Name: Smith Micro Software Inc. (SMSI)
Web Site: http://www.smithmicro.com
Brief Description: Smith Micro Software, Inc. and its subsidiaries engage in the development and marketing of wireless communication software products and services in the United States. Its products include QuickLink Mobile, which turns data capable wireless handsets, PDA’s, and wireless integrated notebook PC’s into wireless data connectivity devices; QuickLink Phone Manager, which enables users to be able to easily edit the phonebook and calendar that reside on a wireless handset on a PC computer; and QuickLink Mobile Enterprise. The company’s fax and communication products enable users to exchange faxes and data files with remote modems, fax/modems, and fax machines on the Mac OS X operating environment. In addition, it offers StuffIt Wireless, an image compression technology, which reduces the size of a JPEG picture file up to 30% without any additional loss in image quality; StuffIt Image, which is used to handle image compression for multiple image formats; StuffIt Deluxe; StuffIt Standard Edition, provides basic compression and decompression functionality; and StuffIt Expander, a universal expansion product that decompresses and decodes compression formats. The company also offers various software products, which provides end-users the hardware information they need to evaluate, fine-tune, and manage their system.

ANALYST OPINION: We initiate coverage of Smith Micro Software Inc. (SMSI) with Neutral rating. SMSI witnessed an impressive growth in the recent quarters, however, we believe it is currently overvalued by less than 10%. [Contact the Analyst]

VALUATION: We assign a price target of $14.7 per SMSI share based on a target forward P/E multiple of 30x on FY07 earnings. SMSI is trading at a high premium to peers's [PCTEL Inc. (PCTI) and Openwave Systems Inc. (OPWV)] P/S and P/B multiples (TTM), partly warranted by superior growth and profitability.

OUR ESTIMATES:

year end - Dec 31	Revenue	EPS, diluted
FY06	$53.8Mn	$0.30
FY07	$83.4Mn	$0.47

POSITIVES:

• Sixth consecutive quarter of record top line and bottom line results. Sales doubled yoy in Q3FY06 and tripled yoy in 9mosFY06 while EPS almost flat yoy for Q3FY06 and almost double yoy for 9mosFY06.
• Decreasing share of operating expenses in total revenues during the last several quarters, however the positive impact on earnings completely offset by decreasing gross margins.
• Return to a more normalized growth trend for broadband QuickLink Mobile connectivity product.
• Significant growth of Music Essential kit, specifically with Verizon Wireless, benefiting from a strong marketing push and launch of the LG VX8500 Chocolate phone.
• QuickLink Music product launched during Q3FY06.
• Management sees StuffIt Wireless program continues progress on track, with several ongoing prototypes in testing with large handset manufacturers, and a wireless carrier.
• Management optimistic about business outlook, expecting continuation of growth, and believing the recent music success can continue to grow with the launch of QuickLink Music.
• Aggressive acquisition strategy: Allume Systems, Inc. brought in June 2005 and PhoTags, Inc. in April 2006.
• Debt free balance sheet with a cash balance of more than one half of total assets [Q3FY06 end]. However, the largest part of current cash balance was received from issuance of common stock during FY05.
• Huge and surging market: according to Gartner, mobile phones sales of one billion units per year will be reached in 2009 and there will be 2.6 billion mobile phones in use by the end of 2009.

RISKS:

• High revenue concentration: largest SMSI's customer - Verizon - accounted for more than 71% of net revenues both in H1FY06 and H1FY05.
• Unfavorable changes in the revenue mix: significant sales of the lower margin Music Essentials Kits in 2006 had a negative impact on consolidated gross margin which decreased from 83% [9 MOS FY05] to 61% [9 MOS FY05].
• Extremely competitive and dynamic market: SMSI is a relatively small player in the markets that are extremely competitive and subject to rapid changes in technology.
• Almost 3 million stock options outstanding [>10% of current number S/O] at an average price of $4.56 as of H1FY06 end.
• The effective income tax rate was under 3% level during several recent years. However we expect the operating loss carryforwards to be consumed by 2007-2008 leading to a normal effective tax rate.
• Large insider sales during the recent several months.

[Contact the Analyst]