Earnings Call Transcript - PHUN Q3 2023

Operator, Operator

Good afternoon, ladies and gentlemen, welcome to Phunware’s Third Quarter 2023 Investor Conference Call. Currently, all parties are in a listen-only mode. Joining me today are Mike Snavely, Chief Executive Officer; and Troy Reisner, Chief Financial Officer. The format today will include prepared remarks by Mike and Troy, 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 upon them. Additionally, the matters being discussed today may include non-GAAP financial measurements. Reconciliation of GAAP to non-GAAP financial information is set forth in the earnings press release, which is available on the Investor Relations section of 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 on Phunware. At this time, I would like to turn things over to Phunware’s CEO, Mike Snavely. Please proceed.

Mike Snavely, CEO

Thank you very much, and welcome to our third quarter 2023 investor conference call. In my short time back at Phunware, I've learned a lot and I'll highlight a few accomplishments in the past quarter to illustrate where we are. I'll talk about our immediate term plans to continue to create a healthier more sustainable business, and I'll shed some light on the Company's strategy moving ahead. Some of you may know that I served as EVP of Software for Phunware in the 2015 - 2016 timeframe. We built that business to about $25 million in annual revenue, most of which was recurring. So, when I was approached to return as the Company's CRO, I embraced this opportunity to get the Company back on track and finish the mission. Upon my return, I found that the technology was sound as ever, the customers we have were happy renewing and buying more, and that the basic issue was a failure of sales execution and a need to think more deeply about how we can monetize our technology advancements. The Board concluded that what the Company needs now is sales-oriented DNA and a CEO, and accordingly, they asked me to take on that role. So I've had the opportunity to say no twice to Phunware, and here I am because I believe our best days are ahead of us. Why do I believe that? First, the product is strong. Our technology in the area of indoor wayfinding is demonstrably superior to that of major competitors like Aruba Meridian and more, according to customers and prospects who have evaluated them head-to-head. Further, the companion product, location marketing, which offers triggered by a combination of who you are and where you are, is delivering value to customers today with increasing adoption. Second, our solution is sticky as customers have historically renewed and bought more. This past quarter, we renewed the $2 billion Virginia Hospital Center, a member of the Mayo Clinic Care Network, for a five-year term. We also saw a renewal at Mayo Clinic in Rochester through our partner HID. Prospectively, our account health indicators are strong with substantial upsells in the pipeline. Further, we regularly see customers ask us to deploy our solution into new buildings or wings and to create new integrations into other software they use to operate their businesses. Finally, we are seeing the beginnings of a turnaround in our new logo acquisition as our account-based marketing approach takes hold. As of today, we have about $8 million in total contract value in the pipeline. Notably, about a third of those are from channel partners like Cox Business, Siemens Connect, and others. These partners and others see what we see, a synergy between their hardware and systems integration work and our consumer-facing mobile applications. We believe our pipeline and partner strength are good indicators of future bookings performance as we continue to drive discipline into the sales process. In our Hospitality segment, we negotiated an outcome with Marriott Corporates about the branding of the Wailea Beach Resort on Maui after some time in development. We believe this opens the door to additional business at Marriott branded properties along the lines of our relationship with Gaylord Hotels, which should result in more logos coming from this, the largest hotel chain in the world. We are in pilot with a couple of large resorts and expect those deals to consummate in the first quarter. We're also in the final stages of negotiations with certain large resort properties under major hospitality brands and smaller regionally managed properties. In Healthcare, we expect to have new logo announcements in the first quarter based on sales cycles that are advancing now. Additionally, as it pertains to cost containment, as previously announced we are winding down our light business, which was non-core and consuming cash. We've also reduced staff headcount overall, and Troy will talk more in detail about those numbers, but we preserved many of the key people who formed the brain trust of Phunware technology. Our strategy will need to build teams back carefully under the leadership of those long-tenured staff members in alignment with the revenue under management. And with that, I will turn it over to Troy to talk about our financial performance. After his remarks, please stay tuned. I'll return to talk about our vision for the future of Phunware, including some exciting announcements on how we'll be linking our software business with the relaunch of our digital asset strategy.

Troy Reisner, CFO

Thanks Mike, and good afternoon, everyone. I'd like to thank you all for joining us today for a review of our third quarter 2023 financial performance and progress reshaping our cost structure. I'll be discussing GAAP Financial Measures, unless otherwise specifically noted. Our press release, 8-K, and website will provide a reconciliation of all GAAP to non-GAAP financial results. So with that said, let's take a look at the numbers. Net revenues for the third quarter of 2023 totaled approximately $2.8 million, of which our platform revenue represented 45% or $1.3 million, and our hardware revenue represented 55% or $1.5 million. Gross margin was 7% compared to 16.7% last year. On a non-GAAP adjusted basis, gross margin was 9.8% compared to 17.9% last year. A significant impact to Q3's gross margin was a non-cash write-down of Lyte inventory of approximately $500,000. Excluding this charge, our gross margin would have been 24.9% and non-GAAP gross margin would have been 27.8%. Our platform gross margin was 50.4% compared to 46.5% last year, and hardware gross margin was negative 28.3% compared to 6% last year, which is reflective of the inventory write-down at Lyte. Total operating expense was approximately $18.7 million, inclusive of a $13.2 million goodwill impairment during the quarter. Other non-cash operating expense items for the quarter were stock-based compensation and amortization of intangibles making up a combined $925,000 this year, compared to $1 million in the prior year. By excluding these non-cash charges and goodwill impairment, adjusted operating expense was approximately $4.6 million compared to approximately $7.7 million last year. Non-GAAP Adjusted EBITDA loss was $4.3 million compared to a loss of $6.7 million last year. Adjusted EBITDA loss was narrowed for the fourth consecutive quarter as we continue executing against our plan to right-size our cost structure. Net loss was approximately $19 million or $0.16 per share, compared to a net loss of approximately $8 million or $0.08 per share last year. The weighted average share used to calculate earnings per share was approximately $120 million versus $98.8 million last year. Backlog and deferred revenue at the end of the quarter totaled approximately $4.8 million, slightly down quarter-over-quarter from $5.2 million. Now, moving to the balance sheet, we closed the quarter with cash of approximately $2.9 million. During last quarter's earnings call, we were in the final stages of amending our existing promissory note with Streeterville Capital. Shortly thereafter, we executed an amendment effective August 1st, which was filed as an exhibit to our second quarter 10-Q. As a reminder, as of August 1st, our note payable to Streeterville Capital was approximately $7.2 million which is payable in approximately nine-monthly installments of $800,000. In addition, Streeterville Capital has the option at its election to convert the outstanding balance to equity. Any conversion would directly offset the cash portion of the monthly amortization. During the third quarter, the note was reduced by $1.6 million through the payment of cash of $800,000 and the conversion of $800,000 in the note or approximately 3.4 million common shares. Also in October, Streeterville Capital converted $600,000 of the remaining note for approximately 3.7 million shares. Phunware and Streeterville Capital agreed to forbear the remaining October cash payment of $200,000. As of November 1, our outstanding balance is approximately $4.96 million. Now we've gone through the historical financials before I hand the mic back to Mike, I wanted to provide some further insight regarding progress towards rightsizing operations. The initial cost reduction steps we took during Q3 decreased our average monthly operating expense to about $1.5 million, which for the quarter, represents a cash savings of approximately $1.5 million or 25%. While the savings from these steps were not fully realized during the quarter, we estimate the annualized savings to be approximately $6.0 million. Further, progress continues subsequent to Q3. Examples include restructuring our SaaS product sales, delivery, and service model. As Mike mentioned, we have kept our people with the ability to scale other resources as needed. We have substantially aligned our headcount to support this new delivery model, which allows us to operate with 28 people today instead of 81. As a result of our streamlined operations and team's ability to successfully work remotely, we've also negotiated an early lease termination of our San Diego office space effective October 31. We paid an early termination fee of approximately $67,000 and eliminated our future lease obligation of approximately $300,000. Additionally, we have reached an agreement in principle with the lessor of the Lyte warehouse to early terminate our lease effective November 30. We expect to pay an early termination fee of approximately $197,000, which will consist of releasing our security deposit of $77,000 and cash of about $120,000, which we believe will come from proceeds related to selling Lyte inventory and other assets. Such termination will eliminate our future lease obligation of approximately $1.7 million. We do expect to execute this agreement within the next week or so. Also, as previously announced, we have committed to exiting our PC systems integration business, Lyte technology, which we expect to complete before the end of 2023. However, we do expect a significant direct net cash burn related to Lyte to cease by the end of November. Lastly, we have engaged a real estate agent to market our remaining office space in Austin while we seek to negotiate an early termination option. Of course, no assurance can be given that we would be successful in either path with respect to this Austin facility. Finally, a quick update regarding Phunware’s ability to continue to navigate our current business environment. As we have previously discussed and disclosed, Phunware has several levers available to continue to fund its operations and growth, which include our cash on hand, which currently approximates $2.4 million. Our at-the-market offering facility, which has more than $88 million currently available, and our facility with Lincoln Park which currently has approximately $29.6 million available. We can also pursue additional capital raises as necessary. We will remain active with both financial conferences and investor meetings in our efforts to tell our story and further strengthen our corporate profile in the capital markets. With that, I'd like to turn the call back over to Mike for closing remarks.

Mike Snavely, CEO

Thanks, Troy. Since we've just covered recent developments in our sales finances, we will now turn our attention to our vision for the future of Phunware, which we're calling Phunware 3.0. Our vision is to drive the ubiquitous adoption of Phunware technologies to connect brands, audiences, and soon our digital asset holders. This triangle of value serves as the foundation of our unique proposition that monetizes anyone, anywhere, while preserving the value of the consumer’s data. We believe that our value is directly proportional to the aggregate size of the mobile audience using Phunware technologies, and we will be employing strategies to drive that audience size as quickly as possible. There are three pillars to this vision. First, we will continue to sell our patent-protected location and wayfinding technologies in combination with our location marketing offering. We will migrate over time towards selling these as software components delivered as SDKs into existing mobile applications with large existing audiences. Our traction with some of the largest brands in hospitality, combined with our existing integration with Epic, the number one EMR provider in the US, puts us in a great position to deepen those relationships with embedded software. Second, we will continue to explore new and additional ways to monetize our patents and other intellectual property. We believe we need to do a better job of exposing the value we believe exists within our IP portfolio, and we are taking steps to highlight its value under different scenarios. We are developing a multi-pronged strategy around our IP portfolio, which includes assessing its value, utility, and deployment in the global digital ecosystem. We believe that our IP can be monetized in various ways, by pursuing recoveries for past and ongoing infringement, entering into IP licenses and software licenses with embedded IP, and entering into other arrangements with partners to purchase, finance, and/or help us further monetize our IP. We also continue to explore opportunities to expand our use of artificial intelligence, either as a new standalone product or by embedding AI into existing products. Finally, we remain committed to completing our digital asset and Blockchain ecosystem for consumer and customer engagement. We will continue to move toward creating a decentralized data and engagement economy to put consumers and small businesses in charge of their data and enable customers to reach and engage with them on a mutually beneficial basis. Why do we pause? The regulatory uncertainty for digital assets, including utility tokens and NFT projects, has been disruptive to our ecosystem. We continue to monitor the recent digital assets, regulatory and enforcement actions particularly around utility tokens and are working hard to ensure our ecosystem remains compliant with the evolving regulatory framework. We believe it is time to continue implementing our vision and ecosystem while navigating the regulatory uncertainty. As such, we expect PhunToken to evolve and play an important role in our ecosystem. PhunCoin is expected to evolve and be the primary product and commercialization focus of our ecosystem. And PhunWallet is expected to evolve and remain as the primary mobile-first connection for consumers and small businesses to the ecosystem. We are working with Securitize to finalize and intend to officially launch PhunCoin for trading in the next several months barring any unexpected digital asset market developments. In parallel, we expect to file a Reg A offering for PhunCoin to enable future purchases of the asset. We will provide more information on our digital assets ecosystem, including the PhunCoin launch and offerings, during the fourth quarter of 2023. I would like to open the call up now for questions through the operator. Operator, please go ahead.

Scott Buck, Analyst

Hey, good afternoon guys. Thanks for taking my questions. Just a couple of quick ones from me. First, Mike, how quickly do you think you can monetize PhunToken and wallet? And what is the kind of additional investment, dollar-wise, required there to get it to a point that you can monetize it?

Mike Snavely, CEO

Yes, pleasure to meet you and thanks for the question. We've done a lot of the work. Simply put, this kind of goes back two or three years, as I understand it, having watched the company from the outside during that period of time. We didn't expect a ton of incremental investments to be able to bring the assets to market, really, at all. Now how long will it take us to monetize? Our Chief Legal Counsel is working through right now, along with some experts in the area of digital assets to kind of figure out how all these things should link together, the sequence and timing associated with that. We believe that we're going to be able to be fairly definitive about that within the fourth quarter here, which really means in the next few weeks. So stay tuned for more definitive guidance on the when of this, but from an investment standpoint, we don't expect to consume a lot of cash in getting to the starting line, so to speak.

Scott Buck, Analyst

Okay. Perfect. Thanks for that. And then second, on Lyte, I guess I'm a little confused by the commentary on the call. Are we winding the business down or is there a potential sale opportunity, or are both kind of a little up in the air at the moment?

Troy Reisner, CFO

Okay. Hey, Scott. Thanks for the question. Yeah, we've used terminology winding down or exiting. So we're pursuing two courses: preparing to shut down or sell. We're working both of those paths and should either direction have it wound down by the end of the year.

Scott Buck, Analyst

Okay. Perfect. That's it for me guys. I appreciate it. Thank you.

Troy Reisner, CFO

Thanks, Scott.

Howard Halpern, Analyst

Good afternoon, guys. So, Mike, if you could talk a little bit more about the software pipeline of engagements that you envision occurring in Q1 of next year. Could you add a little context to it in terms of maybe initial engagement size and then the opportunity within each engagement to grow?

Mike Snavely, CEO

Yeah. You bet. I'm happy to do that. So, we have an existing software business. The performance of that software business has not been what anybody expected. That's a big part of the reason I'm here. What I'll say is this: we have a few dozen opportunities in the pipeline right now across hospitality and healthcare. We find that the healthcare opportunities are going to be larger, probably on average, three times larger in terms of annual revenue than the hospitality ones for a number of different reasons, not the least of which is the size and the sort of the visitor traffic through these facilities. Also, there's a different way of looking at calculating the return on investment for such a thing. But with that said, we expect to enter into a handful of new contracts, yet this quarter and then into the first quarter of next year, that are going to range in value from something like $50,000 annually on the lower end for some of the smaller resort properties to more like $150,000 or $200,000 annually for some of the hospital properties. Beyond the initial sale, which is typically going to be a fixed contract, annual fee for a term of typically three to five years, we are frequently seeing upsell opportunities in both segments of the business. For example, there's a lot of acquisition and consolidation in hospitals. You'll see additional facilities being brought online, and there's kind of a rough proportionality between the number of square feet that we're covering and the fee. So if we double the size, we roughly double the fee, that sort of thing. And then in the hospitality segment, we'll often see opportunities for us to create more digital engagement with the guest by adding additional features into the application. Imagine the case, for example, this is a real-life example from one of our large hospitality customers: think about digital key. Instead of using a plastic card, use the mobile phone to enter the door. That's a big area of investment for lots of these properties and we can control the digital front end of that key experience. So those are a couple of vectors. Anecdotally, I've seen a couple of accounts that have grown by roughly double within a two, two-and-a-half, three-year time frame as a result of a couple of these phenomena that I mentioned.

Howard Halpern, Analyst

Okay. And then in terms of what the strategy is going forward in terms of direct sales versus using your channel partners. How should we look at that over the next year or two?

Mike Snavely, CEO

We're going to continue to have a direct sales operation. In fact, I'm going to be bringing some of the old band back, who were instrumental in helping us drive to the $25 million number that I mentioned earlier in the call. These are people who really know how to sell. Our direct sales operation will continue to be supported by account-based marketing, content marketing, really establishing ourselves as a thought leader, and then getting our customers to tell their stories to the market as well. We will continue to invest in our relationships. I mentioned Cox Business and Siemens Connect as well as a number of others, including, by the way, one of the largest digital key providers in the world, who have become a part of our partner ecosystem. The number of deals that we have in the pipeline right now approximates a third of the total pipeline from a deal-count standpoint, which represents more like 45% of the pipeline in terms of dollar volume. We’re finding that the channel deals come to us because of the synergy reasons I described earlier and we are finding on average they are a little bit bigger than some of the directly sourced deals. So, we'll continue to invest in cultivating those channel relationships in addition to running our direct sales team. It's a complex technical sale, which means that we're providing a ton of support for the sale process to our partners irrespective of whether they are present in the deal. We'll continue to foster intimate partnerships at the deal level with those channel partners.

Howard Halpern, Analyst

Okay. Well, thanks and look forward to the upcoming quarters.

Mike Snavely, CEO

Thanks so much. Appreciate the call.

Ed Woo, Analyst

Thank you for taking my question and welcome to Phunware again. My question is, it sounds like you're targeting some bigger hospitality clients, so it looks like possibly bigger deals. Will it require a greater investment in the sales cycle, as well as should we expect a sales cycle to extend as these deals appear to be bigger?

Mike Snavely, CEO

I think that's a perfectly reasonable assumption. Let me speak to that a little bit. So we will continue the individual property rinse and repeat selling cycle, and I'm talking about how hospitality and healthcare is really kind of the same thing. In parallel with that, what I'm looking for is a little bit of an all-the-above strategy. And what I mean by that is yes, we'll sell individual properties, but I want to bootstrap my way into real conversations with the largest hotel brands in the world as we start to develop critical mass with their individual properties. Imagine a case where we take an existing hotel loyalty app that has tens of millions of users. We could incorporate our location features, including marketing and wayfinding solutions into that application. So overnight, we get an enormous amount of usage which we believe will be directly proportional to the value that we can charge for that. Ultimately, the value we can extract from the overall ecosystem to include the digital assets components as they come online. By their nature, those deals will take longer to run. But we'll be able to mop up not individual properties but hundreds, perhaps thousands of properties at a time as a result of that strategy. So two different approaches, two different timelines for maturity. I wouldn't be surprised if it took a year to incorporate our technologies into a major application like the one I'm talking about, but in the meantime, we'll continue the blocking and tackling at the individual property level.

Ed Woo, Analyst

Thank you for answering my questions, and I wish you good luck. Thank you.

Mike Snavely, CEO

Thanks, sir.

Operator, Operator

It appears we have no further questions at this time. I'd like to turn the floor back to Mike Snavely for any closing remarks.

Mike Snavely, CEO

Thanks a lot, everybody. You know, we've likely taxed the patience of our investors. We believe that we're going to be in a position to put the company back on a solid financial footing. Troy spoke to that in detail, and we expect to have additional announcements forthcoming, in the coming weeks and a small number of months. But I came back here to finish the mission. I have a lot of respect for the leadership that preceded me, for sure. But I believe that this fresh look at where we can take the company is exactly what we need at this moment. I wouldn't be here unless I believe that we have a strong likelihood of success. So we thank you very much for your attention and patience and please stay tuned. Thank you.

Operator, Operator

This does conclude today's program. Thank you for your participation, and you may disconnect at any time.