Phunware, Inc. Q1 FY2023 Earnings Call

Good afternoon, ladies and gentlemen, and welcome to Phunware's First Quarter 2023 Investor Conference Call. Joining me today are Russ Buyse, Chief Executive Officer; Randall Crowder, Chief Operating Officer; and Matt Aune, Chief Financial Officer. The format today will include prepared remarks by Russ, Matt and Randall, followed by a question-and-answer session. As a reminder, today's discussion will include forward-looking statements. These forward-looking statements reflect current views as of today and are based on various assumptions that are subject to risks and uncertainties disclosed in the Risk Factors section of our SEC filings. Actual results may differ materially, and undue reliance should not be placed on them. Additionally, the matters being discussed today may include non-GAAP financial measures. Reconciliation of GAAP to non-GAAP financial information is set forth in the earnings press release, which is available on the Investor Relations section on Phunware’s website at investors.phunware.com. I further encourage you to visit investors.phunware.com to access not only the earnings press release, but also the current investor presentation, SEC filings and additional collateral. At this time, I would like to turn things over to Phunware’s CEO, Russ Buyse. Sir, you may proceed.

Thank you very much, and welcome to our first quarter of 2023 investor conference call. Contextual engagement, how to interact with users where they are, when they are to enhance their experience and reach them in a potential buying moment. That is what Phunware is all about. We bring contextual engagement to brands trying to achieve just that. We made huge strides in Q1 in realizing this purpose. Starting with the product platform, we progressed both our mapping and engagement SDKs, which form the foundation for contextual engagement. We updated our SmartApp module, which underpins our industry solutions and creates a consumer-grade experience for our customers. And we updated our healthcare industry solution, our offering to enable healthcare providers to provide exceptional patient experience. We also launched our Experience Optimizer, which streamlines the patient experience across different hospital buildings and curates unique experiences for sub-brands of large hospitality companies, all without requiring the download or management of multiple mobile applications. This flexibility is a boon to brands and users alike. And while we're talking about product progress, the U.S. Patent Office has awarded Phunware a patent for geofence event prediction technology, a technical innovation that uses machine learning to predict what experiences will matter most to users based on their location, preferences and previous activity. All of these advances serve to enhance brands' ability to delight their users with a more compelling experience and underscore the tremendous progress we've made as a company. On the customer front, Phunware finished its deployment with Gaylord Hotels by Marriott, the Opryland, Texan, Rockies, Palms and national properties are now fully operational. Our deployment teams finished this rollout both under budget and ahead of schedule. VHC Health also expanded their engagement with us, adding 250,000 square feet with their outpatient pavilion and a parking system integration debut. We have several large opportunities at a late stage in the pipeline that we hope to announce soon. The current selling environment is pretty challenging with rising interest rates and nervousness around where the economy is headed, which has delayed decision-making with some prospects. Fortunately, we've been unaffected by the stresses seen on regional banks over the past quarter. I'm also delighted to tell you, Phunware has joined the Siemens Connect ecosystem, a network that brings together experts in software development, IT, cybersecurity, remote and digital services and business intelligence. This partnership brings the power of our Blue Dot wayfinding technology to optimize smart buildings. Our smart workplace and multi-dwelling unit solutions integrate seamlessly with Siemens platforms, including building management systems, the Apigee automation system and related platforms. We look forward to working closely with Siemens and other Connect ecosystems network experts to deliver exceptional experiences to our customers as they journey towards smarter buildings and infrastructure. We see partners as an efficient and effective way to broaden our reach to target customers across markets, and we will be enlisting more of them to complement our direct sales force. We are also strengthening our marketing effort and investments to drive more customer awareness, including publishing more thought leadership content and ROI studies, demonstrating the opportunity and imperative of adopting our industry solutions to reduce costs, gain efficiency and increase revenue. On the blockchain side, we continue to work on fund coin and fun token to facilitate the marketplace between brands and consumers, where brands can reward consumers for the right to engage them. As I mentioned last quarter, we're taking a slow and steady approach on this, given the current crypto winter and continuing regulatory headwinds. This privacy-preserving and fully compliant offering will include ads and offers to help brands reach audiences they want, and it will complement our industry solutions to give our customers greater power to reach their existing and prospective users. On the hardware side, our light business unit faced the same headwinds affecting the whole PC market in Q1. However, we managed to outperform the industry averages while maintaining discipline on customer acquisition and materials costs. And now our CFO, Matt Aune, will cover our financial performance.

Thanks, Russ, and good afternoon, everyone. I'd like to thank you all for joining us today for a review of our first quarter 2023 financial performance and our progress on key strategic initiatives. For clarity, I'll be discussing GAAP financial measures, unless otherwise specifically noted. Our press release, 8-K and website provide a reconciliation of all GAAP to non-GAAP financial results. Net revenues for the first quarter of 2023 totaled $4.7 million, of which our platform revenue represented 28% of net revenues or $1.3 million. Our hardware revenue, or light business unit, represented 72% of net revenues totaling $3.4 million. Gross margin was 7.6% compared to 26.1% last year. On a non-GAAP adjusted basis, gross margin was 12.9% compared to 26.8% last year. Platform gross margin was 5.5% compared to 57.2% last year. On a non-GAAP adjusted basis, platform gross margin was 23.4% compared to 58.9% last year. The cause for the year-over-year drop can be primarily attributable to a mismatch of cost of goods sold and the revenue associated with it. As previously mentioned, we are extremely excited to have completed the Gaylord deployment in Q1. However, GAAP revenue recognition for this project requires that the revenue will be taken over the 5-year life of the contract, which means all the costs associated with deploying the multiple locations in Q1 are not offset by revenue in Q1. If we were able to match the revenue, our non-GAAP gross margin for software would be much closer to last year. This will happen from time to time as we continue to build up a bigger base of SaaS revenue that ultimately will be able to absorb the shift in margins from a single project during the quarter. Our hardware business life by Phunware continued to show operational improvement by trimming the business unit's adjusted EBITDA loss by 46% quarter-over-quarter with a target of reaching profitability in the next 1 to 2 quarters. Total operating expense was $7.6 million, up from $6.8 million last year. Other noncash operating expense items were stock-based compensation and amortization of intangibles, making it a combined $1.3 million this year compared to $0.7 million in the prior year. By excluding these noncash charges, adjusted operating expense was $6.3 million compared to $6.1 million last year. We are pleased to see that our non-GAAP operating expense dropped quarter-over-quarter for the third consecutive quarter. Non-GAAP adjusted EBITDA loss was $5.6 million compared to $4.2 million last year. Adjusted EBITDA loss was narrowed for the second consecutive quarter as we continue on the path to breakeven. We still have a ways to go to get to breakeven, but we are committed to showing improvement in this metric and look forward to sharing long-term breakeven plans in the future. Net loss was $4.3 million or $0.04 per share compared to $14.9 million net loss or $0.15 per share last year. Weighted average shares used to calculate earnings per share were $103.2 million versus $96.8 million last year. Backlog and deferred revenue at the end of the quarter totaled $5.7 million. As Russ mentioned, we have several large deals at a late stage in the pipeline and expect the Q1 backlog and deferred revenue number to be a low point for the year. Moving to the balance sheet, we closed the quarter with $0.7 million in cash and $5.7 million in debt. We currently hold approximately $2.8 million of cash and digital assets based on today's prices. We are actively evaluating various debt and equity options to fund operations as we continue to push towards cash neutrality. We will remain active with both financial conferences and investor meetings and our efforts to tell our story and further strengthen our corporate profile in the capital markets. The next major financial conference we will be attending is the 18th Annual Needham Technology and Media Conference May 16 through 18 and the 2023 Cancer Fitzgerald Tech Conference on June 14 through 15. We look forward to many one-on-one conversations and meetings with high-class institutional investors at those events and other financial conferences as opportunities present themselves. With that, I would like to turn the call over to Randall.

Thanks, Matt. During the quarter, we took great strides to streamline how we price, contract and bundle our core offerings. For a simple annual license, any enterprise can launch a branded mobile application that is configurable, scalable and capable of any number of integrations with third-party point solutions to include our own best-in-class location-based services that deliver real-time blue dot and advanced wayfinding. We can now take care of everything from any required hardware to professional services to maintenance, so our customers are only responsible for a straightforward software license. This is actually an important change that has been very well received by our prospects. In the past, we sold like a custom development shop that resulted in overly complicated contracts and sometimes sticker shock, but now we are offering simplified SaaS pricing, which we believe will drastically improve our sales cycle and close rate. Enterprise customers don't need to settle for low-code templated apps that will not scale and are limited in features and functionality. They can now launch an enterprise-grade mobile application on our proven platform for less than $5,000 a month. Our platform approach is important because our customers benefit from all the product improvements we are making. For example, we successfully tested our configurable location-based services solution at Gaylord Opryland Resort and Convention Center in Nashville. This is something that many vendors have tried but failed to deliver and is considered somewhat of a unicorn in the conference industry. However, Phunware has made the impossible possible. Our platform can finally help event attendees optimize their time and route to the right exhibits while giving organizers the ability to personalize attendee engagement. Conference organizers and venues can seamlessly reconfigure convention center space, and our routes will adjust to account for any new layouts without additional hardware or fingerprinting. We are thrilled to be working closely with several strategic partners who will be reviewing our solution live next month. These partners are able to open significant doors across the hospitality industry, both locally and abroad. Speaking of conferences, we were thrilled to partner with TD Senex at HIMS in Chicago this year and showcase our digital front door to numerous healthcare prospects. We also made great connections at Vive in Nashville and next month will be at Vitec in Las Vegas for casino resorts as well as High-Tech in Toronto, which remains the premier hospitality conference each year where we'll be showcasing our amazing work for Atlanta Tahamas and Gaylord Hotels by Marriott. Regarding blockchain, we are still on track to issue approximately 25% of Fun coin's maximum supply to securitize this summer with regulated trading to follow thereafter. At this time, we are working to ensure all rightful holders have been notified and given time to properly set up their accounts. With the successful test to fund blocks via fun wallet, we are also looking at new ways to drive fun token utility and leverage its functionality within third-party applications. Switching gears to light, we are excited to announce our new workstation line will be available this summer as well, which will increase the size of our serviceable market and take advantage of our growing brand awareness despite headwinds in the industry due to macroeconomic trends. For closing remarks, I'd like to turn things back over to Russ.

Thanks, Randall. To conclude, I am very happy with the progress we've made this past quarter and the changes we've made to extend our reach and deepen our contacts with customers in our target markets. You can expect more developments on these fronts from us going forward as we invest more time and energy into sales and marketing. We're all about market growth, meeting customer needs with our market-leading solution focused on contextual engagement. Expect to see bookings growth and spending discipline to control our operating expenses. At the same time, our strategic transactions committee is actively looking for opportunities to grow the business through inorganic transactions. And one last thing; we are no longer using the term multiscreen as a service or MAS as it fails to capture the range and significance of the investments we've made in our software platform. We call it our location-based platform, which is about more than just a screen and whose capabilities any enterprise can activate almost immediately. We deliver everything you need to engage anyone anywhere in a mobile-first world where context matters. I would like to open up the call now for questions to the operator. Operator, please go ahead.

Thank you. At this time, we will be conducting a question-and-answer session. Our first question is coming from Darren Aftahi with ROTH MKM.

Two, if I may. On your pipeline, can you characterize, I guess, one, how that's changed in the last 90 days? And maybe what verticals those deals are in right now? Sorry, go ahead.

So I was just going to say that it's good to hear your voice again. And how things have changed over the last quarter as we see more opportunities join the pipeline and the ones that were kind of in middle stages are now in later stages. The two verticals that we see the most activity in are hospitality and our healthcare, which are two favorites.

Great. And then that kind of leads to my second question. Given the inroads you've made in hospitality and all the buzz around generative AI, I'm just wondering, is there any sort of roadmap in terms of integrating that into your platform just in terms of opportunity to provide clients with maybe more revenue opportunity or lift over time?

Well, AI is something we're certainly keeping an eye on, especially as large language models have emerged with very naturalistic writing and speaking. We're just looking for opportunities to plug it in where it makes sense for us. We are about contextual engagement, which is reaching those consumers where they are and when they are. There may be an application in the way that we offer essentially writing that will allow them to reach those customers. We're still looking at that.

Great. Maybe one last one for Matt. Just your comments about the mismatch on revenue and deals and costs when you called out Gaylord. But is there any way to smooth that out? Or is that just a function of GAAP accounting and a broader landscape with growth?

Yes. I mean, it is more or less a function of GAAP accounting. Certainly, over time, as we're able to deploy quicker with fewer resources, there won't be as much of that upfront work. As I mentioned on the call, we need to build up a bigger base. So if there's one customer happening last quarter, it had a pretty significant impact on the margins, whereas next year, if something like that happens, it might only change margins by two or three points. It's a matter of we need to grow that base more. And as we mature more, these deployments will get faster and faster. Gaylord was already fast, but still there was a significant amount of work just going to the five different sites. We should see that improve over time; it's just nothing that we can do in the short term due to GAAP accounting rules.

Our next question is coming from Scott Buck with H.C. Wainwright.

I'm curious, could you give us just a little bit of color on what expectations are in terms of scaling up the partnership with Siemens and maybe when we could expect to see some incremental revenue from that partner?

Well, we're sort of hot off the presses in announcing that Siemens partnership. There's a period of kind of ramping up to get that partnership going and doing the cross-training, but we do expect to see deals enter the pipeline within a quarter or so that will be related, especially to the smart workplaces, with Siemens' strength here. It's going to be a function of Siemens working on their set of opportunities themselves. But I expect to see concrete business that we do directly out of that partnership within a quarter or two.

Great. That's helpful, Russ. And then on the hardware business, it looks like revenue is down kind of 20% year-over-year. Is that just the macro environment with people cutting back on discretionary spending? Or is there something else going on there? And as a follow-up, I seem to remember you guys were going to put out some new products there in the pipeline. What's the status of those?

Yes. Thanks for asking. The entire PC market, including Macs, is actually down significantly in Q1. The PC group was basically down almost 30%, and Apple, their Mac sales were down 40%. So we actually were tracking 10 points ahead of the cohort in the PC space. We focused on cost discipline around customer acquisition costs and make sure that we stay in line with our build costs as well. We're tracking ahead of plan. If we had a normal market, I think we would be seeing greater revenue out of that as well as better bottom line results. For the hardware unit, we are expecting to introduce the workstation lines this quarter. This will give us offerings aimed at power business users, and it's a good complement to the gamer market that we already serve.

Great. That's helpful. And then last one for me. Just on operating expenses, you guys have done a nice job of reeling that in versus the last few quarters. Curious if you have additional levers there to pull or what we're looking at this quarter as the expected run rate here for the rest of the year?

Yes, Matt, I'll let you talk about that one.

Yes, sure. We're constantly evaluating our operating expenses. As I said on the call, we've had a couple of consecutive quarters of reductions, and we anticipate Q2 will also see a reduction. The majority of our OpEx is related to headcount. We are evaluating the headcount and making sure we're right-sized for the number of deals we have. We have made a few adjustments towards the end of last quarter that you won't see the impact of until Q2. I think there will be some savings there. We'll continue to evaluate going forward and ensure that our staff aligns with our growth needs. It's going to be a slow process. I don't see us dropping $1 million or $2 million in OpEx in a single quarter, but it's a process of continually evaluating and managing those expenses quarter-over-quarter.

Great. Appreciate that, guys. Thank you very much.

Thank you.

Our next question is coming from Howard Halpern with Taglich Brothers.

With the pivot toward a much more SaaS-based model, are you seeing less hesitation by customers in deploying a fund? But with your business model now and your pipeline, are they really committed to moving forward with projects?

Yes, they are committed. What we've done, which is simplifying the pricing for them, has taken fewer variables for them to consider. We previously had broken out all the costs around fulfillment and beacons around location-based services, everything was kind of unbundled. We rebundled it together, making it easier for them to understand and easier for them to say yes. As you heard Randall talk about earlier, we also lowered the floor, if you will. So now we have a bundle where customers could get started for as little as $5,000 a month. This gives us more range and variability in terms of the packaging we can offer. It doesn't affect the margins or the size of opportunities at the enterprise end; it really opens the middle and lower end more.

Okay. And in terms of your partners, I know you just announced Siemens, but prior announcements, are most of those fully up and running and bringing in leads?

We have a few that are up and running like that, and we are working on more partnerships where we expect to broaden this, especially in markets where we don't have a direct sales effort. It's not exclusive to that. As mentioned with Siemens, they're doing a lot of work on building and constructing smart workplaces for the future. We have a specific outbound focus from within Phunware. We're looking for those kinds of players, and we've approved kind of the training materials and the structure of the agreements to make it easier to train their sales folks as well as provide them the proper incentives to be our advocates.

Okay. And one last one for Matt. Going back to the mismatch in revenues, especially with Gaylord you brought up. But the revenues now that you'll recognize going forward, they're going to be extremely high margin revenue; it's not 100% revenue margin?

Yes, certainly. That portion devoted to deployment will essentially be 100% gross margin going forward, and it'll be blended with our support and maintenance continuing for the next several years. It will rightsized over time; it's just a bigger impact in the first quarter.

Okay, and in the hardware, you're still seeing improvements in gross margin. You're going to maintain that discipline going forward and improve it as much as you can quarter-to-quarter?

Yes. Gross margin quarter-over-quarter dipped slightly in Q1. There are various factors we're still working through in terms of inventory management and getting products out the door. However, on an overall basis, while the light business did lose some money, it improved quite a bit quarter-over-quarter and had its best quarter since we've owned the company. Customer acquisition costs have trimmed considerably since Q3 and Q4 of last year, so we finally feel like we're in the fine-tuning process where we're going to be able to get this to breakeven or better in the next one to two quarters.

Thank you. Have you noticed any change in the pipeline given the uncertain economic environment in your sales cycle?

Yes. The way I would characterize it is just a little bit more slowness and caution. We haven't seen any drop out of the pipeline, but this is kind of a multi-stakeholder decision when it comes to the enterprise end. They are kind of double-checking their alignment and forecasting. Despite interest rates being at a local high for the last decade or more, hospitality is having a good year. We expect them to keep going, and of course, healthcare is pretty countercyclical in nature. This is more a function of natural budget cycles, combined with a little more slowness due to that uncertainty.

I wish you guys good luck. Thank you.

Thank you. We have reached the end of our question-and-answer session. So, I will now turn the call back over to management for any closing remarks.

Well, I have nothing further to add. I think our comments have really covered everything. I'd like to thank you all for your time. Despite the economic environment, it is still a very good time to have the product we do that provides contextual engagement using our location-based platform, helping brands improve the quality of their guest experience, their patient experience while reducing their costs and enhancing their revenue; so there is no season where that is not attractive.

Thank you. This does conclude today's conference, and you may disconnect your lines at this time, and we thank you for your participation.