Smith Micro Software, Inc. (SMSI) Q4 2017 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Smith Micro Fourth Quarter and Fiscal Year 2017 Conference Call. [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 Charles Messman. Please go ahead.

Thank you, operator, and good afternoon everyone. Thank you, for joining us today to discuss Smith Micro Software’s Financial Results for our fiscal 2017 fourth quarter and year-end results ended December 31, 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 of the Board, President and Chief Executive Officer of Smith Micro; and 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 our risk factors discussed in Smith Micro's Form 10-K for 2016 and Form 10-Q filings for the first three quarters of 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 Smith, 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. And thank you for joining us today for our 2017 fourth quarter and year end conference call. Fiscal 2017 proved to be a very important year for the company, as we achieved some very significant goals building upon the restructuring efforts we undertook in 2016. Smith Micro's most significant milestone was the launch of our SafePath platform with Sprint our key partner and customer. While the conversion of Sprint's existing customer base is still underway, it will equal approximately $3.5 million in additional quarterly revenue for the company once it's completed. We're excited about the upside we see from this. As you will recall, we also took significant steps in 2017 to recapitalize the company by adding working capital. Tim Huffmyer, our CFO, will discuss the most recent private placement of $5 million in more detail later in the call. I believe this capital raise will be the last one before the company returns to profitability. Looking ahead, I am pleased with where we stand as we are positioned for a very solid fiscal 2018. By the second half of the year, we expect to be cash flow positive and profitable as a business. Now looking at the financial results. For the fourth quarter, total revenue came in at $5.7 million with a non-GAAP loss of $700,000 or a loss of $0.05 per share. For the year total revenue was $23 million with a non-GAAP loss of $3.5 million or a loss of $0.26 per share. After Tim’s remarks I will give you some details on our outlook and strategic goals for 2018, providing you a more in-depth update on the Sprint launch and present an overview of some new initiatives underway. We'll then take a look at some of the key product areas and provide some insight on their respective opportunities in 2018. With that said, I will now turn the call over to Tim for more detail on our financials. Tim?

Thanks, Bill. I will start with a summary of our recently completed private placement of common stock and warrants. The funding was completed on March 6, and provided several key benefits to the company. First, $4.5 million of net cash was generated to support the business as the Sprint SafePath platform continues to grow subscribers. Second, the balance sheet was improved by extending the maturity date of $1.2 million of short-term debt to Q1 of 2020. And last it will reduce our annual dividend outflow from the newly issued Series B Preferred Stock by approximately $400,000 as certain shares will be converted to common stock in the coming months. The newly issued common stock was priced at $1.75, and included the issuance of a warrant for each share purchased for total proceeds of $5 million. In addition to the securities purchase agreement, the company also entered into a registration rights agreement. Upon filing of the companies 2017 Form 10-K, we will take the necessary steps to complete our obligations under the registration rights agreement, including any outstanding obligations associated with the Series B Preferred Stock registration rights agreement executed in September of 2017. 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 fiscal 2017 and the recently completed fourth quarter. For the fourth quarter, we posted revenue of $5.7 million compared to $7.1 million for the same quarter last year. The wireless segment reported revenue of $4.7 million, compared to $5.6 million last year. Our graphic segment reported revenue of $1.1 million compared to $1.5 million last year. For fiscal 2017, revenue was $23 million compared to $28 million last year. The decrease in revenue year-over-year for both the quarter and the year-to-date was primarily due to lower customer adoption rates with our CommSuite product. During Q4 we rolled out CommSuite product enhancements, which we've now seen positive results from, and we do expect will contribute to 2018 revenue growth. Revenue from the Sprint SafePath launch is expected to accelerate based on recent Sprint actions. These actions though, are completely dependent on Sprint execution. We continue to support those efforts. As a reminder, this launch is unique in that Sprint has an existing base of subscribers using a legacy solution. The legacy solution was originally due to sunset in Q1 of 2018 but has subsequently been delayed for several months. There is no guarantee the sunset day won't be further delayed. This change was based solely on Sprint operations and was not a result of the SafePath application. Bill will discuss this activity in more detail in just a few minutes. For the fourth quarter, gross profit was $4.4 million compared to $5.3 million during the same period last year. Gross margin was 76% for the fourth quarter compared to 75% last year. For fiscal 2017, gross profit was $17.9 million compared to $20.7 million last year. Gross margin was 78% for fiscal 2017 compared to 73% last year. The increasing gross margin for both the quarter and year-to-date compared to last year was primarily due to the cost savings related to the previously-announced restructuring plan. Operating expense for the fourth quarter was $4.9 million a decrease of $4.2 million or 46% compared to last year. From a year-over-year perspective, quarterly selling and marketing expense decreased 32%, research and development expense decreased 41% and general and administrative expense decreased 23%. Operating expenses for fiscal 2017 was $23.6 million, a decrease of $13 million or 36% compared to last year. This operating expense decrease is the result of and consistent with the cost savings from previously announced restructuring plan, and the reversal of certain real estate restructuring reserves due to a change in estimate, offset by the non- asset impairment charge from 2016. In the near term, we expect our quarterly operating expense to be approximately $5.9 million, which excludes any unannounced restructuring plans. The non-GAAP operating loss for the fourth quarter was $1.1 million compared to a non-GAAP operating loss of $3 million last year. The non-GAAP operating loss for fiscal 2017 was $5.6 million compared to a non-GAAP operating loss of $13.8 million last year. The decreased operating loss is a direct result of cost saving achieved by the previously announced restructuring plan to align operating expense with the anticipated revenue. The non-GAAP net loss for the fourth quarter was $700,000 or $0.05 loss per share compared to a non-GAAP net loss of $1.8 million or $0.15 loss per share. The non-GAAP net loss for fiscal 2017 was $3.5 million or $0.26 loss per share, compared to a non-GAAP net loss of $8.6 million or $0.72 loss per share last year. Within the previously mentioned press release, we have provided a reconciliation of our non-GAAP metric to the most comparable GAAP metric. For the fourth quarter, the reconciliation includes the following noncash charges: stock compensation expense of $169,000, intangible amortization of $63,000, amortization of debt discount and issuance costs of $66,000; offset by a reversal of real estate restructuring reserves of $691,000. For fiscal 2017, the reconciliation includes the following noncash charges: stock compensation expense of $1.2 million, intangible amortization of $258,000, loss on debt extinguishment of $405,000, amortization of debt discount and issuance cost of $460,000; offset by a reversal of real estate restructuring reserves of $691,000. 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. During the fourth quarter, we recorded a deferred tax asset related to certain tax credits, which became available through the 2017 Tax Act recently signed. The resulting tax impact, when combined with the operational 38% tax rate, in the fourth quarter for non-GAAP purposes, was tax expense of $140,000 and a fiscal 2017 tax benefit of $1.6 million. This concludes my financial review. Now back to Bill.

Thanks, Tim. As I stated at the beginning of the call, launching our SafePath Family platform with Sprint, slight labeled as Safe & Found was a very solid win for the company. Let me start by updating you on where we currently stand with the rollout of Safe & Found. While we anticipated a full deployment to Sprint's large already installed Family Safety subscriber base in Q4, the conversion to our platform has of been slower than we anticipated. The good news is, that the rate of deployment is increasing, and we believe we'll continue to accelerate as Sprint's messaging program continues to expand. We continue to work very closely with key senior executives of Sprint, including strong C-level support to accelerate the conversion process in order to reach the revenue goals both companies have set with the Safe & Found service. With several new conversion in new subscriber initiatives starting in 2018, such as in-app messaging, digital marketing campaigns, e-newsletter content and trial offers, both Sprint and Smith Micro anticipate the acceleration of the conversion of legacy users as well as the addition of new subscribers to the Safe & Found platform. Continuing on to our SafePath product, providing value-added services to subscribers continues to grow a strategic importance for Tier 1 carriers, not only do these strategic services enable carriers to further monetize their network investments and increase subscriber ARPU, value-added services also help to reduce subscriber churn and increase customer satisfaction and perceive service value. In an increasingly commoditized mobile service market in which carriers often compete on price alone, value-added services provide a critical competitive differentiator. It is a proven fact that customers who pay for value-added services, not only add new revenue streams but also churn less than those that don't. Not only our family plans worth more, they are also more sticky in terms of subscriber retention, making family-plan customers all the more vital for carriers. In terms of these benefits, our SafePath Family solution checks all the boxes for Tier 1 carriers. SafePath provides a great platform upon, which to build a fully integrated family services offering that will extend value past smartphones to in-home devices such as smart TVs and voice-controlled virtual assistants. This leads us into the wearable device world, where we are seeing significant growing demand in the market. Having just returned from Mobile World Congress in Barcelona, I can tell you that a major theme throughout this show was wearables. In various meetings with partners and customers, we saw multiple form factors of family-centric devices from GPS-enabled devices for children and the elderly to real-time pet tracking devices. We saw evidence of devices using the Qualcomm Snapdragon wear chipsets that supports the networks that exist today as well as the newer generation of chipsets that support the networks of tomorrow. These chipsets will accelerate our customers’ time to market by allowing them to rollout great wearables today without waiting for a nationwide rollout of new networks. They can then execute on the Phase 2 of new devices to support these new networks, such as 5G. I believe that we are just on the forefront of a significant growth curve with this product. We are very well-positioned in the market in terms of current product functionality and planned product roadmap. During the coming year, you will see product iterations of SafePath, as we continue to build out the functionality of the platform in 2018. Now let's look at our CommSuite communication suite. During 2017, we completed several new initiatives that reversed the trend of flat revenue growth associated with our CommSuite implementation as Sprint. As a result, CommSuite revenues grew in Q4 of 2017, as we reached new customers by adding new functionality to our Visual Voicemail solution and improving back end workflows. First, we improve the billing integration to expand the types of Sprint users that can use CommSuite. Now for the first time, both corporate and prepaid users are using CommSuite contributing to the profitability of the product. We see upside from this as the prepaid market is growing extremely well, and frankly, corporate users tend to use voicemail more than individual consumers. As our CommSuite application is preloaded on all Sprint phones powered by the Android OS, we have a very large user base to build from, but this isn't enough. While the way mobile consumers are using voicemail is changing, we see opportunities to provide further functionality with CommSuite. This will enable us to capitalize on this evolving market by addressing trends like the growth at BYOD, offering new OTT voicemail apps that connect to several different communication channels of choice, dynamic cloud messaging services, in-app direct communications and others. We see great potential in 2018 to build on a very profitable installed base by continuing to evolve and improve this powerful platform to fit the ever-changing needs of mobile consumers. In Barcelona, we demonstrated a proof-of-concept implementation of delivering voicemail using the Amazon Alexa platform with voice-driven commands. We have many new innovative features to expand the market appeal of CommSuite in 2018. Now on to QuickLink IoT and how we plan to address the extremely dynamic evolving and rapidly growing opportunity that is the Internet of Things. With carriers continuing to accelerate the rollout of purpose built IoT networks, our QuickLink IoT platform will become more relevant and more in demand. As our carrier grade solution with proven end-to-end device management and further functionality, QuickLink IoT is well-positioned to capitalize on the growth of carrier supported IoT deployments. In addition, we will continue to develop and build upon the synergies between QuickLink IoT and our SafePath platform, specifically, in that growing wearables market. This strategy will continue to mature and evolve throughout 2018. Throughout fiscal 2017, we made significant strides in relation to our NetWise family of products by streamlining internal processes and upgrading our core technology to maintain our leadership role in the Wi-Fi optimization space. Through the intelligent device based management of mobile network connections, NetWise will continue to provide our customers with a proven scalable and secure solution that will help them maximize the business value of low cost on license wireless spectrum. We have a very solid base of customers to build upon and expect to see growth with NetWise, particularly in the cable MSO space as they continue to deploy and expand their mobile service offerings. Although the rollout of these alternative mobile services is taking longer than anticipated, they’re are gaining traction in the marketplace and adding subscribers. The NetWise platform plays a crucial role in the success of these Wi-Fi-first mobile services as well as helping traditional mobile operators optimize their network usage. Lastly, on to our graphics group. Fiscal 2017 was all about rebuilding, rebranding and reengaging with a significant and diverse customer base our graphics products attract. I am pleased with this significant progress that was made in 2017 as we maintained a very profitable business unit while rebuilding it from the ground up. There has been a lot of work done behind the scenes that is building momentum and I expect good things coming in 2018. As we looked to 2018, it now is about growth and expansion, which will be achieved by adding new products to our graphics portfolio. During the coming quarters, you will see the launch of several new products as well as new strategic partnerships and expanded global distribution channels. We also will continue to develop and improve both Poser and Moho as well. As our flagship graphics products, the continued vitality of these two titles is crucial to the future of our graphics business. Just to give you some color on the power of these products, our Moho software was used in the creation of film called the Breadwinner, which was just recently nominated for an Academy Award as the best animated feature film at this year's Oscars. In closing, although, the top line didn't meet my expectations for 2017, we've built a very strong foundation for growth and profitability in 2018. In the coming year, we will continue to maximize product lines from a profitability and revenue point of view. I am pleased that we entered the new fiscal year with a strong position from a working capital standpoint. And I'm confident that we'll execute on the opportunities ahead. With that, operator, we can open the call for questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mark Gomes with Pipeline Data. Please go ahead.

Hey, congratulations, gentlemen, looking forward to seeing you return to cash flow positive. So I'm jumping right in. You made – mention of the legacy solution at Sprint being unique in that you have that installed base there. Assuming that the Sprint deployment goes well, it’s my understanding that the legacy solution is also in place at all of the other Tier 1 in the U.S. Is that correct? And would it be safe to assume that if you do have a successful launch at Sprint that that would multiply your opportunity by having opportunity to go after those accounts as well?

Thanks, Mark, this is Bill. Yes, you’re right. All the other Tier 1s use the same legacy platform. Our goal is to ensure that the Sprint launch is incredibly successful. There is no better way to bring other carriers to our platform than to demonstrate what a great decision Sprint made. And so we are totally focused to that goal. And we are executing on that. And once again, I'm just really pleased with the support and the activity that's going on the part of Sprint to grow this platform. And I know it’s critical to their plans going forward.

Okay. Well, I could tell you, I’ve tested product, the latest version it works great, and I'm impressed with the improvements relative to the early reviews. What do you see as kind of coming up for the next version of this product? And how is that – how'll that help you with your deployment in Sprint?

Well, first off, we have a full roadmap that we are executing against with SafePath. We have a next major release coming out in 2018. Really don't want to talk too much about that right now. We have added a lot of features and functionality to it. We’ve listened to the marketplace as to what thing seemed to be matter the most. And we're reacting to that in a very positive way. Our goal is to be the absolute leader in this space in the industry. And being number one, we will set ourselves on the path of extreme growth and very strong profitability. That's what we are here for.

Great. One last question, I'll jump back into the queue. Can you just give us a sense of what advantage do you feel Smith Micro has and not just in product but in terms of selling and servicing carriers specifically? Thanks.

Sure. We are a very unique software house. We have been servicing large Tier 1 carriers for years. They know us well. We have performed extremely well. We do what we say. We understand what it means to be carrier grade. This is a major differentiation between us and other players, not only in the Family Safety business, but in other parts of our product line up, where we really do know how to get the job done. And this is the difference that we bring. And as a result, we have access virtually to every carrier that's out there to have a conversation is not a difficult thing for us. And I think that's really one of our strengths.

Great. Thank you very much and congratulations once again, continued progress.

[Operator Instructions] Our next question comes from Aria Cole with Cole Capital. Please go ahead.

Thank you very much and best of luck to you here in 2018. Question number one, regarding the Safe & Found application being rolled out at Sprint. Based on your press releases, it would seem as if the legacy number of subscribers as may be about 300,000 or so, which would be an attach rate of under 1% relative to the $38 million Sprint subscribers out there. And I'm just curious to know, if my numbers are reasonably on target or way off? Because I'm just wondering why the attach rate with the legacy Sprint product had been so low?

Actually that's a question I would probably prefer you ask Sprint about then to ask us. I will say this that the – there is a great room for growth, actually the total subscriber subbase at Sprint is larger than what you stated. So there is a lot of upside. I think it is the goal of not only Smith Micro but also of Sprint to see millions of subs using the SafePath product and that's a goal that I think would be echoed in the executive aisles of the Sprint campus as well.

And regarding that aspiration, if you look at the new Safe & Found product today, and I'm assuming I hope you had users use the product and compare it with the product that predates it at Sprint and also maybe the other carriers. Have you like systematically compared the products you might have a checklist? Or you have ratings from 1 to 10? And coming over the overall rating and feedback for how well your product is evaluated versus the legacy? Just kind of curious to know how much of the differentiation is there is in the eyes of consumers.

Well, that's actually part of how we make the sausage. So we have to constantly evaluate ourselves to competition, not only the legacy software, that you alluded to, but to other players that are in the marketplace and that's an ongoing thing here at Smith Micro, and we will continue to be so.

Okay. And just last question, if you look at the website for all the various carriers, they have different tiers of this parental control software ranging from $3 to about $10 per month for OnePlus users. I'm just trying to understand what sort of pricing Sprint is going to have for the parental control service on a per line basis? And would you be helping to share maybe 10% of that revenue or some other number?

All right. Let me just say that the Sprint pricings on their website under Safe & Found. They provide a family with up to five lines for $6.99 per month, that’s very competitive to other players in the marketplace. That’s really all that I want to say on that.

Okay. Thank you. Best of luck.

Our next question is a follow-up from Mark Gomes with Pipeline Data. Please go ahead.

Just one quick follow-up with 5G coming up, I was wondering across your different product sets what sort of opportunity you see with the move from 4G to 5G and then, maybe if you can give just a little bit of historical background in terms of how that you would characterize that from the last transition we had? Thanks.

Okay. That’s a interesting question. 5G, first off, I don’t really think you see significant deployment of 5G for another couple of years. You’ll start to see some early deployments, but I don’t think they’re going to be large. As far as the impact of 5G on our current product offerings, I don’t really think there are any of any significance. I think you asked about what was the fact that it is going from let’s say 3G to 4G and I would even go back further when you went from 2G to 3G. I guess the biggest impact in both of those is when you went from 2G to 3G, it was the first time that carriers could offer digital data service, that was effective and usable and something that the market was really looking for. When you went from 3G to 4G, you saw this – the speeds just really increased. And I think the best thing that can happen going from 4G to 5G is you start to see wireless service rates that are equal to plug-in into the wall rate. So I think that’s probably the biggest driver. What’s the effect on Smith Micro or others in the marketplace? Well, I think the biggest effect is it makes wireless data services all the more useful and usable and expands the total market that’s out there for us to service.

Okay. And the other thing I heard about 5G is that it really helped proliferate the Internet of things. So how do you see your business ramping up between now and the rollout of 5G? And then you see 5G actually having a big impact on your IoT business? And that’ll do for me. Thanks.

Okay. Well there’s a – really a lot of focus on the IoT market and really the IoT market is not a broad market, it’s a bunch of vertical markets. There is a broader play and carriers would like to provide a network or our platform for IoT deployment. And that’s something that I think we’re focused on. There should be a thing. We sell really well the carriers. We understand how they do business. We understand what their touch points are, and we understand what are role needs to be. So I think when we look at the IoT market, we see great upsides. It is a strong future’s play, and it’s something that we think we have some great software for, and we look for that market to generate growing profits.

Great. Thanks again.

Okay.

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

Hi guys. I’m sorry I dialed in a little late and missed your prepared remarks, if you covered this already, I apologize. I wanted to know if you commented on the process and the pace at which you expect Sprint to be migrating their customer base over to the SafePath? And if you have any color that you can gave on, what’s been happening with that, more recently?

Yes, Brian, we have talked about that but I’m more than happy to go over it again. Because I think it’s really probably one of the most critical things that we have to really achieve. The Safe & Found deployment at Sprint and the migration of their legacy users over to our platform is accelerating, the rate is accelerating. We still have our ways to go. We are very pleased with the level of acceleration, and we think that if there’s still more growth that can happen beyond this. I think what we’re seeing is that our customer has put together some really strong messaging and is now deploying that messaging, not only to their legacy installed base but to the broader market of just literally tens of millions of subs. And I believe that as you see the growth of Safe & Found going forward, while its critical to bring over the users that were on the legacy platform that real upside, the real brass ring, if you will, is that it comes from the new subscribers that have never used Family Safety before. I think that the importance that carriers place on the family as a sub as a piece of their business is they view family business as a very solid, very stable and churn resistant types of users. When they also our value-added service buyers established that value added service buyers don’t churn as much either. And net-net, that where we sit with Family Safety is right in the sweet spot for every carrier not only here in the U.S. but around the world because every carrier is fighting the issue of competitive threats and the race to zero and some cases on the funds they are collecting from their subs.

Thank you. Do you speak to the wearables markets? And when some of those types of offerings might be added to the Safe & Found product?

We didn’t talk about when. And I’m not really – I don’t think allowed about to talk about when because my customer wanted to tell people when they’re going to do that. I do expect that you will see some things on the market within the next year or less and I guess I’ll just leave it at that.

Okay. That was pretty obvious that they didn’t make this switch just to add more features to the existing customer base, they would want to do this to expand it. Are you seeing in those numbers that you have signed up so far? Is there anything that number that’s new as opposed to the legacy migration?

Yes. There is a very significant number that is not coming from the migration of the installed base but from new net adds. So that part I think is very critical. And the things we talked about, the quality of the user, the quality of the business, these or really meaningful to carriers and it’s something they can build their business case around and so this is the reason that we are enjoying very strong sea-level support from Sprint for this offering because they know this is something that is just critical to their overall strategy. And it doesn’t matter whether we’re talking about future deployment of wearables or other kinds of services, we provide them a platform in Safe & Found, it’s more than just an app and a server, but it’s actually the way you can grow all these different things together in a very appealing service offering for the carrier. Our goal is to make that wildly successful at Sprint and then use that to demonstrate what we can do for all the rest.

All right. Speaking of that, my understanding of the same product that you displaced at Sprint is also used by the other U.S. major carriers. Are you making any progress in learning any of those? Or any signs that they will follow like they did before?

Well, I really don’t want to talk about the future today. I really want to talk about as far as new contracts that aren’t signed. Let me just stay focused on the business that we have because it’s so incredibly meaningful to begin with. And make sure that we keep our focus to get this mission done first, I will only tell you that the sales team is very active and they are very aggressive and they are in the market, and they are talking to many, many other carriers, and we are looking for additional carrier wins for our Safe & Sound.

And this concludes our question-and-answer session. I would like to turn the conference back over to Charlie for any closing remarks.

I want to thank everyone for joining us today. As always, if you have any questions, please feel free to give us a call in the office. We’ll look forward to speaking to you on our next call. Thanks, and have a great day.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.