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EARNINGS CALL TRANSCRIPT
EARNINGS CALL TRANSCRIPT 2020 - Q3
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Operator

Good afternoon, ladies and gentlemen, and welcome to the Phunware’s Third Quarter 2020 Investor Conference Call. Currently, all participants are in a listen-only mode. Joining me today are Alan Knitowski, President, Chief Executive Officer and Co-Founder; Randall Crowder, Chief Operating Officer; and Matt Aune, Chief Financial Officer.

The format today will include prepared remarks by Alan, Randall and Matt, followed by question-and-answer session. As a reminder, today’s discussion will include forward-looking statements.

These forward-looking statements include – including such statements referring to the potential effects or impact of COVID-19 pandemic, reflect current views as of today, and are based on various assumptions that are subject to risks and uncertainties disclosed in the Risk Factors section of our SEC filings.

Actual results may differ materially, and undue reliance should not be placed on them. Additionally, the matters we will be discussing today may include non-GAAP financial measures.

Reconciliation of GAAP to non-GAAP financial information is set forth in our earnings press release, which is available on the investor relations section of our Phunware's website at investors.phunware.com.

I further encourage you to visit investors.phunware.com to access not only our earnings press release, but also the current investor presentation, SEC filings, and additional collateral on Phunware. At this time, I would like to turn things over to Alan Knitowski. Sir, please proceed..

Alan Knitowski

Today, we were pleased to update shareholders on our operational and financial quarterly progress at Phunware. Well, I will touch on many of the high level activities and themes that we've been seeing with our customers, partners and employees, across our product, solutions, data and services.

Our COO, Randall Crowder, and our CFO, Matt Aune will dive deeper and provide additional color within their respective fields. But first, for those who remain new to our story.

I'd first like to give a quick overview and summary of what Phunware does, including the capabilities of our flagship Multiscreen-as-a-Service, MaaS platform and our overall business model and strategy.

Phunware is the pioneer of MaaS, a fully integrated enterprise cloud platform for mobile that provides the world's most respected brands with the products, solutions, data and services necessary to build, manage and monetize their mobile application portfolios and audiences globally at scale.

Founded nearly 12 years ago in February 2009, Phunware helps brands transition from the web to mobile by enabling enterprise level mobile applications through its MaaS platform, including the software, data and infrastructure needed to support these mobile application portfolios on Apple iOS, and Google Android devices, across smartphones, tablets, wearables, smart televisions and digital signage.

Our ideal customer is a Fortune 1000 brand or government organization that standardizes on our MaaS offerings for all of their mobile initiatives and needs. Much like, they would standardize on Microsoft Office for their Productivity Software, Salesforce Marketing Cloud for their CRM, or Oracle NetSuite for their ERP.

Throughout our history as both a private and public company, Phunware has successfully raised over $120 million in debt, equity financing from notable investors, including Cisco Systems, Samsung, PLDT, WWE, Firsthand Technology Value Fund, Wavemaker Partners, Maxima Ventures, Fraser McCombs Ventures, and Khazanah, while providing Fortune 1000 brands and government organizations, everything they need to succeed on mobile.

We focus our competitive efforts globally at the intersection of mobile, cloud, big data and blockchain through four key differentiators.

One, building robust mobile ecosystems for enterprises and government organizations that can't afford to fail at scale, including the unique requirements and challenges associated with both live events and remote engagement.

Two, locating and engaging mobile devices and mobile application users both indoors and outdoors, both onshore and offshore, and both on the ground and in the air, all in real-time. This also includes catering to the needs of those with hearing and visual impairments, and those that are wheelchair bound as well.

Three, curating disparate real-time data sets to make big data actionable, while enabling one-to-one interaction between brands and government bodies and their respective consumers and constituents anywhere and anytime globally, including geo-fence based policy enforcement, workflow optimization and process compliance.

Four, leveraging blockchain technology to optimize media spend, reduce fraud, enhance transparency, drive profitable behaviors and maintain an immutable, auditable public record of brand interactions with consumers worldwide.

We have a diverse enterprise and government customer base across multiple verticals because we offer a comprehensive digital transformation platform with products and solutions for mobile that are seamless, flexible, cost-effective, and proven at production scale globally.

While we have historically supported the healthcare, media and entertainment, hospitality in real estate, retail, aviation, and sports verticals with a core focus, we expect our COVID-19 vertical focus to remain much more specific during Q4 in the first half of next year.

Some of these verticals are healthcare, enterprise, corporate campus, education, smart campus and government smart city environments, which translate to the needs of patients and clinicians, remote workforces, students and faculty and government bodies and agencies that are interacting with and managing our country's citizens at the local, state, and federal level, respectively.

While we expect to see engagements and contracts continuing across all of our customer types in each vertical, including mass renewals, we also expect that the market and economic pressures will remain heightened for an extended timeframe within the specific industries hit hardest by the pandemic even potentially well into 2021.

Moving on, I'd like to share that independent of the ongoing pandemic, we continue executing our operational model and business strategy to become the premier digital transformation platform for mobile initiatives worldwide.

Our latest quarter closed with nearly $8.6 million in backlog and deferred revenue for our Multiscreen-as-a-Service platform, even though a majority of our corporate customers remained in either a lockdown or remote work-from-home operational status.

While we do not expect our non-government customers or partners to be operating at full capacity until the COVID-19 vaccine and therapeutic becomes widely available. We are continuing to see an increase in business activity with each passing week and month.

We believe that there is a significant amount of pent-up demand tied to pending MaaS bookings that will be released throughout the balance of the current quarter, and the first half of 2021, which we intend to capitalize on.

More specifically, net revenues compositions specific to the use of our MaaS platform for mobile continues to account for more than 90% of our net revenues.

These results continue to represent a dramatic year-over-year revenue transformation from one-time non-recurring application transactions revenue to annual and multi-year recurring platform subscriptions and services revenue tied to the licensing and use of the software and infrastructure underlying our enterprise cloud platform.

Anecdotally, and during the underlying transformation period highlighted for the customer set of core interest in the company, we have seen our average customer contract length doubled to 24 months, while our average contract value has tripled to $300,000 in parallel.

Our team is continuing to execute against our existing customer contracts and backlog and is aggressively pursuing new business opportunities and partnerships where our mobile, cloud, big data, and remote expertise intersects directly with the needs of our Fortune 1000 and government customers.

This includes, but is not limited to one, remote telehealth and telemedicine triage for healthcare patient capacity management; two, remote work optimization and back to work initiatives for corporate campuses; three, remote school optimization and back-to-school initiatives for educational campuses; and four, social distance policy enforcement engagement and asset tracking for smart cities and government organizations at the local, state, and federal level.

Looking ahead, our short-term focus remains centered on operational, stability and continuity, including the constant strengthening of our balance sheet, the achievement of operational self-sufficiency, and the deployment of our MaaS infrastructure with our customers and partners in order to address the technological and data needs underlying COVID-19 specific products and solutions for communities worldwide.

Randall will tell you more about these MaaS offerings shortly. It's clear that we have established a strong product market fit.

As we continue to find recurring success with new MaaS customer contracts and partnerships, including Baptist Health South Florida; Cisco Meraki on the enterprise side; Cisco Meraki on the education side; Cisco WebEx; GAIN Innovation; Greater Baltimore Medical Center; Norfolk Southern; Parkview Health; a digital front door deployment for a leading pediatric hospital; a big for corporate campus deployment, a mall developer’s smart shopper deployment; a property developer’s smart residential deployment; and a myriad of application transaction customers from a variety of industries and verticals from mobile engagement and monetization.

And finally, we're extremely pleased to have received two recent awards for our MaaS enterprise cloud platform for mobile, including the Top Mobile Application Developer Award from Expertise and the Best Mobile-Driven Enterprise Cloud Platform for 2020 Award from Corporate Vision Magazine.

With that said, I will now turn things over to our Chief Operating Officer, Randall Crowder, who will elaborate on our business operations in detail.

Randall?.

Randall Crowder

providing individuals and groups with pre-screening guidelines and questions upon arrival at a location; tracking important health, habits and risk information among individuals and groups through user profiles; reviewing and determining if an individual or group is approved to gather based on health attributes and potential risks associated; managing and enforcing social distancing and health protocols, including proactive and reactive messaging, reminders and notifications; monitoring and tracing movements, activities in room presence, subject to facility readiness and integration of our MaaS Location Based Services SDK.

To further enhance our ability to address return to work challenges presented by the COVID-19 pandemic, We were thrilled to announce an integrated room presence solution that takes advantage of Cisco's Webex technology to monitor and determine room occupancy.

In addition, we announced two new listings to the Cisco Meraki marketplace for both our Smart Workplace Solution and Smart Campus Solution.

The Cisco Meraki marketplace is an exclusive catalog of technology partners that showcases applications developed on top of the Cisco Meraki platform, allowing customers and partners to view, demo and deploy commercial solutions.

During the quarter, we also announced a new partnership with GAIN Innovation, in order to bid on state and local government and education contracts in Texas.

With this partnership, and have successfully been seeing working in support of the 2020 presidential campaign, we are excited to expand our ability to sell into the government and advocacy sectors.

These types of partnerships are essential to our sales strategy, as we continue to focus on indirect selling through four primary channels that comprise our global reseller network; one, hardware vendors, two, software developers, three, systems integrators, and four, carriers.

To lead this effort, we were thrilled to recruit and hire Farah Khan, last month as our new VP of Channel Partnerships.

Farah has spent nearly two decades, building and managing robust enterprise channels, and most recently were responsible for a 3x increase in total company revenues within year one of initiating a channel partner program at our last company.

In order to effectively support our channel partners and their customers, we offer comprehensive webinars, case studies, articles, e-books, and additional training opportunities.

The Phunware Phenom Certified Developer Program is also available to provide on demand courses and live training sessions remotely to learn more about MaaS, and how it helps brands better execute their digital strategy, and establish a true mobile presence.

In parallel, we provide full MaaS documentation and software portals via the Phunware Documentation portal and GitHub, respectively. By partnering with and supporting larger companies and their global distribution network, we seek to scale faster without incurring the heavy expensive of a direct Salesforce.

However, the underlying revenues for any new contract wins will be recognized over the course of a 12 month to 60 month contract period.

As a result, we will continue to point to our recent press releases, video interviews, and both backlog and deferred revenue metrics, as important indicators of our success in the sales, which closed last quarter at 8.6 million.

Looking internally, the strategic decisions we made during the first quarter to further streamline operations, help to drive a reduction of our OpEx spend quarter-over-quarter by 5% on a GAAP basis, and 26% on a non-GAAP basis.

Our gross margin also improved to 71%, during the quarter, representing nearly a 1,600 basis improvement over the last year, as we continue our efforts to reach breakeven in terms of both operating cash and adjusted EBITDA. Next, I'd like to talk a bit about our workforce.

At this time, we currently have 56 employees across four offices with an average tenure of over four years, exceeding the average retention benchmark set in Tech by over 64%, according to PACER.

We have maintained 100% continuity and effectiveness, while taking prudent steps to maximize our operational efficiency and ensure our long-term financial health. In fact, we have seen a 93% increase in employee productivity this year, which we measure as a function of revenue per employee.

During the quarter, we were thrilled to have the opportunity to unfurlough several Phunware employees. Additionally, we have plans in place to not only unfurlough other Phunware employees, but also to begin making new hires.

We're actively looking to bring on seasoned executives with enterprise software, sales and channel development experience to help us meet the renewed customer demand we're seeing for a MaaS offering.

Despite this exciting increase in demand and activity, we expect to work remotely for the foreseeable future until we receive more definitive guidance from government officials in Texas, California and Florida, where we have our physical offices.

We are more easily able to work remote than most companies, but do expect to reopen our physical facilities in a safe, responsible and auditable way through the use of our new smart workplace solution, powered by our new healthy spaces functionality.

I will now turn things over to our Chief Financial Officer, Matt Aune, who will discuss our third quarter financials in more detail.

Matt?.

Matt Aune

Thanks, Randall, and good afternoon everyone. I'd like to thank you all for joining us today for a review of our third quarter 2020 financial performance, and our progress on key strategic initiatives. For clarity, I'll be discussing GAAP financial measures unless otherwise specifically noted.

Our press release, 8-K, and website provide a reconciliation about GAAP to non-GAAP financial results. Net revenues for the third quarter 2020 totaled $3.1 million, of which platform subscriptions and services revenue was $2.9 million.

Our focus continues to be on higher margin, longer term software customers, and we are pleased to see that we are continuing to follow this strategy thus far in 2020, with over 90% of our net revenues derived from our MaaS platform subscription and services customers. Gross Margin was 71.3%, compared to 57.1% in the same period last year.

On a non-GAAP adjusted basis, gross margin was 74.8%, compared to 58.4% in the same period of the previous year. That is over a 1,600 basis point improvement year-over-year on a non-GAAP adjusted basis.

And that not only validates to conscious decisions we made earlier in the year to focus on higher margin software and data deals and away from lower margin legacy application transactions, but it also gives Phunware, a launching pad for more profitable and predictable revenues in the future.

Total operating expense was $5.2 million, down from $5.5 million in the same period last year. I'd like to point out though, that stock-based compensation and amortization of intangibles made up $1.6 million this year, compared to just $671,000 in the prior year.

By excluding these non-cash charges, adjusted operating expense was $3.7 million, down from $4.8 million for the same period last year, or 26% improvement year-over-year.

With respect to the legal settlement previously filed, we took a one-time, $4.5 million expense in the quarter, and are pleased to be moving forward without continued overhang or uncertainty. We view this particular settlement as a one-time event, and that's excluded from our non-GAAP calculations.

Payments for the settlement will be made over the next 12 months, starting with the first payment at the end of next month in December. Non-GAAP adjusted EBITDA loss was $1.3 million, compared to $1.5 million in the same period last year, and $1.8 million in Q2 2020.

I'm pleased with the progress we've made year-over-year and quarter-over-quarter, despite the ongoing pandemic. Our strategic focus on profitable behaviors to increase margins and manage operating expenses has continued to show its effects.

Net loss for the quarter was $8.6 million or $0.19 per share, compared to $2.4 million or $0.06 per share in the same period last year. I'd like to remind everyone that this loss is inclusive of a $0.10 net loss per share from extraordinary expense for legal settlements previously mentioned. Moving to the balance sheet.

Ending cash for the quarter was $1.1 million with $1.8 million of cash used in operations for the quarter. This represents the highest cash balance in the quarter, and the lowest amount of cash used in operations for a quarter this year.

Looking ahead, as we managed to the ongoing uncertainties of COVID-19, we continue to position ourselves for success in the future by strengthening our balance sheet, and lowering operational expenses. We are encouraged with our start to Q4 and believe that Q4 software bookings will soon outpace software bookings for all of Q3.

We intend to continue to fund operations with proceeds from organic sales and opportunistically raising additional capital via debt and equity options available to us. We're positioned well to extend our operational runway for maximum stability and flexibility as a business demand continues to return more broadly.

Leading into the fourth quarter, let’s close out the year, we will continue to execute against our existing customer contracts and backlog and will aggressively pursue new business and partner opportunities as outlined above by Alan and Randall.

As we continue to win deals and help customers enhance our mobile application experiences, we intend to drive net revenues and gross margin expansion to reduce our operational cash burn and move toward breakeven on an adjusted EBITDA basis. With that, I'd like to turn the call back over to Alan..

Alan Knitowski

Thanks Matt. I'd like to briefly touch on our mid and long-term goals going forward before I share my closing remarks. Looking ahead, our ideal operating scenario is to achieve and maintain cash neutrality and operational self sufficiency, while reinvesting excess cash and profit for growth, both organically, and in organically.

To that end and post pandemic, we intend to accelerate our topline growth at 30% or more year-over-year net revenues growth, while achieving more than 75% blended gross margins overall.

Notably, and as demonstrated in today's announced financial results for Q3, we have already accelerated our net revenues by more than 40% sequentially over Q2, while simultaneously expanding our gross margins from 65% in Q2 to more than 70% during Q3.

These results are both extremely positive developments for our operating model and actually beat our previous upwardly revised financial guidance from late September.

In parallel and for the foreseeable future, we will remain extremely judicious with our balance sheet improvements, focusing only on equity, structured debt, debt, and government-specific alternatives wherever they might make sense, including any post coronavirus aid relief, an Economic Security Act legislation that may provide additional long-term, low interest rate debt directly from the United States government post-election, such as our previously announced $2.8 million Small Business Administration, Paycheck Protection Program loan.

In addition to our previously announced $4.3 million structured debt refinancing, we will continue to maintain or at-the-market equity offering program against our existing S3 shelf registration statement.

ATMs have remained a popular tool for raising capital, due to the efficiency and flexibility provided in our existing ATM will continue to allow us to minimize dilution as we operate and scale our business rolling forward.

As has been the case previously, we remain committed to driving awareness of everything Phunware has to offer and to increase the institutional exposure to our story.

In addition to past event participation in online financial conferences, such as the Canaccord Genuity’s 40th annual growth conference, we have also recently transitioned our Investor Relations activity to gateway Investor Relations to further accelerate these efforts.

In conjunction with an expansion in our IR initiatives, we remain actively engaged with Canaccord Genuity as our mid-market investment bank of record, while also maintaining ongoing research coverage for our stock via Taglich Brothers and Ascendiant Securities.

We hope to see this research coverage materially expands throughout 2021, as we continue to focus on institutionally-oriented investment discussions, both domestically and abroad. As I have done previously, I want to conclude my remarks today by again expressing a very sincere and special thank you to both our employees and their families.

Not only have they supported us tirelessly despite the ongoing shelter-in-place and work-from-home mandates tied to COVID-19 in some parts of our country, but they have also done so despite the ongoing upheaval to both their personal and professional lives and routines and material, unexpected, and still evolving ways.

Furthermore, I also want to thank our customers and partners, who are not only our biggest advocates, but also trust us with their most valued assets and needs in these extremely turbulent times, as we jointly prepare for an eventual full reopening of the economy.

Importantly, I want to express our sincere gratitude and indebtedness to both our public and private investors for their continued assistance and support and all that we do daily as we continue to execute operationally and financially on their behalf.

Finally, I want to humbly thank our government leaders, healthcare professionals and the citizens of the world for collectively contributing to humanity's efforts to unify and persevere together, now that we are preparing for business and life in a post pandemic environment. With that, we can open up the line for questions.

Operator?.

Operator

Thank you. We will now take questions from our analysts. [Operator Instructions] And our first question comes from Austin Moldow with Canaccord. Please go ahead..

Austin Moldow

Hi. Thanks very much for taking my questions. I have a couple of big picture questions to start out. So, the first one is on alternative mobile mass products already available. Given we live in a mobile world and it’s kind of been that way for some time.

What are these brands that you're approaching? What are they using instead of Phunware to launch and manage their mobile apps and app audiences? If they're not using you, what products are they using and who or what do you after ones or beat out to win those customers..

Alan Knitowski

Sure. This is Alan. I'll be happy to answer that. So, what's really unique about the offering that we have for mass is there actually isn't another holistic platform that comprehensively addresses all the components that you need to either engage, manage or monetize large audiences and communities on mobile, especially for Apple iOS and Google Android.

What we find is that the two alternatives, either look like one of the following.

Either one, it would be internal IT teams or other groups internal to businesses that believe that they're going to create the components they need or build things from the ground up across a whole wide variety of things Using a good analogy, think of that like companies who choose to build their own CRM system internally versus many others that opt to use Salesforce, and just say, what no matter how good we are at, what we do, we're not going to invest our research and development internally to build our own systems.

We're just going to license that capability from Salesforce and move things forward. So, one area that we always see is that conversation about a tradeoff between what people want to build from the ground up internally and we, much like Salesforce believe, we'll always have more investment.

We're up to about $150 million between debt equity, gross margin, over all this time, and think we have a really comprehensive solution. The other is groups that want to stitch together, this false belief of a best of breed.

They want to license standalone content management systems that could come from large scale companies like Adobe or Oracle or others. You see folks with analytics, where they may want to grab things they use from the web and try to port that to the mobile web, or the mobile app environment.

And you see all sorts of different analytics platforms from Mixpanel or Flurry and others. But again, a bunch of point solutions.

And when you go through the rest of the stack when you're talking about marketing automation, mobile engagement, any sort of alerts, notifications and messaging, you would see private companies like Airship, or others that are trying to do pieces of that.

Same thing in location based services, whether those are blue-dot or proximity across the use of indoor Wi-Fi or beacons to supplement what we all see outdoors with GPS in longitude and latitude. And then you see a lot of advertising platforms from the big incumbents to small private companies.

But really, just think about the solution is, you standardize on the Phunware platform.

If you like to build your own applications, we provide ingredients that we call products, those come in the form of software development kits, or application programming interfaces, much like you would think of someone like Twilio, who provides that functionality in different environments, or alternatively, you see, groups that say, what, I don't have the time, money or inclination to figure out how to take all these things and stitch them together.

So we'd like to license off the shelf, commercially available solutions, and we provide those by vertical for digital transformation. The only real difference is we might say, it's the patient experience for healthcare, the fan experience for sports, the traveler experience for aviation and things like that.

But fundamentally, we found nobody that has everything in one location, one log in, one procurement relationship and one architecture that was meant to play nicely together..

Austin Moldow

Got it. That is really helpful. So it sounds like it's a great product.

So, now what does it take to get it to new customers and sign new licensing deals? Can you describe the sales cycle and the timing on that and also where you are currently in terms of the sales force?.

Alan Knitowski

Sure, I'll take the first part, and I'll leave the second part on the composition of the sales and marketing activities and the productivity gains we've seen there to Randall. But what you should think of is on a direct basis with our Salesforce, we typically see three to six month cycles.

As we highlighted, we've seen our average contract link to double here in 2020, and we've seen the average contract size triple in 2020. There's always unique thing different-by-different verticals, for instance, if you're touching government things, there's a little more bureaucracy and process and time.

So I would say government deals would be things that you'd see more like a six months to 12 month timeline. But on average across non-government organizations most Fortune 1000 companies are usually in three to six month sales cycle. And we prioritize direct selling historically.

And then as we highlighted in today's call, we've been adding indirect channels, where we bundle our software through four different groups, hardware providers, that may have networking equipment, and they want to bundle the way to mobile enabled with software, the deployments that they might be making to different types of venues that purchase their network equipment that could be stadiums, that could be colleges, those can be enterprise, campuses.

Those can be hospitals or any number of other facilities. And then in parallel to that, we also see channels like software channels that are very familiar.

We are taking component products like SDKs and APIs or software solutions and then they can add value-add on top to integrate to legacy enterprise systems or any number of other unique feature sets or use cases that they might want to have.

Then we also see groups like carriers and service providers, where they might license voice, video and data bundles to customer, but they want to enable digital transformation and mobile access before they reach facilities, while they're on site and after they leave.

And again, our software becomes that mobile layer to take advantage of those voice, video and data offerings. So again, that's hardware, software, carrier system integrator, and the last one would be consulting groups.

So a lot of those folks that represent some of the big four or the big services arms, where they're doing strategy, consulting, and they're helping customers with digital transformation to stitch together a variety of products and solutions to accelerate those digital transformation needs or to migrate what they did very successfully on the internet to the mobile application environment, which represents 90% of all mobile internet traffic.

Let me turn it over to Randall to let him address the Salesforce composition and the thoughts of direct versus indirect selling..

Randall Crowder

Yeah. Thanks, Alan. I think you hit the nail on the head. For us, we don't want to incur the large expense of building out a direct Salesforce since it’s not an efficient way to go to market. When you think of like last seen, that's really how we're positioned.

How do you get this into as many hands as possible, because this is a transformational technology, the transformational platform. Just like we helped everyone transition from web to mobile back in 2009 when we first started the company, now everyone realizes that mobile, it's going to be table stakes. And we're living in a mobile first world.

It's quickly becoming mobile-only. And our strategy is the sell-through channels, we are accretive to pretty much everything you can imagine, whether it's someone outfitting a smart building, whether someone is deploying a solution for digital front door and healthcare.

There's a lot of different groups that it's an easy cross-sell, up-sell for what we have. And so we really have a small sales team. We have eight people full-time sales and marketing. And we just took our first -- we made our first hire for our VP of Channel Partnerships, Farah that we mentioned on the call earlier.

And so it’s going to be her job to really build out what that channel team looks like. But again, it's going to be efficiently selling-through other channels and we are a B2B platform. And we're really what everybody needs right now as they think about how to establish a true mobile presence.

This isn't about passive applications, just serving up content. It's really about how do you take the mobile device or any screen and how do you stitch together a really comprehensive engagement solution that puts the user top of mind, and really give some information when they need it.

It's idea of contextually marketing and then really informing these real world experiences. So we’re excited to partner with a lot of great folks, keep an eye on our press releases as we announced partnerships. Those take time. We're going to establish those partnerships. We're going to train them, and then really they go out and sell, and we support.

And that's what the kind of company we want to build, and that's kind of company that we're starting to really hit the accelerator on in 2021..

Austin Moldow

Got it. And my last one here is, so it sounds like there is and will be more growth resumption here for the top-line.

So can you just touch on timing of EBITDA profitability what you are currently thinking for that?.

Alan Knitowski

Yes. Let me go ahead and hit part of it, and then I'll let Matt address the rest of what we're doing in 2021. We did actually include in what we distributed not only in our investor presentation, but also as part of earnings transcript. A real breakdown of what 2020 during the pandemic has look liked.

And it showed where we kind of bottomed in Q2 in terms of revenue recognition. It showed Q1, Q2 and Q3, obviously we're extremely excited that we grew more than 40% sequentially quarter-over-quarter. We have sorted of telegraph that in our last announcement and said that we expected that would be a low in Q2.

And we would start accelerating from that point as things started opening up a bit more from the really ugly second quarter of COVID lockdowns. In parallel of that, you see sequential expansion from Q1, Q2, Q3 all the way up to where we are getting our gross margins up above 71%. Again, that was really, really important.

And then what you see in the final chart we provided was the continued acceleration on that drive to the adjusted EBITDA breakeven.

And what I'll do is let Matt actually chime in now relative to some of the timing of how we set up the operating model to get to that cash neutrality position and be able to move forward with a goal to achieve 30% plus year-over-year growth continually; secondarily, 75% plus gross margin.

And then finally, real focus on being able to achieve cash neutrality and invest back into the business for sales and marketing expansion and organic and inorganic growth. Matt, let me hand that over to you..

Matt Aune

Thanks, Alan. Hey Austin, thanks for the question. Yes. So, as Alan mentioned, there's obviously a whole lot of things going on. We're trending in the right direction. We saw Q2 at the low point, Q3 we're coming out of it in terms of above top line revenue, gross margins which obviously will help fund operation.

So when we look at next year, obviously, we kind of look first at bookings. What we're booking now is going to impact next year. When we book at the beginning of next year is going to have heavy impact on where we are next year in terms of profitability on an adjusted EBIT -- on an adjusted EBITDA basis.

So really for us as we work through, we're targeting first half of the year to get there, and it's still a process for us. But with the traction we're getting now kind of coming out of Q3 and into Q4, we're seeing more and more deals signing and we've got more and more confidence going in next year.

So as Alan mentioned, we're going to target growth next year. We're going to target growth in top line, growth in gross margin. And in terms of adjusted EBITDA cash, we're going to try to get there by the middle of the year.

And then we'll kind of go from there and see what makes sense for us whether or not we want to put more cash in the business and grow faster or if we kind of, you know want to just continue to operate as a adjusted EBITDA profitable company..

Austin Moldow

Great. Thanks for answering my questions. They're all really helpful..

Operator

And next we'll go to Howard Halpern with Taglich Brothers. Please go ahead..

Howard Halpern

Congratulations on the quarter and navigating this pandemic environment.

My first question is with regards to what – do you have a rough number on how many customers are included in your recurring MaaS revenue base?.

Alan Knitowski

So in terms of Howe, we haven't actually broken out in that way, I think we've looked at – obviously, we have a wildly diversified piece so that every customer we try to drive to be in a single-digit percent gainer. We have actually sort of -- we have commuted to the market.

We see about equal split in our customer base, between those who buy the platform products, the software developing kids' application programming interfaces, tools, utilities that are kind of the ingredients that provide functionality for people that build their own applications.

And then the other half of our customers that tend to say, you know what, I know I need this for -- transformation in mobile, but it's not our core expertise. So they license our vertical oriented solutions. And then, extend from there.

So we actually can easily take that as an action that we want to look to see to what extent -- Matt can probably highlight the methodology of reporting that we do as it relates to any customer concentrations or top 10 customers where we trigger materiality disclosure, specific to that..

Howard Halpern

Okay..

Matt Aune

Yeah. I mean obviously the concentrations in the queue, it'll be in there. No significant concentration, so we're definitely getting more diversified as a group..

Howard Halpern

Okay. Now in terms of, in the quarter you talk about, you want expanded guest customer contracts from like Parkview and Baptist Health.

Could you talk about the process of I guess, like the initial contracts? And then, what the process is to go about expanding within those, type of customer bases?.

Matt Aune

Yeah, I'd be happy. That's a great question. And I think it's super helpful to think about how our business grows and scales as well. When we typically are doing deals, as I said, there's kind of someone who's more horizontal in nature, where they like to be a do it yourselfers.

And they want components or ingredients that help you to do these engage, manage and monetize activities. So when we see groups that actually want to focus on these high-end application portfolios. Typically you'll see one of two buckets. The do it yourselfers, tend to start with about an $800,000 to $1 million engagement.

As I said, our average contract length has expanded to -- basically its doubled to almost two years. While, some of the contract sizes tripled. So when you're looking at some of these initial engagements, if it's a higher budget, more customized groups that are building, let's think of $800,000 to $1 million as a starting point on the MaaS licenses.

And if you're doing vertical solutions, those range typically from 300,000 to 600,000 within the vertical focus versus the horizontal.

On top of that, usually they'll have some integrations or add-ons they may like to do, much like Salesforce, we like to license our platform and our software and our cloud, and then let others to do that work on the services, but if they want to do that and treat us like a big jar of mobile Advil, we'll do that.

But typically, the license options start at one to five years in length, typically one, three or five years. At one year, we have standard retail software licensing, typically at three years we have a 20% discount, at a five year we have a 30% discount on the licenses.

So the average deal size for vertical engagements, typically starts from 350,000 to 750,000. And then when you're talking about the bigger deployments, those typically start around 900,000 to 1.5 million. Now you correctly said, when people are then adding on or renewing or expanding like a Parkview, like a Baptist Health South Florida.

Those are typically where they're adding more, in those cases, medical facilities, they need more location based services, they have more square footage to deploy. So the software licenses and the support and maintenance licenses typically are expanding incrementally.

And those -- typically you could see add-ons, let's call it on average that might be 20,000 per month, or about a 0.25 million per year on some of the license add-ons.

And then we'll have kind of one-offs, where they're doing smaller facilities that might be sub six digits, but it's really important when we get in first, we tend to see an expansion, and then good net revenue retention and low customer churn..

Howard Halpern

Okay. And one other customer that I noticed that you announced in the quarter is that, the co-living development for your Residential Solution.

Is that really -- is that going to be your biggest customer so far for Smart Residential Solutions? And does that open up for even some of these existing HOA communities that are across the country?.

Matt Aune

Yes, great question. So, we've definitely seen a lot more activity in, what I would call, the real estate domain. So sometimes that's a real estate investment trust, sometimes it's the property management or, to your point, homeowners association.

So, the one that we mentioned was tied to a South Florida facility, one of the largest in the country, who continue to expand especially with all these stay-at-home orders during the pandemic. They're trying to dramatically improve the quality of life experience for resident’s onsite.

So now, these kind of mobile deployments from these smart resident or smart luxury resident experiences, typically imagine where you buy a condominium or an apartment, it's not dissimilar to the work we would do that we've announced with high end luxury resorts like the Wynn, when it deals with casino environment, or Atlantis, Bahamas when you're talking about resort destinations.

These are typically fully featured, where people are either leasing or buying in a mixed use facility or real estate group that's kind of buried in a mall or just surrounding shopping, retail and others.

And what we end up doing is, help activate the full experience after they do that lease or that purchase, so that you get all activities from the property through the mobile application portfolio, that's branded for the facility that you happen to reside.

That includes concierge services, that includes all of the trouble tickets and maintenance, it includes schedule of events throughout, especially, when they have additional amenities that might be pools or workout facilities, laundry facilities, restaurants, you name it.

And it even gets into some of the valet services and parking options that are associated with them. So we expect that that's going to accelerate.

And also what's uniquely fantastic about that is we've seen our relationships and integrations with groups like SALTO, where you can use mobile as an entry exits, and audit platform of sorts to be able to get entry and exit and actually have more controls, especially when you're dealing with things like contact tracing COVID, and just the security in general of who's getting access, how and when, especially if they might have to have some health responses before they can access these facilities..

Howard Halpern

Okay. And one last question. And I'll let someone else jump in. And you talked about how the sales cycle is warmer for governmental type agencies, and I know you announced products for them earlier this year.

Could you talk a little bit about the pipeline that might be coming to fruition in the next three months or so in the government area?.

Alan Knitowski

Yes. I'm actually going to hit one highlight, and then I'm going to hand it over to Randall, as he was instrumental in working through in some of the Smart City solutions that we've done.

So we saw a real opportunity where guests of cities, residents of cities and even constituents of elected officials at the city and county levels specifically, but it also applies at the state level, where all these capabilities we've built for corporate use, or use in educational environments or anywhere else, our government tends to not deploy similar solutions.

And what we wanted to do is to create a full Smart City solution, because the application portfolio in the software is what allows cities to take advantage of the infrastructure that they're deploying across different environments, those can be visitors, bureaus, convention centers, airports, public transit and a number of other things.

And what we did is purposely packaged all the solutions we had done in the corporate environment, so that mayors, city councils could actually have a trusted software layer that could encourage people to download on iOS and Android.

And then facilitate real time engagement trouble ticket, all sorts of other things that are relevant to our community, not only in the downtown environments, but throughout the suburbs.

Randall, you want to actually highlight about how that pipeline has evolved through both, some of the partnerships we just announced, and then also through Pasadena, Texas, tied to Houston, as one of the larger deployments and the first of its kind really in the United States..

Randall Crowder

Yes. Hope, it's the first of many, right. So, I think, for us, its always challenging to have exciting things that we’re working on that would constitute our pipeline and no ability to talk about it. Sometimes, as you can imagine with government contracts, there's confidentiality involved, there's certain things that we can and cannot disclose.

We try to be as transparent as possible. We try to put out as much press as possible, so that we're educating both retail and institutional investors alike. But you just -- sometimes you have to read the tea leaves. So you think about like our really exciting partnership with GAIN Innovation.

For those of you on the call who haven't worked with governments in the past, in Texas, you have to have a DIR contract. And so by partnering with someone like GAIN, we get to take advantage of their DIR contract and bid on really exciting opportunities in, kind of, the flood space and so, state, local government education.

And so, you think that's kind of where we're going with that partnership. We're working hard on opportunities with them and working on opportunities direct and through referred channels to kind of expand our Smart City solution. So while we can't give specifics on kind of what's in the pipeline, obviously, we've established this vertical for a reason.

We're seeing really good traction and really good interest. This is something that everybody's kind of talking about right now. Like, Alan said, how do I stay engage with communities.

And then if you think like large government facilities, what a great place for our Smart Workplace Solutions or a lot of things that we provide, where you're thinking security is paramount, access control is paramount, notifications are paramount.

One of the really interesting things that we can deliver that is top of mind for everyone is threat management.

What do you do in a government building, if you have an active shooter situation? And so, being able to dynamically notify and route users of a mobile app that are in that space to safety, while de-conflicting ingress routes for first responders. That's critical for any government facility.

And so we're under process right now of educating a lot of our government clients about what we can do and why that's important to them and really bullish about what we'll be able to deliver in 2021..

Howard Halpern

Okay. Well, thanks and keep up the great work, guys..

Matt Aune

Thank you..

Alan Knitowski

Thanks, Howard..

Randall Crowder

Thanks, Howard..

Operator

And next, we'll move to Ed Woo with Ascendiant Capital. Please go ahead..

Ed Woo

Yes, congratulations on the quarter. Most of my questions have been asked already and answered. But I also have a question in terms of trying to get back to normal. I know you mentioned that on a weekly, monthly basis, it seems like revenue is returning slowly and steadily.

When do you think we'll get back to some level of normality? And also, do you feel that your customers are feeling much more confident about the business now? They're almost to back to normal levels, or do you still see that there's a lot of hesitant with people still working remotely and whatnot?.

Matt Aune

Yes, that's great question. And I'll be super open and candid about that as we always are. And what we found is, it's a real mixed bag in the United States, so much like, it's taken most of 2020 to get scale in our testing for COVID across the country. We're probably getting a lot closer to that, obviously now.

So the more testing we do the more cases we see. It's great to see the lethality rate of COVID has dropped by about 85% during that window. But obviously, this clearly hasn't gone away and isn't going anywhere anytime soon. Ironically, earlier today, it was great to see Pfizer had announced a potential vaccine, that's got 90% effectiveness.

So, I'm very cautiously optimistic that that may help the process. But as we think about 2020, I don't see anything changing here in Q4 relative to the state of lockdown, shut down, mass social distancing, and all the unique rules and requirements that we're seeing even in our customers or partners and even Phunware.

Obviously, we've got a workforce predominantly in three states. And the COVID rules couldn't be more different. Southern California versus here in Texas versus Southern Florida have wildly different rules from a disease. So we see 2020 is the year where the testing gets ramped.

And if the COVID vaccine, whether Pfizer and even others that come on board, if it has high efficacy, I think that's still going to be a process.

Minimally, I think it's going to take the first half of next year for a vaccine, even if available to be available at the scale and in the dosage needed for everybody to have more safety, security and comfort.

I expect that even if we do have a vaccine, it's going to be minimal a second half of next year, before you start seeing more activity on live events, sports, and a lot of the other components of things that are big scale audiences without capacity restrictions. So, I am optimistic that we achieved where the testing is by the end of this year.

I think, we'll scale vaccines by the middle of next year. And then I think it's going to take all of 2021, before you're going to really see people back as normal. I will say much like here at Phunware. We have not accelerated by any means, bringing people back to the office.

Our business allows us to work more easily remote and with our core customers, in the healthcare domain, obviously the health care groups are open for business.

They're still sorting through what they deem to be normal operations for separating all the COVID activity from non-COVID activity, including elective surgeries and other remote telehealth and other capacity management of how to address and deal with patients, while you're at home before you get to the facilities, while you’re on site and after you leave.

Clearly in California, we've got customers in the Bay Area. They are not opened. Whether we're talking about someone like Kaiser Permanente that is in Oakland or others from the Big 4, that are in downtown San Francisco that the market is not open yet.

So in our case, as we win deals, we have a balance of which markets are fully opened, which markets are not. We’ve had developments more recently, we’re up in the Northeast, in places like New York. We have NYU Langone as a customer in the healthcare domain. We have Mount Sinai, as two examples.

Only more recently, we have intra-state travel been permitted to do expansions at their facilities in person and on site. And so, we don't see anything wildly accelerating. I think if anything people are very concerned during the winter months that we may have a resurgence? I don't have that answer. I won't try to speak medically like we know that.

But I will say, when we highlight more activity is happening. We’re seeing things we never would thought before. We’re meeting groups that we've never met in person.

We’re going through entire sales processes all the way through wining a deal, contracting a deal and deploying solutions and we've still never been on site and we've never met the people face-to-face.

That would have something almost unprecedented to think you’re doing mid-six-digit or low-seven-digit initial contracts, and you've never met anyone in person. So we are taking advantage like everyone else in a lot more Zoom and Webex and other sorts of video conferences.

And we're actually trying everything that we need to, to be able to get on the phone, communicate more, but I think most enterprise campuses are going to be much more deliberate of pulling employees back to their facilities unless they absolutely have to.

And in the middle, it’s probably colleges and universities, where they do have to get people on site. They do need to get them back in the class. But I think to date, there is only about little over a third of all colleges and universities are back in person and fully open. Everyone else is hybrid or full remote.

So hopefully that helps answer at least the timing of what we're seeing. And we did have some pending deals right before COVID hit, that we're just waiting for the markets to open to be able to formally sign those.

And we’re optimistic that we'll start seeing that, here as we get towards the tail end of this quarter, and a lot of that budget that has been deferred or delayed, its going to come back like gangbusters in the first and second quarter of next year..

Ed Woo

Great. Thank you for answering my question. That was very helpful. Thank you and good luck..

Operator

At this time, that does conclude the company’s question-and-answer session. If your question was not taken, you may contact Phunware’s Investor Relations team at PHUN@gatewayir.com. Thank you all for joining us today for Phunware’s third quarter 2020 earnings conference call. You may now disconnect..

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