Smith Micro Software, Inc. Q4 FY2022 Earnings Call

Good day, and welcome to the Smith Micro Fourth Quarter 2022 Earnings Conference Call. I would now like to turn the conference over to Mr. Charles Messman. Please go ahead, sir. Thank you, operator, and good afternoon, everyone. We appreciate you joining us today to discuss Smith Micro Software's financial results for the fourth quarter and year ended December 31, 2022. By now, you should have received a copy of the press release with the financial results. If you do not have a copy and would like one, please visit the Investor Relations section of our website at www.smithmicro.com. On today's call, we have Bill Smith, 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 call consists of forward-looking statements, including, without limitation, 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 expense and the company's 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 a forward-looking statement. For more information, please refer to the risk factors included in our most recent 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 of our management's beliefs and assumptions only as the date they are made. I'd like to point out that in the forthcoming prepared remarks, we will refer to specific non-GAAP financial measures. Please refer to our press release disseminated earlier today for that reconciliation of these non-GAAP financial measures. With that said, I'll turn the ball over to Bill. Bill?

Thanks, Charlie. Good afternoon, and thank you for joining us today for our 2022 fourth quarter and year-end conference call. I'm excited to share with you some important progress we've made on several fronts throughout the fiscal year. But as many of you know, we also recently experienced a setback. As noted in our February 27 press release, we received notice from one of our Tier 1 carrier customers that it has decided to terminate the Family Safety portion of our relationship. That termination takes effect on June 30, after which we will provide support during the transition period for up to 180 days, as specified by our contract. There are a few important points to note. While we no longer expect any growth from this partnership, we expect to continue to earn monthly revenue from this contract until the end of the transition period through the remainder of 2023. While we were taken by surprise and certainly disappointed by this turn of events, it's important to note that the commercial terms of this partnership were those that we inherited in our acquisition of the contract, and candidly, they were not very favorable. So although this news will have a negative impact on our top line revenue, it will yield an increase in our average revenue per subscriber. Additionally, as we eliminate the associated costs and reallocate others to more profitable relationships, we expect to see improvements to our gross margins as early as Q2 of 2023. With all of this said, we clearly understand the impact of what just happened, and our focus is on how we are going to deal with the challenge. The first step is to align our expenses with the new business reality. Effective immediately, we will implement actions to reduce our expenses by $4 million per quarter. We have been able to immediately cease all migration activities for this carrier, which will allow us to significantly reduce personnel, both in terms of the number of resources we need to support product development and delivery efforts for the customer and in terms of back-office resources. In addition, certain nonpersonnel-related costs can be rationalized as a result of this action. Collectively, these factors give us confidence to achieve this level of cost savings in the near term. We believe the balance of our business is solid. I will discuss that viewpoint in more detail in the second part of my presentation after Jim has provided his financial overview. Jim?

Thanks, Bill, and good afternoon, everyone. As a reminder, we acquired the Avast Family Safety Mobile business in April of 2021, which impacts the year-over-year comparisons that I'll be discussing today. I'll now cover the financial details of the fourth quarter and full year 2022. For the fourth quarter, we posted revenue of $11.4 million compared to $14.7 million for the same quarter of 2021, a decrease of approximately 22%, as a result of the decline in CommSuite revenues, coupled with the decrease in Family Safety revenues. When compared to the third quarter of 2022, revenue decreased by approximately $300,000 or 3%. Revenue for 2022 was approximately $48.5 million versus $58.4 million last year. The $9.9 million decrease is due to a decline in CommSuite revenues, coupled with the decline in Family Safety revenues. During the fourth quarter of 2022, Family Safety revenue decreased by $2 million or 17% compared to the fourth quarter of last year, primarily as a result of the reduction of the Safe & Found platform revenue related to the continued attrition of legacy Sprint subscribers, driven by T-Mobile's acquisition of Sprint. Family Safety revenues were essentially flat compared to the third quarter of 2022. During the fourth quarter of 2022, CommSuite revenue was approximately $900,000, which decreased approximately $1.3 million compared to the $2.2 million in revenue produced in the fourth quarter of 2021. This decrease is primarily attributable to the decline in legacy Sprint subscribers on the CommSuite platform as those subscribers have transitioned off the Sprint network onto the T-Mobile network, which was fundamentally completed in 2022. Revenue from CommSuite was down approximately $200,000 sequentially compared to the prior quarter. ViewSpot revenue was approximately $800,000 for the fourth quarter of 2022, which was essentially flat compared to the fourth quarter of 2021, and decreased approximately $200,000 compared to the third quarter of 2022. As a reminder, ViewSpot revenue is comprised of both fixed and variable components. The fixed portion of the revenue is related to license fees and is generally the recurring component of the revenue. The variable portion of the revenue is related to device and promotional campaigns, and the timing and volume associated with this portion of the revenue stream is less predictable. While we are seeing increased levels of marketing for our Family Safety products for certain carriers, we are not expecting a significant increase in subscribers in the first quarter of 2023 given the activity to date. While we do expect revenue to increase for certain of our carrier customers quarter-over-quarter, we don't anticipate enough of an increase to offset the projected decline in revenues for certain of our legacy product lines in the current quarter, including Safe & Found. As such, we expect consolidated revenue for the first quarter of 2023 to be lower by 2% to 5% compared to the fourth quarter of 2022. For the fourth quarter of 2022, gross profit was $8.1 million compared to $10.6 million during the same period in 2021. Gross margin was 70.8% for the fourth quarter of 2022 compared to 72% for the fourth quarter of 2021. The gross profit of $8.1 million for the fourth quarter of 2022 was flat compared to the gross profit produced in the third quarter. In the first quarter of 2023, we would expect gross margins to be relatively in line with the current run rate. For the year ended December 31, 2022, gross profit was $34.3 million compared to $45.7 million during the prior year. Gross margin was 70.7% for the December 31, 2022, year-to-date period. GAAP operating expenses for the fourth quarter of 2022 were $15.2 million, an increase of approximately $700,000 or 5% compared to the fourth quarter of 2021. This increase was caused by an increase in amortization expenses of approximately $1.4 million due to the one-time adjustments related to the finalization of the Avast acquisition purchase accounting recorded in the fourth quarter of 2021. Note that the amortization expense of $1.5 million in the fourth quarter of 2022 was in line with the amortization expense reported in the third quarter. GAAP operating expenses for the year ended December 31, 2022, was $65.2 million, a decrease of $11.4 million or 15% compared to the prior year. Non-GAAP operating expenses for the fourth quarter of 2022 were $12 million versus $13 million in the fourth quarter of 2021, a decrease of approximately $1 million or 8%. Sequentially, non-GAAP operating expenses decreased by approximately $1.1 million or 9% from the third quarter of 2022, primarily due to decreases in personnel-related costs and in contractor costs related to the SafePath migrations. We expect first quarter 2023 non-GAAP operating expenses to decrease from the fourth quarter of 2022 by 4% to 8% due to the continued actions to reduce our cost structure, including the closure of our Prague, Czech Republic operations as of December 31, 2022. As Bill mentioned in his remarks, we are taking additional actions to significantly reduce our costs even further and anticipate that these actions will result in over $4 million of quarterly savings from our aggregate total non-GAAP operating expenses and cost of sales for the fourth quarter of $15.3 million. In other words, out of the $3.3 million in cost of sales and the $12 million in non-GAAP operating expenses reported for the fourth quarter of 2022, we will be eliminating $4 million in quarterly costs by no later than the third quarter of 2023. We are also very confident that we will achieve at least $3 million of these savings in the second quarter of 2023. As some of these savings will be derived from our cost of sales, we are expecting to see an expansion in our gross margins beginning in the second quarter as well. Circling back to the results for 2022, non-GAAP operating expenses for the year ended December 31, 2022, was $52.5 million, an increase of $4.7 million or 10% compared to 2021, primarily driven by the full year impact of the addition of the Avast business in April 2021. The GAAP net loss for the fourth quarter of 2022 was $8 million or $0.14 loss per share compared to a GAAP net loss of $4 million or a $0.07 loss per share in the fourth quarter of 2021. The GAAP net loss for 2022 was $29.3 million, a $0.53 loss per share compared to a GAAP net loss of $31 million or a $0.61 loss per share in 2021. The non-GAAP net loss for the fourth quarter of 2022 was $4.3 million or $0.08 loss per share compared to a non-GAAP net loss of approximately $2.4 million or a $0.04 loss per share in the fourth quarter of 2021. The non-GAAP net loss for the year ended December 31, 2022, was $18.8 million or $0.34 loss per share compared to a non-GAAP net loss of approximately $2.2 million or a $0.04 loss per share in 2021. Within today's press release, we have provided a reconciliation of our non-GAAP metrics to the most comparable GAAP metric. For the fourth quarter of 2022, that reconciliation includes adjustments for intangible asset amortization of $1.5 million, stock compensation expense of $1.1 million, convertible note and stock offering fees and amortization of $1.7 million and severance-related costs of approximately $600,000, partially offset by fair value adjustments of $1.2 million. For the year-to-date period, the reconciliation includes adjustments for intangible asset amortization of $6.3 million, stock compensation expense of $4.4 million, convertible note and stock offering fees and amortization of $3.1 million and severance-related costs of approximately $1.4 million, partially offset by fair value adjustments of $4.7 million. 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 2022 and 2021. The resulting non-GAAP tax expense reflects the actual income taxes expensed during each period. From a balance sheet perspective, we reported $14 million of cash and cash equivalents as of December 31, 2022. This concludes my financial review. Now back to Bill.

Thanks, Jim. Let's now touch on some specific areas of our business as we look ahead. Let's start by looking at our 2 Tier 1 Family Safety customers here in the U.S. We plan on delivering the SafePath-based solution to AT&T during Q2, and we expect it to launch into the market in Q3. Our Q2 delivery will also complete the process of extracting select functionality from the former Avast platform and incorporate it into the SafePath version that AT&T will launch, thereby ensuring we roll out a best-of-both solution going forward. This will also conclude all of our customer migration efforts. In addition to the operational and expense-related benefits of moving AT&T to SafePath, we also believe that the newest versions of SafePath represent a far superior product with greater value to AT&T, its multiline consumer subscribers, and to Smith Micro compared to the incumbent version. This also now creates opportunities for us to upsell additional services on our platform, such as SafePath Home, Drive, and IoT. It will also allow for substantial growth of the Family Safety user base at AT&T. We believe that our relationship at AT&T is strong. AT&T shares our enthusiasm and confidence that their deployment of our solution, AT&T Secure Family, will grow meaningfully once the SafePath-based version rolls out. In conjunction with AT&T, we have put in place a broad go-to-market marketing plan and have begun training activities across different groups within the AT&T organization. We also believe that our T-Mobile relationship is also solid. T-Mobile is already deployed on the SafePath 7 platform. And with the completion of the integration of the best features of the Avast code base into SafePath, we can also offer these extensions to T-Mobile. We believe this enhanced offering will provide new excitement around the family mode product and offer a new opportunity to grow the Family Safety subscriber base. We are working with T-Mobile to develop an exciting marketing campaign for Family Safety, much like we have done with AT&T. Growth of the subscriber base is our primary focus with this customer. We remain focused on helping DISH launch the CommSuite-driven visual voicemail as one of the first value-added services on the DISH wireless network. We're also working closely with DISH on the migration of the Boost Mobile premium visual voicemail subscribers over from the legacy T-Mobile billing system to the new DISH wireless billing system. We believe that these efforts have strengthened our relationship with DISH, and they lead to other opportunities down the road. Our existing ViewSpot business continues to remain stable. I hope you saw our press release last week on ViewSpot's expanded data capabilities. We believe that ViewSpot data can help our customers correlate their consumers' in-store use of retail display devices to the retailers' sales, thereby increasing the value and relevance ViewSpot provides. This is an exciting part of our efforts to make ViewSpot a more important part of the customers' data-driven intelligence and retail success. On another front, we just completed a very successful Mobile World Congress in Barcelona. With our completely rebuilt European sales team, we believe that there are strong opportunities for growth in this market. We believe that both SafePath and ViewSpot have robust applicability and opportunity in Europe. We particularly see untapped potential in the European market, both among Tier 1 carriers and their regional operating companies in higher ARPU markets, each of which often selects vendor partners independently. We met with dozens of European carriers in Barcelona, focusing on both the SafePath and ViewSpot product offerings, and received very positive reactions to our presentations. In conclusion, we made significant progress during fiscal 2022 on one of our primary objectives, the unification of our digital family lifestyle business to a best-of-single platform. We are confident that the outcomes of increased operational efficiencies, cost savings, and a vastly improved product affirm the value of this hard work and provide a strong base from which we can grow. With the significant cost reductions discussed earlier, we see a clear path to profitability, potentially as early as Q2 of this year. We remain bullish on our future and focused on returning to growth, profitability, and free cash flow. With that, I will open the call for questions.

Bill, maybe just to jump in quickly on T-Mobile. It seems like that account has stabilized there. You've got the SafePath integration done. You're waiting for the marketing campaign to begin. When do you expect that to return to sequential growth? Is that something that we should expect in the second quarter? Or is that the second half of this year?

I would think, to be conservative, I would look at the second half, but we may be able to get some growth in the second quarter. We'll have to wait and see.

Got you. And maybe shifting over to AT&T. I think you announced earlier in the year that pricing renegotiations had been completed. When does that kick in? Does that kick in with new subscribers? Is there a timeline where all the existing subscribers are repricing? How should we think about that in terms of when it's going to start to impact the P&L? And the same sort of thing with AT&T, it sounds like you're very confident that this starts to ramp up into the third quarter, right? Integration done in the second quarter, it sounds like campaign in the third quarter. What gives you the level of confidence that, that is going to start to inflect and move in that direction?

Okay. Well, first off, the AT&T contract, the terms took effect when we signed the contract. So they're already in effect. As far as from the standpoint of growth of the installed base, there is extreme excitement within the customer. And they are involving, really, for the first time, so many different areas and strengths that AT&T has. In the past, it was always fairly well-handled by a working team, but it's much broader now. And I think that is the positive side of things. And I feel very, very confident and looking for some real strong and extreme growth going forward out of this customer.

Got you. And lastly, if I could, and then I'll get back in the queue. Just a follow-up on Mobile World Congress. It sounds like there was a lot of dialogue, a lot of positive activity. What are your assumptions for this year or goals? Or did you expect to close a couple of deals? Do you think it's more likely to see Tier 1s, Tier 2s? How should we be thinking about that opportunity, both in '23 and '24?

In Europe, our main focus will be on the large Tier 1 groups. Each group operates companies in different countries, so the rollout typically happens one country at a time. We are confident that we can secure business in Europe, and we are optimistic about what we have observed. We have strengthened our team, which now consists of experienced professionals in selling to wireless carriers. They are eager to get to work, and their enthusiasm was evident at Mobile World Congress. We are very positive about our prospects.

Just as a follow-up on AT&T and T-Mobile. Maybe you get to growth in T-Mobile in 2Q, maybe it's the second half. Is there any timeline for when the new marketing campaigns are going to be released? And could you provide any detail? Are they going to be paying out incentives to the sales force in terms of spiffs or whatnot? Because historically, at least through Sprint, that's whenever you saw the most transactions saw a pretty quick growth in subscribers. Is that the plan for T-Mobile and AT&T?

Josh, it's Charlie. Absolutely, it's a comprehensive strategy. We refer to it as our multichannel approach. I can't discuss specific timing since it primarily depends on T-Mobile and AT&T. I can say that for AT&T, it will be in place at launch. That is part of our current strategy. However, it encompasses everything including digital, retail, and customer support.

And then if you could just provide a little bit more color on the expectation for gross margin? I know you're taking out $4 million of quarterly costs, part of that's in the COGS line. Once you move AT&T over to the new platform in the second half, like what's the expectation for the margin profile for gross margins in the back half of this year?

We expect that as part of the cost reductions discussed by Bill, the gross margins will gradually improve as the year progresses. Once AT&T transitions to SafePath, we will be able to eliminate some legacy ring costs. However, until all carriers are off the legacy products, we won't be able to fully eliminate those related costs. Nonetheless, the cost reduction activities we are implementing will affect the cost of goods sold, leading us to anticipate an increase in gross margins from our current levels.

I have one last question. With the unexpected contract termination, I know the company is under a tighter timeframe. Fortunately, two carriers are looking to ramp up this year. I'm curious about how the company is reallocating resources to potentially speed up the ramp, especially with T-Mobile and AT&T. Is it primarily focused on training and moving to different branches? I'm interested in what actions could be taken to help accelerate this and achieve sequential growth in a more significant way later this year.

Yes, Josh. I think the number one is, as soon as the notice was given to us, we ceased all activity for the canceling customer. And all of our workforce that was working on their product have been reallocated to our other customers. It's also important to note that the revenue that we generated from the canceling customer generated really the lowest possible profit of any of them. So if you had to pick one to lose, this was the one to lose, and we've moved forward from that. By moving a number of people now over to AT&T and working on different projects for T-Mobile and through the roadmap development efforts, we've accelerated all those efforts, and hopefully, we'll be able to move things even faster.

So as far as the $4 million cost cutting goes, would it be reasonable to think about 1/4 of that is in cost of sales and the remainder is in operating expenses?

I don't think we want to provide specific guidance on that at this point, Jim.

Okay.

The action hasn't been taken yet. You need to allow us to proceed with the action, and then we can discuss it further.

I want to confirm that the cost-cutting measures you're implementing now represent the new baseline. Before the Tier 1 customer ended their contract, we all anticipated that costs would decrease anyway. However, with that decision, this $4 million is now considered the new baseline and is not additional to the cost reductions we were already expecting. Is that correct?

Right, right. So the way to think about this is off of the fourth quarter, if you take our total non-GAAP expenses, so if you take the cost of sales plus our OpEx, we are going to take that fourth quarter number, and you're going to see $4 million eliminated from those total costs. So that has been the new line in the sand.

Yes. And I can add to that. When we announced that we were going to be reducing our expenses in the second quarter of '22, we took that action, and you saw our OpEx drop in Q2, Q3, and also in Q4 of '22. So this is a continuation, obviously, a big step towards returning to profitability.

Got it. And as far as the cessation of the work that you've been doing for this Tier 1 customer as well as the, whatever, reductions you're taking, I'm assuming that there's going to be some combination of cash and noncash charges in Q1 and Q2. Is that right?

Yes. That would be accurate.

Great. And I'll just assume that you're going to make me wait for those as well.

I have two questions, one about SafePath and the other about ViewSpot. First, while I understand you can't comment on how the mystery Tier 1 mobile carrier plans to replace your product, it's clear that Family Safety is important to their business. Can you share your thoughts on your IP stack? It seems rather inefficient to replace you, especially if they have favorable contract terms. There's a trend toward keeping things in-house, but this situation is somewhat surprising. Secondly, regarding ViewSpot, attribution of purchase decisions in marketing and advertising is a long-sought goal that seems to be nearing realization. Do you believe you are adequately marketing that product? It seems there could be significant growth potential if you weren't so focused on achieving overall profitability and managing the challenges related to SafePath.

Yes, Matt. I'll address the first part, and then Charlie can take the second. Regarding the first part, we don't believe, based on what they've communicated to us, that they're using a competitive product from a third-party developer like us. We think they're developing this internally. All the points you raise, including their previous low payments to us and now needing to cover that entire cost, certainly give us reason to pause and think. However, I must focus on running a business, achieving profitability, and driving growth to increase our stock price. Therefore, I can't dwell on that anymore. My complete attention is on ensuring that AT&T and T-Mobile are extremely satisfied with their product. My aim is to support both AT&T and T-Mobile in dominating the market with Tier 1 carriers in the U.S. That's what truly matters.

Sure, thanks, Matt. I think it's fair to say that we have quite an aggressive marketing campaign underway with ViewSpot. It involves the same team, but it's a slightly different approach since we are targeting a wider market with ViewSpot. We're not solely focused on carriers anymore; we're also pursuing the retail sector, which ViewSpot has enabled. We plan to continue this direction. Our pipeline is looking very promising right now, and we are really excited about ViewSpot. Therefore, I don't see it as taking away from one area or the other. I believe both aspects will move forward together, if that makes sense. I just want to thank everyone for joining us today. We appreciate you taking the time. We remain very excited. We're actually going to be at the ROTH conference here shortly. So if you happen to be there, please look us up. We look forward to talking to you, and please give us a call with further questions. And we'll talk to you on our first quarter conference call not too far away. Have a great day, everybody. Thanks.

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