Smith Micro Software, Inc. (SMSI) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Smith Micro Third Quarter 2017 Earnings Conference Call. All 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 note this event is being recorded. I would now like to turn the conference over to Charlie 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 third quarter ended September 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 at 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; 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. Forward-looking statements involve risk and uncertainties which could cause actual results or trends to differ materially from those expressed or implied by our forward-looking statements. 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 and second quarter of fiscal 2017. Smith Micro assumes no obligation to update any forward-looking statements which speak to our management’s beliefs and assumptions only as of the date they are made. Before I turn the call over to Bill, I want to point out that in our forthcoming prepared remarks we will refer to certain non-GAAP financial measures. Please refer back to our press release disseminated earlier today for a 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 third quarter earnings call for 2017. This was an important quarter for the company on many fronts as we continue to work our way back to growth and profitability. Important milestones in the quarter included the launch of our SafePath Family platform with Sprint, our first SafePath Tier 1 mobile operator in the U.S. and the completion of a private placement that strengthened our balance sheet by reducing debt and adding new working capital. The Sprint SafePath win should have a profound impact on our recurring revenues in the next few quarters and beyond. Tim will outline the details of the capital raise transaction during his remarks. Overall, I am pleased with the execution of our business plan and believe we are on the path to profitability and growth. Looking at the financial results for the third quarter, revenue came in at $5.8 million with a non-GAAP loss of $554,000 or a loss per share of $0.04, all in line with the expectation we shared on the second quarter earnings call. These results are approximately flat when compared to Q2 as we awaited the launch of SafePath with Sprint. We will discuss the Sprint launch later in the call. Now, I would like to turn the call over to Tim. Tim?

Thanks, Bill. I will start with the recent completion of the $5.5 million private placement of our newly designated Series B convertible preferred stock. The issuance included the conversion of $2.8 million of long-term and short-term debt plus new capital of $2.7 million. The transaction provided several key benefits to the company. It improved our balance sheet by reducing long-term debt obligations by $2 million and short-term debt obligations by $800,000. It generated $2.4 million of net cash to support the business as we transitioned through the new SafePath launch with Sprint and it satisfied our NASDAQ listing obligations, specifically around the $2.5 million minimum stockholders equity requirements. The newly issued convertible preferred will pay a quarterly dividend and includes a common stock conversion feature at $1.14 per share. The transaction did qualify for equity classification and therefore the impact is recorded in the stockholders equity section of our balance sheet. We are excited with this new round of funding as we continue our journey back to revenue and profit growth. Now let’s review the numbers for the third quarter. For the third quarter, we posted revenue of $5.8 million, compared to $6.5 million for the same quarter last year. The Wireless segment reported quarterly revenue of $4.7 million, compared to $5.3 million last year. Our Graphic segment reported quarterly revenue of $1.1 million, compared to $1.2 million last year. For the third quarter year-to-date, revenue was $17.2 million, compared to $21.2 million last year. The decrease in revenue year-over-year for both the quarter and the year-to-date was primarily due to Sprint’s decision to phase out our NetWise platform last year. We expect this revenue decline to be replaced in the near term with revenue from the SafePath launch with Sprint, which we announced on October 13. This launch is unique and that Sprint has an existing base of subscribers using a legacy solution, which is due to some set in Q1 of 2018. Bill will discuss this near term activity and others in just a few minutes. For the third quarter, gross profit was $4.6 million, compared to $4.7 million during the same period last year. Gross margin was 80% for the third quarter, compared to 72% last year. For the third quarter year-to-date, gross profit was $13.5 million, compared to $15.3 million last year. Gross margin was 78% for the third quarter year-to-date compared to 73% last year. The increase in the gross margin for both the quarter and the year-to-date compared to last year was primarily due to the cost savings related to previously announced restructuring programs. Operating expense for the third quarter was $5.6 million, a decrease of $3.7 million or 40% compared to last year. From a year-over-year perspective, quarterly selling and marketing expense decreased 44%, research and development expense decreased 50% and general and administrative expense decreased 12%. Operating expense for the third quarter year-to-date was $18.7 million, a decrease of $8.8 million or 32% compared to the same period last year. This operating expense decrease is the result of and consistent with cost savings from the previously announced restructuring plans. In the near term, we expect our quarterly operating expense to be consistent at approximately $5.8 million, which excludes any unannounced restructuring plans or changes to past restructuring reserve estimates. The non-GAAP operating loss for the third quarter was $900,000 compared to a non-GAAP operating loss of $4.1 million last year. The non-GAAP operating loss for the third quarter year-to-date was $4.5 million, compared to a non-GAAP operating loss of $10.2 million last year. The decreased operating loss is a direct result of cost savings achieved by the previously announced restructuring plans to align operating expenses with the anticipated revenues. For the third quarter, the reconciliation includes the following non-cash charges, stock compensation expense of $167,000, intangible amortization of $65,000, loss on debt extinguishment of $405,000, and amortization of debt discount and issuance cost of $133,000. For the third quarter year-to-date, the reconciliation includes the following non-cash charges, stock compensation expense of $1 million, intangible amortization of $195,000, loss on debt extinguishment of $405,000 and amortization of debt discount and issuance cost of $394,000. Due to our cumulative net loss 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 third quarter non-GAAP tax benefit of $300,000 and a third quarter year-to-date tax benefit of $1.7 million. I’d like to point out the footnote on the presented financials. During the third quarter, the company adopted accounting standard update 2017 11. This newly issued guidance allowed the company to reclassify its treatment of the previously issued and outstanding warrants from a liability to equity. This reduced the long-term warrant liability with an offset to stockholders equity while eliminating the historical and future expense charge to fair value the same liability. The change was adopted retrospectively back to Q3 of 2016 and per the newly issued guidance, we have therefore included an update of the prior year balances. That concludes my financial review. Now back to Bill.

Thank you, Tim. As I noted on the last call, we signed our first U.S. Tier-1 carrier customer for the SafePath family in the second quarter. Now that we have launched and are able to talk about the customer being Sprint, let’s go into a bit more detail regarding the launch and how it will positively impact both our top and bottom-lines. The launch of SafePath with Sprint is unique when compared to our other Tier-1 deployments to-date as there was a large already installed subscriber base currently using their legacy family locator offering. Sprint will transition this subscriber base to their new service offering named life ahead Safe & Found over the next few months. We believe that full deployment to Sprint’s installed base will be completed in Q1 2018. Once successfully completed, we expect our top-line revenue to grow by more than $3.5 million per quarter. After this transition is complete, we will have a much clear path to better forecast a predictable recurring revenue stream that will grow throughout the contract term. We were pleased with the media attention received with the launch of the Safe & Found product as it generated solid media placements with outlets such as Engadget, PCMag, and CNET. A particularly positive comment I would like to share is from the Engadget article and I quote, while all major cell providers have some sort of parental control apps like AT&T’s Smart Limits or Verizon’s Family Base, Sprint, they have leapfrogged them all with even more features. The company just announced Safe & Found, a new service that adds in real-time location, geofencing capabilities and SOS button and a way to find lock and wipe any phone if lost or stolen. We can build upon this type of news and will be working very closely with Sprint to continue the momentum and increase the awareness of the upgraded solution. In fact, we can start now with Sprint users on this call. Do you want to check out Safe & Found, at safeandfound.sprint.com. I also want to note the advantages of SafePath which allowed us to win the Sprint business and our important, as all Tier-1 operators in the U.S. are using the same legacy system as Sprint. The advantages we offer are, we are investing and growing in the SafePath platform unlike the legacy family location system, and are operating as a subject thought leaders in the marketplace. We had evolved and expanded family location offering to include parental and browser controls. We have the ability to fully support language localization that enables us to easily extend the service to customers who primarily speak a different language such as Spanish. SafePath provides for extensibility to support new features, functionality and devices such as wearables. This is exciting as we provide our customers with a single platform to support wearables such as wearable locators and GPS watches for children, pet trackers, location and panic wearables for elderly family members, biometric wearables and other fitness type devices. I want to note that this last point represents a big opportunity for Smith Micro. As the wearables market is in its infancy, based on interest that is coming from carriers, we believe it is a market ready to explode. Our SafePath offering provides carriers a single, easily integrated platform to bring wearable devices to life. We are working closely with carriers and device OEMs to create a wearable story that will drive expansion in the family safety user base with real benefits for the consuming public. You will see in the coming quarters that SafePath will continue to progress with new feature upgrades, the expansion of addressable markets and most importantly, the addition of new customers on the platform. As you can see, there is a lot of potential ahead for the SafePath solution. Let’s talk about some key initiatives that we completed on our CommSuite Solution during the quarter. We added functionality to our CommSuite Visual Voicemail solution that enables it to be sold to mobile subscribers on corporate and prepaid plans for the first quarter. As mobile connectivity continues on the path towards commoditization, we see the prepaid segment as a growth sector for the wireless industry and we see opportunity. It is undeniable that the way mobile consumers use voicemail is changing, as this evolution continues, we will look to capitalize on opportunities created by market trends that are happening such as, bring your own device, over-the-top voicemail apps, and dynamic cloud-based messaging services. You will see some new initiatives launched in fiscal 2018 that we believe can gain us even better penetration. Now on to NetWise. As I have mentioned previously, while mobile service providers now offer all you can eat services, and are competing fiercely on price, the need to leverage a low cost unlicensed spectrum is important and will increases the need for new cost savings measures continues. Our technology leadership in the Wi-Fi optimization space with a proven NetWise platform remains important as we continue to find and maximize profitable revenue opportunities. The Wi-Fi business overall is evolving and changing rapidly. Just look at the cable MSO space where we already have a solid customer base to build upon. It is taking far longer than originally anticipated, but you are starting to see a more aggressive marketing effort around the cable MSO mobile offering. I know this has been said before and it will remain very true as this service grows bringing on new subscribers and truly scales Smith Micro will certainly benefit. We see great opportunity ahead and throughout 2018. You will hear more about NetWise and some new opportunities as they materialize. A fourth component of our business revolves around the IoT market which is very dynamic as well. Changing and growing rapidly to a point we haven’t seen in a very long time. New use cases are continually being discovered and new players enter the fray with innovative solutions designed to capture a small fraction of this multi-billion dollar industry. Our QuickLink IoT platform is positioned well bringing several advantages to the nascent yet fragmented IoT market. As an end-to-end device management solution, that not only provides comprehensive device management functionality, but also has proven far more update technology, QuickLink IoT can bring connected device manufacturers, chipset vendors and system integrators a proven carrier-grade solution that is scalable and secure. Another opportunity to think about comes from looking at some synergies we have between bringing the capabilities of QuickLink IoT to our wearable strategy along with the SafePath platform, offering an even more powerful solution to our customers. We are confident about our strategy as it rolls out over the coming quarters. Lastly, on to out Graphics group. During the first three quarters of the year, we restaffed and integrated the entire graphics team functionally, including a recent management hire in the sales organization who is solely focused on expanding revenues for our graphics products. Some noted milestones achieved during the quarter includes the relaunch of our popular content paradise website bringing a new user experience and new 2D and 3D content to reengage this very loyal customer base. There is excitement building around updates to our two leading software brands, Poser and Moho that are coming in the fourth quarter as well as some unique new SaaS products coming in 2018. Good progress is being made as we rebuild this business in our lower cost geographies allowing us to ensure graphics remains a strong profit center for the company going forward. Overall, we have been very busy and I am pleased with the progress we have made, but we aren’t there yet. The launch of SafePath with a U.S. Tier 1 mobile operator is a great step forward and will bring strong positive impact on the future financial health of our business, but this is only the beginning. We look to add new customers such as our European Tier 1 SafePath customer we spoke about last quarter, to build on the momentum we have achieved and we will maximize each of the product lines from a profitability and revenue standpoint. I fully believe that we are well on our way to returning Smith Micro to growth and profitability in 2018. And to drive that point home, that is my wife and I have invested millions into Smith Micro, we are looking for a very solid return on our investment. With that said, I look forward to opening the call for questions. Operator?

[Operator Instructions] The first question comes from Kevin Dede with H.C. Wainwright. Please go ahead.

Thanks. Hi, Bill. Congrats on the Sprint deal. Very exciting.

Thanks, Kevin.

So, could you just talk a little bit about how you see Sprint marketing the new service versus the old one? And maybe a little bit more on the differentiation between the legacy business that they were offering and what you have for them? And then, lastly, maybe you could touch little bit on the chatter that’s going on about T-Mobile and a possible Sprint combination? And if that were to happen, what you think might the fallout be?

All right. Okay, good. Let’s try to take it from the top. First off, Sprint has a very sizable installed base of their legacy application which was location-based only. It did not have any parental controls built in. With SafePath, they get both within the same app. So there is a substantial growth in capability that this Sprint user will get to realize. And so the first step is to get their installed base moved over to our platform and when that installed base is moved over and we expect some breakage along the way, but when that installed base moves over, that’s where we can see that the SafePath launch will add $3.5 million and up on a quarterly basis. Now in consult with that, Sprint is also looking to substantially increase the size of their family safety user base. They think they have the best solution available here in the U.S. and they want to capitalize on that. So, they are working on a number of different things, programs that they are going to be launching that are totally designed to add more users to their platform. Clearly, that’s even better news for us. So, I think this is just the beginning and we’ll build over each of the quarters of 2018 and should bode extremely well for us. As far as for the T-Mobile, Sprint chatter, first off, that’s an area that I don’t really want to get too heavily in. Sprint and T-Mobile are both customers and as such, this is something I think they have to work out what I think probably doesn’t matter a whole lot. I do say this that the offering that T-Mobile has is based on the legacy platform. So, when – if there was to be a combination, it would seem logical that SafePath would win out on both sides and so, frankly we would actually just grow that user base still further. So, in that sense, I see it as a very positive move. Also think when you look at the SafePath opportunity and we kind of talked about it in the prepared comments, we kind of talked about wearables. And with the wearables, whether it’s a pet tracker or whether it’s a panic button for elderly or a GPS watch for kids, these things in and of themselves until they are fully incorporated into a common platform which SafePath offers, they are marginal. But when you put it into SafePath and it becomes part of its overall theme, you now have the opportunity to substantially grow that family safety user base. And if there is one thing that carriers do just an outstanding job of, that’s selling things, selling devices, and so, devices could be sold in a carrier store and with it comes the membership to the SafePath platform which is yet another way to grow the size of the user base. I’ve probably gone further than I should have, so, Kevin, have I answered your questions?

Yes, yes, yes, absolutely, Bill. Thanks very much. I appreciate the elaboration on the wearable comment too, because it wasn’t clear to me that that was something that you saw carriers would drive. I neglected to ask you detail pricing differential. The new Safe & Found platform will be at the same price that Sprint’s legacy solution is offered now. So there is no difference there?

That’s a question you need to ask Sprint. I don’t want to get into their pricing strategies.

Okay, fair enough. Thanks also for some of the background on NetWise and the CommSuite, because that progress there is always is interesting. I was wondering if there was anything sort of closer in the radar screen that you might see contributing near term versus longer term. I mean, the – my thinking being that we’ve talked about a lot of the developments here. Some have worked and I think most of the promise or a lot of it while it’s obvious from a technology perspective just hasn’t come through in commercial value yet. And I am just wondering if you could speak to timelines a little bit.

Sure. I think the most significant thing and we’ll focus in on CommSuite first. As with the additional capabilities that we’ve added to the product such as that it makes it very easy for corporate users as well as prepaid users for the first time to be able to sign up for CommSuite is a significant growth engine. And based on the early numbers that we are seeing we are starting to see an immediate impact. So, I look forward to that moving forward. So, I think that’s probably the most significant thing that we can talk about. On the NetWise front, it’s just a matter of continuing to work with our customer base as they continue to grow their platforms. Clearly, the cable MSOs have been a lot slower than we had anticipated. But they are our customers and they are very, very big names and we are very pleased to have them.

Great, okay. Thanks, Bill. I’ll hop in the queue.

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

Thank you, and also thank you, Bill for putting your money where your mouth is, you’ve been talking to us for several quarters now on how confident you’ve been on the pipeline of business that have been building at the company. So now we’ve seen an example of it. To kind of follow-on on Kevin’s question about some color on the marketing of Sprint on the SafePath product. Can you give us some ideas of how aggressive or will it be Sprint and Smith Micro doing marketing and do you have any goals in terms of, obviously they are not changing from the legacy to this product without expectations of growing their subscriber base. But maybe you could get a little bit deeper into what we might expect over the coming year or two?

Hey, Brian, this is Charles. I just thought I’d jump in, because this is an area that I’ve been working on. I can tell you that Sprint does have an aggressive marketing campaign. We will be working with them on that as far as bringing people over, it’s a staged event. I don’t want to “talk about it prior before it launches” but it will be focused on initially the current subscriber base. We’ll then move to the family type of plans and then we’ll working as well having a marketing plan that goes in conjunction with them. So that’s about as much color as we can give until they start launching and you will see it. It will be noticeable.

So how soon do you think they’ll be launching this? So they haven’t launched it yet is what you are saying?

No, they’ve launched different pieces of it and I think it’s really a timing upon them as to when they distribute to their particular user base.

Yes, I think their first launch effort was working through their blogs. They have very strong quotes from their CEO and in those blogs which really kind of sheds light on the importance that Sprint places on the service offering and I think basically also talks to the fact that, you’ve got visibility for family safety, all the way to the top of Sprint and which should be part of the driver for growing the size of this market.

And my other part of the question that you have – do you or they have some goals on trying to grow this business that you could share with us?

Okay, let me answer the question first. The first part of the question that is, are there goals? Yes, there are goals. Yes, they represent strong growth over their current platform size as to exactly what those goals are, those are really kind of proprietary to spread and I really can’t comment.

Okay, thank you.

The next question comes from Ian Gilson with Zacks Investment Research. Please go ahead

Very good afternoon, gentlemen. How or what basis are you going to be compensated for by Sprint? And do they have any claim on revenue generated with other carriers and as you look towards the middle and end of next year, roughly what would be a U.S. versus non-U.S. revenues break out?

Okay. Those are lot of questions. That first question – that first part, what was that again?

How are you going to be compensated? Is Sprint going to give you a deal a subscriber or a deal per minute or how does it work?

Yes, okay, let’s start with that. It is a license fee paid monthly per family that is using the service. So it is a recurring predictable revenue stream. And is grows, then that base will generate much higher revenues for Smith Micro. I think, as far as the other carriers, this is a Sprint solution. They really can’t bring in the users from other carriers. It is not an exclusive to Sprint. In other words, we have full rights to sell to the balance of the carriers here in the U.S. and clearly that’s part of our goal. And so, we will, I think, continue to push that. We also will be launching our own over-the-top service which would allow people not only within the U.S. with various carriers, but internationally as well to utilize the service. So stay tuned for that. We’ll probably be talking about that on our next call. As far as the break out between international and domestic, I would say, right now based on the fact that Sprint has such a large install base, they will be the dominant customer for some period of time. Clearly, if we can close another U.S. Tier-1 or if we can get very rapid growth with some of our other Tier-1s, that would bridge the gap. But I think from an expectation standpoint, I would look for most of the revenue coming from the U.S.

Okay. Is there any technical dependency? In other words, 4G, 5G, CDMA, GSM or any other technology that either hedged to or depletes from the opportunity?

No, there is no limitations in the application at all.

Okay, great. Thank you very much.

Okay. Thanks, Ian.

The next question is a follow-up from Kevin Dede with H.C. Wainwright. Please go ahead.

Hi, Bill. I just had some help I was hoping, Tim could offer on the convert. I was little confused on the numbers. Is the convert price at $1.14, so they are in the money now and then just some detail on how that was classified exactly?

Yes, you are correct. The convert price is at $1.14 and it is currently in the money as our stock is trading above that. And that can be converted at any time here in the near future as we prepare the appropriate registration statements to follow-on. As far as the equity classification goes, the transaction was complicated from a preferred standpoint. But ultimately qualified for equity classification which as you know and as I stated in my prepared remarks, ultimately helped us out on the NASDAQ listing requirement side and provided a nice boost to stockholders equity to continue and eliminate our any risk in the near future of a delisting process from NASDAQ.

Great, okay. Thanks very much gentlemen. Appreciated, I appreciate you taking all my questions.

[Operator Instructions] Showing no further questions, this concludes our question and answer session. I’d like to turn the conference back over to Charlie Messman for any closing remarks.

I want to thank everybody for joining us today. We are very excited here at Smith Micro. We got a lot of fun stuff happening. So, we will look forward to talking to you on our fourth quarter call. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.