DNA X, Inc. Q2 FY2020 Earnings Call

Good afternoon, and welcome to Sonim Technologies Second Quarter 2020 Results Conference Call. My name is Chad, 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 proceed, sir.

Thank you, Chad, and welcome everyone to today's Sonim Technologies' results call for the second quarter ended June 30, 2020. Sonim has just 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 our 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, estimates, and projections as of the date of this live broadcast, August 12, 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. Now, I would like to turn the call over to Tom Wilkinson.

Thanks, Matt, and hello to everyone joining us on the call and online. I hope you're all staying safe in these interesting times. The past few months have been a period of strong sequential growth for Sonim. Our transformation into a low-cost and hyper-productive team has paid dividends, enabling us to put revenue back on the right path, reduce our operating expenses, generate cash, and strengthen our balance sheet. We previously reported that the first quarter would be the revenue trough for Sonim at $12.7 million, due to what is normally a seasonally slow period, and it reflects prior software quality issues. We are excited to report second quarter revenue just over $21 million, which is a 65.7% sequential increase in revenue due to the resolution of prior software issues and improved carrier relationships as we continue to increase our market penetration. This increase includes some orders that we were initially targeting for the third quarter that came in early, which is why we're always mindful that enterprise sales can be inconsistent, or as we often say, lumpy from quarter-to-quarter. We also benefited during the quarter from wide-ranging and rapidly evolving changes in the first responder, healthcare, education, government markets as well as commercial customers that are increasingly emphasizing remote work, connectivity, and mobile data. These shifts depend upon mobile devices for success, and in particular, rugged devices such as ours, as our customers increasingly learn that mobile devices must be rugged to be used effectively. We also made meaningful progress on our operating metrics, including increased gross margin, settlement of prior shareholder litigation, and reduced corporate operating expenses. I'll pause here to ask Bob to cover our financial results, and then I'll share some updates on our strategy ahead.

Thanks, Tom. In our press release issued earlier today, we announced the results for the second quarter ended June 30, 2020. A copy of this press release is available in the Investor Relations section of our website. Net revenues for the second quarter of 2020 increased 66% sequentially to $21.1 million. The increase in net revenues was primarily attributable to continued sales of our smartphone, plus increased sales of our XP3 flip phone at our major U.S. carrier. As we have discussed previously, customer orders can often be unpredictable and fluctuate from quarter-to-quarter, especially as carriers try to anticipate end customer demand while keeping their inventory low. As such, we try to maintain flexibility to shift in response to changing order patterns while also seeking to balance our inventory and efficiency of working capital. Gross profits for the second quarter of 2020 increased $4.9 million, or approximately 23% of net revenues, from 17% of revenues last quarter. This increase in gross profit percentage was primarily attributable to increased sales activity over which to spread production costs, as well as the absence of the temporary shutdown that affected our Shenzhen manufacturing facility in Q1, which negatively impacted gross margin in that quarter. Looking at operating expenses, total operating expenses for the second quarter of 2020 increased sequentially by $0.3 million to $11.5 million but declined by 39% from the prior year. Second quarter GAAP operating expenses included a one-time charge of $2 million for the proposed settlement of prior shareholder lawsuits and associated legal expenses of approximately $0.4 million. We would not expect those items to be included in our operating expenses on a go-forward basis. Both research and development and sales and marketing expenses declined sequentially as Sonim seeks to maximize efficiency of its operating costs consistent with its goal to optimize operations under its new business model. We do anticipate reinvesting a portion of our operating cost savings into R&D for our next-generation products going forward, starting in the third quarter. Net loss attributable to common shareholders for the second quarter of 2020 totaled $7.1 million or a loss of $0.22 per basic and diluted share. That is down from a loss of $10 million or $0.48 per share in the first quarter, reflecting both improved operating results and a slightly higher share count as a result of our recent equity offering. This provides a good bridge to move to the balance sheet. We've now generated $5.7 million in positive cash from operating activities during the first half of this year. This was largely due to improved operations and better balance sheet efficiency. Our cash balance at the end of June was $38.1 million, which was the highest in company history. This included the benefit of $27.6 million in gross proceeds raised through our public offering in June. Subsequently, we eliminated more than $10.2 million of debt and accrued interest through a combined payment of cash and stock. This effectively renders Sonim debt-free other than a few low interest rate payment schedules for our corporate insurance program and our past royalty agreements, which we have retained. We also further de-risked the company through the proposed settlement of a shareholder lawsuit for $2 million, subject to definitive documentation and court approval, creating a path for us to focus on our operating and growth strategy there. Consistent with the previous few quarters, we will not be providing specific guidance today. This is primarily due to the continued uncertainty that exists as the COVID-19 pandemic persists in the United States and globally. However, we anticipate continued progress on our strategic goals for the business through the end of the year and we are now fully capitalized, which enables us to shift our focus to long-term growth initiatives. I'll now turn it over to Tom for some additional comments.

Thanks, Bob. As you can see, we've made important progress on improving revenue, increasing gross margin, and bringing operating expenses well down from a year ago, and even the prior quarter, with further gains still to be seen in the coming quarters. Bringing the operating model into balance is an important step from day one of the turnaround, and I'm pleased with the progress we've made. With the progress achieved today, Sonim is also in a position to fund and invest in our next generation of devices in a more cost-efficient manner. To that end, we're making changes to how we will develop our next-generation products, including efforts to reduce Sonim's upfront costs while bringing the most cutting-edge capabilities to our devices. We expect to begin this process in the third quarter and look forward to the benefits we can incorporate for our customers. Unlike other rugged mobile devices in the market, many of which may just be consumer devices that are supposedly toughened up in some manner, Sonim's mobile handsets are designed rugged from the frame. This includes not just choosing different components with higher durability but also working closely with customers to really understand the needs of the field. Our feature sets are crafted not just to meet those needs but to exceed them. That's why our screens are fully sunlight-readable, while our speakers are among the loudest in the industry, so field workers can hear over the commercial environments, and our batteries last longer than the competition, enabling workers to get a full shift from the use of our Sonim devices. It's also why we design our attachment points for maximum flexibility for use with truly ruggedly designed peripherals rather than repurposing commercial peripherals that don't really get the job done. Looking at how we take that forward to the next generation of our devices, we are now prepared to develop two rugged platforms. One will be based on next-generation microprocessors enabling 5G voice and data communications while maintaining the unique rugged mobility, durability, and performance sought by our end users. The second will be a refresh and improvement of our feature phone platform, which is our largest source of volume in revenue. As we develop these platforms, our plan remains to further apply the platform concept to additional low-cost product expansion. In fact, I'm pleased to report that we already have a key design win for our next-generation XP3 product and a major carrier customer who's excited about the increased features and expanded bands. These carriers asked us to perform a software upgrade to the existing XP3 to maintain sales continuity through the period leading up to the refreshed XP3 release. We are also enhancing the ecosystem around our products, including streamlining the ability to deploy Sonim devices to large, diverse, and distributed field workforces. A good example of this is the new SonimWare Enterprise Mobility Software we recently announced. SonimWare helps customers deploy mobile devices faster and manage and support users in the field to increase productivity and improve safety. This free solution only requires a mobile data or Wi-Fi connection and a free Sonim Cloud account to enable full device provisioning management and support. It provides advanced control capabilities on our XP3, XP5S, and XP8 devices and facilitates productivity for our customers, such as enabling enterprises to customize and optimize device screens, keeping them simple for users, and allowing access only to those apps that are work or productivity-related among an array of other features and benefits tailored to our customers. While looking at the next-generation is exciting, we're also taking steps to ensure Sonim's current devices remain at the top of their game for our users. Our current portfolio will soon be enhanced with the release of Android 10 on our XP8 and mission-critical push-to-talk (MCPTT) on both the XP8 and XP5 products. These advances should further increase the usability and appeal of our existing product line as we prepare for the next generation. Taking all this into account, I think it's clear that our shift towards a more proactive, diversified, and market-driven model going forward has put Sonim back on the path to success, enabling us to expand our addressable market opportunity. Bringing it all together, we are pleased with our ability to deliver sequential quarterly growth, improve gross margin, reduce operating expenses, enhance our balance sheet, and close out our prior debt and litigation overhangs. Sonim is now a leaner, more focused company, ready to move into the next stage of our evolution. The work we're doing with our customers and partners continues to open new opportunities to the market, including exciting prospects for the rest of this year. The continuing global pandemic continues to put the benefits of rugged mobility more front and center than ever, and we're working hard to capitalize on these trends for the long term. We continue to believe that Sonim is on track to realize its full potential as a leading provider of rugged mobility solutions and in providing substantially driving long-term shareholder value. I look forward to building on that progress ahead, but before we shift to the Q&A, I'd like to share a fun story about one of our customers that illustrates the use of our products and really how rugged they are. One of our customers is the beach patrol division for the South Florida Fire and Rescue District. This is a great job that provides critical safety and first responder services to beachgoers covering 26 miles of beach with about 10 full-time and up to 80 seasonal staff. They needed a device with smartphone GPS, PTT, high-volume, and alert features that would also survive in the saltwater and sandy environment where they operate. They tried many of our competitor devices, but they were unable to keep a mobile device functional for more than just a few months. That's where we came in. They have been using the XP8 for two full seasons with no complications. The XP8 feature-rich solutions have increased the beach safety division's productivity and helped them continue to focus on the safety of beachgoers. But it gets even better. A tourist recently fished a Sonim device out of the water, there have been lots of Jet Ski patrol in mid-2019. They dried the device off, charged it, and turned it on to find it fully functional after an entire year under saltwater. Now, that is Sonim Rugged. With that, I'll now turn it back to the operator for our Q&A session.

Thank you. We will now begin the question-and-answer session. The first question will come from Jaeson Schmidt with Lake Street. Please go ahead.

Hey, guys, thanks for taking my questions. Tom, I know you mentioned that there were some orders that came in early from Q3, but do you think there were any significant pull-ins into Q2?

No. We're really focused on delivering our products at the pace in which our carrier customers can consume them and get them out to the end users. We did not put any efforts into pulling in revenue.

Was Q2 affected by any component shortages or supply issues?

No, no, not at all. I mean, I think things have changed in the supply chain because we do control our supply chain, we were able to plan for and react. We actually had a substantial number of parts on hand, and we're ready. Probably the longer answer to your short question is as we keep an eye on these things, the only supply chain effect is a lengthening of lead times for certain components, and we are reacting accordingly.

Okay, and the last one for me, and I'll jump back into the queue, obviously early strong sequential improvement in gross margin, should we be thinking about this sort of low to mid-20s as being the new normal going forward?

Hey, it's Bob. I'll take that one. I think it depends on the mix. Our mix has shifted, and we mentioned a little bit in the narrative towards our feature phones, specifically the XP3, which has been doing really well at a couple of customers, and it's grown a lot, and won significant customer, and those are just a little bit lower margin than the XP8 smartphones. So, I think that there is that impact. There is a little bit of lingering overhang from the shutdown of the factory that's in place in Shenzhen in Q1, the additional safety measures and protocols that have been put in place in order to reopen safely and keep our workers there in good shape. I think those are costs that should see a little bit of an impact. So, I think margins will be positively impacted by the efficiency of our operations, little bit negatively impacted by the mix.

Okay, and sorry, just to clarify, I mean it looks like feature phones were 66% of revenue in Q2, I mean, obviously, you mentioned strong XP3, but going forward, I mean, Q2's levels should be the floor base, even if feature phones continue to be strong in the back-half of this year?

I would say without giving guidance, that's a fair statement.

Okay. Thanks a lot, guys.

Yes.

The next question will come from Zack Silver with B. Riley FBR. Please go ahead.

Thanks for taking the question. I understand that you are not providing guidance, but I wanted to ask about the level of activity in July and more generally, what kind of demand COVID may have stimulated for your devices that wasn't there before the pandemic.

Yes, as Bob mentioned, we're not providing guidance, and I don't want to discuss the specifics of the quarter. However, addressing the latter part of your question regarding COVID's impact on demand, as we noted last quarter, a small part of our sales has been through retail. Retail is gradually recovering, but foot traffic hasn't returned to previous levels, and there remains some caution in that segment. On the positive side, enterprise customers who needed to pause are now showing signs of renewed activity. We are seeing extensive testing of our devices, field usage, and the advancement of larger projects, indicating that we are getting back to business.

Yes, got it. That's helpful. The second one is just, you guys are obviously about to embark on somewhat of an R&D cycle to develop the 5G devices. You've heard AT&T talk about rolling out 5G on FirstNet, and I'm sure that other enterprise carriers are going to utilize 5G in their plans going forward. Just wondering how you ensure that you're going to get a good ROI on developing the 5G devices, and what sort of demand you think there is for upgrades from the carriers as they launch 5G over their enterprise networks?

We are actively collaborating with all the carriers on 5G and its implications, especially regarding market feasibility. We have been transparent with them about the costs and the distinctions involved. There are variances in research and development for 5G, particularly between the two types—millimeter wave and sub-6, which require different components and lead to a more expensive phone. We believe in maintaining a premium margin for these phones once they are adopted. As we introduce new technology and products, we expect to return to a strong gross margin percentage.

Right.

So, we're very focused on it. We are almost consultative to them in a way to talk about which features really should be included in which phones so that we can make sure that we have something that the market can bear, but then also still delivers on their promises for 5G in the future.

Got it, and then one more quick one, just around T-Mobile, any update there on talks with them, and do you have confidence that you can begin to do business with them at some point?

We are confident that we can do business with them, but we're not allowed to announce any business with any of the carriers by name. However, we believe we have a strong relationship with T-Mobile.

Okay, that's helpful. Thanks, Tom.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Tom Wilkinson for any closing remarks.

Thank you for joining us on today's call. We'll be participating in a number of virtual investor conferences throughout the year, and we'll let you know about those by press releases as they occur. If you'd like to arrange a call with management, please reach out to Matt Kreps with Darrow Associates. His contact information is included in our press release, and we'll, of course, be happy to arrange a follow-up call if needed. Great questions today, thank you all very much.

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