Smith Micro Software, Inc. (NASDAQ:SMSI) Q3 2023 Earnings Call Transcript

Smith Micro Software, Inc. (NASDAQ:SMSI) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Good day, and welcome to the Smith Micro Third Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Charles Messman, Vice President of Investor Relations and Corporate Development. Please go ahead, sir.

Charles Messman: Thank you, operator, and good afternoon everyone. We appreciate you joining us today to discuss Smith Micro Software’s financial results for the third quarter ended September 30, 2023. By now you should have received a copy of our 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, our Chairman of the Board, President and Chief Executive Officer; and Jim Kempton, our Chief Financial Officer. Please note that some of the information you will hear during today’s discussion consists of forward-looking statements, including without limitations, those regarding the company’s future revenue and profitability, our plans and expectations, new product development, new and expanded market opportunities, future product deployments, migrations and/or growth by new and existing customers, 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 included in our most recently filed Form 10-K and in our subsequent filings on 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 want to point out that in our forthcoming prepared remarks, we will refer to non-specific non-GAAP financial measures. Please refer to our press release disseminated earlier today for a reconciliation of these non-GAAP financial measures. With that said, I’ll turn the call over to Bill.

Bill?

Bill Smith: Okay. Before I kick this off I need to let everybody know I’m in the recovery mode, recovering from a battle with COVID-19. So if I don’t sound like myself it’s probably because I don’t totally feel like myself. But all that said, let’s kick this off. Thanks, Charlie. Good afternoon and thank you for joining us today for our 2023 third quarter conference call. I am excited to provide an update on what I feel has been a very strong quarter for the company, specifically our achieving both operational and financial targets that we previously outlined earlier this year. From a financial perspective, we executed an aggressive plan to significantly lower expenses, improve gross margins, begin to grow our core revenues and achieve non-GAAP profitability while generating cash flow from operations.

During the quarter, we delivered revenue of $11 million, up from the previous quarter and a non-GAAP pretax profit of approximately $700,000. We also produce cash flow from operations of approximately $1.5 million. I am pleased that we achieved these goals during the third quarter. This is a strong testament to our team’s commitment and focus. I also believe that these results really demonstrate the earnings power and potential of the business now that we’re past the significant investment in migration activities that we’ve made over the last two plus years. Speaking of those migration activities with AT&T’s launch of Secure Family on the SafePath platform, during the third quarter, we achieved an important milestone for the company and believe that we are now well positioned for significant growth at this customer.

This has been a tremendous undertaking for Smith Micro and I’m proud of the efforts of our team to get this across the finish line. I am very happy to have these activities behind us as it allows us to fully focus on the future and pivot towards future innovations to advance our core focus of helping to protect families. Later in the call, I will talk about how we are reimaging the vision of digital family lifestyle for 2024 and beyond. To leverage AI and machine learning to better safeguard customers safety and privacy, as well as simplifying SafePath deployments to capture broader segments of the market and new geographic opportunities. But first, let’s turn the call over to Jim to discuss our financials in detail, then I will return and elaborate more on this topic.

Jim?

Jim Kempton: Thanks Bill and good afternoon everyone. Overall, we were really pleased with the results this quarter as we had sequential revenue growth of 6%, improved our gross margins by another 200 basis points over the second quarter, decreased our non-GAAP operating expenses sequentially by $0.5 million dollars and produced a non-GAAP pretax profit of approximately $700,000 for this third quarter. In addition, we produced cash flows from operations of approximately $1.5 million during the quarter. These results align very well with the plan and expectations that we had outlined on our 2022 year-end earnings call back in March. Now let me take a deeper dive into the results for the quarter. For the third quarter, we posted revenue of $11 million compared to $11.7 million for the same quarter of 2022, a decrease of approximately 6% as a result of a decline in revenues in Family Safety and CommSuite.

As I noted in my opening remarks, when compared to the second quarter of 2023, revenue grew by approximately $700,000 or 6%. Year-to-date revenues through September 30, 2023 were $32.3 million versus $37.1 million through the third quarter of last year. The $4.8 million decrease is primarily due to declines in legacy Safe & Found Family Safety revenue related to continued attrition of legacy Sprint subscribers driven by T-Mobile’s acquisition of Sprint coupled with a decline in CommSuite revenues. During the third quarter of 2023, Family Safety revenue decreased by approximately $500,000 or 5% compared to the third quarter of the prior year, primarily as a result of the reduction of Sprint Safe & Found revenue. Family Safety revenues increased by approximately $400,000 compared to the second quarter of 2023.

During the third quarter of 2023, CommSuite revenue was $700,000, which decreased by approximately $300,000 compared to the third quarter of 2022. This decrease is attributable to a decline in DISH revenue coupled with the period-over-period decline in revenue generated from the remaining legacy Sprint deployment, which generated no CommSuite revenue in the third quarter of 2023. Revenue from CommSuite was essentially flat sequentially compared to the second quarter of 2023. ViewSpot revenue was approximately $1.1 million for the third quarter of 2023 which grew by approximately $100,000 compared to the third quarter of prior year and increased by approximately 200,000 compared to the second quarter of 2023. The increase in ViewSpot revenues was primarily due to our new contract with a U.S. mobile virtual network operator, which launched during the third quarter.

I did want to note that in September, one of our ViewSpot customers notified us that they were terminating their ViewSpot contract effective immediately as a result of their cost reduction initiatives. Subsequent to the end of the third quarter, we were also informed by another significant ViewSpot customer that they would not enter into a further extension of our existing ViewSpot contract. The existing contract runs through the end of the year and then we’ll have a transition period of up to six months, during which time we’ll continue to deliver services to that customer. In the fourth quarter of 2023, we are expecting consolidated revenues to decrease by 18% to 23% compared to the third quarter of 2023, when as anticipated, the Verizon Family Safety revenues decline in the fourth quarter as the post termination transition period to that contract concludes.

For the third quarter of 2023, gross profit was $8.5 million compared to $8.1 million during the same period of the prior year due to the period-over-period decline in cost of revenues. Gross margin was 77% for the third quarter compared to 69% in the third quarter of 2022. The gross profit of $8.5 million in the third quarter increased by approximately $800,000 compared to the gross profit produced in the second quarter as a result of the increase in revenues, coupled with an increase in gross margin of approximately 200 basis points. In the fourth quarter of 2023, due to the decline in revenues, we expect gross margins to decrease by 4% to 5% from the gross margin of 77% reported for the third quarter of 2023. For the year-to-date period ended September 30 2023, gross profit was $23.9 million compared to $26.2 million during the corresponding period last year.

Gross margin was 74% for the September 30, 2023 year-to-date period. GAAP operating expenses for the third quarter of 2023 were $10.7 million, a decrease of $5.8 million or 35% compared to the third quarter of 2022. GAAP operating expenses for the year-to-date period ended September 30, 2023 were $36.2 million compared to $50 million in the year-to-date period ended September 30, 2022, a decrease of $13.8 million or 28% compared to last year. Non-GAAP operating expenses for the third quarter of 2023 were $7.7 million compared to $12.8 million in the third quarter of 2022, a decrease of approximately $5.1 million or 40%. Sequentially, non-GAAP operating expenses decreased by approximately $500,000 or 6% from the second quarter of 2023. We expect fourth quarter 2023 non-GAAP operating expenses to be flat to a slight increase of up to 3% compared to the third quarter of 2023.

Non-GAAP operating expense for the year-to-date period through September 30, 2023 was $27.3 million, a decrease of $12.4 million or 31% compared to last year. I would also note that since the cost reduction efforts undertaken in March, our non-GAAP operating expenses have declined by an aggregate $10.6 million in the third and second quarter of this year versus the third and second quarter of last year. This really puts the magnitude of the actions that we’ve been able to execute over the past six months in perspective. The GAAP net loss for the third quarter of 2023 was $5.1 million or $0.08 loss per share compared to a GAAP net loss of $5.8 million or a $0.10 loss per share in the third quarter of 2022. I’m pleased to report that the non-GAAP net income for the third quarter of 2023 was approximately $600,000 or $0.01 income per share compared to a non-GAAP net loss of approximately $4.9 million or a $0.09 loss per share in the third quarter of 2022.

Within today’s press release, we have provided reconciliation of our non-GAAP metrics to the most comparable GAAP metric. For the third quarter of 2023, the reconciliation includes adjustments for intangible asset amortization of $1.5 million, stock compensation expense of $1.3 million, note in stock offering amortization of $1.3 million, changes to derivatives and warrants of $1.5 million and depreciation of approximately $100,000. For the year-to-date period, the non-GAAP reconciliation includes adjustments for intangible asset amortization of $4.4 million, stock compensation expense of $3.3 million, note in stock offering amortization of $5.4 million, changes to derivatives and warrants of approximately $500,000, depreciation of $500,000 and personnel severance and reorganization activity related costs of approximately $1 million.

A software engineer debugging a complex communications infrastructure.

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 non-GAAP purposes, we utilize a 0% tax rate for 2023 and 2022. The resulting non-GAAP tax expense reflects the actual income taxes expense during each period. From a balance sheet perspective, we reported $8 million of cash and cash equivalents as of September 30, 2023. As I mentioned in my opening remarks, during the quarter we generated cash flows from operating activities of $1.5 million. The principal balance remaining on the convertible notes was approximately $4.1 million as of the end of the quarter and I would also note that we had approximately 2 million warrants expire unexercised during the quarter.

This concludes my financial review. Now back to Bill.

Bill Smith: Thanks, Jim for this quarter’s call, I’d like to change things up a little. Moving from our more traditional update to focus a bit more on some of the larger trends we are seeing that affect the family safety market, our vision, and how we see this market evolving. First, though, I’d like to touch on AT&T as I know everyone would like an update on how that is progressing. As you know, Secure Family was launched at the end of August on the SafePath platform. As with any launch of this magnitude, we continue to address migration issues and customers adapting to change by delivering subsequent releases. Overall, new subscribers have provided very positive feedback, which we believe really underscores the growth potential of this product.

We continue to partner with this customer to drive marketing activities to grow the subscribers on the platform. Consistent with prior calls, I can’t speak to the details around our customers specific plans, but I can tell you that I remain very bullish on our prospects for substantial revenue growth related to this customer in the coming quarters. Now, pivoting to the macro Family Safety market, there are some trends that we are observing that are driving our expanded vision that I mentioned in my opening remarks. As we all know, we continue to see an escalation of conflict, chaos, violence all around the world. The dangers are not only limited to the physical world, but also exist online in cases like cyberbullying and exposure to harmful content and bad actors.

A recent Wall Street Journal article cited an increase in teens’ willingness to share their location with their parents, highlighting kids’ increasing concerns for their own protection and safety. Another trend that we have observed is the proliferation of AI-based machine learning models in consumer applications, which are being leveraged to simplify our lives. Additionally, there is a growing demand for consolidated super apps that combine greater functionality within a single platform and unified application. Gartner recently predicted that over the next five years, more than half of the global population will be daily users of such super apps. Our research shows a similar demand for a super app centered around Family Safety. Lastly, service providers continue to look for ways to provide greater value to subscribers while reducing associated operating expenses.

We believe that we are well positioned to capitalize on the market opportunities that these trends are creating. Viewed in aggregate, these factors affirm our strategic focus on family safety and the peace of mind that we offer with our Digital Family Lifestyle solutions. To further align our solutions to address these trends impacting Family Safety, we are excited about some upcoming enhancements to evolve the SafePath platform. In 2024, we’ll introduce SafePath Premium that delivers AI and machine learning driven experiences for users to address the growing risks associated with cyberbullying and other inappropriate content on social media. SafePath Premium will monitor, detect and alert parents about children’s exposure to potentially harmful content, including cyberbullying, self-harm, violence and profanity on popular social media platforms and across multiple languages.

SafePath Premium will also provide expanded physical and location safety features. Our platform will monitor thousands of public safety data feeds to correlate public safety incidents with family members physical locations and provide necessary safety alerts. We are calling this physical safety intelligence. This will also increase consumers use of our solution beyond parenting to protect extended family members and other loved ones safety as well. Now, let’s talk about SafePath Global. SafePath’s robust platform and points of integration into operators infrastructure have created a valuable, differentiable and tightly connected solution for our customers. For some Tier 2 and Tier 3 operators as well as MVNOs, however, their more limited resources can make the fully integrated deployment of SafePath more challenging.

We face similar obstacles in smaller, fragmented markets like Europe, Latin America and others globally. While we believe the demand is there, they may not have the IT resources and other staff to support the integration activities to deploy our Digital Family Lifestyle solutions. To serve these customers and markets, we’re introducing a new alternative global deployment model to allow operators to distribute SafePath with a more rapid time to market and lower dependency on their IT resources. We believe that SafePath Global will accelerate our penetration among Tier 2 and Tier 3 providers worldwide, with particular focus on high ARPU markets in Europe. SafePath Global should also reduce our investment in development resources related to SafePath deployments in these markets, while at the same time expediting our timeline to revenue with these customers.

In summary, the core pillars of our vision for Family Safety include physical safety, which includes location and driving safety, digital safety, including on social media platforms, and data safety, which is safeguarding the individual’s data privacy. As to data privacy, protecting user data is paramount. It’s important to end users and our customers, and it’s important to us. Protecting consumers’ data privacy builds trust between service providers, families and the technologies on which they rely. At Smith Micro, we honor the trust that has been placed in us when we deliver our Family Safety solutions and we provide data securely and only for the purposes entrusted to us. In terms of our business model, we continue to believe that MNOs are the ideal distribution channel for SafePath.

In addition to our long standing MNO relationships, we also recognize that as the primary providers of consumers mobile and broadband connectivity, MNOs are best positioned to serve as trusted gatekeepers and curators of consumers digital lives. Family subscribers remain among the most profitable type of consumer accounts for MNOs, and therefore an integral piece of MNO’s consumer strategy. SafePath offers a proven platform through, which we can serve these customers’ needs while growing brand loyalty and ARPU. With the evolution of our SafePath platform through SafePath Premium and SafePath Global, we believe we are further innovating the digital family safety space to address the trends we’re seeing, which should position us to penetrate additional customers more rapidly, including in new geographic markets, while also driving additional value for our MNO customers and their subscribers.

I can also say with great confidence that this is just the beginning. We have a robust roadmap in place, and we will continue to roll out new features and services to better serve the marketplace. In closing, we look ahead to the remainder of the year and beyond. I am both confident and very excited about the next chapter of our company. Operator, please open the call for questions.

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Q&A Session

Operator: Yes, sir. We will now begin the question-and-answer session. [Operator Instructions] And the first question will come from Scott Searle with ROTH Capital. Please go ahead.

Scott Searle: Good afternoon. Thanks for taking the questions, Bill. I hope you’re feeling better. Maybe just to dive in real quickly on the guidance. Want to understand the sequential decline that you’re expecting in Verizon versus ViewSpot, how big or what’s the magnitude of some of those ViewSpot losses that we should expect sequentially? I think in the case of Verizon, it was supposed to phase out over the course of this quarter, basically have zero revenue contribution once we got into March. Did that happen a little bit quicker? Could you help us just understand the mix there?

Bill Smith: Yes. As far as the Verizon Family Safety contract, we have been informed that the transition services period is going to end at the end of this month, that being November. And so we would expect no material revenue from the contract beyond that. And in terms of the ViewSpot contracts, one of the contracts that we had mentioned, that contract continues till the end of the year, and then there is a transition period of up to 180 days. The other contract was terminated immediately. So we will see no revenue from that contract during the fourth quarter. And that’s several hundred thousand dollars, like roughly somewhere in that range.

Scott Searle: Okay, thank you. That’s helpful. And maybe to follow up, I think there was an expectation you were building a pipeline within Europe, and that it was looking optimistic that you could secure a new contract in that region by the end of the year. I was wondering what your thoughts were on that front. And then just in general, maybe to wrap up the AT&T ramp. I know it’s kind of difficult to give any sort of detailed account, but maybe some broader base comments in terms of where you see that relationship as we get into 2024, how you’re thinking about defining success? And one last one, Jim, on the convert, I want to make sure I understand what we ended the quarter with and what the expectation is to end the year in terms of the outstanding convert? Thanks.

Bill Smith: Do you want to take that last one first, Jim?

Jim Kempton: Sure. I’ll take the last one first. At the end of the quarter, we had approximately $4.1 million in principal remaining on the convert. However, as required under the agreement, we had pre-funded approximately $1.3 million that was included in prepaids. And we would expect the balance of the note to be zero by the end of the year. We expect 1231 [ph] that to completely go away at this point.

Bill Smith: All right, so let’s dive in into Europe first because — I’m sorry I cut you off.

Scott Searle: Oh, no, I apologize. Just to follow up on the interest before moving to Europe, Jim, is the expectation then basically there’ll be no interest expense as we get into the March quarter?

Jim Kempton: Yes, at this point, we’re assuming no interest expense in Q1.

Scott Searle: Great. Thank you.

Bill Smith: Sure. All right, let’s dive into Europe. Yes, we remain very positive and very bullish, and all our expectations remain intact. If anything, they give us hope for even further growth in 2024. So you’ll have to wait until we can publicly state what it’s all about. But I think you should assume that our business relationships are in great shape there. As far as with AT&T…

Scott Searle: Just to clarify before — so is Europe going to be SafePath global, or is some of the existing relationships that are developing or percolating on that front going to be more. I’ll call it SafePath classic.