Smith Micro Software, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Unaudited results; comparative periods are Q2 and first half of 2019. Amounts below are in U.S. dollars.
Business context
Smith Micro develops software and cloud services for wireless and cable providers, including SafePath, CommSuite, ViewSpot and NetWise, as well as Graphics software. In February 2020, it acquired Circle Media Labs’ operator business, including two customer contracts and a parental-control software license, for $13.5 million ($12.15 million cash and $1.35 million holdback).
Financial performance
| Metric | Q2 2020 | Q2 2019 | H1 2020 | H1 2019 |
|---|---|---|---|---|
| Revenue | $12.9M | $10.9M | $26.3M | $19.3M |
| Gross profit / margin | $11.7M / 90.2% | $9.9M / 91.0% | $23.8M / 90.7% | $17.4M / 90.2% |
| Operating income | $1.4M | $2.9M | $3.3M | $3.0M |
| Net income | $1.4M | $3.4M | $3.4M | $3.5M |
| Diluted EPS | $0.03 | $0.10 | $0.08 | $0.10 |
| Operating cash flow | Not presented by quarter | $4.3M | $(1.6)M |
Q2 revenue increased 19%; first-half revenue increased 36%. Wireless revenue drove the growth, primarily from SafePath and the Circle business. Q2 SafePath revenue was $7.3 million versus $3.8 million a year earlier; first-half SafePath revenue was $15.2 million versus $5.9 million. Graphics revenue declined 7% in Q2 and 29% in the first half.
Operating expenses rose materially: Q2 total operating expenses were $10.3 million versus $6.9 million, including R&D of $4.6 million versus $2.7 million. Management attributed increases mainly to additional headcount, SafePath development costs, Circle-related amortization and, in G&A, higher stock compensation. Q2 2019 also included a $0.5 million gain on sale of a software product; its absence, alongside higher expenses, contributed to lower year-over-year net income. The filing reports no income-tax provision for 2020 periods.
Liquidity, assets and capital
- Cash and cash equivalents were $23.6 million at June 30, 2020, down from $28.3 million at year-end 2019. Management reported working capital of $27.7 million.
- First-half investing cash outflow was $13.2 million, primarily the $12.2 million net cash payment for Circle and $0.9 million of capital expenditures. Financing cash inflow was $4.2 million, primarily warrant exercises.
- Total assets were $73.1 million, up from $61.2 million at year-end, reflecting in part acquired intangible assets and goodwill. Intangibles were $15.0 million and goodwill $11.5 million at June 30.
- The balance sheet lists no borrowings; reported liabilities include operating lease liabilities of $6.8 million, including current and non-current portions. The filing does not provide a separate debt figure.
- Common shares outstanding rose from 38.5 million at December 31, 2019 to 41.4 million at June 30, 2020. Warrant exercises generated $4.2 million; the company reported 41,355,673 shares outstanding as of August 6, 2020.
Material developments, outlook and risks
- Customer concentration: T-Mobile and affiliates (including former Sprint) generated 86% of Q2 revenue and 89% of first-half revenue. T-Mobile represented 83% of accounts receivable at June 30. The filing notes that customer agreements may be terminated on limited notice.
- Merger and divestiture exposure: Sprint and T-Mobile merged on April 1, 2020. On July 1, the combined company divested Boost Mobile to DISH; Smith Micro warns that reduced or discontinued use of its solutions by T-Mobile or Boost could materially hurt revenue and profitability. Management also expects Sprint store closures and fewer marketing initiatives during integration to pressure SafePath revenue.
- COVID-19: Management reported fewer SafePath subscribers in Q2 than in March, which it believes reflected the economic slowdown. The duration and severity of effects remain uncertain; customer demand, operations, development, integration and security could be affected. The company may defer nonessential capital spending and reduce costs or discretionary spending if needed.
- Investment and outlook: Management expects R&D expense to increase in coming quarters to accelerate SafePath features for prospective customers. It stated there is no guarantee of winning those contracts. The filing provides no numerical revenue or earnings guidance.
- Other risks and contingencies: Risks include competition, technology and product changes, data privacy/security, service interruptions, acquisition integration, capital availability, profitability and Nasdaq listing requirements. The company disclosed routine litigation and contractual indemnities/guarantees but recorded no related liability; management did not believe current litigation would materially affect results, while noting litigation is unpredictable.
- Taxes and controls: The company continued to reserve U.S. deferred tax amounts, totaling $50.4 million. Management said disclosure controls were effective as of June 30, 2020, with no material changes in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether T-Mobile and Boost continue using Smith Micro’s products, and the revenue impact of Sprint/T-Mobile integration and Boost’s divestiture.
- SafePath subscriber and revenue trends, including the effects of COVID-19 and customer marketing activity.
- Whether Circle’s acquired contracts and technology generate revenue and returns sufficient to support the $13.5 million purchase price and acquired intangibles/goodwill.
- How higher R&D and other operating expenses affect future margins and profitability, particularly if prospective customer contracts are not won.
- Cash consumption, working-capital movements, and the company’s ability to sustain liquidity without additional financing.