Smith Micro Software, Inc. (SMSI) Q2 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the Smith Micro Second Quarter Earnings Conference Call. Participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note, today's event is being recorded. I would now like to turn the conference call over to Charles Messman, Vice President of Investor Relations and Corporate Development. Please go ahead.

Thank you, operator, and good afternoon. Thank you, for joining us today to discuss Smith Micro Software Financial Results for the second quarter ended June 30, 2017. By now, you should have received a copy of the press release with the financial results. If you do not have a copy and would like one, please visit the Investor Relations section of our website at www.smithmicro.com or call us at 949-362-5800, and we will e-mail one to you immediately. On today's call, we have Bill Smith, Chairman, President and Chief Executive Officer of Smith Micro; and our new CFO, Tim Huffmyer, Chief Financial Officer. Please note that some of the information you will hear during our discussion today will consist of forward-looking statements including, without limitation, those regarding the company's future revenue and profitability, new product development and new market opportunities, operating expenses and company cash reserves. Actual results or trends could differ materially from our forecast due to a variety of factors. For more information, please refer to risk factors discussed in Smith Micro's Form 10-K for 2016 and Form 10-Q filings for the first quarter of fiscal 2016 [ph]. Smith Micro assumes no obligation to update any forward-looking statements or information, which speak only as of this respective date. Before I turn the call over to Bill, I want to point out that our forthcoming prepared remarks we will refer to certain non-GAAP financial measures. Please refer back to our press release disseminated earlier today for reconciliation of the non-GAAP financial measures. With that said, I'll now turn the call over to Bill. Bill?

Thank you, Charlie. Good afternoon, everyone. Thank you for joining us today for our second quarter earnings call for 2017. During the quarter, we continue to push forward with several business initiatives, making significant progress with our partners and customers as we prepare for the launch of new mobile services in the second half of fiscal 2017. I'll talk more about that later, but first, I'd like to welcome Tim Huffmyer, who has joined us on the call today. As we announced in June, Tim joined Smith Micro as our Chief Financial Officer. Tim brings an extensive background of financial planning and analysis, experience in the technology sector and a wealth of M&A experience to our team. We are very excited to welcome him on board as we look to the next phase of Smith Micro's development and growth. Looking at our results for the second quarter, revenues came in at $5.9 million with a non-GAAP net loss of $800,000 or a loss of $0.06 per share. As most of you know, during the first half of 2017, we implemented a restructuring plan with changes across all functional areas of the organization to streamline our business processes and align cost appropriately. With this process now complete, we believe we have a strong foundation for solid growth in the second half of the year with the attainable goal of achieving profitability during 2017. After Tim reviews the financials, I will provide additional details on the progress we've made during the quarter. So with that, Tim, welcome to your first Smith Micro conference call.

Thank you, Bill. I appreciate the introduction, and it's a pleasure to have joined the team. The company is gaining momentum, and I look forward to supporting the company's growth. Now let's get to the numbers. For the second quarter, we posted revenue of $5.9 million compared to $7.5 million for the same quarter last year. The wireless segment reported quarterly revenue of $4.7 million compared to $6.3 million last year. Our graphics segment reported revenue of $1.2 million, which was comparable to last year. For the second quarter year-to-date, revenue was $11.4 million compared to $14.7 million last year. The decrease in revenue year-over-year for both the quarter and the year-to-date was due to Sprint's decision to phase out our NetWise platform last year. We continue to invest in new products that will replace this revenue in future quarters. Bill will discuss the company's progress in just a few minutes. For the second quarter, gross profit was $4.6 million compared to $5.5 million during the same period last year. Gross margin was 78% for the second quarter compared to 74% last year. For the second quarter year-to-date, gross profit was $8.9 million compared to $10.6 million last year. Gross margin was 78% for the second quarter year-to-date compared to 73% last year. The increase in gross margin for both the quarter and the year-to-date compared to last year was primarily due to the cost savings related to the previously announced restructuring programs. Operating expense for the second quarter was $6.2 million, a decrease of $3.3 million or 34% compared to last year. From a year-over-year perspective, quarterly selling and marketing expense decreased 41%; research and development expense decreased 47%; and general and administrative expense decreased 22%. Operating expense for the second quarter year-to-date was $13.1 million, a decrease of $5.1 million or 28% compared to the same period last year. This operating expense decrease is the result of and consistent with the previously announced restructuring plans. We expect our quarterly operating expense, excluding any unannounced restructuring plans to approximate the second quarter run rate of $6.2 million less the $300,000 of restructuring expense recognized in the current period. The non-GAAP operating loss for the second quarter was $1.4 million compared to a non-GAAP operating loss of $2.8 million last year. The non-GAAP operating loss for the second quarter year-to-date was $3.6 million compared to a non-GAAP operating loss of $6.2 million last year. The non-GAAP net loss for the second quarter was $800,000 or $0.06 loss per share compared to a non-GAAP net loss of $1.8 million or $0.15 loss per share last year. The non-GAAP net loss for the second quarter year-to-date was $2.2 million or $0.18 loss per share compared to a non-GAAP net loss of $3.8 million or $0.33 loss per share last year. Within the previously mentioned press release, we have provided a reconciliation of our non-GAAP metrics to the most comparable GAAP metric. For the second quarter, the reconciliation includes stock compensation expense of $388,000; intangible amortization of $65,000; change in fair value of the warrant liability of $561,000; and amortization of debt discount and issuance costs of $192,000. For the second quarter year-to-date, the reconciliation includes stock compensation expense of $834,000; intangible amortization of $130,000; change in the fair value of the warrant liability of $147,000; and amortization of debt discount and issuance cost of $382,000. Due to our cumulative net losses over the past few years, our GAAP tax expense is primarily due to foreign income taxes. For non-GAAP purposes, we utilize a 38% tax rate, resulting in a second quarter non-GAAP tax benefit of $500,000 and a second quarter year-to-date tax benefit of $1.4 million. That concludes my review of the financials. Now I will turn the call back over to Bill.

Thank you, Tim. As I noted in our last call, our primary focus for 2017 is new revenue growth, with a focus on those products that are quickest to sell, easiest to implement and that will also provide maximum input to both our top and bottom lines in the shortest period of time. I am pleased to say that we have made significant progress that will have a profound impact on our future. SafePath represents a strong lead product going forward that will provide us the capability to effectively approach a double of this quarter's revenues sometime in 2018. A meaningful revenue impact should also be seen in Q4 of this year as we start to rev up our profits and free cash flow generation. We're excited to share that we successfully launched our SafePath family offering in Latin America with one of the world's largest Tier 1 carriers. This is Smith Micro's first significant win for SafePath. We are bringing comprehensive location tracking and parental control services to subscribers through our SafePath Family platform. This service launched during the second quarter is offering subscribers innovative tools to combat the acute challenges of modern society, such as child safety, cyber bullying, mobile device and content controls, elder care and device theft. And now things get even more exciting. I am very pleased to announce that we have signed our first Tier 1 carrier in the United States. As is the case with each of the U.S. Tier 1 carriers, this new customer relationship provides the opportunity to transition a large, already installed base of Family Safety users to our SafePath platform. This fact allows us to forecast a growing revenue stream of predictable recurring revenue over the contract term. It is planned that deployment of SafePath will begin in Q3 and should provide a meaningful increase of revenues in Q4, leading to profitability and the generation of free cash flow. This is a very significant win for Smith Micro and is key to our growth and long-term profitability. But there's more. We have been awarded another SafePath win, this time in Europe with a Tier 1 carrier with a global business platform. We are working to have a signed contract with this new customer in Q3 and begin deployment as soon as possible. We also have been receiving interest from carriers for a wearables solution based on SafePath. Currently, the wearables market is in its infancy, with several small players offering solutions with completely nonintegrated software. To scale these new solutions, the carriers need a single platform to launch wearables and other family services. Designed with a generic third-party tracker integration layer, our SafePath platform addresses this need. Wearables such as wristwatches, pet trackers and biometric devices can be easily deployed in the field on carrier networks. We see this market gaining rapid momentum, providing us with even more solid reasons to believe that Family Safety market will continue to grow and enhance our profitability. Needless to say, we are very encouraged with the progress we have made with SafePath and expect to see significant revenue growth to begin in Q4 2017 and beyond. As the wireless carriers continue their focus on price competition as a way to expand their business case, the need to leverage low-cost unlicensed spectrum is once again moving to the forefront. Our industry-leading NetWise technology now has the opportunity to play a meaningful role in managing carrier expenses in an environment of declining ARPU. Over the past years, we have demonstrated our ability to help optimize network cost by providing transparent user access to existing Wi-Fi services for both our carrier and cable customers. Look for us to talk more about NetWise as we enter 2018, as we are seeing some amazing new opportunities. As we spoke about on the last call, our Device Management and firmware over-the-air technology, recently rebranded QuickLink IoT, is in high demand with a variety of different customers and prospects. This is driven by a change in the market dynamics over the past year and the fact that we are one of the only independent end-to-end software providers. It is our aim to help companies bring their products to market in a proven, scalable and secure fashion with highly extensible lightweight and OMA standard technology. Lastly, let's talk about our graphics software. The graphics engineering function has now been fully re-staffed in our lower cost locations, allowing us to execute our product strategy, while maintaining a strong profit profile for these offerings. This remains a very profitable business for the company, and we will continue to blend it with our wireless business moving into the first half of 2018. Overall, I am excited and optimistic about the second half of fiscal 2017 and the full year ahead of us in 2018. We have made the difficult decisions necessary to align our expenses and position the company for breakout growth beginning in Q4 2017. We have executed our business case and closed exciting new revenue-generating opportunities. Our sales pipeline remains strong and is poised for even more wins that will further drive our growth. I fully believe that Smith Micro is on the cusp of once again assuming a strong technology growth story as a leader in mobile software technology. With that said, operator, I'll open the call for questions.

[Operator Instructions] And our first question today comes from Jeff Bernstein from Cowen. Please go ahead with your question.

Yes, hi Bill. So I guess the XFINITY Mobile service went live a month or so ago. So are you guys seeing revenue from that yet or was there a certain number of subscribers' worth of revenue that you already had taken in and that has to get burned through or how is that going to work?

Yes. Thanks, Jeff. Yes, we are seeing revenue from all parts of the Comcast organization that we work with. Exact breakout, I'm really not free to talk about, but we are excited to see where the XFINITY offering goes, and we're looking for the best.

And so is it possible that would be a significant from an accounting standpoint, a source of revenue next year?

Yes, it's possible, but I don't think I'd lose sight of the fact of what we've just said about SafePath because that is a much more significant growth story. So I would really focus hard on the part that we really talked about today.

So maybe you could go through some numbers around that to help us understand it?

Well, I really can't because, first off, I haven't been able to disclose who the customers are. But I did in my prepared comments talk about the fact that the U.S. Tier 2/1 carriers all have a fairly sizable installed base of Family Safety users that will be transitioned, like in this particular case, from the predecessor software into our SafePath. It will be large, it will be sizable, it will represent many million dollars a quarter and that's how to think about it.

Could you tell us how many subscribers there are on these services today and what the monthly charges?

No, I can't. I'm sorry.

Okay, thanks.

Our next question comes from Brian Swift from Sutter Securities. Please go ahead with your question.

Well, my question was just asked, so I'll come back if I can find another one.

Okay, thanks Brian.

[Operator Instructions] Our next question comes from Kevin Dede from Rodman. Please go ahead with your question.

Hey Bill, thanks for taking the question, thanks for hosting the call. Congrats on the Tier 1 win in U.S. Listen, you're talking about some pretty significant growth there. And I guess what I'm wondering is how SafePath is marketed? Is it an effort that you've got to drive? Is it something that you expect the carrier to help you with? And then as much as you can talk to, not just the U.S. deal, but the one in Latin American and the one in Europe?

Yes, okay. Let's separate the three deals. The one in Latin America and the one in Europe, they're starting from the ground floor, and they'll be working to build their user base over a period of time. So their revenues will expand over a period of time as well. However, from what we're starting to see in Latin America, their ability to market to their subscriber base is pretty impressive, so we'll wait and see. When we talk about the U.S. however, the carriers in the U.S. have been selling Family Safety as a service for some period of time and as such have built up a fixed amount of subs that are buying the service offering. That service, that base will then be transferred over to SafePath. It will, I think if there is anything that we need to kind of work through is exactly what the rate of transfer is from the predecessor service to us and that will then be the gating issue as to how fast we reach full penetration and how fast we reach the revenue goals that we can see are practical. It is a recurring revenue stream. It is billed monthly, and we get paid monthly for all subscribing families. So I mean, it is not a one and done, it is recurring over the period of the contract. That makes it very predictable, and it makes it something that we can really sink our teeth into to understand where our business case is going, especially as we enter 2018, it should continue to grow throughout that period.

Okay. So you talked about adding additional features and functionality. Is that something that goes hand-in-hand with the subscribers that are already - or that have already signed up for the service or is it something that comes on top with additional cost?

No. When they switch over to our SafePath platform, they will substantially expand the capabilities that they can use to help keep their families safe.

Okay, that's helpful. Now you mentioned some new potential opportunities with your NetWise technology and I know you've been working really hard on that for a long time. Are you able now maybe under the context of the three SafePath deals to spend more on development and marketing that technology or how should we think about it, given the pretty severe restructuring that you've endured over the past, I don't know, maybe two years?

Yes. You know, look, we've gone through some really challenging times and had to make some very difficult decisions. A lot of that is not fun. But we have set ourselves up for future growth. And the NetWise business is one that we see a lot of growth in. We saw some very successful launch with Sprint, and, unfortunately, Sprint canceled that program not because we failed in our objectives, just because they needed to save money. And so, we all understand that those kinds of things happen. But the most important thing is we did execute extremely well with Sprint. So every other carrier who's looking at this knows we know how to scale, knows we know how to meet their needs, especially when they're looking for a way to reduce the cost of operation as their ARPUs are falling, and they're competing on price with unlimited plans, et cetera, that we now suddenly once again find ourselves speaking the right language to the right audience and we see that as a positive growth engine for 2018. But I guess the bottom line is, if you look at where we are and where we're going is that by our execution of contracts already signed plus the execution of contracts that should be signed in the very near future for SafePath, we have reenergized our business case and reenergized our company and we should enter a period of growth and prosperity. And yes, you're right, that will allow us to invest more resources in time in some of our other key products like NetWise, like CommSuite and then also, as we've talked about in the last couple of quarters, our focus on our QuickLink IoT offering. We're seeing a lot of traction there. There's a lot of things that will continue to happen. It's a long answer, hopefully I've covered it.

Yes, very helpful, Bill. Leads me into my next and last question which is regarding QuickLink IoT and perhaps you've addressed this in the past, but I apologize it escapes me. It wasn't clear to me when you rebranded it, if you were going to market through or directly to the enterprise or through the carrier and I was just kind of wondering where you stood in each of those initiatives?

Yes, and actually it's both, it's both. And we're also marketing in with partners into the various verticals. So it is a broad reach and the more traditional providers of this type of technology have all been acquired or are now parts of other firms and like Qualcomm and Samsung. And if you only want to buy from Qualcomm or you only want to buy from Samsung, that's fine, but if you want to buy from other suppliers, you need to find a provider such as us. And we're the only one that has proven scalability that has an end-to-end solution. And as such, we're starting to see some really meaningful activities in the space.

Yes, you do seem pretty excited about it. I'm wondering when do you think you might be able to talk about being successful there?

I think there'll be more announcements coming in that area - in this area. I think it will grow over a period of time, however. It's not like in the case of SafePath where we go from 0 to millions in a very short period of time. So I have to keep going back to trying to keep your focus on the thing where the money is in the fastest period of time.

Yes, fair enough Bill, okay. Thank you so much for taking my questions.

Thanks Kevin.

And our next question does come from Brian Swift from Sutter Securities.

Yes. Could you give us a little bit more of a, you're talking about that your - the new customers that you have signed up, it's going to ramp up in Q4. But can you give us any kind of guidance as to what we should be expecting in Q3? I mean you were up sequentially from - in Q2 versus Q1, but how about Q2 through Q3?

Yes, we're not really going to give guidance on Q3. I will say this, we - our plan is to start the launch in Q3, but I don't think there'll be meaningful revenues at all. It should set us up though for some good revenue growth in Q4 and that should continue to go into Q1 of 2018. It's going to take a couple of quarters, probably the large percentage of their installed base over to our platform could happen sooner, but I'd rather take a more conservative posture.

But do you have other things in your pipeline that could be impacting the September quarter? I mean, not just the...

Yes, we do and we are continuing to focus on that. We are looking at a quarter that probably looks very similar to the one we just posted.

Okay. All right, thank you.

Okay.

[Operator Instructions] Our next question is a followup from Jeff Bernstein from Cowen. Please go ahead with your question.

Just to go back to QuickLink for a minute. Can you just talk about what the end points are that people are going to be using QuickLink with, is this handsets or is this other IoT type of items?

It's kind of both and it's both following a standard OMA DM standard as well as a lightweight M2M standard, so it's a broad market. There are some very exciting verticals, some take longer to get to meaningful size than others. And those are things that we have to factor in as we look at where we invest in the space but we are getting a very strong reaction. We hosted an interoperability TestFest in our Pittsburgh corporate location this past quarter. We performed exceedingly well and there were big names at this event. It was a worldwide event, and we just knocked the ball out of the park. We did a great job. So I think we're in a very strong spot here, and I think it's going to be a nice additive part to our business going forward. But the first thing and the most important thing is we need to post a nice strong profit on the bottom line and generate some cash. And that's going to be driven by SafePath first. All the rest will follow.

Got you, understand. And just on SafePath, is there another opportunity or two out there with existing subscriber migration potential or is that all kind of a one-off?

Oh, no. There's lots of opportunities, and the reception we're getting in the marketplace is very strong. Our product offering is excellent. So we will keep you posted on it, and we feel very bullish about this overall market segment.

Got you. And so has the balance sheet and the cash flow situation been a gating factor for getting deals done in other places up until now? And are you expecting a change as a result of this improvement that's coming?

It has been gating. I mean, clearly, once we're posting some good free cash flow that gives us a couple of things we can look at. If we look at M&A activities going forward, I mean, we're very thankful we were able to close this deal that brought us SafePath with the acquisition of iMobileMagic in Portugal last year, about a year ago and it's paying off big dividends. So yes, I mean, we're going to be able to be much more creative when we have a good cash balance and a decent stock price.

Got you, all right thanks very much.

And with that, ladies and gentleman, we'll conclude today's question-and-answer session. I'd like to turn the conference call back over to Charles Messman for any closing remarks.

I want to thank everyone for joining us today. Should you have any further questions, please give us a call in the office. Obviously, we're excited. We want to welcome Tim on board, and we look forward to talking to you on our next quarter conference call. Thanks.

And ladies and gentlemen, the conference has now concluded. We do thank you for attending today's presentation. You may now disconnect your lines.