Smith Micro Software, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited results; amounts below are in U.S. dollars and millions unless noted. Smith Micro provides wireless software and services and graphics software.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $6.478 | $9.586 | $21.151 | $29.501 |
| Gross profit / margin | $4.680 / 72.2% | $7.627 / 79.6% | $15.327 / 72.5% | $23.353 / 79.2% |
| Operating expenses | $9.237 | $8.395 | $27.471 | $25.344 |
| Operating loss | $(4.557) | $(0.768) | $(12.144) | $(1.991) |
| Net loss | $(4.314) | $(0.770) | $(11.300) | $(2.011) |
| Loss per share, basic and diluted | $(0.35) | $(0.07) | $(0.96) | $(0.17) |
- Revenue drivers: Q3 wireless revenue was $5.237 million, down 36.9%, mainly from a $2.8 million decline at Sprint and a $0.3 million decline in legacy connection manager business. Graphics revenue was $1.241 million, roughly flat year over year. For the nine months, wireless revenue fell 31.1% to $17.513 million; graphics revenue fell 11.1% to $3.638 million.
- Margins and costs: Lower revenue reduced gross margin by 7.4 percentage points in Q3 and 6.7 points year to date. Operating expenses increased 10.0% in Q3 and 8.4% for the nine months, with higher research and development and selling costs, including costs from acquisitions.
- Cash flow: Cash used in operating activities was $7.995 million for the nine months, versus $0.331 million in 2015. Investing activities provided $1.272 million, including $4.080 million from sales of short-term investments, partly offset by acquisition spending and capital expenditures. Financing provided $3.847 million, primarily from debt proceeds.
- Liquidity: September 30 cash and cash equivalents were $5.943 million and short-term investments were $0.001 million. Working capital was approximately $3.669 million ($12.461 million current assets less $8.792 million current liabilities). Cash and short-term investments had fallen from $12.897 million at year-end 2015.
- Debt: The company issued $4.0 million of senior subordinated notes in September, receiving approximately $3.8 million net of issuance costs. Notes bear 10% interest, mature September 6, 2019, and interest is payable quarterly in cash or, subject to contractual terms, common shares. The balance sheet reports $1.766 million net carrying value after discounts; principal outstanding was $4.0 million. The debt was issued with five-year warrants for 1.7 million shares at $2.74 per share. Half of the notes were purchased by CEO/chairman William W. Smith and his wife.
Material changes and notable items
- Revenue declined 32.4% in Q3 and 28.3% year to date, with the largest shortfall in wireless and customer demand. Sprint represented 64.5% of Q3 revenue and 64.7% of nine-month revenue; FastSpring represented 13.7% and 12.8%, respectively. The two customers together accounted for 81% of accounts receivable at September 30, 2016.
- Acquisitions added new operations and assets: Birdstep Technology AB was acquired in April for a net $2.0 million cash purchase price; iMobileMagic was acquired in July for total consideration of $2.318 million, including $1.737 million in stock. Acquired goodwill and intangible assets were recorded; acquisition results are included from their respective closing dates.
- Q3 and nine-month results included favorable fair-value changes of $0.335 million on the warrant liability and $0.668 million on the Pennsylvania grant contingent liability. These non-cash items offset operating losses. The company agreed to repay $0.3 million of a $1.0 million Pennsylvania grant in 20 quarterly, interest-free installments beginning January 2017; it may retain the remaining $0.7 million.
- A one-for-four reverse stock split became effective August 17, 2016; historical share and per-share data were retrospectively adjusted. Shares outstanding were 12,316,479 at September 30.
Outlook, risks and contingencies
- Management said cash, cash equivalents and short-term investments, together with the September debt proceeds and planned cost restructuring, should fund operations for at least the next 12 months. The company was reviewing its organization and cost structure, with changes expected during Q4 2016; no specific savings target or revenue guidance was provided.
- Management warned that slower-than-expected market acceptance or revenue timing could require additional capital, further cost reductions or strategic alternatives for product lines. Additional financing may be unavailable on acceptable terms and could dilute shareholders; insufficient funds could require curtailing operations or relinquishing technology or market rights.
- Risk factors include continued losses, unpredictable wireless revenue, substantial dependence on Sprint and other concentrated customers, competition, product-market adoption, acquisition integration, key-personnel retention, intellectual-property and cybersecurity risks, and potential service interruptions. Management said there were no material changes to the risk factors in its 2015 Form 10-K.
- Operating lease obligations totaled $10.888 million, with $2.415 million due within one year; purchase obligations were $0.858 million. The filing reports no off-balance-sheet arrangements. Management stated that disclosure controls were effective and that no material change in internal control occurred during the quarter.
Key investor verification points
- Whether wireless revenue and Sprint-related demand stabilized after the reported declines, and how customer concentration affects collections and future sales.
- Actual restructuring scope, timing, savings and cash needs, and whether management’s 12-month liquidity assessment remains supportable given operating cash burn.
- Debt terms and future cash interest requirements, the CEO-related acceleration provisions, warrant dilution, and the effect of debt-discount amortization.
- Integration and performance of Birdstep and iMobileMagic, including acquisition accounting and the recoverability of newly recorded goodwill and intangible assets.
- Progress on the Pennsylvania grant repayment and the company’s ability to meet lease and other contractual commitments.