Smith Micro Software, Inc. (SMSI) Q3 2018 Earnings Report, Transcript and Summary

Good day. And welcome to the Smith Micro Third Quarter 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, today’s event is being recorded. I would now like to turn the conference over to Charles Messman, Vice President of Investor Relations and Corporate Development. Please go ahead.

Thank you, operator, and good afternoon, everyone. Thanks for joining us today to discuss Smith Micro Software’s financial results for the third quarter of our fiscal 2018 fiscal year ended September 30, 2018. 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. 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’ll 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 risks 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 the risk factors discussed in Smith Micro’s recently filed 10-K. Smith Micro assumes no obligation to update any forward-looking statements, which speak to our management’s belief and assumption only as of the date they are made. I want to point out that in the forthcoming prepared remarks, we’ll 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 all that said, I’ll now turn the call over to Bill. Bill?

Thanks, Charlie, and good afternoon to everyone. Thank you for joining us today for our 2018 third quarter earnings conference call. Overall, I am pleased with the third quarter as we met our expectations. Revenues came in at $6.5 million, up 12% from the $5.8 million reported in the third quarter of last year. The growth continues to be driven by our two core wireless products, SafePath Connected Life Platform and our CommSuite voice messaging platform. Gross profit for the quarter came in at $5.5 million, up from $4.6 million last year. We achieved non-GAAP profitability of approximately $200,000 or $0.01 earnings per share during the quarter. Looking at the first nine months of the year, overall, we have made continued progress throughout the entire organization, particularly with some new product enhancements that we plan to launch in the fourth quarter. Later in the call, I will go into more detail. But I will now turn the call over to Tim for a detailed financial review of the third quarter. Tim?

Thanks, Bill. For the third quarter, we posted revenue of $6.5 million compared to $5.8 million for the same quarter last year, an increase of 12%. The Wireless segment reported quarterly revenue of $6.3 million compared to $4.7 million last year, an increase of 34%. Our Graphics segment reported quarterly revenue of $242,000 compared to $1.1 million last year. For the third quarter year-to-date, revenue was $18.9 million compared to $17.2 million last year, an increase of 10%. The increase in the Wireless revenue was a result of revenue growth in both the CommSuite voice messaging and SafePath Connected Life Platform as customer adoption rates increased for both product families. During the fourth quarter of 2017, we rolled out CommSuite product enhancements, which has now resulted in four consecutive quarters of revenue growth and the highest number of premium subscribers. We expect modest revenue growth for CommSuite for the rest of 2018. During the third quarter of 2018, revenue from Sprint SafePath Family grew by 30%. We expect revenue growth to continue based on recent and expected Sprint actions, which include continued retail store promotions. These actions are completely dependent on Sprint execution. We continue to support efforts as required. As previously discussed, the Sprint launch is unique in that Sprint has an existing base of subscribers using a similar legacy product. The legacy product was originally due to sunset in the first quarter of 2018, but was subsequently delayed. This change was based on a Sprint operational decision. We continue to work with Sprint on a new sunset date. The decrease in Graphics revenue was in line with our expectations, attributed to the termination of the CLIP STUDIO distribution agreement and lower unit sales of legacy products. We recently launched a new product into our channels and expect additional product launches in the coming quarters. For the third quarter, gross profit was $5.5 million compared to $4.6 million during the same period last year. Gross margin was 85% for the third quarter compared to 80% last year. The increase in gross margin is directly related to the higher Wireless revenue and a mix of Graphics revenue. For the third quarter year-to-date, gross profit was $15.5 million compared to $13.5 million during the same period last year. Gross margin was 82% for the third quarter year-to-date compared to 78% last year. Operating expense for the third quarter was $5.5 million, a decrease of $96,000 or 2% compared to last year. Operating expense for the third quarter year-to-date was $17.4 million, a decrease of $1.2 million or 7% compared to last year. Last quarter, we announced a cost reduction program resulting in modest restructuring expense. This cost reduction program included a reduction of staff and other cost management activities with an expected annual savings of $1 million. We are pleased with the operating expense savings achieved this quarter. We expect our fourth quarter operating expense to be approximately $5.5 million, which excludes any unannounced restructuring plans. The non-GAAP operating income for the third quarter was $380,000 compared to a loss of $710,000 last year. The non-GAAP operating loss for the third quarter year-to-date was $1 million compared to a loss of $3.9 million last year. The non-GAAP net income for the third quarter was $241,000 or $0.01 earnings per share compared to a non-GAAP net loss of $554,000 or $0.04 loss per share last year. The non-GAAP net loss for the third quarter year-to-date was $1 million or $0.05 loss per share compared to a non-GAAP net loss of $2.8 million or $0.21 loss per share last year. Within the recently issued press release, we have provided a reconciliation of our non-GAAP metrics to the most comparable GAAP metric. For the third quarter, the reconciliation includes the following noncash charges: stock compensation expense of $264,000; intangible amortization of $61,000; amortization of debt discount and issuance cost of $66,000; a fair value adjustment of $902,000; and preferred stock dividends of $43,000. For the third quarter year-to-date, the reconciliation includes the following noncash charges: stock compensation expense of $674,000; intangible amortization of $189,000; amortization of debt discount and issuance cost of $197,000; fair value adjustments of $3.1 million; and a preferred stock dividend of $370,000. Due to our cumulative net losses over the past few years, our GAAP task expense is primarily due to foreign income taxes. For non-GAAP purposes, we utilize a 24% tax rate for 2018. The resulting third quarter non-GAAP tax expense was $69,000 and the third quarter year-to-date non-GAAP tax benefit was $348,000. This concludes my financial review. Back to you, Bill.

Thanks, Tim. Let's start off with SafePath, which delivered solid growth during the quarter, contributing approximately $1 million in revenue. These results produced a 30% growth quarter-over-quarter, a truly significant event. I'm sure many of you saw a recent press release we issued prior to Mobile World Congress Americas in September, introducing our new SafePath Connected Life Platform, something I have alluded to on prior calls. I am excited to announce that we plan on delivering the SafePath Connected Life Platform in the fourth quarter. We are serious when we say that we plan on leading the Family Safety market and our SafePath Connected Life Platform will define that market going forward. SafePath reaches beyond just locations, services, parental controls and web filtering to include direct access to a host of digital lifestyle technologies, such as smart home security, wearable devices, pet trackers and connected cars, all under one central hub, white-labeled under the mobile operator's brand. This is unique to the market today. While there are several different devices available that have separate applications, our solution delivers a single-payment glass through which you can view your entire ecosystem. We have already begun building partnerships and expanding this ecosystem with leading consumer IoT providers. As a matter of fact, we will launch our first consumer IoT device under the SafePath banner in the first quarter of 2019. As the market leader, we will continue to accelerate R&D efforts to meet the changing demands of our customers and will enable the delivery of an agile platform to quickly bring on new devices within weeks, not months. It is crucial with the speed of changes happening in the wireless industry that we remain diligent in leading the market by delivering carrier-grade solutions quickly. With the enhanced architecture of the SafePath Connected Life Platform, we also will have the ability to sell both SafePath IoT and SafePath Family either as a bundle or as individual products depending on the customer's timing and needs. There are several new initiatives underway at our largest SafePath customer, Sprint, that will continue to grow the installed base. In the fourth quarter, we are launching a Spanish version of Safe & Found, Sprint's branded SafePath product. Sprint retail stores will run promotional offers to increase sign-ups of new subscribers by sales associates. We will use contest and rewards to drive retail excitement and focus. We also have some digital online marketing campaigns focusing on targeted personas, such as millennial moms, Gen X moms and Hispanic moms, building awareness of the power of Safe & Found in promoting Family Safety. As we drive growth from our Sprint deployment, our vision is even bigger. We are aggressively working to close our next major carrier customer with careful focus on North America. While I cannot share any new details, I believe we are getting closer to our goals. Let's now shift to our CommSuite voice messaging platform, which continues to perform well. We achieved our fourth consecutive quarter of revenue growth and are now at the highest number of paid subscribers we've seen as a company, a solid milestone, and we anticipate continued growth for the remainder of the year. The CommSuite ecosystem provides easy access to your voice-initiated connections, from your cellphone, in your text inbox, and through voice assistants such as Alexa. We are working to expand this base to also include messaging from within your car as well as through third-party messaging apps like WhatsApp. We are actively reengaging with millennials and Gen Z users to make voice messaging function and a paradigm compatible with how they live their lives. Voice messaging is important and relevant, but it needs to morph to meet user needs in the future. We are leading the way in achieving these ends. Smith Micro is putting life back into carrier voice messaging services, while growing revenues for both our carrier customers and ourselves. Just a quick note about our QuickLink IoT product line. As you are aware, we announced our intention in early September to explore strategic alternatives for this product line. Our banker has been working aggressively to divest this technology. We have developed a few options, but have nothing more to report at this time. Moving on to NetWise. Our intelligent connectivity platform remains very relevant to Tier 1 carriers, cable MSOS and MVNOs as end users consume mobile data at unprecedented rates. NetWise enables operators to reduce their cost, while simultaneously enhancing the overall quality of service for mobile users. We have a solid group of great customers who continue to grow their reach and market share. NetWise has a real value in the marketplace. I am pleased with the overall progress that we have made throughout 2018. We have found our way back towards profitability and growth. Both our SafePath Connected Life Platform and our CommSuite voice messaging platform provide us with exciting upside business cases for the future. Our path to sustained profitability and generation of meaningful free cash flow is now clearly defined. Our goal for the fourth quarter is to finish the year strong and enter 2019 with more than enough momentum to maximize the fantastic opportunities ahead of us. With that, I will open the call up for questions. Operator?

[Operator Instructions] The first question comes from Scott Searle with Roth Capital. Please go ahead.

Good afternoon. Thanks for taking my question. Nice quarter. First, a quick housekeeping question related to some financials. Tim, were there any onetime sales events in that $6.5 million figure? And I think you stated this, but in terms of the OpEx going forward, is the $5.5 million, how we should be thinking about 2019 as well going into there as a base level on a quarterly basis?

Hi, Scott. As far as sales events, no onetime sales event activity in the current revenue. And as far as OpEx go, we're at a pretty decent base rate there, and we have talked about the -- our ability to leverage that OpEx as we expect to grow revenues here in the future.

Got you. And moving over to SafePath. Could you give us some idea about what the subscriber base looked like in terms of new subscribers versus converted from location labs? I think, last quarter, you talked about that 50-50. Is that something that held? And looking at the sunset or potential sunset, it sounds like you continue to discuss that. Is there a rough time frame that we should be thinking about sunsetting for the existing location labs space? And also, pricing for SafePath IoP, what - IoT, what would that look like?

Okay. Let me take this. You've got about 3 questions there. Let's talk about the sunset. There is dialogue underway. I really just don't want to say exactly what the plan is. It changed the last time, so I think I'd just rather let it happen and then we'll say it's happened. How's that? I think it's better for all of us. We keep more saying that way. As far as the mix, if you look at the growth, the growth is primarily, quarter-over-quarter, coming from new subscribers. If you look at the overall mix of all the subscribers, it's probably a little bit slanted now towards new subscribers over legacy, but that's the best I can say without having all the numbers right in front of me. I think that's a good indication. As far as pricing for SafePath IoT, that's something that we are working through. It is -- it would be considered a -- an IoT device would be considered a device in a Family plan. That might give you some way to view it. However, there will be, we believe, a lot of SafePath IoT families that were not, prior to that, SafePath Family customers. So they will have a different model to it. I know I'm not being real granular because it's all being worked out, and I don't want to get in front of the process.

Okay. And Bill, if I could, just a follow-up. Since you had thrown it out there earlier, you talked about other carriers and progressing on that front. Is there a time frame? Or how would you handicap that in 2019? And as well on CommSuite, you started to add some new enhanced voice features in terms of Alexa and otherwise. How is that changing the pricing model or what your expectations are for growth? It's been -- you guys have been pretty conservative, I think, and modest in terms of the sequential growth and recovery that we've seen over the last couple of quarters. But does this start to accelerate as we get into 2019? Thanks.

Okay. Let me take the SafePath one first. I think we look at the -- being able to talk about it, our next deal in the first half of next year, that would probably be the most conservative approach to that. Keep in mind that when it's a new deal, there's always startup time, so that might offset a little bit because usually, you can't talk about a new deal until that carrier is ready to start shipping the products. So -- but I think we're looking to close something in the first half. When we will actually be able to announce it will be driven by the launch dynamics of that customer. As far as on the CommSuite side, I think the way to view it is we're adding features and capabilities to CommSuite to enhance the demand for it, and in doing so, we believe we can attract new users that are looking at voice messaging from a little different perspective than some of the users today. But I think, actually, what's maybe the most exciting about it is that we're really talking about a voice messaging platform, and we can now go talk to a lot of carriers who are not our customers right now in the space and talk about what our platform, that has now moved the paradigm forward, what that platform is capable of doing. And I guess the real nice feature from a sales point of view is that if a carrier says, well, fine, but I don't want to drop everything that I have now, can I just get these parts of your platform to add to what I already have, the answer is yes. So that's a conversation that's new and different and something that I know our sales force is pretty excited about.

Great. Thank you. Nice quarter.

Thanks.

[Operator Instructions] The next question comes from Mark Gomes with Pipeline Data. Please go ahead.

Good quarter, guys. So you're looking at Connected Life, you're looking at that to be released in Q4. Is that a little bit earlier on schedule to what you expected? And what has that done, that time frame done to, in terms of carrier discussions around? Are they -- have they been waiting for this in order to move forward with you?

Okay. I'm just thinking about the different parts of your question. I think from a discussion standpoint, first off, we have been able to demo a prototype of this capability to our various sales targets. I think the biggest thing that we can say is this is no longer a prototype, it's real, and it's ready to be deployed. That usually is something that gives a new carrier a lot more confidence. As far as the timing, I think we're pretty close to the timing we had planned on, and I just feel really positive about the quality of the product that I'm seeing coming out. So I think we're well positioned right now.

Okay. And as far as the carrier's response to this relative to wanting this product as opposed to what you're offering today?

Well, a lot of the conversations -- we're having a lot of conversations with carriers who may already have an alternative Family Safety product, but they don't have an answer for consumer IoT. So this is a message point that seems to be working really well. The option is that a carrier can bring on a number of consumer IoT devices all with their own client, so there's sort of a hodgepodge kind of thing, it's not branded to that carrier. And then, through the backdoor, we go back to saying, and oh, by the way, this also can provide all your Family Safety. It's interesting to sell, and it -- we are really in the forefront and it's a way to attack the problem from all sides, I guess, is the way to think it -- about it.

And do you get a sense from your discussion that you're ahead on the IoT development? And how hard is it and how much does your expertise on IoT come into play in having the lead that you have?

Yes, I think we're ahead of the market. Clearly, the fact that for the last -- we have a whole team of engineers in Belgrade, Serbia that had been working on the QuickLink IoT product and working with devices and modules for 10-plus years. That entire team has been moved to SafePath IoT. So this is an incredibly experienced team. They are leveraging a lot of their knowledge. And I think it probably is a good reason that the quality of the product on rev 1 will be so high.

One more question. I'll jump back into the queue. You mentioned a couple of minutes ago, when demoing this product to various sales targets, are these new carriers for you, and you used plural? Or does that include the existing customers that you currently have for SafePath? Thanks.

It would be all of the -- everything that you had talked about. It's existing customers as well as new. And keep in mind that many of the new customers to SafePath are customers we've had relationships with over the years, so that's always been one of the biggest Smith Micro advantages as we're not necessarily an unknown quantity when we walk in, in the door and they have a lot of confidence. So it's all positive, it's all good.

Great. I’ll go back in the queue and come back on line.

The next question comes from Marc Stutman with Trimark. Please go ahead.

Two quick ones. You had mentioned that in Q1 of 2019, the first SafePath IoT device would be released. Is that -- would be yours, or is that a third party?

So no, we don't make the hardware. So no, we're not trying to say that. What we're saying is that the first device that will ship out to the user world and will be powered by the SafePath platform will happen in the first quarter of '19.

Can you tell us what the application is?

No, I can't right now. That would -- that's something that our customer needs to be first to talk about.

Okay. And the next question is regarding CommSuite. You had mentioned that, obviously, carriers have existing voicemail systems. So my question is, which features of CommSuite do they find most attractive that they can add on?

Yes, good question. I mean, I think, first off, the obvious one is working with the voice systems like Alexa and Google Home and things like that. That comes first. The capabilities of interfacing messaging into the car when you're in the car, leveraging capabilities there in a second. Also, I think that the capability of filtering calls by looking at the caller IDs and knowing whether it's a good call or a robocall that the message has left, also maybe identifying that, that the call came from a particular vendor to you, so rather than it's just coming from a number, it's actually coming from your wireless carrier, Verizon or Sprint or whoever. That would be -- all these kinds of things are parts of our platform, but they can be broken out away from the core Visual Voicemail capability.

Okay. So it would be fair to say that this is really -- to interface the third-party devices and providing, let's say, more intelligent filtering of phone calls.

Yes. I mean, I think that's fair. You can look at it that way, just adding more quality to the actual voicemail itself and being able to deliver it to the channel that someone wants to actually get it on. I think that's the key hard part to do. It's very unique.

All right. Thanks.

[Operator Instructions] The next question is a follow-up from Mark Gomes with Pipeline Data. Please go ahead.

Thanks. So on the first consumer device you have coming out, I think I heard you correctly, you -- it sounds like you already have a customer for that product, whatever it might be. Is that correct?

Wait a minute. Say your question again.

When you were answering the previous caller's question, you made mention that you didn't want to discuss in detail what the consumer device was going to be and that there is some, maybe NDA with the customer that you have. So it sounded like you have a customer ready for this already. Is that correct?

That's true. That is correct.

Okay. Okay. Cool. And so maybe this is revisiting an older question, but can you either expound or remind us of what kind of incentive Sprint has to move its location labs, customer base over to Safepath? Obviously, there's been delays in them doing so. What I'm interested in as an investor is whether or not they are having an incentive to do so, whether they want to do so and why?

That's a good question. I think the way to look at is that the legacy platform has been capped. You cannot join the legacy platform. It hasn't been able to pretty much since the day we launched almost a year ago. So this is a platform that's capped out. The only thing that can happen with that platform is that it can get smaller as people leave the service offerings. One of the reasons, I think, for Sprint to move over to -- to get all their people moved over to us is that, number one, we tend to hold our users, they don't churn away, they stay, that we offer a lot more capability and functionality, and that we are upgrading the product and enhancing the product and have done so consistently over the last year and will continue to do so going forward. There is no logical reason to not make the change other than the fact that they have a base of people that are paying them some revenue and they want to make sure that, that revenue doesn't get hit. And I think that we're working through to that with Sprint, and as -- at the point that they feel comfortable, they will make that change.

Great. And then looking more broadly, final question here. Beyond your Visual Voice product, I'm wondering if you have some -- if there are carriers out there that are supporting a product internally through their own internal expenses. How strong of an incentive or how motivated are they to move off from that model and outsource that to you? And then also with the SafePath, a similar question, where there are multiple products sitting out there and some carriers have maybe a small portfolio of similar products, how motivated are they to consolidate around one that can provide everything that they need, like it seems you guys are building? Thanks a lot.

Okay. You guys got to be easier on me doing one question at a time. Anyway, let me take the last one because it's still fresh in my mind. The reason that a carrier wants to use our solution is that all of the consumer IoT devices are then empowered with one user interface. It is branded to the carrier. You're not having to jump between different apps. One defines Susie [ph] and the other defines Fido [ph] or is Johnny [ph] driving the car well, it's all in one place. And so I think that's a big deal to a carrier. They understand that simplifying their solution empowers their solution, and so that's that. Say that...

And the other question was around the Visual Voicemail and whether or not carriers feel a strong incentive to move off of any internal-developed or internal-expensed products and outsource that to you folks as opposed to having a team inside their organization that might do that.

Sure. Well, if you kind of follow the gist of the themes that we're working on, voice messaging is going through a period of change. There are a group of younger users that today aren't really embracing voice messaging because it doesn't work the way they live their lives. We're changing the paradigm. We're developing an answer that can fit all different age groups. And that's something that if you had a Visual Voicemail product, they're probably not investing in and they're probably not going to do what we've just done. We're adding all these more modern interfaces, like using the voice messaging devices like Alexa. So we're moving it all forward, and they don't really have to pay -- if they developed it internally, they would have to have all those people doing all that work to get it done, and it's something we already have. And probably, most importantly, is the model that we take to the street. When we talk to them, we make our money off of rev-sharing value-added services, not charging them for the base product. So if they're employing a whole team to build a product, that's a fixed cost. That makes it a cost center product instead of a profit center product. Our product is profit center.

Great. Thank you very much, guys.

The next question comes from Jon Gruber with Gruber & McBaine. Please go ahead.

Good afternoon. I got on late, so if this question is been asked, I apologize. Where do we stand on a new customer? We've been talking a long time for a new customer, and is -- are we still going to get a new customer by year-end for the service?

Yes, Jon. Yes, we have been talking quite a bit about that. What we answered in the -- in a prior question is that we look to have a new carrier customer sometime in the first half of 2019. Whether we are able to publicly announce it is really probably more tied to when they will launch the service offerings, so that could be the only thing that might change things a little bit. But the good news is that we have a large number of prospects, large number of carriers, that we are having very meaningful discussions with right now and we feel confident that we will get to the goal.

So that -- is that a delay from year-end before?

Well, I guess if it's later than year-end, you're right, and - but it is a positive event in that we think that the customers are there and that they will grow and I think life is fine.

Okay, good. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Charles Messman for any closing remarks.

I just want to thank everyone for joining us today. As you know, if you have any further questions, please feel free to reach out to us directly. I also want to note a couple of calendaring events. We'll be attending a Roth event in New York City on November 14, and we also will be attending the Benchmark event on November 29 in Chicago. So if you happen to be attending either of those events, please sign up to meet with us. Again, thanks for your time today, and we look forward to updating you on our year-end call. Have a great day. Thanks.

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