DNA X, Inc. Q1 FY2020 Earnings Call

Good afternoon. Welcome to Sonim Technologies First Quarter 2020 Results Conference Call. My name is Denial, and I will be your operator today. Joining us for today’s call are Sonim’s CEO, Tom Wilkinson; CFO, Bob Tirva; and Investor Relations Adviser, Matt Kreps. Following their remarks, we will open the call for questions. I would like to remind everyone that, this call will be recorded and made available for replay via link available in the Investor Relations section of the Company’s website at www.sonimtech.com. Now, I would like to turn the call over to Matt Kreps. Please, sir, proceed.

Thank you, Denial, and welcome everyone to today's Sonim results call for the first quarter ended March 31, 2020. Sonim has distributed a press release and filed the Form 8-K with the Securities and Exchange Commission. Those documents are available on the sonimtech.com website under Investors. Information from that press release includes historical financial results, some of which will also be discussed in the company's remarks on this call. Please note that certain information discussed on the call today will include forward-looking statements about future events, Sonim’s business strategy, and its future financial and operating goals and plans. These forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict and may cause the actual results to differ materially from those stated or implied by those statements. Certain of these risks and assumptions are discussed in SEC filings, including the most recent quarterly report on Form 10-Q and the most recent annual report on Form 10-K. These forward-looking statements reflect management’s belief, estimate, and projections as of the date of this live broadcast, May 14, 2020, and Sonim undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this conference call, except as required by law. And with that, now I would like to turn the call over to Tom Wilkinson.

Thank you, Matt, and hello to everyone joining from the call and online. It's been an interesting two months and three weeks. Part of that, as Bob and I expected joining the Sonim team last fall, relates to turnaround—a process that always has a lot of moving parts—but clearly, an unanticipated part of our work has been responding to the global COVID-19 pandemic. For Sonim, the COVID pandemic has been disruptive, but not to the extent and not in the same way it has been for many other companies. In fact, the wide-ranging and immediate changes in first responder, healthcare, education, government, and commercial industries that have decided remote work, connectivity, and mobile data have put a spotlight on mobile devices and, in particular, rugged devices such as ours. These industries are having to quickly deploy people and resources in new and often critical situations, where the ability to instantly communicate is essential, as is the need to aggressively clean and disinfect mobile devices. The last thing a first responder wants to do is bring the virus back to their station or their home. In these conditions, there’s an advantage to our ultra-rugged design, our integrated push-to-talk function, and configurability and deployment and management provided by our Sonim SCOUT applications. As we previously disclosed, we used November and December to complete a thorough review of the Company. It was clear that we were on a declining revenue trajectory through the first quarter of this year due to an inventory buildup with a major carrier as well as delays in ramping other customers. Importantly, we were able to use that time to implement a series of cost reduction and lean operating actions to prepare for what we believe would be a reversal of that trend. The expectation was that the cost benefits would begin to show in the first quarter with additional benefits in the second quarter, which is when we believed revenue could begin to move upward again due to favorable revenue impact from the awaited ramping of a major customer. Looking forward, we expect to increase our variable spending on new product R&D in the third quarter as we begin to develop our next generation 5G devices. The headcount changes we have made and office changes, which we are in the process of already moving Sonim towards a leaner, more distributed workforce, less tied to offices or physical locations. The COVID-19 pandemic in Asia resulted in our manufacturing facility being shut down for approximately three weeks during the first quarter. This slightly delayed our timeline for cost improvements and notably impacted our gross margin for the quarter. The pandemic has shown us all how to work differently, and we plan on responding to that opportunity with lean operations going forward. We're hopeful that the first quarter will be the trough in company results as we have shifted away from the prior business model that was in place when Bob and I arrived, and toward a more proactive, diversified, and market-driven model going forward. We currently anticipate sequential growth in the second quarter as compared to the first quarter, as well as better gross margin and continued benefit from additional cost-saving measures, not fully reflected in the first quarter, mainly due to timing. Having laid out that framework, I’ll ask Bob to review the first quarter numbers in more detail then I'll come back with some more comments on our path forward. Bob?

Thanks, Tom. This afternoon we issued a press release announcing our results for the first quarter ended March 31, 2020, a copy of which is available on the Investor Relations section of our website. Our first quarter 10-Q will also be filed with the SEC shortly. Net revenues for the first quarter of 2020 decreased to $12.7 million, and the decrease in net revenues was primarily attributable to the absence of activity on the road minimum volume border contract, which ended in Q4 of 2019 and a slower-than-expected ramp of our products at additional carriers. As we've discussed previously, these product ramps can be unpredictable from quarter to quarter as carriers try to anticipate end customer demand while keeping their inventory low. Going forward, while we feel that this unpredictability will continue, we are seeing an upward trend in Q2. Gross margins for the first quarter of 2020 decreased to $2.2 million, or 17% of net revenues. The decrease in gross profit percentage was primarily attributable to the COVID-19 driven shutdown of our factory, which negatively impacted our cost dynamics, as well as lower sales volume and a few additional inventory reserve adjustments. Looking at our operating expenses, total operating expenses for the first quarter of 2020 were $11.2 million compared to $13.2 million in Q1 of last year. The quarter included the partial effect of cost reduction activities, and we anticipate further cost efficiency gains ahead as we continue to focus on lean operations. As Tom mentioned, we do anticipate operating cost savings will be partially reinvested into R&D for next generation products going forward. Net loss to common shareholders for the first quarter of 2020 totaled $10 million or a loss of $0.48 per basic and diluted share. The increase in net loss reflected lower revenue and gross profit margin, partly offset by the reduction of operating expenses. As for the balance sheet, we generated $1.1 million in positive cash in the first quarter, bringing our cash balance at the end of March to $12.4 million. This gain in cash reflects increased efficiency in working capital management as we have worked to preserve our available funds in this period of economic uncertainty. The Company decided to suspend its practice of providing forward-looking guidance as of the third quarter of last year. While we are not providing formal guidance today, as Tom mentioned, we are presently anticipating that the second quarter will show sequential growth in revenue and gross margin over the first quarter. Finally, a quick note on the impact to Sonim of the recent merger between T-Mobile and Sprint: Sprint has been a good customer to us, but we do anticipate changes in how our products will be sold, because of our requirement for all stock devices to be sold as T-Mobile certified, which unfortunately we are not. Although this will be a headwind for us later in the year, we do expect our current offerings to be available for sale to traditional Sprint customers on a non-stock basis. We intend to engage with the new T-Mobile in the next product cycle with our next generation of devices. I'll now turn it back over to Tom for some additional comments before we open it up for Q&A.

Thanks, Bob. We've not had a call with investors since our presentation of the third quarter results, but we want them to know we're doing more than simply cost-cutting. During this time, we have resolved a number of technical issues that were plaguing our products in the last half of 2019. These had a particular impact on a key carrier customer and delayed adoption of our products. After being able to demonstrate resolution of those issues and the restart and rollout with the carrier sales force in the first quarter of 2019, we are seeing growing acceptance of our devices, increasing sell-through, and improving quality ratings from our customers. We have increased our engagement and negotiated promotional support from North America's largest enterprise carrier, resulting in an expectation for larger shipments to this carrier in Q2 and beyond. Our going forward plan on research and development, as well as production, will be to engage with ODM partners to bring broader expertise for our team as well as to provide lower costs to larger scale purchasing. We intend to develop our rugged platform based on next generation microprocessors, enabling 5G voice and data communications while maintaining the unique rugged mobility, durability, and performance sought by our end customers. The common platform should be very exciting, and we believe a compelling upgrade path to our current ultra-rugged smartphone product, as well as allowing much lower marginal development costs for derivative products. This also facilitates the production of lower-cost rugged mobile phones, accessory devices, and hybrid devices that combine LTE functionality with alternative communications technology such as radio or satellite communications. By creating a multitude of devices on a single platform, we're able to reduce current and future R&D costs and leverage those costs over multiple product markets. We further plan to expand our product platform beyond rugged devices focused on traditional cell phone capabilities to rugged data collection devices such as barcode scanners, built to operate on cellular and Wi-Fi networks. These devices will compete in what we believe is a larger rugged handheld market by delivering on features demanded, but not yet fulfilled by devices currently offered in this market. In closing, the progress we have made on the financial turnaround, the work we are doing with our customers and partners, and the opportunity for future developments are all exciting aspects for the year ahead. We're in the midst of a very exciting time for our business as the benefits of rugged mobility are more front and center than ever, and we are working hard to capitalize on these trends, not just for the current pandemic, but for the long-term changes in how we work for the next years to come. We believe that Sonim is on track to realizing its full potential as the leading provider of rugged mobility solutions, which is key to driving long-term shareholder value. We're off to a good start, and I look forward to building on that progress ahead. With that, I will now turn it back to the operator for our Q&A session.

We will now begin the question-and-answer session. The first question comes from Zack Silver of B. Riley FBR. Please go ahead.

Okay, great. Thank you for taking the question. The first one is just around, just on the cost of goods impacting the first quarter. Can you help to quantify how much the COVID-driven factory shutdown impacted that? And then how should we expect the gross margins to trend over the balance of the year?

Hey, Zach, it's Bob. So, I think traditionally our margins have been around 30% over the last 2 quarters. I think that's a good indicator of where we were historically. And, the drop was primarily due to the shutdown of the factory in Shenzhen. So, I think that you’d see our margins going back to that general range, maybe a little bit lower, but the majority was the shutdown.

Okay. That's helpful. Regarding the Sprint T-Mobile, I want to clarify that you are working on getting the next round of devices T-Mobile certified. Is that correct? Also, although you don't provide individual customer breakouts, what impact do you expect the Sprint T-Mobile merger to have for the remainder of the year?

Yes, our next round of products is definitely going to be functional on the T-Mobile networks, and mostly in the communication as such. Like you said, we don't give specific breakouts, but I would say that the changes going on there will have a modest impact on this year, not dramatic.

Okay. Sorry, go ahead.

Sorry, Zach. It's kind of a change. Sprint and T-Mobile are merging as rapidly as they can. We have customers who depend on our products and there's no slow down at all. As you're a Sprint customer and you've deployed our XP8, then you have a new addition to your team and you want an XP8, you absolutely can get one through Sprint, not an issue. I think over half our sales to Sprint are either upgrades or line additions to current customers that use our products. And so, that's not going to be impacted in the near future. Eventually, the focus on new devices will be led by T-Mobile. So, it's kind of a later in the year thing.

Okay, that's helpful. And then the last one more broadly, just around the competitive environment for the rugged solutions that you provide and then expanding into different markets was intriguing. So, if you could maybe talk through the competitive environment for some of the examples you referenced like barcode scanners that would be helpful.

Sure. I mean, clearly, we're not describing products that don't exist, but what we've observed is that as other rugged mobile optionality has arisen, the traditional barcode scanners for example haven’t changed that much. They tend to have small screens and they tend to be built on architecture that's been around for several years. So, we think that by bringing out newer devices, by providing an alternative to the form and fit for the customers that will have attractive devices.

Got it. And then just for the competitive environment in rugged mobile devices, any changes from last year on that front?

Not really. We don't really see anyone else coming into the market except for one device from one of the larger producers, I guess dabbling in rugged. But we really don't see any new players. I think everyone is going to be figuring out what their timeline is going to be to 5G just like we are embarking on that, and that will be important for the future.

Great, thank you both.

The next question comes from Jason Smith of Lake Street. Please go ahead.

Hey guys. Thanks for taking my questions. Just curious, if you comment on what you saw from an order pattern standpoint in April and now here through May? And any sort of comments on linearity would be helpful.

I have to be very cautious since Bob mentioned that we are not providing guidance. When considering our products as enterprise offerings, there is seldom any linearity. There are numerous opportunities and multiple project deliveries involved. Deployments are typically large, and our devices do not exhibit a consistent repeatable pattern over a quarter. We don’t observe that kind of pattern. Our work involves collaborating with our carrier partners to obtain solid projections, assisting them in figuring out these projections, which evolve throughout the quarter. We also identify potential growth during this time. Therefore, it's challenging for me to express it in simple terms. That’s why when we analyze it, we look at the overall performance of Q1 versus Q2 rather than month-to-month or focusing on any specific quarter.

Okay, understood. And then obviously your products are critical, but have you seen any sort of trickle-down impact from project constraints or concerns on future budgets?

Not really. I mean, in the beginning for the non-governmental uses, we saw some pauses, but that seems to have—we seem to have moved past that.

Okay. And then just the last one for me, and I'll jump back into queue. On the OpEx just to clarify. So Q2 will sort of be the first quarter reflective of all the cost-cutting measures, or some of that will still bleed into Q3?

So, that was our intent, and we're moving towards that as quickly as possible, but there are certain things that will probably drift into Q3, just because we face the pandemic shutdown as everyone else does. So for example, we intended on June 1st to start subleasing our former headquarters space in San Mateo, California, that is on hold because we basically can't move anybody in here while the office is shut down. And so, the lease costs will continue on until we can succeed in completing the sublease. So certain things like that will not be fully reflected in Q2, but will eventually take shape over time.

Okay, that's helpful. Thanks a lot guys.

Yes.

This concludes the question-and-answer session. I would now like to turn the call back over to Mr. Wilkinson for closing remarks.

Thank you for joining us on today's call. We want to thank our employees, our customers, our partners, and our investors for supporting us through this transition. If any of you would like to arrange a call with management, please reach out to Matt Kreps and their associates. His contact information is listed on our press release. We'd be happy to arrange a follow-up call if needed.

Thank you for joining us today for Sonim Technologies' first quarter 2020 earnings conference call. You may now disconnect.