Smith Micro Software Inc (SMSI) 2006 Q2 法說會逐字稿

Welcome to the Smith Micro Software Corporate second quarter conference call. At this time all participants are in a listen only mode. [Operator Instructions] As a reminder this conference is being recorded today, Wednesday July 26, 2006. I would now like to turn the conference over to Bruce Quigley, VP of Investor Relations. Please go ahead.

Thank you. Good afternoon, and thank you for joining us today to discuss Smith Micro Software’s financial results for its fiscal 2006 second quarter ended June 30, 2006. By now you should have received a copy of the press release discussing our second quarter results. If you do not have a copy, and would like one, you may acquire it at Smith Micro’s website at smithmicro.com, or by calling 949-362-5800, and we will fax or email one to you immediately. With me on today’s call are Bill Smith, President and Chief Executive Officer; and Andy Schmidt, Vice President and Chief Financial Officer.

During the course of this conference call we may make forward-looking statements regarding future events or future performance of the company. Actual events or results, of course, could differ materially. These forward-looking statements speak only of today’s date, and are based upon the information currently available to the company. The company does not intend to update publicly any such forward-looking statements, whether in response to new information, future events, or otherwise. Such statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied in any forward-looking statements, including competitive factors, technology and product development, Mattet demand for our products, and our ability to execute our business plan.

For further information on potential factors that could affect our results, we refer you to the documents the company files from time to time with the Securities and Exchange Commission, specifically the company’s most recent Form 10Q, available in mid-August, and our Form 10K filings. These documents contain and identify important factors that could cause actual results to differ materially from those contained in any forward-looking statements. At this time I would like to turn the call over to Bill Smith, President and CEO of Smith Micro.

Thanks Bruce. Good afternoon everyone, and thank you for joining us today on our second quarter earnings conference call. We appreciate your interest in Smith Micro. Before Andy takes you through our second quarter financial results, I’d like to review some brief highlights of the quarter.

We are very pleased to report another very strong quarter for the company. We again achieved record results on both the top and bottom lines. Revenues for the second quarter came in at a record $12.6 million, up 277% over the $3.3 million reported from the last year, and sequentially up 27% over our record first quarter results of $9.9 million. Looking at our bottom line, pro forma net income for the second quarter was also a record $3.2 million, or $0.13 per diluted share, which compares to $764,000 or $0.03 per diluted share for the second quarter of 2005, and up sequentially from the first quarter pro forma net income of $2.9 million or $0.12 per diluted share.

Our backlog entering third quarter 2006 was $4.1 million, down from $4.6 million in the first quarter, yet up substantially from the $1.3 million in the same quarter of last year.

The second quarter was very exciting for Smith Micro across all product platforms. To briefly review, our OEM business continues to prosper. We are very excited about our QuickLink Music program, which is now ready for shipment and being Matteted to several wireless carriers worldwide. Our enterprise software business made significant progress, signing on three new customers for initial deployment, and adding two more customers already in the third quarter.

We expanded our StuffIt Wireless prototype program by incorporating handset resource compression along with our enhanced JPEG compression into a select number of prototype handsets. Reflecting our solid progress, Smith Micro has been added to the Russell 2000 index, and we have applied for a NASDAQ national Mattet listing.

I will provide additional color in detail on our overall business following Andy’s detailed financial review. Andy, take it away.

Thanks Bill. First let me discuss unique items that affect our financial statements this quarter. As we have in past quarters, we have provided pro forma results and a reconciliation of pro forma results and GAAP results. Our pro forma results, net out amortization of intangibles associated with acquisitions, and net out stock compensation related expenses to provide comparable operating results. Accordingly, all results I refer to are pro forma amounts.

As we announced on our last quarter call, the PhoTags acquisition closed on April 5. As such, our quarter includes integration costs in our operating expenses. These expenses are not netted out as far as our pro forma adjustments are concerned. Previously we had noted that we expected the acquisition to be dilutive while we readied the PhoTags technology for the wireless Mattet. In short order we have completed the integration effort and it was a great success. As Bill noted, we had readied the QuickLink Music product for shipment in the third quarter, which was an incredible effort. While doing so we saw sales of existing PhoTags products cover incremental integration expenses this period. All in all, the PhoTags acquisition was earnings neutral for the quarter.

Also of note, we’ve had another great quarter for our stock. Our average share price increased from $8.62 in the first quarter to $13.31 in the second quarter. Our average volume for the period increased from 322,000 average daily shares traded in Q1 to 744,000 average daily shares traded in Q2. The increase in liquidity has been outstanding, and of course we are now included in the Russell 2000 and 3000 indexes.

This is all great news, however, it should be noted that the increase in share price affects our diluted share calculation, which has increased from 24.3 million diluted shares in Q1 to 25.6 million diluted shares in Q2. The quarterly change in share count alone costs us half a cent on our current quarter results as compared to Q1 ’06.

Now let’s talk about our detailed second quarter results. As Bill noted, we posted record revenues of $12.6 million, and earnings of $0.13 per fully diluted share, despite integrating the new acquisition. Total revenues at $12.6 million increased from revenues of $3.3 million for the second quarter of 2005, an increase of 277%. In addition, revenues increased 27% from our then record $9.9 million first quarter 2006 performance.

Second quarter revenues consisted of $10.1 million from our wireless and OEM segment, $2.2 million from our consumer product segment, and approximately $300,000 of miscellaneous revenue. In our OEM segment, music contributed $7.2 million, up from $3.9 million in Q1 of 2006. Our Connection Manager product contributed $2.5 million, down from a very strong $3.1 million in Q1 2006.

The current quarter results are affected by a significant shipment of embedded modules to the laptop manufacturers, and subsequent burn off of PC card inventory at our carrier customers. There’s a difference in how we recognize revenue given the two connectivity alternatives. We recognize revenue when we ship PC card software to the PC card manufacturers, but don’t do the same when embedded modules are shipped by the same manufacturers. In the case of embedded modules, we recognize revenue once a customer purchases the laptop and activates the module. Since this quarter is the first time embedded modules have shipped in significant quantities, there’s a delay of revenue recognition assuming the customer activates the EBDO service once they purchase their laptop.

In addition, Verizon in particular has been updating their PC card offering, and expects to make changes to that lineup in Q3. This also contributes to the lower buying levels in Q2 and inventory burn off.

Our consumer products group continues to deliver as expected results, posting revenue of $2.2 million. As previously stated, the second quarter is a seasonally low sales period for our Allume product. However, revenue of $2.2 million for this period is up about 20% over the year previous period for Allume Systems Inc. of $1.8 million. For reference, our consumer products group posted revenue of $2.6 million in the fourth quarter of 2005.

Switching to gross profit, as we consistently point out, we manage our business to maximize our gross margin dollars rather than our gross margin as a percentage of revenue. Gross margin dollars of $7.6 million increased $4.8 million, or approximately 172%, from the same period last year. In addition, gross margin dollars increased approximately $700,000 from first quarter 2006, representing our fifth consecutive quarter of gross margin growth. Gross margin as a percentage of revenue was 60.4%, which is lower than previous periods, due to outstanding sales of the new Music Kits. Again, kits include hardware components, which result in a lower gross margin percentage than a pure software sale. Gross margin for our kits this quarter averaged 45%, which is lower than the 50% to 60% margins we initially estimated for our kit product. The reason for the margin percentage reduction was the cost of design of new cables for new V Cast phones, and the cost of component air freight to meet accelerated launches.

Given the continued introduction of new V Cast phones, and exceptional performance of the music launches by our carrier customers, we expect to continue to see new product development expediting costs. Hence, we expect our gross margin for the Music Kit product to remain at approximately 45%.

In regard to our Connection Manager product, PC card software sales represented 77% of sales, with kits representing 17% and embedded activations representing approximately 6%. Gross margins for our consumer product groups was 88%. We expect to see this group continue in the mid 80% range for margins.

Operating expenses for the second quarter of 2006 increased approximately $500,000 from first quarter 2006. The increase is attributed to the integration of PhoTags, cost of Sarbanes-Oxley compliance work, and continued building of our product management and engineering infrastructure. Going forward, we expect to add approximately $100,000 to $200,000 of operating expenses to our current base line for our Sarbanes-Oxley compliance work as we enter our testing phase of the program.

Operating margin for the current period was 23.9% as compared to 27.6% for Q1 2006. The primary driver to our lower operating margin was a change in product mix for the quarter, with the lower gross margin Music Kits representing 57% of our revenue in Q2 2006 versus 39% for Q1 2006. More important, operating income increased approximately $300,000 to $3 million in Q2 from Q1 2006’s strong performance of $2.7 million.

Net income for the second quarter was $3.2 million or $0.13 per diluted share, as compared to $764,000 or $0.03 last year, and $0.12 for diluted earnings for Q1 of 2006. The current quarter represents the fifth consecutive quarter of earnings growth.

From a balance sheet perspective, our cash position closed at $31.3 million at June 30, 2006, an increase of $10.1 million from the beginning of the year, despite using $2 million cash for our purchase of PhoTags. Accounts receivable decreased for the second straight quarter to $4.2 million, despite increasing sales. Net working capital increased to $31.5 million, and increase of $6.1 million or 24% from the beginning of the year.

In regard to the affect the PhoTags acquisition has on our balance sheet, we’ve increased our intangible assets to $4.5 million from $4.1 million at the beginning of the year. Total amortization of intangibles will be approximately $370,000 per quarter for the next two quarters. Good will has increased from $9.3 million to $15 million, also as a result of the PhoTags acquisition.

In summary, we posted another strong quarter, and our fifth consecutive quarter of earnings growth, record revenues accompanied by record earnings. Our product and customer diversification efforts paid off this quarter, as we saw new product growth outpace what we expect to be a temporary flattening of another key product. In the third quarter we are launching yet another marquis product, QuickLink Music, which will further expand our diversification efforts.

We expect gross margins as a percentage of revenue to continue to shift with changes in product mix. Given the 45% gross margin as a percentage of revenue for Music Essentials Kits versus a near 100% gross margin for our QuickLink Music product, it’s difficult to guide to the next couple of quarter’s gross margin percentage expectations. However, we’ve proven a strong track record of increasing our gross margin dollars over time, which is our ultimate goal.

In regard to operating expenses, our expenses hit our expectations each period, and are well within management’s control. As noted, we expect to increase operating expenses approximately $100,000 to $200,000 for Sarbanes-Oxley compliance work in third quarter 2006.

Finally, while we continue to report a backlog number, we expect this number to have limited value in the future, as we continue to grow. In particular, if the industry embraces embedded modules, we will not be able to report a backlog of Connection Manager software orders as we utilize an activation model for such sales. Additionally, our QuickLink Music product is a pure software sale. Such sales don’t require significant lead time, hence backlog, to deliver. All in all, reporting the backlog number provides an important growth metric when we were reporting quarterly sales in the $2 million to $5 million range, but going forward it will not be a good indicator of our next quarter’s opportunity. At this time, I’ll turn the call back to Bill.

Thanks, Andy. I now would like to give you an update on the progress of our core businesses. Starting with our OEM software business, I want to begin by stressing the importance of our continued strong relationship with our OEM partners, especially with Verizon Wireless.

We continue to work very closely with Verizon on several different fronts and have a long-term contractual relationship currently in place, which has several years remaining. Our business relationship with Verizon continues to be very strong, as is evidenced by their contribution to our results for the quarter.

As we had stated on our first quarter call, Verizon’s launch of V Cast Music was a very strong contributor to our financial results. It is clear to see that they have continued their aggressive Matteting campaign, which accelerates sales of our Music Essentials Kits. We expect to see strong growth throughout the remainder of the year, with the Music Essentials Kit.

We are extremely pleased with the progress of our QuickLink Music application, largely the result of the efforts of our new Israeli team. We have been actively Matteting QuickLink Music to several large wireless carriers. We anticipate that we will announce multiple carriers before the end of the year and remain hopeful to have a customer shipping QuickLink Music during the third quarter. We particularly want to note that these deals have a very strong international flavor and should represent a significant expansion of our carrier customer base.

Recently, we also announced that we will ship QuickLink Mobile to UTStarcom for distribution to IUSACELL, one of Mexico’s leading wireless carriers. Smith Micro’s QuickLink Mobile connection manager will provide high speed remote Internet access from a notebook PC used by IUSACELL’s expanding wireless subscriber base.

We also made progress with our new sales office in Jerusalem, where we have strengthened our international efforts throughout Europe, Asia and Australia.

Now, let’s talk about stuff at wireless for a minute. Last quarter, we noted that we have prototype testing with two of the largest, worldwide handset manufacturers and also two of the largest US carriers involved in the testing process. I am pleased to say that, during the quarter, we have expanded our prototype testing to an additional two worldwide handset manufacturers. I am pleased with the progress we are making towards having our compression technology designed into future handsets. And, as I have stated in the past, I believe we are on track to secure our first contract in 2007.

We now have working handset prototypes that are capable of both handset resource compression and our enhanced JPEG photo compression. As we have said in the past, the JPEG compression will reduce the picture size by up to 30%. And now we can add that handset resources can be compressed by up to 40%. We believe that resource compression can offer a significant cost savings to the handset manufacturer and should significantly spur the adoption of Stuffit Wireless as this is a decision that can be made by the handset manufacturer without carrier involvement.

Last quarter, we announced the release of a new Stuffit OEM product called Stuffit Image. This product is aimed at the high-end digital camera Mattet and is designed to compress raw images. Also, Stuffit Image is designed to provide photo encryption of images to protect authorship.

We have been Matteting Stuffit as well to the online photo processing sites to compress JPEG images to enhance utilization of the server infrastructure. Our technology is aimed at reducing the overall cost of storing and transmitting photo data. We are currently Matteting this technology and experiencing very favorable reaction from the large online photo processing sites.

Turning to our enterprise sales opportunity, looking at our enterprise software business, we made significant progress during the second quarter, where we signed three new enterprise customers, one of which was our first government enterprise customer. And we have signed two additional deals already in the third quarter. The last two deals include the large commercial bank and international consultancy I have mentioned on previous calls. In total, we believe that we can now sell approximately 75,000 seats of enterprise software over the next 18 to 24 months to these fine customers.

As we noted in the past, we expect to experience strong growth on the enterprise front throughout 2006 and are very pleased with the progress to date. Our pipeline of enterprise prospects is also growing rapidly and should provide additional customer relationships in the third and fourth quarters and beyond.

Now the third part of our business, the consumer sector. The consumer business continues to perform as we had anticipated and has provided a highly predictable revenue base to the rest of our businesses. During the quarter, contributions of the consumer products group have been on track. We announced several new additions recently, such as Internet Cleanup 4, Aquazone Bass edition and the Universal Binary versions of Aquazone.

In conclusion, I would like to finish my prepared reMatts by providing an updated outlook on the second half of 2006. While we did not provide specific quarterly guidance, we can say that we remain very optimistic about our growth prospects for the remainder of the year. We continue to expect strong revenue growth throughout the remainder of the year, as well as strong bottom line results. We believe our success and continued progress will accelerate further with the launch of QuickLink Music. The Music Essentials Kit already represents the largest portion of our business and sales of the new QuickLink Music application will be purely additive and should feed directly to our bottom line.

What is even more amazing is that Music has reached this dominant role in only two quarters and in spite of the strong growth of the data connectivity portion of our business to both carriers and enterprises. Although we remain pleased with having achieved yet another record quarter on both the top and bottom lines, we firmly believe that the best is yet ahead of us. So, please stay tuned.

With that, I’d like to turn the call over for questions. Operator?

[OPERATOR INSTRUCTIONS]

Our first question comes from Christin Armacost, with Lazard Capital Mattets. Please go ahead.

Thank you and nice quarter. Bill, I was wondering, can you follow up and flesh out your comments about the progress you’re making in the international Mattets with the QuickLink Music and tying that to the commentary in the press release about being able to generate revenue from QuickLink Music in before the end of this year? Is that – are you more confident today with that statement and think that it could happen sooner in the second half of this year? Or, do you think that, due to timing and some size that we should look at Q4 as being one of the first quarters of QuickLink Music? Thank you.

OK, Christin. I guess the way I would look at it is we believe that we should be able to have a customer shipping of QuickLink Music before the end of the second quarter. But again, you’re dealing with very large carriers and schedules can shift. So, that’s always a possibility but we still believe that we’re on track for a customer shipping QuickLink Music during this quarter.

I think you will see additional customers coming online in the fourth quarter and we are very excited about what we’re seeing so far. And we continue to expand our outreach to carriers on a worldwide basis and look for some strong results yet this year, and going out into 2007. Music is a great play for us.

Do you think you’ll be able to make announcements of these customers?

Christin, that’s always a Catch-22. I don’t know, you know, I always want to make the announcement. It’s really in the hands of my customers as to whether I can. And, of course, there’s always the caveat that always happens and that is that we’ll never be able to make an announcement probably before the product is officially shipped by that carrier. So, that’s another timing constraint.

Our next question comes from Reg King, with Nollenberger Capital Partners. Please go ahead.

Thank you, congrats Bill on the ending of the quarter. I was hoping you could help me, if you could clarify the comments that you made about the revenue recognition change that’s happening, I guess, as we speak. Can you help me with that?

Sure. In the case of the Connection Manager, again, it was a PC card sale, which has been dominant, if you consider the Connection Manager options as far as PC Card Tethered Solution, which is a kit or an embedded module. That product, we recognized revenue once we shipped the product to be kitted with the PC Card, in other words, when we ship it to the PC Card manufacturer. So, that’s basically an early recognition.

In the case of the embedded module, as you’ve noticed in other announcements, there have been some key players out there announcing some very good quarters based on their shipment of embedded modules to the PC manufacturers. Those modules now will take probably a couple of months to actually land in consumers’ hands. That being the case, we don’t recognize revenue once those suppliers supply an embedded module to the PC Card manufacturer or when we ship software. We basically recognize revenue once that laptop is in the customer’s hands and they actually activate the service with a carrier. So, that’s a much delayed effect.

So, in this current period right now, we may be, maybe not, but may be seeing a transition to embedded modules. As that occurs we’re going to have a slight delay in revenue recognition.

And, how’re you finding out about that? Do the PC manufacturers report back to you? Or, are you just tracking it through the system yourself?

Well, just like everyone else, we’re looking at the press releases from the usual suspects that actually manufacture the embedded modules. And, of course, you know, we can see it in our volume. Our customers remain extremely committed to the EBDO rollouts and so, right now, it’s just a lot of planning as far as how that whole product offering evolves.

Our next question comes from Anton Wahlman, with ThinkEquity Partners. Please go ahead.

Hello everyone, can you hear me?

Yes we can, Anton.

Andy, you went over a couple of things a little bit fast; I’m not sure I got it that precisely. Maybe you can clarify. You mentioned the 77% vs. 17% vs. 6%. What did that represent again? It was the middle one was Kits and the last one was embedded, but I wasn’t sure I got the whole context.

Sure. Just in context of the Connection Manager product, 77% were PC Card solutions, which represent a 95% margin for us. We then had the Tethered Solution, or the Kit solution, which represented about 17%. That’s a 50% to 60% margin solution for us. And then, 6% are activations of embedded modules, which is a 100% margin solution.

OK, and for one more clarification, you said the consumer was $2.2 million, Connection Manager was $2.5 million ; that leaves about what, $7.9 million or so for Music Kit? Was that the correct number?

The Music Kits were $7.2 million, and then we have a certain amount of miscellaneous revenue including about $300,000 from our new Pho Tags acquisition, which is all international revenue.

OK, so you don’t throw that into any of the other [two people talking at once].

That’s part of the OEM product mix. It’s an OEM sale, but it’s new to us this quarter.

OK, all right. Now, on the embedded modules and so forth, I mean, a couple of observations I’d like you to comment on. First of all, when you order a computer, you say, you go to Dell.com and then you order an embedded – a new laptop with an embedded module, then presumably, you have a pretty much determined – I mean, it’s not like you’re going to order this thing and not activate it when you get it. And, if you don’t activate it, why is that the case? That [somebody] might have gone out and bought a Card anyway, for Lord knows what reason.

So, and the second observation is I mean, there aren’t that many laptops yet, as far as I can see, that have embedded modules, I mean there are a few [Linos] a few Dells and so forth, but it doesn’t seem to me like it really has flooded the Mattet yet, so if you could comment on how that will sort of play out and the speed – from the time when you go to Dell.com and you order your thing, and you get it at home, I mean it should be, what, a week or two? So it doesn’t seem like that would impact the revenue recognition that much in comparison to a card.

Anton, I think what was being alluded to – a couple of things; first off we expect the transition to the embedded modules to continue this quarter. The second quarter was the first quarter that we saw any appreciable numbers out of the embedded activation. We make our money when that module is activated. We concur with you, that when you purchase a PC and you add the option, which I think is running about $50 for the embedded module, the likelihood of you activating is extremely high, and we expect that to be the track record. We are working very closely with our carrier customers, especially with Verizon Wireless, to monitor the rollout of embedded modules. We do expect embedded modules will eat in, somewhat, to the PC card side of the business, but we don’t know that for sure, because we don’t have enough history.

What we can say is, that when we look at, in the past, at backlogs, etc., we looked at a large number of PC cards and various different types of kits that have a standard lead time, and therefore orders are made before the start of the quarter and that gives us a nice backlog going into the next quarter. When we start looking at embedded modules that will not be the case. There will be no backlog, because we only get to recognize revenue when the product is activated. So the fact that it’s shipped to a PC card, by a PC card manufacturer to a PC manufacturer means nothing to us, that was the only point.

Our next question comes from Rich Valera with Needham and Company; please go ahead.

Thank you, good afternoon. A question on the margins of your Music Essentials Kits, you mentioned there’s sort of frictional issues putting pressure on the margins. You mentioned the cable development and the expedited shipping. While I could seem them persisting for maybe a quarter or two, it doesn’t seem like that should be a long term trend. At some point I would think there would be some stability in terms of number of cables and having to actually FedEx things. Do you agree with that, and has there been any other change, or has there been a pricing change that would, in fact, tend to limit that margin at that lower 45% level sort of permanently?

I think there’s a couple of ways to look at that, Rich. First off, you’re right, this is a period where you have a number of new handsets entering the Mattet and trying to be expedited onto store shelves, and so we did have some added costs. Now a positive side, assuming that kits in the future will also include QuickLink Music, which adds gross margin dollars, that will reduce the pressure on margin and actually bring them back up somewhat. So that decision has not been made, we are not publicly announcing that at all today. That’s a decision that will be made and announced at the appropriate time by our customer. So we look to manage the process, and hopefully that answers your question.

OK, and one more if I could. I know you don’t want to give quarterly guidance, but do you have any sense of sequential trends? You had a tremendous music quarter. Do you have any sense of sell through of the Music Kit, and also perhaps how much of it’s due to stocking for new handsets? Just any sense of how that might trend sequentially would be very helpful.

That’s an excellent question, but it’s probably a question you ought to be directing to Verizon Wireless. They very closely guard some of that data, so we really can’t directly comment. We can say that the music rollout by our customer has been very successful and they’re very pleased with it. Yet I think it’s very important to note that as successful as it has been in yet just the first two quarters, this is just the beginning and by no stretch of the imagination does this represent the magnitude of growth that we believe music will actually achieve. While we can be impressed now, let’s be more impressed a year from now.

Our next question comes from Rich Church with Unterberg, please go ahead.

Thanks, nice quarter guys. Can you give us the percentage of revenue for Verizon, and are there any other 10% customers? And within that, can you talk about Alltel and Vodaphone?

Sure, Verizon was 74% of revenue in Q2; that compares with 70% in Q1. Alltel for Q2 is about 2%.

The next closest customers in the 10% threshold would be Digital River.

And that comes out of our consumer side.

OK. And just kind of characterizing the mix going forward, on the Connection Manager, do you think that this quarter is more just an issue of waiting for the embedded modules to be activated, or do you think we’re at a more sustainable long term revenue level at this level, and therefore music will continue to be a larger piece of the overall business?

I think the best way to answer that is to look at two events that are happening. Yes, you see the impact of the embedded modules, but that should work itself out in the next quarter or so in any event, and will normalize. I think the other unique event is that you see some transitions taking place in PC card technologies that really will be implemented in the third quarter, and as such it has somewhat of a dampening effect on inventory levels and buy ins late in the second quarter. I think it’s a one time event.

Our next question comes from Chad Bennett with Miller Johnson Steichen Kinnard, please go ahead.

Good quarter guys, just a couple of questions. I know you explained it as somewhat of an irrelevant metric going forward, but can you give us any composition on the backlog number?

Sure. We gave the backlog number, I believe, at 4.1 and that is primarily Music Kits. As we had mentioned there’s quite a bit of transition going on in the Connection Manager front. So we’re not seeing a lot of that in the backlog right now, as basically the carrier customers get their supply chain set for what’s coming next.

Is there any way to give us, quantitatively, the significance or the impact of the embedded modules that you shipped, but obviously can’t recognize without giving any type of proprietary data?

Well first off, we don’t ship the embedded modules. In other words, they’re made by the embedded module/PC card manufacturer and shipped into the notebook manufacturers. We don’t know the exact numbers that have been shipped in, other than by public releases by the embedded module manufacturers and their quarterly comments. So we can’t give you much color on that. I might have stepped on your question, I apologize.

Our next question comes from Bob Lee with Sidoti, please go ahead.

Thank you, good afternoon. I just wanted to clarify StuffIt Wireless and see if you can talk about how it can be applicable to the music arena, since you mentioned about the handset resources and compression.

Yes Bob, as we have said at a number of different conferences and conference calls, our intent is to add to the StuffIt Wireless product offering, the capability of compressing MP3 files, which are the data that music are in, and the various variants thereof of MP3. We are working on that, and we are having a certain level of success, and you should expect that this capability will be added to StuffIt Wireless in the not too distant future. I think the reason that I emphasized, this quarter, the importance of the handset resource compression is that we believe this is a decision that could be made in a much more timely manner, and doesn’t require as much infrastructure modifications as are required for either JPEG, or in the future, music file compression implementation.

StuffIt Wireless for multimedia files requires the implementation of compression, both on the handset and in the central office. It’s a nontrivial undertaking, and we’re making very good progress on this. I think the importance here is that the handset resource compression, which will have the ability to directly impact the cost of the bill of material of handsets going forward, is a much quicker sell. That was really the message I was trying to get across.

OK. Then I guess when you integrate the handset resources, a portion of it, that hasn’t delayed any of your own internal projections for rolling out the StuffIt Wireless?

No, if anything it reinforces and enhances them. We still see the industry, in the future, shipping in excess of one billion handsets a year. We still very much believe that StuffIt Wireless has a place on every single one of those, and we are working hard to execute on that strategy. It is a very big play for us.

Our next question comes from Amit Dayal with Rodman and Renshaw, please go ahead.

Good quarter guys, can you hear me?

Yes, we can.

Thank you very much. I just was wondering if you could provide some color on deployment cycles on the enterprise side, and how revenues are recognized on that front.

OK, that’s a good question. The first step, of course, is to get through all the evaluation process, which can take anywhere from – for those of you who have been around for a while, you know I’ve been talking about that large commercial bank and that international consultancy I think for almost a year. It took that long to get the contract signed. The rollout and the deployment plans we work in conjunction with our customers on. Some will start right away and will ramp over time. Some will ramp on a very steady and planned state on a quarterly basis. It varies from account to account. We are recognizing the revenue, and remember, revenue on the enterprise space really has two flavors; there’s the cost per seat and then there’s the annualized maintenance.

Clearly the annualized maintenance, which then allows you to update the client to work with new hardware that will come out next month, next quarter, or next year, is something that we spread over the 12 months of the contract. In the case of the seat revenue, we have decided to be extremely conservative in the recognition of that revenue. We will recognize the seat revenue rather than being in one chunk; we will spread that out and recognize it ratably over a 12 month period.

Therefore it will probably take about 12 months for the enterprise revenue to get large enough it will be really meaningful in our core results. However, I believe starting in the third quarter numbers; you will start to see building a deferred revenue number, which we view as a very nice annuity going forward.

So can I take this deferred revenue number to be one of the metrics that we should look for going forward, like how we were looking at your backlog earlier?

Yes, that’s correct.

OK, thank you.

Our next question comes from Matt Hoffman with Cohen and Company. Please go ahead.

Thank you gentlemen. We’re seeing an increase in EVDO RevA activity at Verizon, KDDI and other key CDMA operators at the infrastructure chip level. That’s usually a pretty good indicator of their forward direction. Do you guys see RevA as a significant incremental driver of both music and data card uptake? And second, tell me about the challenges you need to address on the software side to make the most of that opportunity in RevA. Thanks.

We’re sort of restricted as to what we can say about RevA, but we can say a couple of things. First off we receive hardware long before it’s ready for primetime. This allows us to build the necessary drivers and software modifications necessary for both data connectivity and utilization of the music side of the handset devices. We are clearly in that process now and we are clearly working on that. We see RevA as actually a significant opportunity for us, going forward, as it will then cause yet a whole new change out of hardware, both PC Cards handsets, and I guess embedded modules, or you’ll replace embedded modules with PC Cards. I don’t know how that works out.

And, there will be new copies of the software needed in all cases, because the software we build today works with the hardware that ships today. It will most likely definitely not work with hardware that ships tomorrow. So, it’s an actual catalyst and driver for our business, going forward; great question.

Thanks [inaudible].

Our next question comes from Joe Hudak, with Wachovia Securities. Please go ahead.

Great quarter, guys; most of my questions have already been asked. Just going forward, my usual, SG&A; we’re looking at the same numbers, barring any further acquisition?

Well as I mentioned, we expect to add about $100,000 to $200,000 in Q3, Q4, primarily due to our SOX, the status of our SOX work. In Q3 and Q4, we go into heavy testing. So, that burns consulting and audit hours.

I mean, so that $200,000 will be per quarter, going forward?

That’s correct, between $100,000 and $200,000, we will add to our current baseline, for Q3 and Q4.

OK, great; also, current headcount?

Let me get that for you.

Current headcount is about 106, and that is up from about 99 in Q1, 90 at the beginning of the year. So once again, it’s been good progress for us as far as our plan to actually build our infrastructure. We do plan to continue hiring, but it’s always an interesting challenge. Good people are always hard to find.

Our next question is a follow up question from Christin Armacost. Please go ahead.

Thank you. I mean, it’s very clear that you’re executing on all the different Mattet segments that you’re in and updating us with, you know, the number of new customers. It’s my sense that a lot of people have focused on your backlog number as a sort of one-dimensional gauge of your progress. So, is there any additional color about your backlog composition that could help us track your success or any other things, metrics, that we should look at?

That’s a tough question. You know, the backlog is just what it is. It’s orders received in the prior quarter that will ship in the following quarter, and, you know, we have used it in the past. You know, with the embedded modules coming online with more software, especially with the QuickLink Music software that doesn’t have long lead times to build CD ROMs, the backlog as Andy indicated will most likely become a somewhat passé concept.

And at some point, we may just phase it out as a discussion item. We’ve given you a new one that you’ll start to see showing up next quarter. That will be a deferred revenue number and that will be a good indicator of the success of the enterprise sales efforts. I’m not sure what else I can say. Andy, can you add anything?

No, I think we’re relegated to being able to announce the product launches and the carriers that we shoot to launch Music off to.

I appreciate the clarity and look forward to seeing more updates on the enterprise, the number of [seeds] that you gave out this quarter was helpful. Thank you.

Good, thanks.

There is time for one final question and our final question comes from Anton Wahlman, with ThinkEquity Partners. Please go ahead.

I need two clarifications on these cards and things. First, you mentioned in the beginning that Verizon was updating its card offering. It seems to be a comment that is quite aside from the mixed with embedded. When you say updating its card offering, I mean, what are you really referring to? I mean, I just went on the Verizon site here and they’ve been adding some cards, you know, from almost the beginning three years ago of, you know, a card [added] every few months.

Now they have several of them, but I don’t see anything particularly strange or unusual in that regard.

I think, Anton, that’s probably a question you ought to aim at Verizon Wireless. You know, I think what we can say is that there are some new technology devices we’ve been working on and they are coming to the Mattetplace. And, as such, I think we saw a burn off of older card inventories as the new ones start to take their place on the shelves. That’s really all that we’re really alluding to.

So, that basically, this is not stuff that has show up yet, say, on VerizonWirelss.com. You’re referring to stuff that’s coming around the corner?

I think I’ll be careful how I answer that question. Why don’t you go to Verizon on that?

Thank you. Management, I would like to turn it back over to you for any additional comments.

OK, this is Bruce. I would like to thank everyone for joining today’s call. I’m sorry to have to cut it off, but if anybody has any additional questions, feel free to call me at 949 362 5800. And with that, we’re looking forward to our next call, which would be our third quarter financial results conference call in October. And again, feel free to give me a call or our investor relations firm, MKIR.

Thank you and have a great day.

Ladies and gentlemen, this concludes the Smith Micro Software Corporate second quarter conference call. You may now disconnect, and have a pleasant day.