DNA X, Inc. Q4 FY2020 Earnings Call

Good afternoon, and welcome to the Sonim Technologies Incorporated Fourth Quarter 2020 Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Matt Kreps, Head of Investor Relations. Please go ahead.

Thank you, and welcome everyone to today's Sonim Technologies' results call for the fourth quarter ended December 31, 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 the Investors link. 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, which we expect to file in the next few days. These forward-looking statements reflect management's belief, estimates and projections as of the date of this live broadcast, March 10, 2021. 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. 2020 was a year of transition and transformation for us as we've communicated on prior quarterly calls. We've implemented changes that position our business to deliver a more diverse range of products to broader addressable markets and new geographic opportunities on a global scale. A big part of that transformation in 2020 was about reducing our operating costs and moving to a lean and flexible operating model. We have made great strides in that direction, most of which were initially reductions in costs and creating efficiency within the business. I would like to spend a few minutes on the most recent pieces of that puzzle, which have recently been completed in shift previously higher fixed costs to what we believe will be lower variable costs that are more favorable on an operating basis. In December, we struck an agreement with Coforge to transfer the bulk of our software team in India to their company and entered into a cost-advantage agreement to continue providing software services for current and future products. This agreement accommodates our company's forward path of working with ODMs for product development, including most of the software configuration. We have retained within our company the resources necessary to perform the more differentiated software work such as MCPTT, Z-Axis and our SonimWare products. Overall, we expect a more predictable and manageable costs for our software work while also supporting our customers. In the second cost-saving move, we outsourced our manufacturing assembly work to Unicair, one of our existing supply chain partners. Our experiences in 2020 helped solidify the clear need for contract manufacturing. In the first quarter of 2020, we were compelled to shut down our production, but we were not able to shut down our costs, resulting in a much higher than normal cost per unit. Likewise, as we experienced variability in demand from one quarter to the next, we would also see unacceptable variability in cost per unit. By moving from a high fixed cost in-house manufacturing system to contract manufacturing, we believe we have stabilized our costs at a favorable rate. Our contract manufacturing partner has locked in the cost of assembly per unit for our existing products at a level comparable to our historically most efficient quarters. We expect that it will stay that way through the life cycle of our existing products. Our plan is that future units manufactured by our ODM partners will yield the same stabilized results. Third, we have made a shift to increase the use of ODM partners in new products. Our current ODM partners are UniStrong and FIH, a subsidiary of Foxconn. UniStrong has been our development partner for our newly released rugged smart scanners and rugged tablets that I will talk more about in a moment. We just announced that FIH is working on our next-generation rugged feature phones. We have developed strong relationships with both of these partners. There are many advantages to working with an ODM partner, including leveraging their existing development work and a larger volume supply chain, as well as relying on the ODM's ability to invest in the product development to enhance our own balance sheet efficiency. While we are receiving excellent engineering support from both partners, our software and hardware engineers are directly involved in the whole process to add our particular and differentiated expertise as well as our attention to quality. Now I'd like to talk about some of our exciting new products, which are key to Sonim’s future growth. In Q1, we began shipping the first of our smart scanner product platform, the RS80. This eight-inch screen rugged barcode scanner will provide both the scanning function and a larger screen user experience that is missing from the current market. By integrating our SonimWare suite of software, including Sonim Scan, we are supporting the centralized management and deployment of these devices for a broader range of enterprises. The RS80 is configured for stand-alone or connected by Wi-Fi or LTE with a focus on data collection. We've also developed and expect to ship in Q2, the RS60, our rugged handheld computer and barcode scanner, providing similar functionality to its larger sibling, but with a more compact six-inch screen. Also integrated with SonimWare and Sonim Scan, this version will be connected by LTE and is configured for voice and data. You might recall that I conducted our last quarterly results call using a test model of RS60 and it performed flawlessly. The RS60 has been submitted to AT&T for certification. We are very excited about our ongoing work with our next generation of feature phones. Feature phones are Sonim’s highest volume products and deliver the ultra-rugged durability that our customers value. Many customers want the voice-focused dependability of a feature phone with integrated PTT features without the complexity of a full smartphone. A particular note, while our feature phones are highest volume products and consistently receive strong positive reviews from customers, they do not currently support use in Europe or the rest of the world. That is an opportunity that we will address starting in 2021. Our next-generation feature phones will utilize new processors for increased performance and expanded network support, for additional and new carriers in the U.S. as well as in Europe and the rest of the world. These next-generation devices also include new features and usability requirements based on feedback from our current customers. One area where our feature phones have done well, especially the XP5s, is for commercial customers moving from radios to push-to-talk over cellular. This includes areas like school bus communication, security deployments and industrial deployments. We expect the move towards push-to-talk over cellular to have strong growth for a number of years in both North America and in Europe. We expect the first of our next-generation feature phones to release in the third quarter of this year and additional form factors to follow. We’re incorporating numerous customer-driven features into the design, particularly for our LMR to push-to-talk user who are accustomed to certain network capabilities that we can incorporate into our device to be even more competitive in that market. We are continuing our work to transition our product set to 5G. This new technology continues to rapidly evolve as it rolls out around the world. At the outset, there was a great deal of uncertainty around chip availability, costs, functionality and end-user pricing. As we’ve engaged in the process, we purposely held off on development to position ourselves better for the long-term. We understood that most of our end-user customers would not be able to take advantage of 5G performance in 2020 or 2021, making a rush to market unnecessary and potentially costly if we made the wrong choices. However, we also understand that 5G is the future, and it’s important to engage in the technology at the right time. Based on the roadmaps we are seeing from leading mobile processors, we are starting to see some stabilization in the chip choices for 5G. Therefore, we are engaged on future generation devices to be released with 5G capabilities, along with our own industry-leading ruggedness and SonimWare functionality that Sonim is known for. Let me stop here for a few minutes and ask Bob to cover our financial results. Then I will share more about our strategy ahead and the continued transformation of Sonim.

Thanks, Tom. Our press release issued earlier today announced the results for the fourth quarter ended December 31, 2020. A copy of the release is available in the Investor Relations section of our website. Net revenues for the fourth quarter of 2020 increased to $15.8 million. The sequential increase in net revenues was primarily attributable to an increase in sales of our XP8 smartphone. As mentioned in our prior call, the XP8 was recently upgraded to the Android 10 operating system, which has extended the life of that product. Shipment of XP8 increased by 42% on a unit basis over the prior quarter, this was partially offset by a decline in sales of our feature phones of about 19% on a unit basis versus Q3. Gross profit for the fourth quarter of 2020 was $3.7 million or approximately 23.5% of net revenues, which is down from 30.6% of net revenues in the prior quarter. As discussed on our last call, the margins in Q3 benefited from lower than expected customer discounts and rebates that were required to sell our products in that quarter. Margins in Q4 were negatively impacted by rising component prices for certain legacy products, which are approaching end of life. We anticipate that margins will stabilize as our new products begin to ship throughout 2021. Looking at our operating expenses, total operating expenses for the third quarter came in at $11.2 million. This represents an increase of $672,000 from the Q3 level. The increase is primarily the result of a $2.3 million increase in R&D expense over Q3, which was driven by the accelerated development of our next-generation products. The increase was partially offset by a decline in SG&A, which is a reflection of our continued commitment to maintaining a lean operating model. Net loss for the fourth quarter of 2020 totaled $6.4 million compared to a net loss of $8.3 million in the fourth quarter of 2019 and compared to a net loss of $6.5 million in the third quarter of 2020. The sequential and year-over-year decline in net loss reflects the improved operating model efficiencies Sonim has implemented to date. Turning to the balance sheet, our cash balance at the end of December was $22.1 million and we remain effectively debt-free. The decline in our cash balance is primarily attributable to our net loss of $6.4 million for the quarter, a $2 million payment to settle our securities litigation as well as payments made for our ODM partners to help develop our next-generation products over the next few quarters. As Tom mentioned, we believe that given our improved operations and strong balance sheet, we have sufficient capital to develop and launch our next generation of products, as we execute our 2021 plan. As in previous quarters, we will not be providing specific guidance today. However, I would like to point out that we continue to wind down the sales of our legacy products, while our next-generation products led by the RFID in March are just beginning to ship. In addition, Q1 is a seasonally low quarter for our business historically. These factors could impact our top line growth in the near term. I will now turn it back over to Tom for some additional comments.

Thank you, Bob. We're at the point where we have taken the company through a year of operational transformation. The pace of transformation was assuredly influenced by the COVID-19 pandemic. But as we have gotten through our business changes, we are hopefully announcing the end of the pandemic itself. Going forward, the Sonim story will not be about reorganization and cost-cutting. Rather, we will now build our company through products and market expansion. New rugged barcode scanners, rugged tablets, and our refreshed rugged cell phones will quadruple our addressable market by the end of 2021. Our sales team has expanded to Europe, we have started a U.S.-based inside sales team, and our centralized marketing efforts are growing. We have been partnering with distributors to expand our geographical reach to leverage the relationships with key channel partners, a key part of my success and our pioneering operating rugged business. We expect these investments in product and people will create future growth and expand our leadership and brand recognition for rugged electronics. While we bring our new devices to market, we intend to remain lean in order to focus our resources on research and development, to maintain our reputation for innovation and ruggedness and work enabling software tools for our first responder and industrial customer base. Our dependability is paying off. One recent example is a large U.S.-based company that has decided to refresh 8,000 rugged feature phones with up-to-date models. This highlights the ability to look at something as rugged and long-lasting as Sonim product while also having a recurring revenue stream from satisfied customers. We expect to find and develop more opportunities such as this with investments we've already made into our sales and marketing systems and to relationship development with historical customers. The Sonim team is excited and ready for the challenges 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. Our first question is from Mike Crawford with B. Riley. Please go ahead.

Thanks. Can you talk about how the business model works through the channel? Are you recognizing revenue as the new tablets go into the channel and when they're sold through and maybe further, if you could give any commentary on potential expectations of revenue for such product in the back half of this year?

So great question. Each of our channel partners will have their own unique agreement. Our goal is to enter into an agreement that would allow us to recognize revenue as we ship. So that we can reduce the amount of work later in determining how much it's sold through. Should an agreement work in another way, we would have to coordinate, but we would be looking for that type of distribution partner to report swiftly and quickly, and not hold too much inventory at any one time, so that we’re pretty close to an on-ship, on-ship-out kind of arrangement. With regards to the back half of the year, as I can quote our CFO, Bob Tirva, we don’t give guidance for the future, even on kind of a particular unit basis, but our Q1 sales of the RS80 have gone very well. We believe by the end of this month, we will have shipped out all that we have been able to manufacture. And then we’re looking to ship both the RS60 and RS80 for Q2.

Okay. I have two related questions about the Sonim Scan. First, what are some of the unique features of this software? Second, is there a possibility for a recurring revenue stream associated with Sonim Scan?

Well, on our XT8, we have a recurring revenue from Sonim Scan, which is a camera capture-based technology. With the rollout of actual barcode scanners, it’s intrinsic to the functionality of the device. So, basic barcode scanning is not a revenue stream for us, because they need to function as a swipe. But Sonim Scan is tied into the entire suite of SonimWare products, which is how we expect to create loyalty and be the preferred manufacturer for any new customers. In Sonim Scan, we’re offering them Sonim SOS. We’re offering tools that help them with centralized deployment. We expect that the ease of use of our software and managing what would hopefully be thousands of devices in the field will make us the go-to choice time and time again for all of their products.

Okay, great. Thank you. And then last question is I believe you’re introducing these new products that are pretty disruptive price points relative to what might be out there from Zebra or someone else. Is that the strategy going forward or do you – is that more of an entry pricing strategy?

Well, no, I mean, what we saw as an opportunity here is that we could be product-design differentiated as well as price differentiated on a permanent basis. Therefore, it’s not just sort of a short-term thing. We believe that we’ll be able to be in this space and be successful long-term.

The next question is from Martin Yang with Oppenheimer. Please go ahead.

Hi, good afternoon. Thanks for taking my question. Can you maybe talk about how, on a like-for-like basis, how does the ODM model provide operating savings for you? And does it allow you to address new verticals in the future more effectively when the opportunity arises?

That’s a great question. The biggest difference is in our ability to variabilize our costs of production. We can produce one unit or we can produce 100,000, and the price from the ODM is appropriate to one unit or 100,000 units. So, when we have over/under-capacity quarters, we’re not going to experience the variability in our manufacturing costs that we’ve seen in the past. Additionally, when we work with an ODM, we rely on their supply chain. The larger ODMs are working with numerous other product companies, and just as an example, FIH makes cell phones for other people; therefore, we can lean upon their larger purchasing in their supply chain to attain lower costs on our devices than we could ever achieve with our own purchasing internally.

Yes. I would just add that the same goes on the R&D side. So, we have currently a small spike in R&D spending because we are working with our ODMs to expedite new product launches. Once those products are out in the market, that spending will reduce. In the past, the company relied on staffed employees within the organization, and you would continue to incur those costs, maybe supplementing with contractors when you’re rushing to get a new product out, but at the end of the day, you still carried the base cost. That won’t be the case for us going forward as much other than with the key resources that we keep to differentiate our products in key areas.

Yes. And I think you had a second part to your question, which was how does this impact product expansion? And that’s really where having ODMs does help; when trying to manage everything in-house, we’re limited by the number of engineers we have or can hire, and you create inefficiencies around having to hire people that might not be fully utilized. By working with ODMs, we can work with multiple partners. We’re doing that now. We can collaborate with ODMs who are specialists in their field and further enhance the excellence of the products that we come up with.

Great. So, a follow-up on that: can you maybe describe the costs associated with new products being developed with ODM? Bob mentioned that there could be a temporary spike when you try to accelerate certain product developments. Are the costs characterized in a way that you will incur a more significant outlay at the beginning of the project, and then share the costs with your ODM partner? Or are the cash flow characteristics of the R&D in the ODM model more regular, more spread out throughout all the projects?

I’ll let Bob address the timing, but the overall theory, and what we’ve consistently experienced, is that the ODM’s cost of development is much less in total than our internal costs would be. Part of that is their own efficiencies and part of it is that they invest into the product development themselves. Therefore, we're not necessarily incurring the full cost.

As far as timing goes, it really depends on the specific project. We hope to establish smoother operations where we’re getting one product out to market just as we start to develop the next one instead of multiple products simultaneously. This would create a more regular cadence of development and launch compared to the spikiness we might see at the moment.

Got it. Makes sense. My last question is on your geographic expansion. Can you maybe highlight a couple key milestones we should watch for, for the rest of the year, and also address if there are any potential regional competitors you expect to encounter and how you plan to differentiate against those regional competitors, especially in Europe?

Sure. Probably the first thing that you can watch for is our continued addition of regional partners in the form of resellers and distributors. That's sort of where things start. I mean, I don't think you're going to see us announce new hires, but we do have hiring underway. We have two sales professionals in Great Britain right now and will be expanding. Ultimately, I mean—we will be reporting our revenues regionally for everyone to be able to see the progress. It is new territory for us in a lot of ways. We're going to get started, and we have sales now into Europe that we've recorded in Q1. So everything is looking very promising. As far as competitive counts, there are differences in various regions. The North American product regime is a lot stricter than those in any other part of the world regarding the quality of our devices. We believe that our U.S.-based branded products will be seen as a premium product worldwide, including Europe. There are numerous small competitors globally, but they are generally less visible in the United States unless marketed as unlocked products on platforms like Amazon. However, we're not a consumer product; we are selling to businesses, and these products are bought as much as they are sold. We believe our partners will help identify large-scale opportunities, and our product differentiation will be clear; they are truly more rugged and functional than any competitors we might encounter. We are confident that with the right opportunities, we will be successful outside of North America.

Great. Thank you.

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 our call today. We will be participating in a number of investor conference events throughout the year and will announce these by press release as they occur. If any of you would like to arrange a call with management, please reach out to Matt Kreps and Darrow Associates; his contact information is listed on our press releases. We would be happy to arrange a phone call if needed. Thank you.

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