Soundthinking, Inc. Q1 FY2023 Earnings Call

Good afternoon, and welcome to SoundThinking's First Quarter 2023 Conference Call. My name is Ali, and I will be your operator for today's call. Joining us are SoundThinking's CEO, Ralph Clark, and CFO, Alan Stewart. Please note that certain information discussed on the call today will include forward-looking statements about future events and SoundThinking's business strategy and future financial and operating performance. 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 SoundThinking's SEC filings, including its registration statement on Form S-1. These forward-looking statements reflect management's beliefs, estimates, and predictions as of the date of this live broadcast, May 9, 2023, and SoundThinking undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. Finally, I would like to remind everyone this call will be recorded and made available for replay via a link available in the Investor Relations section of the company's website at ir.soundthinking.com. I would now like to turn the call over to SoundThinking's CEO, Ralph Clark. Sir, please proceed.

Good afternoon, and thank you for joining our Q1 2023 quarterly conference call and our first public earnings call as SoundThinking. We're very excited about our rebranding effort and the positive response we've seen from prospects, clients, partners, employees, and many of you, our investors. As I pointed out in my recent investor letter, our corporate rebrand is an intentional effort to signal the next phase of our growth journey as a platform play that not only includes the world's leading acoustic gunshot detection offering but also other complementary and adjacent solutions as well. The SafetySmart platform is focused on digitizing and automating manual law enforcement processes and converting data into actionable intelligence. Digital transformation will help accelerate law enforcement agencies of all sizes to be more efficient, effective, and equitable in co-producing public safety outcomes. We believe the opportunity remains extremely attractive and significantly underpenetrated. And our go-to-market strength as a trusted advisor uniquely positions us to bring additional relevant capabilities that address the pressing needs of law enforcement agencies throughout the world, not only today but in the future. Turning to financial performance, our Q1 2023 revenues were mostly in line with our expectations with $20.6 million compared to Q1 2022 elevated revenue of $21.2 million due to some material catch-up revenue from our LEEDS division. Adjusted EBITDA was $2.9 million or 14% of revenues compared to $4.5 million or 21% of revenues for Q1 2022. Again, this was primarily driven by the catch-up revenue from LEEDS in Q1 2022 that mostly flowed to the bottom line. We went live in 6 new cities and delivered 8 expansion projects with the ShotSpotter solution this quarter. This included approximately 22 miles of Detroit going live within the quarter, placing them as our third largest ShotSpotter deployment with approximately 30 square miles total. We currently have over 80 contracted miles represented by 22 projects in the process of being deployed over the next 3 months plus, including 22 miles of the recently contracted Suffolk County and a modest expansion in Cape Town, South Africa. Speaking of Cape Town, South Africa, we held a very successful press conference with the Mayor, Hill-Lewis, and Alderman JP Smith, who is responsible for the security portfolio for the City of Cape Town. And as fate would have it, during the Q&A session, a ShotSpotter alert came in where the assembled press had the opportunity to view livestream CCTV footage showing the tactical response to the scene within 2 minutes of the alert. The on-scene investigation led to 2 arrests, and we subsequently learned that those arrested individuals were on the lam for prior murder charges. We believe this extremely positive showing and press coverage has created strong momentum to drive discussions around a much-needed and larger expansion opportunity in Cape Town. Just yesterday, the mayor of Cape Town publicly presented his budget request that allocates more budget dollars for additional ShotSpotter expansions, along with other technologies that will help improve public safety. We continue to build a strong pipeline of our investigative solutions, CrimeTracer and CaseBuilder that we feel very good about. The large Department of Corrections opportunity that we have discussed in previous calls has made another substantial positive step forward with a statement of work, cloud agreement, and service level agreement contract elements all having been formally negotiated and documented. This is expected to be a $16 million 5-year deal that includes professional services work and delivery, along with an annual subscription and support fee. Given the size and complexity of the deal, we have been very intentional on ensuring the expectations and risk allocation were fairly negotiated and properly documented. The proposed contract is now in the process of getting formally registered within the Office of Management and Budget, OMB, as a part of this particular customer's procurement process. We hope to be able to publicly announce the execution of this agreement by our Q2 2023 earnings call. We're also very pleased to report that we had no reported attrition despite the significant press coverage of the recent Chicago mayoral election that led to the election of Brandon Johnson. Our ShotSpotter deployment represents $8 million of annual recurring revenue, and the contract was recently extended through mid-February of 2024 under the current Mayor Lightfoot's administration. We have taken measured steps to shore up our support among the city council, the Chicago Police Department, and residents, and we're encouraged with the more recent public position of Mayor-elect Johnson, where he proposes a view that, 'there might be better uses for funds currently going to ShotSpotter.' This pivots the public discourse around the value discussion, and we are well equipped and experienced in having to articulate and demonstrate our value. To date, we've been very successful on this front, which is indicated by our high overall retention rate. That being said, we felt we needed to adjust for a potential risk of cancellation of the contract before the end of its contracted term in February of 2024. That adjustment, combined with some recent contract renewal and payment issues in Puerto Rico, have led us to reduce our full year's revenue guidance to the range of $92 million to $94 million. We still expect that our full year adjusted EBITDA margin will be in the range of 24% to 26% of revenues. And with that, let me turn the call over to Alan.

Thank you, Ralph. We're pleased with our performance in the first quarter. As Ralph mentioned, this quarter, we went live with our ShotSpotter gunshot detection solution in 6 new cities, expanded our ShotSpotter coverage in 7 cities and 1 university. We also added 2 new CaseBuilder customers and added a new state agency for our CrimeTracer solution. Revenue is relatively flat from Q4 to Q1, which is partially explained by some significant catch-up revenue related to a couple of renewals in the fourth quarter of 2022. We had no attrition this quarter. That said, we are experiencing a delay in our renewal with Puerto Rico that ended at the end of 2022. While we expect a renewal to ultimately get awarded, the annual revenue of the Puerto Rico deployment is over $2 million, and our revenue will be negatively affected if they are not permitted to start the new renewal on the original due date. Let me provide more details on the quarter, and then I will share some thoughts around the balance of the year. First quarter revenues were slightly behind expectations at $20.6 million. Revenue is less than Q1 of 2022 primarily due to onetime catch-up of approximately $2.4 million from our LEEDS subsidiary that was recognized in Q1 of 2022 versus the expected Q4 of 2021. Without that onetime increase, our revenue for the first quarter of last year would have been approximately $18.8 million, resulting in this year's revenue being approximately 10% higher than Q1 of 2022. The additional $2.4 million of revenue in Q1 of last year also positively affected gross margin, net income, and adjusted EBITDA as it had only about $600,000 of associated costs. You will see those impacts as I cover the rest of this year's financials versus Q1 of last year. Gross profit for the first quarter of 2023 was $11.3 million or 55% of revenue versus $12.9 million or 61% of revenue for the prior year period. As noted, gross margin for the first quarter of 2022 benefited from the additional $2.4 million in revenue. We expect gross margin to improve throughout the rest of this year. Our adjusted EBITDA for the first quarter of 2023 was $2.9 million, down from $4.5 million in the first quarter of 2022. As a reminder, adjusted EBITDA, a non-GAAP financial measure, is calculated by taking our GAAP net income and adding back interest income, income taxes, depreciation, amortization, stock-based compensation expenses, and acquisition-related expenses. Turning to our expenses, our operating expenses for the first quarter were $13.1 million or 64% of revenues versus $12.5 million or 59% of revenues in the first quarter of 2022. Operating expenses increases were primarily related to higher headcount and employee-related costs. Breaking down our expenses, sales and marketing expense for the first quarter was $5.8 million or 28% of total revenue versus $5.6 million or 26% of total revenue for the prior year period. Our sales and marketing teams continue to build our sales pipelines and expand our marketing efforts. We also continue to focus on maintaining high levels of customer satisfaction, which helps keep our attrition rates low. Our R&D expenses for the first quarter were $2.7 million or 13% of total revenue versus $2.6 million or 12% of total revenue for the prior year period. We continue to invest in increasing the functionality of all of our products. G&A expenses for the quarter were $4.6 million or 22% of total revenue compared to $4.3 million or 20% of total revenue for the prior year period. G&A expenses were higher due to headcount increase and other employee-related costs. We expect our G&A expenses will continue to increase in absolute dollars as the company grows. Our adjusted net loss for the first quarter was $1.8 million or $0.15 per share loss based on 12.3 million basic and diluted weighted average shares outstanding. This compares to adjusted net income of $488,000 or $0.04 per share based on $12.2 million basic and 12.3 million diluted weighted average shares outstanding for the prior year period. Adjusted net income, a non-GAAP financial measure, is calculated by taking our GAAP net income and adding back acquisition-related expenses. When accounting for acquisition-related expenses, our GAAP net income was $387,000 or $0.03 per share basic and diluted for last year's quarter. Deferred revenue at the end of the quarter was $37.5 million versus $43.7 million at the end of the fourth quarter of 2022, and the decrease was primarily related to the timing of renewals and related billings. We ended the quarter with $5.1 million in cash and cash equivalents versus $10.5 million at the end of the fourth quarter of 2022. The decrease is primarily related to $1.5 million paid to the LEEDS sellers for achievement of their 2022 earnout and payment of 2022 company bonuses during the quarter. During the first quarter, we also repurchased 35,369 of our shares at an average price of $35.43 or approximately $1.3 million. As of today, we have approximately $10 million in cash. We have no short or long-term debt outstanding. And as previously discussed, we possess approximately $25 million available in our line of credit if ever needed. Turning to our full year 2023 outlook, we are reducing our full year 2023 revenue guidance to a range of $92 million to $94 million, representing approximately 15% year-over-year growth at the midpoint compared to 2022, primarily related to the delay in our ShotSpotter renewal with Puerto Rico and also factoring in any potential risk of a change to our Chicago contract before the current end date of February 2024. We are reaffirming our expectation for adjusted EBITDA to be approximately 24% to 26% of forecasted revenue in 2023. Now back to Ralph for some final thoughts, and then we'll be happy to take your questions.

Thank you, Alan. We want to publicly acknowledge the tragic sacrifice of Chicago Police Officer, Areanah Preston. Our thoughts and prayers go out to her family and the Chicago Police Department. She wanted to help make the world a better place and do work that matters. We'll now open it up for your questions.

Our first question is coming from Brian Ruttenbur with Imperium Capital.

You talk about adjusted EBITDA being maintained in the 20s. Is there something that happened in the first quarter where you're going to make up that core or that underperformance in terms of adjusted EBITDA in the second, third, or fourth quarters to make up for that delta?

Yes. This is Alan. I'll go ahead and start, and then Ralph, you can add as well. Well, we have had a little bit of reduction in terms of the first quarter revenue related to Puerto Rico. That is still costing us in terms of depreciation. Hopefully, that will get improved as we go forward. The other thing, though, is we've already added costs significantly to our sales and marketing, R&D, and G&A already through the first quarter. We're not going to need to add a significant amount of any of that for the rest of the year. So as revenue continues to go up as we hit closely to our revenue guidance, the operating expenses are going to be relatively flat, although up a little bit. All of that is going to increase our adjusted EBITDA.

Great. Will it be weighted then just a follow-on weighted to the third and fourth quarters? Are we going to see a dramatic improvement in second quarter versus first quarter? How should we be thinking about that adjusted EBITDA margin expansion?

Yes, great question. It is more weighted than the third and fourth quarter primarily, although we are going live in a lot of miles. That's going to help us. The majority of the revenue increase is most likely going to come in the third and fourth quarter, especially as we get the Department of Corrections contract that we'll talk about potentially more in the Q&A finally exercised and ramping up.

Our next question is coming from Richard Baldry with ROTH MKM.

Maybe to follow up on that then. On the Department of Corrections deal as it sits today, can you talk about the types of deliverables, timings, deployment cycles, things like that, that would help us understand sort of what that revenue recognition would look like, whether it's equal weighted, annually, front-end loaded on implementation, back-end loaded on recognition. Just so that we have an idea of how you expect that to play out over a multiyear period.

Do you want to take that, Alan?

Yes, sure. So this is Alan. I guess the good news is, as we've said the last couple of quarters, the total amount has continued to increase. We know that at this point, the contract will be approximately $16 million, which is the highest we've mentioned before. Out of that, there's approximately $6 million of that, a little bit more than $6 million, which is professional services. It's a 5-year contract, but those professional services we expect will be complete within the first probably 2 to 2.5 years. So that will ramp up relatively quickly. We think that will add a significant amount of revenue for us in Q3 and Q4. The remaining balance of the $16 million, which is basically $9 million as a subscription, that is a little lower in year 1 and then almost doubles in year 2, 3, and 4 and 5.

Great. And on the Puerto Rico renewal, you had a history of sometimes these things push out. Is there anything unusual about this renewal negotiation process that makes you think it's more risky than others? Or is it really just a matter of timing, getting right documents in the right place?

Yes, this is Ralph. I'll take that one. Sorry, do you want to go, Alan?

Go ahead, Ralph.

Yes. So I think this does represent a slightly different risk profile because, in this particular case, the comments that are being made by the customer are that even if they were to renew, and we have every expectation that they will renew at some point in time, they might have a difficult time going back retro to compensate us for the services we delivered to date. And so that's the reason that we're making the adjustment that we are. Typically, customers, even though they might renew late, we always are able to kind of go back and start the term at the point in time that the contract in that even though they renewed 3 or 4 months later. And that's what kind of represents some of that lumpy catch-up revenue from time to time we experienced. We're going to be negotiating pretty hard with Puerto Rico and making sure that we're going to be compensated for services that have been delivered as of the beginning of this year.

Yes. So that I guess creates one question, which is if they were to pay for that, do you think, in the future, you've got to build a contract that's got firmer terms around, if deals aren't concluded on time, you have to actually cancel the service immediately so that you're not left in a position where you've been providing a service that's not compensated for, maybe play a little harder ball with these people.

Yes. So I mean I think this is a fairly unusual conversation. We haven't confronted this before. And it's still yet to be resolved. So I think we're not giving up on it just yet. I think it's going to be a matter of negotiation. But to be very clear, if the customer chose not to renew and then obviously not compensate us for the services that we've already delivered, that's a $2 million hit to us. It represents about $2 million of ARR and because the contract term was to start at the early part of this year, it would represent $2 million of GAAP revenue that sits at risk.

Our next question is coming from Jeremy Hamblin with Craig-Hallum.

I wanted to clarify the components of the revenue guidance for the year. To reach the midpoint of your guidance for the rest of the year, it looks like it's around $24 million per quarter for the second, third, and fourth quarters. You mentioned that approximately 30 contract miles are expected to go live in the second quarter. Assuming the typical run rate of about $75,000 per square mile, that would translate to around $2.25 million annually. I'm trying to determine if the guidance includes catch-up revenue for Puerto Rico, and what assumptions are made regarding the $16 million five-year deal in the 2023 guidance.

Yes. Great question. This is Alan, and I'm happy to respond. If you look at our performance in the first quarter and simply multiply that by four, you arrive at approximately $82.5 million in revenue. I can say that the additional GAAP revenue we anticipate from go-live miles this year will be over $4 million more. You can do the math yourself and see how well things are progressing with new miles. In the Department of Corrections, we expect several million in revenue. When you combine all of this, you get very close to $90 million. The remainder includes items such as international expansions, Forensic Logic expansions, CaseBuilder expansions, and LEEDS expansion in terms of additional professional services we anticipate. Moreover, we will be generating some new revenue this year from our labs. Adding all this up makes it straightforward to reach our guidance.

Got you. That's helpful. And then the other question I wanted to follow up on was a follow-up here around gross margin. And it sounds like you're going to see a much bigger ramp in the second half of the year. Just in terms of thinking about kind of the current run rate, in the last few quarters, we've been kind of more in that mid-50s gross margin range. Can you just help walk us through in terms of thinking about that level versus kind of the high 50s level? And I think you're probably looking in like the 59% range for the year, which would imply back half got to get to like 60% plus. But I was hoping for a little bit more color around that.

Sure. This is Al, and I'll provide some information. Ralph can add as well. First off, the actual gross margin for Q1 was slightly lower due to increased depreciation and maintenance and repair costs that were primarily one-time expenses related to last year's 3G replacements. We needed to catch up on some maintenance and repair costs, which were one-time in nature for Q1. As a result, gross margins should improve with that alone. Additionally, we are experiencing some increased costs, partly due to the hiring of staff in anticipation of revenue growth. Some of these costs affect the cost of goods sold related to customer success and various operational allocations. We strongly believe our gross margins will improve, especially by Q3 and Q4 when additional revenues come in, and we have already hired the necessary personnel for that.

I understand. That's helpful. One last thing, you mentioned briefly that you repurchased about 35,000 shares. What was the average price per share for that? Also, what is your current cash balance and how do you plan to allocate that capital moving forward?

Yes. Great question. It was a little over $35 per share, so a little north from where we are now. But even after doing that, paying bonuses and paying out the LEEDS earnout that they earned, we still ended the quarter slightly north of $5 million in cash. Today's cash balance is actually close to $10 million. So we continue to do very well in terms of cash. I would say that the Board did approve a $25 million share repurchase. Historically, we've looked at what the market has thought about our stock, and it would not be surprising if we did use some of that to repurchase more shares.

Our next question is coming from Jaeson Schmidt with Lake Street.

I'm curious if the situation with the Department of Corrections contract and the delay in Puerto Rico means that this year's timing does not adhere to the usual seasonal patterns. Do you believe that's the case this year?

Yes, this is Alan. I can definitely say that. Last year was somewhat unusual, particularly in the first quarter, as we had $2.4 million that should have been recognized in 2021 if the contract had been finalized on time. Consequently, 2022 appeared to be relatively flat throughout the year. However, in 2023, we anticipate a different trend. This year, we expect to see a consistent increase in revenue throughout the quarters, with a significant rise expected in the third and fourth quarters.

Okay. That's helpful. And apologize if I missed it. But how should we think about OpEx trending the remainder of this year?

Yes, this is Alan again. Well, we have been investing significantly in sales and marketing for basically the last 2 years. We still are adding some costs related there for things that are wise. R&D this year, it will go up a bit because we are adding more capability in terms of personnel, particularly related to having 4 software products now, although it's not going to be significant. G&A will go up a bit but should be relatively flat as well. So I mentioned earlier that we have already invested in all 3 of those categories. So even though they are going to go up a bit, they're going to go up less than the amount of revenue continues to go up.

Our next question is coming from Willow Miller with William Blair & Company.

Just a clarifying question first. How much of the guidance revision to revenue is driven by Chicago versus Puerto Rico? I know you mentioned Puerto Rico could be as much as $2 million if that contract is not renewed. So any color there would be really helpful.

Yes. This is Ralph. I'll address that. The total exposure, if Chicago were to cancel a contract around July 1, despite being contracted until mid-February 2024, and if Puerto Rico were to neither fully renew nor reconcile the services we've provided previously, would expose us to about $6.4 million in GAAP revenue. We assess the risk collectively, estimating approximately $2 million of cross-border exposure. It's not helpful for us to analyze it individually, so we consider all risks together. We don't believe the exposure is zero, nor do we think it's the full $6.4 million, and we determined that a risk-adjusted figure of $2 million is more accurate.

Okay. That makes sense. And then my next question is, last quarter, you called out strong performance in the Tier 4 and Tier 5 cities just based on one salesperson, and you were looking to expand. How is that initiative going? And do you believe you can expand beyond the 4 reps that you called out previously?

Yes, that's a great question. We've made significant progress in this area. Currently, we have three representatives who are fully dedicated to Tier 4 and Tier 5. As you may have heard during this call, we've successfully onboarded six new customers, which is quite an achievement. The cities involved include Cleveland, Ohio; Hawaiian Gardens; Holyoke; Manchester; and Palatka, Florida. Additionally, during our expansions, some Tier 4 and Tier 5 customers have increased their initial commitments. This initiative is progressing very well. We've previously mentioned the shorter sales cycles in this segment, and we're excited about it. We're also eagerly looking to add a fourth sales representative to complete our team for Tier 4 and Tier 5.

At this time, this concludes our question-and-answer session. If your question was not taken, you may contact SoundThinking's Investor Relations team by e-mailing ssti@gatewayir.com. I will now hand it back to Mr. Clark for any closing comments he may have.

Great. Thank you very much. Just very excited to be in this opportunity space. We know we're making a difference, and thank you all very much for dialing in and asking some really good questions about the business. Looking forward to the one-on-one calls here in a bit.

Thank you. This does conclude today's call. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation.