2023-06-07 18:21:59 ET
Summary
- Smith Micro Software, Inc. reported Q1/2023 results largely in line with muted expectations but forecasted a return to profitability in Q3 following the completion of recent cost savings initiatives.
- Management expects AT&T to launch a new version of the company's family safety software in the third quarter.
- In addition, the company anticipates signing new customers for its ViewSpot product in the very near future.
- Investors should remain wary of ongoing dilution resulting from scheduled installment payments in newly issued common shares under the company's toxic convertible notes.
- With substantial cost savings expected already for the current quarter and an anticipated family safety software launch by AT&T in Q3, I am upgrading Smith Micro Software, Inc.'s shares from "Strong Sell" to "Hold". To become more constructive on the stock, a return to revenue growth and free cash flow cash generation would be required.
Note:
I have covered Smith Micro Software, Inc. ( SMSI ) previously, so investors should view this as an update to my earlier article on the company.
Last month, mobile communications software provider Smith Micro Software, Inc. or "Smith Micro" reported first quarter 2023 results largely in line with muted expectations:
On the conference call , management guided for Q2 revenues to be flat to down 4% on a sequential basis but forecasted margins to expand by up to 250 basis points.
Following the recent surprise contract termination by Verizon Communications ( VZ ), Smith Micro has started to right-size the organization as disclosed in the company's annual report on form 10-K (emphasis added by author):
On February 21, 2023, the Company received written notice of termination of a U.S. Tier 1 customer agreement for the Company’s family safety solution, effective June 30, 2023. Thereafter, the Company is obligated to deliver service under the agreement for a transition period of up to 180 days at the election of the customer. The agreement accounted for approximately 33% of the revenues of the Company for the year ended December 31, 2022. (...)
In response to this notification, the Company has been reviewing its cost structure and has begun taking steps to reduce its expenses. On March 13, 2023, the Company began making workforce reductions by executing terminations in the United States and Portugal. On March 14, 2023, the Company announced the planned closure of its Slovakian operations, effective June 30, 2023. On March 17, 2023, the Company notified employees in Serbia that certain positions were being eliminated. In the aggregate, these actions will result in a reduction of approximately 26% of the Company’s total global workforce .
Management expects to achieve its goal of $4 million in quarterly cost savings (as compared to Q4/2022) in the current quarter.
In the press release, CEO William Smith provided a constructive outlook for the remainder of the year:
Looking ahead we remain very positive and excited about our Fiscal 2023. We expect a new launch with one of our Tier 1 carrier partners on the SafePath ® platform, and our sales pipeline in both the U.S. and European markets is growing nicely for both our SafePath and ViewSpot ® platforms, building momentum as we look at the remainder of our fiscal year.
On the conference call, management stated expectations for customer AT&T ( T ) to launch a new version of the company's family safety software in the third quarter.
In addition, the company expressed optimism with regards to its ViewSpot product:
We are seeing a significant opportunity to expand our ViewSpot business and anticipate that our business development efforts will yield additional customers in the near-term. Perhaps both in North America, as well as in the EMEA region. Prospective customers are recognizing the value that ViewSpot can add with its analytics and content filtering capabilities.
Our existing ViewSpot business remains stable, with a recent extension of one of our existing contracts being executed in March. Beyond our ViewSpot opportunities, I remain very optimistic as our sales team has driven an expansion of our sales pipeline over the past several months, and has positioned us to close a portion of these opportunities over the next several quarters.
The feedback from our sales prospects both in the U.S. and high ARPU markets across Europe has been very positive.
Most importantly, management reiterated its target to return to profitability in the third quarter.
At the end of Q1, cash and cash equivalents were down to just $8.7 million but projected cost savings should help to reduce cash burn substantially in the current quarter. With profitability expected for Q3, Smith Micro might be able to avoid raising additional capital in the near term.
That said, even without the company raising additional equity, common shareholders will likely be diluted quite meaningfully over the next few quarters as the company has started to make installment payments on its $15 million in toxic convertible notes in newly issued common shares as disclosed in the company's quarterly report on form 10-Q:
In accordance with the 2022 Notes and Warrants offering described further in Note 4, during the quarter ended March 31, 2023, at the Company's election, 1,644,738 shares were issued for the April 1, 2023 installment date and the payment for the April 1, 2023 installment date was completed on March 31, 2023, which reduced the convertible notes balance by $1.5 million (...). During the quarter ended March 31, 2023, at the Company's election, 1,592,359 shares were prefunded for the May 1, 2023 installment date, which is represented in the balance sheet line "Prepaid expenses and other current assets" as of March 31, 2023. There were no conversions by the holders of the Notes during the first quarter of 2023.
At prevailing prices, outstanding common shares would exceed 70 million upon full redemption of the convertible notes at the end of this year.
Bottom Line
With substantial cost savings expected already for the current quarter and an anticipated family safety software launch by AT&T in Q3, I am upgrading Smith Micro Software, Inc.'s shares from " Strong Sell " to " Hold ".
That said, investors should remain wary of management's constant pattern of overpromising and underdelivering in recent quarters but with growth in the all-important family safety software segment being almost entirely dependent on carrier marketing decisions, management's ability to accurately forecast customer product launches remains limited.
In addition, with Smith Micro Software, Inc. looking to protect its dwindling cash reserves, scheduled redemption payments of the company's toxic convertible notes are likely to be made in newly issued common shares.
At prevailing shares prices, aggregate dilution for existing shareholders could be in the range of 25%.
To become more constructive on the stock, a return to revenue growth and free cash flow cash generation would be required.
For further details see:
Smith Micro Software: Upgrading On Improved Cost Structure And Potential Near-Term Launch With AT&T