Smith Micro Software, Inc.
Q3 2007 Earnings Call Transcript

Published: 1 Nov 2007

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for standingby. Welcome to the Smith Micro Software third Quarter Financial ResultsConference Call. During today's presentation, all parties will be in alisten-only mode. Following the presentation the conference will be open forquestions (Operator Instructions). This conference call is being recorded today, Wednesday,October 31st of 2007. I will now turn the conference over to Bruce Quigley, VPof Investor Relations. Please go ahead sir.

[Bruce Quigley:]

Good afternoon, and thank you for joining us today todiscuss Smith Micro Software financial results for the fiscal 2007 thirdquarter ended September 30, 2007. By now you should have received a copy of thepress release discussing our third quarter results. If you do not have a copy andwould like one, you may find it at Smith Micro's website at www.smithmicro.comor by calling 949-362-5800 and we will fax or e-mail you one immediately. With me today on today's call are Bill Smith, President andChief Executive Officer, and Andy Schmidt, Vice President and Chief FinancialOfficer. During the course of this conference call we may make forward-lookingstatements regarding future events or the future performance of the company.Actual events or results, of course, could differ materially. Theseforward-looking statements speak only as of today's date and are based uponinformation currently available to the company. The Company assumes no obligation to update publicly anysuch forward-looking statements whether in response to new information, futureevents or otherwise. Such statements involve a number of risks anduncertainties that could cause actual results to differ materially from thoseexpressed or implied in any forward-looking statements including competitivefactors, technology and product development, market demand for our products andour ability to execute our business plan. For further information on potential factors that couldaffect our results, we refer you to the documents the company files from timeto time with the Securities and Exchange Commission specifically the company'sreports on Form 10-Q and Form 10-K. These documents contain and identifyimportant factors that could cause actual results to differ materially fromthose contained in any forward-looking statements. At this time I would like to turn the call over to BillSmith, President and CEO of Smith Micro.

[Bill Smith:]

Thanks, Bruce. Good afternoon, everyone, and thank you forjoining us today. Today we announce our third quarter 2007 results. I am pleasedto announce another quarter of record revenues for the company. During thequarter we achieved several significant milestones, as well as strong top andbottom line results. Later in the call I will breakdown specifics within eachbusiness segment. During the third quarter we recorded record revenues of$20.4 million, an increase of 37.8% from the $14.8 million we reported in thirdquarter of 2006. Looking at our bottom line, non-GAAP net income for the thirdquarter was $6.7 million or $0.21 per diluted share. For the nine months ended the company reported record netrevenues of $53.4 million. That was up 43.4% over the $37.2 million we reportedlast year and non-GAAP net income for the nine months was $18.1 million or$0.58 per share, which was up 72.7% over the $10.4 million or $0.42 per sharewe reported last year. I was also pleased with the overall progress we made as acompany during the quarter. We saw a number of new customer relationships fromCricket to HGC and now also U.S. Cellular. We saw a continued evolution of ourbusiness case as again, we saw several new cross-selling opportunities comingfrom our acquired businesses. And we also made significant progress with a major new SmithMicro branded product Revue for the fast growing SmartPhone worldwide market. Iwill update you later in the call about these subjects plus more, but first I'dlike to turn the call over to Andy Schmidt, CFO and Vice President to go overthe financial results in more detail. Andy?

[Andy Schmidt:]

Thank you, Bill. First let me go over our customaryintroductory items. As we have in the past quarters, we have provided non-GAAPresults and a reconciliation of non-GAAP and GAAP results. The non-GAAP resultsprovided net-out amortization of intangibles associated with acquisitions,stock compensation-related expenses and non-cash tax expense to providecomparable operating results. Accordingly, all results I refer to in myprepared remarks about 2007 and 2006 are non-GAAP amounts. All right. Let's discuss our detailed third quarter results.As Bill, noted we posted revenues of $20.4 million earning of $0.21 per dilutedshare. Total revenues of $20.4 million increased from revenues of $14.8 millionfor third quarter of 2006, an increase of 38%. International revenue was $1.5million this quarter across all business groups. As discussed at our last conference call, the Vista driverissue, which affected our second quarter multimedia revenue is behind us. Thirdquarter revenue for multimedia was $8.0 million or the same with Q3 of 2006.Connectivity and security posted another record quarter with revenues of $8.0million for the quarter as compared to $3.8 million last year. Compression and consumer posted record revenues of $3.7million as compared to $2.6 million last year. Mobile device management revenuewas approximately $400,000 for the quarter and is a new revenue stream for us.And finally we reported approximately $300,000 of other revenue, which isconsistent with our third quarter of 2006. In regard to deferred revenue, total deal revenue for ourenterprise customers across all product groups was approximately $860,000 thisquarter as compared to revenue we recognized of $515,000. Total deferredrevenue at September 30th 2007, was approximately $710,000. Okay. Switching to gross profit, as we consistently pointout, we manage our business to maximize our gross margin dollars rather thangross margins as a percentage of revenues. Non-GAAP gross margin dollars of$14.5 million increased $5.5 million or approximately 57% from the same periodlast year. Non-GAAP gross margin as a percentage of revenue was approximately71% for Q3 2007 compared to 61% for Q3 of 2006. Non-GAAP gross margins by business unit were as follows;Multimedia, 56%, connectivity and security, 94%, compression and consumer, 74%,mobile device management 56%, and other revenue 46%. As we've noted before, ourmargins are driven strictly by product mix. Okay. Switching to operating expenses, non-GAAP operatingexpenses for the third quarter of 2007 increased to $8.4 million orapproximately $0.9 million from second quarter of 2007. The change is asexpected as we added infrastructure and personnel and marketing, selling andadvertising expense associated with the new VMware product line. Non-GAAP operating margin for the current period wasapproximately 30% as compared to 27% for Q3 of 2006. As follows non-GAAPoperating income increased $2 million to $6 million for the current period.Despite acquisitions and significant investment in our operating infrastructurewe have seen our non-GAAP operating margin increase to 29.5% year-to-date from26.1% for the nine months ended September 30th 2006. Non-GAAP net income forthe third quarter was $6.7 million or $0.21 per diluted share as compared to $4.3million or $0.17 last year. From a balance sheet perspective our cash position closed at$83 million at September 30th 2007, a decrease of approximately $9.5 millionfrom the beginning of the year. Cash generated from operations year-to-date wasapproximately $6 million. The primary uses of cash included the acquisition ofInsignia for approximately $15.3 million, the Ecutel acquisition for $8million, and the payout of the PhoTags earn out of $3.5 million. Cash generatedfrom stock sales and stock options totaled $9.1 million year-to-date. Accounts receivable increased to $17 million primarilydriven by the timing of sales during the quarter, which is heavily skewedtowards the last month of the quarter. Finally, networking capital at the endof Q3 was $94.4 million. Again I'd like to emphasize that while we reported recordrevenues all of our operating metrics including gross margin, operating marginand net income are also significantly improved from our year previous period.Looking forward to the last quarter of the year, gross margins will continue todepend on product mix. We expect gross margin to continue at the 70 to 75%range in Q4. In regard to operating expenses based on the significantleverage in our model, we expect to continue to invest in our business byadding new talent to our roster and to spend marketing dollars to support thelaunch of a Revue. Finally we expect SOX related expenses of approximately 300to 350,000 for the quarter as we prepare for our fiscal year-end 10-K process. We expect non-GAAP operating expenses to increase to the $9million to $9.5 million range in Q4. And as stated before, we expect operatingmargin to run around the 30 to 35% range for the back half of the year assumingstatus quo. This number can change based on either new acquisitions or newproduct launches. In regard to taxes, our current estimate is that cash basedtaxes will be around 5% of non-GAAP net income for the balance of the year.This estimate is based on our existing NOLs and our internal forecast ofprofitability and deductions such as those driven by stock option exercises allwhich of are very difficult to predict. As previously noted, we began 2007 with equity NOL carryforwards of approximately $15 million federal and $12 million state. In termsof housekeeping, we expect to file our current quarter 10-Q by November 9th. Inaddition, we're going to make a format change to our cash flow statement forour 2006 fiscal year 10-K and June 30, 2007 10-Q. For fiscal 2006, and the six months ended June 30, 2007, wehad significant stock option exercises. As per FAS 123R enacted in 2006, weshould include the tax benefit related to stock option exercises in thefinancing section of the cash flow statement rather than the operating sectionof the cash flow statement. As our stock option exercises were significant during theperiods I mentioned, we'll make the change for this line item moving it fromcash generated from operating activities to cash generated from financingactivities. Let me stress, that the cash flow statement as a whole isunchanged and that there's absolutely no change to the P&L balance sheet orstatement of stockholders equity for these periods. Expect to see the cash flowrevisions filed along with our current 10-Q on November 9th. At this point I'll turn the call back to Bill.

[Bill Smith:]

Thanks, Andy. Starting with our connectivity and securitybusiness segment I was extremely pleased with this overall performance duringthe quarter, where we saw record revenues, which were up 109% from thirdquarter of last year. Our QuickLink Mobile brand for connectivity solution sawstrengths from all our customers including Verizon Wireless, a All Tell andEnterprise accounts such as Siemens, an account that came to us via the Ecuteltransaction. During the quarter Reap Wireless which markets productsunder the Cricket Wireless brands announced that they will begin shippingQuickLink Mobile and U.S. Cellular announced just last week the availability ofQuickLink Mobile shipping on their first two wireless data devices. We expectto see more contributions from these customers in the coming quarters as theyroll out new data services to meet customers' demands. We continue to work very hard on signing new carriers anddevice manufacturers and we expect to announce new customer wins during thefourth quarter of this year. We believe that the strength in this product suiteacross the Board is attributable to several factors, with the most importantbeing wider adoption of wireless broadband services throughout the marketplace. In the recent past, we saw the majority of users beingcorporate executives or road warriors, but now we are seeing a broader massmarket as wireless data services reach the enterprise audience and our expectationis that this trend will continue. As wireless carriers continue to offercustomers a reasonable price point and various new data plan options, the easeof using wireless broadband will drive broader consumer adoption. Our acquisition of Ecutel in February is now fullyintegrated into the company. The new combination of connection management,session persistence and mobile VPN marketed under the QuickLink Mobility branddelivers an industry leading end-to-end connectivity solution with enhanced wirelessaccess security, policy management and the ability to automatically connect toyour approved networks and roam seamlessly across different wired and wirelessnetworks. All this is facilitated via a very user-friendly accessexperience while providing all the power features demanded by the enterprisecustomer. We continue to build our IP portfolio and received and announced anew wireless patent persistence in masses for secured network mobility, aprocess that provides continuous secure communication sessions between mobileusers, devices and their home network information resources. Looking forward to fourth quarter, we are expectingcontinuing strong revenue growth for our connectivity and security businessunit. Now looking at our mobile device management segment; although, revenuesfor the business unit was down from the prior quarter, I am pleased with thecontinued progress we've made with the integration of the Insignia acquisition. To fall back on what I will call delay in revenues was dueto restructuring of Legacy and Insignia contracts. This event in essencelengthened the sale cycle as we changed contracts to better fit the Smith Microbusiness model. We believe that the future opportunities for our OTAtechnology will reside with device manufacturers, wireless carriers and theenterprise as they seek new ways to remotely update wireless devices deployedaround the world. There is a lot of activity in the marketplace as we haveopened many new doors into large wireless players who have a need for thepowerful Insignia technology. The Insignia technology was always Best-of-Breedand now with our strong financial backing doors that were closed in the pastare now opening. We announced a major new customer in HTC, the largestworldwide manufacturer of Windows-based SmartPhones. HTC will begin shippingour Insignia client on their SmartPhone lineup in fourth quarter and willexpand their deployment throughout 2008. We have other new customeropportunities, so look for this unit to improve their top line performance in2008. Now turning to our compression and consumer division, whichposted an extremely strong quarter, we have several high profile ongoingconversations with many the major wireless handset manufacture, as we continueto move forward with our StuffIt Wireless compression solution. I was verypleased that our consumer side of the business contributed its strongestquarter in its history at $3.7 million and results that were up 44% over lastyear. The business segment's growth got a strong assist from ourrecent agreement we signed with VMware, the global leader in software forvirtualized desktops and servers. The infusion combines a very clean andintuitive user experience that allows Mac users to run P.C. applicationsseamlessly alongside existing Mac applications on Intel-based Macs. This is asignificant agreement and we expect to see strong contributions moving forward. We continue to expand our popular StuffIt product line andhave launched a new product StuffIt Expander for Windows. This product is afree companion product to our StuffIt product line and have launched a newproduct, StuffIt Expander for Windows. This product is a free companion productto our StuffIt Deluxe archive and compression software, which allows users toopen archives compressed in Smith Micro's StuffIt X format. StuffIt Expanderalso supports archives compressed using the legacy Zip compression method. The compression and consumer business continues to generatestrong cash flow for the company and we see an accelerating revenue growthcurve moving into 2008 highlighted by the launch of our Revue product. We lookfor continued top line improvement in the fourth quarter. This moves us intoour multimedia segment where we saw a return to more normalized revenues in thethird quarter. Issue we faced earlier in the summer timeframe with Vistaupgrades has worked itself out and we saw a return to expected revenueperformance. Within this category, we saw revenue growth from our Sprintrelationship, which is encouraging, and we expect this to continue to grow overthe coming quarters as Sprint offers more music capable devices. I now want to address some of the recent rumors that havebeen floating in the marketplace. First off, the rumor regarding the Real Networksannouncement, we see Real Networks as more of a content play than a directcompetitor with Smith Micro. While Real Networks has a multimedia client andhas for some time, we do not believe it meets the needs of our carriercustomers. We also have heard incorrect rumors in regards to our relationshipwith Verizon Wireless. I want to once again reiterate to you that we have hadand continue to have a very strong and strategic relationship with VerizonWireless, our largest customer, and in no way whatsoever do we see thischanging any time soon. Now looking in more at the multimedia market as a whole, Ican say that we do expect some evolution in the way our customers market theirmusic products. First off, some of our customers are starting to offer phones,which come with cables and ear buds in the box. Such phones will use -- excuseme. Such phones will use our music only software solution instead of shipping aseparate kit. By no means do we expect to see music kits going away, but we doexpect to see more of a mix happening with software only being shipped withsome new handset devices. The result of such a shift in product merchandising is goodfor us from a gross margin standpoint as the gross margin percentage for asoftware only package is double that of a music kit. Over time this shift mayimpact our top line revenues as kits bring in more revenue dollars than asoftware only package. We don't anticipate dramatic effects, but in this shortrun, it may impact this business segment's revenue growth. Another change we see happening within the market is a movefrom a music only offering to a more robust multimedia solution that wouldinclude music, full motion video and still image photo capabilities all-in-one.We believe that the deployment of complete multimedia applications will takecenter stage within the next few quarters. Now, I would like to give you an update on our first SmithMicro multimedia branded product, Revue. As I stated on the last conferencecall, this is a very unique solution offering consumers a rich multimediaexperience that includes music, photos and video on a SmartPhone operating onthe Microsoft Windows mobile platform. Revue will help retailers, devicemanufacturers, and wireless carriers enhance their SmartPhone revenueopportunity. Revue is engineered from the ground up for the very fast growingSmartPhone market. It offers users a robust media experience that fits in theirpocket while still remaining loyal to their favorite high-speed network. Revue gives SmartPhone users integrated access to theirmedia to browse music by song title, artist, play list, album or key words. Youcan display your music in album view or list view. View and edit your photos inmore than one way, rotate, flip, crop your photos and a first technologybreakthrough for any SmartPhone, our auto restore and auto enhance thateliminates red eye and improves image clarity. You can even make your own slideshows on your SmartPhone. Throughout the quarter, we have worked to line up severalnew strategic partners for our launch, including content offerings andstrategic online marketing and retail store partners. Many initial buy-in dealsfor Revue are complete and we expect to have the product available both onlineand in stores for the holiday season. OEM sales efforts for Revue areprogressing on a number of fronts. Look for OEM Revue relationships to comeonline in the first half of 2008. Finally, our multimedia business unit is also focused onadding value in its product portfolio as messaging has emerged as one of thehighest value revenue generators of our wireless carrier customers. Byacquiring new technology from business SMS, we are poised to enhance our SMSand MMS offerings to provide the capabilities to seamlessly transfer multimediarich media files. Before I turn the call over to questions, I would like toreiterate a few key points. Our business case continues to evolve very nicelyand we continue to achieve record growth and new customers further enhance ourleadership in the wireless software universe, invest heavily in new productdevelopment and continue to add new key personnel to the Smith Micro team. Wealso remain very active on the M&A front and look to complete one or maybetwo transactions this quarter. I believe we are just starting to see the growthcurve in a number of our markets and we are very optimistic about the future. With that, I'd like to turn the call over for questions.Operator?

[Operator:]

Thank you. And ladies and gentlemen, at this time we willbegin the question and answer session. (Operator Instructions) And our firstquestion comes from the line of Lauren Ye with JPMorgan. Please, go ahead.

[Lauren Ye:]

Hi, guys. The first question is just -- what was Verizon'spercentage of revenue this quarter?

[Bill Smith:]

68.5.

[Lauren Ye:]

Okay. Very helpful. And then around Revue, are therecarriers looking at this product and what do you think is the opportunity thereI guess as you go into 2008 in terms of carrier maybe relationships?

[Bill Smith:]

Yes. I think right now on the OEM front, we have a number ofefforts ongoing. They all look very, very positive. You should view that theOEM relationships will be with wireless carriers as well as devicemanufacturers and we look to bring these to the market as soon as they'resigned and we're kind of targeting the first half of 2008.

[Lauren Ye:]

Okay. And you mentioned the mix of music manager, withVerizon between the kit and just software. Is there a way to quantify this?What is the mix between those two right now and how do you think that will playout? And I guess has Verizon communicated with you if they plan to packagetheir phones this way going forward on all their phones or is it on aphone-by-phone basis?

[Bill Smith:]

Let me take the last part first, because I thought I waspretty clear in my comments.

[Lauren Ye:]

Okay.

[Bill Smith:]

We do not see music kits going away, period. We do see a mixdeveloping where some phones will have the cable, ear buds and software in thephone box. We don't know the exact mix and I don't really know that if that'sknown to my customer either. It's being evaluated on a case-by-case basis. Soit's very hard for us to guide you as to how to split it on a percentage basis.I wish I could help you more, but I can't.

[Lauren Ye:]

Okay. And then just, Andy, do you have an update in terms ofwhat your tax situation looks like in '08?

[Andy Schmidt:]

No. Not at this time. We just recommend everyone stick withthe 30% that our modelers are using.

[Lauren Ye:]

Okay. Got you. Thanks, guys.

[Operator:]

(Operator Instructions) And our next question comes from MaynardUm with UBS. Please go ahead.

[Maynard Um:]

Hi, thanks, guys. Your guidance implies less than 16%sequential top line growth kind of at the high end of the range, given kind ofall the variables. Historically you've kind of seen that 16% to 17% growth inprevious years. Can you talk about why we're seeing if this is at the highend of the range we're kind of seeing less than historical seasonality. Is thata reflection of the software bundled in the boxes or can you talk a little bitmore about that and I have a follow-up?

[Bill Smith:]

We'd have to look at your analysis. We've not given anyguidance for Q4, so I'm not sure where you're coming up with your sequentialcalculations.

[Maynard Um:]

Well, I was just taking kind of your gross margin guidance,your OpEx guidance and then your operating margin guidance and just kind oftrying to extrapolate backwards.

[Bill Smith:]

Well, again those are just broad guidelines that certainlywe could beat or fall right within the partner. It's not intended to giverevenue guidance at this point. It's just basically a very broad range to helpyou model, but it's not implied to give you revenue guidance.

[Maynard Um:]

Okay. And then secondly you talked about the shift of a fewphones going to software in box rather than kits and I understand therelationship there on the revenue side, but can you help us a little understandthe gross profit, profit dollar impact, not margin but dollar. On my math, you'd probably have to sell somewhere aroundfive software for each music essentials kit or five software in box versus onemusic essential kit to kind of make up that same gross profit dollar whichdoesn't seem a stretch given that the take rate in box is 100%. Is my math offthere? Can you just help me out. Thanks.

[Bill Smith:]

Yes. I really don't want to get into trying to figure outthe model at this point but what I can say is this. You're correct in theconcept that when the software is in the phone box, there's 100% audience thatyou get to speak to where when there's a stand-alone kit it's some subset ofthat that you get to earn revenue and then profits from. We do lose some profit that we make on the kits. May wedon't do it for nothing, we are in business to make money, so when we don'tship a kit, we lose some profit dollars and there is the possibility that Ithink you're suggesting that that could be compensated for by a higher volumeas far as overall tax rate. The other thing to keep in mind, when you look at thisparticular opportunity, the software that goes in the box we get revenue for.That software, its main function in life is to take you automatically to adownload site and download the music manager. When the user downloads the musicmanager, we make more revenue dollars, but there could be some breakage inthere, so you have to kind of play that in as well. It's not an easy model. I would be the first one to acceptthat and there are trade-offs. I think the biggest thing to kind of consider isthat it could have some top line effect in the short- term. I think that as thebusiness continues to grow and we're just talking about the multimedia businessright now, that that will be, disguised in other new revenue opportunities.So..

[Maynard Um:]

Just to be clear, you're saying that you get paid for eachsoftware that goes in the box and then you'll get paid more if the downloadactually happens for the music manager?

[Bill Smith:]

That's correct.

[Maynard Um:]

Okay. Thank you.

[Operator:]

Thank you. Next question comes from Rich Church with CollinStewart. Please go ahead.

[Rich Church:]

Thanks, guys. Just, Bill, if you could, I know you don'tgive guidance but just curious if you could make any comment about letting allof this out if you're comfortable with where the Street is for Q4 on the topand bottom line or how do you think that should?

[Bill Smith:]

Well, I don't really look at where the Street is. I kind oflook at, where my internal model is and that's really, what I drive things to.I can say that we are looking for sequential growth in the top, top-line andwe'll see how it shakes out on the bottom line because we're also clearlyexpanding some of our cost basis as we build on our infrastructure, but I cansay we are looking for sequential growth on the top line.

[Rich Church:]

Okay. And can you say how much Sprint was in the quarter interms of revenue?

[Bill Smith:]

No, we didn't. We don't break that out.

[Rich Church:]

Okay. But was it up sequentially?

[Bill Smith:]

Yes, it was.

[Rich Church:]

Okay. And, Andy, could you give us the reconciliation fornon-GAAP on the line items?

[Andy Schmidt:]

Yes, sure. On the operating expenses non-GAAP selling andmarketing was $3.2 million, non-GAAP R&D was $3.1 million non-GAAP andG&A 2.1 for a total of 8.4.

[Rich Church:]

Was there any in COGS as well?

[Andy Schmidt:]

Yes, there was a minor amount here. So let me see. Totalcost of sales GAAP was about 6.4 and total cost of sales non-GAAP is 5.9.

[Rich Church:]

Okay. Thank you.

[Operator:]

Thank you. Next question comes from Reg King withNollenberger Capital Partners. Please go ahead.

[Reg King:]

Yes, thank you. Regarding the mobile device managementsegment, Bill, I think you said that that segment was down a little bit thisquarter, but you do expect to see some rebound in it. Can you give us a littlebit about the customer activity that you're seeing in that group?

[Bill Smith:]

Yes. We're seeing a lot of -- there are a number of fairlylarge opportunities. Unfortunately these opportunities take a little bit oftime to get closed, but I think you will see an uptick on the revenue line forthat operating unit most likely also in fourth quarter. But I think you'll see it start to really grow as we getinto 2008. I think we saw some of the structural contract issues and some ofthe basic business practices that we inherited from Insignia and I think we'reset to move forward.

[Reg King:]

No Bill, is there some insight you can give us to how youmight have restructured this so that restructured the deal so they fit betterwith Smith Micro?

[Bill Smith:]

I can't get into details but I can say that obviously it'snot an easy matter to go to a customer who really doesn't want to change thecontract and convince them it's in their best interest. So it was -- it took a little bit of work. It took a littlebit of focus but I'm pleased to be able to say that we're pretty much done withthat and we're able to get through that.

[Reg King:]

Okay. Thanks very much, Bill.

[Operator:]

Thank you. Our next question comes from Richard Valera withNeedham & Company. Please go ahead.

[Richard Valera:]

Thank you. Good afternoon, gentlemen. Just with respect tomulti media, Bill, you've alluded to some of the potential issues in terms ofthat could hurt top-line near-term in terms of the mix towards the boxes, butcan you give us any sense at all in the fourth quarter of where you expect thatdirectionally, up, down or flat versus the third quarter?

[Bill Smith:]

It's very difficult because it really gets into whatproducts sell and because I don't really have direct visibility and when I saywhat products, I'm saying what handsets are the hot movers. I mean we can think we know, but when the numbers come outand you look at it at the end of the quarter, it's sometimes different and keepin mind we're not buying the handsets and we're not doing the marketing And so much of it is driven by what the customer does andunfortunately they don't always share that with us and we're not privy to theirdecision processes, so I wish I could help you, but I don't know how to answerthe question otherwise.

[Richard Valera:]

That's fair. Do you have any sense on inventory,historically you've had some issues with inventory occasionally building, etcetera. Is there any sense of where that stands with your largest customer atthis point?

[Bill Smith:]

Yes. From what we can see the inventory is what you wouldexpect to be going into the fourth quarter, which is typically a strong sellingseason. So you know, I don't see anything abnormal there at all.

[Richard Valera:]

Okay. That's helpful. Thank you.

[Operator:]

And your next question comes from Chad Bennett withNorthland Securities. Please go ahead.

[Chad Bennett:]

Yes. I'll give you your eighth question on multimedia. Justtalking about the Real Networks, Verizon Deal, Real announced last night on theircall that they'd be deploying their music platform, whatever that entails, withVerizon in early 2008 and I guess what you're telling us is you are going to beworking with both Real and Verizon with your piece of the platform goingforward in that Real either not at this point or doesn't plan on offeringsimilar functionality to you guys?

[Bill Smith:]

Okay. First off, I wouldn't have a clue what functionalityReal wants to offer because again, they're not my customer. All I can say isthat in this process in dealing with Verizon Wireless who is my customer Iunderstand what their strategies and plans are as they've told us and they doplan on moving to the new Real MTV store. The timing of that has not been announced by VerizonWireless. I know what Real Networks said on their call last night reportedly,but again I'm not going to comment on that. That's an announcement to come fromthe customer. Our job is to make sure that our customer, Verizon Wireless,is happy and they have the right products and the products work in a fashionand manner that they find to be their desire going forward and that's whatwe're focused on and we're getting that job done and our customer's happy andthat makes us happy.

[Chad Bennett:]

Okay. Fair enough. Account activity, great quarter on thatside of the business at least relative to what I was thinking. You indicatedsequential growth, I guess, going into Q4. I guess my question is what are weseeing -- I mean obviously the PC card guys and the hardware guys are showingrapid growth. I assume you're just not seeing any letup there. Is there any risk that, a couple quarters down the road whenwe go to the next or whatever it is, next note, that there's any hiccup thereor are we just at a level of penetration now that it's just pretty much asustainable business?

[Bill Smith:]

I think you have to look at history and I am a strongbeliever history tends to repeat itself. There is a very substantial amount ofgrowth happening in the connectivity space. When you allude to Rev B, allthat's going to do is accelerate any more growth. So it's not a matter of risk. It's a matter of, very strong top line and bottom linegrowth in this part of our business case. It's an incredibly good thing. Thereare really I don't see -- I really can't understand any downside risks to it inthe foreseeable future. I don't know how else to say it more directly.

[Chad Bennett:]

Okay. No. That's fair enough. I just -- even thoughlonger-term it's probably the best thing I'm just wondering if there's any typeof hiccup there in the future, but you're not seeing it, so you answered it.

[Bill Smith:]

Yes. Don't see it hiccup.

[Chad Bennett:]

And can you give any clarity on the consumer side how muchthe Fusion deal helped you this quarter and care to garner a forecast on howmuch -- I don't know, percentage of growth that helps the consumer businesslooking out in '08?

[Bill Smith:]

Okay. Clearly, it's a fairly nice step up from thehistorical numbers for the consumer group that we were able to report this timearound. The Fusion business was very helpful and we'll probably be even morehelpful next quarter. He mean we didn't have it for a full -- I mean we didn'thave it for a full quarter this time. You add on top of that the fact that in the current quarterwe have begun shipping the next version of our StuffIt for the Macintosh. Salesare running ahead this year. It's an annual update so, that bodes well as well.The consumer group guys are just really executing their business case verycrisply and you're seeing it in the numbers. Like I said I think you shouldexpect to see continued growth in fourth quarter of the top-line and you shouldprobable see that trending out in 2008.

[Andy Schmidt:]

Yes Chad, the key take away is it's not a one-time event.It's actually a new layer now for that business so, what you're seeing is anestablished new benchmark for the quarter that's up significantly from lastquarter. So you can extrapolate it from there.

[Chad Bennett:]

Oh, absolutely, I agree. I know it's ongoing. I justwondered how much of it was Fusion versus -- I don't know if you call itLegacy, but the other part of the consumer business, but that's fine. The lastquestion…

[Bill Smith:]

Hey, Chad, we need to move on. So you can either requeue orwe'll talk to you later this afternoon.

[Chad Bennett:]

Thanks.

[Operator:]

Thank you. Next question comes from Anton Wahlman withThinkEquity Partners. Please go ahead.

[Anton Wahlman:]

Hey, Andy and Bill, I've got a housekeeping question firston the numbers. Kind of the mirror image of an answer you provided to Richard'squestion earlier on the breakdown of the stock comp to $3.9 million to 1million. Is there any chance you can just give us the actual amounts, not thenet amounts but the actual break down of the 3.921?

[Andy Schmidt:]

Sure. It's 91,000 in cost of sales, $1.6 million in sellingand marketing, 700,000 in R&D and about $1.6 million in G&A.

[Anton Wahlman:]

Okay. And the $858,000 listed under the amortize, where isthat?

[Andy Schmidt:]

It's 390,000 in cost of sales, 160,000 in selling andmarketing and 300,000 in R&D.

[Anton Wahlman:]

Okay. And the tax effect, 1.433 is attributable to what tierpercentage?

[Andy Schmidt:]

That is obviously just done on a tax line and that is theadjustment from GAAP taxes to cash taxes.

[Anton Wahlman:]

Okay. That's fine. All right. And in the earlier answer, Iforgot if it was you, Andy, or it was Bill that said I was just a little bitunclear I wasn't sure if I heard correctly, did you say that you were or youweren't looking for sequential growth?

[Andy Schmidt:]

We were, positive. Potential growth.

[Anton Wahlman:]

All right. Thanks for relieving us on that. Very good. Verygood. So the final question I had was just on a comment in the beginning yousaid, Andy, on the 860,000 of the deferred revenue and the 515,000 and the710,000, I'm just not quite clear on exactly what that was.

[Andy Schmidt:]

Sure.

[Anton Wahlman:]

Could you please just go over that again?

[Andy Schmidt:]

Sure. That's just to give you a differentiation between,revenue that we book from an enterprise perspective versus deals that we sign.So the point that we were making is we did about 860,000 worth of enterprisedeals this quarter of which case we only booked 515,000 of it. The balance going into deferred revenue. So in other words,we often times do more business than we can book, so to speak, from anaccounting perspective and as we're doing more and more enterprise business,I'll always give you guys an update of what deal revenue looks like versusbooked revenue.

[Anton Wahlman:]

And the enterprise goes into, essentially a combination ofthe overall buckets including device management and other…

[Andy Schmidt:]

Right. Most of it is in either mobile device management orthe connectivity.

[Anton Wahlman:]

Okay. All right. Well, that's very helpful. That's all I hadfor now. Thank you.

[Operator:]

And your next question comes from Jason Tsai with Montgomery& Company. Please go ahead.

[Jason Tsai:]

Hi, guys. A couple of questions real quick. Bill, can youtalk a little bit more about the Music Essentials Kit. I know we've kind ofbeaten this one here but just one more time. Can you just give us a sense inregards to your internal planning when are you expecting to see or when youstarted to build in a decline in that business on a sequential basis?

[Bill Smith:]

Well, okay, first off I think sometime probably early in2008 it be will cease to be a music kit but will become a multimedia kit. Theeffect of that I don't know how to evaluate yet. It's obviously going to be abroader market reach because it will reach further than just music. It willalso get into photos, but assuming that that happens, you don't know how it'sgoing to look. I mean there's a lot of unknowns as well as opportunities. So Iwouldn't say that we are anticipating a decline in the number of kits, althoughit could happen in the short-term, which might be the next quarter.

[AndySchmidt:]

Yes I think a key takeaway as well is interestingly enoughto us we've had a number of our customers, large customers, interested in kits.So while, as Bill pointed out there could be, we don't know a slight transitionof our largest customer Verizon, we could completely offset that and then somewith other customer additions. So that's where again it's unknown, there's no guaranteewhatsoever that anything is going to drop. As a matter of fight we might be onthe next phone call going sorry guys it's up. And therefore our gross marginslook like X, Y, Z. So it's just more of a heads up that it's out in themarketplace that there are new phones coming out that actually have cables nearbut in the box, and this is just how we look at it and how we're answering thatquestion.

[Jason Tsai:]

Okay. Fair enough and then speaking of new products comingout, I know that Juke (ph) has a sink cable included in there. What about theother three devices that Verizon has introduced or at least talked about andare planning to release in the fourth quarter? Do you know if most of those arestarting to come out with sink cables in there preinstalled or are you justwaiting to hear?

[Bill Smith:]

Jason, I guess I'm the wrong guy. We can get you thatanswer. I mean I know there are a couple handsets that are planned to have thecable and the earbud and the software disc in the phone box. However, there area number of others that it won't be in the phone box and the way you would getthe gear that you need for music would be to buy a music kit. So…

[Andy Schmidt:]

Yeah. It's a dimension again as for the press; there are twonew phones that may have the earbuds and the cable in the box. But there areover 20 phones at Verizon that are music phones.

[Jason Tsai:]

Right.

[Andy Schmidt:]

So, it's obviously a very small subset at this point.

[Jason Tsai:]

Okay. All right. Great. Well, thanks a lot, guys.

[Operator:]

Thank you. Your next question comes from Kevin DeDe withMorgan Joseph. Please go ahead.

[Kevin DeDe:]

Good afternoon, guys.

[Bill Smith:]

Yeah.

[Kevin DeDe:]

Nice job, nice job having that multimedia bounce back. I waswondering, Bill, if you could talk to the promotional activity that you're seeingat Sprint and Verizon going into the quarter. And how that might compareespecially on the music side vis-à-vis last year pre-holiday season?

[Bill Smith:]

I think we're all going have to stay tuned. I really can'tcomment. Even if I did know, I wouldn't be allowed to talk about it. So, Ithink that you will see promo activities from both of the large carriers thatshould be of help to us as we build through the fourth quarter, so I just can'tanswer your question, Kevin.

[Kevin DeDe:]

Okay. Can you give us a little more on insight and congratson this the Cricket deal and the U.S. Cellular deal? How long was that salecycle and do you think you'll push deeper into those carriers perhaps with yourmultimedia product?

[Bill Smith:]

We'd like to think so. You don't close carriers quickly, Imean these are six month or more sales cycles and I think both of them werelonger than that, so it takes time. The fact that they are letting us tell youabout the deals and the fact that they're now shipping product, bodes well, butif you look at all OEM deals, they tend to start in a, relatively low volumeand then grow as they expand out the reach into more devices and, and they gettheir marketing campaigns in place. So, we look forward to seeing, the Cricket and the U.S.Cellular deal grow into a meaningful piece of business for us and we wish themwell as they launch into the data connectivity space which is an area candidlythat neither of them had really been in before. As far as, it's always ourstrategy and it has been our business strategy, and we've talked about it on anumber of calls and a number of conferences to build a portfolio of softwareproducts we could take into the wireless business both to carriers as well as devicemanufacturers. And the trick was always to get one product in the doorfirst and then once you're operating from the inside and you get to call on thecustomer, it tends to become a little easier to sell them some of the otherproducts in the lineup. And clearly, that is our strategy for both U.S.Cellular and Cricket, just as it is and just as we execute at Verizon Wirelessor Sprint or any of the other folks that we do business with. I mean, we are always constantly looking to expand ourbusiness really in the easiest place, which now is at people that know you andtrust you and believe in what you're doing. And I think we're blessed with somereally great customers, and we think we've done a pretty good job for them andthey seem to agree with that and so you should expand, expect to see us expandour reach.

[Kevin DeDe:]

Andy, last question for me, you mentioned $9 million to $9.5million in OpEx in Q4. That's on a non-GAAP basis and I'm just wondering, ifyou could give us sort of a line item view of that and how you'd expect thatexpense to trend going into '08. Given that you're launching Revue and some ofthe costs associated to that could be the factor for the increase?

[Andy Schmidt:]

Sure. I mean the best way to look at it is as I discussed.There's about 300 to 350 that I noted would be SOX related, so that would beadmin and then the lion's share of the balance would be in the sales andmarketing associated with Revue, VMware and so on and so forth. And then a scatteringin other areas for headcount additions, but the primary drivers are launchingRevue, continuing to launch VMware and then, of course our SOX side on theG&A.

[Kevin DeDe:]

Okay. And then into '08 would you expect some of that toback off a little or…

[Andy Schmidt:]

You know what? The answer is probably no. We will still haveSOX with us for Q1 which we all love and enjoy and then we will continue, ofcourse, with the marketing because as you can probably tell VMware's with usfor quite some time which we're thrilled about and Revue is just starting butwe'll do it smartly. We'll try to match the revenue on the launches with theexpense but we will have to front load a little bit. I mean that's just thereality of it.

[Kevin DeDe:]

Thanks very much for taking my questions, gentlemen, andnice job.

[Operator:]

Thank you. Next question comes from Amit Dayal with Rodman& Renshaw. Please go ahead.

[Amit Dayal:]

Thank you so much. Could you elaborate a little bit on youracquisitions that you just mentioned? You might close one or two this quarter.Are these going to be more technology oriented or are these going to be revenueoriented if you could just give us a sense of what's going on that side.

[Bill Smith:]

Well, have I to keep a few secrets so, you'll just have tostay tuned. As soon as we have definitive deals signed, we'll race to theStreet with the news about them and what they're all about and what they mean forour business case. Now clearly we believe that we wouldn't buy them if wedidn't think they were going to be helpful to the growing of our business andwe think in both these cases they would be extremely positive. So we're very busy. There's a lot of work that needs to bedone. Diligence is not a trivial undertaking. You don't want to find out a lotof things after the fact, surprises like that could cause me to have even lessair and you know I don't have much. We don't need that, but we are busy, we arefocused and we're pretty excited about both these deals. So let's see if we canget them done.

[Amit Dayal:]

Next question is, are these domestic or international?

[Bill Smith:]

Why don't you just say that they probably will have impactboth this side of the pond and on other sides of the pond.

[Amit Dayal:]

Is that Asia, Europe?

[Bill Smith:]

There's two sides to the pond.

[Amit Dayal:]

All right. Thanks so much.

[Operator:]

Thank you. Our next question comes from Bob Lee with Sidoti.Please go ahead.

[Bob Lee:]

Good afternoon, guys. Just one more question on QuickLinkMusic here or V CAST Music Manager. Bill, you seemed very confident that the Realtransaction with Verizon is more content based. Has Verizon had any discussionswith you in terms of making your non-over the air platform available to Realand if hypothetically if yes. How flexible and how long would it take for youto transform your product to address the new content in sight?

[Bill Smith:]

Okay. I mean look, if Verizon would like to us assist Realin some way that would help facilitate a better user experience for the Verizoncustomer and we can make money at it, you can bet your sweet bippy we'd do it.Even if we broke even, we might still do it, but we don't do those kinds ofdeals. So we're going to make money at it, if we do it. I think that we see Real as a very significant player in thecontent space and we welcome the opportunity to work with Real just like wework with all the other content guys that are out there and we'll continue todo so going forward. They're not our enemy. They're a part of the food chainthat we need to be able to work with and that's what we plan on doing.

[Bob Lee:]

Okay. And then moving away from that, Bill, you haven'tmentioned anything in terms of Kyocera and SuffIt Wireless. Is there any kindof update in terms of timing to look for a launch of StuffIt Wireless on theirhandsets and maybe even number of handsets that it could potentially belaunched on?

[Bill Smith:]

Yeah. We continue to work with Kyocera and we have along-term business relationship with Kyocera on a number of fronts. As you areprobably aware, there are other activities ongoing at Kyocera right now ofM&A (ph) nature and candidly as close as we are to them I don't know thatwe know exactly what the impact of that activity is going to be, but we areworking with them. We don't know if that activity will impact release schedulesor not. We're just waiting to see.

[Bob Lee:]

Okay. Thank you very much.

[Operator:]

Thank you. Our next question comes from Seth Potter withMerriman Curhan. Please go ahead.

[Seth Potter:]

Hi. Good afternoon. Just a quick question of the $1.4million sequential increase in your consumer business, what percentage of thatwas from your VMware product? Thanks.

[Bill Smith:]

I would say basically more than 50%.

[Seth Potter:]

Okay. And of the total consumer business what percentage isI guess non-smith Micro product that you just publish like VMware?

[Andy Schmidt:]

I couldn't give you that answer. Again…

[Bill Smith:]

I think you will probably find that the majority of it isSmith Micro product. I mean the biggest seller going away is StuffIt and Idon't see that changing in the near-term. It might get a big help hopefully, ifeverything goes well from Revue, but the publishing business is lucrative to usand it is growing and it's a nice adder. The VMware deal is probably biggerthan some of the publishing deals and they're all meaningful and at the end ofthe quarter when you add up the numbers.

[Seth Potter:]

Okay. And in terms of non-cash comp maybe you mentioned thisgoing forward expect to see this $3.9 million, $4 million range quarterly andalso just in general seasonality, is there usually seasonality going into firstquarter?

[Andy Schmidt:]

We've been on such a growth curve that we haven't reallybeen able to chart seasonality at this point. That still seems to hold true. Ithink we're too early on the growth curve at this point to really see that. Theonly place we had seasonality baked in was in the consumer business andtraditionally Q2 was the weakest quarter from that perspective. That will probably still remain true, but for the balance ofthe business we're just too early on the growth curve and adding customers andso on to actually see a real seasonality effect on our financials.

[Seth Potter:]

Okay. In terms of the non-cash comp just in general is itabout $4 million a quarter?

[Andy Schmidt:]

About 3.7, 3.8.

[Seth Potter:]

Okay. Great. Thanks a lot.

[Operator:]

Our next question comes from Ian Gilson (ph) with the SacksInvestment Research. Please go ahead.

[Ian Gilson:]

Yeah. Thanks very much. Housekeeping question for Andy. Whatwas the tax rate -- sorry, the share count for the non-GAAP earnings? Icalculate it as $0.22 EPS and you reported 21.

[Andy Schmidt:]

Okay. I have 31.4 million shares fully diluted.

[Ian Gilson:]

Okay.

[Andy Schmidt:]

Basic outstanding 30.2.

[Ian Gilson:]

Okay. That takes care of that. Going forward, how are welooking at the non-GAAP expenses and the impact on the tax rate once you workthrough your NOL?

[Andy Schmidt:]

Okay. Right now, the non-GAAP tax rate we're suggestingpeople model with is 30% for 2008 just to be conservative. As we close out 2007and again it's a lot of estimates that we use at this point until we actuallyclose out a tax year, that's what we're going with and then as we close out our10-K and what not, we'll give some very definitive guidance.

[Ian Gilson:]

Okay. Now, a question for Bill. When you stop bundling thekits with the phones, is that just for Verizon or across the board?

[Bill Smith:]

Okay. First off in the case of Verizon, what we're talkingabout where we would have software only units going out with phones are caseswhere Verizon has gone to the handset manufacturer and requested as part of theproduct that they get delivered that it include the cables and the earbuds andthen we build the CD-ROMs and get those over for them to kit it up. So, today we are looking predominantly at Verizon Wirelessbecause Verizon Wireless is the only one that sells kits today. As Andyalluded; however, there are other opportunities that we are working on andactually very close in, where other folks will be selling some sort of, I guessI will categorize it more as a multimedia kit then just a music kit and thatwill change the mix then as to who we sell kits to and that might have somewhatof a profound effect on overall kit revenues, but we have to wait for it to getclose and get started.

[Ian Gilson:]

Okay. And last question is a discussion about Verizonworking with Google or talking to Google about using Google's operating systemon SmartPhones?

[Bill Smith:]

Yes.

[Ian Gilson:]

Do you already have software capability for that or wouldyou have to build it?

[Bill Smith:]

Okay. Well, we would have to build it because we don't havedevices that run a Google operating system as yet. I understand fromdiscussions with both my customer and from what I read in the press as well,that there is interest within the industry at looking at what Google canprovide in the way of an operating environment for a handset. I think we have to sit back and watch that and we will workwith Google just like we work with anybody else that builds operatingenvironments for devices and we would welcome that.

[Ian Gilson:]

Okay. Thank you very much.

[Bill Smith:]

Sure.

[Operator:]

Thank you. Our next question is a follow-up from Maynard Umwith UBS. Please go ahead.

[Maynard Um:]

Hi, thanks. Just a question on your acquisition. Are thereany kind of prerequisites or can you help us in terms of thinking about arethese deals accretive, neutral or dilute active and then I have a follow-up?

[Bill Smith:]

Yes. It's always our goal to do accretive deals. We neverlook to do diluted deals and if they are dilutive even after the fact we arebusy figuring out ways to make sure we flip them back to the accretive column. So I mean, I think you should rest assured that the deals wedo will be all about software and we will look to try to do accretive dealscoming out of the chute. Both the deals we're looking at right now would appearthat they would be accretive.

[Maynard Um:]

Great. And then a question on your OpEx and your commentarythere about the first half, you said that the first half spending because ofVMware and Revue will continue, offensively keeping your Op margins kind of inthe 30% or 35%. But I'd anticipate that you'd expect some of the leveragefrom that spending to kind of come through. When would you anticipate that? Isthat a back half or should we look beyond that to grow beyond that range?Thanks.

[Andy Schmidt:]

At this point it's kind of hard to model as Bill has saidwe've got two acquisitions, we're trying to close and that always throws awrench in the works of modeling. So, we simply can't talk about those yet. Sowe'll stick with the 30% to 35% and as we bring forward different acquisitionsand so on, we'll give you some advice as far as how to model those becauseintegration over the first couple quarters of any acquisition always has somedegree of effect on what happens with our Op margins. Let me add some color to that if I could and that would bethat as we go into the start of the year this is also relatively strong tradeshow part of the year, this is where you see not only the big CTIA show, butyou also see 3GSM. On a conserver side they have MAC, MAXWELL and CES, so theyare a lot of marked in expenses that happen in the earlier part of the year. In addition to that, we have invested, we are investingheavily in building out our infrastructure from a sales and marketing point ofview in both the European markets as well as the Asian markets. In doing so we have raised some of our expenses and thoseexpenses do front then for what we hope will be a follow-on revenues that wouldcome in, in the mid to later part of 2008. So you should see if everything goesas planned, a diversification of our revenue away from just being so totallyNorth American centric to a broader amount of revenue coming from other partsof the world. And we've been able to higher some great executives to runour sales efforts that come out of the out of the wireless industry that havegreat track records, we have gone for the best and we're very bullish on someof the things that are going on as I say on the other side of the pond.

[Maynard Um:]

Very helpful. Thanks.

[Operator:]

Thank you. Your next question is also a follow-up from ChadBennett with Northland Securities. Please go ahead.

[Chad Bennett:]

Yes, Andy, regarding the cash flow changes that we're goingto see I believe in the queue that comes out, can you just give us a dollarimpact of that?

[Andy Schmidt:]

Sure. I mean roughly and this is just broad right now, whenwe look at fiscal year 2006 total be roughly about $4 million moving from Opcash flow to financing and then for the midyear the six months ended June 30,2007, about $2 million moving from Op cash flow to financing cash flow. Again,this is just a reclassification.

[Chad Bennett:]

Okay. Yes, I understand. And then did we have any other 10%customers outside of Verizon?

[Andy Schmidt:]

No, we did not.

[Chad Bennett:]

That's all I have. Thanks.

[Operator:]

Thank you. And Mr. Quigley, at this time I'll turn the callback to you for closing comments.

[Bruce Quigley:]

Thank you. I would like to thank everyone for attending thiscall. If anyone has any other questions, feel free to call us. We look forwardto doing this again next year when we will report our 2007 fiscal year results.Good afternoon.

[Operator:]

Thank you. Ladies and gentlemen, that will conclude today'steleconference. We do thank you again for your participation, and at this timeyou may disconnect.