Two years in the past, Smith Micro Software program, Inc. (NASDAQ:SMSI), or “Smith Micro,” introduced the shock acquisition of the Household Security Cellular Software program Enterprise of competitor Avast PLC, thus including main U.S. wi-fi carriers AT&T Inc. (T) and Verizon Communications Inc. (VZ) to its buyer base.
Previous to the acquisition, Smith Micro’s household security choices within the U.S. had been largely restricted to the smallest Tier 1 provider Dash, which ended up being acquired by T-Cellular (OTCQX:DTEGY, OTCQX:DTEGF) in 2020.
Sadly, issues have not performed out as envisioned by administration at the moment, as T-Cellular has been hesitant to actively promote the most recent iteration of its household security providing whereas AT&T’s migration to Smith Micro’s new SafePath software program platform has skilled unexpected delays.
In consequence, the corporate’s monetary efficiency has deteriorated materially in latest quarters, with revenues for the first 9 months of 2022 declining by greater than 25% year-over-year.
Even worse, Smith Micro has skilled substantial money outflows this yr, thus ensuing within the requirement to entry the capital markets once more in August.
As of September 30, 2022, the corporate had $19 million in money and $15 million in doubtlessly poisonous convertible notes excellent, with installment funds scheduled to start on April 1. The notes can be maturing on December 31.
To be completely trustworthy, I would not have thought of Smith Micro a promising funding earlier than Monday’s announcement, however after the shock contract termination by a U.S. Tier 1 provider – which I might assume to be Verizon – issues have began to look actually ugly:
Smith Micro Software program, Inc. at this time introduced that on February 21, 2023, the Firm acquired written discover of contract termination from a U.S.-based Tier 1 provider buyer for the Firm’s household security answer, efficient June 30, 2023. On the buyer’s election, the Firm stays obligated to ship service below the settlement for a transition interval of as much as 180 days past June 30, 2023. The Firm is reviewing and expects to take applicable motion to scale back bills related to the affected buyer settlement, and can reallocate sure assets to the Firm’s a number of different Tier 1 U.S. provider clients and to its clients exterior of the U.S.
“We have been shocked to have acquired this discover from our buyer, and although we’re upset, we imagine we now have positioned the Firm properly over the previous few years to diversify our general shopper base. This buyer portfolio will proceed to incorporate our largest Tier 1 buyer and one other Tier 1 provider that only recently entered into a brand new multi-year contract with us for our household security options,” stated William W. Smith Jr., President, and CEO of Smith Micro.
Mr. Smith continued, “Wanting forward, we’ll proceed to honor our obligations below the terminating contract via the rest of the fiscal yr whereas receiving compensation in accordance with the phrases of the prevailing contract. We can even instantly take steps to reallocate assets to speed up development and integration efforts with our different clients and companions. We can even speed up the fee saving initiative that started final yr, to raised align our value construction mannequin as we glance to return the Firm to development and profitability.”
The corporate’s respective 8-Ok submitting with the SEC held much more dangerous information (emphasis added by creator):
On February 21, 2023, the Firm acquired written discover of termination of a U.S. tier 1 buyer settlement for the Firm’s household security answer, efficient June 30, 2023. Thereafter the Firm is obligated to ship service below the settlement for a transition interval of as much as 180 days on the election on the shopper. The settlement accounted for about 32% of the revenues of the Firm for the nine-month interval ended September 30, 2022. The Firm is reviewing and expects to take applicable motion to scale back bills related to the affected buyer settlement, and in reference to its evaluate expects to reallocate sure assets to the Firm’s a number of different tier 1 U.S. provider clients and to its clients exterior of the U.S.
In reference to the discover of termination of the shopper settlement (…), the administration of Smith Micro Software program, Inc. is conducting an impairment evaluate below relevant accounting guidelines to find out whether or not, and to what extent, this alteration creates any impairment. (…)
Primarily based on Smith Micro’s disclosures, I might estimate the annual income loss to be in a variety of $15 million to $16 million, which might equate to a gross revenue influence of roughly $11 million.
With the corporate attempting to speed up latest value financial savings initiatives whereas on the similar time “reallocating assets to speed up development and integration efforts with our different clients and companions,” I might anticipate working bills to stay elevated relative to the a lot smaller footprint of the corporate going ahead.
However the elephant within the room stay the corporate’s lately issued senior secured convertible notes, which comprise a poisonous conversion function that could be very prone to come to fruition now.
On the firm’s election, each quarterly curiosity and month-to-month installments may be made in newly issued widespread inventory which can be valued at a significant low cost to prevailing share costs thus incentivizing noteholders to brief the corporate’s widespread shares forward of conversion dates:
“Installment Conversion Worth” means, with respect to a selected date of dedication, the bottom of (i) the Conversion Worth then in impact, and (ii) the better of (x) the Ground Worth and (y) 90% of the quotient of (a) the sum of the closing costs of the Widespread Inventory for every of the three (3) Buying and selling Days with the bottom closing costs of the Widespread Inventory through the twenty (20) consecutive Buying and selling Day interval ending and together with the Buying and selling Day instantly previous to the relevant Installment Date, divided by (b) three (3).
Please word that the conversion flooring worth has been set at simply $0.62, so there’s nonetheless loads of flesh on the bone for convertible noteholders seeking to maximize returns.
Assuming an combination 16.5 million in principal and accrued curiosity to be transformed at a median conversion worth of $1.35, Smith Micro could be required to subject 12.2 million new shares.
As a consequence, fairness holders will probably have to organize for substantial near-term dilution as the corporate is seeking to restrict money outflows.
The second main headache can be liquidity going ahead. With the contract scheduled to finish on June 30 and transitional companies probably being required for a lot of the second half of the yr, the total influence of the termination will not be felt earlier than 2024.
That stated, Smith Micro urgently wants to scale back money burn going ahead as in any other case the corporate could be at risk of operating out of funds by yr finish.
Clearly, Avast’s resolution to unload its household security software program enterprise was the appropriate strategic transfer, with Smith Micro Software program, Inc. now being left holding the bag.
Whereas the corporate nonetheless has contracts with the remaining U.S. Tier 1 carriers, outcomes have been pretty disappointing in latest quarters.
Given this subject, it is tough to examine a near-term inflection level in Smith Micro Software program, Inc.’s enterprise, notably when contemplating the corporate’s looming debt and liquidity points.
Smith Micro Software program, Inc. fairness holders seem to have been caught between a rock and a tough place, as they may both be saddled with substantial dilution and even face an outright chapter submitting subsequent yr.
Contemplating the apparent lose-lose state of affairs, traders ought to take into account promoting current positions in Smith Micro Software program, Inc. and transferring on.