Smith Micro Software's CEO Discusses Q3 2011 Results - Earnings Call Transcript

| About: Smith Micro (SMSI)

Smith Micro Software, Inc. (NASDAQ:SMSI)

Q3 2011 Earnings Call

November 2, 2011 4:30 PM ET

Executives

Charles Messman – President, MKR Group, Inc.

William Smith – Chairman, President and CEO

Andrew Schmidt – CFO, Secretary and VP

Analysts

Jason North – Jefferies & Company

Scott Sutherland – Wedbush Securities

Charlie Anderson – Dougherty & Company

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Smith Micro Third Quarter Earnings Conference Call. During today’s presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) Today’s conference is being recorded November 2, 2011.

I would now like to turn the conference over to Charles Messman of MKR Group. Please go ahead.

Charles Messman

Good afternoon and thank you for joining us today to discuss Smith Micro Software’s third quarter ending September 30, 2011 financial results.

By now you should have received a copy of the press release discussing our quarterly results. If you do not have a copy and would like one, please visit www.smithmicro.com or call us at 949-362-5800 and we will immediately e-mail one to you.

With me on today’s call are Bill Smith, Chairman, President and Chief Executive Officer; Andy Schmidt, Vice President and Chief Financial Officer; and Tom Matthews, Senior Vice President and Chief Strategy Officer.

Before we begin the call, I want to caution that on the call, the company will make forward-looking statements that involve risks and uncertainties, including without limitation, forward-looking statements related to the company’s financial prospects and other projections of its performance, the company’s ability to increase its business, and the anticipated timing and financial performance of its new products and potential acquisitions.

Among the important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements are changes in demand for the company’s products from its customers and their end-users, new and changing technologies, customer acceptance of those technologies, new and continuing adverse economic conditions, and the company’s ability to compete effectively with other software companies. These and other factors discussed in the company’s filings with the Securities and Exchange Commission, including its filings on Form 10-K, 10-Q, and 8-K, could cause actual results to differ materially from those expressed or implied in any forward-looking statements.

The forward-looking statements contained in this conference call are made on the basis of the views and assumptions of management regarding future events and business performance as of the date of this conference call, and the company does not undertake any obligation to update these statements to reflect events or circumstances occurring after the date of this release and conference call.

Before I turn the call over to Bill Smith, Chairman, President, and CEO of Smith Micro, I want to point out that in our forthcoming prepared statements, we will refer to certain non-GAAP financial measures. Please refer back to our press release disseminated earlier today for reconciliation of the non-GAAP financial measures.

With that said, I’ll now turn the call over to Bill. Bill.

William Smith

Thanks, Charles. Good afternoon, everyone, and welcome to our third quarter ending September 30, 2011 earnings conference call.

Revenues for the quarter were $12.6 million with approximately $10.2 million coming from our wireless products and $2.4 million resulting from our productivity in graphics product line. Non-GAAP gross profit was $10.2 million for the quarter with gross margins up 81%.

As indicated in our preliminary announcement on October 13, we’ve recorded a charge for impairment of goodwill and other live – other long-lived assets of $112.9 million and net deferred tax asset allowance of $11.4 million. Excluding these one-time non-cash charges, non-GAAP net loss for the third quarter was approximately $9.7 million.

Clearly, we are disappointed in these results. The growing trend to access the mobile Internet through smartphones and tablets has affected our connection management software business much quicker than we had anticipated. Consumers are rapidly transitioning to smartphones devices with an embedded hotspots or mobile hotspot pucks for accessing mobile broadband services. These form factors have begun to overtake USB and embedded wireless modems as a primary means of connecting to the wireless data networks.

The accelerating rate of change in this technology transition has been the primary driver for the pressure on our revenues. We are delivering new products to capitalize on this transition and I will discuss the initial market response to these products later on this call.

We are also keenly focused on dramatically lowering our cost structure and changing our operational approach to meet new market reality in order to get back to profitability as soon as possible. We have already made good progress with a number of cost reductions and we are accelerating our efforts to restructure our operations to a significantly leaner and lower cost organization. I will get into both our restructuring efforts and new product initiatives in greater detail after I turn the call over to Andy, who will take you through the details of the financial results. Andy?

Andrew Schmidt

Thank you, Bill. First, let me go over our customary introductory items.

As we have in past quarters, we have provided non-GAAP results and a reconciliation of non-GAAP and GAAP results. The non-GAAP results discussed on this call net out amortization of intangibles associated with acquisitions, stock compensation-related expenses, and non-cash tax expense to provide comparable operating results.

In addition, our non-GAAP results net out goodwill and long-lived asset impairment charge that we took this quarter and the reserve allowance established for our net deferred tax assets both of which are non-cash items.

For both 2011 and 2010, I will focus on non-GAAP amounts. Our earnings release which will be furnished to the SEC on Form 8-K contains a presentation of the most directly comparable GAAP financial measures and a reconciliation of the difference between each non-GAAP financial measure provided in the press release, and the most directly comparable GAAP financial measure. The earnings release can also be found in the Investor Relations section of our website at smithmicro.com.

Before I begin with our non-GAAP operating results, I want to talk briefly about goodwill and long lived asset impairment charges. As a result of our declining revenues, declining stock price and other triggering events as per generally accepted accounting principles, we will require to test for asset impairment in Q3.

We engaged a third-party valuation firm to provide the impairment analysis and based on a step one and step two impairment test concluded that an asset impairment had occurred. As of the end of Q3, we have impaired all of our goodwill of $94.2 million, all of our intangible assets of $13.4 million and $5.3 million of our fixed assets for a total one-time non-cash charge of $112.9 million. In addition, the one-time non-cash charge to create a reserve allowance against our net deferred tax assets was $11.4 million.

Please refer to our upcoming third quarter 10Q for a complete accounting discussion of our impairment charges. Continuing with our operating results, in detailed manner for the financial modelers, let me provide the difference between GAAP and non-GAAP P&L metrics.

In terms of stock compensation, stock comp totaled $1.3 million for the current period broken out as follows; $5,000 for cost of sales, $378,000 selling and marketing, $170,000 R&D and $748,000 for G&A. In terms of amortization, the total for the current period was $2 million broken out as follows; $1.26 million for cost of sales, $707,000 selling and marketing and $62,000 for R&D. Going forward, there will no longer be amortization of intangibles as these assets have now been a 100% impaired.

Moving on, for the third quarter, we posted revenues of $12.6 million and a loss of $3.76 per share GAAP and $0.27 per share non-GAAP. Revenue for the quarter compares to $34 million for the same period last year. International revenue was approximately $1.7 million this quarter across all business groups.

For 2011, we are reporting revenue as Wireless and Productivity & Graphics. Our Wireless segment reported revenues for the quarter of $10.2 million as compared to $31.3 million last year. Our Productivity & Graphics segment posted revenues of $2.4 million as compared to $2.6 million last year. Total deferred revenue at September 30, 2011 was $642,000.

Switching to gross profit, non-GAAP gross margin dollars of $10.2 million compares with $31.8 million during the same period last year. Non-GAAP gross margin as a percentage of revenue was approximately 80.7% for Q3 2011, compared to 93.5% for Q3 of 2010. The reduction in gross margin is due to lower sales volume covering fixed maintenance and support expense. Non-GAAP gross margins by segment were as follows: Wireless, 81%; Productivity & Graphics, 79%.

Switching to operating expenses, non-GAAP operating expenses for the third quarter of 2011 was $21.9 million, which includes restructuring expenses of approximately $1 million. Netting out restructuring expense, total non-GAAP operating expense was flat year-over-year. Restructuring expense for the period was primarily related to the shutdown of our Chicago facility.

From a year-on-year perspective, non-GAAP engineering expenses increased 1%, selling and marketing expense decreased 9% and administrative expense, which includes our cost of facilities increased 9%.

We expect restructuring expenses in the fourth quarter of 2011 to be approximately $2 million to $2.5 million. These charges will be primarily for severance costs which are estimated at approximately $1.5 million to $2 million. Of the total charges, all but approximately $400,000 will be cash expenditures incurred in the fourth quarter.

Non-GAAP operating loss for Q3 was $11.8 million, as compared to an operating profit of $10.9 million in Q3 of 2010. Non-GAAP net loss for the third quarter was $9.7 million or $0.27 per share, as compared to $7.9 million or $0.23 per share profit last year.

From a balance sheet perspective, our cash position closed at $54.1 million at September 30, 2011, a decrease of $18.5 million from the beginning of the year primarily due to investment in capital equipment to build out our data centers and our operating losses. Net working capital at the end of the quarter was $60.6 million.

In terms of housekeeping, we expect to file our quarter end 10-Q this week which will represent our final financial statements for the period.

At this time I’ll turn the call back to Bill.

William Smith

Thanks Andy. Our top three carrier customers Verizon, AT&T and Sprint collectively contributed 57% of our revenue in Q3. Each of these customers represent 10% or more of our quarterly revenue on an individual basis. While revenue for our least key customers is down materially from levels a year ago, we are engaged in several opportunities to help these customers with their own transitions.

There will be a long tail on the USB and embedded connectivity business as technologies and opportunities to support new devices and methods of connecting rapidly emerge. While we believe that our core connectivity business supporting mobile broadband modems and data services will continue to be around for quite a while to come, it is clear that new innovations and products will be the catalyst for increasing revenues with these customers, and that is where we are placing our effort.

We are in various stages of collaboration and discussion with each of these customers on new products such as Mobile Network Director, Experience Manager, Application and Policy Control, SODA and other initiatives. As a result, we are encouraged by the initial reaction and test results for many of our new product initiatives.

Our mobile network product which enables the carrier or its end users to move data session seamlessly across 3G, 4G and Wi-Fi networks, aims to address a critical market problem of data congestion on certain carrier networks. We are happy to say that we expect to have our Mobile Network Director solution into commercial deployment and generating revenue in the near-term. We believe this product has the potential to operate on millions of Android smartphones and handle data offload to Wi-Fi networks based upon policy criteria established by the operator and supported by our software.

We anticipate another Mobile Network Director trials to begin in Europe, Asia and the Americas early in 2012. We believe this product offers great value and we’re optimistic that these initial wins will become a springboard for additional deployments with other operators as they seek to more effectively handle data volumes and stitch together 3G, 4G and Wi-Fi network services.

We are also hearing from our customers that there is a need for an improved connected experience for users that are accessing network services from multiple devices including a smartphone, a tablet and a PC. Users want a consistent way of connecting across these different devices and have difficulty navigating the many different menus and applications provided by each platform. Additionally, carriers want to deliver a consistent way of connecting devices while capturing analytical data, providing improved visibility into data usage and presenting users with an easy way of accessing various carrier branded services.

Our Experience Manager product can deliver consistent connectivity, visibility and control across these different form factors while offering the carrier an improved way of marketing their services – service offerings to the end users in order to increase retention, build loyalty and drive revenues. We had our first win with this product last quarter, PT Bakrie, and we’re already seeing a demand there for added feature support such as hotspot management functions.

The work we have done on our product for Bakrie has led to increased proposal activity back in North America and a boost to interest in this product from several Tier 1 carriers around the globe. While our key customers in North America continue to be a primary focus of our revenue recovery efforts, the overall increasing global trends for mobile internet services has lead us to invest resources to participate in the growth opportunities emerging outside of North America.

Our traction has been developing over the past few quarters with a number of wins and we’re pleased to say that progress continues with two new wins with large carriers in India. We signed a master service agreement with Reliance Communications, India’s largest operator with over 100 million subscribers. We expect to launch our video platform as the first product with them in the first half of 2012. We have also inked a deal for enhanced connectivity experience with analytics with MTS India, another large carrier. This should being producing revenues in the first half of 2012.

Although our technology platform is flexible and it enables improved speed to market, we know that we have long sales cycles, extensive trial periods and potentially slow ramp times with every customer win. The evolution happening within our core product line coupled with a soft slow nature of the growing revenues from embedded software products in the wireless industry has caused us to execute significant cost reductions and improve the efficiency measures.

We are restructuring our operation while maintaining the appropriate support for the long tail on our current core connectivity business and while balancing the need to invest in future products. We began this process at the beginning of 2011 and accelerated our efforts last quarter and have been rationalizing head count, facilities, products and all expenses within the business.

Our quarterly non-GAAP operation expenses in Q3 were down some $1.6 million excluding restructuring charges over Q2 and we will continue to drive these numbers down to eliminate the cash burn. Over the course of Q4, we plan to further consolidate facilities, projects and teams eliminating overhead and salary expense in a click and decisive fashion.

This process is well underway and we anticipate Q4 operating expense levels to come down slightly from Q3 excluding restructuring charges with Q1 levels to be well under $20 million. As we complete this process and our restructuring cost are behind us, the current identified plan should result in quarterly non-GAAP operating expenses in the range of $17 million to $18 million starting in Q2 2012.

Our head count which was at a high watermark a few quarters ago of approximately 585 full-time equivalency including contractors will likely be under 400 when we have completed this process. With this ongoing cost containment – with these ongoing cost-containment efforts along with the revenue opportunities that we believe we can achieve, we intend to get back to profitability within the next three to five quarters. Of course, as the business, economic environment, and opportunities arise, we will make the appropriate adjustments and report back on our progress.

In closing, I am pleased to report that the Board of Directors has approved a buyback of up to 5 million shares of Smith Micro common stock in the coming quarters. The Board believe that the repurchase of company stock represented a positive investment opportunity and confidence in the future recovery of our business case.

Before I turn the call over for questions, I’d like to say – I’d like to close by saying that even though the shift in technology of our core connection manager businesses has come with a force and speed that no one had – could have predicted, we definitely see business as having a long tail that is certainly not going away overnight.

We recognize that it is often in times of technology transitions like what we are experiencing that new opportunities for innovative and disruptive solutions office – often surface. Our primary market, the wireless industry, is evolving and growing at an accelerating pace. We intend to keep evolving along with these changes, serve our customers better, and capitalize on the emerging opportunities unfolding before us.

With that, operator, I’d like to open the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Peter Misek with Jefferies & Company. Please go ahead.

Jason North – Jefferies & Company

Hi, thank you. This is Jason North for Peter Misek. Two questions; the first one is in terms of your new products coming out. How do you tier them in terms of revenue opportunity here in the next two to three quarters? And, secondly, what are you thinking in terms of free cash flow over the next couple of quarters? Thank you.

William Smith

Okay, let me take the first one, and I’ll let Andy try to grab the second one. As we look at the product line-up, we are looking at basically three strong areas of growth. One would be Mobile Network Director. The other would be Experience Manager which really is the outgrowth of where connectivity is heading as we move away from the connection management business. And, the third would be our access control for tethering. All three of these have great potential. Obviously, we can’t talk about the revenues right now but we’re hopeful that that’s where we can start to really grow our business back. I think that’s the best way to answer that.

Andrew Schmidt

Sure. And, Jason, as Bill referred to in his prepared remarks, we’re looking to be – get back to profitability in three to five quarters; that’s the limit of the guidance we’re going to give in terms of revenue or our cash flow or profitability. So, we’ll pass on the near-term free cash flow.

Jason North – Jefferies & Company

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Scott Sutherland with Wedbush Securities. Please go ahead.

Scott Sutherland – Wedbush Securities

All right, great. Thank you. First, Andy, a couple of housekeeping; what was your operating cash flow and CapEx in the quarter?

Andrew Schmidt

All right, let me give you that real quickly here. All right, so CapEx in the quarter was about $1.8 million; that’s primarily focused around our Visual Voicemail product that’s out in the market and Mobile Network Director product that’s the server based – has a server-based component that we’re preparing – that’s ready for market and we’re preparing for customer wins in that product. Free – and cash flow, you asked?

Scott Sutherland – Wedbush Securities

Yeah, operating cash flow.

Andrew Schmidt

Operating cash flow was use of cash about $5.8 million.

Scott Sutherland – Wedbush Securities

Okay. What’s your guy’s strategy going forward with CapEx. I know you’ve been doing some network resources for some of your services. Is most of that built out or do you have to have some more major investments on the CapEx side?

Andrew Schmidt

Most of that’s built out at this point. So, we don’t see significant CapEx; again, it’s going to be product-driven. If in fact we have some very significant wins again on the Visual Voicemail type products or the MND type products, Mobile Network Director, then we will build to scale, but at this point, we think we’re in very good shape for the upcoming quarters.

Scott Sutherland – Wedbush Securities

You look at some of the new products coming out for connectivity solutions, we’ve thought about the old USB or dongles in the mid-single dollars per unit. How should we think about the pricing models with these new products per unit?

Andrew Schmidt

It’s in single dollars but obviously at the lower end because you’re addressing a much broader market. You’re not only talking about PC users, but you’re talking about smartphone and tablet users. So, volume there is substantially higher and makes a big, big difference.

Scott Sutherland – Wedbush Securities

Okay. You’ve got this buyback in place and obviously at current levels, it’s less than $10 million over the next year. How do you balance the buyback with making sure that you have cash to invest in the new products and get back to profitability?

William Smith

That’s a good question and that’s why in my comment, I said that the Board when it considered this, looked at the investment quality of what we were about to do and also balance that with what we see as the recovery of the business going forward and based on that moved forward with the buyback.

Scott Sutherland – Wedbush Securities

Hey guys my last question, as you look back over the last year, start of the year you felt like it was more of an inventory issue, how much do you think that it was still inventory issue versus just the new dynamics of the connectivity moving to phones and tablets and other types of devices?

William Smith

Well, if there was – as we talked about an inventory issue that reflected the move to mobile hotspots of different types, so that the sales of USB devices just plain slowed down. We don’t see any inventory issue as we sit here right now. What we see is a market that has gotten a lot smaller and but will continue for some period of time and a new market opportunity going forward for different types of software.

Scott Sutherland – Wedbush Securities

Okay, thank you.

Operator

Thank you. (Operator Instruction) Our next question comes from the line of Charlie Anderson with Dougherty & Company. Please go ahead.

Charlie Anderson – Dougherty & Company

Yeah, good afternoon, thanks for taking my questions. I am just wondering when you guys are thinking about getting back to profitability I think if I am doing my math right, you’re going to assume you are over $20 million in revenue again to get there. What is your view on sort of the trajectory of the core business which is contributing at least a big chuck of the revenue still the Connection Manger business? Does that grow to get back up there or does that go down and you need a pretty large contribution from the new products to get there, any color on that would be helpful?

William Smith

Yeah, I think the way we try to phrase it is it’s a business with a long tail. It’s a business that we believe is in a mode where it’s stabilizing at a certain run rate and that that run rate can move out for a few quarters. It will over time decrease. In the meantime that’s why our focus on the new technologies; an effort that frankly we started to build a few years ago, and these products have now come into the marketplace. And so where you look at Mobile Network Director where we believe we can see deployment in the very near term. And then we have additional trials around the globe for Mobile Network Director that this is the type of product that will provide the elevator force to kind of move us back up. So I can’t argue with your basic analysis of what the sales level needs to be to return to profitability. It makes a lot of sense to me and that’s where we’re focused on, that’s what it’s all about.

Charlie Anderson – Dougherty & Company

What will be the biggest component in that +$8 million or so from where you’re today to get back to profitability, is it Mobile Network Director, would that be the nearest term opportunity to fill that gap?

William Smith

It’s the nearest term but there are, the other products Experienced Manager, Application Control so the video as we talked about with Reliance are all quality products that will step it up as well. We also have other products that are in our portfolio that we don’t necessarily focus on or talk about like the Push-To-Talk and maybe more importantly Visual Voicemail which is a very strong contributor to our business and a part of our business that’s getting larger not smaller. All these products can contribute to recovering from the revenue loss that we’ve experienced because our core business that being Connection Management has gotten a lot smaller.

Charlie Anderson – Dougherty & Company

Thanks for taking my questions.

William Smith

Sure.

Operator

Thank you. And I show no further questions in the queue at this time. I’d like to turn the conference back to management.

Charles Messman

Okay, I’d like to thank everyone for joining us today. Should you have any further questions please feel free to give us a call here at the office. Thank you and have a great day.

Operator

Ladies and gentlemen, this concludes the Smith Micro third quarter earnings conference call. Thank you for your participation. You may now disconnect.

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