Smith Micro Software - A Turnaround For 2014

Smith Micro Software, Inc (SMSI) is a small cap wireless stock that is about to return to profitability in the current quarter. The stock has, in recent years, fallen off the radar of investors and this is reflected in its very low market cap. A reduction in its legacy businesses over the last few years hurt revenue growth and sent the stock price to its current levels. SMSI, however, is about to put in its first profitable quarter in many years and is also about to officially announce a major contract win they secured a few weeks ago. This major contract win, that we will go into in detail in this article, could be transformative for the company and for those invested in it. The restructuring that SMSI has undergone over the last year, and the contract win, have set the stage for SMSI to return to profitability in the current quarter.

Background:

Smith Micro Software, Inc. provides software and services that simplify, secure, and enhance the mobile experience. The company operates in two segments, Wireless, and Productivity & Graphics. The Wireless segment develops various software products and going forward will be the bulk of the companies revenues and growth. As of the last quarter this segment was $7.2m of sales. This segment includes:

• QuickLink - connectivity solutions that allows mobile users to easily connect a tablet, laptop, or other wireless devices to cellular or Wi-Fi networks

• NetWise - a policy-based control solution, which allows subscribers to automatically connect to and transparently move between 3G, 4G, and Wi-Fi networks to ensure the best possible user experience, as well as facilitate Wi-Fi discoverability, provide detailed device analytics, and enable management of mobile devices over the air

• CommSuite - enhances mobile communications through voice, video, and messaging services.

The Productivity & Graphics segment focuses on developing software for the consumer, prosumer, and professional markets. Revenues for this segment came in at $1.5m last quarter. NORAD's Santa Tracking website is powered by SMSI.

Financials:

SMSI over the last year has been in the midst of a restructuring turnaround that is about to pay dividends. Some key highlights from the last quarterly report include:

• revenues of $8.7 million for the third quarter


• gross profit on both a GAAP and non-GAAP basis was $6.3 million


• GAAP gross profit as a percentage of revenue was 71.5 percent


• GAAP net loss for the third quarter of 2013 was $13.0 million, or $0.35 per share


• Q3, 2013 operating expense was down $1.5 million sequentially from Q2


• Total cash and cash equivalents were $18.1 million.


• CommSuite revenues increased 58.5% yoy and 14.5 sequentially

The net loss for the most recent quarter included $5.6m in restructuring costs. Excluding this net loss would have been $4.0 million, or $0.11 per share. Cash burn over the last four quarters has been approximately $4m.

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Path to Profits:

In the guidance given for the current quarter SMSI expected non-GAAP operating expenses to decline to under $11m, from $12.9m in the 3rd quarter. In the table below we are going to use this guidance, along with the assumption SMSI will break even, to determine what revenues will be for the current quarter. The breakeven assumption is based on the guidance SMSI gave on its conference call, "So that's really the drivers for the return to profitability for Q4 and our growth going forward into 2014." We have assumed cost of revenues will remain the same as the last quarter, This is justified based on the last four quarters, which have seen fluctuating revenue and yet a stable COR. The company has already given guidance of operating expenses coming in at under $11m. We used $11m. Using these 2 pieces of the puzzle we are able to calculate total revenue for the current quarter at $13.5m, an increase of $4.7m or 54%. Gross profit will increase 76% in the current quarter. This is a dramatic turnaround in the business of SMSI that is not being reflected in its stock price.

The Clues:

In the 3rd quarter conference call we were given many details throughout the presentation of a big contract win, details that when pieced together give us a strong indication that SMSI has won Applied Materials, (AMAT) as a customer.

1. Bill Smith - Chairman, President and Chief Executive Officer "In Q3 we delivered mobile broadband interface module or MBIM components to a major chip manufacturer."

2. "We are going to see some pretty strong growth in revenues coming out of a very strategic chip manufacturer in Q4 and we will see some continued recovery and probably our largest customer is, they are now coming out of their merger period. So that's really the drivers for the return to profitability for Q4 and our growth going forward into 2014."

3. "I can add it's probably fairly reasonable to expect that the silicon customer will cross over the 10% barrier for Q4, so this is meaningful business."

4. Andy Schmidt - Vice President and Chief Financial Officer "...as Bill was alluding to in his prepared remarks and so on is when he looked to Q4, our net technologies are really starting to take hold and there is going to be different customers that we look forward to announcing in our Q4 that as you work with us for quite some time, we can't announce them until we get approval to."

Using comments that the CFO and CEO on the conference call gave us we believe that SMSI has signed a contract with Applied Materials, . As noted above, the CEO stated that the large Silicon Valley chip manufacturer they are currently shipping product for is coming out of its merger period. There is only one Silicon valley Chip manufacturer that is in a merger as of the last quarter: AMAT. In September AMAT announced a merger of equals when they agreed to merge with Tokyo Electron Ltd. in a $29 billion deal. Tokyo Electron is a big player in the wireless market, the market SMSI targets. The clues from the conference call, when taken together, all point to AMAT as SMSI's new customer. Winning a large chip manufacturer from silicon valley is a big validation of SMSI technology. That company possibly being AMAT, the 2nd largest chip manufacturer in the world, is a major validation of SMSI. The rapid increase of sales from this new contract, from zero revenues to 10% or more of sales in less than a quarter, is the likely reason for SMSI projecting profitability going forward.

December Trend:

SMSI has a tendency of beginning large price moves in the month of December. In 2011 SMSI moved from a price of $1.08 on December 15th, 2011 to $2.87 on February 8, 2012, a gain of 165%. SMSI secured a contract with Sprint (S) that was the reason for this move. Sprint continues to be the largest current revenue generator for SMSI at 61%. In December of 2012 SMSI moved from a price of $1.21 on December 14th to a high of $1.89 on December 21, a gain of 56%. This move came on no news. SMSI stated in the last conference call that major news announcements would be forthcoming in Q4. There are only a few days left in the quarter for these announcements.

Conclusion:

SMSI has just completed a very difficult restructuring of its business. Many times when companies enter restructuring periods their stock prices suffer and investor interest wanes. Even when these companies successfully complete their restructuring, the move back to profitability goes unnoticed by investors. Such an opportunity exists here with SMSI. As we have detailed above, SMSI appears to have secured a large contract win with AMAT, a contract they have already begun shipping product on and a contract that will result in possibly AMAT becoming one of their largest customers in just a short period of time. SMSI expects to turn profitable in the current quarter with a projected 54% increase in sales and a 76% increase in gross profit. Based on the return to profitability, the high profile contract win, the December trend of large returns and the extreme low market valuation, SMSI is a stock investors should take a very close look at now.

Source: Smith Micro Software - A Turnaround For 2014

Disclosure: I am long SMSI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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