Smith Micro Software Inc (SMSI) 2006 Q3 法說會逐字稿

Good afternoon ladies and gentlemen, thank you for standing by. And welcome to the Smith Micro Software Corporate Third Quarter Financial Results Conference Call. [OPERATOR INSTRUCTIONS] I would now to like to turn the conference over to Mr. Bruce Quigley, Vice President of Investor Relations. Please go ahead, sir.

Good afternoon, and thank you for joining us today to discuss Smith Micro's financial results for it's first -- its fiscal 2006 third quarter ended September 30, 2006. By now, you should have received a copy of the news release discussing our third quarter results. If you do not have a copy and would like one, you may acquire at Smith Micro's website at www.smithmicro.com or by calling 949-362-5800, and we will fax or email one to you immediately.

With me today on the 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 the future performance of the company. Actual events or results, of course, could differ materially. These forward-looking statements speak only as of today's date, and are based upon the information currently available to the company.

The company disclaims any intent to update publicly any such forward-looking statements, whether in response to new information, future events or otherwise. Such statements involve 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, market 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 10-Q, available later this month, and our Form 10-K filings. These documents contain and identify important factors that could cause actual results to differ materially from those contained in any forward-looking statements.

All forward-looking statements speak only as of today's date and are based on the information currently available to the company. Smith Micro disclaims any obligation to revise or update publicly any forward-looking statements, whether in response to new information, future events or otherwise.

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. We appreciate your interest in Smith Micro, and thank you for joining us today for our Third Quarter Earnings Conference Call. Before Andy takes you through our quarterly financial results in detail, I'd like to review some brief highlights of the quarter. We are pleased to report another very strong fiscal quarter for the company. We, again, achieved record results for the sixth quarter in a row with revenues for the third quarter at a record $14.8 million, up 115% over the $6.9 million we reported last year and sequentially up 18% over our record second quarter revenues of $12.5 million.

Looking at our bottom line, our pro forma net income for the third quarter was also a record of $4.3 million or $0.17 per share, which compared to $2.3 million or $0.10 per share in the third quarter of 2005 and was up sequentially from the record second quarter pro forma net income of $3.2 million or $0.13 per share. We were also very pleased with our gross margins, which were up over the second quarter to 61%. Later in the call, Andy will give you more detail about that rise.

The third quarter overall was a very exciting time for Smith Micro across our entire product platform, and we reached several milestones for the company. In addition to the record being -- excuse me, in addition to the quarter being our sixth consecutive quarter of record revenues and bottom line performance, we began trading on the NASDAQ global market. The company was added to the Russell 2000 trading index. We, again, were named to the Deloitte's Orange County Technology Fast 50 program, and the Orange County Business Bureau included us in their listing of the fastest-growing public companies.

Looking at our business, we continue to prosper across all platforms. Our wireless business was extremely strong. I was very excited to see the significant uptick in our connectivity product line in the third quarter. And again, Music led the way with an exceptional quarter. Our enterprise software business continues to make progress as we are now rolling out product to enterprises for deployment to their end users, and our sales pipeline continues to grow with the addition of new enterprise prospects.

We expanded our Stuffit wireless prototype testing, incorporating handset resource compression along with the enhanced JPEG compression into additional prototype handsets. We also saw significant enhancements with our consumer business, where we launched Stuffit Deluxe 11.0 and also signed significant relationships with Morpheus, EMC as well as watching the Anonymizer Anonymous Surfing Suite.

Reflecting on our solid progress, I will provide additional color and detail on our overall business and our recent announcements following Andy's detailed financial review. Andy, take it away.

Thanks, Bill. First, let me go over our customary introductory items. As we have in past quarters, we have provided pro forma results and a reconciliation of pro forma results in GAAP results. Our pro forma results net out amortization of intangibles associated with acquisitions and net out stock compensation related to expenses to provide comfortable operating results. Accordingly, all results I refer to for both 2006 and 2005, are pro forma amounts.

All right, let's discuss our detailed third quarter results. As Bill noted, we posted record revenues of $14.8 million and earnings of $0.17 per fully diluted share. Total revenues of $14.8 million increased from revenues of $6.9 million for third quarter of 2005, an increase of 115%. In addition, revenues increased 18% from our then record $12.6 million second quarter 2006 performance. Third quarter revenues consisted of $12 million from our wireless and OEM segment; $2.5 million from our Consumer Products segment; and approximately $300,000 in miscellaneous revenue.

In our OEM segment, Music contributed $8 million, up from $7.2 million in Q2 and $3.9 million in Q1 2006. Our Connection Manager product contributed $3.7 million, up from $2.5 million in Q2 2006, which is consistent with our message last quarter that we expected this segment to return to growth this period. In regard to our Connection Manager product, PC card software sales represented 63% of Connection Manager sales with kits representing 31% and downloads and activations representing 5%. Our Consumer Products Group continues to deliver as expected results, posting revenue of $2.5 million. Revenues of $2.5 million for this period is about a 9% increase over the year-previous period of $2.3 million.

Switching to gross profit, as we consistently point out, we manage our business to maximize our gross margin dollars rather than our gross margins as a percentage of revenues. Gross margin dollars of $9 million increased $3 million or approximately 50% from the same period last year. In addition, gross margin dollars increased approximately $1.4 million or 18% from second quarter 2006 representing our sixth consecutive quarter of gross margin growth.

Gross margin as a percentage of revenues was approximately 61%, which is slightly higher than the previous period as Q2 and Q3 product mix are similar. As we've noted before, our margins are driven strictly by product mix as our pricing is stable. Gross margins by product are consistent with the Connection Manager product, contributing approximately 90% gross margin; Music approximately 45%; and Consumer Products approximately 85% gross margin.

Looking at future product releases and expected shipments for Q4, we expect overall gross margins to increase. Operating expenses for third quarter 2006 increased approximately $400,000 from second quarter 2006. The increase is attributed to Sarbanes-Oxley compliance work, both consulting and auditor fees, our recent NASDAQ global market registration as well as continued building of our product management and engineering infrastructure.

Going forward, we expect our S-Ox expense to remain high in Q4 as we continue with testing. In addition, we had seasonal marketing expense increases in our Consumer Products Group during Q4. All in all, we expect to add $100,000 to $200,000 of operating expense to our Q3 baseline in Q4.

Operating margin for our current quarter was 27% as compared with 23.9% in Q2 and 27.6% in Q1 of 2006. As we've consistently noted, we expect to post operating margins of 25% to 30% as we expect to continue to invest in our infrastructure and R&D, given our significant technology assets and our new product opportunities. As follows, operating income increased approximately $1 million to $4 million in Q3 2006 from Q2 2006's strong performance of $3 million.

Net income for third quarter was $4.3 million or $0.17 per diluted share as compared to $2.3 million or $0.10 last year and $0.13 for diluted earnings for Q2 of 2006. The current quarter represents, again, the sixth consecutive quarter of earnings growth. From a balance sheet perspective, our cash position closed at $34.9 million at September 30th, an increase of $13.7 million from the beginning of the year, despite using $2 million cash for our purchase of [Botax]. Accounts receivable increased to $6.9 million on increasing sales. Networking capital increased to $36.6 million, an increase of $11.3 million or 45% from the beginning of the year.

In summary, we posted another strong quarter and our sixth consecutive quarter of earnings growth, record revenues accompanied by record earnings. In addition, all of our key product -- product lines posted meaningful growth this period. Looking forward, we expect gross margins as a percentage of revenue to increase with the introduction of new products. 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 as Sarbanes-Oxley compliance work should peak in the fourth quarter of 2006.

In regard to taxes, we started 2006 with a sizable NOL. We've posted very impressive profitability growth each quarter this year. If we continue with our profitability growth in fourth quarter, our taxable income may exceed our remaining NOLs generated from operations. To the extent that the operating NOLs are fully utilized, we will then be able to utilize our equity NOLs. It should be noted that utilizing equity NOLs does not offset tax expense, but is instead credited to additional paid-in capital or APIC.

All in all, we may see a tax charge in Q4 2006 and following in 2007. However, for cash flow purposes, equity NOLs reduce taxes payable, so any P&L charge in fourth quarter 2006 would be a non-cash charge. For modeling purposes, we may see up to a $2 million non-cash tax charge in Q4 2006 and would expect our 2007 net income to be fully taxed at a 40% rate.

At this time, I'll turn the call back to Bill.

Thanks, Andy. I would now like to give you a update on the progress of our core businesses starting with our Wireless software businesses. As I said earlier, our Wireless business remains extremely strong, up 178% over last year. I was very pleased to see Connectivity return to what we believe is a more normalized growth trend. As Andy just said, this had an impact on our gross margins, which increased slightly over the second quarter results.

Once again, our Verizon Wireless Music offering led the way, showing very strong growth. The strong marketing push by Verizon Wireless with the new Chocolate phone especially helped to drive the sales momentum. Looking forward, we expect to see continued growth in our Wireless software business throughout the remainder of the year and into the first half of 2007 and beyond.

I want to spend a little time to talk about the benefits of QuickLink Music, a truly robust product. From a wireless carrier standpoint, QuickLink Music offers a tailored, multi-media management experience from the start to finish, driving customers to a preferred, online music store, increasing subscriber data usage, while supporting the industry standard digital rights management, OMA and OMA II. When we look at the end user, it provides a streamlined application, integrates support for connectivity, overall ability to navigate the storage of the PC as well as organize your music library directly from your PC. To say the least, it is a powerful product.

Our first customer is in the final stages, and we look forward to a launch shortly. I can also say that we remain on track with a strong list of potential targets and expect to sign up additional carriers during the current quarter. I also should reiterate that our business relationship with Verizon Wireless continues to be very strong, as evidenced by our strong results. We expect to see a continued growth trend throughout the remainder of the year and into 2007.

Now, let's talk about Stuffit Wireless for a minute. Our Stuffit Wireless program continues on track. We have several prototype testing projects ongoing with large worldwide handset manufacturers. As many of you know, this is a long process, but we continue to keep a sharp focus and we believe we remain on schedule to see -- secure our first contract in 2007. As we announced last quarter, we have working handset prototypes that are capable of both handset resource compression as well as enhanced JPEG photo compression. As we have said in the past, JPEG compression will reduce the image size by up to 30%, and we can now add that handset resource compression can now be compressed up to 40%.

We believe that the resource compression can offer a significant cost savings to the handset manufacturer and should significantly spur the adoption of Stuffit Wireless. And this is a decision that could be made by the handset manufacturer without carrier involvement. This is becoming more and more relevant to the marketplace as the market continues its evolution. We continue to see more and more data moving through the spectrum, including music, video and photos. Specifically, we anticipate multi-media applications continuing to become a more prominent player in the market, especially as we look to 2007.

This vast amount of data moving through the networks is large and cumbersome and the ability to streamline and reduce bandwidth consumption will become a necessity to both carriers and handset manufacturers. Turning to our enterprise sales opportunity, looking at the enterprise software business, we made progress during the third quarter as we are now seeing the start of deployment. As I look at the pipeline, we continue to expect strong growth on the enterprise side throughout 2007.

And now the third part of our business, the Consumer sector, the Consumer business continues to perform very well. Revenues increased, and we have made significant technology strides. We launched in September, the new Stuffit Deluxe 11.0, improving its overall performance. We also launched Morpheus Photo and Animation Suite into the retail market, and recently, we released the Anonymizer Anonymous Surfing Platinum Suite, offering an -- offering unparalleled protection of users' vital information.

I should also note that we signed a significant agreement with EMC, launching the EMC Restrospect Express into the retail market. As I have stated before, this may not be the sexiest business, but it remains on track, growing at a nice level and remains very profitable to Smith Micro.

In conclusion, before I open up the call to questions, I want to reiterate our extreme confidence in our business case. While we are not providing specific quarterly guidance, we can say that we remain very optimistic about our growth prospects for the remainder of the year and into 2007. We expect to see a continuation of our strong revenue growth as well as bottom line results.

We believe our success and continued progress will accelerate further with the launch of QuickLink Music. The Music Essentials kits already represents the largest portion of our business, and the sales of our QuickLink Music application will be purely additive and will feed directly to our bottom line. I still think it is amazing that Music has reached this dominant role in only three quarters. And this is in spite of the strong growth of our 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 line, we firmly believe that the best is yet ahead of us. So, stay tuned.

With that, I'd like to open the call to questions. Operator?

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Christin Armacost of Lazard Capital Markets. Please go ahead.

Thank you, and congrats on beating our raised numbers during the quarter.

That was a good job, huh?

Yes. A question, now that you've had about three quarters of shipping the Music Essentials kit, I think about ten models available at Verizon, how would you describe their order pattern and sort of the predictability of the business now, especially going into the holiday season?

That's a great question, Christin. First off, I would say, we are incredibly pleased with the order patterns coming out of Verizon. They are obviously hitting the ball out of the park with Music, and the Chocolate phone was a very strong success. But that -- this is just the first Chocolate phone. There's more that are going to follow and -- but that's a subject to take up with LG and Verizon Wireless. We're very happy with what we see.

As far as predictability, this is a period of what I would categorize as extreme growth in this part of the business. So being able to model it perfectly, although I know you guys always do that, and sometimes it is difficult. And I think that the whole experience with the LG 8500 Chocolate phone pointed that out. There were times where we were definitely in crisis mode trying to keep the shelves full, so it's a challenge. But, what's a challenge? And, we look forward to more challenges, and clearly, are expecting to be challenged again in the fourth quarter.

And on the evolution of the Music Essentials kit, with the QuickLink Music application available, do you plan to -- can you give us any idea how the pricing structure on the QuickLink Music, is it going to be integrated into the Music Essentials kit or a per user basis from the carrier? Any thoughts on that?

Well first off, we have not announced who our first customer is, and therefore, really can't say too much about that as to how that customer is going to ship the product. It's clearly our fond hope and our -- that our largest customer, Verizon Wireless, will see the merits of QuickLink Music and will decide to include that product in their offering on the go-forward, but that's all I can say at this point.

Okay, thank you.

Thank you. Mike Walkely with Piper Jaffray, please go ahead with your question.

Great, thanks. Just maybe building a little bit on what Christin said, can you talk a little about the QuickLink Music? I know you said it would be additive to the bottom line too, but could you maybe, Andy, give us a little color on where you think the 45% gross margins in the Music segment might go over time?

Well, the easiest way to describe it is all incremental revenue from that product is 100% margin. That being the case, again, it's going to depend on the mix. As Bill pointed out numerous times, when we look at the different way carriers can offer this product, we'll have some that will choose to go with a strict download model, some with a CD and some with -- may actually go with a supplement to a kit. So once again, it'll depend on how it's rolled out.

But again, as we said before, as we expect our new products to launch, we expect gross margins to increase overall. And we expect the new Music offering to be a significant contributor, which in our model is a seven-figure contributor. So under those circumstances, again, the margins are expected to go up. And, it just depends how well the other sectors perform as, frankly, all sectors are growing right now.

Okay, great. That's helpful. And then, in terms of your Connection Manager product, it had a really nice bounce back this quarter. As you're looking out with Verizon's network upgrade over time, can you maybe just discuss in big picture how you see that product developing into '07?

Yes Mike, first off, that bounce back's really not a surprise to us. We tried to convey that message during last quarter's call that we thought that was somewhat of an anomaly that it was a just a one-quarter event. And, I think all this does prove is we do know our business. We look for continued growth out of our connectivity products for the balance of foreseeable future. We see growth both through the carriers as well as through the enterprises. The enterprises are just getting started, and we see that there'll probably be some fairly significant growth drivers in the not too distant future there. So, we're very bullish on our connectivity product, and we think that horse has a long ways to run.

Great, thanks. Maybe just two quick questions and I'll pass it on, just for Andy. Can you give us Verizon as a percent of sales? And then for Bill, maybe just on the Stuffit initiatives you have going on, is there any color you can share with us on maybe how we should think about your pricing for that? Is it going to be on a per handset basis? Anything you can share would be quite helpful. Thanks a lot.

Okay. Real quickly, Verizon was 77% of sales for Q3 '06.

Thanks.

And then on the Stuffit side, we're in discussions as to how to price and we're looking at a number of different models. The models can vary from a percentage of the savings that we can generate for the handset manufacturer to just a flat fee per phone. In all cases, it's a leveraged model however. We're not particularly intrigued with the concept of a one-time pay. That doesn't do us much good. It's not our business and not how we do business. So I hope that kind of gives you some flavor.

Great, thanks a lot. And good luck in all your initiatives.

Thank you.

All right, thank you. Anton Wahlman with ThinkEquity, please go ahead with your question.

Yes. Bill, I have a question on -- also on the Stuffit Mobile. And that is, I've been kind of listening to the arguments for why to have it to begin with as they are nicely applicable to a mobile handset and transmission scenario for all the obvious reasons, small footprint in general, physically as well as very expensive bandwidth. In principal, don't those arguments also apply to larger devices and fixed networks?

Now, maybe the problems aren't quite as acute, but in principal, I hear nothing from fixed operators, other than the fact that they're also running out of bandwidth all the time and would like to have things compressed, more than would go across their pipes as well as the fact that laptop makers and others also want to be able to make cheaper hardware. So how -- what are your thoughts on going after markets beyond the sort of mobile handsets and mobile transmission or photo and the like?

It's a good question, Anton. I think the way to look at is, we are trying to de-lever on what we've said on the wireless side. We are working in other areas with Stuffit and Stuffit Wireless. Clearly, we're focused on the Internet side as well for the handling of JPEG pictures, especially by the large photo-sharing sites and the photo-printing sites. And, we're in substantive dialogs with nothing really to talk about on this call. Hopefully once the deal's done, we'll come to the street and tell you all about it.

As far as fixed Royal -- or fixed side, we haven't really, I think, really focused hard on that, because we've been just trying to narrow our focus and get through what we started out to get done. I think I can give you a little bit more color, and I think it's -- there are new operating environments coming for handsets going forward, a lot of those coming out of our friends down at QUALCOMM. And they're much more graphic -- graphically oriented and highly compressible and actually -- but also just like Windows, as we all know, when DOS turned to Windows and Windows turned to where it is now, it keeps getting bigger and bigger with every release. That just puts more pressure on the handset guys to try to figure out ways to compress things even tighter. So, there are many drivers working in our favor that will allow us to be very successful in the Stuffit Wireless compression space.

Now I haven't even focused on this call really on what we're doing on the carrier side, because I think that, as I've said before, the handset side will come first. And, I think that will be the early wins and then you'll see us start to knock down some deals on the carrier side for the JPEG, and we're getting very close to having Music compression. And we're working on full video compression as well, and there's a lot of interest on both of those from the carrier side as well.

So it's a very exciting futures play. I mean, it should be pointed out to everybody on the call that none of the Stuffit Wireless revenue -- there is no Stuffit Wireless revenue in any of our numbers yet. So as good as they are, it's a driver to make them better. And it's a big upside.

Yes, good. Just one quick one on the Connection Manager. You said downloads and activations were 5% of those numbers, PC cards still being the larger part. And it seems to me that the rebound, as it were, and new growth, the resumption in growth in the PC -- so that the card Connection Manager business, really came from mostly the refresh of the card that [dimmed] the whole new generation of Rev A capable cards that really were the larger drivers, not any sort of follow-through in terms of embedded or all of these things that are tied to the handset.

Yes. I would say that you should view the embedded module as still a futures area. It hasn't really seen a lot of growth yet. I will say, you mentioned Rev A, keep in mind that our largest customer is Verizon Wireless. And, Verizon Wireless has said nothing about their plans for Rev A publicly as yet. So, it would not in any way, shape or form, imply that the resurgence is because they're now shipping Rev A cards, because they're not.

I think it's more a fact that you see the Express cards now out on the market. There was, we believed, a somewhat of a sell-down of older technology cards that hit in the second quarter, and that caused that quarter to be sequentially a little weaker than anybody would have guessed. But, the results that you've seen this quarter clearly demonstrate the strength of this segment of our business and the fact that it is very resilient and growing.

Good, thank you.

All right, thank you. Chad Bennett with MJSK, please go ahead with your question.

Yes. Good quarter, congrats on beating the unraised numbers in the quarter.

Oh, is that a challenge for the next quarter? Okay.

Just comical. Anyways, looking at gross margin as a percentage in the quarter, it was somewhat flattish if you look at it sequentially, I believe, on a pro forma basis. And, you saw a big sequential increase in connectivity in the quarter from, I think, $2.5 million to $4 million at a 90% plus gross margin. I'm just wondering kind of if margins stayed the same in the respective product areas, why didn't we see a bigger gain as a percentage in the overall gross margin line?

Well actually again, the math works out. It was actually an increase of $2.5 million to $3.7 million, but the Music is up fairly significantly again. It was up about the same amount. And so again, the product mix was almost dead similar. It's just all groups grew at about the Consumer Products was also up about the same amount percentage wise. So honestly, it's just plain and simply, all groups grew in a similar mix.

Okay. And then, if we look at receivables, obviously you had a great quarter. They were up, I believe, 60%-ish sequentially. DSOs still look like a reasonable number though. Can you just talk about maybe about linearity of the quarter? Or does that speak to linearity?

It does somewhat. And again, we do get always a big push here near ends of quarters. And we've always talked that we don't understand yet in these growth businesses, seasonality or whatnot. But certainly, we had a very big September. And we look forward it may end up being a very big third months of quarters on a go forward. That's a primary driver.

And then some other way we put it is, when we deal with large OEMs, they're obviously perfect credit risks and great payers. And our primary focus is less about reducing DSOs to a certain day, but actually streamlining the process for them, given their size so that we actually work out invoicing and billing patterns that help them actually pay on a regular basis but also help them through their administration with their accuracy, if you will. So frankly, we're less concerned about moving to DSO 10 days earlier, if you will, versus actually streamlining and being a good customer for the big bureaucracies.

Okay, fair enough. And then another question, did we ship or recognize any revenue related to QuickLink Music this quarter?

There are no revenues from QuickLink Music in these numbers.

Okay. And one last question, in The Journal today, there was a article about Cingular Wireless and introducing their music service. And they talked about being able to download songs from the PC to the handset via a data cable and then next year, potentially introducing over air -- over the air download capability. I guess first of all, how are they doing it? And are they a customer of yours -- as much as you can say?

That's a great question. You ought to talk to them and ask exactly how they're doing it. And until we see product, we can't even comment. I can very categorically tell you that they are not the first customer we've alluded to for some time, if that's your question. We are -- we are talking to all the major carriers on a worldwide basis, and we would love to have Cingular as a customer going forward. But that's not something that's in the cards right now.

Okay. Thanks guys, good quarter.

All right, thank you. Reg King with Nollenberger Capital Partners, please go ahead with your question.

Great, thank you. Congrats, Bill and Andy, on the quarter. Andy, can you give us a little bit of insight into maybe the visibility as you're moving through the December quarter here. I think last quarter you gave us some insight to deferred revenue. Maybe you can give us a little bit of what the pipeline looks like in your business.

Actually, I'll turn that back to Bill on the pipeline with enterprise.

Are we talking about enterprise or are we talking about the backlog kind of thing? What are you getting at, Reg?

I'm actually getting at both, Bill, if you can comment on both.

Okay. Well for the -- I told everybody I wouldn't do it, but I'll do it one more time and then I'm not going to issue backlog numbers again. Backlog for the quarter was about 4.3 million, give or take, so it was a very nice backlog going into the quarter. Don't consider it to be a particularly meaningful number. Frankly, we got a huge order, like a few days after the start of the quarter, and we could have told you we had a backlog twice that size and then some. And I don't know what that means. So backlog is strong.

As far as the pipeline on the enterprise side, we've seen the deployment, the very, very large international consultancies have started deployment in about 30 geo's, none of which by the way, are in North America at the present time. They will deploy in North America, but that's not where they chose to start. So they are actually moving at a pretty rapid rate. You've got to keep in mind that while a large enterprise might want to deploy tens of thousands of seats, they don't do it all at once. They do it x thousand a month or whatever, however they can manage if for their own sanity and move it through, but they are working very well.

A number of other customers, I can give you some color on it, a number of other customers -- all of our customers by the way, are multi-carrier customers. We are in no way, shape or form competing against our largest customer. We're really in that sweet spot, which is where large enterprises want multiple carriers in their infrastructure. They need a client that does the whole thing.

A number of our clients that are signed have delayed the start of their deployment, although we expect that to happen in the current quarter, because they were waiting to try to make up their mind whether they wanted to buy PC cards that were EVDO capable cards or Rev A capable cards, and also waiting for Rev A cards to become available and -- and go through the testing process to certify them. All of that's underway and going along just fine. So we expect a number of the other accounts that we have closed to start deployment during the current quarter. And I hope that gives you some color.

Great, thanks Bill. Bill, can you -- you've talked a couple of times about feeling comfortable that you would have a couple of carriers signed up on Music product. What's your confidence level as we go into the last couple of months of the year here?

You've got me on the spot because actually I'm on the hook because I thought we would have one shipping in the third quarter and obviously that didn't happen. It's not because we didn't have a customer it was -- we have the customer. There -- certain process with the product we're kind of working through their launch dynamics and unfortunately we can't really exert much pressure on that. We have to be very supportive. So quite to the contrary we have to work with them. And I think it's all going great and we'll see that customer launch.

We have a number of other customers that have given us the green light, they're going to go with us and are all talking about launching in the fourth quarter. So we do believe we'll have more than one carrier shipping at the end of fourth quarter but just like in this case, you're dealing with carriers. They're large, they have a lot of dynamics that's hard for all of us to understand at times. But they have to work through their process. And the thing that we have to do is always be a helpful partner not a problem and work with them to solve whatever issues they may have and that's something that we do very well.

So that's our focus. I think you'll see a couple of customers at least, maybe more, in the fourth quarter and I feel pretty strongly about that. But I was wrong last quarter and I'll take the lashing for that. How's that?

Thanks Bill. Andy, you made some comments earlier on taxes that was giving us some insight into the tax impact I think, for the December quarter and beyond. Can you just review that again, I think that's gotten lost in your comments there?

Yes, tax accounting and book accounting, obviously, are a little different. A statement we've been making all year which will hold true is we're not going to be a meaningful taxpayer this year. We have -- we started the year with 14.7 million in NOLs and those NOLs will shelter our tax bill as we go forward.

Now when we do a deep dive into that NOL approximately 8.5 million of that NOL is attributed to stock option exercises. Those are treated differently from a book perspective. Again, they do work as a NOL and reduce your tax liability and reduce the cash that you have to pay, which is what's most important. But from a book perspective those are handled differently and they don't offset your P&L tax expense.

So what we are looking at is -- again, a good problem to have, we've been so successful this year it looks like we're going to burn through all of our operating NOLs which are a direct offset to tax expense on your P&L. And we'll start digging into our, what are called equity NOLs, here in the fourth quarter. And again what that will mean is on the books we'll have to show a tax expense but when you look at the cash flow statement, you're going to see that it's not a cash event. So it's a non-cash type charge.

As we get into 2007, again, we expect to do well enough to where we will burn through all equity NOLs and at that point then we'll be working with more current real time tax tools, if you will, to try to reduce our tax rate. But for modeling purposes, just to be safe, we're telling everyone to model a 40% tax rate in '07 and we'll do our best to reduce that. Does that help?

Yes. And Andy how should we think about the December quarter then? It looks like in the December quarter you're actually going to get a probably a hit on taxes, more than you originally planned. So should we also think 40% for the December quarter?

What I had said is it could be up to a $2 million charge. But again that will be a non-cash charge.

Okay, got it. Thanks very much guys.

Let me jump in here real quick, we're on a time constraint right now, and I know there is a few others on the -- that are waiting to ask questions, so if you could limit it to one question and one follow-up on that question I'd appreciate it. And if you have any additional questions we can always follow-up after the call.

Okay. Thank you. Rich Valera with Needham & Company please go ahead with your question.

Just wondering if I can take a crack at the trajectory of your business. Seems like last quarter you seemed fairly comfortable that at a minimum you would be sequentially flat and possibly up, and of course you were up nicely. Is there any sense at all you can give us on if we have any reason to expect you to be down sequentially and what do you think would be sort of a seasonally strong fourth quarter for wireless or any other color you can give us there?

Rich, your phone is breaking up. It's hard to hear you, but did you -- give me the question again.

Sorry about that. Around just sequential revenue trends in the fourth quarter, last quarter you seemed fairly confident that you'd be at worst flat I think, and possibly up. And of course now were up nicely. I was just wondering if you have any similar color in terms of the fourth quarter relative to the third quarter, this quarter?

Okay. I mean, I think you're saying what I say to my salesman, "Are you sandbagging me?" We give you the best insight we have at the time. I think, as I said in my prepared comments, we expect fourth quarter to be sequentially up, both top and bottom. And we feel good about our business. I don't know how else to say it. We're not making any excuses, it's a great business.

That's helpful actually. And just also, Andy, did you mention that you expected gross margin specifically to be up in the fourth quarter or was that more of a general comment about next year?

We expect to get our -- as Bill pointed out we expect to have our QuickLink Music product shipping in fourth quarter and that's going to be a catalyst to increase margins.

Okay, that's very helpful. Thank you.

All right. Thank you. Amit Dayal with Rodman & Renshaw please go ahead with your question.

Thanks guys. Just coming to the EVDO business, last quarter you highlighted a shift in how revenues would be recognized going forward due to embedded modules and laptops and its subsequent activation by the end consumers. I don't know if you've already touched upon this, but I'd like to know what is the level of activation that you are seeing currently on this side?

When you consider the 3.7 million in connection management products we did in third quarter, only 5% were related to activations or downloads. So it's a very small number now, and then Bill had commented that at least from our perspective we have not seen that catch on yet. So right now that doesn't have any affect on us.

Let me add some color to that that maybe will be helpful so you can try to understand why. We don't all know why, I don't know exactly why, but I have an insight and the insight is that presently if you order a PC with an embedded module it's an EVDO embedded module. Most people know that, especially enterprises know that -- Rev A is out there. One major player, Sprint, has already announced, and actually announced their first city, San Diego, last week. So a lot of people are asking a simple question, "Why would I buy a PC with an EVDO embedded module knowing that in the next couple of months or a quarter or two, whatever, Rev A is going to come out and my only answer then is to go get a REV A, PC card and slip it inside of the PC."

"Why even buy an embedded module to begin with at the present time?" It's a great question. I think that it may speak to what some of the issues are on the embedded side. I'm glad we're in the software business. We really don't care how you plan on using our software, whether it's with a tethered phone, a Bluetooth phone, a PC card or an embedded module, we just want you to use it. And that's really the bottom line.

So basically the way we could look into this is when this Rev A comes into effect or starts being deployed on a mass scale, if you want to call it that, it could be a catalyst for the stock, in some sense?

Yes, certainly when you look at the connection product, well our product and just the service, I think most people would agree that the Rev A is going to be something that really enhances the product.

And just one follow-up question and I got this question from an investor. At this point next year, at this time next year do you think non-Verizon revenues are going to exceed Verizon revenues?

I think that's a great goal. Certainly -- because again, Verizon given the size and their success, I've got to tell you, if we can -- it's a great goal for us to set and if we actually do that we will be a very large company.

Okay, thank you guys.

Bob Lee with Sidoti & Company, please go ahead with your question.

I just got this question concerning the Music Essentials kit, are you seeing any of the future Verizon handset OEMs coming up with putting some of the components within the music kit within their product, before shipment?

Not in any meaningful way. There was one handset out of LG that had a cable in it, that came with the phone, but that's probably it. We haven't seen any indication of that trend and we don't see any forecasts coming from Verizon that the way they're doing business now is going to change. So I have no real way to help you on it other than to say we just don't see it right now.

And then lastly is, I guess you had the Shelf Registration during this quarter. I just wanted to see if you can discuss why you did that and is there any kind of immediate need for that?

Yes, we -- as all of you know, we filed a Shelf Registration this quarter. The intent, the purpose here is that our goal is to become the dominant software house in the wireless space. One of the ways that you become the dominant player is that you have a portfolio of technologies that is large enough to satisfy a very high percentage of the needs of your customers and your future customers.

They also have a need as was just pointed out in that last question, as important as Verizon Wireless is to us and as incredibly strong as our relationship is with Verizon Wireless, we understand the need to expand to other customers. One of the ways to achieve all of this is to become very active on the M&A side.

There are many ways you can do M&A transactions, you can print a bunch of stock and you can hand it over to the prior owners of a company that you are about to buy and that you lock them up for six months and it creates a huge overhang and a big problem. It just really isn't a very responsible way to do it. We have chosen therefore to setup a shelf such that we can move quickly to the marketplace with a fully marketed secondary or some transaction like that that would put the shares in the hands of a wide range of institutional investors that were really targeted, as we know these are great people to have hold your stock, grow their value and increase the success of their funds.

We are going to be very active on the M&A side. We have a good amount of cash, we have up to 35 million, that's up substantially from the start of the year. We expect the business to continue to generate cash. But to do the kind of acquisition work that we think the market is, number one, prepared to see -- we've already started to see consolidation in the wireless side. And also, to meet the demands of our customers and our future customers we have to be prepared to move. That's why we filed the Shelf.

Clearly, we're always monitoring that and we're prepared to pull that down at the appropriate time and we'll come to the Street and tell them all about it and answer all of the questions.

Great. Thank you and good luck.

All right, thank you. We have time for one final question that's coming from Kevin Dede with Merriman Curhan Ford. Please go ahead sir.

Hi, guys, congrats on the quarter. Thanks for taking the question. Bill, I was hoping you could dive in a little bit more on the enterprise side. A couple of points I'm curious about, can you discuss to a greater extent your visibility there, how you see the ramp increasing, when you think it becomes a meaningful contributor to revenue? And lastly, the relationship that your team has with Verizon on the enterprise side?

We have a very strong relationship with Verizon, across the board. I hear rumors from the Street that there are some issues with Verizon and that is all bunk. It has always been all bunk and it will probably continue to be that. But we have a very strong relationship with Verizon Wireless and we're privileged to have that and we work hard to keep it that way. And I guess that's what we do better than almost anybody else in the OEM software space.

We do work with their enterprise folks. We build an enterprise-level client for Verizon Wireless that is logo'd to Verizon Wireless and supports the Verizon Wireless network. We saw a number of years ago now and a couple of years ago, that there was going to be a broader opportunity. And we came to you and we came to the street and we said we're going to launch our own enterprise software initiative. We said at the time that we felt that enterprises both business and governmental would probably follow the same trend that they did with their voice lines and they would use multiple carriers.

That by and large is holding true. The very largest enterprises want to use many, many carriers. In the case of the international consultancy they had no choice. They want to be in 90 different geo's, there is no carrier that covers and services 90 different geo's, not even Vodafone. So they're effectively going to use 100 or more different carriers in their total infrastructure. They wanted a client, a single client that would do both the GSM side of wireless data as well as the CDMA side of wireless data transparently. Everything to look the same, to feel the same. If they didn't want there to be any difference for their users, from their perspective, as to what carrier they were on or what part of the world they were in. And they wanted a single client that the IT folks would need to support.

And probably the strongest thing that all of our customers say is that they want a product that enhances data security. Whether that be for WiFi access or for wireless LAN access, to guarantee that by providing wireless connectivity to the corporate infrastructure doesn't provide the opportunity for breaches into that corporate database.

Well, that's what our product does, and it does it very, very well. We are closing deals. Now, as I said, there are some other things going that -- other dynamics. On the CDMA side you have a -- we're poised for a transition at some point from the world of EVDO to the world of Rev A and so enterprises have a significant investment. If they're going to deploy 10, 20, 30, 40, 60, 80, 100,000 seats of wireless enterprise software and a hardware to support it you're talking about a significant investment.

Now in the case of the software, they also pay a 20% per annum maintenance. So they would get the upgrades. In the case of the hardware, that's not the case. If they buy 10,000 EVDO cards and the world turns to Rev A in a couple of months, those 10,000 EVDO cards are basically a bad investment maybe, in their eyes. And they will therefore defer to start and start deployment with Rev A to get -- from the get-go.

So those are some of the dynamics that hit this part of the market. We are very bullish on it. We still see extreme growth in the enterprise space. I still believe it's going to be a part of our business that is very large. Now we have kind of made it difficult for my enterprise sales guys to really show off how good they are because we then said we want to recognize the revenue in the most conservative manner. And so we'll spread the initial seat revenue over the first 12 months. So that kind of waters it down.

And I think we've talked about at various conferences as well as on conference calls like this, that the enterprise revenue would probably grow over time and sometime maybe in the latter part of 2007 you might say, "Gee, it's significant now and I'm impressed." But I think behind that you have to see the work that's going on and sometimes we can tell you and sometimes we can't. In most cases our customers won't even allow us to use their names in public because we are part of their wireless security system. And they just actually forbid us from doing that. So we have to live by that.

Very well, Bill, thank you very much for taking the question. And congratulations again on a nice quarter.

Thanks Kevin.

Gentlemen, there are no further questions please continue with any closing comments.

Yes, I would like to thank everyone for joining us on today's call. We look forward to our next call which will be our 2006 year end financial results conference call in February 2007. We apologize if we were not able to get to your question. Please feel free to contact us or our IR firm, The NKR Group, and we'll answer those questions for you. Have a good day.

All right, thank you. Ladies and gentlemen this concludes the Smith Micro Software Corporate Third Quarter Financial Results Conference Call. You may now disconnect. Thank you for using the ACT Conferencing. Have a very pleasant day.