No. We had Verizon (inaudible) that 50% and 40% for the year, and then we always have AT&T and Sprint making our greater than 10% list for the year as well.

Chad Bennett – Northland Capital Markets

Okay. And the somewhat kind of piggybacking on a question from before. So, since you preannounced, do you, I guess, do you have any better visibility in terms of how long kind of the transition will take to kind of get back up to speed and get back to levels that you were at before?

And obviously, if we think we’re going to have a pretty good sequential increase in June, if you’re just reasonably back to normal, that would imply that. I mean, what would drive that? I mean, would that be mobile hotspot wins that start coming in or would that just be people getting back to normal on the Connection Manager side?

Andy Schmidt

Okay. I think when you view 2011 you kind of got to view it in steps. Second quarter needs to be a quarter where we see a recovery and order patterns from all of our large customers so we don't have any inventory issues by the end of that quarter. And if all falls to plan we would look to getting back to at least a breakeven kind of spot for Q2, then going into 3 and 4 we look for more normalized ordering patterns on Connection Management plus the kick in of Hotspot Manager plus other new product offerings like video and mobile network director, as well as other customer wins both in North America, but more and more likely, so outside of North America in Asia-Pac and Europe.

So we look for the back half of the year to look like the kind of strong results you saw in Q4. Unfortunately the first two quarters going to be a little bit more challenging.

Chad Bennett – Northland Capital Markets

Yeah. Okay. And on the hotspot win, I think, it seems you’re fairly close to a couple of wins for that product. Would the Hotspot Manager or maker product or both, would – based on your knowledge today would they use that piece of software, that product on their whole line of hotspots, as you understand it now or would it be on a portion of them.

Andy Schmidt

Well, until the contracts, ink is dry and we work through all of the issues with the various customers we’re working with, I can't definitely say, but I would anticipate that if a carrier is going to launch Hotspot Manager on some lines they’re going to launch it on all lines and that’s just the normal way things are done and because they really are looking for a common user experience across all the possible hardware platforms that the carrier offers. So and I think that's the best way to view it.

Chad Bennett – Northland Capital Markets

Okay. And you touch on it a little bit, but can you just give us an update on your thoughts on, progress on the network director product and the video products and kind of what we should expect over the next couple of quarters there?

Andy Schmidt

There is a lot of interest. We have some deals where they’re really waiting for the completion of the product, so that we can actually start shipping and everything. Because the video is pretty much there. Mobile Network Director will follow. I think most of our focus at the present time is probably around Hotspot Manager because the market opportunity is so huge and then added to that is the overall so the standard that will start by being focused on all the hotspot options both hardware and operating system driven as well as smartphones and tablets and then will be expanded probably later in second quarter to speak to the needs of all types of devices that would be more normally serviced by Connection Management.

But I think the key thing is that we are making substantial progress in selling the concept of SODA. And we expect to be making some exciting announcements between now and CTIA or maybe we’ll just wait until CTIA. But in any events we have carriers that are signed up. We have device manufacturers that are close and we are very excited by the success we’re seeing and expected to continue.

Chad Bennett – Northland Capital Markets

Okay. Sorry just one last one for me on SODA. So carriers have basically – blessed is a strong word – but blessed the product or the standard. So are they going to – at least domestically they carry this way. Are they going to quote unquote force the device makers to comply with SODA, do you think?

Andy Schmidt

We will let the carriers speak for themselves, but in order to reap the benefits of SODA and the key benefits of SODA for carrier are substantially improved trying to market for devices. Better reliability of new products coming out of the chute. Then the only way they can really gain those benefits is to standardize across all of the products they offer.

So I guess that’s the best way for answer that and also I would kind of quickly add that as much as we’re excited about what we’re seeing here in North America. We are equally excited about what we’re seeing by and really actually even larger markets when you start thinking of all of Asia-Pac and Europe. The benefits of SODA don’t know any national boundaries. The benefits are there and they are provable and it is easier to understand and it’s a hard thing to argue against. So that's how we see it.

Chad Bennett – Northland Capital Markets

Got it. Thanks, guys. Good job on the balance sheet, Andy.

Operator

Thank you. Our next question comes from the line of Lauren Choi with J.P. Morgan. Please go ahead.

Lauren Choi – J.P. Morgan

Hi, guys. And I think you mentioned that you’re trying to mitigate this from happening again. I just want to kind of get your thoughts on how you were trying to do that in terms of is it more controlled on your side or maybe contract minimum, just want to understand that one?

Bill Smith

No, Lauren, what I said was we are definitely very sensitive that we don't want to see this happen again. The best way to make sure that doesn't happen again is by adding a substantial number of cost customers which by definition means they have to come from geos outside North America. And you’ve seen some early indications of what we are doing with the two wins that we announced at Mobile World Congress.

And we look forward to making more announcements in the not too distant future about additional win. So, the way to really fix this, we are happy is not have any one cost customer with that large a market share that if they catch a cold we end up with the flu.

Lauren Choi – J.P. Morgan

Okay. Got you. And then the next area, I guess you mentioned that the visibility you’ve gotten from Verizon that it has to do with some of the product launches maybe a little later. Do you have any idea is it one product launch or multiple? And I guess on top of that, if it is kind of a product launch thing, can you get the volumes back to even know where we were before or it just again like you need to be more things…

Bill Smith

Actually I don't think I used the word Verizon, so but to say…

Lauren Choi – J.P. Morgan

Okay.

Bill Smith

We have a large customer, large customer and what we expect is that we will see an order volume coming from all of our large customers that will look rather sequential on serial growth on quarter-over-quarter basis except for this one troubling spot that we are see in Q1. It will get better in Q2 and if you could take those two quarters out of the chart it would look like a pretty nice line growing when you hit three and four and hopefully move into 2012.

Lauren Choi – J.P. Morgan

Got you. One question for Andy, can you give us some color in terms of how your expense structure looks like in terms of what percentage variable versus fixed? And then also, because of the subs going on in Q1, how are you managing your costs given the top line? Are you cutting back anywhere? And how should we think about that going forward?

Andy Schmidt

Sure. We are primarily fixed. So as you see a decrease in revenue, again we’re very leveraged. So if revenues go up, that's where we feel very bullish our margin. But when revenues go down it’s likewise. We don’t have ladders to fall. Or at this time, given what we know today and certainly in the last number weeks, we discussed it quite a bit. We feel that this could be a well temporary scenario that we’re going through. So we are not changing plans at this point from an expense perspective. And what it looks like is we still have some investments that have been in play. In particular as we have talked about before, the tech center we are building in Pittsburgh, depreciation of the data center is coming into play in Q1 and Q2 and basically the whole year. So expenses will go up; I won’t get into how much at this point just in that we are trying to stay clear from giving too much guidance here until we get more clarity on the revenue side. So, just to let you know that there are no plans for cutbacks. At this point we are pursuing the plan we had in place before the inventory issue arose.

Lauren Choi – J.P. Morgan

Got you. And just last question, the revenue visibility that you get from this large customer, is there like a time that you will get it that you know of or it is whenever they get back on track that you will know?

Bill Smith

We are constantly talking about all of our large customers including this one. We understand what their sell through looks like and we can monitor the burn down of that inventory buildup. So I think we have pretty good visibility now.

Lauren Choi – J.P. Morgan

Great. Thanks very much.

Operator

Thank you. Our next question comes from the line of Scott Searle with Merriman Capital. Please go ahead. Pardon me, sir, your line is open. Please check to see if your phone is on mute?

Scott Searle – Merriman Capital

Good afternoon. Hey guys, I know you mentioned your 10% plus customers, but did you give a percentage for Verizon or just greater than 10%?

Bill Smith

Yes, we did. They were 50% for Q4 and 40% total for 2000.

Scott Searle – Merriman Capital

Great. In terms of some of the recent pricing you are seeing in the international markets for Bakrie and Telecom New Zealand, can you give us a sense how is that shaking out relative to the North American markets? Are you seeing comparable pricing? It sounds like there are some other deals in the pipeline. As we look out to the second half of this year, the end of this year, how would you expect the international mix to size up at the end of this year? Is it 10% of the mix? Is it 20% of the mix or should we not get carried away on that front?

Andy Schmidt

Well again, I think one of the keys to getting started is as we always say, they start somewhat slowly and they build from there. Adding some color to it, some of the customer wins too, as some are connection managers and some are going to be first time product and so basically they are going to be establishing pricing worldwide for us as a company. So that’s going to be something different. As far as what percentage (inaudible) it is too difficult right now to set that type of target. Again these are new GOs and brand new contracts and we are trying to work through the current scenario and see really where things get back on and footing for 2011 domestically.

Bill Smith

One thing to add is we have worked aggressively over the last year and implement a core strategy where a large percentage of every connection manager that we build comes from a common set of code that gives a very effective way to manage our overall cost of building a product such as this as well as guaranteeing a high level of quality, something that I think we are very unique about, and allows us to really compete very effectively and make a strong profit in all GOs around the world. So I think it’s all good for us.

Scott Searle – Merriman Capital

Were these new wins with a competitive bids and/or did you displace anyone?

Bill Smith

They are all comparative bids. But by and large we were competing against the one competitor in the Asia Pacific region and we are very successful in beating them both on quality and future set up.

Scott Searle – Merriman Capital

Got you. And maybe on the SODA front, you guys have been pushing this model ahead pretty aggressively and it’s evolving a little bit, but what are your current thoughts in terms of how the pricing model is going to work? I think originally you speculated that you might be able to be able to get paid by both the OEMs and ultimately the operators or will this ultimately be something that you give away the SODA capabilities with the expectation that as it gets implemented you make money with the connectivity manager or Hotspot manager settled on the back end, I mean how should is the model evolving at this point in time and how should we think about it?

Bill Smith

Let’s take the carrier first. When you look at the carrier, the carrier will get SODA as part of a product offering that they would be purchasing from us. Whether that is Hotspot manager or connection manager and in that case we don’t have to charge for SODA. It’s part of the benefit of buying those products from us when we talk about the device manufacturers that comes a little different. In those cases, we are really saving them OpEx. We are going to give them a standard by which to build all of their API interfaces to the various carrier networks. They don’t have to then fund all of that the development effort. It all comes from us but to the extent that they want to implement SODA then on software that they want to offer to the market, they will pay us a royalty on a per unit shipped for SODA. So in that case, we are collecting added revenues from SODA.

Scott Searle – Merriman Capital

Got you. And lastly, just to follow-up on some of your earlier comments for mobile Hotspot manager, it sounds like the activity is pretty robust right now. Are there a couple of milestones that we should be thinking about over the next quarter or two that by the middle of this year you would expect to have at least one carrier signed up or whatever the metric might be?

Bill Smith

Yeah, I think you probably want to come and see us during CTIA and hopefully we would be able to talk about some various wins in the Hotspot and SODA area.

Scott Searle – Merriman Capital

And then Bill, you know just along those lines from a Hotspot perspective, how should we be thinking about pricing relative to the traditional connectivity manager?

Bill Smith

Pricing is very comparable to the other connectivity offerings that we have to actually being in some cases somewhat higher. It is all in pricing.

Scott Searle – Merriman Capital

Great, thank you.

Bill Smith

Okay.

Operator

Thank you. Our next question comes from the line of Kevin Dede with Brigantine Advisors. Please go ahead.

Kevin Dede – Brigantine Advisors

Afternoon, gentlemen, and congratulations on a great year.

Bill Smith

Thanks, Kevin.

Kevin Dede – Brigantine Advisors

This question might be best addressed from Tom. I am kind of curious about the mix between enterprise and consumer on the connectivity management side and how do you saw that change through 2010 given that you see greater strength on the Enterprise side going forward just kind of wondering how to look at your business from that mix?

Tom Matthews

Well Kevin, really I think the 2010 versus 2009 mix of mobile broadband subscribers using our branded connection manager from the carriers remain pretty steady. There wasn’t much change and in course it skewed very, very heavily towards the enterprise with a rate plans of $50 or $60 per month are typically enterprise-type rate plans. And until we see some more consumer oriented pricing models, I think the enterprise will continue to dominate. One of the things that we are anticipating in 2011 is an upgrade cycle coming from those existing embedded customers, right the enterprise customers that are now using 3G offerings. And we believe that as the enterprise gets more comfortable with the footprint of the 4G networks, the device types better understands the nuances and difference between the device – the network protocols and the device types themselves, and we are going to see that upgrade cycle begin. So heavily skewed towards the enterprise.

Kevin Dede – Brigantine Advisors

Great. Okay. Thanks for the color, Tom. On Europe I know you folks have been trailing over there tooth (inaudible) for years and more recently we have seen some of your European competitors make end roads here but we haven’t really seen reciprocity. And I know you have been trying – kind of wondering if you can give me a 20,000 foot view what that market looks like and where you think your biggest hurdles are given that you are bringing a much broader feature than your competitors?

Bill Smith

Okay. I think you have to think SODA, SODA and SODA and add a little bit of Hotspot on top and you have got a good idea of how we are going after Europe.

Kevin Dede – Brigantine Advisors

Okay. I – are we going to have to wait, Bill to see the sort of an RFP come up or are you going to (inaudible) customers and (inaudible) on our business.

Bill Smith

You can’t RFP SODA because we are the only place to get it, so unless you want to drink coke or Pepsi. So I think that’s the first thing. The second thing, if you wait for RFPs you’ve already either (inaudible) more at a loss with business. You are either helping write the RFP or you are just filling out the blanks and you have already lost. You want to be well out in front of the RFP game. So I think that’s where we are now and I think you are going to see some wins from other parts of the world, and that’s really all that I can say. You have seen a couple sold so far, and there is more to come.

Kevin Dede – Brigantine Advisors

Okay, thanks, Bill. I’m curious on Europe given the greater concentration of 3G data users and I think that’s why, in my mind, it plays out to be a more important market?

Bill Smith

Well, okay. That’s an interesting comment, but let me quickly counter, whilst Western Europe and the North American markets are large and very well established markets, they don’t show the growth curves that some of the other markets like Asia PAC shows where by and large Asia PAC right now is just launching 3G. So go back in time and look at what happened when North America’s 3G got launched, mobile broadband services are suddenly effective, and they can actually be brought to the market. When you look at Asia PAC markets where you don’t even – in many areas you don’t really have established wire line services this is the first time in Asia PAC in many GOs that you can actually offer wireless – effective internet offerings. So you can get people to the Internet using a laptop, using a Smartphone or using a tablet. So the Asia PAC is not something to – it’s something to really be followed. And in following that, you got to look at WiFi [ph] and other parts of the world, but Asia is a strong market right now and a great opportunity.

Kevin Dede – Brigantine Advisors

Appreciate the color. Thanks, Bill One last question from me and it’s on the network director software and how, I mean you mentioned that it might be a little bit further behind in development than video. I guess what I’m wondering is why you are not as focused in getting those to market as you are in the mobile Hotspot software given that it seems to me with operator issues and handling data and a desire to push stuff off on a Wi-Fi it seems me that network director addresses that part just as well as anything you have read.

Tom Matthews

Yeah. Hey Kevin, it’s Tom again. So I wouldn’t characterize our development efforts as lagging in mobile network direction. In fact, they have been accelerating. The one thing that I would say about mobile network director versus the mobile Hotspot maker and manager with respect to the opportunities to take it to market quickly is that the component parts that have to lineup for mobile network director are very, very much…

Bill Smith

They are finite.

Tom Matthews

When you have carrier elements and carrier components that vary from carrier to carrier. So you have got infrastructure components that have to interface with what you have got, policy management components that the carriers are implementing today. So there is a lot more complexity inside the network, the network architectures as well as complexity with our client product. So getting the architecture right in SODA market with that product is a much tougher and longer cycle with our carriers than low Hotspot directors is – there is a need today and clearly it’s a more simple eco system to control in that we are really controlling it and working and collaborating with the same device partners that we work with, with our connection managers today. So that’s I think why it’s going to take a little longer to get the mobile network director to market.

Kevin Dede – Brigantine Advisors

Okay. And then, Tom, while I have you, just help me understand the difference on where that is getting to market versus video, my understanding being that you already have a customer on video. That’s what I referred to in terms of lagging; I just meant time to market and understanding the difference?

Tom Matthews

Yeah, well video is obviously – there is a lot of activity given the data growth that’s happening in the market around video around optimization, around presentations, better presentation of content to handsets and tablets. And so, the video product is out there in the market where we are outselling it. We are doing demos and trials today with customers and that product is (inaudible) and Wi-Fi, the mobile network director product is probably lagging at least a couple of quarters, and again it’s because of the complexity of the ecosystem that I mentioned earlier in terms of making that all work together and getting the network architectures agreed upon.

Kevin Dede – Brigantine Advisors

Fair enough. Thanks again for the color, Tom, and thank you too, Bill and again, good luck and thanks.

Bill Smith

Thanks, Kevin.

Operator

Thank you. There are no further questions in the queue. I would like to turn the call back to management at this time for any closing remarks.

Bill Smith

I just want to again thank everyone for joining us today. Should you have any further questions, please feel free to give us a call in the office. We also get a chance to see us at the CTI Wireless trade show in Orlando. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes the Smith Micro fourth quarter and year-end 2010 financial results conference call. We thank you for your participation. You may now disconnect.

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