Smith Micro Software, Inc. (SMSI) Q2 2020 Earnings Report, Transcript and Summary

Good day, and welcome to the Smith Micro Second Quarter 2020 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. 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. We appreciate you joining us today to discuss Smith Micro Software financial results for the second quarter of our 2020 fiscal year ended June 30, 2020. By now, you should have received a copy of the press release with the financial results. If you don't have a copy and would like one, please visit the investor relations section of our Web site 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 limitations, those regarding the company's future revenue and profitability, new product development, 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 including our most recently filed Form 10-K and Form 10-Q. 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. I'd like to point out that in our 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 that said, I'll now turn the call over to Bill. Bill?

Thanks, Charlie. Good afternoon, everyone, and thank you for joining us today for our 2020 second quarter earnings conference call. I hope that all of you are well and safe in these COVID-19 driven times. Overall, I'm glad to report that we're in good shape at Smith Micro and I remain pleased that we continue to be productive and efficient working remotely. From a revenue standpoint, I am pleased to report to the second quarter exceeded the guidance we provided on our last call. It's important to note that we continue to deliver profitable results and we were cash flow positive during the quarter despite a slight sequential decline in revenues. For the quarter, revenues came in at $12.9 million, a 19% increased over the $10.9 million we reported in the second quarter of 2019. Gross profit for the quarter was $11.7 million compared to $9.9 million for the same quarter last year. Non-GAAP net income for the second quarter was $3 million or $0.07 per share. Looking at cash flow, we generated $2.1 million from operations during the quarter. I'd like to address the recurring theme of Smith Micro's expanding investment in R&D over the last several quarters and the near future. We have talked about this on prior calls but I think now is the time to be much more direct. We are aggressively growing our engineering organization even during the COVID driven short-term decline in revenues. We are doing this to ensure that our products are ready to meet the needs of our customers when they are ready to buy. We are presently in pursuit of multiple new carrier customers. Clearly, the R&D investments are focused first on the SafePath platform, followed by ViewSpot and lastly, CommSuite. Speaking about SafePath, many of these new product features are being delivered as a result of the Circle acquisition earlier this year, but many others are being developed as a result of accelerating our roadmap to meet clearly stated prospect maps. All of these prospects are in the late sales stages. We are currently in contract negotiations with a number of these prospects. Our recently announced Telus win was the first in what we believe will be a number of wins for Smith Micro over the next few quarters. We are confident we will convert most, if not all of these prospects, but a failure to invest now would likely result in our losing apps. These future customers include some of the largest names in the carrier world. Some others are more midsize carriers while others are smaller. Collectively, these new accounts should provide Smith Micro with significant revenue growth opportunities in 2021. Later in this call, I will provide more color regarding the progress we've made with our three main products, SafePath, ViewSpot and CommSuite. I will also provide an update on the new customer front, as well as shed some light on our expectations for the third quarter and beyond. Now I'd like to turn the call over to Tim for a more detailed review of the second quarter financial results. Tim?

Thanks Bill. For the second quarter, we posted revenue of $12.9 million compared to $10.9 million for the same quarter last year, an increase of 19%. When compared to the first quarter of this year, revenue was down 3%, which was favorable to the guidance range we provided. For the second quarter year-to-date, revenue was $26.3 million compared to $19.3 million last year, an increase of 36%. The increase in revenues was primarily a result of the SafePath platform revenue growth. During the second quarter of 2020, SafePath increased 95% to $7.3 million compared to the second quarter of last year. Revenue from the SafePath platform decreased 6% sequentially compared to the first quarter of this year. This decrease was within the guidance range we provided. The primary reason for the sequential decrease in revenue is directly related to COVID-19 causing Sprint store closures, and all related marketing initiatives for those stores not to occur. The COVID-19 situation has also caused a reduction in the number of subscribers as unemployment rates have increased. In the coming quarter, based on the current status of the Sprint stores and the current subscriber activity in July, we expect SafePath to be down 2% to 7% compared to the second quarter. This guidance assumes a flat subscriber base equal to the second quarter subscriber exit rate. We remain excited about new SafePath opportunities and are encouraged by progress with T-Mobile, including continued support of the existing Sprint subscriber base. Bill will discuss this further in a few minutes. During the second quarter of 2020, CommSuite revenue was $4.1 million, down 5% compared to the first quarter and down 13% compared to the second quarter of last year. The current quarter decrease was due to the loss of Sprint subscribers within the quarter, offset by an increase in Boost subscribers. Boost is now part of Dish and comprise approximately 25% of the CommSuite revenue in the second quarter. We continue to navigate the Sprint,T-Mobile merger as subscribers now have an option to move from Sprint to T-Mobile network for voice services. Additionally, we are excited to work with Boost to increase the CommSuite subscriber base. Consequently, we expect CommSuite revenues to be flat to down for the third quarter of 2020 compared to the second quarter. Revenue for CommSuite advertising during the second quarter was approximately $200,000, which was less than both the first quarter of this year and the second quarter of last year. The current quarter amount was in line with our expectations. As a reminder, this is a variable revenue stream independent on third party activities. We do expect the third quarter of 2020 comm suite advertising revenue to be between $100,000 and $200,000. ViewSpot revenue was approximately $970,000 for the second quarter of 2020, up 30% compared to the first quarter and down 28% compared to the second quarter of last year. The current quarter results exceeded our expectation due to the greater variable revenue with our tier one U.S customer. Also, during the second quarter, we added a new customer, which contributed to an increase in our ViewSpot revenue base. This is the second new customer to be added in 2020, and we looked forward to additional wins in the coming quarters. As a reminder, we separate ViewSpot revenue into two categories, fixed and variable. The fixed portion of the revenue is related to license fees and is generally recurring component of the revenue. The variable portion of the revenue is related to device and promotional campaigns, which are short burst of activity resulting in revenue, and the volume is less predictable. Based on the current run rates, we expect ViewSpot revenue to be flat in the third quarter compared to the second quarter. Overall, for all the reasons discussed, including the impact COVID-19 is having on store activity, we are expecting third quarter total revenue to be down between 2% and 7% compared to the second quarter of this year. For the second quarter, gross profit was $11.7 million compared to $9.9 million during the same period last year. Gross margin was 90% for the second quarter compared to 91% last year. For the second quarter year-to-date, gross profit was $23.8 million compared to $17.4 million during the same period last year. Gross margin was 91% for the second quarter year-to-date compared to 90% last year. GAAP operating expense for the second quarter was $10.3 million, an increase of $3.3 million or 48% compared to last year. GAAP operating expense for the second quarter year-to-date was $20.5 million, an increase of $6.1 million or 42% compared to last year. Non-GAAP operating expense for the second quarter was $8.6 million, an increase of $2.3 million compared to last year. And non-GAAP operating expense for the second quarter year-to-date was $16.8 million, an increase of $3.7 million compared to last year. The increase in non-GAAP quarterly operating expense is primarily related to an increase of $1.7 million for compensation and employee related expenses as our headcount has increased 34% year-over-year, and an increase of $400,000 for third-party contract development costs. These costs are variable and allow flexibility to increase or decrease the number of engaged resources. As previously discussed and to provide additional comments around operating expenses, we continue to aggressively recruit and hire resources in all of our markets. And currently, expect to add approximately 30 additional employees in the second half of 2020. We will also continue to engage the third-party contract development firm as needed. These additional internal and external costs were and are necessary to complete the SafePath 7 integration, accelerate the SafePath roadmap by adding features and functionality sooner than originally expected and support the pursuit of new customers. We operate in a highly competitive environment and timing of customer opportunities is very critical. We are currently pursuing multiple opportunities to sell our SafePath platform for both family and IoT. Although, there is no guarantee this effort will result in additional revenue, we are optimistic enough to make the investment and pursue the wins. Based on this activity, we expect third quarter non-GAAP operating expenses to increase by approximately $600,000 over the second quarter to $9.2 million. 50% of this increase is related to compensation and employee related costs, and 50% is related to third-party contract development costs. During this time of investment, we expect to remain profitable and cash flow positive. The non-GAAP net income for the second quarter was $3 million or $0.07 diluted earnings per share compared to a non-GAAP net income of $3.6 million or $0.10 earnings per share last year. The non-GAAP net income for the second quarter year-to-date was $7.1 million or $0.17 diluted earnings per share compared to a non-GAAP net income of $4.3 million or $0.13 earnings 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 second quarter, the reconciliation includes the following adjustments; stock compensation expense of $808,000 and intangible amortization of $849,000, all of which are non-cash. For the second quarter year-to-date, the reconciliation includes the following adjustments; stock compensation expense of $1.4 million, intangible amortization of $1.4 million and acquisition costs of $918,000, some of which are non-cash. Due to our cumulative net losses over the past few years, our GAAP tax expense is primarily due to certain state and foreign income taxes. For the non-GAAP purposes, we utilize a zero percent tax rate for 2020 and 2019. The resulting non-GAAP tax expense reflects the actual income taxes expensed during each period. To wrap up my financial review, I will add some comments around capital. We closed the second quarter of 2020 with $23.6 million of cash. During the quarter, we generated $2.1 million of cash flow from operations and received $2.2 million of cash from warrant exercises, resulting in $3.7 million warrants still outstanding. In the short-term, we will continue to invest the excess cash balance to preserve capital. In the mid to long term, the company will continue to evaluate strategic alternatives for utilization of capital to maximize shareholder return. This concludes my financial review. Now, back to you Bill.

Thanks Tim. Now let's discuss some of the key product milestones we achieved during the second quarter. As Tim just discussed, we have been investing heavily in R&D recently to drive continued improvement and expansion of product functionality. ViewSpot, our smart retail platform, is a perfect example of this investment. Recently, we announced some exciting new features for ViewSpot that we see as incredibly relevant and useful in today's retail environment. As we all know, the COVID-19 pandemic has caused a rapid shift in consumer sentiment regarding health and safety. Many consider shopping in traditional brick and mortar retail stores to be risky. To help wireless carriers adapt to shifting consumer expectations, our patent pending technology enables touch free interactions with demo devices in wireless retail stores to help minimize physical contact and e-shopper concerns about contamination. Touch free interaction is accomplished by using the embedded components on smartphones and tablets to detect a human face, either with or without a face covering. Once a device detects the human face, ViewSpot launched on-device demo experience automatically, eliminating the need for human touch on the device. To complement this new touchless component of ViewSpot, we also integrated dynamic sanitization notifications into the Attract Loop running on in-store demo devices. When enabled, these onscreen notifications notify shoppers that a device has been sanitized by a retail associate. Once the ViewSpot powered device is touched, the notification will disappear unless we've manually reset by an associate once the device is clean and sanitized. This is a simple yet powerful tool developed in response to our new normal. We have received very positive feedback from existing ViewSpot customers, as well as prospects and we’ll continue to explore new ways to extend the platform’s touchless feature set. Continuing on the R&D theme, we also completed our self service management toolset for ViewSpot during the second quarter, called ViewSpot Studio. This new platform tool makes it much easier for wireless carriers to create and deploy content for in store demo devices. As I discussed on last quarter's call, ViewSpot Studio greatly expands the total addressable market of the platform, particularly in the European marketplace. Moving on to ViewSpot customer news, I am excited to report that we began deploying ViewSpot and another North American wireless carrier during the second quarter. While the beginning of the launch was pushed back slightly because of the pandemic, I am happy to see the continued growth and diversification of our ViewSpot client base. This deployment is our first with the prepaid wireless brand and we have been very pleased to see the roll out of ViewSpot at a large number of stores. Looking forward, we continue to develop new features for ViewSpot to increase market demand. In addition to the new features I've already mentioned, we also made good progress on the platform’s integration capabilities during the second quarter. With these improvements, ViewSpot will integrate more seamlessly to other digital signage platforms that power electronic shelf labels, further broadening the market opportunities. CommSuite, our mainstay voice messaging solution, continues to generate profitable result for Smith Micro. While CommSuite revenues continue to trend slightly down and there remains several unknowns as we navigate the Sprint, T-Mobile merger, the platform remains key to our business. Overall, I am pleased with the progress our team has made in migrating existing visual voicemail customers over to both T-Mobile and Dish. As Dish’s acquisition of Boost Mobile was only recently finalized on July 1st, we are still in the beginning stages of this migration effort and see good opportunities as Dish begins to roll out its mobile services. I look forward to providing everyone with more updates on the CommSuite front on our next call in the fall. Now let's look at SafePath. We're excited to announce the launch of our SafePath IoT solution at Telus last month, named Telus Track+, the new service will enable Telus subscribers to track pets, luggage, bikes and other valuables. Telus is the first Canadian carrier to launch our SafePath platform. We are hopeful that this deployment will serve as a springboard for further expansion of SafePath with Telus. As I discussed before, the modular architecture of SafePath enables us easily expand the offering once it's installed at a wireless carrier. The subscriber value and revenue potential of a SafePath based solution will only grow as the carrier implements additional modules, whether it's supporting another IoT use case or launching SafePath Family or SafePath Home. It's easy for us to ramp these deployments once the relationship is established. Several integration efforts are underway to continue the expansion of capabilities and customer base of SafePath. These endeavors will broaden the amount and type of connected devices that states that have IoT cansupport. For example, we are currently expanding our platform to bring to market a wearable location device in the coming months. Currently, there are several devices that are well entrenched that we expect to support. With regards to the ongoing integration efforts directly related to the Circle acquisition, our engineering teams have been hard at work integrating the two core basis into an overall solution. The finish line is insight and we are pleased we will be able to demo the new SafePath 7 the end of the summer. Once the integration is complete, SafePath Family will be the most complete white label offering of its kind on the market, and our connected home offering SafePath Home will be available on the platform as well. Planning efforts for the launch of SafePath 7 at both T-Mobile and Sky, the acquired customers for the Circle acquisition, are moving along nicely. While the T-Mobile, Sprint merger complicated by the impacts of COVID-19 are having an impact on our ability to move the new T-Mobile to SafePath before the holiday season begins, we remain focused on transition and contract consolidations. We think the process is progressing well and look for early 2021 implementation. In addition to significant SafePath integration efforts, we have also developed several new platform features that we’ll debut with the launch of SafePath Version 7 in the near future. These features are critical as they tie directly to the customer opportunities we are pursuing. Overall, this has been a very large undertaking for the company and timing is extremely important. I couldn't be proud of the progress our team has made on SafePath over the past few months. It has truly been all hands on deck. Watch for official announcement regarding to SafePath 7 very soon. To summarize today's call, we're purposely investing in the future of Smith Micro. And yes, we are really so thoughtfully, even though revenues are declining in the short-term, driven by the effects of COVID-19. Again, we are doing this to ensure that products are ready to meet the needs of both our current customers and our sales prospects who want to become our customers going forward. As I stated earlier, we are in an enviable position of having many prospects desiring to purchase our products now. These efforts are all in late sales stages, which will allow us to announce new customer wins in the next few quarters, all resulting in significant revenue growth opportunities in 2021. But this will only be possible if we invest now to enrich our products to include the features these customers are seeking. Smith Micro is in a great position for increased revenue and profitability. I am very excited with the road ahead in spite of the COVID created challenges. And I have every conference that our team is prepared to complete the task at hand. Operator at this time, I’d like to open the call for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] [Operator Instructions] The first question today comes from Scott Searle of Roth Capital.

Good afternoon. Thanks for taking my question. Nice job guys in a difficult operating environment. Tim, just quickly I want to make sure I heard a couple of numbers correctly. The CommSuite ad revenue in the second quarter. Could you just tell us that figure again? And then as it related to the Boost comment around 25% of sales. Was that specific to ViewSpot, or is that for overall revenues? And then I have a couple of questions around SafePath.

The CommSuite ad revenue was about $200,000 in the quarter. And the revenue -- the comment that I made about Boost had to do with CommSuite, not ViewSpot. And I was indicating that about 25% of the CommSuite revenue, $4.1 million in the quarter, was related to Boost.

And you know if I could on the SafePath front, it sounds like the integration with Circle is on track. I want to make sure that just to follow-up on that and clarify if the integration is expected to be completed still by the end of the current September quarter. And as it relates to some of the incremental investment, I'm wondering if you could provide a little bit more color around what that exactly means? You have been investing and expanding the ecosystem. But what are some of those feature sets? You've got pets and other devices today, but are you starting to bring health applications in auto? What should we be looking for as part of SafePath 7.0?

I think first off, yes, we are very comfortable that we will have the SafePath 7 completed by the end of this quarter. We will be then really start focusing on customer and implementations, which will rollout over the coming quarters. The way to view it is we talked about the fact that we will be adding a new consumer IoT support for a wearable device. We talked about a number of other feature enhancements that are being asked for by various carriers. Because none of this is announced yet, I really don't want to get into exactly what they are. Just I will say these were features that were on our roadmap, they have been accelerated substantially, to have them ready for launch with SafePath 7 and they represent a very significant undertaking. So they will expand the feature set, they will expand the total addressable market.

And if I could follow up just in terms of the Sprint, T-Mobile integration and progress on the front, sounds like you're increasingly optimistic that something is going to happen on the T-Mobile front. Could you -- I just want to want to clarify what that timeframe looks like? It sounded like you said you expected some positive event later this year, but start to see subscriber growth and contribution next year. Is that correct?

What we said was that the combination, this is a major merger effort I know for everybody involved. And then you compound that with the effects of COVID, it just makes it that much more difficult. I think we had hoped that we could get T-Mobile up on SafePath 7 for the holiday season. It just seems that that might be a bridge too far that we're more likely looking at a launch after the first of the year. I think that's fine. I think everything's is going to be fine. I think that we have some really neat things that we will be a little offered to the T mobile customers that are coming from the circle platform in the past and we'll be able to offer some really nice upgrades for the Sprint customers that will be coming from SafePath.

And lastly, if I could, just I know this is looking out further on the horizon. But given the feature sets and investments and how you're accelerating things forward, and it sounds like there are a number of relationships that are getting lower in the opportunity funnel, if you will. How should we’d be thinking about 2021 and SafePath, not only from a diversification standpoint but how should we be thinking about that opportunity or that TAM as we go into 2021? Seems like you’re going to be working with multiple operators. I’m now sure if there's a number that you're willing to sign up to at this point in time, or diversification away from that Sprint base to give us some more color as we're looking into 2021. Thanks.

I mean, clearly it is a number of operators. They are around the world heavy focused on the Americans, and Europe and the Middle East. I would say that we think that the growth of SafePath will be profound and it will be the lead engine. But I also would say that our other two products with ViewSpot, I think you’ll see a number of wins there and then you’ll see continued growth, especially at Dish on the CommSuite front. So feel very bullish about where we're headed in 2021 and beyond.

The next question comes from Josh Nichols of B. Riley. Please go ahead.

I guess could you provide a little bit of color as far as what you've seen for subscriber trends from like the beginning of the pandemic in late March early April to July? And have you seen now like a leveling out of churn where we are today?

So I think, Josh, the way to view it is that we saw a drop off in number of subs right after the start of the pandemic and the closing of the stores and then the closing of the merger. And there was just a cascading number of events that happened. I think by the end of the quarter, we've seen things level out. And I think if we look at where we'd like to be for the next quarter or so is this kind of same level. In other words, be able to grow back the user base from the standpoint of the trial platform and that then being able to cover any churn that might happen at all and keep us in a kind of a flat mode.

And then I guess let's say that you would have finalized new agreement with T-Mobile late this year or something that would ramp up in early 2021. Is it fair to assume that that's one of that that starts to see like a fairly quick ramp in SafePath users again shortly thereafter, or would there be a little bit of a ramp up period? How should we think about that in 2021?

I would say that we see a great opportunity for growth at the new T-Mobile once the product is launched. We still will have to deal with whether stores are generally open or not, and we'll have to deal with that issue. We have been building out and refining a lot of our digital marketing campaign efforts and we think that that is an area of growth for us going forward. So that even if the stores can't fully reopen or be fully functioning, we can still continue to really grow this user base. I would say that there's a great pent up demand and we think that we’re going to have a really great product and we're looking for some really good growth throughout 2021.

So then, clearly, you're pretty optimistic about the future and securing some new carriers on multiple fronts. Outside of the clear T-Mobile opportunity that most people on the call are aware of. Could you help frame the size in some of these potential customer opportunities that you're in late stage negotiations with, I mean, compared to the company's current revenue base?

Yes, I would say to you that as I said in my prepared comments that this list of new customers includes some of the biggest names in the carrier world. These are substantial opportunities feathered in with that then with the other wins, which would be more midsize carriers and there will be some smaller ones as well. But collectively, when all this is said and done and launched in public hand, you're going to see a very nice and and broadened customer base that will reduce risk from an investment standpoint. Yet, also provide us with a upside opportunity through which we can really look to grow our revenues and profitability going forward. This is a very exciting time and these things don’t happen a lot in one's career. I am glad I’m here to experience the things, this is going to be a lot of fun.

I look forward to the future announcements. And then just on the hiring front, I get the need to invest ahead with the revenue growth. But as far as the trajectory of the hiring, you're looking at OpEx going up to $600,000 quarter-over-quarter in 3Q. Is most of the hiring going to be a little bit more like 3Q related, or are you going to see a similar increase in the fourth quarter regarding OpEx expenses?

Josh, I would expect most of it to occur in the third quarter as I've got it.

And then last question just housekeeping. What did you say the SafePath revenue was for the quarter?

7.3.

[Operator Instructions] The next question comes from Jim McIlree of Bradley Woods.

Tim, you talked about contract costs the delta in Q2 and Q3. can you tell us what the level of contract costs are Q2?

We're going to nearly double the contract costs in 3Q versus 2Q. So we're growing them by about $300,000 is what I guided. So that's nearly double of what we're -- that's going to be double what the rate was in 2Q.

But were contract costs de minimis in Q1? What I'm really trying to get at, when I just get [Multiple Speakers] what I'm trying to get at is what happens [Multiple Speakers]. So what happens at…

They didn't exist in Q1, they were about $300,000, $400,000 in Q2 and we're going to add $300,000 in Q3.

And what I'm really trying to get at is what happens after these projects are completed? Do these costs get distributed elsewhere, or do they go away completely? So what happens after these projects are done?

Yes, I see the third quarter is being a high watermark for us, Jim. And then I see those costs coming down in the fourth quarter being offset by hiring that we talked about and then a leveling off to the best that I can see right now, leveling off. We might always have some of those contract costs out there, they're a nice lever that we can pull from when we need it. We'll guide on 2021 later. But I see -- that's how I see the third and fourth quarter playing out.

And let me add maybe a little color to that. And that is that, clearly, we're seeing that the products that we're building are in high demand. And we expect, as we continue to rollout with the new customers that I've been talking about that that probably will drive others to take a good look at what we have to offer. So we don't see this as a onetime event. This is -- I think we're on a growth trajectory and we just have to stay very vigilant and making sure that our product is a market leader, and it is the best product out there, that's what this is all about.

So the features that you're developing for the new customers, if for some reason the new customers decide not to sign up. Are those features relevant, or excuse me, are those features reserved for those new customers, or they're freely available to offer to anybody out there if those features…

They're freely available for all customers.

And as far as the Circle current subscribers concerned, I want to make sure I understand. Are they under the current contract, are they enabled to use the SafePath 7 features, or only if the contract is renegotiated, do they have access to the SafePath 7 features?

They have access to the original circle features under the contract, and any extensions that come with SafePath 7 would require a enhanced contract coverage.

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

Thank you everybody for joining today. Watch that we’re doing couple of virtual conferences, so maybe we'll get a chance to talk to you in the future. If you have questions or comments, please feel free to reach out to us here. And wishing everyone to be safe as we go forward, thanks for taking the time today. Have a great day.

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